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On August 30, 2023, the U.S. Department of Labor issued a proposed rule to revise its regulations implementing minimum wage and overtime exemptions for executive, administrative, and professional employees, among others, under the Fair Labor Standards Act (“FLSA”). The proposal, if finalized, would revise the minimum wage and overtime exemptions issued by the Trump Administration in 2019, which have been in effect since January 1, 2020.

Among other things, the proposal would increase the compensation thresholds that are used when determining whether an employee qualifies for the executive, administrative, or professional exemptions. Under the Department’s existing regulations an employee qualifies for an exemption if: (1) she is paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed; (2) the amount of salary paid meets a minimum specified amount; and (3) her job duties are primarily executive, administrative, or professional. The Department has periodically revised the minimum salary component of the test, most recently in 2019, when it set the minimum salary at $684 per week ($35,568 on an annual basis).

The Department’s proposal would increase the salary threshold substantially. The Department proposes to increase the threshold to at least $1,059 per week, which is approximately $55,000 per year, representing a nearly 55 percent increase over the current threshold. The proposal also leaves open the possibility that the Department might use more recent wage data when it finalizes the rule, which means the compensation thresholds could easily be as high as $1,140 or $1,158 per week, or approximately $60,000 per year. (A higher threshold applies under state law in only a handful of states, such as California which requires that exempt employees earn at least $1,240 per week.) These increases are the result of the Department’s proposal to tie the compensation thresholds to the 35th percentile of wage survey data of full-time salaried workers in the lowest-wage Census Region—as opposed to 20th percentile of wage survey data of full-time salaried workers in the lowest-wage Census Region and of retail workers nationally.

The proposal would also increase the compensation threshold for the highly compensated employees exemption. Employees earning at least $107,432 annually currently qualify for this exemption if they regularly perform at least one executive, administrative, or professional duty. The Department proposes to increase the compensation threshold to $143,988, an increase of approximately 34 percent.

These changes to the Department’s compensation thresholds would, if implemented, have significant consequences for many employers. It is estimated that the changes will expand the number of workers who would be eligible for overtime wages by at least 3.6 million.

The Department also proposes to automatically increase the compensation thresholds every three years to account for changes in wage survey data collected by the Bureau of Labor Statistics. If implemented, the automatic increase mechanism would likely result in significantly higher compensation thresholds in the coming years.

Increases to the compensation threshold, including automatic increases, were included in the Obama Administration’s 2016 rule. That rule, which would have increased the compensation threshold to $913 per week ($47,476 on an annual basis), was enjoined before it took effect. It was later struck down by the U.S. District Court for the Eastern District of Texas on the grounds that the Department’s reliance on salary thresholds to the exclusion of an analysis of employees’ job duties exceeded the Department’s authority under the statute. A similar challenge should be expected to any final rule resulting from the Department’s new rulemaking, particularly in light of Justice Kavanaugh’s dissent in Helix Energy Solutions Group, Inc. v. Hewitt, 598 U.S. 39 (2023), which suggested that the Department’s compensation threshold test may be inconsistent with the FLSA.

Interested parties will have 60 days to submit comments on the proposed rule after it is published in the Federal Register. The Department may issue a final rule as soon as early-to-mid 2024. As noted, legal challenges are possible once a final rule is adopted.

The following Gibson Dunn attorneys assisted in preparing this client update: Eugene Scalia, Jason Schwartz, Katherine Smith, Andrew Kilberg, and Blake Lanning.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment or Administrative Law and Regulatory practice groups, or the following authors and practice leaders:

Eugene Scalia – Co-Chair, Administrative Law & Regulatory Group, Washington, D.C.
(+1 202-955-8210, [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])

Helgi C. Walker – Co-Chair, Administrative Law & Regulatory Group, Washington, D.C.
(+1 202-887-3599, [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.

Orange County partner Blaine Evanson and Washington, D.C. associate Jeremy Christiansen are the authors of “How ‘Purely Legal’ Issues Ruling Applies To Rule 12 Motions” [PDF] published by Law360 on August 30, 2023.

Los Angeles partner Theodore Boutrous and New York associates Lee Crain and Randi Kira Brown are the authors of “How NY SLAPP Defendants Can Recover Fees In Fed. Court” [PDF] published by Law360 on August 29, 2023.

New York associate Connor Sullivan contributed to the article.

Because of an expiring transition rule, a partner that currently relies on a “bottom dollar guarantee” to support an allocation of liabilities may be required to recognize gain under section 731(a) unless that partner takes action before October 4, 2023.[1] After a brief overview and discussion of the applicable Treasury regulations, we describe the action that should be taken.

I. Overview

In October 2019, the IRS and Treasury issued final regulations (the “2019 Regulations”) that provide that “bottom dollar payment obligations” (commonly referred to as “bottom dollar guarantees”) do not cause a partnership’s liabilities to be treated as recourse with respect to the partner providing the guarantee. The result of this rule is that a bottom dollar guarantee does not cause the guaranteed liability to be allocated to the partner providing the guarantee.[2] The absence of such an allocation may cause the partner providing the guarantee to recognize gain in an amount up to the amount of the liabilities. The 2019 Regulations are effective for partnership liabilities incurred and guarantees entered into on or after October 5, 2016.

The 2019 Regulations include a seven-year transition rule for a partner that had a “negative tax capital account” immediately before October 5, 2016 and was relying on an allocation of recourse liabilities to avoid gain recognition. In general, a partner would have a “negative tax capital account” to the extent that the partner has previously been allocated losses or deductions or received distributions from the partnership in excess of the partner’s capital investment in the partnership (i.e., capital contributions to the partnership and previous allocations of income or gain by the partnership to the partner). The transition rule also applies to liabilities incurred and payment obligations entered into before October 5, 2016 that were subsequently refinanced or modified.

When the transition rule expires on October 4, 2023, bottom dollar guarantees will no longer be effective to cause partnership liabilities to be treated as recourse with respect to the partner providing the guarantee. As a result, absent other action, the partner may recognize gain under section 731(a) to the extent of the partner’s remaining “negative tax capital account.”

II. Discussion

A. Background on the Allocation of Partnership Liabilities

An entity that is classified as a partnership for U.S. federal income tax purposes allocates its liabilities among its partners in accordance with section 752 and the regulations interpreting section 752. Any liability that is allocated to a partner increases that partner’s basis in its partnership interest. A partner with a share of liabilities may, therefore, be able to receive greater distributions of money from the partnership without recognizing gain under section 731(a) or claim deductions for a greater amount of partnership deductions than would be possible without the share of liabilities.

When a partner’s share of a liability decreases—whether because the liability is repaid or because it is allocated to a different partner—the partner whose share decreases is treated as receiving a distribution of money in an amount equal to the reduction. If the amount of the reduction exceeds the partner’s basis in its interest, the partner recognizes taxable gain under section 731(a).

Whether a partnership liability is allocated to a particular partner depends, in the first instance, on whether the liability is “recourse” or “nonrecourse.” A liability that is “recourse” to a particular partner is allocated to that partner. A liability that is not recourse to any particular partner is considered “nonrecourse” and generally is allocated among all partners (though, in many cases, there is substantial flexibility with respect to the allocation of nonrecourse liabilities under Treas. Reg. § 1.752-3).

For this purpose, a liability is a recourse liability when a partner or related person bears the “economic risk of loss” with respect to that liability. To determine whether any partner or related person bears the economic risk of loss with respect to a liability, the Treasury regulations require the partnership to determine whether any partner would have a “payment obligation” if all of the assets of the partnership (including cash) became worthless and the liabilities became due (this is sometimes referred to as the “atom bomb test”).[3]

B. Use of Guarantees to Cause Allocations of Liabilities

A partner that wishes to be allocated a share of partnership liabilities in excess of its share of nonrecourse liabilities sometimes will guarantee repayment of some or all of the partnership’s liabilities. For example, if a partner with a $0 basis in its interest is entitled to a distribution of money from the partnership, and the partner does not want to recognize taxable gain on the distribution, the partner might guarantee a partnership liability before the distribution. If the amount of the guarantee is at least equal to the amount of money to be distributed, the distribution does not cause the partner to recognize gain under section 731(a) because the liability “supports” the distribution by providing additional basis.

This well-understood and perfectly acceptable planning technique, of course, is not without economic risk; a partner that guarantees a liability may be called upon to satisfy that guarantee. With lower-leverage partnerships, this can be relatively low risk. In a higher-leverage partnership—for example, certain real estate joint ventures—however, the risk can be more significant.

Before the issuance of temporary Treasury regulations in October 2016, a partner that sought to be allocated a share of liabilities while reducing the associated economic exposure sometimes entered into a so-called “bottom dollar guarantee.” Unlike other guarantees (in which the guarantor is liable for the amount guaranteed beginning with the first dollar of the unsatisfied outstanding principal balance), a bottom dollar guarantee requires the guarantor to make a payment only to the extent that the lender ultimately collects less than the amount guaranteed. That is, a bottom dollar guarantee exposes the guarantor to the last dollars of loss rather than the first. A bottom dollar guarantee thus caused a liability to be a recourse liability that exposed the guarantor to lower risk while still constituting sufficient risk exposure to support an allocation of liabilities (in an amount equal to the guarantee). This allowed the partner providing the guarantee to avoid gain recognition to the extent of the associated liabilities.

C. IRS and Treasury Response to Bottom Dollar Guarantees

The IRS and Treasury perceived bottom dollar guarantees as lacking commercial substance and, in January 2014, proposed an initial set of regulations seeking to curb their use. Under the final 2019 Regulations, “bottom dollar payment obligations” are not recognized (i.e., a bottom dollar guarantee does not result in the guarantor partner being treated as having the economic risk of loss with respect to the liability). Under the regulations, a bottom dollar payment obligation generally includes any payment obligation under a guarantee or similar arrangement with respect to which the partner (or a related person) is not liable for up to the full amount of the payment obligation in the event of non-payment by the partnership. In other words, the lender must be able to recover from the guarantor beginning with the lender’s first dollar of loss. In determining whether a guarantee meets the definition of a bottom dollar payment obligation, and, relatedly, whether the partner (or a related person) bears the economic risk of loss, every aspect of the guarantee must be considered, including whether, by reason of contract, state law, or common law, the partner has a reimbursement or contribution right (for example, by claiming reimbursement or contribution from the joint venture on a priority basis relative to the other partners, from the other partners, or from third parties).

The determination of whether a particular guarantee meets the definition of “bottom dollar payment obligation” is, therefore, a mixed issue of law and transaction-specific facts.

D. Special Rule for “Vertical Slice” Guarantees

One important clarification of the bottom dollar guarantee rules is the rule for so-called “vertical slice” guarantees. The 2019 Regulations provide that a guarantee is not a bottom dollar guarantee if the guaranteed obligation equates to a fixed percentage of every dollar of the guaranteed partnership liability. That is, a partner does not need to guarantee the entire liability but rather can guarantee a “vertical slice” of the entire liability. For example, suppose a partner agrees to guarantee ten percent of a $100 million partnership liability, which would be $10 million. In a typical guarantee, the partner would be liable for the first $10 million of the lender’s losses—that is, if the lender recovers less than $100 million, the guarantor is liable for up to $10 million. If, however, the partner enters into a “vertical slice guarantee” for ten percent of the lender’s loss up to the same $10 million amount, the partner would be liable for ten percent of each dollar of the lender’s loss, thus reducing its effective economic exposure in the event of a loss. That is, if the lender recovered only $60 million from the partnership, the guarantor would be liable for $4 million (ten percent of the $40 million loss). Unlike a bottom dollar guarantee (which, in the example, would not have resulted in a payment obligation because the lender recovered in excess of the $10 million guaranteed amount), a “vertical slice guarantee” exposes a guarantor partner to liability from the first dollar of loss.

Accordingly, a partner seeking to provide a guarantee of only a portion of a partnership liability may be able to use a “vertical slice guarantee” to accomplish this goal while reducing economic exposure in the event of a loss.

E. Anti-Abuse Rule

The 2019 Regulations contain an anti-abuse rule pursuant to which a payment obligation is disregarded if the facts and circumstances indicate a plan to circumvent or avoid the obligation. Factors cited by the regulations as evidence of such a plan include the partner (or a related person) not being subject to commercially reasonable contractual restrictions that protect the likelihood of payment and that the terms of the partnership liability would be substantially the same had the partner (or related person) not agreed to provide the guarantee. These rules should be considered if entering into a guarantee or other payment obligation.

III. How May The Expiration Of The Transition Rule Impact You?

If you:

are a partner in an entity classified as a partnership for U.S. federal income tax purposes;
guaranteed one or more partnership liabilities before October 5, 2016; and
your share of partnership liabilities exceeded your basis in your partnership interest at that time;

then you should consult your tax lawyers to determine whether the guarantee is a bottom dollar payment obligation. If it is, the transition rule described above will expire on October 4, 2023, and you should consider whether to take any action before that date. Actions that can be taken include entering into a replacement guarantee that complies with the 2019 Regulations before October 4, 2023. If you do not, you may recognize gain equal to all or a portion of your current “negative tax capital account,” either in 2023 or later.

____________________________

[1] Unless indicated otherwise, all “section” references are to the Internal Revenue Code of 1986, as amended (the “Code”), and all “Treas. Reg. §” references are to the Treasury regulations promulgated under the Code.

[2] The 2019 Regulations finalized temporary regulations promulgated in T.D. 9788 on October 5, 2016.

[3] There is a special rule for liabilities with respect to which the lender may look only to specific partnership assets. In that case, the liability is treated as satisfied by transferring the property to the lender.

This alert was prepared by Emily Leduc Gagné,* Evan M. Gusler, James Jennings, Andrew Lance, and Eric B. Sloan.

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

Tax Group:
Dora Arash – Los Angeles (+1 213-229-7134, [email protected])
Sandy Bhogal – Co-Chair, London (+44 (0) 20 7071 4266, [email protected])
Michael Q. Cannon – Dallas (+1 214-698-3232, [email protected])
Jérôme Delaurière – Paris (+33 (0) 1 56 43 13 00, [email protected])
Michael J. Desmond – Los Angeles/Washington, D.C. (+1 213-229-7531, [email protected])
Anne Devereaux* – Los Angeles (+1 213-229-7616, [email protected])
Matt Donnelly – Washington, D.C. (+1 202-887-3567, [email protected])
Pamela Lawrence Endreny – New York (+1 212-351-2474, [email protected])
Benjamin Fryer – London (+44 (0) 20 7071 4232, [email protected])
Kathryn A. Kelly – New York (+1 212-351-3876, [email protected])
Brian W. Kniesly – New York (+1 212-351-2379, [email protected])
Loren Lembo – New York (+1 212-351-3986, [email protected])
Jennifer Sabin – New York (+1 212-351-5208, [email protected])
Hans Martin Schmid – Munich (+49 89 189 33 110, [email protected])
Eric B. Sloan – Co-Chair, New York (+1 212-351-2340, [email protected])
Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224 /+1 212-351-2344), [email protected])
Edward S. Wei – New York (+1 212-351-3925, [email protected])
Lorna Wilson – Los Angeles (+1 213-229-7547, [email protected])
Daniel A. Zygielbaum – Washington, D.C. (+1 202-887-3768, [email protected])
Emily Leduc Gagné* – New York (+1 212-351-6387, [email protected])
Evan M. Gusler – New York (+1 212-351-2445, [email protected])
James Jennings – New York (+1 212-351-3967, [email protected])

Real Estate Group:
Andrew Lance – New York (+1 212-351-3871, [email protected])

*Anne Devereaux is of counsel in the firm’s Los Angeles office who is admitted only in Washington, D.C.; Emily Leduc Gagné is an associate in the firm’s New York office who is admitted in Ontario, Canada.

On August 23, 2023, the U.S. Securities and Exchange Commission (the “SEC”) by a 3-2 vote adopted final rules (the “Final Rules”) under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), which modify certain aspects of the rules initially proposed on February 9, 2022 (the “Proposed Rules”) and adopt others largely as proposed. The Final Rules reflect the SEC’s asserted goal of bringing “transparency” to the inner workings of private funds and their sponsors by restricting or requiring extensive disclosure of preferential treatment granted in side letters, as well as imposing numerous additional reporting and other compliance requirements.[1] While several of the Final Rules require further clarification, and industry practice will undoubtedly evolve as the Final Rules are further analyzed and, to the extent possible, implemented, the following table sets forth a high-level overview of key requirements and restrictions reflected in the Final Rules. Following the table is a Q&A addressing some of the most frequently asked questions sponsors and other industry participants have asked us. These materials are a general, initial summary and do not assess the legality of the Final Rules, which remain subject to potential challenge.

Private Funds Rules – Overview of Key Requirements and Restrictions

Requirement or Restriction	High-Level Observations	Compliance Date[2] / Grandfathering of existing funds[3]
Preferential Treatment Rule (Disclosure Requirements): An adviser may not admit an investor into a fund unless it has provided advance disclosure of material economic terms granted preferentially to other investors, and must disclose all other preferential treatment “as soon as reasonably practicable” after the end of the fundraising period (for illiquid funds) or the investor’s investment (for liquid funds) and at least annually thereafter (if new preferential terms are granted since the last notice).	As set forth below, this requirement fundamentally changes the rules of the game with respect to a fund’s typical MFN process and requires advance disclosure of material economic terms, including to those investors who are not entitled to elect them, and to those who would not typically see them (e.g., smaller investors who do not have side letters).Because the disclosure requirements apply to existing funds, older funds will need to disclose preferential treatment previously granted but not yet disclosed.	Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers) Existing funds grandfathered? No.
Quarterly Statement Rule: Registered advisers must issue quarterly statements detailing information regarding fund-level performance; the costs of investing in the fund, including itemized fund fees and expenses; the impact of any offsets or fee waivers; and an itemized accounting of all amounts paid to the adviser or its related persons by each portfolio company.	As set forth below, the requirement to show performance metrics for illiquid funds, both with and without the impact of fund-level subscription facilities, and to spell out clearly all fund-level and portfolio company-level special fees and expenses (e.g., monitoring fees) and provide a cross-reference to the section of the private fund’s organizational and offering documents setting forth the applicable calculation methodology with respect to each is extremely burdensome and could provide another basis for the SEC staff to review performance calculations and fee and expense allocations during exams. We also expect the timing deadlines for the quarter- and year-end statements to present significant operational challenges for sponsors.	Compliance Date: 18 months (Larger and Smaller Advisers) Existing funds grandfathered? No
Private Fund Audit Rule: Registered advisers must obtain an annual audit for each private fund that meets the requirements of the audit provision in the Advisers Act custody rule (Rule 206(4)-2), and will no longer be able to opt out of the requirement using surprise examinations.	Many private fund sponsors are already providing audited financial statements in compliance with the custody rule. Sponsors who opt out of this requirement in favor of surprise examinations will be affected. We note that the SEC has re-opened its comment period with respect to its proposal regarding safeguarding client assets to allow commenters to assess its interplay with the Private Fund Audit Rule.	Compliance Date: 18 months (Larger and Smaller Advisers) Existing funds grandfathered? No
Adviser-Led Secondaries Rule: Registered advisers must obtain and distribute an independent fairness opinion or valuation opinion in connection with an adviser-led secondary transaction, and disclose material business relationships the adviser has had in the last two years with the opinion provider.	We believe that a U.S. market norm has likely developed in recent years where many sponsors are already providing fairness opinions or valuation opinions as a best practice in GP-led secondaries. This requirement will, however, increase expenses for transactions that have not historically relied on such opinions (such as where a third-party bid establishes the price), and ultimately such expenses will be passed onto investors.	Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? No
Books and Records Rule Amendments: Requirement to maintain certain books and records demonstrating compliance with the Final Rules.	We believe that the books and records amendments generally clarify that sponsors must maintain specific records of compliance with the new rules. We anticipate the SEC staff will focus on this requirement in considering possible deficiencies related to the new rules as part of routine exams.	Compliance Date: Based on the compliance date of the underlying rule for which records are required Existing funds grandfathered? No
Restricted Activities Rule (Investigation Costs): An adviser may not allocate to the private fund any fees or expenses associated with an investigation of the adviser without disclosing as much and receiving consent from a majority in interest of fund investors (excluding the adviser and its related persons), and is prohibited from charging the fund for fees and expenses for an investigation that results or has resulted in a sanction for a violation of the Advisers Act or the rules thereunder.	We believe this rule will adversely affect and burden sponsors.[4] Sponsors will no longer be able to allocate costs of an investigation to a fund unless a majority in interest of unaffiliated investors consent. The adopting release makes clear that the SEC intends that sponsors seek separate consents for each investigation, which would suggest that the practice of describing such costs with generality in the fund’s governing document would not be sufficient. Even if sponsors obtain consent to allocate costs related to an investigation to a fund, they will not be able to do so if the investigation results in sanctions for violations of the Advisers Act.	Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Yes, if disclosed.[5]
Restricted Activities Rule (Regulatory/Compliance Costs): Advisers may not charge or allocate to the private fund regulatory, examination, or compliance fees or expenses unless they are disclosed to investors within 45 days after the end of the fiscal quarter in which such charges occur.	The adopting release makes clear that the SEC continues to view advisers charging to the fund “manager-level” expenses that it feels should more appropriately be borne by the adviser as “contrary to the public interest and the protection of investors.” As is currently the case, an adviser that allocates its regulatory, compliance and examination costs to a fund should ensure that this practice is clearly permitted under the fund’s governing documents. However, even with such authority, the level of granular disclosure regarding such costs that the Final Rule seemingly requires could have a chilling effect on the practice (where applicable) and discourage investment in compliance.	Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Disclosure requirement generally applies
Restricted Activities Rule (After-tax Clawback): Advisers may not reduce the amount of a GP clawback by amounts due for certain taxes unless the pre-tax and post-tax amounts of the clawback are disclosed to investors within 45 days after the end of the fiscal quarter in which the clawback occurs.	Advisers who wish to reduce their GP clawback amount by their actual or hypothetical taxes (the latter being a common practice permitted by most fund governing documents) will need to provide investors with notice of having done so and disclosure of specific dollar amounts.	Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Yes, with disclosure
*Restricted Activities Rule (Non-pro rata* investment-level allocations):** Advisers may not charge or allocate fees or expenses related to a portfolio investment on a non-pro rata basis when multiple funds and other clients are invested, unless the allocation is “fair and equitable” and the adviser distributes advance notice describing the charge and justifying its fairness and equitability.	We believe that this requirement will put additional pressure on advisers to determine, at the outset of a fundraise, whether certain costs, such as those related to AIVs or feeder funds set up to accommodate particular investors’ unique tax or regulatory profiles, will be allocated across the fund or instead allocated exclusively to such investors. Increased disclosure will likely lead to more allocation of these costs across the fund. This rule also places additional pressure on the practice of disproportionately allocating broken deal expenses to the fund as opposed to investors who were proposed to have invested alongside the fund, which is a longstanding focus of the SEC.	Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Disclosure requirement generally applies
Restricted Activities Rule (Borrowing from the fund): Advisers may not borrow or receive an extension of credit from a private fund without disclosure to and consent from fund investors.	This rule does not apply to the more typical practice of sponsors lending money to the fund. In light of the clarification that disclosure and consent are required, a minority of sponsors may seek to include the ability to borrow from the fund on certain pre-defined terms in the fund’s governing documents.	Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Yes.[6]
Preferential Treatment Rule (Redemption Rights): An adviser may not offer preferential treatment to investors regarding their ability to redeem if the adviser reasonably expects such terms to have a material, negative effect on other investors, unless such ability is required by law or offered to all other investors in the fund without qualification.	State pension funds and sovereign wealth funds, in particular, often negotiate special redemption rights. Sponsors are being placed in the difficult position of determining whether such rights have a material, negative effect on other investors, when they are not driven by laws, rules or regulations applicable to the investor. The SEC has provided little guidance to assist in this determination, which must be examined on a case-by-case basis.	Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Yes.[7]
Preferential Treatment Rule (Portfolio Holdings Information): An adviser may not provide preferential information about portfolio holdings or exposures if the adviser reasonably expects that providing the information would have a material, negative effect on other investors, unless such preferential information is offered to all investors.	Attention should be given to information required by bespoke reporting templates to determine whether this provision applies.	Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers Existing funds grandfathered? Yes.[8]
Compliance Rule Amendment: All registered advisers (including those without private fund clients) must document in writing the required annual review of their compliance policies and procedures.	We believe this codifies an informal position that the SEC examinations staff has already imposed on advisers.	Compliance Date: 60 days after publication of the Final Rules in the Federal Register Existing funds grandfathered? N/A

Frequently Asked Questions:

The following Q&A sets forth our answers to questions to frequently asked questions:

Question: Which of the Final Rules apply to various types of sponsors?

- Registered investment advisers to private funds are subject to all of the rules and restrictions set forth in the table above.
- Exempt reporting advisers and other unregistered advisers are not affected by the Quarterly Statement Rule, the Private Fund Audit Rule, the Adviser-Led Secondaries Rule or the Compliance Rule Amendment.
- Offshore advisers whose principal place of business is outside the U.S., whether registered or unregistered, are technically subject to the Final Rules, but the SEC has indicated that it will not extend the requirements of these rules to the adviser’s activities with respect to their offshore private fund clients, even if the offshore funds have U.S. investors.
- The Final Rule states that Quarterly Statement Rule, Private Fund Audit Rule, Adviser-Led Secondaries Rule, Restricted Activities Rule and Preferential Treatment Rules do not apply to investment advisers with respect to securitized asset funds they advise; real estate funds relying on Section 3(c)(5)(C), and other collective investment vehicles that are not “private funds”[9] are also outside the technical scope of those rules.
- Real estate fund managers that are not registered with the SEC (or filing reports as an exempt reporting adviser) on the basis that they are not advising on “securities” are not subject to the Advisers Act or the Final Rules.

Question: What do sponsors have to disclose before and after admitting investors, and how will the current MFN process change?

Sponsors will now have to disclose (i) fee and carry breaks or other material economic arrangements preferentially granted to other investors ahead of admitting new investors into their private funds, and (ii) all preferential treatment as soon as reasonably practicable after the final closing of a closed end fund or the admission of the new investor in an open-end fund, and at least annually thereafter if preferential terms are provided that were not previously disclosed. This disclosure requirement applies to existing funds, even if they have held a final closing prior to the compliance date.

In a statement released concurrently with the release of the Final Rule, Commissioner Caroline A. Crenshaw stated that “collective action problems appear to prevent coordination among investors to bargain for uniform baseline terms.”[10] The SEC’s decision to require disclosure of material economic terms ahead of admitting investors to the fund and disclosure of all preferential treatment post-final closing takes aim at that purported collective action problem.

Notably, the SEC seemingly narrowed its original proposal by opting to require advance written disclosure of “any preferential treatment related to any material economic terms,” as opposed to advance disclosure of all preferential treatment, as originally proposed.[11] Notwithstanding that concession, all preferential treatment (notably, without the materiality qualifier) must invariably be disclosed as soon “as reasonably practicable” following the end of the private fund’s fundraising period (for illiquid funds) or the investor’s investment in the private fund (for liquid funds).[12]

The SEC notes that “as soon as reasonably practicable” will be a facts and circumstances analysis, but suggests that it believes that “it would generally be appropriate for advisers to distribute the notices within four weeks.”[13] We find this proposed timeline ambitious and, in the absence of a hard deadline, would predict that many sponsors will continue take additional time to complete their MFN process. The “as soon as reasonably practicable” requirement would, however, cut against conducting an MFN process an excessive number of months after the final closing, as sometimes happens at present.

Material economic terms that require prior disclosure include, without limitation, “the cost of investing, liquidity rights, fee breaks, and co-investment rights.”[14] The SEC cited excuse rights as an example of non-economic preferential terms which must be disclosed post-closing. Providing a summary of preferential treatment provisions with sufficient specificity to convey its relevance will satisfy this requirement, as will providing the actual provisions granted, and in each case this may be done on an anonymized basis.[15]

In our experience, most investors in private funds with commitments in excess of a certain threshold negotiate side letters with sponsors that contain a “most favored nations” (“MFN”) clause entitling them to view all or part of the side letters granted to other investors and, most frequently, to opt into those more favorable terms negotiated by other investors who make commitments that are equal to or lesser than their capital commitment (and are not otherwise inapplicable to them). This process (the “MFN Process”) typically happens after the fund’s final closing in the closed-end fund context. Accordingly, the Final Rules essentially require sponsors to conduct a portion of their MFN Process in piecemeal fashion, with part of the process conducted prior to the final closing and the rest conducted post final closing, and to do so with respect to each investor regardless of whether such investor negotiated a side letter with an MFN clause or is entitled to elect any of the disclosed provisions. This will curtail the common practice of only showing other investors’ side letter provisions to those investors with MFN provisions and of only showing investors those provisions which they are eligible to elect. Due to the ongoing disclosure requirements, those sponsors of closed-end funds which already held their final closings and ran a more limited MFN process will now be required to disclose any preferential treatment granted to other investors, regardless of size, that had not been previously disclosed. There is no requirement to offer the election of such provisions to the investors who receive the disclosure.

While, as a technical matter, only disclosure of the key terms is required (and not an opportunity to elect such terms), the natural consequence of disclosure is that investors may ask sponsors at the time they are informed of key terms (regardless of whether they have a side letter with an MFN provision) to be granted the same terms as other similarly situated investors.

We expect that these disclosure requirements will present a substantial logistical challenge and may affect previously negotiated commercial arrangements. The SEC has not prescribed a method of delivery for electronic notices, so sponsors will be able to choose whether to do so in the private placement memorandum (the “PPM”), as a standalone disclosure document in an electronic data room, via email or otherwise. PPM supplements may be a natural place to make this disclosure, since private funds typically accept investors across multiple closings over the course of a fundraising and already provide supplements to PPMs, although virtual data rooms may also be an attractive alternative delivery method.

Sponsors will face the issue of how to handle their first closing and how to handle disclosure of terms that are being negotiated concurrently in the final hours before a later closing. In a typical fund closing, multiple side letters are negotiated concurrently with investors in the days leading up to the closing date. Time will tell where the industry lands on this point, but one potential reading of the Final Rules suggests that a sponsor concerned about managing these closing dynamics could take the position that any preferential terms granted as of the same date and at a given closing can be deemed not to have been granted prior to the capital commitments made by any other investor in that closing, and therefore may be disclosed later. It remains to be seen, however, whether this approach is consistent with the intent of the Final Rules and whether, alternatively, the Final Rules would effectively obligate sponsors to communicate two dates to their prospective investors for their closings: one being the “drop dead” date when all side letter terms need to be agreed to, and the second being a later date when commitments will be accepted and the closing will occur. This approach would give the fund, and legal counsel, time to disclose any additional material economic terms to all investors and make any last-minute updates to their side letters in response to any requests to opt into those terms that they are eligible for. In any event, we expect that the Preferential Treatment Rule’s disclosure requirement, assuming it can be practically implemented, will increase organizational expense costs for sponsors. Many sponsors agree to organizational expense caps with their investors, and some are able to negotiate that the MFN Process falls outside of those caps. If at least a portion of the MFN Process, which can be lengthy and expensive, must take place ahead of closing investors, then sponsors are likely to seek increases to their organizational expense caps to accommodate these added costs. The Final Rules will also allow smaller investors, including those that did not themselves negotiate a “most favored nations” clause (or even have a side letter), to view the provisions negotiated by larger investors. This may result in more protracted negotiations with investors who are making capital commitments at sizes which, in the view of sponsors, do not typically entitle them to a side letter arrangement, or to propose in the fund’s PPM fee breakpoints and other means of giving preference based on size, timing and other pre-determined criteria instead of doing so through the side letter process.

Question: How will sponsors’ quarterly and annual reports be affected?

Under the Final Rules, registered investment advisers are required to prepare quarterly statements for each of their private funds that include (A) a table with a detailed accounting of all fees, compensation and other amounts paid to the adviser or any of its related persons by the fund as well as all other fees and expenses paid by the fund during the relevant reporting period, (B) a table with a detailed accounting of all fees and compensation paid to the adviser or any of its related persons by the fund’s covered portfolio investments and (C) performance measures of the fund for the relevant reporting period.[16] Advisers must comply with the quarterly statement requirement for a new fund once it has had two full fiscal quarters of operating results. The Final Rule goes into granular detail about what information needs to be clearly and prominently disclosed in the quarterly statements, including the methodologies used and assumptions relied upon in the quarterly statement, as further described below.

(A) Quarterly Statement: Fund-Level Fee, Compensation and Expense Disclosure

The Quarterly Statement Rule requires registered investment advisers to disclose on a quarterly basis (1) a detailed accounting of all compensation, fees, and other amounts allocated or paid to the adviser or any of its related persons by the private fund during the reporting period, including, but not limited to, management, advisory, sub-advisory, or similar fees or payments, and performance-based compensation (e.g., carried interest), (2) a detailed accounting of all fees and expenses allocated to or paid by the private fund during the reporting period other than those listed in (1), including, but not limited to, organizational, accounting, legal, administration, audit, tax, due diligence, and travel fees and expenses, and (3) the amount of any offsets or rebates carried forward during the reporting period to subsequent quarterly periods to reduce future payments or allocations to the adviser or its related persons.

The SEC emphasizes in several places throughout its commentary to the Final Rules that there should be separate line items for each category of compensation, fee or expense and that the exclusion of de minimis expenses, the grouping of smaller expenses into broad categories or the labeling of any expenses as miscellaneous is prohibited, which will require significant effort on the part of advisers. Additionally, they advise that to the extent a certain expense could be categorized as either adviser compensation or a fund expense, the Final Rule requires that such payment or allocation be categorized as adviser compensation. For example, if an adviser or its related persons provide consulting, legal or back-office services to a private fund as a permitted expense under the private fund’s governing documents, such amounts should be categorized as compensation as opposed to an expense. This highlights the technicalities that the Final Rule imposes upon advisers and the potential pitfalls that may arise in compliance.

The SEC also noted in its commentary that the definitions of “related person” and “control” adopted under the Final Rules are consistent with the definitions used on Form ADV and Form PF, which registered investment advisers are familiar with.

This set of disclosure must be done before and after the application of any offsets, rebates or waivers to fees or compensation received by the adviser, including, but not limited to, any fees an adviser or its related person receives for management services provided to a fund’s portfolio company.

(B) Quarterly Statement: Portfolio Investment-Level Fee and Compensation Disclosure

Similar to the above, the Quarterly Statement Rule requires registered investment advisers to disclose a detailed accounting of all portfolio investment compensation allocated or paid by each covered portfolio investment during the reporting period in a single, separate table from the disclosure table noted above.

The definition of a portfolio investment is broad and is intended to cover any entity through which a private fund holds an investment, including through holding vehicles, subsidiaries, acquisition vehicles, special purpose vehicles or the like. In its commentary to the Final Rules, the SEC recognizes that this may impose challenges specifically for funds of funds, as it may be difficult to determine portfolio investment compensation arrangements at the underlying fund level.

This prong of the Final Rule also similarly requires a detailed line-by-line itemization of all portfolio investment compensation. Additionally, the SEC also notes in its commentary to the Final Rules that advisers are required to list the portfolio investment compensation allocated or paid with respect to each covered portfolio investment both before and after the application of any offsets, rebates or waivers. However, it is not clear how this is intended to apply at this level, as such offsets are taken into account at the fund level, not the portfolio company level.

“Portfolio investment compensation” includes any compensation, fees, and other amounts allocated or paid to the adviser or any of its related persons by the portfolio investment attributable to the private fund’s interest in the portfolio investment, including, but not limited to, origination, management, consulting, monitoring, servicing, transaction, administrative, advisory, closing, disposition, directors, trustees or similar fees or payments. Notably, this requirement could cause some sponsors to consider transitioning in-house or affiliated operating groups to unaffiliated entities (e.g., owned by the operating advisors themselves).

(C) Quarterly Statement: Performance Disclosure

Under the Final Rule, registered investment advisers are required to provide standardized fund performance information in each quarterly statement. The performance metrics shown will depend on whether a private fund is classified as a liquid fund or an illiquid fund. An “illiquid fund” is defined as a private fund that does not have investor redemption mechanisms and that has limited opportunities for investor withdrawal other than in exceptional circumstances. A “liquid fund” is defined as a private fund that is not an illiquid fund.

(1) Liquid Funds

For liquid funds, registered investment advisers are required to show performance based on (A) annual net total return for each fiscal year for the 10 fiscal years prior to the quarterly statement or since inception (whichever is shorter), (B) average annual net total returns over one-, five-, and 10-fiscal year periods, and (C) cumulative net total return for the current fiscal year as of the end of the most recent fiscal quarter. It is anticipated that estimations may need to be made for liquid funds that have been operating for lengthy periods of time that did not keep adequate records of the earlier years.

(2) Illiquid Funds

For illiquid funds, registered investment advisers of illiquid funds are required to (i) show performance based on internal rates of return and multiples of invested capital (both gross and net metrics shown with equal prominence) (A) since inception and (B) for the realized and unrealized portions of the illiquid fund’s portfolio, with the realized and unrealized performance shown separately and (ii) present a statement of contributions and distributions. The Final Rule defines the terms “internal rate of return” and “multiple of invested capital”, on both a gross and net basis, and provides color on what is expected to be included in the statement of contributions and distributions.[17] This illustrates the granular and prescriptive nature of the Final Rule, which will require concerted effort on behalf of fund sponsors to ensure compliance.

Advisers are required to consider the impact of fund-level subscription facilities on returns and disclose such performance information for illiquid funds on both a levered and an unlevered basis. In its commentary to the Final Rules, the SEC is repeatedly focused on standardizing information across private funds as much as possible, and as such has provided no room for exclusions to this rule, such as possibly exempting advisers from providing unlevered returns on short-term subscription facilities or excluding subscription line fees and expenses from the calculation of net performance figures.

The SEC notes in its commentary to the Final Rules that to the extent that certain funds rely on information from portfolio investments to generate the required performance data and such information is not available prior to the distribution of the quarterly statement, an adviser would be expected to use the performance measures “through the most recent practicable date”, which is likely the end of the immediately preceding quarter.

An additional prong to the quarterly statement rule is to include clear and prominent disclosure of the methodologies and assumptions made in calculating performance information. This includes, but is not limited to, whether dividends were reinvested in a liquid fund, or whether any fee rates or fee discounts were assumed in the calculation of net performance measures.

This Final Rule also requires the quarterly statement to include cross-references to the sections of the private fund’s organizational and offering documents that set forth the applicable calculation methodology for all expenses, payments, allocations, rebates, waivers, and offsets. This will likely result in significant changes to how private placement memoranda and the operating agreements of private funds are drafted going forward. Furthermore, to the extent that the allocation and methodology provisions in existing operating agreements are not adequately detailed, this requirement under the Final Rule may prompt future LPA amendments that require limited partner consent.

This consequence of the Final Rules is in tension with the legacy status (i.e. grandfathering) that the Final Rules afford governing agreements entered into prior to the date that the Final Rules take effect. The cross-reference requirement of the Quarterly Statement Rule may effectively eliminate the protections provided by the legacy status concept if sponsors will be required to amend their governing agreements to include sufficient allocation and methodology provisions according to the SEC’s new standards. Notwithstanding the fact that many sponsors may already disclose some of the information required under the Quarterly Statement Rule to their investors, it is anticipated that compliance with the Quarterly Statement Rule will result in significant increased cost to advisers and funds, especially at the outset in establishing compliant quarterly statement templates and disclosures.

Such disclosures must be included in the quarterly statement itself as opposed to in a separate document. The SEC noted that while advisers are not required to provide all supporting calculations in quarterly statements, such information should be made available to investors upon request.

With regards to timing, the Final Rule mandates that registered investment advisers must distribute the quarterly statements to the private fund’s investors within 45 days after the end of the first three fiscal quarters of each fiscal year and within 90 days after the end of each fiscal year, and in the case of fund of funds, within 75 days after the end of the first three fiscal quarters of each fiscal year and within 120 days after the end of each fiscal year.

Question: Which of the Proposed Rules were not adopted or were modified by the Final Rules?

While the Final Rules will require sponsors to provide investors with significantly more “transparency” regarding preferential economic arrangements granted in side letters (notably, with respect to material economic terms, before closing new investors into their funds) and fees received by the adviser and related persons, as well as providing new rules on quarterly statements, fund audits, adviser-led secondaries, books and records, annual compliance reviews and certain restricted activities, and some of the “disclose and consent” requirements may operate in practical effect as prohibitions on the relevant conduct, it is worth noting that the Final Rules do not specifically adopt the following items which had been set forth in the Proposed Rules.

In particular, the Final Rules do not:

(i) require all preferential rights granted by side letter to be disclosed prior to investment (only material economic terms must be disclosed prior, the rest must be disclosed later);

(ii) eliminate sponsors’ ability to be indemnified, or limit liability, for simple negligence (preserving the “gross negligence” standard for indemnification);

(iii) prohibit clawbacks of carried interest net of taxes (as noted above, this was replaced by a disclosure requirement);

(iv) expressly prohibit allocating portfolio investment fees and expenses to funds on a non-pro rata basis, subject to disclosure requirements; or

(v) prohibit borrowing from a fund (which may done with disclosure and consent).

Further, the Final Rules also do not provide the specific prohibition against charging accelerated monitoring fees that was noted in the Proposed Rules; although members of the SEC staff clarified during the open meeting held on the Final Rules on August 23, 2023 (the “Open Meeting”) that they did not feel specific language on accelerated monitoring fees was necessary because they believe such fees are already prohibited under applicable guidance. The Final Rules also do not expressly prohibit charging an adviser’s regulatory, compliance, examination and certain investigation costs to the fund (except, in some cases, with consent and disclosure and excluding those investigations that result from a violation of the Advisers Act). Our view, however, is that the SEC’s consistent messaging on the impropriety of such charges, combined with burdensome disclosure requirements, could function as a de-facto prohibition of such charges.

___________________________

[1] Resources:

– Link to the Final Rule and the Adopting Release (Release No. IA-6383; File No. S7-03-22 , RIN 3235-AN07, 17 CFR Part 275, Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews: Final Rule)

– Link to the SEC’s Fact Sheet concerning Final Rules

[2] For purposes of the compliance date, the SEC recognized that smaller advisers will require more time to implement certain rules and provided size-based deadlines for implementation, which will be staggered starting from the publication of the Final Rule in the Federal Register. “Larger Advisers” means advisers with assets under management attributable to private funds (“Private Funds AUM”) of $1.5 billion or more. “Smaller Advisers” means advisers with Private Funds AUM of less than $1.5 billion.

[3] The Final Rules grandfather in certain existing arrangements if the private fund has “commenced operations” and has made contractual arrangements related to the provision that were entered into prior to the compliance date, and if the Final Rules would require amending such agreements.

[4] Note that the term “investigation” does not appear to include examinations of the adviser, which are addressed in the row immediately below.

[5] Except that costs associated with investigations resulting in Advisers Act sanctions may not be allocated to new or existing funds even with disclosure and consent.

[6] For loan agreements entered into prior to the compliance date if compliance would require an amendment to such agreements

[7] With respect to contractual obligations entered into prior to the compliance date.

[8] With respect to contractual obligations entered into prior to the compliance date.

[9] Issuers that would be investment companies but for the exclusions contained in Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940.

[10] “Statement Regarding Private Fund Adviser Rulemaking”, Aug. 23, 2023, Commissioner Caroline A. Crenshaw (https://www.sec.gov/news/statement/crenshaw-statement-private-fund-advisers-082323?utm_medium=email&utm_source=govdelivery)

[11] Release, page 292.

[12] Release, page 294.

[13] Release, page 299.

[14] Id.

[15] Id at 297.

[16] 17 C.F.R. § 275.211(h)(1)-2(b)-(c).

[17] See 17 C.F.R. § 275.211(h)(1)-1. “Multiple of invested capital” means (i) the sum of: (A) the unrealized value of the illiquid fund; and (B) the value of distributions made by the illiquid fund; (ii) divided by the total capital contributed to the illiquid fund by its investors. “Internal rate of return” means the discount rate that causes the net present value of all cash flows throughout the life of the private fund to be equal to zero. Gross metrics are calculated gross of all fees, expenses and performance-based compensation borne by the private fund, whereas net metrics are calculated net of all fees, expenses and performance-based compensation borne by the private fund.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding the issues and considerations discussed above, and we will continue to monitor developments in the coming months. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Investment Funds practice group, or any of the individuals listed below:

Investment Funds Group:
Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, [email protected])
Kevin Bettsteller – Los Angeles (+1 310-552-8566, [email protected])
Albert S. Cho – Hong Kong (+852 2214 3811, [email protected])
Candice S. Choh – Los Angeles (+1 310-552-8658, [email protected])
John Fadely – Singapore/Hong Kong (+65 6507 3688/+852 2214 3810, [email protected])
A.J. Frey – Washington, D.C./New York (+1 202-887-3793, [email protected])
Shukie Grossman – New York (+1 212-351-2369, [email protected])
James M. Hays – Houston (+1 346-718-6642, [email protected])
Kira Idoko – New York (+1 212-351-3951, [email protected])
Gregory Merz – Washington, D.C. (+1 202-887-3637, [email protected])
Eve Mrozek – New York (+1 212-351-4053, [email protected])
Roger D. Singer – New York (+1 212-351-3888, [email protected])
Edward D. Sopher – New York (+1 212-351-3918, [email protected])
William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, [email protected])

Tax Group:
Pamela Lawrence Endreny – New York (+1 212-351-2474, [email protected])
Brian W. Kniesly – New York (+1 212-351-2379, [email protected])
Daniel A. Zygielbaum – Washington, D.C. (+1 202-887-3768, [email protected])

The following Gibson Dunn attorneys assisted in preparing this client update: Kevin Bettsteller, Shannon Errico, Greg Merz, and Rachel Spinka.

This Client Alert provides an update on shareholder activism activity involving NYSE- and Nasdaq-listed companies with equity market capitalizations in excess of $1 billion and below $100 billion (as of the last date of trading in 2022) during 2022.

Announced shareholder activist activity increased relative to 2021. The number of public activist actions (82 vs. 76), activist investors taking actions (54 vs. 48) and companies targeted by such actions (72 vs. 69) each increased. The period spanning January 1, 2022 to December 31, 2022 also saw several campaigns by multiple activists targeting a single company, such as the campaigns involving: Alphabet Inc. that included activity by NorthStar Asset Management and Trillium Asset Management; C.H. Robinson Worldwide, Inc. that included Ancora Advisors and Pacific Point Wealth Management; and SpartanNash Company that included Ancora Advisors and Macellum Advisors. In addition, certain activists launched multiple campaigns during 2022, including Ancora Advisors, Carl Icahn, Elliott Investment Management, Engine Capital, JANA Partners, Land & Buildings, Starboard Value and Third Point Partners, which each launched three or more campaigns in 2022 and collectively accounted for 32 out of the 82 activist actions reviewed, or 39% in total. Proxy solicitation occurred in 17% of campaigns in 2022—a slight decrease from the amount of solicitations in 2021 (18%).

By the Numbers—2022 Public Activism Trends

2022 Annual Activism Update Chart

*Study covers selected activist campaigns involving NYSE- and Nasdaq-listed companies with equity market capitalizations of greater than $1 billion as of December 31, 2022 (unless company is no longer listed), and all information is derived from publicly available sources

**Ownership is highest reported ownership since the public action date and includes economic exposure to derivatives where applicable.

Additional statistical analyses may be found in the complete Activism Update linked below.

Notwithstanding the increase in activism levels, the rationales for activist campaigns during 2022 were generally consistent with those undertaken in 2021. Over both periods, board composition and business strategy represented leading rationales animating shareholder activism campaigns, representing 63% and 39% of rationales in 2022 and 58% and 34% of rationales in 2021, respectively. M&A (which includes advocacy for or against spin-offs, acquisitions and sales) increased in importance relative to 2021, as the frequency with which M&A animated activist campaigns was 40% in 2022 and 33% in 2021. At the opposite end of the spectrum, management changes, return of capital and control remained the most infrequently cited rationales for activist campaigns, as was also the case in 2021. (Note that the above-referenced percentages total over 100%, as certain activist campaigns had multiple rationales.)

23 settlement agreements pertaining to shareholder activism activity were filed during 2022, which is an increase from the 17 filed in 2021. Those settlement agreements that were filed had many of the same features noted in prior reviews, including voting agreements and standstill periods as well as non-disparagement covenants and minimum-share ownership and/or maximum-share ownership covenants. Expense reimbursement provisions were included in less than half of those agreements reviewed, which is a decrease from previous years. We delve further into the data and the details in the latter half of this Client Alert.

We hope you find Gibson Dunn’s 2022 Annual Activism Update informative. If you have any questions, please reach out to a member of your Gibson Dunn team.

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The following Gibson Dunn lawyers prepared this client alert: Barbara Becker, Richard Birns, Dennis Friedman, Andrew Kaplan, Saee Muzumdar, Kristen Poole, Daniel Alterbaum, and Joey Herman.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this publication. For further information, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following practice leaders, members, and authors:

Barbara L. Becker (+1 212.351.4062, [email protected])
Dennis J. Friedman (+1 212.351.3900, [email protected])
Richard J. Birns (+1 212.351.4032, [email protected])
Andrew Kaplan (+1 212.351.4064, [email protected])
Daniel S. Alterbaum (+1 212.351.4084, [email protected])
Kristen P. Poole (+1 212.351.2614, [email protected])
Joey Herman (+1 212.351.2402, [email protected])

Mergers and Acquisitions Group:
Robert B. Little – Dallas (+1 214-698-3260, [email protected])
Saee Muzumdar – New York (+1 212-351-3966, [email protected])

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202.955.8287, [email protected])
Brian J. Lane – Washington, D.C. (+1 202.887.3646, [email protected])
James J. Moloney – Orange County, CA (+1 949.451.4343, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202.955.8671, [email protected])
Lori Zyskowski – New York (+1 212.351.2309, [email protected])

Gibson Dunn’s Public Policy Practice Group is closely monitoring the debate in Congress over potential oversight of artificial intelligence (AI). We have previously summarized major federal legislative efforts and White House initiatives regarding AI in our May 19, 2023 alert Federal Policymakers’ Recent Actions Seek to Regulate AI. We have also covered two U.S. Senate hearings that focused on AI in our June 6, 2023 alert “Oversight of AI: Rules for Artificial Intelligence” and “Artificial Intelligence in Government” Hearings.

On July 25, 2023, the Senate Judiciary Committee’s Subcommittee on Privacy, Technology, and the Law held the second in a series of “Oversight of AI” hearings, following its May 16, 2023 hearing on “Rules for Artificial Intelligence,” with a focus on “Principles for Regulation.”[1] A bipartisan group of Senators, led by Chair Richard Blumenthal (D-CT) and Ranking Member Josh Hawley (R-MO), emphasized the urgent need for AI legislation in the face of rapidly advancing AI technology, including generative algorithms and large language models (LLMs).

Witnesses included:

Stuart Russell, Professor of Computer Science, The University of California – Berkeley;
Yoshua Bengio, Founder and Scientific Director, Mila – Québec AI Institute; and
Dario Amodei, Chief Executive Officer, Anthropic.

I. Points of Particular Interest from July 25, 2023 Hearing

We provide a full hearing summary and analysis below. Of particular note, however:

Chair Blumenthal opened the hearing by noting that, when speaking to constituents about AI, the word he heard most often was “scary.” He pointed to the hearing’s witnesses as “provid[ing] objective, fact-based views to reinforce those fears.” Although he recognized these fears as existential threats, Chair Blumenthal continued to emphasize AI’s enormous potential for good and reiterated the need not to stifle innovation and to maintain U.S. leadership in the AI sector.
Both Chair Blumenthal and Ranking Member Hawley extolled the rare bipartisan support for AI regulation. In particular, Chair Blumenthal and Ranking Member Hawley highlighted their recent introduction of a bill to waive immunity under Section 230 of the Communications Act of 1934 for claims related to generative AI, following the Subcommittee’s May 19 discussion of whether such immunity should apply to actors in the AI sector.[2]
Senator Amy Klobuchar (D-MN) emphasized the need to act quickly to capitalize on this bipartisan appetite for AI regulation and avoid “decay[ing] into partisanship and inaction.”
Ranking Member Hawley emphasized AI’s potential impact, questioning whether it will be an innovation more like the Internet or the atom bomb. Ranking Member Hawley thought the question facing society, and Congress specifically, is whether Congress will “strike that balance between technological innovation and our ethical and moral responsibility to humanity, to liberty, to the freedom of this country.”
The subcommittee and its witnesses invoked recent efforts by the White House to secure voluntary commitments from leading AI companies—including Mr. Amodeo’s company, Anthropic—to safeguard against key risks.[3] However, Chair Blumenthal stated that many of these commitments are non-enforceable and relatively unspecific. Chair Blumenthal emphasized that this hearing, in contrast, sought to develop legislation and regulations that would create specific, enforceable obligations on actors in the AI sector.

II. Alleged Risks of Particular Concern

In his opening statement, Ranking Member Hawley commented that he had no doubt that AI will be good for large companies, but that he was less confident that AI would be good for the American people. Much of the hearing, therefore, discussed key areas of risks or alleged harms posed by unregulated AI.

The witnesses testifying before the subcommittee typically divided these risks between immediate or short-term risks that may currently exist in AI—such as privacy concerns, copyright issues, alleged bias in algorithms, and possible misinformation—and more medium-term or long-term risks that may present themselves as AI technology advances. The witnesses emphasized the need for Congress to act urgently to prevent these longer term risks from materializing. Professor Bengio drove home this need, explaining that many AI experts had previously “placed a plausible timeframe for [the] achievement of [human-level AI] somewhere between a few decades and a century” but now considered “a few years to a couple of decades” to be the appropriate estimate.

Throughout the hearing, senators focused on a number of short-term and longer term risks, primarily relating to: (i) misinformation and political influence, (ii) national security, (iii) privacy, and (iv) intellectual property.

a. Misinformation and Political Influence

As in the subcommittee’s previous hearing, concerns about misinformation—particularly in the context of elections—took center stage, with Chair Blumenthal noting that “[i]f there’s nothing else that focuses the attention of Congress, it’s an election.” Both the lawmakers and witnesses highlighted risks associated with “deep fakes” and other forms of misinformation or external influence campaigns using AI.

While Mr. Amadeo noted that his company, Anthropic, trains its AI not to generate misinformation or politically biased content, Ranking Member Hawley pushed back on the idea that AI companies can be trusted to police these lines in the face of business pressures commenting that certain decisions about ethics may be “in the eye of the beholder.” Ranking Member Hawley expressed that, in his view, the control that a relatively small number of companies exercise over the AI sector creates a “serious structural issue” regarding who makes decisions about ethics and misinformation.

Other lawmakers and witnesses echoed Ranking Member Hawley’s concerns about the difficulty of policing AI-generated misinformation, with Senator Klobuchar noting the need to comply with the First Amendment’s protections for free speech and Professor Russell invoking the Orwellian specter of “Ministry of Truth.” Professor Russell proposed, however, that Congress could look to other highly regulated industries like banks and credit cards for guidance on how to balance effective and truthful disclosure requirements with free speech concerns.

b. National Security

Concerns about AI’s implications for national security permeated the hearing, with Ranking Member Hawley listing this issue as one of his top four priorities.

Some of these alleged national security risks related to the use of lethal weapons. For example, Chair Blumenthal noted agreement between the U.S. and China that on limiting certain uses of AI in connection to nuclear weapons, and Professor Russell echoed the popular position against the creation of lethal autonomous weapons systems (LAWS) with the ability to kill in the absence of direction or input from a human actor.

Mr. Amodei specifically addressed concerns that AI could enable malicious actors to develop sophisticated biological weapons. His company had, he explained, conducted a six month study that found that current AI systems are capable of filling in some, but not all, steps in the highly technical process of developing biological weapons. This study extrapolated, however, that AI systems may be able to fill in all steps of these processes within two to three years, allowing malicious actors that lack specialized expertise to weaponize biology.

Ranking Member Hawley and Mr. Amodei also discussed national security risks that could arise if the U.S. fails to secure the AI supply chain, with Mr. Amodei noting the significant number of bottle necks that currently exist in the semiconductor manufacturing process. (For more detailed discussion of U.S. efforts to secure the semiconductor supply chain, see our previous client alerts on the implementation of the CHIPS Act, here and here.) Ranking Member Hawley expressed particular concern about the U.S.’s reliance on Taiwan-origin chips, in light of the possibility of a Chinese invasion of Taiwan.

Some witnesses, however, provided comfort by emphasizing the leadership of the U.S. and its allies in the AI sector. When asked about the AI capabilities of U.S. adversaries, Professor Russell indicated that the U.S., the UK, and Canada currently have the most advanced AI technology in the world whereas, in his view, China’s capabilities have been “slightly overstated.” While he acknowledged China’s extensive investments in AI and its strength in voice and face recognition technology, he suggested that numerical publication requirements on China’s academic sector have limited the country’s ability to produce technological breakthroughs.

c. Privacy

Several senators raised the potential privacy risks that could result from the deployment of AI, often invoking Congress’s perceived failure to address the privacy implications of social media proactively to emphasize an urgent need for AI guardrails. Ranking Member Hawley pointed out that these privacy concerns, if left unchecked, could exacerbate other alleged risks if, for example, an AI program gained access to voter files and used them to target certain voters with misinformation.

Senator Marsha Blackburn (R-TN) stressed her view that the U.S. is “behind” its allies on issues of online consumer privacy, pointing to the digital privacy regimes of the EU, UK, New Zealand, Australia, and Canada as examples. Specifically, she expressed concern that consumers’ personal data was being used to train AI systems, often without their knowledge. Senator Blackburn queried whether a federal privacy standard would help address this concern without interfering with the U.S.’s position as a global leader in generative AI. Professor Russell supported a federal standard, including an absolute requirement to disclose whether systems are harvesting data from users’ conversations.

Mr. Amodei pointed to his own company as an example of how to navigate these concerns, explaining that it relies primarily on publicly available information to train its AI and that the program is trained not to produce results containing certain types of private information.

d. Intellectual Property

Senator Blackburn emphasized the profound impact that unregulated AI could have on the creative sector, suggesting that AI is “robbing [authors, actors, and musicians] of their ability to make a living off of their creative work.” Senator Blackburn queried whether artists whose artistic creations are used to train algorithms are or will be compensated for the use of their work. Professor Russell agreed that existing intellectual property laws may not always be sufficient to address these concerns.

III. Key Regulatory Proposals

As indicated by the hearing’s title, “Principles for Regulation,” the lawmakers and witnesses focused not just on potential risks associated with AI but also with concrete policy measures that could mitigate these risks.

At the end of the hearing, Ranking Member Hawley asked each witness for “one or two recommendations for what Congress should do right now” to regulate the AI industry.

Professor Russell would establish a federal agency tasked with regulating the AI sector. He would also remove from the market any AI systems that violate a designated set of “unacceptable” behaviors associated with the risks and alleged harms discussed above. Professor Russell described this latter recommendation as creating not just positive effects for consumer protection but also as incentivizing companies to conduct rigorous research and testing to ensure their products are effective and controllable before putting them on the market.
Professor Bengio would invest in the safety of AI systems, both at the levels or hardware and cybersecurity measures, through a mix of direct investments and incentives for companies. Professor Bengio emphasized that U.S. investment in AI safety should be “at or above the level of investment” that goes into developing AI programs.
Mr. Amodei would develop rigorous testing and auditing regimes for the AI sector, stressing that “without such testing, we’re blind” to the capabilities and future risks that AI may pose. He also reiterated the importance of an enforcement mechanism for these measures, although he was agnostic on whether that should come from a new federal agency or from existing authorities.

Beyond these high-level recommendations, the subcommittee and witnesses discussed the following regulatory and legislative measures: (a) a potential AI federal agency and auditing regime, (b) labeling and watermarking requirements for information generated by AI, (c) limitations on the release of pre-trained, open source AI models, and (d) the creation of private rights of action authorizing lawsuits against AI companies.

e. AI Federal Agency

Building on conversations from the subcommittee’s May 19, 2023 hearing, the lawmakers and witnesses discussed the possibility of a new federal agency focused on regulating AI, with Chair Blumenthal stating that he had “come to the conclusion that we need some kind of regulatory agency” focused on AI. Chair Blumenthal stressed that this should not be a “passive body” and should instead invest proactively in research to develop countermeasures that can effectively address potential AI risks.

While Chair Blumenthal was the only subcommittee member whose questions focused expressly on the creation of a new federal agency, the witnesses voiced support for the idea throughout the hearing. Noting the rapid development of new AI technology, Professor Bengio observed that legislation alone will be insufficient to mitigate against future AI risks. “We don’t know yet” what regulations might be necessary in one, two, or three years, Professor Bengio commented, and “having an agency is a tool toward [the] goal” of responding agilely to evolving technology. Mr. Amodei also agreed with Chair Blumenthal that this new agency should play a proactive role in researching countermeasures, rather than simply responding to new risks. Mr. Amodei stressed that centralizing research efforts in a new agency, or even through the Department of Commerce’s National Institute of Standards and Technology (NIST) would allow the U.S. to create consistent standards against which to measure risks and benefits associated with AI.

The witnesses believed that one centralized agency focused on AI would provide benefits beyond streamlined domestic implementation of AI regulation. For example, Professor Bengio was of the view that a single agency could better coordinate with the U.S.’s international allies, allowing the U.S. to speak with a single voice while advocating for global standards.

The witnesses emphasized, however, that a federal agency will not, by itself, be sufficient to tackle AI-related risk. Professor Russell observed that “no government agency” will be able to match the tremendous resources—which he estimated at more than $10 billion—that the private sector invests in the creation of AI systems. He suggested that his proposal for involuntary recall provisions could bridge this gap by incentivizing robust testing of AI models by the private sector before these models are released commercially.

f. Labeling and Watermarking Requirements

One of the most frequently mentioned methods of tackling AI-generated misinformation was a regime of labeling and watermarking materials produced by an AI system. As Mr. Amodei and Professor Russell explained, labeling requirements would require as a matter of policy that AI outputs be clearly labeled as produced by AI wherever they are published; watermarking, on the other hand, is a technical measure by which the provenance of both original and AI-generated content can be established. Professor Russell emphasized the need for international coordination to avoid fragmented enforcement, suggesting the creation of an encrypted global escrow system capable of verifying the provenance of any piece of media uploaded to the system.

Chair Blumenthal noted a growing bipartisan consensus on this issue and stressed that labeling and watermarking would be necessary to address election-related misinformation. Senator Klobuchar likewise pointed out that her recently introduced REAL Political Advertisement Act would require election materials produced by AI to be labeled as such.[4]

g. Limitations on Open-Source Model Releases

All three witnesses raised concerns related to the availability to the public of pre-trained open source AI models, because, as Mr. Amodei observed, “when a model is released in an uncontrolled manner, there is no ability to [control it.] It is entirely out of your hands.” This prompted discussion of whether open source AI should be restricted in any way.

Despite the tremendous benefit open source programs may offer in scientific fields, Professor Bengio warned that these could open the door for exploitation by malicious actors who would not otherwise have the technical expertise and computing power necessary to create their own models. He observed that many of these open source systems were being developed at universities and proposed the creation of ethics review boards for university AI programs that could ensure future releases are carefully evaluated for potential risks before they are released. Professor Russell also suggested that “the open source community” may need to face some form of liability “for putting stuff out there that is ripe for misuse.”

h. Private Rights of Action Against AI Companies

The subcommittee and its witnesses focused not just on the legal frameworks necessary to protect against AI-related risk but also on mechanisms for enforcing these laws.

One key enforcement mechanism highlighted by Ranking Member Hawley was the private right of action authorized by the “No Section 230 Immunity for AI Act” that he recently introduced alongside Chair Blumenthal.[5] Ranking Member Hawley described this as an important mechanism to allow Americans to vindicate their privacy rights in court. Specifically, the bill would allow civil actions—as well as criminal prosecutions—“if the conduct underlying the claim or charge involves the use or provision of generative artificial intelligence.”[6]

IV. How Gibson Dunn Can Assist

Gibson Dunn’s Public Policy, Artificial Intelligence, and Privacy, Cybersecurity and Data Innovation Practice Groups are closely monitoring legislative and regulatory actions in this space and are available to assist clients through strategic counseling; real-time intelligence gathering; developing and advancing policy positions; drafting legislative text; shaping messaging; and lobbying Congress. Gibson Dunn also offers holistic support representing our clients in, and ensuring our clients are prepared to respond effectively to, any civil, criminal, or congressional investigations or litigation relating to the development and/or deployment of AI systems.

___________________________

[1] Oversight of A.I.: Principles for Regulation: Hearing Before the Subcomm. on Privacy, Tech., and the Law of the S. Comm. on the Judiciary, 118th Cong. (2023), https://www.judiciary.senate.gov/committee-activity/hearings/oversight-of-ai-principles-for-regulation.

[2] No Section 230 Immunity for AI Act, S. 1993, 118th Cong. (2023).

[3] See Press Release, Fact Sheet: Biden-Harris Administration Secures Voluntary Commitments from Leading Artificial Intelligence Companies to Manage the Risks Posed by AI, The White House (Jul. 21, 2023), https://www.whitehouse.gov/briefing-room/statements-releases/2023/07/21/fact-sheet-biden-harris-administration-secures-voluntary-commitments-from-leading-artificial-intelligence-companies-to-manage-the-risks-posed-by-ai/.

[4] Real Political Advertisements Act, S. 1596, 118th Cong. (2023).

[5] No Section 230 Immunity for AI Act, S. 1993, 118th Cong. (2023).

[6] Id.

The following Gibson Dunn lawyers prepared this client alert: Michael Bopp, Roscoe Jones, Jr., Vivek Mohan, Cassandra Gaedt-Sheckter, Amanda Neely, Daniel Smith, and Sean Brennan.

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following in the firm’s Public Policy, Artificial Intelligence, or Privacy, Cybersecurity & Data Innovation practice groups:

Public Policy Group:
Michael D. Bopp – Co-Chair, Washington, D.C. (+1 202-955-8256, [email protected])
Roscoe Jones, Jr. – Co-Chair, Washington, D.C. (+1 202-887-3530, [email protected])
Amanda H. Neely – Washington, D.C. (+1 202-777-9566, [email protected])
Daniel P. Smith – Washington, D.C. (+1 202-777-9549, [email protected])

Artificial Intelligence Group:
Cassandra L. Gaedt-Sheckter – Co-Chair, Palo Alto (+1 650-849-5203, [email protected])
Vivek Mohan – Co-Chair, Palo Alto (+1 650-849-5345, [email protected])
Eric D. Vandevelde – Co-Chair, Los Angeles (+1 213-229-7186, [email protected])
Frances A. Waldmann – Los Angeles (+1 213-229-7914, [email protected])

Privacy, Cybersecurity and Data Innovation Group:
S. Ashlie Beringer – Co-Chair, Palo Alto (+1 650-849-5327, [email protected])
Jane C. Horvath – Co-Chair, Washington, D.C. (+1 202-955-8505, [email protected])
Alexander H. Southwell – Co-Chair, New York (+1 212-351-3981, [email protected])

On July 31, 2023, the European Commission (the “Commission”) adopted the first set[1] of European Sustainability Reporting Standards (the “ESRSs”)[2] for use by all entities subject to the Corporate Sustainability Reporting Directive (the “CSRD”)[3]. The ESRSs are now subject to a two month scrutiny period (extendable by up to two months), during which the European Parliament and the Council of the European Union (“EU”) may approve (in its entirety) or reject the ESRSs. If approved, the ESRSs will apply, in the first instance, to companies that are already subject to the EU’s non-financial reporting framework (based on the Non-Financial Reporting Directive (the “NFRD”)[4]) for reporting periods beginning January 1, 2024: namely, so-called “large” EU undertakings exceeding an average of 500 employees during the financial year that either have securities admitted to an EU-regulated market or are regulated financial entities (e.g., banks or insurance companies). The CSRD and the ESRSs will be phased-in for other categories of entities, including companies outside the EU, over the next five years.

The ESRSs now provide a detailed basis for in-scope entities to begin to assess their potential reporting obligations, including assessing which aspects are material under the new, broad “double materiality” standard of the CSRD, looking both at the impact of the company (inside-out) as well as the financial impact on the company (outside-in). Such analysis will allow companies to undertake the requisite due diligence on material topics and integrate changes to their reporting process. Effective implementation will require substantial resources and a thorough analysis of the ESRSs and the CSRD reporting obligations resulting thereof.

In this alert, we provide context and an overview of the 12 standards in the first set of ESRSs, along with a review of key changes as compared to earlier ESRSs drafts.

Background

The CSRD came into force on January 5, 2023, and the Commission mandates that each EU member state implement the CSRD into national law by July 6, 2024. The CSRD extends the scope of non-financial reporting under the NFRD to include sustainability reporting and requires such disclosures from an expanded range of entities, including large companies, listed small and medium-sized companies (“SMEs”) and even non-EU parent companies of such in-scope companies, and certain branches. The NFRD’s requirements remain in force until companies have to comply with the national laws implementing the CSRD. More detailed discussions of the CSRD, including its impact for non-EU entities with a significant presence in the EU, can be found in our client alert available here.

The CSRD, as a directive, requires the Commission to develop standards for what a reporting entity must disclose about its material impacts, risks and opportunities in relation to certain environmental, social and governance (“ESG”) matters. In accordance with the CSRD, the ESRSs are based on draft standards developed by EFRAG (previously known as the European Financial Reporting Advisory Group), a non-profit organization dedicated to the advancement and advocacy of European perspectives in financial and sustainability reporting.

EFRAG submitted its first draft ESRSs to the Commission on November 22, 2022 (the “Draft ESRSs”).[5] The Draft ESRSs were developed based on input that EFRAG had received from public consultation on exposure drafts of the ESRSs developed from April to August 2022.[6] Following EFRAG’s submission of the Draft ESRSs, the Commission carried out further consultations leading to the publication for consultation of the first set of Draft ESRSs for a four-week public feedback period from June 9 to July 7, 2023.

The consultation process confirmed that the Draft ESRSs broadly met the CSRD’s mandate. However, various stakeholders drew attention to potential issues with the Draft ESRSs, including the challenging nature of disclosure requirements against a backdrop of limited primary source data and the lack of coherence between disclosures under the ESRSs and the disclosure obligations under other European regulations including the Sustainable Finance Disclosure Regulation or ‘SFDR,’ the Benchmarks Regulation and the Capital Requirements Regulation (cumulatively, the “Financial Regulations”).[7]

The Commission made a number of modifications to the Draft ESRSs in response to this feedback. The Commission published and adopted their final version of the ESRSs on July 31, 2023.

Overview of First Set of ESRSs

The first 12 standards in the ESRSs include two “cross-cutting” standards that apply across all ESG topics and 10 topical standards divided across ESG matters. Compared to the Draft ESRSs, the final set of ESRSs reflect a reduction in both the number of disclosure requirements (from 136 to 84) and the number of qualitative and quantitative data points (from 2,161 to 1,144).

“Cross-Cutting” Standards

ESRS 1 General Requirements

ESRS 2 General Disclosure

Environmental Standards

ESRS E1 Climate Change

ESRS E2 Pollution

ESRS E3 Water and Marine Resources

ESRS E4 Biodiversity and Ecosystems

ESRS E5 Resource Use and Circular Economy

Social Standards

ESRS S1 Own Workforce

ESRS S2 Workers in the Value Chain

ESRS S3 Affected Communities

ESRS S4 Consumers and End-Users

Governance Standards

ESRS G1 Business conduct

The ESRSs include descriptions of the disclosure requirements under each standard. For example, for the disclosure requirement related to ESRS 2’s integration of sustainability-related performance in incentive schemes, the ESRSs state that reporting entities shall disclose whether and how climate-related considerations are factored into the renumeration of members of the administrative, management and supervisory bodies, including any assessment against GHG emissions reductions targets.

Another example includes the disclosure requirements under ESRS E1’s transition plan for climate change mitigation. The ESRSs instruct reporting entities to disclose their transition plans, including explanations of how it’s targets are compatible with the limiting of global warming to 1.5°C in line with the Paris Agreement and explanations of the decarbonization levers identified, and key actions planned, including changes in the reporting entity’s product and service portfolio and the adoption of new technologies in its own operations, or the upstream and/or downstream value chain.

Key Changes from the Draft ESRSs

The Commission received 604 comments and pieces of feedback on the Draft ESRSs. The top five categories of respondents were companies (26.66%), business associations (24.17%), non-governmental organizations (“NGOs”) (14.07%), EU citizens (13.25%) and others (10.60%) and the top five countries where respondents provided feedback were Germany (18%), Belgium (17%), Netherlands (13%), France (10%) and the United Kingdom (5%).[8]

The Commission responded to stakeholder feedback with the following modifications in the ESRSs:[9]

Most Disclosures Limited by Materiality (But Double Materiality Standard Retained)

The Draft ESRSs would have required companies to report on the following standards regardless of whether they were material to their business: the “Climate Change” standard (ESRS E1), certain data points under the “Own Workforce” standard (ESRS S1) for companies with more than 250 employees, and certain data points that correspond to information required by the Financial Regulations.

The ESRSs will now only mandate that all reporting companies to address the “General Disclosure” standard (ESRS 2). Otherwise, all other standards, disclosure requirements and data points must only be disclosed if they are assessed to be material[10] to the company.

The Commission expects these changes will lessen the burden of implementing and complying with the ESRSs by requiring companies to focus on those ESG impacts, risks and opportunities that are material.[11] However, companies should not underestimate the potential reporting burden and compliance costs presented by this approach. The ESRSs’ “double materiality” standard for assessing materiality (taken from the CSRD) represents for many reporting entities, a significant departure from the investment-decision-based or financial materiality tests under U.S. securities law and other reporting standards.

Double materiality assesses matters from two perspectives: (1) an ‘inside-out’ impact perspective, meaning a company’s actual or potential impact on people or the environment; and (2) an ‘outside-in’ financial perspective, meaning how social and environmental issues create financial risks and opportunities for the company. Matters that are material under one or both of these standards must be disclosed. Notably, companies will not be making these determinations in a vacuum, as materiality assessments are subject to external, third-party assurance in accordance with the CSRD.[12] When certain matters are determined to be immaterial, the company must also affirmatively state that determination and its analysis in its reports.

For example, a reporting entity is required to provide a thorough explanation if it concludes that the “Climate Change” standard (ESRS E1) is not a material topic for its business. In a similar vein, if a reporting entity concludes that a certain data point corresponding to information required by the Financial Regulations is not material, it must explicitly state that the data point is “not material.” The ESRSs also indicate that reporting entities should include a table in their disclosures with all such data points, with either the location of the data point in the report or stating it is “not material,” as applicable.

The Commission asked EFRAG to prepare additional guidance on the ESRSs for reporting entities, including on the materiality assessment.[13] During its August 23, 2023 public session, EFRAG will provide an update on the first draft “EFRAG Implementation Guidance and FAQ” regarding the materiality assessment and value chain. In addition, EFRAG will consider responses from the Commission’s four-week public feedback period on the Draft ESRSs to identify priority areas for further guidance. EFRAG will also soon have a place on its website for stakeholders to submit ESRSs application questions.[14]

Additional Phase-In Requirements

The Commission included further phase-ins, in addition to those provided in the Draft ESRSs, to support applicable reporting entities in transitioning from existing methodologies or frameworks to the ESRSs. Under these phase-ins:

Reporting entities with fewer than 750 employees may omit:
- for its first year of applying the ESRSs – Scope 3 GHG emissions data (included in ESRS E1) and the disclosure requirements specified in the “Own Workforce” standard (ESRS S1), and
- for its first two years of applying the ESRSs – the requirements in the standards on Biodiversity and Ecosystems (ESRS E4), Workers in the Value Chain (ESRS S2), Affected Communities (ESRS S3) and Consumers and End-Users (ESRS S4).
All reporting entities (regardless of the number of employees) may omit, for the first year of applying the ESRSs:
- financial effects related to non-climate environmental issues, such as Pollution (ESRS E2), Water (ESRS E2), Biodiversity (ESRS E4) and Resource Use (ESRS E5), and
- certain data points related to their own workforce (ESRS S1) (social protection, persons with disabilities, work-related ill-health, and work-life balance).

Desired Interoperability with Global Standard Setting Initiatives

Comments to the Draft ESRSs raised concerns that the standards would not be consistent with the EU’s sustainability ambitions and other pieces of sustainability legislation, and did not ensure the interoperability of global standards such that companies could use the same sustainability-related information for multiple legislations or standards. The Commission noted that it worked to ensure a “very high degree of interoperability” among the ESRSs, the global reporting framework under development by the International Sustainability Standards Board (the “ISSB”) and the Global Reporting Initiative (“GRI”). The ESRSs were also created in parallel with the first two standards under the ISSB, IFRS S1 and IFRS S2, which were published on June 26, 2023. The Commission, EFRAG and the ISSB discussed the standards at length in an effort to provide a high degree of alignment where the standards overlap. For example, companies that are required to disclose under the requirements of the “Climate Change” standard (ESRS E1) of the ESRSs are expected, to a large degree, to be able to report the same information under the ISSB climate-related disclosures (IFRS S1).

While the ESRSs and the ISSB standards are built on existing reporting frameworks, including the Task Force on Climate-Related Financial Disclosures (“TCFD”)[15], it is important to note that the ESRSs and the ISSB requirements are not interchangeable, so if and when the ISSB Sustainability Standards come to be adopted by national regulators, reporting entities will need to review each set of standards to confirm that all requirements are being applied and met.

The ESRSs’ anticipated adoption of the CSRD’s double materiality standard[16] is a principal area of divergence from the ISSB’s financial materiality standard. While the ESRSs use the broad double materiality standard discussed above, the ISSB standard is modeled on the financial materiality standard used by the IFRS international accounting standards: that information is material if its omission, obfuscation or misstatement could be reasonably expected to impact investor decisions. This reflects in part the purpose of each standard. ISSB intends to address the needs of financial stakeholders (e.g., investors and lenders) for a global ESG reporting framework while the CSRD and ESRSs intend to address the needs of a broader range of stakeholders, including investors, NGOs, trade unions, civil society organizations, consumers, community and value chain and indeed when undertaking their materiality assessment for CSRD purposes, reporting entities are required to consult with their broader base of stakeholders.

EFRAG has created a TCFD recommendations and Draft ESRSs reconciliation table and they are working on a mapping table that includes requirements for each of the ESRSs and the ISSB standards. The TCFD/ESRSs reconciliation table and the draft version of the ESRSs/ISSB table are available on their website.

Expanded Voluntary Disclosures and Further Reporting Options

Although the Draft ESRSs included several voluntary data points, the Commission included even more in the ESRSs by converting a limited number of reporting requirements from mandatory to voluntary. These modifications included, for example, biodiversity transition plans, specific indicators related to “non-employees” in the reporting entity’s own workforce and an explanation as to why a particular sustainability topic is not material.

The Commission also introduced certain flexibilities for disclosure against some mandatory data points instead of converting them to voluntary data points. For example, there are additional flexibilities in the disclosure requirements on the financial effects stemming from sustainability risks and engagement with stakeholders, as well as in the methodology used for the materiality assessment process.[17] Furthermore, the Commission modified the data points concerning corruption and bribery, as well as the protection of whistle-blowers, which the Commission was concerned could be perceived as impairing the right to refrain from self-incrimination.[18]

Final Approval Pending

In the second half of August 2023, the ESRSs will be formally transmitted to the European Parliament and to the Council of the EU for a two month scrutiny period (extendable by up to two months). The European Parliament and the Council of the EU may approve (in its entirety) or reject the ESRSs, but neither can amend it. If approved by the European Parliament and the Council of the EU, the ESRSs may apply for some companies as early as January 1, 2024 (for reporting in 2025).

Reporting obligations for in scope companies begin as early as the 2024 reporting period. Companies or reporting entities that fall within the scope of the CSRD need to review these standards to begin assessing potential reporting obligations and compliance costs.

What’s Next

In the ESRSs, the Commission responded to feedback and reduced the weight of the reporting burden by allowing reporting entities to focus more on meaningful materiality assessments and the quality of disclosures. However, the ESRSs have received a mix reception from the market. Various stakeholder groups, including some groups of investors[19], have bemoaned the dilution introduced by the Commission in the ESRSs. Despite these complaints, it is expected that stakeholders will benefit in the mid-longer term if material reliable disclosures are made by reporting entities.

In addition to developing guidance to support companies disclosing against the standards, EFRAG has been tasked with developing sector-specific standards. First drafts of standards for eight sectors are already up and running. The CSRD requires the Commission to adopt additional sets of ESRSs by June 2024, including at least eight sector-specific standards, proportionate standards for listed SMEs and standards for non-EU companies. EFRAG is currently developing draft sector-specific standards from the following sectors: (1) Oil and Gas, (2) Coal, Quarries and Mining, (3) Road Transport, (4) Agriculture Farming and Fisheries, (5) Motor Vehicles, (6) Energy Production and Utilities, (7) Good and Beverages and (8) Textiles, Accessories, Footwear and Jewelry. Any decisions taken to start new sector work will be published on EFRAG’s website.[20] The final work stream in relation to the development of standards will be the formation of specific standards for reporting at the level of non-EU company parent companies, which will commence for financial year 2028 (for reporting in 2029).

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[1] The CSRD requires the Commission to adopt a second set of sustainability reporting standards by June 30, 2024, specifying sector-specific standards, standards for small and medium sized enterprises and to take account of the development of international standards.

[2] Commission Delegated Regulation supplementing Directive 2013/34/EU as regards sustainability reporting standards (available here), including Annex 1 (available here) and Annex 2 (available here).

[3] Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, available here.

[4] Accounting Directive by Directive 2014/95/EU of the European Parliament and of the Council of 22 October 2014 amending Directive 2013/34/EU as regards disclosure of non-financial and diversity information by certain large undertakings and groups, available here.

[5] Draft Commission Delegated Regulation supplementing Directive 2013/34/EU as regards sustainability reporting standards (available here), including Draft Annex 1 and Draft Annex 2.

[6] Exposure drafts of the ESRSs are published on EFRAG’s website, available here.

[7] All comments and feedback on the Draft ESRSs are published on the European Commission website, available here.

[8] The European Commission, Total of valid feedback instances received: 604, available at https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13765-European-sustainability-reporting-standards-first-set/feedback_en?p_id=32180832.

[9] Additional information can be found in our client alert “European Union’s Corporate Sustainability Reporting Directive — What Non-EU Companies with Operations in the EU Need to Know,” accessible at the following link.

[10] EFRAG is developing additional guidance on the materiality assessment, the process to determine material matters and material information. Additional information is below.

[11] Commission Delegated Regulation (EU) of 31.7.2023 supplementing Directive 2013/34/EU of the European Parliament and of the Council as regards sustainability reporting standards, Article 2, available at http://ec.europa.eu/finance/docs/level-2-measures/csrd-delegated-act-2023-5303_en.pdf.

[12] Under the CSRD, the Commission must adopt legislation requiring independent assurance of sustainability reports and metrics by a third-party auditor. This has the goal of raising the quality of sustainability reporting to the same level as financial reporting. See Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, starting at point sixty (60) of Article 1, available here.

[13] Commission Delegated Regulation (EU) of 31.7.2023 supplementing Directive 2013/34/EU of the European Parliament and of the Council as regards sustainability reporting standards, Article 2, available at http://ec.europa.eu/finance/docs/level-2-measures/csrd-delegated-act-2023-5303_en.pdf.

[14] EFRAG, Press Release, EFRAG Welcomes the Adoption of the Delegated Act on the First Set of European Sustainability Reporting Standards (ESRS) by the European Commission(July 31, 2023), available at efrag.org/News/Public-439/EFRAG-welcomes-the-adoption-of-the-Delegated-Act-on-the-first-set-of-E.

Sustainability Reporting Standards, EFRAG Sector Specific ESRS, available at https://www.efrag.org/lab5.

[15] In addition to the TCFD, the ESRSs and ISSB standards are built on existing frameworks from the Sustainability Accounting Standards Board (SASB) and Climate Disclosure Standards Board (CDSB).

[16] Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, at point twenty-nine (29) of Article 1, available here.

[17] An example of the additional flexibilities is included in General Disclosure (ESRS 2): disclosure of “the undertaking’s understanding of the interests and views of its key stakeholders” –”key” added.

[18] Commission Delegated Regulation (EU) of 31.7.2023 supplementing Directive 2013/34/EU of the European Parliament and of the Council as regards sustainability reporting standards, Article 2, available at http://ec.europa.eu/finance/docs/level-2-measures/csrd-delegated-act-2023-5303_en.pdf.

[19] See, Better Finance (The European Federation of Investors and Financial Services Users), Diluted European Sustainability Reporting Standards Raise Greenwashing Concerns (August 7, 2023), available here; World Wildlife Fund for Nature (WWF), EU Commission undermines standards for sustainability reporting (July 31, 2023), available here; Reuters, EU confirms watering down of corporate sustainability disclosures (August 1, 2023), available here.

[20] EFRAG Sustainability Reporting Standards, EFRAG Sector Specific ESRS, available at https://www.efrag.org/lab5.

The following Gibson Dunn lawyers prepared this client update: Elizabeth Ising, Cynthia Mabry, Sarah Phillips, Selina S. Sagayam, Ferdinand M. Fromholzer, David Woodcock, Robert Spano, Judith Raoul-Bardy, and Lauren M. Assaf-Holmes.

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, the authors, or any of the leaders and members of the firm’s Environmental, Social and Governance (ESG) or Securities Regulation and Corporate Governance practice groups:

Environmental, Social and Governance (ESG) Group:
Susy Bullock – London (+44 20 7071 4283, [email protected])
Ferdinand Fromholzer – Munich (+49 89 189 33 170, [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])
Cynthia M. Mabry – Houston (+1 346-718-6614, [email protected])
Michael K. Murphy – Washington, D.C. (+1 202-955-8238, [email protected])
Patricia Tan Openshaw – Hong Kong (+852 2214-3868, [email protected])
Judith Raoul-Bardy – Paris (+33 (0) 1 56 43 13 00, [email protected])
Selina S. Sagayam – London (+44 20 7071 4263, [email protected])
Robert Spano – London/Paris (+44 20 7071 4902, [email protected])
David Woodcock – Dallas (+1 214-698-3211, [email protected])

Securities Regulation and Corporate Governance Group:
Aaron Briggs – San Francisco (+1 415-393-8297, [email protected])
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, [email protected])
Brian J. Lane – Washington, D.C. (+1 202-887-3646, [email protected])
Julia Lapitskaya – New York (+1 212-351-2354, [email protected])
James J. Moloney – Orange County (+1 949-451-4343, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
Michael J. Scanlon – Washington, D.C. (+1 202-887-3668, [email protected])
Michael Titera – Orange County (+1 949-451-4365, [email protected])
Lori Zyskowski – New York (+1 212-351-2309, [email protected])

Decided August 21, 2023

Raines v. U.S. Healthworks Medical Group, S273630

This week, the California Supreme Court held that a business entity acting as an agent of an employer may be held directly liable as an “employer” for alleged violations of California’s Fair Employment and Housing Act.

Background: Plaintiffs Kristina Raines and Darrick Figg were job applicants who received offers of employment contingent upon passing a medical screening. The screening included a detailed health history questionnaire that the applicants were required to complete.

These pre-employment screenings were not conducted by the plaintiffs’ prospective employers, but instead by third-party occupational health services providers. Plaintiffs sued these providers on behalf of a putative class, alleging that the questions were intrusive and overbroad in violation of California’s Fair Employment and Housing Act, or the FEHA. Plaintiffs sued in state court, and the providers removed the case to federal court.

The FEHA generally precludes “any employer or employment agency” from “requir[ing] a medical or physical examination” of a job applicant. Cal. Gov’t Code § 12940(e)(1). It does, however, allow employers to require such examinations of a “job applicant after an employment offer has been made,” so long as the examination is “job related and consistent with business necessity.” Id. § 12940(e)(3). The statute elsewhere defines “employer” as “any person regularly employing five or more persons, or any person acting as an agent of an employer, directly or indirectly.” Id. § 12926(d).

The providers argued that even if they were “agents” of the plaintiffs’ prospective employers, agents could not be held directly liable for FEHA violations separately from their employer-principals. The district court agreed. On appeal, the Ninth Circuit observed the significance of the issue on employment litigation throughout the state, and that the California Supreme Court had previously reserved judgment on the issue in Reno v. Baird, 18 Cal. 4th 640 (1998). The Ninth Circuit accordingly certified the question of an agent’s direct liability under the FEHA to the California Supreme Court.

Issue: California’s Fair Employment and Housing Act defines “employer” as “any person regularly employing five or more persons, or any person acting as an agent of an employer.” Can a business acting as an agent of an employer be held directly liable for employment discrimination?

Court’s Holding:

Yes. Businesses with at least five employees that carry out FEHA-regulated activities as an agent of an employer may be held directly liable for employment discrimination under the FEHA.

“[W]e conclude that legislative history, analogous federal court decisions, and legislative policy considerations all support the natural reading of [the FEHA] advanced here, which permits business-entity agents to be held directly liable for FEHA violations in appropriate circumstances.”

Justice Jenkins, writing for the Court

What It Means:

By interpreting the FEHA’s definition of “employer” to include an employer’s agents in a manner beyond simply incorporating the ordinary principles of respondeat superior, the opinion opens up businesses acting as agents to potential FEHA litigation that was otherwise not clearly available to employees under the statute.
Still, the California Supreme Court clarified that its decision was limited to answering the specific question posed by the Ninth Circuit: “whether a business-entity agent may ever be held directly liable under the FEHA.” The court therefore declined to “identify the specific scenarios” in which a business-entity agent could face direct liability under the statute. And it stated that it was not ruling on the “significance, if any,” of the degree of employer control over the agent’s acts on the ultimate question of liability.
The court observed that a large business acting as an agent, like the screening providers, may have the bargaining power either “to avoid contractual obligations that will force it to violate the FEHA” or to secure agreements from employers to indemnify it for any FEHA liability. But the court left open the question whether businesses acting as agents and having fewer than five employees could be held directly liable for FEHA violations.

The Court’s opinion is available here.

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

Appellate and Constitutional Law Practice

Thomas H. Dupree Jr. +1 202.955.8547 [email protected]	Allyson N. Ho +1 214.698.3233 [email protected]	Julian W. Poon +1 213.229.7758 [email protected]
Blaine H. Evanson +1 949.451.3805 [email protected]	Bradley J. Hamburger +1 213.229.7658 [email protected]	Michael J. Holecek +1 213.229.7018 [email protected]

Related Practice: Labor and Employment

Jason C. Schwartz
+1 202.955.8242
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Katherine V.A. Smith
+1 213.229.7107
[email protected]

Related Practice: Litigation

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

Theane Evangelis
+1 213.229.7726
[email protected]

We are pleased to provide you with the latest 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

Ripple Secures Landmark Win Against SEC, SEC Seeks To Appeal

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, delivering a landmark legal victory for the cryptocurrency industry. The ruling provided a win for a cryptocurrency company in a case brought by the SEC, while also giving the SEC a partial victory. The judge determined that Ripple’s XRP sales on public exchanges were not offers of securities, but sales to sophisticated investors amounted to unregistered sales of securities. The case has significant implications for the broader crypto industry and has triggered calls for Congress to provide clear rules and legislation for digital assets. Following the ruling, both Coinbase and Kraken, large U.S. crypto exchanges, announced they will allow trading of XRP on their platforms again. On August 9, the SEC stated in a letter to the court that it plans to seek an interlocutory appeal, which is a generally disfavored procedural step that would require Judge Torres’s approval. On August 17, Judge Torres permitted the SEC to file a motion to file an interlocutory appeal by the following day. Ripple will have until September 1 to file its response to the motion, and the SEC will have until September 8 to file a reply. Only if Judge Torres grants the motion will the SEC then be allowed to seek permission for an interlocutory appeal also from the Second Circuit. The Block; Blockworks; Client Alert; CoinDesk; Reuters; Order

Landmark Ripple Determination Endorsed, But Split Arises In Rejection Of Do Kwon And Terraform Labs’ Motion To Dismiss

On July 31, U.S. District Court Judge Jed Rakoff denied Terraform Labs and founder Do Kwon’s motion to dismiss the SEC’s lawsuit against them alleging fraud involving various cryptocurrencies. Terraform and Do Kwon argued that the above Ripple decision invalidated the SEC’s case against them. Significantly, Judge Rakoff agreed with Judge Torres’ Ripple ruling that the SEC could not establish as a matter of law that a crypto token was a security in and of itself. However, Judge Rakoff rejected the Ripple opinion’s distinction between institutional versus retail purchasers for whether a token was offered as a security. The case is currently headed for trial. Bloomberg; The Block; Client Alert; Financial Times; Reuters; Order

Bankman-Fried Jailed Pending Trial, Campaign Contribution Charge Still Possible

FTX founder Sam Bankman-Fried was ordered to jail when Judge Lewis A. Kaplan of the Manhattan Federal District Court revoked his bail, concluding that Bankman-Fried’s communications with the media and an attempt to contact a former FTX employee constituted attempts “to tamper with witnesses at least twice” in the lead-up to his trial, which is scheduled to start on October 2. The presiding judge had imposed a temporary gag order in the case while considering prosecutors’ request to jail Bankman-Fried. Bankman-Fried had been under house arrest at his parents’ home since December, released on a $250 million bond. The U.S. government sought modifications to Bankman-Fried’s bail agreement after he showed a reporter private writings of Caroline Ellison, the former head of the crypto hedge fund he founded and his former girlfriend, who is a key witness for the prosecution. Bankman-Fried also had phone calls with journalists and was in contact with an author who is writing a book about his rise and fall that is set for publication the week before the trial begins.Meanwhile, U.S. prosecutors announced they intend to file a superseding indictment that will incorporate Bankman-Fried’s alleged campaign finance charge into existing charges, reversing a reported late-July decision to drop the campaign contribution charge from their fraud case against Bankman-Fried, after he argued it was not part of his extradition agreement. Bankman-Fried also faces fraud and conspiracy charges that could lead to decades in prison if convicted. ABC News; Bloomberg; CoinDesk; CoinTelegraph; DOJ; NPR; NYTimes

Judge Appears To Side With Coinbase Against SEC In Pre-Motion Conference; Coinbase Files Motion For Judgment On Pleadings; Scholars File Amicus Brief In Support of Coinbase

On July 13, 2023, Judge Katherine Polk Faila of the U.S. District Court for the Southern District of New York held a pre-motion conference in the SEC’s suit filed in June against Coinbase. The SEC alleges that Coinbase violated securities laws by listing on its platform digital assets that the SEC considers securities. At the conference, Judge Faila expressed “skepticism” with the SEC’s position, that the Court “would have thought the [SEC] was doing diligence” when it approved Coinbase’s Form S-1 to commence trading, and that the SEC failed to warn Coinbase that “maybe some day there could be a problem” and sued two years later. The Court also voiced concerns over the breadth of the SEC’s definition of securities, its ability to communicate this definition to the public, and the vagueness of the Howey test, the SEC’s criteria for whether a digital asset qualifies as a security.

On August 4, Coinbase filed its motion for judgment on the pleadings, maintaining that the SEC’s claims fall outside the agency’s Congressionally delegated authority because the platform does not trade securities. The motion contends that the SEC’s claims must be dismissed because (i) the SEC fails to allege a contractual undertaking beyond the point of sale, (ii) the alleged transactions lack expectation in income, profits, or assets of a business, (iii) the major questions doctrine prohibits the SEC’s interpretation of “investment contract,” (iv) the SEC fails to allege Coinbase acts as a “broker” by making Wallet software available, and (v) Coinbase’s alleged staking services do not involve relinquishment of property creating risk of loss or profits generated by managerial efforts. The case is closely watched for its potential impact on cryptocurrency trading and exchange listings.

On August 11, a group of six securities law scholars filed an amicus brief in support of Coinbase. The law professors argue that the tokens traded on Coinbase are not “investment contracts” under the settled meaning of the term in that they lack a contractual undertaking and an expectation in income, profits, or assets of a business, and, therefore, are not securities.

U.S. Senator Cynthia Lummis (R-WY) and the Blockchain Association, a pro-crypto lobbying group, also filed amicus briefs in support of Coinbase’s motion, arguing in part that Congress has not granted the SEC authority to regulate crypto assets. Axios; Bitcoinist; Decrypt; Hearing Transcript; Motion; The Verge; Professors’ Amicus Brief; CoinTelegraph; Sen. Lummis Amicus Brief; Blockchain Association Amicus Brief

SEC Sues Crypto Founder Richard Heart Alleging Fraud

On July 31, the SEC sued Richard Heart, also known as Richard Schueler, and three entities under his control (Hex, PulseChain, and PulseX) for conducting unregistered offerings of crypto asset securities that raised over $1 billion from investors. The SEC also accused Heart and PulseChain of fraud by misappropriating at least $12 million of proceeds from the offerings to buy luxury items, including sports cars and a 555-carat black diamond. Heart allegedly promoted Hex as a high-yield “blockchain certificate of deposit,” and claimed returns as high as 38% for a “staking” feature for Hex tokens, misleading investors with promises of wealth. The SEC’s complaint seeks injunctive relief, disgorgement of ill-gotten gains, penalties, and other equitable relief. SEC Press Release; CoinDesk; Bloomberg; The Block

DOJ Consolidates Crypto Enforcement Team

The U.S. Department of Justice (DOJ) announced the merging of the Computer Crime and Intellectual Property Section (CCIPS) with the National Cryptocurrency Enforcement Team (NCET) to strengthen efforts to combat cybercrime. The merger will double the Criminal Division attorneys available for digital currency-related cases, elevate the status of cryptocurrency work within the DOJ, enhance tracing and seizure of cryptocurrency assets, and multiply the entire DOJ’s capacity to charge digital assets cases. The announcement emphasizes that “every modern prosecutor needs to be able to trace and seize cryptocurrency.” The DOJ aims to tackle cyber threats, such as ransomware, by leveraging the expertise of the newly combined CCIPS and NCET teams and promoting collaboration with the DOJ’s National Security Division. DOJ Announcement; Coin Geek

Bitfinex Hacker “Crypto Couple” Pleads Guilty To Money Laundering

A New York couple, Ilya Lichtenstein and Heather Morgan, pleaded guilty to money laundering conspiracy after hacking into cryptocurrency exchange Bitfinex and stealing assets now worth over $4.5 billion. According to the DOJ, Lichtenstein used advanced hacking techniques to fraudulently authorize over 2,000 transactions transferring bitcoin to his crypto wallet. At the time of their arrest, the DOJ had seized around 120,000 bitcoin (then worth approximately $3.6 billion) that the couple allegedly had conspired to steal, and subsequently recovered an additional $475 million related to the hack. Reuters; Law360

Celsius Founder Alex Mashinsky Arrested, Faces Suits By Four Agencies

On July 13, Alex Mashinsky, founder and former CEO of bankrupt crypto-lender Celsius Network, LLC, was arrested and charged with seven counts of fraud by the DOJ under an indictment that also names Celsius’s Chief Revenue Officer, Roni Cohen-Pavon. The CFTC, FTC, and SEC simultaneously filed civil suits alleging similar claims against Mashinsky. The FTC’s complaint also names Celsius officers Shlomi Daniel Leon and Hanoch “Nuke” Goldstein. Mashinsky is accused of having schemed to defraud customers about the security of the Celsius platform, and made false or misleading statements about profits and Mashinsky’s purchases and sales of Celsius’s token to inflate the token’s value and to attract customer deposits of digital assets to the platform. Mashinsky is further accused of misappropriating deposits, unregistered offers and sales of securities, using false statements to obtain customer information of a financial institution, consumer harm, acting as an unregistered commodity pool operator (CPO) and associated person (AP) of a CPO, and failing to make commodity pool disclosures. Mashinsky faces up to 115 years in prison if found guilty on all criminal counts. Mashinsky pleaded not guilty and was released from custody on a $40 million bond. CoinDesk; CFTC; CFTC Complaint; Decrypt; DOJ Indictment; FTC Complaint; SEC Complaint; Wired

New York U.S. Attorney Announces Indictment For Decentralized Exchange Smart Contract Exploit

On July 11, the U.S. Attorney for the Southern District of New York announced the unsealing of an indictment and arrest of New Yorker Shakeeb Ahmed, a senior security engineer for an international tech company, for using his expertise to reverse engineer smart contracts and blockchain audits to exploit a vulnerability in a crypto exchange’s smart contract and inject fake pricing data, causing it to generate fraudulent fees worth approximately $9 million. After withdrawing the fees as cryptocurrency, Ahmed communicated with the crypto exchange, offering to return most of the stolen funds on the condition that he avoid referral to law enforcement. Ahmed then laundered the proceeds of the exploit through various transactions, including swapping tokens, bridging blockchains, exchanging into Monero for anonymity, and using overseas cryptocurrency exchanges. Ahmed subsequently conducted online searches related to the exploit, his criminal liability, fleeing the U.S., and avoiding extradition. Ahmed, aged 34, pleaded not guilty to charges of wire fraud and money laundering, each carrying a maximum sentence of 20 years in prison. Ahmed was released on bond and reportedly will be permitted to live at his Manhattan apartment pending trial. DOJ; CoinTelegraph; Decrypt; Forbes; Blocking.net; Yahoo Finance; International Business Times; TechNext; CyberNews; Blockworks; Gizmodo

Bittrex Inc. And Founder Settle Unregistered Exchange Charges With SEC

Crypto trading platform Bittrex Inc. and its co-founder William Shihara have agreed to settle SEC charges of operating an unregistered national securities exchange, brokerage, and clearing agency. Bittrex Inc.’s foreign affiliate, Bittrex Global GmbH, also agreed to settle charges that it failed to register as a national securities exchange. The SEC’s complaint, filed in April 2023, also alleged that Bittrex provided services to U.S. investors with crypto assets that were considered securities and that Shihara, the company’s former CEO, directed issuers to remove from public channels certain statements that would alert regulators to investigate whether the crypto asset was offered and sold as a security. As part of the settlement, Bittrex and Shihara neither admit nor deny the allegations and will pay $24 million in disgorgement, prejudgment interest, and civil penalties, pending court approval. SEC Press Release; CoinTelegraph

U.S. Treasury Defeats Tornado Cash Suit, District Court Upholds OFAC Sanctions

On August 17, a federal judge in Texas sided with the U.S. Department of the Treasury against a group of plaintiff developers and investors who sued in September last year, seeking to invalidate the Office of Foreign Assets Control’s (OFAC’s) addition of Tornado Cash to the Specially Designated National and Blocked Persons (SDN) List. The U.S. District Court for the Western District of Texas, Judge Robert Pitman, found that Tornado Cash qualified as an association, composed of its founders, its developers, and its DAO, with the common purpose of developing, promoting, and governing Tornado Cash, and thus could be designated under OFAC regulations, despite arguments that Tornado Cash was autonomous software. The court then held that it would defer to OFAC’s determination that smart contracts constitute property. Specifically, the court found whereas contracts are property under the regulations, smart contracts are a “code-enabled species of unilateral contracts,” “like a vending machine.” Judge Pitman further found that Tornado Cash had a beneficial interest in the smart contracts, stemming from an expectation that they would generate revenue in the form of tokens. The court additionally rejected plaintiffs’ First Amendment arguments, holding (among other things) that the Amendment does not protect a right to make political donations through any bank or service of their choosing. Lastly, the court held the plaintiffs’ Fifth Amendment Takings Claim was waived as the plaintiffs failed to pursue it against the government’s motion. The plaintiffs may appeal. CoinDesk; Order; CoinTelegraph

International

Worldcoin Token And Protocol Launch; French Investigators Reinforce Worldcoin Investigation; Kenya Temporarily Bans Worldcoin Operations, Police Raid Warehouse

Following a July 24 launch of Worldcoin’s token (WLD) and blockchain protocol, French and Argentine data protection regulators CNIL and AAIP, respectively, announced investigations of Worldcoin due to concerns over data collection and retention practices. Worldcoin requires that users provide an iris scan in exchange for a digital World ID and in certain countries pays a user 25 tokens for a scan. Operators of Worldcoin’s iris-scanning Orbs receive tokens as incentives as well. WLD tokens currently trade for around $2. Worldcoin reportedly has collected over 2.2 million individuals’ iris scans to date. CNIL’s investigations support the ongoing and previously reported work on the project of Bavarian privacy regulators, who bear primary responsibility under EU law. The project has reiterated its compliance with EU’s law on biometric data under the General Data Protection Regulation (GDPR). Worldcoin also faces concerns from the UK’s Information Commissioner’s Office regarding the sufficiency and ability to withdraw consent consistent with data processing rights.

On August 2, the Kenyan minister of internal security announced a temporary ban on Worldcoin from operating in the country until authorities had the opportunity to assess any risk to residents. On August 7, Kenyan police reportedly raided a Worldcoin warehouse in Nairobi and seized machines believed to store Worldcoin data. The Kenyan Data Commissioner alleged that Worldcoin’s parent company, Tools for Humanity, had misrepresented its intentions when registering and the Kenyan Interior Cabinet Secretary stated that Worldcoin was not a registered legal entity. Worldcoin stated it plans to cooperate with the government before resuming operations. Bloomberg; CoinDesk; CoinTelegraph; KahawaTungu; Reuters; Semafor

Crypto Bridge MultiChain CEO And Sister Arrested In China, Operations Shuttered Following $130M Hack

MultiChain, a cryptocurrency project facilitating cross-blockchain connectivity, announced its closure following news that its founder and CEO, known as Zhaojun, was apprehended by Chinese authorities on May 21. In a Twitter statement, MultiChain explained that Zhaojun’s unexplained absence since late May prompted the decision. As a crypto bridge, MultiChain enabled users to exchange digital tokens across different blockchains they operated on. CoinDesk; Decrypt; Economic Times; DLNews

Regulation and Legislation

United States

Coinbase Wins Approval To Sell Crypto Futures In U.S.

On August 16, Coinbase announced that it had gained approval to sell cryptocurrency derivatives directly to retail consumers in the U.S. The approval comes from the National Futures Association (NFA), a CFTC-designated self-regulatory organization, and permits Coinbase to operate as a Futures Commission Merchant (FCM) as well as eligible U.S. customers to access derivatives products alongside Coinbase’s spot market. According to the announcement, the global crypto derivatives market comprises approximately 75% of worldwide crypto trading volume. Coinbase previously acquired FairX in 2022, now known as the Coinbase Derivatives Exchange, which is open to third-party brokers, FCMs, and market makers, and which offers retail-investor-sized nano BTC and ETH futures as well as BTC and ETH futures trading for institutional investors. Coinbase also launched a derivatives exchange in Bermuda in May. Bloomberg; Coinbase; CoinTelegraph; Forbes

Federal Reserve Establishes Program To Enhance Supervision Of Banks’ Crypto Activity

On August 8, the Federal Reserve introduced the Novel Activities Supervision Program (Program). The Program will primarily focus on four types of activities: (1) complex, technology-driven partnerships with non-bank entities to offer banking services to end customers, including through application programming interfaces (APIs) with automated bank infrastructure access; (2) crypto-asset-related activities, including custodial services, crypto-collateralized lending, facilitation of crypto trading, and issuance or distribution stablecoins/dollar tokens; (3) projects utilizing distributed ledger technology (DLT) with “potential for significant impact on the financial system,” which the supervision and regulation letter to Federal Reserve officers recognizes as including dollar token issuance, as well as tokenization of securities and other assets; and (4) banking organizations concentrating in offering traditional banking services like deposits, payments, and lending to crypto-asset-related entities and fintechs. The Program is designed to work in partnership with existing Federal Reserve supervisory teams to monitor and examine novel activities, and banks engaged in such novel activities will not be moved to a separate supervisory portfolio. The Federal Reserve will notify institutions in writing whose novel activities will be subject to examination through the Program. CoinDesk; CoinTelegraph; CryptoSlate; Federal Reserve SR 23-7

Federal Reserve Issues Guidance On Bank Preapprovals For Stablecoin/Dollar Token Activity

Also on August 8, the Federal Reserve outlined the supervisory nonobjection process for state member banks seeking to use DLT or similar technologies to conduct payments activities as principal, including by issuing, holding, or transacting in stablecoins, which the Federal Reserve refers to as “dollar tokens.” The guidance provides that a state member bank will be required to show, to the satisfaction of its Federal Reserve supervisors, that it has established appropriate safe and sound controls and to obtain a written notification of supervisory nonobjection from the Federal Reserve prior to engaging in the proposed activities. Assessment by Federal Reserve staff will focus on various factors, including operational, cybersecurity, liquidity, illicit finance, and consumer compliance risks tied to dollar tokens, as well as compliance with applicable laws. The two Federal Reserve supervisory letters were released in conjunction with the previously announced interagency crypto-asset policy sprint. CoinDesk; CoinTelegraph; CryptoSlate; Federal Reserve SR 23-8; Interagency Joint Statement on Crypto-Asset Policy Sprint

GAO Releases Crypto Oversight Report Commissioned By Former House Financial Services Committee

On July 24, the GAO released a report concluding that there is a significant regulatory gap as to digital assets among federal agencies and recommending that the CFPB, CFTC, FDIC, NCUA, OCC, and SEC adopt an enhanced coordination mechanism going forward. Commissioned by the last House Financial Services Committee, the report found that no single regulator had authority over digital assets that are not “securities” and further noted that no uniform rules existed for requiring stablecoins to disclose reserve assets and risk profiles. CoinDesk; Report

House Republicans Introduce Updated Digital Asset Oversight Bill

On July 20, House Republicans introduced an updated version of proposed legislation first released in June that would clarify the regulatory responsibilities of the SEC and CFTC over digital assets. The new draft defines “digital assets” more broadly to include an additional range of decentralized finance tokens, leading some critics to argue that the SEC and other regulatory agencies could stretch the language to continue enforcement actions the legislation is intended to forestall. CoinDesk; Bill

SEC Chair Requests Additional Funding To Combat Digital Asset “Noncompliance”

On July 19, SEC Chair Gary Gensler asked the Senate Appropriations Committee for an additional $72 million in funding to combat “noncompliance” in the digital assets industry, which he described as the “Wild West.” The request, which would represent an approximately 3% increase in the agency’s current draft budget, would go toward hiring dozens of additional full-time staff members to conduct additional enforcement activities. CoinDesk

Senate Considers Bill To Regulate Digital Asset Providers Like Banks

On July 18, a group of U.S. senators introduced the Crypto-Asset National Security Enhancement Act of 2023, a bipartisan bill that would require decentralized finance (DeFi) providers to impose know-your-customer and identity verification requirements akin to those currently required of regulated banks. Subject entities would be required to vet and collect information on customers, run anti-money laundering programs, report suspicious activity to the government, and block sanctioned individuals from protocols. The bill would apply to anyone who controls, makes available, or invests more than $25 million in developing a DeFi protocol. CoinDesk; Bill

U.S. Stablecoin Bill Meets House Opposition, Bipartisan Negotiations Lose Steam

Negotiations toward a potential bipartisan compromise over stablecoin legislation in the House of Representatives appear to have hit an impasse. According to House Financial Services Committee Chair Patrick McHenry (R-NC), the White House encouraged minority committee members to stall over concerns that the legislation did not go far enough to regulate anonymous payments and embraced an overly decentralized licensing regime. Meanwhile, Rep. Maxine Waters (D-CA), the Committee’s ranking Democrat, noted that neither the Federal Reserve nor the U.S. Treasury support the current version of the bill, identifying limited licensing oversight and potential state and federal regulatory conflicts as problematic. Nevertheless, the House bill was successfully voted out of committee by a 34-16 vote last week and introduced by McHenry (R-NC) as the Clarity for Payment Stablecoins Act. CoinDesk; CoinDesk; CoinTelegraph; Decrypt

Federal Reserve’s Instant-Payment System Raises Concerns About National Digital Currency

On July 20, the Federal Reserve officially launched FedNow, a new instant-payment service that replaces the existing hour- or day-long bank-to-bank payment system with just-in-time payments. The service will operate around the clock and brings the U.S. banking system in line with many other countries including the EU, UK, India, and Brazil where similar services have existed for years. Although the Fed emphasized that FedNow does not signal a shift toward a central bank digital currency, critics have pointed out that FedNow adopts many of the same speed and efficiency goals as the digital asset industry and paves the way for issuance of a national, and centrally monitored, digital currency. CoinDesk; CoinDesk; Federal Reserve; Forbes; Reuters

Nasdaq Halts Plan For Crypto Custody Solution Due To Changing Regulatory Ecosystem

On July 18, Nasdaq announced that it is halting plans for the launch of a crypto custody solution in light of “the shifting business and regulatory environment in the U.S.” with respect to cryptocurrencies. The exchange had first revealed its intention to develop the custody service in September alongside the establishment of its crypto business, Nasdaq Digital Assets. Nasdaq will continue to list cryptocurrency exchanges and services, to provide technology for crypto custody, and to partner with crypto ETF-issuers to enable tradable exchange-listed products. Bloomberg; CNBC; CoinDesk; CryptoNews; Financial Times

Crypto Miners Establish Lobbying Group

On August 15, the Digital Energy Council (DEC) officially launched as the first member association focused solely on digital asset mining and energy security, aiming to drive policies that enhance grid resilience, sustainable energy practices, U.S. competitiveness, and national security. Founder Tom Mapes has emphasized the need to foster collaboration between the digital asset mining and energy sectors to fortify energy infrastructure during a pivotal moment of energy modernization. The DEC will facilitate productive discussions among members, regulators, and policymakers to dispel misconceptions and promote economic development, notably engaging with figures like U.S. Senators Lisa Murkowski and Cynthia Lummis to pioneer collaboration and responsible practices in these domains. Bitcoin Magazine; CoinDesk

International

EU Regulators Prepare Draft MiCA Regulations For Crypto Asset Providers

European securities and banking regulators have released draft regulations implementing the EU’s Markets in Crypto Assets (MiCA) law, which was approved last year and establishes a uniform licensing regime for crypto asset service providers across the bloc’s 27 member nations. Member states and interested parties are invited to comment on the proposals. Further proposals are expected to issue later this year and submission to the European Commission is slated for June 2024.

On July 12, the European Securities and Markets Authority (ESMA) issued its first of three consultation packages, in this first tranche seeking input on proposed rules that would impose additional disclosure and conflict-of-interest requirements, boost know-your-customer and money laundering protections, require the segregation of customer assets, and introduce standards for handling customer complaints. The ESMA has invited comments from stakeholders on this first package by September 20, 2023 and intends to publish a second in October 2023.

On July 24, media outlets reported that the European Banking Authority (EBA) will release proposed regulations that would subject “significant” cryptocurrencies to centralized EU, rather than member state, control, including by imposing uniform stress test and reserve requirements. Those proposals would be in line with earlier statements from the EBA on implementation of the MiCA. CoinDesk; CoinDesk; ESMA

Abu Dhabi Licenses Rain As First Retail Cryptocurrency Exchange In UAE

On July 25, Abu Dhabi’s Financial Services Regulatory Authority approved the UAE’s first retail virtual-asset exchange after a five-year inquiry process. The license went to Rain, a Bahrain-based digital assets company backed by crypto exchange Coinbase. Rain’s Abu Dhabi unit is now authorized to open a bank account in the UAE, enable clients to fund their own accounts, and provide services to institutional and certain retail customers in the Abu Dhabi Global Market financial free zone, an economic hub located off the coast of the emirate. The Block; CoinDesk; Reuters

Dubai Grants Binance License To Operate As Virtual Asset Exchange

On July 31, Binance announced that its Dubai-based subsidiary, Binance FZE, obtained a license to operate as a virtual asset exchange in Dubai. The crypto exchange won an Operational Minimum Viable Product license after meeting the pre-conditions since receiving a preparatory license in September 2022 from Dubai’s Virtual Assets Regulatory Authority (VARA). The license allows Binance FZE to offer crypto services to institutional and qualified retail investors in the emirate subject to Dubai’s know-your-customer and due-diligence requirements. Specifically, the license allows the exchange to open a domestic bank account to hold clients’ funds locally, operate a crypto exchange and offer payments and custody services. “We are honored to be the first exchange to be granted an operational Minimum Viable Product License by VARA,” said Richard Teng, head of regional markets of Binance. Teng went on to say the company’s priority is to “operate this first fully regulated exchange [in Dubai] . . . setting the stage for global scalability.” The Operational Minimum Viable Product license is step three of four to becoming fully regulated in the jurisdiction. The fourth step, a Full Market Product license, is expected after demonstration of compliance with all rules of Dubai’s licensing process. Binance Blog; CoinDesk; CoinTelegraph; The Block

Russia Adopts Legal Framework For Central Banking Token

On July 24, Russian President Vladimir Putin signed legislation authorizing the Russian central bank to issue a digital ruble. The Bank of Russia has been working toward the central bank digital currency since 2020, when the Bank published its first analysis on the project, and may begin testing the electronic currency in August. The cryptocurrency has been the subject of a pilot program with several Russian banks since February 2022, and has been viewed by the Bank of Russia as a method to circumvent financial sanctions imposed by the U.S. and Europe and to allow Russian authorities better control over money allocated for domestic projects. Bloomberg; CoinDesk

UK Economic Secretary Rejects Proposal To Regulate Crypto As Gambling

On July 20, the UK’s Economic Secretary rejected a proposal issued by the House of Commons Treasury Committee to regulate cryptocurrencies more harshly by relying on the country’s gambling laws. According to the Secretary’s response, the UK Government remains committed to establishing a new regulatory regime for digital assets that protects customers without departing from international norms, which would risk driving digital asset providers out of the country and redirecting interested customers to foreign markets. CoinDesk; Report

Indonesia Launches National Cryptocurrency Exchange

On July 20, officials with the Indonesian commodities regulator confirmed that the nation’s cryptocurrency exchange and clearinghouse had been operational since July 17 after a number of significant delays. The exchange is managed by the nation’s central bank and financial regulators and operates much like a traditional securities market with built-in fairness and consumer-protection requirements. CoinDesk

Hong Kong Approves First Retail Cryptocurrency Exchanges, Positions Itself As Crypto Hub

HashKey Exchange and OSL have become the first cryptocurrency exchanges in Hong Kong to secure licenses enabling retail investors to trade on their platforms. The milestone comes two months after the local regulatory authority announced permitting for companies to offer such services. The licenses mark the establishment of Hong Kong as a crypto hub, an especially notable development against the backdrop of some relatively cautious markets following the collapse of FTX. With this opening of HashKey Exchange’s and OSL’s services to everyday retail investors, the platforms aim to boost crypto adoption and engagement within the region. Nikkei; CoinDesk; Bloomberg; Yahoo Finance; CoinTelegraph

Singapore Grants Crypto Exchange Blockchain.com Major Payment Institution License

On August 1, Blockchain.com was granted a major payment institution (MPI) license from the Monetary Authority of Singapore (MAS) that will allow it to expand its services to institutional and accredited investors. The MPI license enables it to offer payment services, including digital payment token services and cross-border transfers. Blockchain.com’s approval follows an in-principle approval that MAS first issued to Blockchain.com in September 2022. The Singapore headquarters of the global crypto exchange Crypto.com and stablecoin issuer Circle recently received licenses to provide digital payment token services in June 2023. Blockworks; CoinDesk; CoinTelegraph; Press Release; The Straits Times

Civil Litigation

United States

FTX And Genesis Reach Agreement Regarding Bankruptcy Dispute

Bankrupt crypto firms FTX and Genesis have reached an agreement in principle to settle their ongoing dispute. Genesis emerged as the largest unsecured creditor of FTX, owed $226.3 million, while FTX claimed that Genesis owed FTX nearly $4 billion, later reduced to $2 billion, which Genesis denied. The agreement, detailed in a letter filed with the U.S. Bankruptcy Court for the Southern District of New York in the Genesis Chapter 11 proceedings, stated that the settlement would resolve the claims made by both parties, but did not include specific details about the agreement. Genesis Global Capital had temporarily halted redemptions and new loans following the collapse and Chapter 11 filing of FTX in November due to market dislocation and loss of industry confidence. Genesis in turn filed for bankruptcy protection in January, already weakened by losses from the collapse of Three Arrows Capital. Bloomberg; CoinDesk

FTX Estate Sues Bankman-Fried And Former Executives In Bid To Recoup $1 Billion

On July 20, the bankruptcy estate for crypto firm FTX filed a complaint against its founder Bankman-Fried and three of its former executives, Caroline Ellison, Gary Wang, and Nishad Singh, in an attempt to claw back over $1 billion in allegedly misappropriated value to the company. The estate claims that the former executives breached their fiduciary duties by misusing customer funds on luxury condominiums, political and charitable donations, and speculative investments, as well as abused their control over the exchange and its related companies. Further, the executives allegedly issued hundreds of millions of dollars of equity to themselves without value to the estate, and cash to make investments unrelated to the estate. CoinTelegraph; Reuters; The Guardian

Winklevoss’ Gemini Sues Digital Currency Group And Founder Barry Silbert For Alleged Fraud

Crypto trust firm Gemini has filed a lawsuit against Digital Currency Group (DCG), claiming fraud by DCG subsidiary Genesis, and its founder Barry Silbert. The suit aims to recover funds from DCG that assertedly were tied to Gemini’s Earn program and managed by Genesis. Gemini alleges that Genesis falsely presented robust risk management practices and thorough vetting processes. The suit accuses Silbert of urging Gemini to continue the Earn program despite knowing of Genesis’s insolvency and attempting to conceal its financial issues. DCG countered the claims as defamatory and called the lawsuit a “publicity stunt.” Bloomberg; CoinDesk

Crypto Custodian Prime Trust Files For Chapter 11 Bankruptcy

Crypto custodian Prime Trust filed for Chapter 11 bankruptcy protection in Delaware on August 14. The filing comes after confronting a shortfall in customer funds—the company has between 25,000 and 50,000 creditors and estimated liabilities between $100 million and $500 million versus $50 million to $100 million worth of estimated assets. The firm’s top five unsecured creditors assert claims of roughly $105 million, with the largest claim for $55 million. The bankruptcy also follows a June 21 cease and desist order against Prime Trust issued by Nevada’s business regulator, saying the firm’s financial condition was “critically deficient” and unable to honor customer withdrawals. On June 26, the Nevada regulator petitioned a court to place the firm into receivership, which the court approved on July 18. At the time of the regulator’s petition, Prime Trust owed over $85 million in fiat to its clients but only had around $2.9 million. Its digital asset liabilities were smaller, with Prime Trust owing about $69.5 million in crypto while holding approximately $68.6 million. Bankruptcy Filing; The Block; Cease & Desist Order; CoinTelegraph; Receivership Petition

Speaker’s Corner

United States

SEC Chief Accountant Warns Accounting Firms About Legal Liability For Crypto ‘Audits’

In a public statement on July 27, SEC Chief Accountant Paul Munter warned accounting firms of the potential pitfalls of purported crypto “assurance” work. In particular, Munter highlighted accounting firms’ potential legal liability for statements made by their clients and responsibilities with respect to auditor independence. Reflecting on a renewed focus on accounting firms following recent developments and insolvency in the industry, as well as a recent trend involving crypto platforms and others engaging accounting firms to perform reviews and marketing these as “audits” to investors, Munter cautioned that accounting firms could face legal liability under antifraud laws for statements made by their clients, if the clients mislead about the extent of a financial review or the “scope of work” done by the accounting firm. As part of their public responsibilities, the SEC Chief Accountant insisted, accounting firms must ensure that accountants’ names or services are not used to convey a false sense of legitimacy or to mislead investors. Thus, where an accounting firm learns that a client has made misleading statements to the public about the nature of its non-audit work, the Office of the Chief Accountant staff view that best practice is for the firm to consider making a noisy withdrawal to disassociate from the client. SEC Statement

Gensler Raises Concerns About Fraud And Manipulation For Bitcoin ETFs

SEC Chair Gary Gensler expressed skepticism about the crypto marketplace when asked about pending applications for spot bitcoin ETF applications in a televised interview on July 27. Though Gensler did not make a direct statement regarding the recent wave of filings spurred by BlackRock in the interview, he did raise concerns about general fraud and potential manipulation in the crypto industry. “The platforms themselves, where trading is occurring of various crypto tokens, though some of it comes under the securities laws, currently they’re not necessarily compliant with those time-tested protections against fraud and manipulation,” Gensler said. The Block; Bloomberg

International

South Korea Urges Crypto Platforms To “Strengthen Compliance Capacity”

On July 27, the Korean Financial Intelligence Unit (KoFIU)—a government agency dedicated to tackling money laundering and terrorist financing—held a consultative body meeting to “strengthen the compliance capacity of virtual asset service providers.” At the meeting, KoFIU Commissioner Rhee Yunsu said that the agency “will operate a strategic analysis team on virtual assets to more systematically analyze criminal activities involving virtual assets” to provide data to investigative authorities. The purpose of the initiative is to support virtual asset service providers’ compliance efforts and to combat relevant crime as the country awaits proper legislation to address illegal activities in the market. Five domestic crypto services providers attended the meeting and reported their measures for dealing with potential crime. The Block

Japan’s Prime Minister Says Web3 Can Transform Internet

During the WebX web3 conference in Tokyo on July 25, Japan’s Prime Minister Fumio Kishida said that web3 has the capacity to transform the traditional internet and contribute to social change in Japan. Kishida said the government was dedicated to creating an ecosystem amenable to the promotion of web3 as part of his administration’s “new capitalism” economic platform designed to address social issues through growth and innovation. “Web3 is part of the new form of capitalism,” the Prime Minister declared. The Block

Other Notable News

Cboe Amends Five Spot Bitcoin ETFs To Enter “Surveillance Sharing Agreements” With Coinbase Following Refiling Of Blackrock Spot Bitcoin ETF

On July 11, exchange operator Cboe Global Markets submitted amendments to the SEC for five proposed spot bitcoin ETF applications to include a surveillance-sharing agreement (SSA) with Coinbase. The amended filings include ETFs from Invesco, VanEck, WisdomTree, Fidelity, and the joint fund ARK Invest and 21Shares. Cboe stated that it “reached an agreement on terms” with Coinbase for the SSAs. Coinbase’s shares surged as much as 11% on June 11 following the announcement. Cboe’s filings follow on the heels of Nasdaq’s refiling for BlackRock’s ETF in July, which also listed Coinbase as a surveillance sharing partner. The SSAs are intended to meet the SEC’s standards for preventing fraud and protecting investors, as outlined by the regulator earlier this year. If approved, the filings would mark the first spot bitcoin ETFs. The Block; CoinTelegraph

Two Major Crypto VC Funds Announce New Fundraisings, Buck “Crypto Winter”

Polychain Capital, one of the most prominent venture capital firms in the crypto space, has raised around $200 million in the “first close” of its fourth crypto venture capital fund. The firm further plans to raise around $400 million total for this fund. Polychain has around $2.6 billion in assets under management. Coinfund, a New York-based crypto venture capital firm, also announced that it raised $158 million in its latest funding round and is focusing on crypto infrastructure projects that enable greater decentralization, a trend that has emerged after the implosion of FTX last year. Both successful raises come in the midst of an extended crypto winter that has seen a broad retreat from crypto-related investments following a series of failures throughout 2022, further complicated by higher interest rates that have increased the cost of borrowing. But Alex Felix, Coinfund’s co-founder and chief investment officer, has pointed out that this slower-paced environment raises the quality of entrepreneurs competing for more limited funds. CoinDesk; Fortune; Decrypt

Ethereum DeFi Spooked By Hacks And Curve Finance Liquidation Threat; Risks Mitigated

On July 30, around $70 million was stolen in a string of attacks on several key DeFi platforms, including Curve Finance, one of the most popular decentralized exchanges. The attacks also targeted lending protocol Alchemix, yield platform Pendle, synthetic asset tool Metronome, and decentralized NFT protocol JPEG. Spooked traders withdrew roughly $1.5 billion worth of digital assets after hackers stole around $62 million from Curve. The price of the Curve DAO (CRV) declined 20.91% on the day of the hack, and continued to decline the next day to a seven-month low. By the morning of August 1, the market valuation of CRV had plummeted 46%. This drop in turn triggered wider market fear as Curve Finance founder, Michael Egorov, had loans worth roughly $100 million secured against CRV, collateral that was at risk of liquidation if the price of CRV dipped below a certain threshold. Several actions were taken to mitigate any risk of a liquidation crisis for Curve—and to avoid any systemic risk for DeFi more broadly. On August 1, Egorov sold 39.25 million CRV tokens for stablecoins to a number of notable decentralized finance investors, including Justin Sun, the founder of Tron blockchain, for a total of $15.8 million. Egorov also made partial repayment on certain of his loans, reducing liquidation risk. Further, the DAO that governs one of the lending platforms that Egorov had borrowed from, Abracadabra, approved an emergency measure to change how it tracks those tokens’ prices to prevent inadvertent selling of CRV tokens. As of August 11, Curve Finance had recovered 70% of funds worth about $50 million lost in the hacking incident. The Block; CoinDesk; CoinTelegraph; Forbes; NewsBTC; TechCrunch; Yahoo Finance

PayPal Launches U.S. Dollar Stablecoin

On August 7, PayPal launched a U.S. dollar-denominated stablecoin called PayPal USD (PYUSD), aimed at leveraging the potential of stablecoins for web3 payments and digital environments. The stablecoin will be an Ethereum-based token fully backed by U.S. dollar deposits, short-term U.S. Treasuries, and similar cash equivalents, and will be redeemable 1:1 for U.S. dollars. It will enable eligible U.S. PayPal customers to transfer funds, send person-to-person payments, fund purchases, and convert cryptocurrencies within the PayPal ecosystem. The stablecoin’s issuance is managed by Paxos Trust Company and is designed to bridge the gap between fiat and digital currencies, while promoting transparency through public monthly reserve reports and third-party attestations of value. CoinDesk; PayPal Press Release

Binance Japan To Begin Onboarding Users

Binance Japan, a subsidiary of Binance, announced that it is set to begin onboarding users to its new platform, with existing Binance customers able to migrate to the Japanese subsidiary as soon as mid-August. The Japanese subsidiary will enable users to spot trade, earn products, and participate in an NFT marketplace. It will also feature 34 tokens available for trading, including Binance Smart Chain’s BNB, which will be available in Japan for the first time. CoinDesk

Pro-Bitcoin Argentine Presidential Candidate, Javier Milei, Wins Presidential Primary

Javier Milei, a libertarian candidate, unexpectedly won Argentina’s open presidential primary election with over 30% of the vote, positioning him as a front-runner for the fall general election. Milei has called for abolition of Argentina’s central bank as a “scam” and spoken favorably of Bitcoin, remarking that it “represents the return of money to its original creator, the private sector.” Milei’s party, La Libertad Avanza, also has tweeted positively of El Salvador’s use of Bitcoin as legal tender. Milei, however, advocates for dollarization of the Argentine economy as triple-digit inflation afflicts the nation. The general election is set for October, with a potential runoff in November. CoinDesk; Finbold; NYTimes

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, Jessica Howard, Nathaniel Tisa, and Simon Moskovitz.

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])

On July 12, 2023, United States Senators Cynthia Lummis (R-WY), a member of the Senate Banking Committee, and Kirsten Gillibrand (D-NY), a member of the Senate Agriculture Committee, reintroduced the Lummis-Gillibrand Responsible Financial Innovation Act (the “RFIA”).[1] Although it is unclear whether the RFIA will pass the Senate in its current form, certain consumer protection provisions were modified from the prior 2022 version to pick up more votes. Regardless of the RFIA’s future viability, the RFIA is driving a broader conversation within Congress. For example, shortly after reintroduction, provisions of the RFIA addressing crypto asset anti-money laundering examination standards and anonymous crypto asset transactions were added to the 2024 National Defense Authorization Act (“NDAA”).[2]

As such, the RFIA’s “enhanced” approach sheds light on the priorities of the U.S. Congress and, in turn, makes clear those areas that warrant attention. The RFIA addresses industry uncertainty surrounding the role of federal regulators; the classification of, and subsequent restrictions to, certain assets; and the interaction of these assets with the existing anti-money laundering and tax regimes.

Compared to the initial 2022 version of the RFIA,[3] the 2023 version reflects revisions to adjust to the changing cryptocurrency market, particularly in light of the string of 2022 cryptocurrency exchange bankruptcies. In particular, for purposes of this client alert, we focus on the following provisions of the RFIA that represent significant departures from the initial 2022 version:[4]

Draws a clear division between Securities and Exchange Commission (“SEC”) and Commodity Futures Trading Commission (“CFTC”) jurisdiction over cryptocurrencies, and creates the Consumer Protection and Market Integrity Authority;
Provides substantive regulations rooted in consumer protection principles for both Crypto Asset Intermediaries and Payment Stablecoin Issuers (each as defined below);
Prioritizes combating illicit finance; and
Revises the federal tax code to more precisely reflect crypto asset and securities transactions.

We review each of these developments in turn below, highlighting the provisions of the RFIA that represent significant updates from 2022. Following this review, we provide our thoughts on the potential implications to covered entities should the RFIA, or other similar bills, be enacted.

1. Altered Federal Regulatory Framework

As currently drafted, the RFIA proposes a new federal framework for the regulation of crypto assets[5] and crypto asset intermediaries.[6] The framework strives to clarify and differentiate the governing role of the CFTC and SEC by providing the necessary statutory authority, directing the agencies to engage in rulemaking while also introducing the concept of a Customer Protection and Market Integrity Authority. These provisions will have a notable impact on these agencies, as determining whether a certain asset is a security will dictate the regulator, restrictions and obligations of the crypto asset and the related entity.

1a. Enhanced CFTC Authority

The CFTC’s existing statutory authority over spot market commodities, including cryptocurrencies, is limited to enforcement authority over fraud and manipulation in those markets; however, the CFTC’s regulatory authority is limited to the derivatives markets (e.g., futures and swaps). As currently drafted, the RFIA provides the CFTC the statutory authority to regulate the spot crypto asset markets, including crypto issuers, crypto assets and other aspects of the crypto asset markets, leaving the SEC a defined, but more limited role.

Spot Market Jurisdiction

The RFIA grants the CFTC spot market jurisdiction over all commercially fungible crypto assets that are not defined as securities, including endogenously referenced crypto assets (colloquially known as “algorithmic stablecoins,” though these assets are prohibited from referring to themselves as stablecoins; notably, the CFTC does not regulate stablecoins, as further discussed below).[7] This would mark the first time that the CFTC would have broad jurisdiction over a class of spot market commodities. In particular, the RFIA provides the CFTC with exclusive jurisdiction over any agreement, contract, or transaction involving a sale of a crypto asset, including ancillary assets.[8] Notably, in addition to limiting the CFTC’s jurisdiction to crypto assets that are not securities and that are commercially fungible, the RFIA excludes from the CFTC’s jurisdiction digital collectibles and other unique crypto assets.[9] Accordingly, the RFIA would carve many non-fungible tokens (“NFTs”) outside the scope of the CFTC’s jurisdiction. Nonetheless, this expansive jurisdiction marks the CFTC as the primary crypto asset regulator.

Crypto Asset Exchanges

The RFIA defines “crypto asset exchange” as a trading facility that lists for trading at least one crypto asset.[10] Any trading facility that seeks to offer a market in crypto assets or payment stablecoins must register with the CFTC, except truly decentralized protocols.[11] The RFIA tasks each crypto asset exchange with establishing and enforcing its own rules, ensuring only assets that are not readily susceptible to manipulation, and protecting the safety of customer assets.[12] Additionally, each crypto asset exchange must segregate customer assets from exchange assets.[13]

Under the RFIA, the CFTC has new regulatory oversight over registered crypto asset exchanges. Although crypto asset exchanges are banned from conducting proprietary trading, the CFTC may engage in rulemaking to establish standards for permissible market making.[14] Further, any change of control of a crypto asset exchange resulting in an individual or entity gaining ownership of greater than 25 percent must first receive approval from the CFTC.[15]

Covered Affiliates

Under the RFIA, “covered affiliate” means, based on the totality of the facts and circumstances as determined by the CFTC, a person with substantial legal or financial relationship to an entity registered under the Commodity Exchange Act that is primarily engaged in crypto asset activities.[16] The RFIA empowers the CFTC to order the examination of a covered affiliate and to limit covered affiliates from providing services to a registered entity or entering into legal relationships or specified transactions with a registered entity.[17]

Risk Management Standards for Self-Hosted Wallets

The RFIA also tasks the CFTC with promulgating rules to adopt risk management standards relating to money laundering, customer identification, and sanctions for self-hosted wallets that conduct transactions with a futures commission merchant. The term “self-hosted wallet” means a digital interface used to secure and transfer crypto assets, in which the owner of the assets retains independent control in a manner that is secured by that interface.[18]

1b. The Role of the SEC

Although the RFIA establishes the CFTC as the primary federal regulator of most crypto assets, the SEC would have jurisdiction over digital assets that are securities. To the extent that the digital asset in question provides the holder of the asset with a debt or equity interest, liquidation rights, a right to a dividend payment, or other financial interest in a business entity, the asset would not be treated as a “crypto asset” or an “ancillary asset” subject to the CFTC’s jurisdiction and, instead, would be subject to the SEC’s jurisdiction.[19]

Notably, should conflict arise as to whether a digital asset should be treated as a crypto asset, the RFIA grants the U.S. Court of Appeals for the D.C. Circuit authority to resolve the conflict by determining whether the asset represents a financial interest in a business entity and thus is a security.[20] The RFIA is silent on which party must bring the conflict to the U.S. Court of Appeals for the D.C. Circuit.

These provisions represent a major change from the status quo and are an attempt to provide a clearer regulatory regime than the previous version of the RFIA. As currently drafted, the SEC would not have the role of the primary digital asset regulator, but would still have the authority to treat certain assets as securities and challenge the CFTC’s claimed jurisdiction over other assets. An aggressive SEC, such as the current one, could use that authority to maintain a prominent role in crypto regulation.

1c. Customer Protection and Market Integrity Authority

As currently drafted, the RFIA creates a Customer Protection and Market Integrity Authority (“Authority”), which is a self-regulatory organization (“SRO”) for crypto asset intermediaries that is jointly chartered by the SEC and the CFTC.[21] Membership in the Authority is limited to only crypto asset intermediaries. The Authority is tasked with regulating, supervising, and disciplining crypto asset intermediaries,[22] essentially serving as a Self-Regulatory Organization, though the RFIA does not define it as such.

Under the RFIA, the Authority must have the following allocation of a 13-member board of directors: three governmental directors (the Director of the Office of Financial Innovation of the CFTC, the Director of the Office of Financial Innovation of the SEC, and the Director of FinCEN), four independent directors appointed by the President, and six directors appointed by the members of the Authority.[23]

SROs are nothing new in the financial industry—the National Futures Association oversees aspects of the derivatives industry, and the Financial Industry Regulatory Authority (“FINRA”) oversees aspects of the securities industry. Indeed, an intermediary of a crypto commodity or a crypto security would already be required to join one of those SROs. The establishment of a special SRO for crypto not only imposes unique costs on crypto intermediaries, but also risks unnecessary overlap between the requirements of the new SRO and the old ones.

2. Substantive Regulation of Crypto Asset Intermediaries and Stablecoin Issuers

Beyond proposing a new federal statutory framework under which agencies would engage in rulemaking, the RFIA proposes concrete restrictions and obligations. In particular, these substantive requirements trend toward consumer protection ideals and particularly target Crypto Asset Intermediaries and Stablecoin Issuers.

2a. Consumer Protection

The new stated purpose of the RFIA is “to provide for consumer protection and responsible financial innovation to bring crypto assets within the regulatory perimeter.”[24] This new focus on consumer protection is found throughout provisions in the RFIA and is likely influenced by the aftermath of the 2022 cryptocurrency exchange bankruptcies.

Proof of Reserve Requirement

The RFIA provides that all crypto asset intermediaries must maintain a system to demonstrate cryptographically verifiable possession or control of all crypto assets under custody or otherwise provided for safekeeping by a customer to the intermediary.[25] The system must be protected against disclosure of customer data, proprietary information, and other data that may lead to operational or cybersecurity risk.[26] The crypto asset intermediary must retain an independent public accountant to verify possession or control of all crypto assets under custody.[27] This verification must include an examination of the system and shall take place at a time chosen by the independent public accountant without prior notice.[28] Should the accountant identify any material discrepancies, they must inform the appropriate regulator and the Authority within one day.[29]

Permissible Transactions

The RFIA provides that each crypto asset intermediary must ensure that it clearly discloses the scope of permissible transactions that the intermediary may undertake involving crypto assets belonging to a customer in a customer agreement.[30] Further, each crypto asset intermediary must provide clear notice to each customer and require acknowledgement of the following: (i) whether customer crypto assets are segregated from other customer assets and the manner of the segregation; (ii) how the crypto assets of the customer would be treated in a bankruptcy or insolvency scenario and the risk of loss; (iii) the time period and manner in which the intermediary is obligated to return the crypto asset of the customer upon request; (iv) applicable fees imposed on a customer; and (v) the dispute resolution process of the intermediary.[31]

Lending

The RFIA provides that a crypto asset intermediary must disclose any lending arrangement to customers before any lending services take place, including the potential bankruptcy treatment of customer assets in the case of insolvency.[32] In any lending arrangement, the crypto asset intermediary must also disclose whether the intermediary permits failures to deliver customer crypto assets or other collateral, and in the event of a failure to deliver, the period of time in which the failure must be cured.[33] Notably, the RFIA expressly prohibits the rehypothecation of crypto assets by a crypto asset intermediary.[34] This last provision originates from the collapse of FTX, which rehypothecated customers’ crypto assets without informing those customers.[35] Such a ban would disadvantage crypto intermediaries vis-à-vis traditional lenders. In traditional finance, lenders use rehypothecation to access credit for their own use, thereby pursuing their own goals. A ban for crypto intermediaries will limit their ability to take similar risks for their own purposes.

2b. Stablecoins

Under the RFIA as currently drafted, no entity other than a depository institution[36], or a subsidiary thereof, may issue a payment stablecoin.[37] This has the potential to affect current stablecoin issuers, many of which are not depository institutions. The term “payment stablecoin” means a claim represented on a distributed ledger that is: redeemable, on demand, on a one-to-one basis for instruments denominated in United States dollars; issued by a business entity; accompanied by a statement from the issuer that the asset is redeemable from the issuer or another person; backed by one or more financial assets, excluding other crypto assets; and intended to be used as a medium of exchange.[38]

Depository institutions need to apply to issue stablecoins by filing an application to the appropriate Federal banking agency or State bank supervisor. The Federal banking agency or State bank supervisor must approve the application unless the payment stablecoins are not likely to be conducted in a safe and sound manner; the depository institution lacks resources and expertise to manage the stablecoin; or the depository institution does not have required policies and procedures related to the stablecoin.[39]

Should a current stablecoin issuer hold a non-depository trust company charter or a State license that only persons engaged in crypto activities may obtain, the stablecoin issuer may in effect “skip the line” upon application to receive a charter as a depository institution and issue payment stablecoins.[40] These applications, while still reviewed, will be reviewed before applications from other entities.

Once approved, the issuing depository institution must clearly disclose to customers that a payment stablecoin is neither guaranteed by the U.S. government nor subject to deposit insurance by the Federal Deposit Insurance Corporation.[41] Though payment stablecoins are not guaranteed or insured, in the event of the receivership of the issuing depository institution, a person who has a valid claim on a payment stablecoin is entitled to priority over all other claims on the institution with respect to any required payment stablecoin assets, including claims with respect to incurred deposits.[42]

Restrictions

The RFIA provides that stablecoins may only be used in permissible transactions. They may not be pledged, rehypothecated, or reused, except for the purpose of creating liquidity to meet reasonable expectations of requests to redeem payment stablecoins.[43]

Further, the RFIA restricts which assets may properly use the term “payment stablecoin” or “stablecoin.” Endogenously referenced crypto assets cannot use the terms payment stablecoin or stablecoin in advertising marketing materials.[44] Endogenously referenced crypto assets are assets that will be converted, redeemed, or repurchased for a fixed amount of monetary value, or assets for which a mechanism exists to achieve such conversion, redemption, or repurchase, and assets that either rely solely on another crypto asset to maintain the fixed amount of monetary value or rely on algorithmic means to maintain the fixed amount of monetary value.[45]

3. Combatting Illicit Finance

As currently drafted, the RFIA includes new provisions to combat illicit finance risks, ranging from enhanced oversight of cryptocurrency ATMs to increasing efforts to combat illicit finance across government agencies.

Cryptocurrency ATMs

The RFIA provides a refreshed regime for combatting illicit finance. Notably, the RFIA directs the Financial Crimes Enforcement Network (“FinCEN”) to require crypto asset kiosk owners to submit and update the physical addresses of the kiosks owned or operated.[46] Further, FinCEN must require crypto asset kiosk owners and administrators to verify the identity of each kiosk customer by using government issued identification.[47] These provisions are similar to those in another bill sponsored by Senator Elizabeth Warren (D-MA), which has been heavily criticized by the crypto industry.[48]

Financial Technology Working Group

Additionally, the RFIA establishes the Independent Financial Technology Working Group to Combat Terrorism and Illicit Financing, consisting of the Secretary of the Treasury, senior-level representatives from FinCEN, the Internal Revenue Service, the Office of Foreign Assets Control, the Federal Bureau of Investigation, the Drug Enforcement Administration, the Department of Homeland Security and the United States Secret Service, the Department of State, and five individuals to represent financial technology companies, distributed ledger intelligence companies, financial institutions, and institutions engaged in research.[49]

The Independent Financial Technology Working Group has a broad mandate and is tasked with conducting independent research on terrorists and illicit use of new financial technologies; analyzing how crypto assets and emerging technologies may bolster the national security and economic competitiveness of the United States in financial innovation; and developing legislative and regulatory proposals to improve anti-money laundering, counter-terrorist, and other illicit financing efforts in the United States.[50]

4. Tax Implications

As currently drafted, the RFIA proposes an alternate tax treatment of crypto assets. Gross income does not include gain from the sale or exchange of any crypto asset, unless the sale or exchange is for cash or cash equivalent; property used by the taxpayer in the active conduct of a trade or business; or any property held by the taxpayer for the production of income.[51] Notably, this exclusion does not apply if the value of such sale or exchange exceeds $200 or if the total gain exceeds $300.[52] At bottom, this exclusion will ensure that consumers who transact in small amounts of crypto do not face the same type of tax liability as those who transact in large sums.

The RFIA also disallows loss deductions from wash sales. No deduction is allowed with respect to any loss claimed to have been sustained from any sale or other disposition of specified assets where it appears that, within a period beginning 30 days before the date of such sale or other disposition and ending 30 days after such date, the taxpayer has acquired substantially identical specified assets, or entered into a contract or option to acquire, or long notional principal contract in respect of, substantially identical specified assets.[53] Under current law, these restrictions apply to securities transactions. Thus, even if a crypto asset is a commodity under the rest of the RFIA’s provisions, it would still be treated like a security in this instance.

Concluding Thoughts

As discussed at the onset of this alert, the RFIA aims to solve for certain industry pain points surrounding the regulations, restrictions, and protections applicable to the cryptocurrency industry. However, the effectiveness of the updated provisions within the RFIA remain to be tested and could present some glaring issues for the industry to address. In particular, we note a few provisions:

The obligation to become a depository institution in order to issue a payment stablecoin would represent a significant—and perhaps insurmountable—burden for many Fintech industry participants. There is not presently a single stablecoin issuer in the United States that is a depository institution. The provisions in the RFIA could render existing stablecoins impermissible overnight and subject all issuers to the regulation, supervision, and enforcement authority of federal and state banking regulators. Further, fiat-backed stablecoins inherently require 100% reserves, while banks operate on a business model that is predicated on fractional reserves. These distinctly different business models and use cases raise questions surrounding whether stablecoins will even be palatable to banks. These points certainly merit further discussion among all industry stakeholders and policymakers through the legislative process.
The RFIA, in effect, deems the CFTC the primary federal regulator of nearly all crypto assets, crypto asset exchanges, and affiliates. While the industry may welcome this provision as the preferred regulatory regime, we do not anticipate a seamless transition of regulatory authority from an aggressive SEC, which still retains jurisdiction, albeit more limited jurisdiction, over digital assets that are securities. The competing agencies may create friction in the industry, as entities work towards figuring out their proper classification under the RFIA and adjust to a potentially new regulator.

________________________

[1] Lummis-Gillibrand Responsible Financial Innovation Act, S. _, 118th Cong. (2023).

[2] S. Amdt. 1000, 118th Cong. (2023).

[3] Lummis-Gillibrand Responsible Financial Innovation Act, S. 4356, 117th Cong. (2022).

[4] This client alert focuses on provisions of the RFIA that are completely new, or represent major changes from the 2022 version of the bill. For a section by section summary of the RFIA, including new and legacy provisions alike, see Cynthia Lummis & Kirsten Gillibrand, Lummis-Gillibrand Responsible Financial Innovation Act of 2023: Section-by-Section Overview, https://www.lummis.senate.gov/wp-content/uploads/Lummis-Gillibrand-2023-Section-by-Section-Final.pdf

[5] The term “crypto asset” means a natively electronic asset that (1) confers economic, proprietary, or access rights or powers; (2) is recorded using cryptographically secured distributed ledger technology or any similar analogue and (3) does not represent, derive value from, or maintain backing by, a financial asset (except other crypto asset). Crypto assets do not include payment stablecoins or other interests in financial assets represented on a distributed ledger or any similar analogue. RFIA, § 101(a). “Crypto asset” also excludes an asset that provides the holder of the asset with any of the following rights in a business entity: (1) a debt or equity interest in that entity; (2) liquidation rights with respect to that entity; (3) an entitlement to an interest or dividend payment from that entity; and (4) any other financial interest in that entity. RFIA, § 401.

[6] Crypto asset intermediary is defined by the Bill as a person who holds or is required to hold a license, registration, or any other similar authorization that conducts market activities relating to crypto assets and is not a depository institution. RFIA, § 101(a).

[7] RFIA, § 403(a).

[8] Id. The term “ancillary asset” means an intangible, fungible asset that is offered, sold, or otherwise provided to a person in connection with the purchase and sale of a security. Ancillary assets benefit from entrepreneurial and managerial efforts that determine the value of the assets, but do not represent securities because they are not debt or equity or do not create rights to profits, liquidation preferences, or other financial interests in a business entity. RFIA, § 301(a)(1).

[9] RFIA § 403(a).

[10] RFIA, § 401(a). We note a potential inconsistency: the RFIA limits the definition of crypto asset exchanges to those exchanges which trade crypto assets. Payment stablecoins are expressly exempt from the definition of crypto assets. However, the RFIA requires those offering a market in payment stablecoins to register as a crypto asset exchange.

[11] Id. The RFIA creates a definition of “decentralized crypto asset exchange”: (i) software that comprises predetermined and publicly disclosed code deployed to a public distributed ledger; (ii) permits a user or group of users to create a pool or group of pools for crypto assets; (iii) enables a user or group of users to conduct crypto asset transactions from a pool or group of pools, with such transactions occurring pursuant to the code described in clause (i), and; (iv) no person, or group of persons, known to one another who have entered into an agreement (implied or otherwise) to act in concert, can unilaterally control or cause to control the software protocol through altering transactions, functions, or actions on the protocol, or blocking or approving transactions on the protocol.

[12] RFIA, § 404(a).

[13] RFIA, § 705(c).

[14] RFIA, § 404(a).

[15] Id.

[16] RFIA, § 405(a).

[17] Id.

[18] RFIA, § 403(a).

[19] RFIA, § 501.

[20] Id.

[21] RFIA, § 601(a).

[22] Id.

[23] Id.

[24] RFIA, § 101.

[25] RFIA, § 203(a).

[26] Id.

[27] Id.

[28] Id.

[29] Id.

[30]RFIA, § 205. The Bill also advises the Consumer Financial Protection Bureau to issue guidance setting forth best practices for standard crypto asset intermediary customer agreements, in consultation with the SEC and CFTC.

[31] Id.

[32] RFIA, § 205.

[33] RFIA, § 206(a).

[34] Id.

[35] See Jonathan Chiu & Russell Wong, What is a Crypto Conglomerate Like FTX? Economics and Regulations, No. 23-09 (March 2023). https://www.richmondfed.org/publications/research/economic_brief/2023/eb_23-09.

[36] The term depository institution includes: an insured bank or any bank which is eligible to make application to become an insured bank, any mutual savings bank, any savings bank, any insured credit union or any credit union which is eligible to make application to become an insured credit union, or any savings association which is an insured depository institution.

[37] RFIA, § 701. Note that the Bill neither defines “stablecoin issuer” nor considers what activities are considered issuance.

[38] RFIA, § 101(a).

[39] RFIA, § 701.

[40] RFIA, § 706(a).

[41] RFIA, § 701.

[42] Id.

[43] Id.

[44] RFIA, § 702(c).

[45] RFIA, § 702(a).

[46] RFIA, § 303(b).

[47] RFIA, § 303(c).

[48] Digital Asset Anti-Money Laundering Act of 2023, S. _, 118th Cong. (2023).

[49] RFIA, § 304(b)(1)-(3).

[50] RFIA, § 304(c)(1)-(3).

[51] RFIA, § 801(a).

[52] Id.

[53] RFIA, § 805(a).

The following Gibson Dunn lawyers prepared this client alert: Sara Weed, Jason Cabral, Jeffrey Steiner, Karin Thrasher, Alexis Levine, Roscoe Jones Jr., Amanda Neely, and Christian Dibblee.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of Gibson Dunn’s FinTech and Digital Assets, Financial Institutions, or Public Policy practice groups, or the following authors:

Financial Institutions Group:
Jason J. Cabral – New York (+1 212-351-6267, [email protected])

FinTech and Digital Assets Group:
Jeffrey L. Steiner – Co-Chair, Washington, D.C. (+1 202-887-3632, [email protected])
Sara K. Weed – Washington, D.C. (+1 202-955-8507, [email protected])

Public Policy Group:
Roscoe Jones, Jr. – Co-Chair, Washington, D.C. (+1 202-887-3530, [email protected])
Amanda H. Neely – Washington, D.C. (+1 202-777-9566, [email protected])

In the recent decision of Re Shandong Chenming Paper Holdings Ltd [2023] HKCFI 2065[1] (“Re Shandong”), the Court of First Instance (the “CFI”) held that the principle in Guy Kwok-Hung Lam v Tor Asia Credit Master Fund LP [2023] HKCFA 9[2] (“Guy Lam”) (namely, that the Court will generally dismiss a bankruptcy petition where the debt under dispute was subject to an exclusive jurisdiction clause (“EJC”)) was equally applicable where the debtor had raised a cross-claim, in an amount exceeding the petitioning debt, which was subject to an arbitration agreement.

1. Background

On 15 June 2017, Arjowiggins HKK 2 Limited (the “Petitioner”) issued a petition (the “Petition”) seeking the winding up of Shandong Chenming Paper Holdings Limited (the “Company”) on the grounds of insolvency arising from non-payment of an arbitration award (the “Award”).

On 20 June 2022, the Company commenced an arbitration against the Petitioner (the “2nd Arbitration”) advancing claims under the same agreement which had given rise to the arbitration that resulted in the Award (the “Cross-Claim”). The amount of the Cross-Claim exceeds the debt established by the Award. The substantive hearing of the 2nd Arbitration is due to take place in May 2024.

On 25 October 2022, the Company issued an application seeking the dismissal or adjournment of the Petition. The Company argued that, as the amount of the Cross-Claim exceeds the debt established by the Award and such Cross-Claim will be determined in an arbitration, the Petition should be dismissed or stayed.

2. The CFI’s Decision

As noted in our previous article, the Court of Final Appeal (the “CFA”) in Guy Lam held that where the underlying dispute of the petition debt was subject to an EJC, the court should generally dismiss the petition absent countervailing factors and the determination of whether the debt was bona fide disputed on substantial grounds was a threshold question which might or might not be engaged when the Court decided whether to exercise its bankruptcy jurisdiction; in such circumstances, the debtor is not required to demonstrate a bona fide defence on substantial grounds in order to defeat the petition.

The issue in Re Shandong was whether the same principle applies in the context of an arbitrable cross-claim raised by the debtor against the petitioner.

The CFI held that the same principle applies in these circumstances – the Court should therefore dismiss or stay a petition where the debtor has raised a cross-claim that is subject to an arbitration clause which exceeds the amount of the petition debt. The CFI examined the relevant authorities and observed that:

As a general principle of insolvency law, in examining whether the debtor can establish a defence to a winding-up petition, no distinction is drawn between a claim and a cross-claim.
The Singapore Court of Appeal in AnAn Group (Singapore) Pte Ltd v VTB Bank (Public Joint Stock Co) [2020] SGCA 33 had examined this issue and held that “when a court is faced with either a disputed debt or a cross-claim that is subject to an arbitration agreement, the prima facie standard should apply, such that the winding-up proceedings will be stayed or dismissed as long as (a) there is a valid arbitration agreement between the parties; and (b) the dispute falls within the scope of the arbitration agreement, provided that the dispute is not being raised by the debtor in abuse of the court’s process”. Such a decision is consistent with the established principles.
Even though the Petitioner argued that there is no merit in the Cross-Claim, it did not go so far as to suggest that the Cross-Claim obviously constituted an abuse of process such that the Court should disregard the Company’s objection. Merits of and delay in bringing the Cross-Claim are not of themselves capable of bringing a case within that category.
Nothing in the CFA’s judgment in Guy Lam suggested that a defence and a cross-claim should be treated differently or should engage different principles. The CFI should not be invited to strain to find ambiguities in appellate judgments.

Whilst the Court would normally dismiss the Petition in these circumstances, given the lengthy and torrid history of this particular case, the CFI considered it appropriate to stay the Petition so as to preserve the current date of presentation of the Petition in case it becomes relevant in the future.

3. Comments

The CFI’s decision in Re Shandong provides welcomed clarity to the application of the approach in Guy Lam. In addition to clarifying that the Guy Lam approach extends to cross-claims raised by a debtor, the CFI helpfully confirmed that such approach applies to arbitration clauses (and not just EJCs).

As such, when entering into commercial agreements, parties should bear in mind that the existence of EJCs or arbitration clauses may have a material bearing on the conduct of winding-up or bankruptcy proceedings in Hong Kong.

__________________________

[1] Available here.

[2] See our article on this judgment at: https://www.gibsondunn.com/hong-kong-court-of-final-appeal-upholds-dismissal-of-bankruptcy-petition-debt-under-dispute-was-subject-to-exclusive-jurisdiction-clause/.

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, or the following authors in the firm’s Litigation Practice Group in Hong Kong:

Brian W. Gilchrist OBE (+852 2214 3820, [email protected])
Elaine Chen (+852 2214 3821, [email protected])
Alex Wong (+852 2214 3822, [email protected])
Andrew Cheng (+852 2214 3826, [email protected])

On August 16, 2023, the Federal Trade Commission announced the resolution of an antitrust investigation into the proposed acquisition by EQT Corporation of THQ Appalachia I, LLC and THQ-XcL Holdings I, LLC, two companies backed by equity commitments from funds managed by Quantum Energy Partners. As part of the resolution, Quantum is required to relinquish any rights to a seat on EQT’s board, forgo the acquisition of a board seat on seven other natural gas producers active in the Appalachian Basin, and dissolve a separate, pre-existing joint venture between EQT and Quantum, among other commitments. The announcement is a reminder that companies must continue to be mindful of potential Clayton Act Section 8 concerns when considering mergers and other combinations.

Background

An interlocking directorate—where competing firms share common officers or directors—raises potential antitrust concerns because of the perceived risk that the officer or director may serve as the conduit for an anticompetitive agreement or an exchange of competitively sensitive information.

The agencies have dramatically ratcheted up the frequency and tenor of their warnings on Section 8 compliance. As discussed in a prior Client Alert,[1] DOJ Antitrust Division head Jonathan Kanter promised in an April 2022 speech to bring litigation to break up alleged interlocks. In 2019, the FTC published a blog post, Interlocking Mindfulness, on the need to avoid director interlocks, particularly where mergers or spin-offs are involved.[2]

Clayton Act, Section 8

Section 8 of the Clayton Act (15 U.S.C. § 19) is the primary vehicle by which the U.S. antitrust agencies police interlocking directorates. In general, the statute prohibits one person from being an officer (defined as an “officer elected or chosen by the Board of Directors”) or director at two companies that are “by virtue of their business and location of operation, competitors.” The agencies have asserted that “person” has a broader meaning than a natural person, and includes a single firm or other entity that “deputizes” an agent or agents to sit on boards of competing corporations.[3] Under this very broad construction, which remains untested in court and unclear in application, a single firm could be at risk of a Section 8 violation by appointing directors or officers of two competing corporations, even if different individuals are appointed.

Section 8 broadly defines “competitors” to include any two corporations where “the elimination of competition by agreement between them would constitute a violation of any of the antitrust laws.” Section 8 is broad and potentially applies where two competitors have an officer or director in common, subject to certain exceptions.

There are three potential safe harbors from Section 8 liability:

The competitive sales of either company are less than 2% of that company’s total sales;
The competitive sales of each company are less than 4% of that company’s total sales; or
The competitive sales of either company are less than $4,525,700 as of 2023.

While there are no penalties or fines imposed due to a Section 8 violation, the statute requires that the parties eliminate the interlock if a violation is found to have occurred. There is a one-year grace period to cure violations that develop after the interlock has occurred (e.g., competitive sales surpassing de minimis thresholds), provided the interlock did not violate Section 8 when it first occurred.

An antitrust investigation into a potential interlock may force the resignation of key officers or directors, lead to a consent settlement relating to Section 8 compliance, delay the closing of a proposed transaction, or trigger a broader examination of information sharing or possible collusion between the firms involved.

The Quantum-EQT Enforcement Action

Under the terms of the proposed transaction, which was announced in September 2022, EQT (the largest producer of natural gas in the Appalachian Basin) would acquire: 1) Quantum Energy’s Tug Hill, alleged to be the eleventh largest producer of natural gas in the Appalachian Basin, and 2) Quantum Energy’s XcL Midstream, which holds gas processing and transportation assets for production from Tug Hill’s assets. In exchange, Quantum would acquire up to 55 million EQT shares and the right to a seat on EQT’s board of directors. The parties contemplated that Quantum’s CEO, Wil VanLoh, would sit on EQT’s board.

After an extended investigation lasting almost twelve months, the FTC announced a proposed consent order clearing the transaction subject to the following commitments:

A prohibition on any Quantum-affiliated person serving on EQT’s board for 10 years (and vice versa);
A prohibition on any Quantum-affiliated person serving on the board of any of the seven largest producers of natural gas in the Appalachian Basin without FTC approval;
Divestiture of Quantum’s EQT shares, and a prohibition on acquisition of any additional shares without FTC approval;
Dissolution of EQT and Quantum’s The Mineral Company joint venture, which was a cooperative arrangement to acquire mineral rights in the Appalachian Basin that pre-dated the proposed transaction; and
Implementation by Quantum and EQT of an antitrust compliance program.

The action is notable in several respects.

First, despite Section 8’s textual limitation to corporations, the FTC’s analysis of the proposed consent order indicates that “Quantum is subject to the prohibition on interlocking directors and officers under Section 8 of the Clayton Act, despite Quantum’s limited liability and limited partnership corporate structure.”[4] If approved, this may mark the first instance (albeit in an uncontested settlement) in which Section 8 was applied to a non-corporate business structure and could have important ramifications for private equity firms such as Quantum.

Second, the case would mark the FTC’s first Section 8 enforcement action in 40 years. Section 8 has traditionally been enforced by DOJ, and the Quantum-EQT action suggests that both DOJ and FTC will act to enforce alleged Section 8 violations going forward.

Third, the complaint alleges that The Mineral Company joint venture and board seat arrangement are each an “unfair method of competition” in violation of Section 5 of the FTC Act. As discussed in a prior Client Alert,[5] the FTC issued a Policy Statement in November 2022 announcing its intent to expand enforcement of Section 5 of the FTC Act to a wide range of alleged anticompetitive conduct, including alleged interlocking directorates and anticompetitive joint ventures. The Quantum-EQT action may mark the first such instance of Section 5 being applied in this way following the November 2022 Policy Statement.

Section 8 Compliance in the Current Regulatory Environment

Companies should take reasonable steps to detect interlocks before they occur and monitor existing ones to ensure they comply with current Section 8 safe harbors.

Companies whose directors or officers are being considered for an outside position should first evaluate the position for potential Section 8 concerns. Where a company’s director or officer holds an outside position at another firm subject to a safe harbor due either to a lack of competition or a de minimis overlap, counsel should reevaluate the relationship periodically to ensure marketplace developments do not cause the position to run afoul of Section 8. This can occur because of growing sales in existing overlaps or entry into new lines of business. These checks can be incorporated as part of existing director/officer independence analyses.

Companies engaged in financial transactions, such as spin-offs where the parent’s directors or officers may hold positions at the spin-off, should check whether the parent and the spin-off may compete in any line of business and evaluate potential Section 8 issues.

Private equity firms holding board seats or appointing leadership in multiple portfolio companies should evaluate whether any could be considered “competitors” for Section 8 purposes.

Expect DOJ and FTC to continue to push expanded interpretations of Section 8 that strain precedent and look beyond the individuals themselves who sit on a board of directors and look instead to the companies appointing them and/or whether those directors have affiliations that might trigger antitrust scrutiny.

Other antitrust statutes, particularly Section 1 of the Sherman Act (which prohibits agreements that unreasonably restrain trade), but possibly now Section 5 of the FTC Act, continue to apply even if the interlock is within Section 8 safe harbors. A sound antitrust compliance plan will therefore also establish reasonable procedures to prevent sharing of competitively sensitive information, among other things.

____________________________

[1] https://www.gibsondunn.com/doj-antitrust-division-head-promises-litigation-to-break-up-director-interlocks/.

[2] Michael E. Blaisdell, Interlocking Mindfulness, June 26, 2019, available at: https://www.ftc.gov/enforcement/competition-matters/2019/06/interlocking-mindfulness.

[3] Interlocking Mindfulness (Section 8 “prohibits not only a person from acting as officer or director of two competitors, but also any one firm from appointing two different people to sit as its agents as officers or directors of competing companies”).

[4] Analysis of Agreement Containing Consent Order to Aid Public Comment, In the Matter of EQT Corp., File No. 221-0212, available at: https://www.ftc.gov/system/files/ftc_gov/pdf/2210212eqtquantumaapc.pdf.

[5] https://www.gibsondunn.com/ftc-announces-broader-vision-of-its-section-5-authority-to-address-unfair-methods-of-competition/.

The following Gibson Dunn lawyers prepared this client alert: Michael Piazza, Rahul Vashi, Chris Wilson, and Zoë Hutchinson.

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, Mergers and Acquisitions, Private Equity, or Oil and Gas practice groups, the authors, or the following practice leaders:

Antitrust and Competition Group:
Rachel S. Brass – San Francisco (+1 415-393-8293, [email protected])
Stephen Weissman – Washington, D.C. (+1 202-955-8678, [email protected])

Mergers and Acquisitions Group:
Robert B. Little – Dallas (+1 214-698-3260, [email protected])
Saee Muzumdar – New York (+1 212-351-3966, [email protected])

Private Equity Group:
Richard J. Birns – New York (+1 212-351-4032, [email protected])
Ari Lanin – Los Angeles (+1 310-552-8581, [email protected])
Michael Piazza – Houston (+1 346-718-6670, [email protected])

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

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice. Please note, prior results do not guarantee a similar outcome.

Originally published by Bloomberg Law

After years of speculation and thwarted efforts to regulate US foreign investments in critical technologies, the White House and Congress took unprecedented steps the last two weeks to safeguard national security by regulating outbound investments.

Organizations will soon face new transaction disclosure requirements and prohibitions on transactions in certain sectors implicating national security.

The Biden administration’s August 9 executive order brings clarity and uncertainty alongside efforts in Congress to include the Outbound Investment Transparency Act as an amendment to the must-pass National Defense Authorization Act.

Gibson Dunn’s lawyers analyze recent federal and congressional moves to ramp up scrutiny of outbound investments in technology and other sectors impacting national security.

Read More

Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, [email protected])
Amanda H. Neely – Washington, D.C. (+1 202-777-9566, [email protected])
Chris R. Mullen – Washington, D.C. (+1 202-955-8250, [email protected])
Hugh N. Danilack – Washington, D.C. (+1 202-777-9536, [email protected])

Multinationals doing business in Asia are facing unique compliance risks arising from the rapidly evolving regulatory and geopolitical landscape in the region. Please join us for a discussion on how companies can navigate the compliance risks of doing business in Asia.

A panel of Gibson Dunn lawyers provides a comprehensive walkthrough of the compliance due diligence process in cross-border transactions and offer insights on strategies to effectively mitigate the compliance risks associated with cross-border transactions. The panel discusses recent FCPA enforcement actions that highlight internal audit’s role in identifying, communicating and addressing potential compliance issues within a company, and outlines practical steps that companies can take to ensure their compliance programs align with regulators’ expectations and industry best practices.

Topics discussed include:

How to Conduct Compliance Due Diligence
Key Risk Areas and Compliance Expectations
Diligence Considerations in M&A Transactions
Internal Audits
Recommended Best Practices

PANELISTS:

Kelly Austin leads the Gibson, Dunn & Crutcher LLP White Collar Defense and Investigations Practice Group in Asia and is a global co-chair of the firm’s Anti-Corruption and FCPA Practice Group. She is a partner in the firm’s Denver office and a partner (non-resident) in the Hong Kong office. Kelly served as Partner in Charge of the Hong Kong office from 2012 to 2022 and has twice served as a member of the firm’s Executive Committee. Her practice focuses on investigations, regulatory compliance and international disputes. She has extensive expertise in government and corporate internal investigations, including those involving the Foreign Corrupt Practices Act and other anti-corruption laws, and anti-money laundering, securities, and trade control laws. Kelly also regularly guides companies on creating and implementing effective compliance programs. Ms. Austin graduated with distinction with a Bachelor of Arts degree from the University of Virginia and received her law degree from Georgetown University. She is a member of the bars of Colorado, Virginia and the District of Columbia, and is admitted to practice in a variety of district and appellate courts in the United States. She is also admitted to practice as a solicitor in Hong Kong.

Oliver D. Welch is a resident partner in the Hong Kong office and a partner in the Singapore office of Gibson, Dunn & Crutcher. He is a member of the firm’s Litigation and White Collar Defense and Investigations Departments. Mr. Welch has extensive experience representing clients throughout the Asia region on a wide variety of compliance and anti-corruption issues. His practice focuses on internal and regulatory investigations, including those involving the Foreign Corrupt Practices Act (FCPA). He regularly counsels multi-national corporations regarding their anti-corruption compliance programs and controls, and assists clients in drafting policies, procedures, and training materials designed to foster compliance with global anti-corruption laws. Mr. Welch frequently advises on anti-corruption due diligence in connection with corporate acquisitions, private equity investments, and other business transactions. Mr. Welch received his law degree cum laude from the University of Michigan Law School, where he was an Executive Editor of the Michigan Law Review. Mr. Welch speaks Korean.

Bonnie Tong is an associate in Hong Kong. She is a member of the firm’s Litigation and White Collar Defense and Investigations, as well as the Antitrust and Competition Practice Groups. Prior to joining the firm, Bonnie worked at the United Nations Headquarters in New York City and the American Bar Association Rule of Law Initiative in Washington, D.C., specializing in international law and human rights law. She completed her training contract at an international firm in Hong Kong and served as a law clerk to the Justices at the Court of Final Appeal. Bonnie received her Bachelor of Laws degree with honors from the University of Hong Kong in 2009, where she was a member of the Dean’s List. She earned her Master of Laws degrees from Columbia University in 2016 as a James Kent Scholar and Georgetown University in 2014 with Distinction and was placed on the Dean’s List. Bonnie is admitted to practice in Hong Kong. She is fluent in Mandarin and Cantonese.

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Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.0 ethics hour.

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Neither the Connecticut Judicial Branch nor the Commission on Minimum Continuing Legal Education approve or accredit CLE providers or activities. It is the opinion of this provider that this activity qualifies for up to 1.0 hour toward your annual CLE requirement in Connecticut, including 1.00 hour(s) of ethics/professionalism.

Application for approval is pending with the Colorado, Virginia, Texas and Washington State Bars.

The Second Circuit decertified the class in Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., concluding that the Defendants rebutted the presumption of reliance with evidence that the generic alleged misstatements had not impacted the company’s stock price.

The decision turned on the court’s application of the Supreme Court’s 2021 decision in the same dispute. There, the Supreme Court observed that where 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 in deciding whether defendants have rebutted the presumption. Goldman Sachs Grp., Inc. v. Ark. Tchr. Ret. Sys., 141 S. Ct. 1951, 1961 (2021) (“Goldman”). Applying this guidance, the Second Circuit held that the “mismatch” between generic statements and a highly specific disclosure was sufficient to “sever the link” between the statements and the stock price drop. Ark. Tchr. Ret. Sys. v. Goldman Sachs Grp., Inc, — F.4th —-, 2023 WL 5112157, at *21, 24 (2d Cir. 2023) (“ATRS”).

Background

Securities class actions can only proceed on a class-wide basis when plaintiffs can avail themselves of the presumption of reliance. See Basic Inc. v. Levinson,485 U.S. 224, 242–43, 246–47 (1988). The presumption applies when plaintiffs purchase stock that trades in an efficient market, and the theory is that anyone purchasing the stock implicitly relies on all public, material information incorporated into the current price. Id. at 247. Without the presumption of reliance, plaintiffs must prove that each individual class member relied on the alleged misstatements when deciding to purchase stock. In Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014), the Supreme Court held defendants could rebut the presumption with evidence showing the statements did not impact the stock’s price.

This dispute spans more than a decade, has been presented to the Second Circuit four times, and reached the Supreme Court. Plaintiffs allege that the Defendants made false and misleading general statements about Goldman Sachs’ business principles and conflict-of-interest management procedures and that the “truth” was “revealed” through announcements about regulatory enforcement actions and investigations into certain transactions. Goldman Sachs’ stock price did not go up when the challenged statements were made. It did drop following the alleged corrective disclosures.

At class certification, Plaintiffs invoked the presumption of reliance. Defendants presented expert evidence showing that (1) dozens of pre-corrective disclosure statements criticizing the company’s conflicts practices did not cause the stock price to drop, and that (2) the stock drops were caused by news of regulatory actions not a correction of the challenged statements. They also argued that the statements were so generic they could not impact Goldman Sachs’ stock price.

In 2021, the Supreme Court held that courts should consider the genericness of challenged statements at the class certification stage. Goldman, 141 S. Ct. at 1960–61. The Court also observed that where plaintiffs are proceeding on an “inflation maintenance” theory—meaning they are using a stock drop that occurred when a statement is allegedly corrected rather than an increase when the statement was made to show the statement’s price impact—the court should consider whether the statement and the correction sufficiently “match.” Id. The severity of the mismatch between the two may call into question whether the price movement is attributable to the challenged statement. Id.

After the Supreme Court’s decision, the Second Circuit remanded the case to the district court, which certified the proposed class again. The Second Circuit has now reversed the class certification order and remanded with instructions to decertify the class.

Issue

Whether the district court erred in rejecting Goldman Sachs’ argument that the specific alleged corrections were insufficiently “matched” to the generic challenged statements for the drop accompanying the alleged correction to reflect the statement’s “price impact.”

Court’s Holding

The Second Circuit held the district court misapplied inflation maintenance theory, reasoning that the match between the challenged statements and the corrective disclosure was insufficient. The court concluded when a plaintiff relies on inflation maintenance theory, it cannot simply “identify a specific back-end, price-dropping event” and match it to “a front-end disclosure bearing on the same subject” unless “the front-end disclosure is sufficiently detailed in the first place.” ATRS, 2023 WL 5112157, at *21. Instead, the specificity of the statement and alleged correction must “stand on equal footing.” Id. The Second Circuit also noted that in conducting the “mismatch” analysis, other indirect evidence of price impact could be considered, including whether there was “pre- or post-disclosure discussion in the market regarding a generic front-end misstatement.” Id. at *22.

Applying these principles, the Second Circuit concluded 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.” Id. at *24.

What It Means

The Second Circuit has confirmed with this opinion that the opportunity to rebut the presumption of reliance to defeat class certification in a securities class action is meaningful. Where the only connection between vague challenged statements and specific, severe alleged corrective disclosures is the general subject matter, the case is not appropriate for class certification because there is no common method of proving shareholders relied on the vague statements.
The majority also concluded that for purposes of assessing price impact at class certification, there must be a “closer fit (even if not precise) between the front- and back-end statements” than would be required to establish loss causation. Id. at *18 n.11.
The majority considered each of defendants’ arguments separately while Judge Richard J. Sullivan, who dissented from the Second Circuit’s 2020 decision affirming an earlier certification order, advocated for a more holistic evaluation. Id. at *24 (Sullivan, J., concurring).
We will continue to monitor how courts apply the Supreme Court’s guidance in assessing whether defendants have presented sufficient evidence to rebut the presumption of reliance.

The Second Circuit’s opinion is available here.

The following Gibson Dunn attorneys assisted in preparing this client update: Monica Loseman, Lissa Percopo, and Lydia Lulkin.

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

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

Brian M. Lutz – San Francisco/New York (+1 415-393-8379/+1 212-351-3881, [email protected])

Craig Varnen – Los Angeles (+1 213-229-7922, [email protected])

On August 9, 2023, the Biden Administration issued its long-awaited Executive Order (“EO”)[1] outlining controls on outbound U.S. investments in certain Chinese entities, although without imposing any immediate new legal obligations or restrictions. Uniquely, this EO was accompanied by an Advance Notice of Proposed Rulemaking (“ANPRM”)[2] issued by the U.S. Department of the Treasury (“Treasury”), the agency tasked with primary implementation authority for the EO. The ANPRM provides further details about the contours of the potential requirements and restrictions to come, but seeks significant public input to assist in the crafting of the final text of the forthcoming regulations, which could still be months away from actual implementation.

The proposed new restrictions largely track recent reports that the Biden Administration would focus on a narrow set of high technology sectors, imposing an outright ban on a small set of transactions and requiring notification to the U.S. government on a broader set of others. Specifically, the Administration’s directive focuses on direct and indirect investments by “U.S. persons” in a “covered foreign person,” which the EO and ANPRM define to consist of Chinese, Hong Kong and Macau entities engaged in the business of targeted “national security technologies and products” (all terms defined and discussed below). As anticipated, the targeted sectors include:

Semiconductors and Microelectronics;
Quantum Information Technologies; and
Artificial Intelligence (“AI”) Systems.

The text of the EO makes clear that these efforts are directly intended to combat efforts by countries of concern to “eliminate barriers between civilian and commercial sectors and military and defense industrial sectors, not just through research and development, but also by acquiring and diverting the world’s cutting-edge technologies, for the purposes of achieving military dominance.”[3]

It is critical to consider these new proposed regulations within the context of, and as a further outgrowth of, the broader geopolitical tensions between the United States and its allies and China. This proposed regime is just one of a number of levers of economic statecraft that the United States has used and almost certainly will continue using pursuant to its overall national security strategy vis-a-vis China. As such, while there are wholly unique elements to this program, distinct from traditional trade controls imposed by the United States (e.g., export controls on commodities, software, and technology; U.S. sanctions programs restricting transactions with specified parties or regions; and inbound foreign direct investment controls under the Committee on Foreign Investment in the United States (“CFIUS”)),[4] these proposed outbound investment rules draw to a large extent upon elements from each of these other regulatory regimes, but create another layer and channel of controls, specifically targeting the flow of capital and intangible benefits—identified in the ANPRM as “managerial assistance, access to investment and talent networks, market access, and enhanced access to additional financing”[5]—that often accompany such investments to sectors of the Chinese economy that are perceived as threats to the national security of the United States.

As such, these additional rules should be viewed holistically with other trade-related regulations, and will no doubt add to the complexity of the compliance challenges facing companies today. As just one example, while these proposed rules contemplate an exception for certain investments in publicly traded securities or exchange-traded funds (“ETFs”) (discussed below), other active U.S. sanctions against certain Chinese companies currently listed on the Office of Foreign Assets Control’s Non-SDN Chinese Military-Industrial Complex Companies List prohibit U.S. persons from engaging in “the purchase or sale of any publicly traded securities, or any publicly traded securities that are derivative of such securities or are designed to provide investment exposure to such securities” of the named companies.[6] As this example illustrates, companies must view contemplated business activity through multiple regulatory lenses, including these new rules, once implemented.

When Do the Proposed New Rules Come Into Effect?

There is no effective date set as of yet, and considering both the extended timeline which comes with a proposed rulemaking process, as well as the broad list of 83 specific questions which Treasury has posed to the public for comment in this first set of proposed rules, we anticipate that it may be some time before the final rules are implemented.

As noted above, neither the EO nor the ANPRM directly implements new restrictions or obligations. Rather, drawing upon the authority granted to the President in the International Emergency Economic Powers Act (“IEEPA”)[7] and the National Emergencies Act,[8] the EO directs the U.S. Secretary of the Treasury, in coordination with the Department of Commerce and other heads of U.S. government departments and agencies, to issue regulations giving effect to the requirements outlined in the EO.

This is somewhat of a unique approach in the context of an IEEPA-based EO, which is explicitly designed to afford the Executive Branch the ability to implement rules quickly in response to a national emergency, without proceeding through the standard administrative stages.

In terms of next steps, the corresponding ANPRM opens a 45-day window to allow for public comment that is scheduled to close on September 28, 2023. At some undefined point after public comments are received and digested, Treasury will issue a Proposed Notice of Rulemaking setting out the near-final version of the regulations and allowing for one more period of public comment. The actual rules will come into effect at some point after that public comment period ends, which is very likely months away.

In broad strokes, the EO and accompanying proposed rules aim to establish a program that will:

Prohibit “U.S. persons” from directly or indirectly entering into certain types of transactions with a “covered foreign person” engaged in activities involving the specified “covered national security technologies and products”; and
Require notification to Treasury by “U.S. persons” who directly or indirectly enter into the same types of transactions for a broader set of defined “covered national security technologies and products.”[9]

Below we address each of these key defined elements in more detail, as well as discuss some of the currently proposed exceptions.

To Whom Do the Rules Apply?

The ANPRM proposes to adopt the definition of “U.S. person” set out in the EO, which comports with the standard definition in U.S. sanctions practice, and includes “any United States citizen, lawful permanent resident, entity organized under the laws of the United States or any jurisdiction within the United States, including any foreign branches of any such entity, and any person in the United States.”[10] Notably, this definition does not include foreign subsidiaries of U.S. businesses directly, but the ANPRM proposes rules that would place obligations on U.S. parents, or other controlling U.S. entities, to enforce the rules at their non-U.S. controlled entities.

Specifically, the ANPRM anticipates requiring U.S. persons to (1) notify Treasury of “any transaction by a foreign entity controlled by such United States person that would be a notifiable transaction if engaged in by a United States person” and (2) “take all reasonable steps to prohibit and prevent any transaction by a foreign entity controlled by such United States person that would be a prohibited transaction if engaged in by a United States person.”[11] Such reasonable steps could explicitly include the following:

Relevant binding agreements between a U.S. person and the relevant controlled foreign entity or entities;
Relevant internal policies, procedures, or guidelines that are periodically reviewed internally;
Implementation of periodic training and internal reporting requirements;
Implementation of effective internal controls;
Testing and auditing function; and
The exercise of governance or shareholder rights, where applicable.[12]

Treasury proposes to define “controlled foreign entity” as “a foreign entity in which a U.S. person owns, directly or indirectly, a 50 percent or greater interest.”[13]

In addition, the EO calls for prohibitions on U.S. persons “knowingly directing” transactions which would be prohibited for a U.S. person to conduct itself.[14] The ANPRM proposes to define this standard to capture actions where a U.S. person “orders, decides, approves, or otherwise causes to be performed a transaction that would be prohibited under these regulations if engaged in by a U.S. person,” and the U.S. person has “actual knowledge, or should have known, about the conduct, the circumstance, or the result.”[15] Sanctions practitioners may note this appears to be very similar to the standard anti-”facilitation” provisions found in most U.S. sanctions regulations, although notably here, the standard for liability is knowledge.

The EO and ANPRM also contain prohibitions against any activity, whether engaged in by U.S. or non-U.S. persons, designed to evade the rules or which cause a violation of the rules. An open question at this point is whether, and to what extent, such “causation” provisions create diligence obligation on foreign funds or other entities which are not controlled by U.S. persons but in which U.S. persons are invested.

Importantly, the ANPRM envisions excluding “the provision of a secondary, wraparound, or intermediary service or services such as third-party investment advisory services, underwriting, debt rating, prime brokerage, global custody, or the processing, clearing, or sending of payments by a bank, or legal, investigatory, or insurance services,” which is a narrower range of restrictions than afforded in the EO.[16]

Do the Proposed Rules Only Impact Investments in China? Who Is a “Covered Foreign Person” and What Is a “Country of Concern”?

While the final rules are likely to have wide impact on the covered sectors, the annex to the EO makes the target of these restrictions clear, specifically naming the People’s Republic of China, including the Special Administrative Regions of Hong Kong and Macau, as the only “country of concern” identified to date.[17] This approach aligns with the Biden Administration’s description of China as its “pacing challenge” in its recent National Security Strategy.[18] While the structure of the ANPRM allows for the addition of other countries in the future, the recent actions are clearly targeted at stemming the flow of capital and accompanying intangible benefits to China in the targeted sectors of national security concern. These efforts are expected to work in tandem with the Biden Administration’s implementation of expansive export controls on semiconductor manufacturing technology, advanced integrated circuits, and supercomputers in October 2022.[19] Through both efforts, the focus has clearly been to target China’s civil-military fusion through which critical technologies and products are used to aid in the development of China’s military, intelligence, surveillance, and cyber-enabled capabilities.[20]

Treasury has proposed to define “covered foreign person” to mean:

A “person of a country of concern” that is engaged in, or a “person of a country of concern” that a U.S. person knows or should know will be engaged in, an identified activity with respect to a “covered national security technology or product”; or
A person whose direct or indirect subsidiaries or branches are referenced in item (1) and which, individually or in the aggregate, comprise more than 50 percent of that person’s consolidated revenue, net income, capital expenditure, or operating expenses.[21]

The definition of “person of a country of concern” under consideration by Treasury is broad, and would include the following:

Any individual that is not a U.S. citizen or lawful permanent resident of the United States and is a citizen or permanent resident of a “country of concern”;
An entity with a principal place of business in, or an entity incorporated in or otherwise organized under the laws of a “country of concern”;
The government of a “country of concern,” including any political subdivision, political party, agency, or instrumentality thereof, or any person owned, controlled, or directed by, or acting for or on behalf of the government of such “country of concern”; or
Any entity in which a person or persons identified in items (1) through (3) holds individually or in the aggregate, directly or indirectly, an ownership interest equal to or greater than 50 percent.[22]

Importantly, Treasury is seeking comment on whether these definitions should be changed or elaborated upon and what the impact, intended or not, of the definitions as they stand could be.

What Constitutes a “Covered Transaction”?

The definition of “covered transaction” would apply equally to “prohibited transactions” and “notifiable transactions” discussed in detail below and, as proposed, would include a U.S. person’s direct or indirect:

Acquisition of an equity interest or contingent equity interest in a covered foreign person;
Provision of debt financing to a covered foreign person where such debt financing is convertible to an equity interest;
Greenfield investment that could result in the establishment of a covered foreign person; or
Establishment of a joint venture, wherever located, that is formed with a covered foreign person or could result in the establishment of a covered foreign person.[23]

In a departure from most sanctions programs administered by Treasury, which typically apply a strict liability standard, the ANPRM states that a “knowledge standard” could be adopted across the program.[24] Borrowing from the knowledge standard most often employed by the Department of Commerce’s Bureau of Industry and Security in the context of export controls, a U.S. person would “need to know, or reasonably should know” from an appropriate amount of due diligence, “that it is undertaking a transaction involving a covered foreign person and that the transaction is a covered transaction.”[25] Importantly, knowledge would also be inferred from a conscious or willful avoidance of facts.[26]

Additionally, the application of this definition will not be retroactive and will not cover “transactions and the fulfillment of uncalled, binding capital commitments with cancellation consequences made prior to the issuance” of the EO.[27] The ANPRM does, however, forewarn that in order to further develop the outbound investment program, Treasury may request information from U.S. persons concerning transactions that were “completed or agreed to after the date of the issuance of the [EO].”[28] Moreover, the ANPRM clearly articulates Treasury’s focus on targeting indirect transactions and attempts to evade the restrictions through the use of third parties as conduct that will be prohibited, citing the example of a “U.S. person knowingly investing in a third-country entity that will use the investment to undertake a transaction with a covered foreign person that would be subject to the program if engaged in by a U.S. person directly.”[29]

While the breadth of covered transactions may at first glance seem daunting, the ANPRM proposes the following activities will be excluded from the operative definition, so long as they do not clearly meet the definitional elements and are not undertaken for the purpose of evasion:

University-to-university research collaborations;
Contractual arrangements or the procurement of material inputs for any of the “covered national security technologies or products” (such as raw materials);
Intellectual property licensing arrangements;
Bank lending;
Processing, clearing, or sending of payments by a bank;
Underwriting services;
Debt rating services;
Prime brokerage;
Global custody;
Equity research or analysis; or
Other services secondary to a transaction.[30]

“Excepted transactions,” discussed in more detail below, would also be excluded.

Based on the above exclusions, financial institutions may be able to continue to provide certain financial services to a “covered foreign person,” potentially including certain capital market activities such as advising on, underwriting, or carrying out an initial public offering. The ANPRM notes that Treasury is considering excluding some of these activities (such as third-party investment advisory services and underwriting) from the definition of “directing” for the purpose of the prohibition on U.S. persons “knowingly directing transactions.”[31] These exclusions suggest that Treasury does not intend to significantly restrict the ability of financial institutions to provide services to “covered foreign persons” provided that they avoid the express prohibitions outlined above. For example, ordinary bank lending may ultimately be unaffected, provided the bank ensures that under no circumstances will it acquire an equity interest in a “covered foreign person” as a result of the lending (e.g., the bank declines to take a charge over equity in a “covered foreign person” as security for a loan).

Questions undoubtedly remain, and Treasury seeks further input on what types of transactions will ultimately fall within the definition of “covered transactions,” as well as how to address debt financing, unintended impacts on investment flows, the role of follow-on transactions, and what secondary or intermediary services may be captured under the proposed definition, among other topics.

What are the “Covered National Security Technologies and Products” That Fall Within “Covered Transactions”? Which Transactions Will Be Prohibited and Which Will Be Subject to Notification Requirements?

As noted above, the ANPRM envisions an outright prohibition on “U.S. persons” undertaking “covered transactions” with “covered foreign persons” engaged in specified activities related to “covered national security technologies and products,” while imposing a notification requirement for others.

The EO defines “covered national security technologies and products” to mean sensitive technologies and products in the following sectors: (1) semiconductors and microelectronics, (2) quantum information technologies, and (3) AI capabilities, that are “critical for the military, intelligence, surveillance or cyber-enabled capabilities of a country of concern.”[32] This language clearly indicates that the end-use of a technology or product will, therefore, be relevant in determining if the transaction constitutes a “covered transaction” involving “covered national security technologies and products.” For example, an AI product that exclusively has commercial marketing uses would be unlikely to fall within the definition of “covered national security technologies and products,” as the ANPRM clearly acknowledges that the definition “may be limited by reference to certain end uses of those technologies or products,” as applicable.[33]

The specific technologies and products that are expected to fall within the new restrictions are set out in the table below:

Semiconductors and Microelectronics[34]

Proposed Notifiable Transactions

Proposed Prohibited Transactions

(1) Integrated Circuit Design: The design of integrated circuits for which transactions involving U.S. persons are not otherwise prohibited.

(2) Integrated Circuit Fabrication: The fabrication of integrated circuits for which transactions involving U.S. persons are not otherwise prohibited.

(3) Integrated Circuit Packaging: The packaging of integrated circuits for which transactions involving U.S. persons are not otherwise prohibited.

(1) Technologies that Enable Advanced Integrated Circuits

Software for Electronic Design Automation: The development or production of electronic design automation software designed to be exclusively used for integrated circuit design.
Integrated Circuit Manufacturing Equipment: The development or production of front-end semiconductor fabrication equipment designed to be exclusively used for the volume fabrication of integrated circuits.

(2) Advanced Circuit Design and Production

- Advanced Integrated Circuit Design: The design of integrated circuits that exceed the thresholds in Export Control Classification Number (“ECCN”) 3A090, or integrated circuits designed for operation at or below 4.5 Kelvin.
- Advanced Integrated Circuit Fabrication: The fabrication of integrated circuits (defined as the process of forming devices such as transistors, poly capacitors, non-metal resistors, and diodes, on a wafer of semiconductor material) that meet any of the following criteria:

(i) Logic integrated circuits using a nonplanar transistor architecture or with a technology node of 16/14 nanometers or less, including but not limited to fully depleted silicon-on-insulator (FDSOI) integrated circuits;

(ii) NOT-AND (NAND) memory integrated circuits with 128 layers or more;

(iii) Dynamic random-access memory (DRAM) integrated circuits using a technology node of 18 nanometer half-pitch or less;

(iv) Integrated circuits manufactured from a gallium-based compound semiconductor;

(v) Integrated circuits using graphene transistors or carbon nanotubes; or

(vi) Integrated circuits designed for operation at or below 4.5 Kelvin.

Advanced Integrated Circuit Packaging: The packaging of integrated circuits that support the three-dimensional integration of integrated circuits, using silicon vias or through mold vias, where “packaging of integrated circuits” is defined as the assembly of various components, such as the integrated circuit die, lead frames, interconnects, and substrate materials, to form a complete package that safeguards the semiconductor device and provides electrical connections between different parts of the die.

(3) Supercomputers: The installation or sale to third-party customers of a supercomputer, which are enabled by advanced integrated circuits, that can provide a theoretical compute capacity of 100 or more double-precision (64-bit) petaflops or 200 or more single-precision (32-bit) petaflops of processing power within a 41,600 cubic foot or smaller envelope.

Quantum Information Technologies[35]

Proposed Notifiable Transactions

Proposed Prohibited Transactions

None are currently contemplated.

(1) Quantum Computers and Components: The production of a quantum computer (defined as a computer that performs computations that harness the collective properties of quantum states, such as superposition, interference, or entanglement), dilution refrigerator, or two-stage pulse tube cryocooler.

(2) Quantum Sensors: The development of a quantum sensing platform designed to be exclusively used for military end uses, government intelligence, or mass-surveillance end uses.

(3) Quantum Networking and Quantum Communication Systems: The development of a quantum network or quantum communication system designed to be exclusively used for secure communications, such as quantum key distribution.

AI Systems[36]
Proposed Definition: The ANPRM acknowledges the continued difficulty with defining AI and proposes to limit the restrictions to those transactions involving an “AI system,” defined as “an engineered or machine-based system that can, for a given set of objectives, generate outputs such as predictions, recommendations, or decisions influencing real or virtual environments. AI systems are designed to operate with varying levels of autonomy.”[37]
Proposed Notifiable Transactions	Proposed Prohibited Transactions
The development of software that incorporates an AI system and is designed to be exclusively used for: (i) Cybersecurity applications, digital forensics tools, and penetration testing tools; (ii) The control of robotic systems; (iii) Surreptitious listening devices that can intercept live conversations without the consent of the parties involved; (iv) Non-cooperative location tracking (including international mobile subscriber identity (IMSI) Catchers and automatic license plate readers); or (v) Facial recognition. The ANPRM also contemplates the phrasing “primarily used” in lieu of “exclusively used.”	The development of software that incorporates an AI system and is designed to be exclusively used for military, government intelligence, or mass-surveillance end uses. The ANPRM also contemplates the phrasing “primarily used” in lieu of “exclusively used.”

Of the 83 questions posed by Treasury in the ANPRM, 23 are directed at defining the semiconductors and microelectronics, quantum information technologies, and AI systems that should fall within the proposed restrictions, clearly indicating that the categories and subcategories of “covered national security technologies and products” are likely to change in the final rule and are notably areas in which Treasury is actively seeking public participation.

Treasury is also seeking comment on whether investment by U.S. persons in these areas may provide a strategic benefit to U.S. national security and whether modifications should be made to the technical scope and definitions under consideration.

For transactions falling within the notification requirements, Treasury is proposing that U.S. persons must file the required notifications “no later than 30 days following the closing of a covered transaction.”[38] As currently envisioned, notifications would require, at minimum, the following information:

The identity of the person(s) engaged in the transaction and nationality (for individuals) or place of incorporation or other legal organization (for entities);
Basic business information about the parties to the transaction, including name, location(s), business identifiers, key personnel, and beneficial ownership;
The relevant or expected date of the transaction;
The nature of the transaction, including how it will be effectuated, the value, and a brief statement of business rationale;
A description of the basis for determining that the transaction is a “covered transaction”—including identifying the “covered national security technologies and products” of the “covered foreign person”;
Additional transaction information including transaction documents, any agreements or options to undertake future transactions, partnership agreements, integration agreements, or other side agreements relating to the transaction with the “covered foreign person” and a description of rights or other involvement afforded to the “U.S. person(s)”;
Additional detailed information about the “covered foreign person,” which could include products, services, research and development, business plans, and commercial and government relationships with a “country of concern”;
A description of due diligence conducted regarding the investment;
Information about previous transactions made by the “U.S. person” into the “covered foreign person” that is the subject of the notification, as well as planned or contemplated future investments into such “covered foreign person”; and
Additional details and information about the “U.S. person,” such as its primary business activities and plans for growth.[39]

The information would be provided via a portal hosted on Treasury’s website (likely similar to Case Management System (“CMS”) currently used for CFIUS filings), and the ANPRM notes that Treasury is currently evaluating the “appropriate confidentiality requirements and restrictions around the disclosure of any information or documentary material submitted or filed” as part of the disclosure process.[40]

What Carveouts Are Contemplated? How Might This Impact Non-U.S. Funds That Accept Investors Who Are U.S. Persons?

Importantly, the proposed outbound investment regime is not a “catch and release” program, and in contrast to the mandatory filing requirements under CFIUS, Treasury has clearly stated that it is “not considering a case-by-case determination on an individual transaction basis as to whether the transaction is prohibited, must be notified, or is not subject to the program.”[41] Rather, the onus will be on the parties to a given transaction to determine whether the prohibitions or notification requirements apply.

Treasury is, however, contemplating a category of “excepted transactions” that present a lower likelihood of concern and would be excluded from the definition of “covered transactions.” Such “excepted transactions” would include:

Various types of common investments such as the following:
- Investments in publicly traded securities, index funds, mutual funds, ETFs, or similar instruments (including associated derivatives) offered by an investment company or by a private investment fund; and
- Solely passive investments by a limited partner (“LP”) into a venture capital fund, private equity fund, fund of funds, or other pooled investment funds below a de minimis threshold to be set by Treasury.
Acquisitions of equity or other interest owned or held by a “covered foreign person” in an entity or assets located outside of a “country of concern” where the “U.S. person” is acquiring all interests in the entity or assets held by “covered foreign persons”;
An intracompany transfer of funds from a U.S. parent company to a subsidiary located in a “country of concern”; or
A transaction made pursuant to a binding, uncalled capital commitment entered into before the date of the EO.[42]

Notwithstanding the above, if an investment described in (1) above provides a U.S. person rights beyond ordinary “minority shareholder protections” such investment will not be considered an “excepted transaction.”[43] Examples of such additional rights provided in the ANPRM include:

Membership or observer rights on, or the right to nominate an individual to a position on, the board of directors or an equivalent governing body of the “covered foreign person”; or
Any other involvement, beyond the voting of shares, in substantive business decisions, management, or strategy of the “covered foreign person.” [44]

The categories of “excepted transactions” are potentially quite broad and would allow U.S. persons to continue to invest, with some restrictions, in “covered foreign persons,” particularly where the investment is indirectly made through a fund. The exemptions above may be particularly relevant to managers of ETFs, some of which may have considerable exposure to certain “covered foreign persons” because such entities are included on an index tracked by the ETF.

The proposed new rules likely present some additional considerations for non-U.S. person general partners of non-U.S. private funds if the fund allows any U.S. person LPs. In such circumstances, the parties will likely need to consider how to diligence and negotiate investments and investment structures to obtain comfort that the U.S. investors do not run afoul of their legal obligations.

In addition to the “excepted transactions” discussed above, the ANPRM contemplates exempting transactions that are in the “national interest of the United States,” that may be allowed despite falling within the final restrictions.[45] Such transactions would be permitted if determined by the Secretary of the Treasury, in consultation with the heads of other agencies, as appropriate, that they would:

provide an extraordinary benefit to U.S. national security; or
provide an extraordinary benefit to the U.S. national interest in a way that overwhelmingly outweighs relevant U.S. national security concerns.[46]

Importantly, Treasury is not “considering granting retroactive waivers or exemptions (i.e., waivers or exemptions after a prohibited transaction has been completed).”[47]

What Will Enforcement Look Like and What Happens Next?

While the EO envisions both civil and criminal penalties for violations of the proposed regulations,[48] the ANPRM focuses on civil penalties, as is standard, with potential criminal activities being referred to the U.S. Department of Justice. The ANPRM proposes imposing penalties up to the maximum allowed under IEEPA (currently US $ 356,579 per violation)[49] for the following:

Material misstatements made in or material omissions from information or documentary material submitted or filed with Treasury;
The undertaking of a prohibited transaction; or
The failure to timely notify a transaction for which notification is required.[50]

Importantly, the EO also gives the Secretary of the Treasury the power to “nullify, void, or otherwise compel the divestment of any prohibited transaction entered into after the effective date of the regulations.”[51] Treasury has made clear that they will not look retroactively to transactions that were not prohibited at the time of their completion, but they reserve the right to request information from parties to cover investments that were completed subsequent to the effective date of the EO.[52]

As noted above, it will likely be some time before the final rules take shape. Even after the final rules are determined following the rounds of public comment anticipated over the next several months, the EO requires the Secretary of the Treasury to provide the President with a report on the effectiveness of the regulations and recommendations for improvement within one year of the issuance of the final rules, and at least annually thereafter.[53] And while not required, the EO also authorizes the Secretary of the Treasury “to submit recurring and final reports” to Congress, who, on their own accord, may also impose additional reporting requirements through separate legislation.[54] These reporting requirements indicate that the final restrictions are likely to be revised and fine-tuned over time to confront emerging national security threats and concerns voiced by industry.

How Does This Fit Into the Broader Global Context?

As widely reported, the Administration appears to have expended considerable effort to inform and engage U.S. allies in outlining the scope of the proposed restrictions. The Fact Sheet released by the U.S. Department of the Treasury specifically states that the Administration “engaged with U.S. allies and partners regarding its important national security goals, and will continue coordinating closely with them to advance these goals,” indicating that outbound investment regimes may be gaining traction in other jurisdictions as well.[55] For example, in March 2023, European Commission President Ursula von der Leyen stated that “Europe should develop a targeted instrument on outbound investment,”[56] and in May 2023, leaders at the G7 Summit in Hiroshima, Japan, issued a statement recognizing that “appropriate measures designed to address risks from outbound investment could be important to complement existing tools of targeted controls on exports and inbound investments, which work together to protect . . . sensitive technologies from being used in ways that threaten international peace and security.”[57]

In addition to rhetorical endorsement, the United States is not alone in taking steps to implement an outbound investment regime. In June 2023, the European Commission (“EC”) and the High Representative published a Joint Communication on a European Economic Security Strategy, which, according to the accompanying press release, called upon the EC to “examine, together with Member States, what security risks can result from outbound investments and on this basis propose an initiative” by the end of 2023.[58] Relatedly, in its recent Strategy on China, Germany acknowledged that in the context of investments in China, “appropriate measures that are designed to counter risks connected with outbound investment could be important as a supplement to existing instruments for targeted controls of exports and domestic investments.”[59] And following the announcement of the proposed rules, news outlets began reporting that the UK was closely watching the process and weighing whether it should follow suit with similar restrictions.[60]

Is Further Congressional Action Still Possible?

For months, both Republicans and Democrats in Congress have advocated for concrete actions to stem the flow of U.S. investments to China, particularly in industries of national security concern. Recently, the Senate voted 91 to 6 to include the Cornyn-Casey Outbound Investment Transparency Act as an amendment to the must-pass National Defense Authorization Act (the “Cornyn-Casey Amendment”).[61] This amendment would require U.S. companies to notify the federal government 14 days before investing in sensitive technologies in China if the activity is not a secured transaction, and within 14 days of the activity if it is a secured transaction. The covered sectors are broader than those contemplated by the Biden Administration and would include (1) advanced semiconductors and microelectronics; (2) AI; (3) quantum information science and technology; (4) hypersonics; (5) satellite-based communications; and (6) networked laser scanning system with dual-use applications. Even prior to the Administration’s recent actions, the Cornyn-Casey amendment faced headwinds from key players in both parties, with some arguing that tougher measures were needed and others claiming that such measures would be ineffective at best and advantageous to China at worst. While the legislative fate of the Cornyn-Casey Amendment and other similar measures remains to be seen in light of the actions taken by the White House, additional action by Congress in this space cannot be wholly discounted and may indeed be compatible with the Biden Administration’s proposed regulations.

What are the Next Steps in the Regulatory Process?

The ANPRM provides useful insight into the likely scope and scale of the final regulations and seeks comments from the public on the final text, including 83 specific questions with which Treasury seeks input. Comments may be submitted by mail or through the Government eRulemaking portal (Regulations.gov) and must be received by September 28, 2023. Commenters have the opportunity to provide empirical data and analysis to support their view on “the relative benefits and costs of the recommended approach.”[62] Written comments can be supplemented with requests to meet with the Treasury Department to engage in discussions on the stakeholders’ views.

Following the end of the ANPRM’s notice and comment period, Treasury must issue a Notice of Proposed Rulemaking (“NPRM”) which signals the beginning of the standard notice-and-comment procedure. The NPRM will be published in the Federal Register and will include either the text of the proposed rule or a more detailed description of its content. A public comment period will be announced, which usually lasts at least 30 days, though this period can be significantly longer, depending on the issue’s complexity. During the public comment period, members of the public usually have the opportunity to respond to one another’s comments. Once the public comment period has expired, formal regulations are expected to follow.

What Steps Can Companies Take to Prepare for the Proposed New Regulations?

In light of these recent developments, companies contemplating outbound investments in sensitive technologies should take stock of their current position so they are prepared to act as regulations are finalized and in order to minimize the risk of becoming a target of congressional or executive branch inquiry. Specific steps companies should take include:

Provide Written Comments: As part of the notice-and-comment period, the U.S. Department of the Treasury is actively soliciting public opinion on the proposed regulations. As noted previously, companies may provide comments by mail or at Regulations.gov.

Gain Visibility: Understand how the company’s investments work in China (and other potential “countries of concern,” such as Russia). What are the company’s current investments? What investments may be pending or are under consideration? What involvement do “U.S. persons” have?

Flag Sensitive Transactions: Identify those investments that may benefit from additional review by the company, including any that may fall within the parameters of the proposed restrictions.

Establish Guardrails: Determine where mitigating risk versus restricting investment may be most appropriate for the company and apply those guardrails throughout the company’s investments in more sensitive sectors and/or regions.

___________________________

[1] Exec. Order No. 14,105, 88 Fed. Reg. 54,867 (Aug. 11, 2023).

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

[3] Exec. Order No. 14,105, 88 Fed. Reg. at 54,867.

[4] See, e.g., Gibson, Dunn & Crutcher LLP, 2022 Year-End Sanctions and Export Controls Update (Feb. 7, 2023), https://www.gibsondunn.com/2022-year-end-sanctions-and-export-controls-update.

[5] ANPRM, 88 Fed. Reg. at 54,962.

[6] Exec. Order 14,032, 86 Fed. Reg. 30,145 (June 7, 2021).

[7] 50 U.S.C. § 1701 et seq.

[8] 50 U.S.C. § 1601 et seq.

[9] See Exec. Order No. 14,105, 88 Fed. Reg. at 54,868.

[10] Exec. Order No. 14,105, 88 Fed. Reg. at 54,870; see ANPRM, 88 Fed. Reg. at 54,963–64.

[11] ANPRM, 88 Fed. Reg. at 54,971.

[12] Id.

[13] Id.

[14] Id. at 54,970–71; see Exec. Order No. 14,105, 88 Fed. Reg. at 54,869.

[15] ANPRM, 88 Fed. Reg. at 54,971.

[16] Id.; see Exec. Order No. 14,105, 88 Fed. Reg. at 54,869.

[17] Exec. Order No. 14,105, 88 Fed. Reg. at 54,872. Notably, Hong Kong’s autonomous treatment distinct from China was formally revoked by former President Trump on July 14, 2020. See Exec. Order 13,936, 85 Fed. Reg. 43,413 (July 17, 2020). This determination was renewed most recently by President Biden on July 11, 2023, for one year. See Continuation of the National Emergency With Respect to Hong Kong, 88 Fed. Reg. 44,669 (July 12, 2023).

[18] White House, National Security Strategy 20 (Oct. 2022), https://www.whitehouse.gov/wp-content/uploads/2022/10/Biden-Harris-Administrations-National-Security-Strategy-10.2022.pdf.

[19] See Implementation of Additional Export Controls: Certain Advanced Computing and Semiconductor Manufacturing Items; Supercomputer and Semiconductor End Use; Entity List Modification, 87 Fed. Reg. 62,186 (Oct. 13, 2022); see also Gibson Dunn, United States Creates New Export Controls on China for Semi-Conductor Manufacturing Technology, Advanced Semiconductors, and Supercomputers in New Phase of Strategic Tech Competition (Oct. 13, 2022), https://www.gibsondunn.com/us-new-export-controls-on-china-for-semi-conductor-manufacturing-technology-advanced-semiconductors-in-new-phase-strategic-tech-competition.

[20] See ANPRM, 88 Fed. Reg. at 54,962.

[21] Id. at 54,964.

[22] Id.

[23] Id.

[24] Id. at 54,969–70.

[25] Id. at 54,970.

[26] See id. at 54,969.

[27] Id. at 54,964.

[28] Id.

[29] Id. at 54,964–65

[30] Id. at 54,965.

[31] Id. at 54,971.

[32] Exec. Order No. 14,105, 88 Fed. Reg. at 54,867.

[33] ANPRM, 88 Fed. Reg. at 54,967.

[34] Id. at 54,967–68.

[35] Id. at 54,968.

[36] Id. at 54,968–69.

[37] Id. at 54,969.

[38] Id. at 54,970.

[39] Id.

[40] Id.

[41] Id. at 54,971.

[42] See id. at 54,965–66.

[43] Id. at 54,965.

[44] Id.

[45] Id. at 54,971.

[46] Id. at 54,972.

[47] Id.

[48] Exec. Order No. 14,105, 88 Fed. Reg. at 54,868, 70.

[49] See Inflation Adjustment of Civil Monetary Penalties, 88 Fed. Reg. 2,229 (Jan. 13, 2023).

[50] ANPRM, 88 Fed. Reg. at 54,972.

[51] Exec. Order No. 14,105, 88 Fed. Reg. at 54,870.

[52] ANPRM, 88 Fed. Reg. at 54,964, 72.

[53] Exec. Order No. 14,105, 88 Fed. Reg. at 54,868–69.

[54] See id. at 54,869.

[55] U.S. Dep’t of the Treasury, FACT SHEET: President Biden Issues Executive Order Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern; Treasury Department Issues Advance Notice of Proposed Rulemaking to Enhance Transparency and Clarity and Solicit Comments on Scope of New Program (Aug. 9, 2023), https://home.treasury.gov/system/files/206/Outbound-Fact-Sheet.pdf.

[56] Ursula von der Leyen, President, European Commission, Speech on EU-China Relations to the Mercator Institute for China Studies and the European Policy Centre (Mar. 30, 2023), https://ec.europa.eu/commission/presscorner/detail/en/speech_23_2063.

[57] Press Release, White House, G7 Leaders’ Statement on Economic Resilience and Economic Security (May 20, 2023), https://www.whitehouse.gov/briefing-room/statements-releases/2023/05/20/g7-leaders-statement-on-economic-resilience-and-economic-security.

[58] Press Release, European Commission & High Representative, An EU Approach to Enhance Economic Security (June 20, 2023) (emphasis in original), https://ec.europa.eu/commission/presscorner/detail/en/IP_23_3358; see Eur. Comm’n, Joint Communication to the European Parliament, the European Council and the Council (June 20, 2023), https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52023JC0020&qid=1687525961309.

[59] Government of the Federal Republic of Germany, Strategy on China of the Government of the Federal Republic of Germany 41 (2023) (emphasis in original), https://www.auswaertiges-amt.de/blob/2608580/317313df4795e104f1ea3263d41860d8/china-strategie-en-data.pdf.

[60] See, e.g., George Parker & Michael O’Dwyer, Rishi Sunak Weighs Following Joe Biden on Curbing Tech Investment in China, Financial Times (Aug. 10, 2023), https://www.ft.com/content/cfcfcae7-3af9-4d6f-b690-a45ea864cf5e.

[61] S. Amdt. 931 to S. Amdt. 935 to S. 2226, 118th Cong. (2023).

[62] ANPRM, 88 Fed. Reg. at 54,962.

The following Gibson Dunn lawyers prepared this client alert: Adam M. Smith, Stephenie Gosnell Handler, David Wolber, Amanda Neely, Chris Mullen, Arnold Pun, and Nick Rawlinson.

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:

Judith Alison Lee – Washington, D.C. (+1 202-887-3591, [email protected])
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])
Amanda H. Neely – Washington, D.C. (+1 202-777-9566, [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])
Arnold Pun – Hong Kong (+852 2214 3838, [email protected])
Daniel P. Smith – Washington, D.C. (+1 202-777-9549, [email protected])
Nick Rawlinson – New York (+1 332-253-7646, [email protected])
Claire Yi – New York (+1 212-351-2603,[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])

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])

On August 8, 2023, Hong Kong’s Securities and Futures Commission (“SFC”) published its consultation conclusions on proposed amendments to enforcement-related provisions of the Securities and Futures Ordinance (“SFO”) (the “Consultation Conclusions”).[1] We previously covered the SFC’s consultation paper regarding the same (“Consultation Paper”) in a client alert.[2]

By way of refresher, the SFC had previously proposed in its Consultation Paper to make three key significant reforms to the SFO: (i) to amend the scope of section 213 to allow it to seek orders under this provision where the SFC has exercised its disciplinary powers under sections 194(1), 194(2), 196(1) or 196(2) against a regulated person, including an order that would allow the Court of First Instance (“CFI”) to restore parties to any transaction to the pre-transaction position; (ii) to amend section 103(3)(k) to focus on the point in time when the advertising materials are issued; and (iii) to extend the scope of the insider dealing provisions in Hong Kong to address insider dealing in Hong Kong with regard to overseas-listed securities or their derivatives, and to address conduct outside of Hong Kong in respect of Hong Kong listed securities or their derivatives.

In light of significant concerns raised by the industry, the SFC has eventually decided to only proceed at this stage with the amendments to the insider dealing provisions. However, the SFC has stressed that it remains committed to investor protection despite deciding not to proceed with the other amendments at this stage, as discussed further below. In this client alert, we provide some colour to the SFC’s responses and policy rationale under the Consultation Conclusions.

I. Expansion of section 213 of the SFO

The SFC had proposed to:

introduce an additional ground in section 213(1) which would allow the SFC to apply for orders under section 213 where it has exercised any of its powers under sections 194(1), 194(2), 196(1) or 196(2) of the SFO against a regulated person (i.e. wherever it finds that a regulated person has engaged in misconduct or is no longer fit and proper);
introduce an additional order in section 213(2) that would allow an order to be made by the CFI to restore the parties to any transaction to the position in which they were before the transaction was entered into, where the SFC has exercised any of its powers under sections 194 or 196 in respect of the regulated person; and
enable the CFI to make an order under section 213(8) against a regulated person to pay damages where the SFC has exercised any of its disciplinary powers against a regulated person (collectively, the “Section 213 Amendments”).

The concerns raised by respondents in relation to the Section 213 Amendments can be grouped into five key themes, as summarised below alongside the SFC’s responses to each of these concerns:

Concerns raised by respondents

The SFC’s responses

Legal and jurisprudence concerns

A number of respondents questioned whether it would be appropriate from a jurisprudential perspective to allow the SFC to seek court orders for a breach of codes and guidelines (e.g. the SFC’s Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (“Code of Conduct”)) which do not themselves have the force of law and are not subject to the same scrutiny and oversight in their formulation. Respondents also considered this to be a concern given that the SFC’s codes and guidelines are broad and principles based and as such the Section 213 Amendments could create significant legal and regulatory uncertainty to intermediaries. Respondents also noted that the proposed amendments were likely contrary to section 399(6) of the SFO, which provides that any failure to comply with the provisions of codes and guidelines does not give rise to a right of action.

The SFC did not agree that allowing legal consequences to stem from a breach of the SFC’s codes and guidelines would fundamentally alter the status of these codes and guidelines. The SFC pointed out that the current law already allows the SFC to seek section 213 orders for breaches of licensing conditions, which also do not have the force of law.

The SFC further stated that the legislative intent of section 213 has always been “to allow the court to exercise its discretion and order relief as it considers necessary to protect investors adversely affected by others’ misconduct (in a general sense of the word), whether in the form of a breach of a statutory provision or a condition of a licence.”

Further, while reiterating that it did not consider these amendments would have changed the legal status of codes and guidelines, the SFC acknowledged that it would have needed to amend section 399(6) to align the two provisions if it had proceeded with these changes to section 213 in order to avoid inconsistencies.

Implementation difficulties

Some respondents pointed to a risk of parallel proceedings and conflicting outcomes, namely, where an appeal to disciplinary proceedings to the Securities and Futures Appeals Tribunal (“SFAT”) and the Court of Appeal could lead to a different outcome from the CFI’s decision in relation to section 213 proceedings.

The SFC acknowledged that the Section 213 Amendments would have created a new link between the disciplinary regime and section 213 where currently none exists. While noting that it was aware of the possibility of parallel proceedings prior to the release of the Consultation Paper, the SFC noted that this issue could be “administratively mitigated” by the SFC not commencing section 213 proceedings until the appeal process in relation to disciplinary proceedings had been exhausted.

Fairness and proportionality concerns

Some respondents raised concerns that the Section 213 Amendments would result in all forms of disciplinary action potentially triggering an action under section 213, including where the misconduct in question was minor. Other respondents noted that intermediaries could face both disciplinary sanctions and section 213 orders (including significant monetary penalties) stemming from the same misconduct, which they considered could lead to an unduly harsh burden on intermediaries.

Other respondents pointed out that the Section 213 Amendments could lead to a potential extension of the limitation period. At present, the statutory limitation period starts from the date of the loss or the date of the breach. Under the SFC’s proposal, the SFC’s power to apply for section 213 orders would be triggered after a disciplinary action is made. Effectively, this could mean that the statutory limitation period commences from the date of the disciplinary action as opposed to the date of the loss or breach. This extension could significantly increase the potential liability of intermediaries.

The SFC acknowledged the industry’s concerns regarding the impact of the Section 213 Amendments, and indicated that it would consider these concerns in further detail. In particular, the SFC noted that while it was not its intention to extend the statutory limitation period, that would have been the “natural result” of the proposed amendments in their initial form.

They noted that while the industry may perceive section 213 compensation orders as “punitive in nature” due to their size, the fundamental nature of these orders is to restore aggrieved investors to the position that would have been in had the intermediary’s misconduct not taken place. This is distinct from the purpose of regulatory fines which are to deter future non-compliance.

Concerns regarding Hong Kong’s competitiveness and status as an international financial centre

Many respondents raised concerns regarding the Section 213 Amendments’ impact on Hong Kong’s competitiveness and status as an international financial centre. In particular, respondents argued that the lack of predictability about the total financial impact of SFC enforcement actions, coupled with the combined financial burden of compensation orders under section 213 and disciplinary sanctions, could dissuade companies from participating in high risk regulated activities (e.g. sponsoring of IPOs), or even drive businesses away from Hong Kong.

The SFC strongly rejected these concerns. Instead, the SFC emphasised that:

it considered an effective regulatory regime should aim to strike a balance between “providing a proportionate degree of protection for investors and enabling the industry to conduct business in an environment which is not hampered by unnecessary regulatory barriers to innovation and competition”; and
higher regulatory standards and active enforcement of such standards would in fact strengthen investor confidence in the market, thereby making Hong Kong an attractive and competitive market for international investors.

Concerns regarding adequacy of current investor compensation regime

Several respondents stated that the current laws already provide adequate legal protection and safeguards for investors, and questioned whether there was a need for the Section 213 Amendments. These respondents pointed to existing frameworks under consumer protection laws, the option of civil litigation, the Financial Dispute Resolution Scheme, as well as intermediaries’ own complaint handling procedures.

The SFC strongly rejected these concerns, and expressly stated that it did not consider that the current regime ensured investors (especially retail investors) were appropriately compensated when they suffer loss as a result of intermediaries’ misconduct. The SFC noted that this was due to the limited resources often available to retail investors to pursue civil actions and the lack of a class action mechanism in Hong Kong. Given these factors, the SFC stated that it considered it to be appropriate for the SFC to obtain compensation on behalf of investors.

While ultimately stating that it would place the Section 213 Amendments “on hold” for the time being, the SFC was at pains to emphasise that it considers its inability to require intermediaries to compensate aggrieved clients or investors for losses as a result of breach of SFC codes or guidelines to be a “clear regulatory gap” which these amendments were intended to fix. However, the SFC has acknowledged that respondents raised a number of complex concerns which warrant further study, and noted that it may need to consider a broader range of options for remedying this gap, including strengthening the existing disciplinary regime.

Given this, we consider the key takeaway from the Consultation Conclusions in relation to the Section 213 Amendments to be that the SFC remains determined to protect investors by improving their ability to receive fair compensation in intermediary misconduct cases. As such, we expect to see future proposals from the SFC in this space in the short to medium term which will be intended to either overcome or avoid the concerns raised by the industry in relation to the Section 213 Amendments.

II. Amendments to exemptions in section 103 of the SFO

The second change proposed by the SFC was to amend section 103(3) of the SFO. Section 103(1) makes it a criminal offence to issue or be in possession for the purposes of issue of an advertisement, invitation or document which, to the person’s knowledge, contains an invitation to the public to enter into an agreement to deal in securities or any other structured products, to enter into regulated investment agreements, or to participate in a collective investment scheme, unless authorized by the SFC to do so. Section 103(3) further contains a list of exemptions to the marketing restrictions under section 103, including section 103(3)(k), which provides an exemption from the authorization requirement for advertisements of offers of investments that are disposed of, or intended to be disposed of, only to professional investors (the “PI Exemption”).

In the Consultation Paper, the SFC proposed the amendment of section 103(3)(k) (and consequential amendments to section 103(3)(j)) to focus on the point in time when the advertising materials are issued, by exempting from the authorisation requirement those advertisements which are issued only to PIs (the “Section 103 Amendments”).

The respondents’ comments centred on the necessity of the Section 103 Amendments and the operational difficulties and impact on business development and marketing processes. In light of the feedback received, the SFC has decided not to proceed with the Section 103 Amendments, as summarized below:

Concerns raised by respondents

The SFC’s responses

Necessity of the Section 103 Amendments

Many respondents questioned whether the amendments are necessary on the basis that they viewed there to be no material risk to retail investors from merely being exposed to unauthorised advertisements of investment products given that these investors are not allowed to invest in these products.

Respondents raising these concerns emphasised that the existing framework, current suitability requirements,[3] risk disclosures and know-your-client (“KYC”) procedures already provide sufficient safeguards to investors. As such, respondents argued that the SFC has not identified a specific harm posed to investors by general distribution of advertisements concerning investment products.

Operational difficulties and impact on business

Many respondents also argued that the Section 103 Amendments are detached from commercial realities, and would have unnecessarily disrupted common marketing activities. These respondents pointed out that PIs are usually reluctant to provide KYC information upfront at the preliminary marketing stage. By limiting marketing efforts to PIs who have already been identified through intermediaries’ KYC procedures, the Section 103 Amendments would significantly reduce intermediaries’ ability to market to prospective investors. Furthermore, the Section 103 Amendments would also disproportionately restrict online marketing efforts, which could jeopardise Hong Kong’s competitiveness and status. For example, many intermediaries currently make marketing materials freely available on their website to users, or allow only self-certification of PI status to access certain marketing materials. If the Section 103 Amendments were made, many forms of online marketing would likely be in contravention.

The SFC reasoned that the original legislative intent of section 103 of the SFO is to protect investors at the point when marketing materials are issued. The proposed amendments to section 103(3)(k) aim to reflect this original legislative intent.

The SFC noted that it was also motivated by multiple instances of intermediaries selling products intended for PI to retail investors (e.g. Chapter 37 bonds) in breach of suitability requirements.[4] That being said, it acknowledged that the upside of investor protection must be balanced against the practical impact any such amendments have on existing marketing processes. In particular, it acknowledged two practical difficulties (see table at left) highlighted by respondents in relation to i) PIs’ reluctance to provide detailed KYC information in the pre-marketing stage and ii) impact on online distribution of investment products.

The SFC’s decision not to pursue the Section 103 Amendments should not be seen as an abandonment of the issue, as the SFC emphasised that it would monitor the need for amendments in this area in the longer term and would consult again if necessary. However, it also noted that it would take a strong view against anyone misusing the PI Exemption to attempt to sell unsuitable products to retail investors. Instead, the SFC stated in the Consultation Conclusions that any person seeking to rely on section 103(3)(k) must be able to demonstrate a clear intention to dispose of investment products only to PIs, and that in order to do so, it should be “plainly apparent” from the face of the advertisement that the underlying investment product is intended only for disposal to professional investors.

Importantly, the SFC noted that it considers the “clear display of an appropriate message or warning on all advertising materials would go a long way” in helping an issuer in establishing this intention, and that intermediaries should consider how best to present this message or warning and put in place appropriate safeguards. Notably, it has indicated that it is considering providing further guidance to the market on this point.

III. Amendment to territorial scope of insider dealing provisions

The final change proposed by the SFC concerns the civil and criminal regimes under sections 270 and 291 of the SFO in respect of insider dealing. The SFC’s proposed amendments will extend the scope of the insider dealing provisions in Hong Kong to address insider dealing in Hong Kong with regard to overseas-listed securities or their derivatives, and to address conduct outside of Hong Kong in respect of Hong Kong listed securities or their derivatives (the “Insider Dealing Amendments”).

Most respondents supported the Insider Dealing Amendments on the basis that it would strengthen investor protection, protect the integrity and reputation of Hong Kong’s markets, and align the SFC’s insider dealing regime with other major common law jurisdictions. In light of this support, the SFC will proceed with the Insider Dealing Amendments.

During the consultation, several respondents requested clarifications on the scope and application of the Insider Dealing Amendments. These requests and the SFC’s corresponding responses are summarized as follows:

Clarifications requested by respondents	The SFC’s responses
Whether insider dealing would be determined by reference to Hong Kong or the laws of the overseas jurisdiction when assessing insider dealing of overseas-listed securities or their derivatives	The SFC stated that the amended insider dealing provisions will stipulate that the misconduct would also need to be unlawful in the relevant overseas jurisdiction. However, the SFC will not prescribe a list of selected overseas markets to which the amended insider dealing provisions will apply, as this would counterintuitively narrow the scope of enforcement against cross-border insider dealing.
Whether the Insider Dealing Amendments would apply to over-the-counter (“OTC”) transactions in overseas-listed securities	The SFC clarified that the Insider Dealing Amendments change the territorial scope, and not the applicability, of the insider dealing regime. This means that once the Insider Dealing Amendments are enacted, the insider dealing regime would apply to OTC transactions in overseas-listed securities, just as how existing insider dealing laws apply to OTC transactions in Hong Kong-listed debt securities.
Whether the SFC will provide a transition period to enable firms to update their internal compliance policies and manuals to reflect the Insider Dealing Amendments	The SFC will not be introducing any transitional period. From the SFC’s standpoint, firms will have sufficient time to update their internal procedures and manuals once the legislative amendments are published.
Whether a regulated person is required to report breaches with respect to overseas-listed securities and how such reports should be made, especially considering data transfer restrictions in different jurisdictions	The SFC clarified that reporting obligations set out under the Code of Conduct would apply to breaches of the Insider Dealing Amendments, once enacted.[5]

The SFC’s responses make clear that its intention is to expand its ability to take action in relation to cross-border insider dealing to better protect the reputation of Hong Kong’s markets. In explaining its decision to proceed with these amendments, the SFC noted that while it is open to it to deal with cross-border insider dealing by providing intelligence to securities regulators in other jurisdictions under existing cross-border regulatory cooperation arrangements, this is not always the most effective means to tackle cross-border insider dealing.

IV. Next steps

The SFC indicated that it will now proceed with introducing the Insider Dealing Amendments, although it has not specified a timeframe for introducing the draft text of the amendments to the Legislative Council. It has indicated that the industry will have the opportunity to review the draft text of these amendments in the course of the legislative process.

We recommend that intermediaries continue to monitor this issue to ensure that they update their internal policies and procedures in relation to insider dealing in a timely fashion once the timeline for the enactment of the Insider Dealing Amendments becomes clearer.

We suggest that intermediaries also review their use of disclaimers in advertisements reliant on the PI Exemption to ensure that they are in line with the SFC’s guidance in the Consultation Conclusions. We recommend intermediaries also continue to monitor for any further guidance from the SFC with respect to best practices when relying on the PI Exemption.

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[1] “Consultation Conclusions on Proposed Amendments to Enforcement-related Provisions of the Securities and Futures Ordinance” (August 8, 2023), published by the SFC, available at: https://apps.sfc.hk/edistributionWeb/api/consultation/conclusion?lang=EN&refNo=21CP3.

[2] “Hong Kong SFC Consults on Significant Reforms to the SFO Enforcement Provisions” (June 14, 2022), published by Gibson, Dunn & Crutcher, available at: https://www.gibsondunn.com/hong-kong-sfc-consults-on-significant-reforms-to-the-sfo-enforcement-provisions/.

[3] See “Frequently Asked Questions on Compliance with Suitability Obligations by Licensed or Registered Persons” (last updated on December 23, 2020), published by the SFC, available at: https://www.sfc.hk/en/faqs/intermediaries/supervision/Compliance-with-Suitability-Obligations/Compliance-with-Suitability-Obligations#759450F3651D4BBF8AAA2F39C9F2BE88.

[4] The SFC has previously clarified that bonds offered for subscription and listed under Chapter 37 of the Main Board Listing Rules (“Chapter 37 Bonds”) are unsuitable for sale to retail investors, and warned intermediaries against this practice. See “Circular to Licensed Corporations distribution of bonds listed under Chapter 37 of the Main Board Listing Rules and local unlisted private placement bonds” (March 31, 2016), published by the SFC, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/suitability/doc?refNo=16EC18.

[5] Under the Code of Conduct, a licensed or registered person should report to the SFC immediately upon (among other things) “any material breach, infringement of or non-compliance with any law, rules, regulations, and codes administered or issued by the [SFC], the rules of any exchange or clearing house of which it is a member or participant, and the requirements of any regulatory authority which apply to the licensed or registered person”. See paragraph 12.5 of the “Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission” (“Code of Conduct”) (March 2023 edition), published by the SFC, available at: https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-and-futures-commission/Code_of_conduct-Mar-2023_Eng.pdf?rev=7b4576843262491cb40638b09441d89b.

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 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])

In January 2021, the Corporate Transparency Act came into effect. The law, passed as part of the National Defense Authorization Act, requires millions of U.S. and non-U.S. companies to file information with the Financial Crimes Enforcement Network (“FinCEN”) regarding identity of the beneficial owner(s) of the company.[1] In September 2022, FinCEN promulgated a final rule laying out further details of which companies need to report, what information needs to be reported, and by when.[2]

In less than six months, millions of corporate entities in the United States will be required to file beneficial ownership information directly with FinCEN.[3] Specifically, FinCEN’s beneficial ownership regulation comes into effect on January 1, 2024. Companies that were in existence prior to that time have one year to comply (i.e., by January 1, 2025), and new companies formed after January 1, 2024 will have 30 days to comply with this new regulation.[4] Further, there are potential civil penalties of $500 per day and criminal penalties of up to $10,000 or 2 years in prison for failure to comply.[5]

While we expect that private investment funds and potentially their subsidiaries will generally be exempt from these reporting requirements pursuant to one of the exemptions set forth below, the existence of these new regulations means that each sponsor should undertake a thorough review of its entire structure, including upper tier parent company entities, special purpose vehicles, special accounts, and other entities which exist within the sponsor’s overall corporate structure to identify an applicable exemption for each (if available) or prepare to comply with the new regulation.

The breadth of companies covered by this regulation is quite broad. The regulation covers (a) any domestic corporation or LLC or entity which has filed a document with a Secretary of State (or similar office) and (b) any foreign corporation, LLC, or similar entity that has registered to business in a U.S. state or jurisdiction.[6] Companies that are required to report will have to provide for their “beneficial owners” (defined as those who exercise substantial control over, or own and control at least 25% of the company) information such as legal name, date of birth, address, and an image of a government identification document.[7] And companies created after January 1, 2024 will have to provide similar information for “company applicants,” meaning those directly involved in or primarily responsible for the filing that creates the company.[8]

Notably, however, the beneficial ownership regulation contains 23 exemptions for various types of entities. Some of the exemptions which may be most relevant to our investment funds clients include:

Certain SEC Registered Entities—The regulation exempts various entities that have registered with the SEC, including certain securities issuers, broker dealers, and entities registered under the ‘34 Act.[9]

Fund Advisers—The regulation also exempts an individual entity that meets the definition of an investment advisor or investment company, as well as venture capital fund advisers.[10]

Pooled Investment Vehicles (“PIVs”)—Another exemption covers PIVs operated by, among other entities, broker dealers, investment advisers, and venture capital fund advisers.[11]

Subsidiaries—Any entity “whose ownership interests are controlled or wholly owned, directly or indirectly,” by some—but critically not all—of the other entities that are exempt are also exempt.[12] Notably, for instance, subsidiaries of PIVs are not included as part of this exemption, although PIV subsidiaries may be exempt under other exemptions.

Large Operating Companies—Another important exemption is for “large operating companies,” which are defined as employing more than 20 full time employees in the United States, having an operating presence at a physical office within the United States, and having more than $5 million in gross receipts or sales from sources inside the United States.[13]

Determining whether the beneficial ownership regulation applies requires an entity-by-entity analysis, including for large and complicated corporate structures. For example, while many portfolio and operating companies of a fund may be exempt (e.g., as a large operating company), a holding company that sits above these companies may not qualify for any of the exemptions in the rule. Because this regulation comes into effect in less than six months, we recommend that our clients begin evaluating which of their entities are required to report and, for those entities, who qualifies as a beneficial owner.

* * *

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding the issues and considerations discussed above, including assisting your organization in conducting the entity-by-entity analysis required by the new rules. Gibson Dunn’s Anti-Money Laundering practice group provides legal and regulatory advice to all types of financial institutions and nonfinancial businesses with respect to compliance with federal and state anti-money laundering laws and regulations, including the U.S. Bank Secrecy Act as amended by the USA PATRIOT Act. The group’s members have experience as government lawyers with the Department of the Treasury, the U.S. Department of Justice (DOJ), the U.S. Securities and Exchange Commission (SEC), and the U.S. Attorneys’ Offices, as well as private practitioners.

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[1] William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, H.R. 6395, § 6403.

[2] 31 C.F.R. § 1010.380.

[3] 31 C.F.R. § 1010.380.

[4] 31 C.F.R. § 1010.380(a)(1).

[5] 31 U.S.C. § 5336(h).

[6] 31 C.F.R. § 1010.380(c)(1).

[7] 31 C.F.R. § 1010.380(b)(1).

[8] 31 C.F.R. § 1010.380(b)(1)(iv).

[9] 31 C.F.R. § 1010.380(c)(2)(i), (vii), (ix).

[10] 31 C.F.R. § 1010.380(c)(2)(x)-(xi).

[11] 31 C.F.R. § 1010.380(c)(2)(xviii).

[12] 31 C.F.R. § 1010.380(c)(2)(xxii).

[13] 31 C.F.R. § 1010.380(2)(xxi).

The following Gibson Dunn attorneys assisted in preparing this client update: A.J. Frey, Shannon Errico, Stephanie Brooker, M. Kendall Day, Linda Noonan, and Chris Jones.

Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Investment Funds or Anti-Money Laundering practice groups, or the following authors, practice leaders and members:

Investment Funds Group:
Jennifer Bellah Maguire – Los Angeles (+1 213-229-7986, [email protected])
Kevin Bettsteller – Los Angeles (+1 310-552-8566, [email protected])
Albert S. Cho – Hong Kong (+852 2214 3811, [email protected])
Candice S. Choh – Los Angeles (+1 310-552-8658, [email protected])
John Fadely – Singapore/Hong Kong (+65 6507 3688/+852 2214 3810, [email protected])
A.J. Frey – Washington, D.C./New York (+1 202-887-3793, [email protected])
Shukie Grossman – New York (+1 212-351-2369, [email protected])
James M. Hays – Houston (+1 346-718-6642, [email protected])
Kira Idoko – New York (+1 212-351-3951, [email protected])
Eve Mrozek – New York (+1 212-351-4053, [email protected])
Roger D. Singer – New York (+1 212-351-3888, [email protected])
Edward D. Sopher – New York (+1 212-351-3918, [email protected])
William Thomas, Jr. – Washington, D.C. (+1 202-887-3735, [email protected])
Shannon Errico – New York (+1 212-351-2448, [email protected])

Anti-Money Laundering Group:
Stephanie Brooker – Washington, D.C.(+1 202-887-3502, [email protected])
M. Kendall Day – Washington, D.C. (+1 202-955-8220, [email protected])
Linda Noonan – Washington, D.C. (+1 202-887-3595, [email protected])
Ella Capone – Washington, D.C. (+1 202-955-8220, [email protected])
Chris Jones – Los Angeles (+1 213-229-7786, [email protected])

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

I. International

1. SBTi consults on guidance for financial institutions’ targets

The Science Based Targets initiative (“SBTi”) is developing new resources to provide financial institutions with clear guidance, criteria and recommendations to set science-based near and long-term targets consistent with net-zero and limiting global temperature rise to 1.5°C. On July 6, 2023, SBTi held two webinars to discuss the public consultation on the three new draft finance sector resources, being: (i) SBTi financial institutions net-zero standard, conceptual framework and initial criteria; (ii) SBTi near-term financial sector science based targets guidance and SBTi near-term criteria and recommendations for financial institutions; and (iii) SBTi fossil fuel finance position paper. The consultation is open for feedback until August 14, 2023.

2. International Maritime Organization adopts revised strategy on GHG emissions from ships

On July 7, 2023, Member States of the International Maritime Organization (“IMO”) adopted the 2023 IMO strategy on reduction of greenhouse gas (“GHG”) emissions from ships, which includes an enhanced common ambition to reach net-zero GHG emissions from international shipping close to 2050, a commitment to ensure an uptake of alternative zero and near-zero GHG fuels by 2030, as well as indicative check-points for 2030 and 2040. The 2023 Strategy sets out a timeline towards the adoption of a basket of measures focused on mid-term GHG reduction measures with a view towards adopting a further revised strategy in 2028.

3. ISDA publishes conceptual framework for climate scenario analysis in the trading book

The International Swaps and Derivatives Association (“ISDA”) published on July 12, 2023 a conceptual framework for climate scenario analysis in the trading book, which is in response to the survey of ISDA members carried out in 2022 that highlighted that trading book scenario analysis is a priority for many banks. The framework, which was prepared in collaboration with Deloitte and over 30 ISDA member banks, sets out a detailed approach to the design and implementation of climate scenarios and their impact on traded assets. At the implementation stage, the impact of the climate scenario on macro-economic factors is translated into market risk factors and applied to trading book portfolios. During the second half of 2023, ISDA plans to test the usefulness of the Conceptual Framework and to generate estimates of potential climate risk impacts on a set of hypothetical portfolios.

4. IFRS Foundation publishes comparison of the new IFRS S2 with the TCFD Recommendations

On July 24, 2023, the International Financial Reporting Standards Foundation (“IFRS Foundation”) published a comparison of the requirements in IFRS S2 climate-related disclosures and the Task Force on Climate-related Financial Disclosures (“TCFD”) recommendations. The requirements in IFRS S2 are consistent with the four core recommendations and 11 recommended disclosures published by the TCFD, and companies that apply the International Sustainability Standards Board (“ISSB”) Standards will meet the TCFD recommendations. IFRS S2 includes additional requirements for companies to disclose industry-based metrics, to disclose information about their planned use of carbon credits to achieve their net emissions targets and to disclose additional information about their financed emissions. Although the work of the TCFD is completed, the TCFD recommendations remain available for companies to use. Going forward, the IFRS Foundation will take over the monitoring of the progress of companies’ climate-related disclosures from the TCFD.

5. IOSCO endorses the ISSB standards on sustainability disclosure and climate-related disclosures

On July 25, 2023, the International Organisation of Securities Commission (“IOSCO”) announced its endorsement of the IFRS S1 and IFRS S2 sustainability-related financial disclosures standards issued by ISSB. After an independent review and analysis of the ISSB Standards, IOSCO has determined that the ISSB Standards are “appropriate to serve as a global framework for capital markets to develop the use of sustainability-related financial information in both capital raising and trading and for the purpose of helping globally integrated financial markets accurately assess relevant sustainability risks and opportunities”. As per their press announcement, IOSCO now calls on its 130 member jurisdictions to consider ways in which they might adopt, apply or otherwise be informed by the ISSB Standards, “in a way that promotes consistent and comparable climate-related and other sustainability-related disclosures for investors”.

II. United Kingdom

1. Draft voluntary code of conduct for ESG ratings and data product providers issued for consultation

On July 5, 2023, the ESG Data and Ratings Working Group commissioned by the United Kingdom Financial Conduct Authority (“FCA”) published a draft voluntary code of conduct for ESG ratings and data product providers. Once adopted, the code will apply to all UK based companies that compile ESG ratings on market participants. The draft code is based on recommendations made by IOSCO in an effort to ensure global interoperability and coherence. The public consultation is open until October 5, 2023, with the final version of the code expected to be published by the end of the year. In the UK, regulation is being considered in parallel, with the possibility that ESG ratings and data providers could become subject to the regulatory auspices of the FCA.

2. UK Emissions Trading Scheme Authority publishes report on the functioning of the UK carbon market and announces new limits on emissions

In July 2023, the UK Emissions Trading Scheme Authority (the “UK ETSA”) published a report on the functioning of the UK carbon market, which provides a high-level summary of the 2021 and 2022 scheme years of operation. In parallel with its report, on July 3, 2023, the UK ETSA announced a new set of reforms that propose to limit industrial, power and aviation emissions from 2024. The UK ETSA also stated that these reforms will be extended to cover more sectors, namely the domestic maritime transport industry from 2026 and the waste industry from 2028, with an intention to roll out a phased removal of free carbon allowances for the aviation industry in 2026.

3. The UK Endorsement Board consults on draft letter considering connectivity between ISSB sustainability and disclosure standards and IASB accounting standards

In May 2023, the ISSB published a request for information in a consultation on ISSB’s agenda priorities, which will inform its strategic direction and priorities over the next two years. On July 13, 2023, the UK Endorsement Board issued a draft comment letter to ISSB, which specifically focuses on connectivity between ISSB sustainability and disclosure standards and IASB accounting standards. Stakeholder comments were received until July 23, 2023, with a view to sending the letter to ISSB in August 2023.

4. FCA delays finalisation of its SDR and investment labels consultation for the second time

On July 18, 2023, the Regulatory Initiatives Forum under the FCA announced that it was delaying providing updates to its Regulatory Initiatives Grid, which includes the publication of its conclusion to the sustainability disclosure requirements (“SDR”) and investment labels consultation. The FCA published its first Discussion Paper (DP 21/4) in November 2021, which was followed by a Consultation Paper (CP 22/20) in October 2022. The FCA’s final Policy Statement was previously scheduled to be published in the first half of 2023, but it is now due to be released during Q4 of this year due to the significant number and range of responses received. The latest SDR proposals require asset managers and investment advisers to provide mandatory ESG disclosures, including to prevent greenwashing. Whilst announcing the delay, the FCA commented that the anticipated changes “will help the UK’s asset management sector thrive by setting standards that improve the sustainability information consumers have access to”.

5. The Financial Reporting Council Lab releases ESG data distribution and consumption report

On July 20, 2023, the UK’s Financial Reporting Council Lab published a new report on ESG data distribution and consumption which examines how investors obtain and use ESG data on companies, and highlights what actions companies can take to optimise the flow of ESG data. The findings of the report identify, among others, that investors want companies to include ESG risks, opportunities and progress relevant to their business in their annual reports.

6. UK High Court dismisses renewed oral application from ClientEarth to bring derivative claim against the directors of Shell

On July 24, 2023, the High Court of Justice in the UK dismissed a renewed oral application by ClientEarth to bring a derivative claim on behalf of Shell plc against Shell’s board of directors for alleged failure to effectively address climate related risks to the detriment of Shell’s shareholders. ClientEarth announced on the same day that they intend to appeal the decision.

III. Europe

1. ESMA and NCAs to assess ESG disclosures and sustainability risks in the investment fund sector

On July 6, 2023, the European Securities and Markets Authority (“ESMA”) launched a common supervisory action (“CSA”) with National Competent Authorities (“NCAs”) on sustainability-related disclosures and the integration of sustainability risks in the investment fund sector. The main objectives of the CSA include: (i) assessing whether market participants adhere to applicable rules and standards in practice; (ii) gathering further information on greenwashing risks in the investment management sector; and (iii) identifying further relevant supervisory and regulatory intervention to address the underlying issues. Until Q3 2024, NCAs will undertake their supervisory activities and share knowledge and experiences through ESMA.

2. European Council reaches agreement on Batteries Regulation 2023

On July 10, 2023, the European Council adopted a new regulation that strengthens sustainability rules concerning batteries and waste batteries and promotes a circular economy. The regulation regulates the entire life cycle of batteries, from production to reuse and recycling. The regulation applies to all batteries including all waste portable batteries, electric vehicle batteries, industrial batteries, starting, lightning and ignition batteries (used mostly for vehicles and machinery) and batteries for light means of transport (e.g. electric bikes, e-mopeds, e-scooters). The new regulation will replace the current batteries directive of 2006.

3. ESMA issues public statement on the sustainability disclosures in prospectuses and publishes latest sustainable finance implementation timeline

On July 11, 2023, ESMA issued a public statement on the sustainability disclosures expected to be included in equity and non-equity prospectuses. The statement sets out how the specific disclosure requirements of the EU Prospectus Regulation in relation to sustainability-related matters should be satisfied.

In addition, ESMA published an updated timeline for the implementation of sustainable finance disclosure requirements and undertakings.

4. European Parliament passes proposals for Nature Restoration Laws

On July 12, 2023, the EU’s proposal for a Regulation on Nature Restoration passed through the European Parliament. This regulation, which is a key element of the EU Biodiversity Strategy, aims to: (i) enable the long-term sustained recovery of biodiverse and resilient nature; (ii) contribute to achieving the EU’s climate mitigation and climate adaptation objectives; and (iii) meet international commitments on nature restoration and preservation. The regulation contains seven specific targets, including protecting urban ecosystems by aiming for no net loss of green urban space by 2030 and improving river connectivity so that at least 25,000 km of rivers are restored to a free-flowing state by 2030.

5. EU proposes new measures on circular economy with respect to the automotive sector

On July 13, 2023, the European Commission issued a proposal for a regulation on Circularity Requirements for Vehicle Design and on Management of End-of-Life Vehicles and issued an associated Q&A on the topic. The proposed regulation, which would replace the current Directives on End-of-Life Vehicles and Reusability, Recyclability and Recoverability of Vehicles, is expected to have substantial environmental benefits, including an annual reduction of 12.3 million tons of CO2 emissions by 2035 and increased recovery of critical raw materials. The proposed actions are expected to generate €1.8 billion in net revenue by 2035, with additional jobs created and enhanced revenue streams for the waste management and recycling industry.

6. European Banking Association publishes decision concerning ad hoc collection of institutions’ ESG data and consults on draft templates for collecting climate-related data from EU banks

On July 18, 2023, the European Banking Authority (“EBA”) published a decision of July 6, 2023 concerning ad hoc collection by competent authorities of Member States of institutions’ ESG data. The EBA intends to collect data from large, listed institutions based on their Pillar 3 quantitative disclosure requirements on ESG risks, until a supervisory reporting framework on ESG has been put in place. The ad-hoc data collection will provide national competent authorities with data to monitor ESG risks and contribute to the European Commission’s Strategy for financing the transition to a sustainable economy. Competent authorities shall submit to the EBA the data on a semi-annual basis, with a first submission set for December 31, 2023.

On July 20, 2023, the EBA launched a public consultation on draft templates for collecting climate related data from EU banks. This effort is part of the EBA’s work on climate stress-testing, notably the one-off Fit-for-55 climate risk scenario analysis, which the EBA will carry out together with the other European Supervisory Authorities and with the support of the European Central Bank and the European Systemic Risk Board. The draft templates are accompanied by a template guidance, which includes definitions and rules for compiling the templates. A workshop public hearing will be hosted on September 28, 2023, after which the consultation will remain open for comments until October 11, 2023. Seventy banks will take part in the exercise, being the same banks as those included in the 2023 EU-wide stress test. National competent authorities may request other banks in their respective jurisdictions to participate. The one-off Fit-for-55 climate risk scenario analysis is targeted to start by the end of 2023, with the publication of results expected by Q1 2025.

7. European Commission adopts first set of European sustainability reporting standards

On July 31, 2023, the European Commission adopted a Commission Delegated Regulation, with related Annexes 1 and 2, setting out the first set of EU sustainability reporting standards (“ESRS”), together with a Q&A on the adoption of the ESRS. The standards cover the full range of environmental, social, and governance issues, including climate change, biodiversity and human rights, and provide information for investors to understand the sustainability impact of the companies in which they invest. The European Parliament and Council are expected to formally review the Delegated Regulation for two months upon which they may reject it, but they may not amend it. Companies subject to the Corporate Reporting Sustainability Directive will have to report according to the ESRS. For further information on the CSRD, please refer to our client alert available here.

IV. United States

1. House Financial Services Committee begins month of hearings focused on ESG

As our June 2023 Update anticipated, the House Financial Services Committee held a series of hearings that focused on concerns over ESG disclosures and regulations as part of “ESG Month”. Of the numerous bills proposed, we highlight the following for their potential impact on the Securities and Exchange Commission (the “SEC”), public reporting companies, and the investment community:

The “Guiding Uniform and Responsible Disclosure Requirements and Information Limits (GUARDRAIL) Act of 2023” would in part amend the Securities Act of 1933 to make clear that the SEC only requires issuers to disclose material Under proposed amendments to the Securities Exchange Act of 1934 (the “Exchange Act”), the SEC would be required to maintain a list of any non-material disclosure requirements for issuers and provide a justification every five years for such requirements. Additional Exchange Act amendments would remove private liability for issuers that fail to disclose non-material information under federal securities laws and establish a “Public Company Advisory Committee” within the SEC to provide the Commission advice on issues related to public reporting and corporate governance, the proxy process and capital formation, among other matters.
The “Protecting Americans’ Retirement Savings from Politics Act” would significantly impact the shareholder proposal process under Rule 14a-8 and the activities of proxy advisory firms, institutional investors, and investment firms. For Rule 14a-8 shareholder proposals, issuers would be authorised to simply exclude proposals relating to environmental, social, or political issues or significant policy issues from their proxy statements. The act would also nullify the SEC’s July 2022 proposed amendments to Rule 14a-8 regarding the exclusion of proposals that have been substantially implemented or duplicate other submitted proposals and require the SEC to revise the current resubmission thresholds for proposals that substantially duplicate proposals previously included in the proxy statement or consent solicitations. Institutional investors would in part be required to disclose certain information about their shareholder proposal voting decisions, while large asset managers would have to include economic analyses for such decisions. Proxy advisory firms would be required to register with the SEC, disclose specific information, and set standards for managing conflicts of interest. And the Investment Advisers Act of 1940 would be amended to address how pecuniary and non-pecuniary factors are considered and to require the SEC to study climate change and environmental disclosures by municipal bond issuers, among other changes.
Under the “Businesses Over Activists Act,” the SEC would be prohibited from requiring issuers to include shareholder proposals in their proxy statements. The act further states that the SEC does not have the authority to override states’ regulations regarding proxy/consent solicitation materials or shareholder proposals.

2. SEC adopts new rules on cybersecurity disclosure for public companies

On July 26, 2023, the SEC adopted a final rule requiring the disclosure of material cybersecurity incidents and cybersecurity risk management, strategy, and governance by public companies, including foreign private issuers. The final rule imposes a substantial reporting burden on public companies and introduces complexity to incident response for all public companies. The final rule will become effective 30 days after publication in the Federal Register. You can read a detailed summary and commentary on this topic in our client alert available here.

3. Thirteen U.S. state attorneys general target Fortune 100 CEOs on diverse hiring following the Supreme Court’s landmark affirmative action decision

On June 29, 2023, the Supreme Court released its much-anticipated decisions in Students for Fair Admissions v. Harvard and Students for Fair Admissions v. University of North Carolina, where the Supreme Court held that the universities’ use of race in their admissions processes violated the Equal Protection Clause and Title VI of the Civil Rights Act. Although existing law governing employers’ consideration of the race of their employees (or job applicants) is not explicitly modified, the decisions have important legal and strategic ramifications for employers. In particular, the Court’s broad rulings in favour of race neutrality could accelerate the trend of reverse-discrimination claims. Shortly after the decision, 13 state attorneys general sent a joint letter to the chief executive officers of the Fortune 100 to reiterate the Supreme Court’s decision, request compliance with certain “race-neutral-principles”, and threaten accountability for continued use of race-based preferences or quotas. You can read an extensive commentary on this topic in our client alert available here.

V. APAC

1. The Philippines publishes inaugural sustainability report

On July 2, 2023, the central bank of the Philippines, Bangko Sentral ng Pilipinas (“BSP”), published its inaugural sustainability report, which highlights BSP’s integration of ESG considerations into strategic objectives and functions and the progress made in promoting sustainability in financial markets. The report provides an overview of BSP’s ESG initiatives in the sphere of financial supervision, monetary policy, reserve management, credit operations and support operations. The report also identifies a number of proposed initiatives targeted at advancing sustainability objectives, including the creation of taxonomy, granting of regulatory incentives to encourage financing for sustainable projects and investments and improvements to stress-testing guidelines, prudential reports and disclosure requirements.

2. ESG initiatives by the Securities and Exchange Board of India

On July 3, 2023, the Securities and Exchange Board of India (“SEBI”) introduced the Securities and Exchange Board of India (Credit Rating Agencies) (Amendment) Regulations, 2023, which specifically seek to regulate ESG rating providers. These regulations govern the activities of ESG rating agencies, ensuring transparency and reliability in their operations. According to the regulations, no person can act as an ESG rating provider unless they have first obtained a certificate from SEBI.

In addition, on July 12, 2023, SEBI set out a new regulatory framework prescribing the disclosure and assurance requirements for Business Responsibility and Sustainability Reporting Core, which require listed companies to make ESG disclosures covering firms in their value chain.

3. Singapore launches public consultation to advance climate reporting

On July 6, 2023, the Accounting and Corporate Regulatory Authority and Singapore Exchange Regulation launched a public consultation on the recommendations by the Sustainability Reporting Advisory Committee to advance climate reporting in Singapore. The recommendations provide that listed issuers lead the way and report International Sustainability Standards Board-aligned climate-related disclosures starting from financial year 2025. The public consultation is open for comments until September 30, 2023.

4. Australian Prudential Regulation Authority publishes practice guide on investment governance for superannuation trustees

In July, the Australian Prudential Regulation Authority published final guidance to trustees in the formulation, implementation, maintenance and oversight of an investment strategy. It sets out prudent practices in relation to investment risk management arrangements to assist trustees in meeting their obligations under the prudential standard on investment governance.

5. Malaysia launches part 1 of the country’s national energy transition roadmap

On July 27, 2023, the Ministry of Economy of Malaysia launched the first part of the national energy transition roadmap, which sets out the country’s roadmap to energy transition by outlining ten flagship catalyst projects and initiatives based on six energy transition levers, being energy efficiency, renewable energy, hydrogen, bioenergy, green mobility and carbon capture, utilisation and storage. Part 2, expected to be forthcoming later this year, will focus on establishing the low-carbon pathway, national energy mix and emissions reduction targets as well as the enablers needed for the energy transition.

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: Vesselina Dobreva, Elizabeth A. Ising, Lauren M. Assaf-Holmes, Grace Chong, 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])