On December 14, 2022, the Securities and Exchange Commission (“SEC” or “Commission”), in a rare unanimous vote, adopted final rules on the affirmative defense to insider trading liability and new disclosures related to insider trading. The final rules: (i) add new conditions to the affirmative defense to insider trading pursuant to a contract, instruction, or plan intended to satisfy the conditions of Exchange Act Rule 10b5-1(c) (a “Rule 10b5-1 plan”), (ii) introduce new periodic disclosure requirements related to insider trading, including with respect to company insider trading policies and procedures and the adoption and termination of Rule 10b5-1 plans by directors and officers, and director and officer equity compensation awards made close in time to the company’s disclosure of material nonpublic information (“MNPI”), and (iii) require identification of transactions made pursuant to a Rule 10b5-1 plan on Forms 4 and 5, and require that bona fide gifts be reported on Form 4 within two business days rather than after year-end on Form 5. The final rules are thematically aligned with the rule proposal issued by the Commission in December of last year[i] – also in a unanimous vote – but with meaningful changes and the addition of several carve outs, particularly for companies.

The adopting release is available here and a Fact Sheet is available here. The final rules will become effective 60 days after publication in the Federal Register (the “Effective Date”), at which point any Rule 10b5-1 plan thereafter adopted or modified should comply with the new requirements. Companies will be required to comply with the new periodic disclosure requirements in the first filing that covers the first full fiscal period that begins on or after April 1, 2023 (i.e., the second-quarter Form 10-Q for a company with a December 31 fiscal year-end). Smaller reporting companies have until the first filing covering a period that begins on or after October 1, 2023 to comply (i.e., the fiscal 2023 Form 10-K for a company with a December 31 fiscal year-end). Section 16 insiders will be required to comply with the amendments to Form 4 beginning with reports filed on or after April 1, 2023. Set forth below is a summary of the final rules and some considerations for companies and insiders.

Summary of Final Rules

New Conditions for Rule 10b5-1 Plans. The rules introduce new conditions on the availability of the affirmative defense to Rule 10b-5 liability pursuant to a Rule 10b5-1 plan. Any plans adopted after the Effective Date must comply with the new conditions or the person adopting the plan will not be able to rely on the affirmative defense. Note that these changes do not affect the affirmative defense available under an existing Rule 10b5-1 plan that was entered into prior to the Effective Date, unless it is modified in a manner that is treated as an adoption of a new plan (described below) after the Effective Date.[ii] The new conditions for Rule 10b5-1 plans consist of the following:

1. Cooling-Off Period. In a significant change from the rule proposal, the final rules do not require any cooling-off period for companies. Rule 10b5-1 plans adopted by directors and officers[iii] must provide that trading under the plan cannot begin until the later of: (a) 90 days after the adoption of the Rule 10b5-1 plan; or (b) two business days following the disclosure of the company’s financial results in a Form 10-Q or 10-K for the fiscal quarter in which the plan was adopted, or, for foreign private issuers, in a Form 20-F or 6-K that discloses the company’s financial results. The required cooling-off period for directors and officers is capped at a maximum of 120 days after the Rule 10b5-1 plan’s adoption. Persons other than directors and officers are subject to a 30 day cooling-off period following a Rule 10b5-1 plan’s adoption. Notably, certain changes to Rule 10b5-1 plans are treated as the adoption of a new plan. The final rules codify that any change to the amount, price, or timing of the purchase or sale of the securities (including a change to a written formula or algorithm, or computer program affecting these terms, the “Essential Terms”) underlying a Rule 10b5-1 plan constitutes a termination of such plan and the adoption of a new plan, triggering the same cooling-off period described above. Other changes that do not alter the Essential Terms, such as an adjustment for stock splits or a change in account information, will not trigger a new cooling-off period.[iv]The cooling-off period requirements of the final rules appear less burdensome on directors and officers as compared to the proposed rules, but they are more complex and introduce uncertainty as to when the first purchase or sale under the plan can occur. The proposed rules contemplated an inflexible 120 day cooling-off period for the Rule 10b5-1 plans of directors and officers.[v] Under the final rules, the cooling-off period for directors and officers will vary between 90 and 120 days, depending on when/whether a Form 10-K or Form 10-Q is filed during this period.

2. Director and Officer Certifications. When adopting a Rule 10b5-1 plan, directors and officers must include a representation in the Rule 10b5-1 plan certifying, at the time of the adoption of a new or modified plan, that: (a) they are not aware of MNPI about the company or its securities; and (b) they are adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5. Because the plan is typically a form document prepared by the broker-dealer, counsel for directors and officers should review the plan to ensure that this new representation is included in any new or modified Rule 10b5-1 plan entered into after the Effective Date.
3. Prohibition on Overlapping Plans. A person (other than the company) may not have another outstanding (and may not subsequently enter into any additional) Rule 10b5-1 plan for purchases or sales of any class of securities of the company on the open market during the same period. Unlike the proposed rules, the final rules permit several exceptions. A person may have two separate Rule 10b5-1 plans so long as (a) the later-commencing plan does not begin trading during the cooling-off period that would have applied if the later-commencing plan was adopted on the date the earlier-commencing plan terminates, and (b) the plans meet all other conditions applicable to Rule 10b5-1 plans.In addition, the final rules provide an exception to allow for separate Rule 10b5-1 plans for “sell-to-cover” transactions in which an insider instructs their agent to sell securities in order to satisfy tax withholding obligations at the time an equity award vests. An insider may maintain additional eligible Rule 10b5-1 plans so long as the additional plans only authorize qualified sell-to-cover transactions, where the plan authorizes an agent to sell only such securities as are necessary to satisfy tax withholding obligations in connection with the vesting of a compensatory award, such as restricted stock or restricted stock units, and the insider does not otherwise exercise control over the timing of such sales. It is important to note that this exception does not extend to sales incident to the exercise of option awards, as the SEC posits that option exercises create a risk of opportunistic trading.[vi]The final rules clarify that a series of separate contracts with different broker-dealers or other agents acting on behalf of the person (other than the company) may be treated as a single Rule 10b5-1 plan, provided that the contracts with each broker-dealer or other agent, when taken together as a whole, meet all of the applicable conditions of, and remain collectively subject to, Rule 10b5-1(c)(1). In such a scenario, the modification of any of the individual contracts will be considered a modification of the other contracts constituting the Rule 10b5-1 plan. Substituting a broker-dealer or other agent with another broker-dealer or other agent would not be considered a modification so long as the Essential Terms are not changed. Although the final rules introduced these exceptions, it also expanded the scope of the prohibition relative to the proposed rules. Under the proposed rules, the prohibition would have only applied to the same class of the company’s securities,[vii] whereas the final rules prohibit overlapping plans for any class of the company’s securities. In the adopting release, the SEC recognized that, given the likelihood that the values of different classes of a given company’s securities are highly correlated, allowing the use of multiple plans for trading in the securities of a company would allow for opportunistic behavior.[viii]

4. Restrictions on Single-Trade Plans. A person (other than the company) may not have more than one single-trade Rule 10b5-1 plan during any 12-month period. The defense will only be available for a single-trade plan if such a person had not, during the preceding 12-month period, adopted another single-trade plan that qualified for the affirmative defense, meaning that an ineligible plan does not preclude the availability of the affirmative defense for another plan.[ix] As with the prohibition on overlapping plans, the final rules introduce an exception to this restriction for “sell-to-cover” plans. A single-trade plan is one “designed to effect” (e.g., has the practical effect of requiring) the purchase or sale of securities as a single transaction. A plan is not designed to effect a single transaction where the plan (a) leaves the person’s agent discretion over whether to execute the plan as a single transaction, or (b) provides that the agent’s future acts will depend on events or data not known at the time the plan is entered into (such as a plan to execute specified sales or purchases at each of several given future stock prices) and it is reasonably foreseeable at the time the plan is entered into that it may result in multiple transactions.[x]

5. Act in Good Faith. The person entering into a Rule 10b5-1 plan must act in good faith with respect to the Rule 10b5-1 plan. This requirement extends the existing requirement – i.e., to enter into the Rule 10b5-1 plan in good faith – from the time of adoption through the duration of the Rule 10b5-1 plan. This departs from the proposed rules, which would have required the Rule 10b5-1 plan to be “operated” in good faith,[xi] a term that many commentators found ambiguous.

New Periodic Reporting Requirements. The final rules introduce the following new periodic reporting requirements:

1. Quarterly Disclosure of Trading Arrangements. In Forms 10-Q and 10-K, companies will be required to disclose whether, during the company’s last fiscal quarter, any director or officer adopted or terminated (i) any contract, instruction or written plan for the purchase or sale of securities of the company that is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c) (e.g., a Rule 10b5-1 plan), or (ii) a “non-Rule 10b5-1 trading arrangement.” A non-Rule 10b5-1 trading arrangement is a written trading arrangement that complies with the old Rule 10b5-1 affirmative defense (circa 2000 to 2022) but does not comply with the new affirmative defense conditions of Rule 10b5-1(c). The SEC requires disclosure for these arrangements to make clear that one cannot avoid disclosure of trading plans that are structured to comply with alternative liability defenses other than the Rule 10b5-1 affirmative defense.[xii]Companies will also be required to indicate whether the arrangement is a Rule 10b5-1 plan or non-Rule 10b5-1 trading arrangement and provide a description of the material terms, other than with respect to price, such as:
   • The name and title of the director or officer;
   • The date of adoption or termination of the trading arrangement;
   • The duration of the trading arrangement; and
   • The aggregate number of securities to be sold or purchased under the trading arrangement.

Unlike the proposed rules, the final rules do not require disclosure of whether the company adopted a Rule 10b5-1 plan or non-Rule 10b5-1 trading arrangement.[xiii] The proposed rules also did not specifically carve out price from the material terms of Rule 10b5-1 plans or non-Rule 10b5-1 trading arrangements that are required to be disclosed.[xiv]

2. Annual Disclosure of Insider Trading Policies and Procedures. Companies will be required to disclose in Forms 10-K or 20-F and proxy and information statements whether they have adopted insider trading policies and procedures governing the purchase, sale, and other dispositions of their securities by directors, officers, and employees, or the company itself that are reasonably designed to promote compliance with insider trading laws, rules, and regulations, and any listing standards applicable to the company. If a company has not adopted such insider trading policies and procedures, it must explain why it has not done so. The disclosure may be incorporated by reference from the proxy statement into the Form 10-K if the proxy statement is filed within 120 days of the fiscal year-end. A copy of the insider trading policies and procedures must be filed as an exhibit to Form 10-K and 20-F.
3. Disclosure of Certain Equity Awards Close in Time to Release of MNPI. In their discussions of executive compensation (i.e., in Part III of Form 10-K or a proxy statement), companies will be required to discuss their policies and practices on the timing of awards of stock options, stock appreciation rights (“SARs”) or similar option-like instruments in relation to the disclosure of MNPI by the company, including how the board determines when to grant such awards (e.g., whether the awards are granted according to a predetermined schedule). Companies must also discuss whether, and if so, how, the board or compensation committee takes MNPI into account when determining the timing and terms of an award, and whether the company has timed the disclosure of MNPI for the purpose of affecting the value of executive compensation.In addition, if, during the last completed fiscal year, stock options, SARs or similar option-like instruments were awarded to a named executive officer (“NEO”) within a period beginning four business days before the filing of a periodic report, or the filing or furnishing of a current report on Form 8-K that discloses MNPI (including earnings information), and ending one business day after the filing of such report, the company must provide information concerning each such award for the NEO on an aggregated basis in the following tabular format:

Name	Grant date	Number of securities underlying the award	Exercise price of the award ($/Sh)	Grant date fair value of the award	Percentage change in the closing market price of the securities underlying the award between the trading day ending immediately prior to the disclosure of material nonpublic information and the trading day beginning immediately following the disclosure of material nonpublic information
PEO
PFO
A
B
C

The window in which awards will trigger disclosure is significantly reduced from the proposed rules, which would have covered 14 days both before and after the relevant filing.[xv] The final rules also clarify that a Form 8-K reporting a material new option award grant under Item 5.02(e) would not trigger the disclosure requirement, and removes company share repurchases as events that would trigger disclosure.

This new disclosure requirement will not affect foreign private issuers.

4. Inline XBRL Tagging. The periodic disclosure requirements outlined above will be required to be tagged in Inline XBRL.

New Beneficial Ownership Reporting Requirements. The amendments add a checkbox to Forms 4 and 5 for insiders to indicate whether the reported transaction is pursuant to a plan that is “intended to satisfy the affirmative defense conditions” of Rule 10b5-1(c). In addition, insiders will be required to report dispositions of bona fide gifts of equity securities on Form 4 (rather than Form 5), thereby shortening the deadline to report gifts from 45 days after fiscal year-end to two business days following the date of execution. The final rules do not adopt the proposed second checkbox for indicating a transaction was made pursuant to a plan that did not qualify for Rule 10b5-1(c).[xvi]

Importantly, the adopting release builds on the note from the proposing release that opined that gifts are subject to Section 10(b) liability, and the SEC reiterated that the affirmative defense of Rule 10b5-1(c)(1) is available for any bona fide gift of securities.[xvii]

Observations and Considerations for Companies and Insiders

Insider trading policies should be updated as of the Effective Date, but existing Rule 10b5-1 plans do not need to be amended unless any Essential Terms are modified after the Effective Date. Companies should update their current insider trading policies and procedures (including any separate Rule 10b5-1 plan guidelines), to amend any provisions that conflict with the final rules. For example, many companies already require their employees’ Rule 10b5-1 plans to have cooling-off periods. If the cooling-off periods permissible under a company’s policy are shorter than those under the final rules, the policy should be updated to reflect the required cooling-off periods, subject to the grandfathering accommodations for Rule 10b5-1 plans existing prior to the Effective Date. Companies may consider removing policy provisions requiring insiders to trade only through Rule 10b5-1 plans in light of the final rules, which will require disclosure of the number of shares insiders intend to sell under such plans. This disclosure could cause an unfavorable market price reaction and become a topic of discussion in shareholder engagement or a point of contention for shareholder activists, causing a chilling effect on the use of Rule 10b5-1 plans by insiders. Some companies may determine to instead encourage insiders to trade during ordinary open window periods after pre-clearance from the company’s general counsel, at least with respect to transactions other than sell-to-cover trades. In addition, with the new requirement to file insider trading policies and procedures as an exhibit to the Form 10-K, companies may want to revisit their policies to make sure they are sufficiently robust.

Companies should consider waiting at least two business days following the release of MNPI to make equity compensation awards. The new disclosure requirement regarding equity awards made close in time to the release of MNPI is meant to combat the practice of “spring-loading,” in which equity grants are made immediately before positive MNPI is released so that executives benefit from the increased share price when the MNPI is made public. Companies should be aware of the optics of making awards close to the public release of MNPI, and can mitigate potential concerns by waiting at least two business days following the release of MNPI before making equity awards. This will entail coordinating board and board committee meeting and/or schedules with the reporting calendar for periodic reports and any planned Form 8-K filings.

Corporate insiders should be cautious when gifting while aware of MNPI. The SEC has historically been silent with respect to the liability of gifts under Section 10(b). With the Commission’s reaffirmations in the adopting release, corporate insiders who are aware of MNPI should proceed with caution when gifting company securities, as they could be liable if they gift securities when they are aware of MNPI and while knowing (or being reckless in not knowing) that the donee would sell the securities prior to the disclosure of the MNPI. Many, if not most, non-profit organizations have a policy of immediately selling any securities received as a gift, as they are not in the business of holding securities. Companies also may want to revisit how their insider trading policies apply to gifts.

There are no new share repurchase requirements for companies, but this is likely to change. The single new condition on Rule 10b5-1 plans applicable to companies is the requirement to act in good faith, as companies are carved out from the other new conditions, allowing them to implement overlapping and multiple single-trade plans, all without cooling-off periods. Although the proposed rules contemplated periodic disclosure requirements with respect to a company’s adoption and termination of Rule 10b5-1 plans, these provisions were removed in the final rules. However, the Commission noted in the adopting release that it is continuing to consider whether regulatory action is needed to mitigate the risk of misuse of Rule 10b5-1 plans by companies, such as in the share repurchase context.[xviii] The SEC is still working on final rules for share repurchase disclosure, which were originally proposed alongside the insider trading rules last year. The SEC recently reopened the comment period for the share repurchase rule proposal so that commenters could consider a SEC Staff memorandum analyzing the impact of the new excise tax on share repurchases on the potential economic effects of the SEC’s rule proposal.[xix]

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[i] For our discussion of the proposed rules, see Gibson Dunn Client Alert, SEC Proposes Rules on Insider Trading, Rule 10b5-1 and Share Repurchases (Dec. 23, 2021).

[ii] Insider Trading Arrangements and Related Disclosures, Exchange Act Release No. 96492 (Dec. 14, 2022) (the “Adopting Release”) at III, available at https://www.sec.gov/rules/final/2022/33-11138.pdf.

[iii] The term “officer” refers to how that term is defined in Exchange Act Rule 16a-1(f).

[iv] Adopting Release at II.A.1.c.

[v] See Rule 10b5-1 and Insider Trading, Exchange Act Release No. 93782 (Dec. 15, 2021) (the “Proposing Release”), at II.A.1, available at https://www.sec.gov/rules/proposed/2022/33-11013.pdf

[vi] Adopting Release at II.A.3.c.

[vii] Proposing Release at II.A.3.

[viii] See Adopting Release at II.A.3.c.

[ix] Id.

[x] Id.

[xi] Proposing Release at II.A.4.

[xii] See Adopting Release at II.B.1.c.

[xiii] See Id.

[xiv] See Proposing Release at II.B.1.

[xv] Proposing Release at II.C.

[xvi] See Proposing Release at II.B.4.

[xvii] See Proposing Release at II.B.2.; Adopting Release at II.E.3.

[xviii] Adopting Release at II.A.1.c.

[xix] Reopening of Comment Period for Share Repurchase Disclosure Modernization, Exchange Act Release No. 96458 (Dec. 7, 2022), available at https://www.sec.gov/rules/proposed/2022/34-96458.pdf.

The IRS and Treasury released proposed regulations on December 9, 2022 that, according to the preamble to the proposed regulations, is aimed at eliminating an approach taken by some consolidated groups to minimize income inclusions of their “pro rata share” under sections 951 (“subpart F” income) and 951A (“GILTI”).  The preamble describes the approach involving the “shifting” of ownership in the stock of lower-tier controlled foreign corporations (“CFCs”) between different members of the group during a taxable year.[1]

Background

Under section 951(a)(2)(A), a United States shareholder’s “pro rata share” of subpart F income or GILTI of a lower-tier CFC generally is the amount that would have been distributed with respect to the CFC stock that the shareholder owns, directly or indirectly, if, on the last day in the CFC’s taxable year in which it is a CFC, the CFC had distributed (pro rata) its subpart F income and GILTI income (or, if the CFC was not a CFC for its entire year, a proportionate amount of that income).  Section 951(a)(2)(B) requires the shareholder’s inclusions be reduced by the amount of any dividends received with respect to such stock by any other person during that taxable year (with the amount of the reduction generally capped at a portion of the subpart F income and GILTI, respectively, of the CFC for the part of the year during which the shareholder did not directly or indirectly own the CFC stock).

Under section 959(b), the earnings and profits of a lower-tier CFC attributable to amounts that are, or have been, included in the gross income of a United States shareholder as subpart F income or GILTI, generally is not, when distributed to an upper-tier CFC, included in the gross income of the upper-tier CFC for purposes of computing the upper-tier CFC’s subpart F income or GILTI.  In the preamble to the proposed regulations, the IRS and Treasury observed that, as a result of the 2017 Tax Cuts and Jobs Act, “there is (and will continue to be) a substantial amount of previously taxed earnings and profits (“PTEP”) in the U.S. tax system.”

Proposed Regulations

The proposed regulations would provide that, when stock of a lower-tier CFC is transferred within a consolidated group, the consolidated group members are treated as a single United States shareholder so that the member that owns (within the meaning of section 958(a)) the lower-tier CFC stock at the end of the year cannot reduce its subpart F or GILTI inclusion by reason of section 951(a)(2)(B) for section 959(b) distributions by the lower-tier CFC before the transfer.  The new rule would apply to taxable years for which the original consolidated income tax return is due (without extensions) after the date on which a Treasury decision adopting these rules as final regulations is published in the Federal Register.

Example 1 of the proposed regulations describes a situation in which P owns M1 and M2, and all three entities are U.S. corporations that together file a consolidated return. Throughout Year 1, M1 owns all of the stock of CFC1, which, in turn, owns all of the stock of CFC2.  In Year 1, CFC2 has $100 of subpart F income. M1’s pro rata share of CFC2’s subpart F income for Year 1 is $100, which M1 includes in its gross income under section 951(a)(1)(A). In Year 2, CFC2 has $80 of subpart F income and distributes $80 to CFC1 (the “CFC2 Distribution”). Because the distribution consists of subpart F income, and because it is made to an upper-tier CFC, section 959(b) applies, and CFC1 is not required to include it in gross income.  On December 29 of Year 2, M1 transfers all of its CFC1 stock to M2 (in an exchange described in section 351(a)). As a result, on December 31 of Year 2 (the last day of Year 2 on which CFC2 is a CFC), M2 owns all of the stock of CFC1, which owns all of the stock of CFC2.

Under current law, because M2 owned the CFC1 stock on the last day of Year 2, sections 951(a)(2)(B) and 959(b) require M2 to reduce its subpart F inclusion by the $80 dividend from CFC2 to CFC1, subject to a cap based on the portion of the year during which CFC2 was owned by M1, even though M1 and M2 are both members of the same consolidated group.  Because the transfer occurred on December 29, the operation of section 951(a)(2)(B) would result in a substantial reduction in any subpart F inclusion with respect to CFC2 for Year 2.

The proposed regulations would provide that section 951(a)(2)(B) would not apply to this fact pattern because all of the members of the P consolidated group are treated as a single United States shareholder for purposes of determining the portion of the tax year in which a shareholder did not own the stock of a CFC.  Accordingly, because M1 and M2 (both members of the P consolidated group) together owned the stock of CFC2 for all of Year 2, M2 would be treated as owning the stock of CFC2 for the entire year. Thus, the section 951(a)(2)(B) multiplicand would be $0 (0 days (the number of days that M2 did not own CFC2 stock)), and M2 would be required to include the full (unreduced) $80 subpart F income in its gross income under section 951(a)(1)(A).

 Example 2 of the proposed regulations shows the application of the same rule in the context of the transfer of a lower-tier CFC between two upper-tier CFCs; as in the first example, there is no reduction in the aggregate inclusion amount by reason of section 951(a)(2)(B). The example goes on to note that the two members of the consolidated group must  include their pro rata shares of the lower-tier CFC’s subpart F income based on their relative ownership of the lower-tier CFC on December 31 of Year 2.

Additional Guidance Expected; “No Inference”

The IRS and Treasury are widely expected to issue additional proposed regulations addressing issues involving PTEP, an area that is closely related to subpart F and GILTI inclusions, so it is somewhat surprising that the government saw fit to issue this short and discrete proposed regulation as a standalone item rather than including it in the larger guidance package. In addition, it is notable that the proposed regulation includes “no inference” language, meaning that taxpayers are forewarned that the IRS may consider challenging positions contrary to rule of the proposed regulations before their finalization.

Please contact any Gibson Dunn tax lawyer for updates on this issue.

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[1] Prop. Treas. Reg. § 1.1502-80(j) (Dec. 9, 2022).   All “section” references are to the Internal Revenue Code of 1986, as amended, and all “Prop. Treas. Reg. §” are to the proposed regulations.  Because the rule contained in the proposed regulations would apply only in the context of consolidated groups, the IRS and Treasury included the proposed regulations in the section 1502 consolidated return regulations rather than in the regulations governing either subpart F and GILTI inclusions under sections 951 and 951A, or the distribution of previously taxed earnings and profits under section 959.

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This alert was prepared by Mike Desmond, Matt Donnelly, Pamela Endreny, Eric Sloan, Jeffrey M. Trinklein, and Anne Devereaux.

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 and Global Tax Controversy and Litigation 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])
Brian R. Hamano – Los Angeles (+1 310-551-8805, [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])
John-Paul Vojtisek – New York (+1 212-351-2320, [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])

Global Tax Controversy and Litigation Group:
Michael J. Desmond – Co-Chair, Los Angeles/Washington, D.C. (+1 213-229-7531, [email protected])
Saul Mezei – Washington, D.C. (+1 202-955-8693, [email protected])
Sanford W. Stark – Co-Chair, Washington, D.C. (+1 202-887-3650, [email protected])
C. Terrell Ussing – Washington, D.C. (+1 202-887-3612, [email protected])

*Anne Devereaux is an of counsel working in the firm’s Los Angeles office who is admitted only in Washington, D.C.

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

With ongoing challenges of the COVID-19 pandemic, the Russia-Ukraine conflict and other global developments and trends, companies have been navigating a challenging 2022 capital raising market. Join partners of Gibson Dunn’s Capital Markets and Securities Regulation and Corporate Governance practice groups, as they provide an overview of market activity in 2022 and how companies have reacted to the market impact of these developments. This webcast also discusses thoughts on 2023 capital raising and the key issues and opportunities that may impact companies considering capital raise transactions in the next year.

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PANELISTS:

Hillary H. Holmes is a partner in the Houston office of Gibson, Dunn & Crutcher, Co-Chair of the firm’s Capital Markets practice group, and a member of the firm’s Securities Regulation and Corporate Governance, Energy, M&A and ESG practice groups. Ms. Holmes’ practice focuses on capital markets, securities regulation, and corporate governance. She is Band 1 ranked by Chambers USA in capital markets for the energy industry and recognized in nationwide Energy Transactions and M&A/Corporate. Ms. Holmes represents issuers and underwriters in all forms of capital raising transactions, including IPOs, registered offerings of debt or equity, private placements, joint ventures, structured investments, and sustainable financings. Ms. Holmes also frequently advises companies, boards of directors, special committees and financial advisors in M&A transactions, and conflicts of interest and other special situations.

Tom Kim is a partner in the Washington, D.C. office of Gibson, Dunn & Crutcher and a member of the firm’s Securities Regulation and Corporate Governance practice group. Mr. Kim focuses his practice on advising companies, underwriters and boards of directors on registered and exempt capital markets transactions, SEC regulatory and reporting issues, and corporate governance, as well as on general corporate and securities matters. Mr. Kim has been recognized by Chambers USA in the Securities Regulation: Advisory category since 2015. Mr. Kim served for six years as the Chief Counsel and Associate Director of the Division of Corporation Finance at the SEC.

Robyn E. Zolman is Partner-in-Charge of the Denver office of Gibson, Dunn & Crutcher, where she practices in the firm’s Capital Markets and Securities Regulation and Corporate Governance practice groups. Ms. Zolman represents clients in connection with a broad range of capital markets transactions. She advises clients with respect to SEC registered and Rule 144A offerings of investment grade, high-yield and convertible notes, as well as initial public offerings, follow-on equity offerings, at-the-market equity offering programs, PIPE offerings and issuances of preferred securities. In addition, she has extensive experience with tender offers, exchange offers, consent solicitations and corporate restructurings. Ms. Zolman also regularly advises clients regarding securities regulation and disclosure issues and corporate governance matters, including Securities and Exchange Commission reporting requirements, stock exchange listing standards, director independence, board practices and operations, and insider trading compliance.

Robert D. Giannattasio is of counsel in the New York office of Gibson, Dunn & Crutcher and practices in Gibson Dunn’s Capital Markets Practice Group, Securities Regulation and Corporate Governance Practice Group, and Global Finance Practice Group.  Mr. Giannattasio has a broad corporate and capital markets practice representing issuers and underwriters on a variety of public and private debt and equity offerings, including acquisition financings, investment-grade and high-yield debt offerings, IPOs and follow-on equity offerings, and liability management transactions.

Daniel Burton-Morgan is head of Americas Equity Capital Markets Syndicate at Bank of America Securities, having taken on the role in November 2020. Prior to this, he was Head of UK & Ireland Equity Capital Markets (August 2018 to November 2020) having previously been Head of the EMEA Equity Capital Markets Syndicate for over five years. In total Daniel has over 16 years of experience in UK Investment Banking and Global ECM, starting at Merrill Lynch in 2006. In his previous role Daniel worked on over 200 transactions including sell-downs in ABN, Renault, Lloyds Banking Group, Evonik, Engie, Nordea, ENEL and EADS, IPOs of Aena, Auto Trader, Worldpay, Moncler and Allied Irish Banks, and capital raises for E.On, Barclays, Standard Chartered and Unicredit. Daniel graduated from the University of Warwick with a First Class degree in Management in 2006.

Laurie Campbell joined the Global Capital Markets Division at Bank of America in 2005. She is head of the group responsible for coverage of investment grade companies in the Technology and General Industries sectors. Prior to joining Bank of America, Laurie was a Managing Director in Debt Capital Markets at Goldman Sachs from 1997 to 2003. From 1992 to 1997 Laurie was a Principal with Morgan Stanley in their Debt Capital Markets group. She also worked as an Associate in Corporate Finance at Salomon Brothers from 1989 to 1992. Laurie received an M.B.A. from the University of Western Ontario in 1989 and a Bachelor of Commerce from McGill University in 1983.

Reprinted by permission. Copyright © 2023 Bank of America Corporation (“BAC”). The information is provided “as is” and none of BAC or any of its affiliates warrants the accuracy or completeness of the information.

Join us for a recorded 60-minute briefing covering key developments in the executive compensation space. Mike Scanlon, Tino Salazar and Krista Hanvey outline recent legislative and regulatory developments and provide practical tips to help you prepare for proxy and incentive compensation grant season.

Topics to be discussed:

• The SEC’s new Pay versus Performance disclosure requirements
• The SEC’s new Clawback rule requirements and DOJ focus on such policies
• State law restrictive covenant trends and how they may affect your grant agreements
• ESG performance metrics in incentive compensation

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PANELISTS:

Krista P. Hanvey is Co-Chair of Gibson Dunn’s Employee Benefits and Executive Compensation practice group and Co-Partner-In-Charge in the firm’s Dallas office. She counsels clients of all sizes across all industries, both public and private, using a multi-disciplinary approach to compensation and benefits matters that crosses tax, securities, labor, accounting and traditional employee benefits legal requirements. Ms. Hanvey has significant experience with all aspects of executive compensation, health and welfare benefit plan, and retirement plan compliance, planning, and transactional support. She also routinely advises clients with respect to general corporate and non-profit governance matters.

Michael J. Scanlon is a partner in the Washington, D.C. office of Gibson, Dunn & Crutcher. He is a member of the firm’s Securities Regulation and Corporate Governance, Securities Enforcement, and Corporate Transactions Practice Groups, and has an extensive practice representing U.S. and foreign public company and audit firm clients on regulatory, corporate governance, and enforcement matters. Mr. Scanlon advises corporate clients on SEC compliance and disclosure issues, the Sarbanes-Oxley Act of 2002, and corporate governance best practices, with a particular focus on financial reporting matters. He frequently represents both accounting firms and public company clients on SEC and PCAOB accounting and auditing matters, including financial statement materiality and restatement issues, internal control issues, auditor independence, and other accounting-related disclosure issues.

Tino Salazar is an associate in the Los Angeles office of Gibson, Dunn & Crutcher. He is a member of the firm’s Corporate Department and a member of the firm’s Executive Compensation and Employee Benefits Practice Group. His practice focuses on all aspects of executive compensation and employee benefits. Mr. Salazar’s practice encompasses tax, ERISA, accounting, corporate, and securities law aspects of equity and other incentive compensation plans and executive employment and severance arrangements.

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MCLE CREDIT INFORMATION:

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit.

Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

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 hour.

California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.

This webcast covers key developments to be aware of as you prepare your 2023 proxy statement, including recent and upcoming SEC rulemaking and comment letters, proxy season trends and investor and proxy advisor updates.

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PANELISTS:

Aaron K. Briggs is a partner in Gibson Dunn’s San Francisco, CA office, where he works in the firm’s securities regulation and corporate governance practice group. Mr. Briggs’ practice focuses on advising public companies of all sizes (from pre-IPO to mega-cap), with a focus on technology and life sciences companies, on a wide range of securities and governance matters. Before rejoining Gibson Dunn, Mr. Briggs served for five years as Executive Counsel – Corporate, Securities & Finance, at General Electric Company. His in-house experience—which included responsibility for SEC reporting and compliance, board governance, proxy and annual meeting, investor outreach and executive compensation matters, and included driving GE’s revamp of its full suite of investor communications (proxy statement, 10-K, earnings releases, and integrated report)—provides a unique insight and practical perspective on the issues that his clients face every day.

Julia Lapitskaya is a partner in the New York office of Gibson, Dunn & Crutcher. She is a member of the firm’s Securities Regulation and Corporate Governance and its ESG (Environmental, Social & Governance) practices. Ms. Lapitskaya’s practice focuses on SEC, NYSE/Nasdaq and Securities Exchange Act of 1934 compliance, securities and corporate governance disclosure issues, corporate governance best practices, state corporate laws, the Dodd-Frank Act of 2010, SEC regulations, shareholder activism matters, ESG and sustainability matters and executive compensation disclosure issues, including as part of initial public offerings and spin-off transactions.

Geoffrey E. Walter is an associate in the Washington, D.C. office of Gibson, Dunn & Crutcher and a member of the firm’s Securities Regulation and Corporate Governance Practice Group. Mr. Walter advises public companies and their boards of directors on a wide range of corporate law matters, including securities and corporate governance practices and disclosure issues, compliance with SEC regulations and executive compensation disclosure issues, shareholder engagement and activism matters, insider trading and other company policies, and shareholder proposals and responses to SEC inquiries. Mr. Walter also has experience advising nonprofit organizations on issues related to corporate governance.

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MCLE CREDIT INFORMATION:

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit.

Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

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 hour.

California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.

All communications between EU-qualified external lawyers and their clients benefit from Legal Professional Privilege

In a recent judgment, the European Court of Justice underlined the importance of Legal Professional Privilege in the EU and expanded its scope and nature as compared to the previous situation. The judgment underlines the importance of the fundamental right of respect of communications between a client and their lawyer, and provides reassurance to companies that irrespective of their scope or nature, such communications do not need to be provided to public authorities.

The background to the dispute

The case in question relates to EU legislation (Directive 2011/16/EU) that requires all intermediaries involved in potentially aggressive cross-border tax-planning that might lead to tax avoidance and evasion to report relevant practices to the competent tax authorities. The obligation also covers those who provide advice in that regard, although each EU Member State may grant lawyers (“lawyer-intermediaries”) a waiver from that obligation where it would breach Legal Professional Privilege (LPP) protected under national law. In such a situation, the lawyer-intermediary must nevertheless notify other intermediaries or the relevant taxpayer of their reporting obligations under the relevant legislation.

On that basis, the Flemish decree which transposed the Directive outlined that a lawyer-intermediary must inform other intermediaries that he or she could not fulfil the relevant reporting obligations him- or herself. Two lawyers’ professional organizations argued in front of the Belgian Constitutional Court that by providing even this information, lawyer-intermediaries would breach LPP. The European Court of Justice (ECJ) ruled on this issue on 8 December 2022 in response to a request for guidance from the Belgian Constitutional Court.

The ECJ judgment

The judgment first outlines a number of general principles about the sanctity of communications between lawyers and clients and the nature of LPP itself, even though this was not in itself the subject matter of the request for guidance from the Belgian Constitutional Court. It invokes both the EU Charter of Fundamental Rights as well as case-law of the European Court of Human Rights to highlight:

• the confidentiality of correspondence between individuals and the strengthened protection in that regard to exchanges between lawyers and their clients;
• that such protection covers not only the activity of defence but also legal advice;
• the secrecy of such legal consultation must be guaranteed, both with regard to its content and to its existence;
• individuals who consult a lawyer must therefore have a legitimate expectation that their lawyer will not disclose to anyone, without their consent, that they are being consulted.

Against this backdrop, the judgment goes on to answer the specific request for guidance in relation to the Directive. It holds that the obligation for a lawyer to notify other intermediaries of their obligations under the Directive is in itself an interference of the fundamental right of respect of communications between lawyer and client because those other intermediaries become aware of the identity of the notifying lawyer-intermediary, of their assessment that the arrangement at issue is reportable and of their having been consulted in connection with the arrangement

Since even fundamental rights are not absolute, the judgment then assesses whether such interference is justified in terms of whether it is necessary to achieve a general interest. It holds that the interference is not strictly necessary, inter alia because the reporting obligation of the Directive is clear and already applies to all relevant intermediaries without it being necessary for a lawyer to be involved.

The Court therefore holds that the obligation to notify set out in the Directive infringes the fundamental right of respect for communications between a lawyer and their client.

Implications of the judgment

Beyond the specific subject-matter of the case, the judgment is significant because of the importance it attaches to LPP and the expansion of its scope and nature. These issues were not the specific subject-matter of the request for guidance from the Belgian Constitutional Court and so it is noteworthy that the ECJ, sitting in its Grand Chamber composition, sought to highlight them. By importing provisions from the EU Charter of Fundamental Rights and jurisprudence of the European Court of Human Rights, the judgment significantly expands the nature of LPP in the EU. Under the previous case-law (e.g. the AM&S and Akzo cases), LPP covered only communications relating to the defence of a client or earlier communications related to the subject-matter of the investigation. In practice, this raised questions about which pre-investigation communications could benefit from LPP.

The judgment means that this question is now moot – there is no longer any potential temporal or subject-matter limitation to the notion of LPP in the EU since all communications between lawyers and clients are presumed to benefit from such protection. In practice therefore, clients will no longer be subject to any uncertainty about whether and if so which lawyer-client communications benefit from LPP in the EU. Clients continue to need to be aware that in the EU, in contrast to the situation in the United States, communications with in-house lawyers are not deemed to benefit from LPP and only EU-qualified lawyers benefit from LPP under the EU rules.

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The following Gibson Dunn lawyers prepared this client alert: Nicholas Banasevic* and Christian Riis-Madsen.

Gibson Dunn’s lawyers are available to assist in addressing any questions that you may have regarding the issues discussed in this update. For further information, 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 Antitrust and Competition practice group:

Antitrust and Competition Group:

Nicholas Banasevic* – Managing Director, Brussels (+32 2 554 72 40, [email protected])

Christian Riis-Madsen – Co-Chair, Brussels (+32 2 554 72 05, [email protected])

Ali Nikpay – Co-Chair, London (+44 (0) 20 7071 4273, [email protected])

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

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

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

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

The U.K. Financial Conduct Authority (the “FCA”) Final Notice against Julius Baer International Limited (“JBIL”)[1], including the imposition of a fine of more than £18 million, marks the latest in a series of enforcement actions against FCA authorised firms relating to failings in arrangements with third party intermediaries. In this alert, we draw out the key themes from those enforcement actions, highlighting particular areas of FCA concern and focus, and set out some practical steps that firms can take so as not to fall foul of regulatory requirements and expectations.

The JBIL Final Notice

JBIL, an investment advisory and wealth management firm, was found by the FCA to have failed to conduct its business with integrity, failed to take reasonable care to organise and control its affairs and failed to be open and cooperative with the FCA.[2]  The finding, in particular, that JBIL failed to act with integrity stands out, with there being very few cases where the FCA has considered that there has been a breach of Principle 1 of its Principles for Businesses.[3]

The FCA concluded that JBIL facilitated finder’s arrangements between Bank Julius Baer (“BJB”) and an employee (the “Finder”) of a number of holding companies incorporated in various jurisdictions which owned the residual non-Russian assets of a Russian oil group (the “Client Group Companies”). Under these arrangements, BJB paid finder’s fees to the Finder for introducing Client Group Companies to Julius Baer. This was done on the understanding that the Client Group Companies would then place large cash sums with Julius Baer from which Julius Baer could generate significant revenues.

In particular, uncommercial FX transactions were made in which the Client Group Companies were charged far higher than standard rates, with the profits being shared between the Finder and Julius Baer. The Finder received commission payments totalling approximately USD 3m as a result of these arrangements. These fees were improper and together with the uncommercial FX transactions showed a lack of integrity in the way in which JBIL was undertaking this business.

Further, the FCA found that JBIL failed to have adequate policies and procedures in place to identify and manage the risks arising from the relationships between JBIL and finders (external third parties that introduced potential clients to Julius Baer in return for commission). This included having no policies which defined the rules surrounding the use of finders within JBIL until after June 2010. Policies introduced after that date were found to be inadequate.

Finally, JBIL became aware of the nature of these transactions – including the commission payments to the Finder – in 2012 and suspected that a potential fraud had been committed. However, it did not report these matters to the FCA immediately, as required, or at all until July 2014.

Previous FCA enforcement action against other firms

As noted above, the JBIL Final Notice follows a number of Final Notices imposed on other firms by the FCA. These range from Final Notices for  not taking reasonable care to establish and maintain effective systems and controls for countering the risks of bribery and corruption associated with making payments to overseas third parties who assisted in winning business from overseas clients, to a Final Notice issued earlier this year relating to, broadly, the third-party introducers it used in its insurance business and bribes being made by such persons.

Key themes

(1) Policies and procedures

One recurring theme from the Final Notices is that the firms had failed to ensure that they had adequate policies and procedures in place to identify and manage the risks of using the third party intermediaries. For example, prior to 11 June 2010, there were no policies which defined the rules and guidelines to be adopted in respect of the use of finders within the Julius Baer group or JBIL. After that date, JBIL relied on BJB policies and procedures in relation to finders, which were inadequate, and other entities within the Julius Baer group were responsible for managing and overseeing key aspects of finder relationships, including the contractual terms and payment of fees.  As a result, JBIL failed to ensure that it identified and managed potential conflicts of interests, both between finders and its clients and between the Julius Baer group and its clients.  JBIL also failed to ensure that clients were properly informed of its arrangements with finders and consented to any payments made to finders.  A particular similarity between the JBIL Final Notice and previous Final Notices is that firms have had an over-reliance on group procedures, which were not, on their own, sufficient.  Firms should, therefore, be cognisant of their own regulatory responsibilities and not simply follow a group-wide policy without ensuring that the policies appropriately cover their own activities.

(2) Systems and controls

Principle 3 requires a firm to take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems. In the JBIL Final Notice, it was determined that the conduct of the relationship with the Client Group Companies highlighted serious issues with JBIL’s control environment.  Amongst other things, the FCA found that JBIL: (i) did not have a sufficient understanding of the relationships between finders and introduced clients to enable it to identify potential conflicts of interests and did not have sufficient information or oversight to identify any other risks that might arise from relationships with finders; (ii) was not able to take steps adequately to monitor or control the risks arising from relationships with finders, or to assess whether it was appropriate for Julius Baer to maintain such relationships at all; and (iii) was not able to and did not control the disclosure of relationships with finders to clients.

Interestingly, in the JBIL Final Notice and previous Final Notices, the FCA has been critical of the firms in question for not having taken into account relevant key publications produced by the FCA that should have served as a warning and guidance to them. For example, in the JBIL Final Notice, the FCA specifically referred to the “financial crime risks presented by firms’ use of Finders [having] been highlighted by the Authority in publications and enforcement action against firms including Aon (6 January 2009), Willis (21 July 2011) and Besso (17 March 2014)”.  This is a clear message that firms should be monitoring the publication of relevant guidance by the FCA and seeing if any lessons can be learned from enforcement action against other market participants.

Another recurring theme of the Final Notices in this space has been what the FCA perceives as inadequate governance, including the manner in which risks, including those relating to financial crime, were presented to certain committees did not enable them to assess the risks holistically and relevant risks and issues were not appropriately escalated to control functions. It is vital, therefore, that firms ensure: (i) the flow of appropriate MI to the relevant committees; (ii) that such information is properly scrutinised and, where necessary, challenged; (iii) that individuals with appropriate skills and experience are sitting on the Board or relevant committees; and (iv) that individuals holding important roles such as the MLRO function are at a sufficiently senior level.

(3) Communicating with the FCA

It is interesting to contrast the views of the FCA on how JBIL and other firms have communicated with it prior to and throughout the enforcement process. In the JBIL Final Notice the FCA noted that “[on] 22 May 2014, [JBIL] reported potential acts of bribery and corruption to UK law enforcement. It referred to payments made by BJB to [the Finder] in finder’s fees and stated that the payments may have been tainted by a ‘scheme’ by [the Finder] and [another individual], to defraud the [Client] Group Companies of money. [JBIL] informed the [FCA] of this on 7 July 2014”. Whilst firms will always want to take time to establish the facts before reporting potential issues to regulators, care must be taken to avoid overly long delay. In this case, the FCA highlighted the gap between the date of internal escalation of serious concerns and the date on which the FCA were notified of the issue: “The [FCA] expects to be notified of allegations of financial crime immediately and should have been promptly informed about the concerns raised on 30 November 2012”.

By contrast, in other Final Notices, the FCA has acknowledged the assistance that firms have provided to it during its investigation when coming to the amount of the fine issued.  Firms should, therefore, give great consideration to how and when they communicate with the FCA. This is particularly important in the context of ensuring that firms appropriately comply with their Principle 11 notification obligations.

Practical steps

We set out below a table of examples of “good” and “poor” practice that should assist firms in their approach to ensuring they are complying with FCA expectations in the context of relationships with third party intermediaries, primarily viewed through an anti-bribery and corruption lens. It is informed by the FCA’s guidance in Chapter 13 of its “Financial Crime Thematic Reviews” guide.

Examples of “good practice”	Examples of “poor practice”
Governance
Clear, documented responsibility for anti-bribery and corruption apportioned to either a single senior manager or a committee with appropriate terms of reference and senior management membership, reporting ultimately to the Board.	Failing to establish an effective governance framework to address bribery and corruption risk.
Regular and substantive MI to the Board and other relevant senior management forums, including: an overview of the bribery and corruption risks faced by the business; systems and controls to mitigate those risks; information about the effectiveness of those systems and controls; and legal and regulatory developments.	Failing to allocate responsibility for anti-bribery and corruption to a single senior manager or an appropriately formed committee.
Where relevant, MI includes information about third parties, including (but not limited to) unusually high commission paid to third parties.	Little or no MI sent to the Board about bribery and corruption issues, including legislative or regulatory developments, emerging risks and higher risk third-party relationships or payments.
Assessing bribery and corruption risk
The firm takes adequate steps to identify the bribery and corruption risk. Where internal knowledge and understanding of corruption risk is limited, the firm supplements this with external expertise.	The risk assessment is a one-off exercise.
Risk assessment is a continuous process based on qualitative and relevant information available from internal and external sources.	Efforts to understand the risk assessment are piecemeal and lack coordination.
Firms consider the potential conflicts of interest which might lead business units to downplay the level of bribery and corruption risk to which they are exposed.	Risk assessments are incomplete and too generic.
The bribery and corruption risk assessment informs the development of monitoring programmes; policies and procedures; training; and operational processes.	Firms do not satisfy themselves that staff involved in risk assessment are sufficiently aware of, or sensitised to, bribery and corruption issues.
Policies and procedures
The firm clearly sets out the behaviour expected of those acting on its behalf.	The firm has no method in place to monitor and assess staff compliance with anti-bribery and corruption policies and procedures.
The team responsible for ensuring the firm’s compliance with its anti-bribery and corruption obligations engages with the business units about the development and implementation of anti-bribery and corruption systems and controls.	Staff responsible for the implementation and monitoring of anti-bribery and corruption policies and procedures have inadequate expertise on bribery and corruption.
There should be an effective mechanism for reporting issues to the team or committee responsible for ensuring compliance with the firm’s anti-bribery and corruption obligations.
Third party relationships and due diligence
Where third parties are used to generate business, these relationships are subject to thorough due diligence and management oversight.	A firm using intermediaries fails to satisfy itself that those businesses have adequate controls to detect and prevent staff using bribery or corruption to generate business.
Third-party relationships are reviewed regularly and in sufficient detail to confirm that they are still necessary and appropriate to continue.	The firm fails to establish and record an adequate commercial rationale for using the services of third parties.
There are higher, or extra, levels of due diligence and approval for high risk third-party relationships.	The firm is unable to produce a list of approved third parties, associated due diligence and details of payments made to them.
There is appropriate scrutiny of, and approval for, relationships with third parties that introduce business to the firm.	There is no checking of compliance’s operational role in approving new third-party relationships and accounts.
The firm’s compliance function has oversight of all third-party relationships and monitors this list to identify risk indicators, such as a third party’s political or public service connections.	A firm assumes that long-standing third-party relationships present no bribery or corruption risk.
Evidence that a risk-based approach has been adopted to identify higher risk relationships in order to apply enhanced due diligence.	A firm relies exclusively on informal means, such as staff’s personal knowledge, to assess the bribery and corruption risk associated with third parties.
Enhanced due diligence procedures include a review of the third party’s own anti-bribery and corruption controls.	No prescribed take-on process for new third-party relationships.
Inclusion of anti-bribery and corruption-specific clauses and appropriate protections in contracts with third parties.	A firm does not keep full records of due diligence on third parties and cannot evidence that it has considered the bribery and corruption risk associated with a third-party relationship.
Providing good quality, standard training on anti-bribery and corruption for all staff.

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[1] https://www.fca.org.uk/publication/final-notices/julius-baer-international-limited-2022.pdf.

[2] The FCA also published decision notices for three connected individuals (available here).

[3] The most recent instance prior to this was the Coverall Worldwide Ltd Final Notice in 2016: https://www.fca.org.uk/publication/final-notices/coverall-worldwide-ltd.pdf.

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Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact the Gibson Dunn lawyer with whom you usually work, any member of Gibson Dunn’s Global Financial Regulatory team, or the following authors in London:

Michelle M. Kirschner (+44 (0) 20 7071 4212, [email protected])
Matthew Nunan (+44 (0) 20 7071 4201, [email protected])
Martin Coombes (+44 (0) 20 7071 4258, [email protected])
Chris Hickey (+44 (0) 20 7071 4265, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On November 21, 2022, Governor Hochul signed into law Bill A8092B, which amends the New York Labor Law (“NYLL”) to provide a new potential claim for employees who are retaliated against for taking lawful absences from work.  The amendments also expressly prohibit employers from using “no-fault” attendance policies that penalize employees for taking protected absences.  The new provisions of NYLL will be effective on February 20, 2023.

New Anti-Retaliation Provisions

When effective, the NYLL will prohibit employers from discharging, threatening, penalizing, discriminating or retaliating against an employee “because such employee has used any legally protected absence pursuant to federal, local, or state law.”  Legally protected absences include absences taken pursuant to federal and state leave laws, such as the Family and Medical Leave Act (“FMLA”), the New York State and City Paid Sick Leave Laws, and the New York State Paid Family Leave Law.

The amendments will also restrict New York employers from maintaining “no-fault” attendance policies whereby an employer assigns “points” to employees for certain absences and imposes disciplinary action against employees who reach a certain number of points.  The amended law expressly prohibits employers from imposing “any demerit, occurrence, any other point, or deductions from an allotted bank of time, which subjects or could subject an employee to disciplinary action, which may include but not be limited to failure to receive a promotion or loss of pay” when an employee takes a protected leave.  This effectively prohibits no-fault attendance policies in New York to the extent that a policy penalizes employees for absences covered by an applicable leave law.

Legal Landscape

Employers are already prohibited from penalizing employees for taking protected leave under many statutes that are covered by these amendments to the NYLL.  For example, the U.S. Department of Labor and some courts have interpreted the FMLA to prohibit employers from assessing points under no-fault attendance policies for FMLA-protected leave.  See Woods v. START Treatment & Recovery Centers, Inc., 864 F.3d 158 (2d Cir. 2017).  Moreover, the New York City Sick Leave Law specifically prohibits the “maintenance or application of an absence control policy that counts safe and sick leave as an absence that may lead to or result in an adverse action.”

New York legislators have nevertheless expressed concern that these existing protections are not sufficient to curb employers’ use of no-fault attendance policies in a manner that penalizes employees for taking protected leave.  This law therefore aims to “make clear” that the practice of assessing points for any leave taken pursuant to applicable law is not permitted.

In addition to reinforcing existing law, these amendments allow employees to pursue claims against employers for retaliation for taking leave under any applicable leave law.  For example, whereas the New York Paid Family Leave Law and the New York City Sick Leave Law only allow for administrative enforcement, the NYLL contains a private cause of action that allows employees to seek back pay, front pay, reinstatement, and/or liquidated damages when employees experience retaliation related to protected leaves.

The amendments will also permit the State to impose higher fines for violations of the anti-retaliation provisions of leave laws.  For example, employers that violate the New York City Sick Leave Law may be fined up to $2,500 for each violation.  Under the amended NYLL, the State Department of Labor is authorized to impose fines of up to $10,000 for initial violations (and up to $20,000 for subsequent violations) of the same anti-retaliation prohibitions.

Key Takeaways for Employers

In light of the impending amendments, New York employers should review their policies – and revise them if necessary – to ensure they do not penalize employees for taking protected leave.  Companies that currently utilize no-fault policies might also wish to train managers and HR personnel to ensure compliance with this new law.

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The following Gibson Dunn attorneys assisted in preparing this client update: Harris Mufson, Alex Downie, and Mimra Aslaoui.

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 practice group, or the following:

Zainab N. Ahmad – New York (+1 212-351-2609, [email protected])

Mylan Denerstein – New York (+1 212-351-3850, [email protected])

Gabrielle Levin – New York (+1 212-351-3901, [email protected])

Danielle J. Moss – New York (+1 212-351-6338, [email protected])

Harris M. Mufson – New York (+1 212-351-3805, [email protected])

Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C.
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Senator Kyrsten Sinema (I-AZ) announced on December 9, 2022, that she would change her party registration from the Democratic Party to Independent. In an interview with CNN’s Jake Tapper, she explained: “I know some people might be a little bit surprised by this, but actually, I think it makes a lot of sense.” Elaborating in an op-ed in the Arizona Republic, Senator Sinema declared that she “never fit in perfectly with either national party,” and pledged to “to continue doing exactly what I promised—to be an independent voice for Arizona.”

As a result of the party switch, the question arises whether Senate Democrats will have 51 seats in the Senate (technically 48 Democrats and three Independents who caucus with the Democrats) as expected after the Georgia runoff. The answer is Senator Sinema’s switch does not necessarily change the Senate’s voting math. As detailed below, we explain what may have motivated Senator Sinema to identify as an Independent and how her switch impacts the Senate’s business going forward. In short, Senator Sinema’s switch likely won’t impact the Democrats’ narrow control of the Senate.

Background on Senator Sinema’s Party Switch

Senator Sinema’s party switch—timed to be announced after Senator Raphael Warnock’s (D-GA) runoff victory in Georgia—likely has to do with the changing politics in Arizona and Senator Sinema’s attempt to secure her own re-election in 2024. It may be an attempt to thread the needle of maintaining political support from Senate Democrats’ campaign resources while heading off a party primary challenge from the progressive left.

Democratic Primary:

Senator Sinema’s decision likely turned on concerns about a strong primary challenger from within the Democratic Party, bolstered by concerns that her recent votes have motivated the party’s campaign arm to throw its support behind a challenger. Recent polling suggests that Senator Sinema’s next primary race may be a close one, as her numbers have steadily declined with Democrats in her home state. No candidates have formally announced challenges to Senator Sinema, but Phoenix-area Representative Ruben Gallego (D-AZ) has been publicly forecasting a primary run for some time.

By leaving the Democratic Party, Senator Sinema avoids a primary challenge and possibly puts herself in a three-way general election in November 2024. The assumption may be that positioning herself as an “Independent,” rather than a Democrat, may allow her to fare better with Republican and Democratic voters in a general election and force Democrats to support her campaign. But it also runs the risk that a three-way race may lead to a Republican being elected senator from Arizona in 2024. Indeed, by abandoning the Democratic Party, a question arises whether Senator Sinema will further alienate the voters that used to be her base. And the National Democratic Party will have a decision to make on whether to support a “Democrat” in the 2024 Arizona Senate election or to back Senator Sinema. But backing Senator Sinema could upset the Democratic base who may or may not turn out to support an “Independent” and cost Democrats a U.S. Senate seat in Arizona.

Arizona:

Demographic changes and shifting ideological blocs have redrawn the map of Democratic focus—and no state perhaps better exemplifies that shift than Arizona. The state has become a critical focus for Democrats in recent years. Arizona is the most recent Sun Belt state to morph from a solidly red state to a critical purple pickup for Democrats—beginning with Senator Sinema’s own narrow defeat of then-sitting Senator Martha McSally in 2018. That victory marked Democrats’ first win of an open Arizona Senate seat since 1976, and signaled to national party leadership, per the New York Times, “a remarkable shift in Arizona’s political landscape,” after the state had been a “Republican bastion for decades.”[1]

Democrats’ strategic reorientation towards Arizona has already paid dividends. This midterm cycle, Democrats invested major talent and resources to successfully protect an endangered Senate seat, as Senator Mark Kelly (D-AZ) kept the seat he won in 2020’s special election, and even more remarkably for the once solidly-red state, picked up a governorship with the election of Secretary of State Katie Hobbs (D-AZ), with whom Senator Sinema has maintained a close relationship for years.

Senator Sinema no doubt understands these changes and the need to appeal to Independents and moderate Republicans in her state. Indeed, more than a third of Arizona’s voters identify as “other” and Republicans outnumber Democrats by more than 166,000.

Party Resources:

Senator Sinema’s move will have major consequences for continued party investments in Arizona, especially in her upcoming reelection bid. Party leadership could choose to 1) continue to back Senator Sinema, as they do with Maine’s Independent Senator Angus King, 2) sit back and watch or 3) actively support a Democratic challenger. Now that she’s formally renounced her party membership, at least nominally, the Democratic Senatorial Campaign Committee (DSCC), Senate Majority PAC, and other party campaign instruments may not support her in 2024, or choose to invest resources in a party challenger instead. However, the fact that Senate Democratic leadership is not seeking to punish Senator Sinema for her switch may suggest that—at least as of now—the DSCC is likely to back her again in 2024.

Independents have traditionally faced an uphill battle in national politics—from fundraising to organizing to marshalling the support of elected officials—that Senator Sinema herself is likely familiar with (the now-U.S. Senator ran for the Arizona House of Representatives as an Independent and lost). While Senator Sinema is known as a strong fundraiser, the DSCC standing back would mean “she would lack party resources—like a ground game—that are critical for voter turnout, particularly in a sprawling state like Arizona.”

As described above, by positioning herself as an Independent, Senator Sinema is betting that the Democratic Party will eventually support her, but if she loses that bet and the Party supports a “Democrat” and not her, she runs the risk of allowing a Republican to win the Senate race.

Personal Brand:

Senator Sinema actively practices bipartisanship, from friendships with Republican senators to playing a key role in advancing bipartisan legislation to President Biden’s desk this Congress. Her commitment to bipartisanship may also have motivated her party switch decision. In her op-ed explaining her decision, Senator Sinema wrote, “[i]n catering to the fringes, neither party has demonstrated much tolerance for diversity of thought. Bipartisan compromise is seen as a rarely acceptable last resort, rather than the best way to achieve lasting progress.” 

These words are consistent with Senator Sinema’s past positions since she ran for the U.S. Senate. From her first election to the Senate, she has sworn to “be an independent voice for all Arizonans.” In her announcement interview with Tapper, she reiterated: “I’ve never fit neatly into any party box. Removing myself from the partisan structure—not only is it true to who I am and how I operate, I also think it’ll provide a place of belonging for many folks across the state and the country, who also are tired of the partisanship.”

Even before running for the Senate, Senator Sinema has done things her own way, from the beginnings of her career as a Green Party activist to more recent moves sending Democrats in the Senate back to the drawing board to gain her support for key legislation. Once a staffer on Ralph Nader’s 2000 presidential campaign, Senator Sinema has become progressively more moderate as she climbed from a 2004 win in the Arizona House of Representatives to a 2010 Arizona Senate seat, then a 2012 U.S. House of Representatives win. Senator Sinema won each of those races as a Democrat. 

What This Means for the Senate 

To understand the potential importance of Senator Sinema’s switch to being an Independent on the U.S. Senate, one must first understand how the change from a 50-50 Senate to a 51-49 Senate would change the overall dynamics of the institution. The Georgia U.S. Senate runoff led to a 51-49 U.S. Senate, which was supposed to change the chamber and firm up Democratic control in several ways:

• Establish a real majority in committees. Democrats have chaired Senate committees the past two years, but there was equal representation on committees, which increased the chances of a tie vote that required time-consuming “discharge” votes on the Senate floor. It also meant that Democratic committee chairs could not issue subpoenas without Republican support. As a result, subpoenas were not used by Senate committees in the 117th Congress. With a 51-49 Senate, Democrats would have one more member than Republicans on all committees, ensuring legislation and nominees would advance if all Democratic caucus members stick together. Democrats would now also have a larger budget and bigger staffs.
• Advancing judicial and executive nominations. For the last two years, with a 50-50 Senate, Republicans were able to slow down the nominations process since the committees had equal representation. If a tie vote occurred in committee, the full Senate must first vote to bring the nomination to the Senate floor and then vote on the nomination itself. Now, with a 51-49 Senate, a Democratic-controlled Senate may be able to more quickly advance nominations through the confirmation process and have more cushion to deal with absences at full Senate confirmation votes on nominees.
• Manchin and Sinema influence. With Democrats having a 51 seat majority in the U.S. Senate, one theory is that Senators Joe Manchin (D-WV) and Sinema would have less influence over the legislative process. While 60 votes are usually required to advance most legislation in the Senate, certain items can pass on a simple majority vote using the budget reconciliation process or for nominations. But that forced Democrats to have no room for defections (or absences) and Senators Manchin and Sinema were at times difficult to win over. But with a 51 seat majority, it is more likely that Democrats can pass legislation or nominations without the support of either Manchin or Sinema if all other Democratic Senators are onboard.
• Less reliance on the Vice President to break ties. A 50-50 Senate has been a weight on Vice President Kamala Harris, who has had to limit her travel in order to be available for tiebreaking votes in the Senate. In fact, Vice President Harris has broken 26 ties in the last two years, the most by a Vice President in nearly 200 years. But a 51-49 Senate, after the Georgia runoff, was supposed to lessen the burden on the Vice President who the Senate may rely on less to break legislative ties in the Senate.

The main question in Washington after Senator Sinema’s announced party switch was how would her decision impact Democratic control over the U.S. Senate. In other words, would the Senate in fact still be a 51-49 Senate or would it go back to effectively being a 50-50 Senate, effectively denying the benefits Democrats expected after the Georgia runoff victory? While Senator Sinema’s move generated significant news coverage, it is not expected to change the balance of power in the Senate. In an interview with Politico, Senator Sinema herself said, “I don’t anticipate that anything will change about the Senate structure. I intend to show up to work, do the same work that I always do. I just intend to show up to work as an independent.”

In the words of Punchbowl News, “Sinema declared that ‘nothing will change about [her] values or behavior’ in announcing her party switch, and top Democrats seem to have accepted that.” Indeed, both the White House and Majority Leader Chuck Schumer (D-NY) have released conciliatory statements regarding the switch.

Most importantly, while Senator Sinema has declined to publicly say whether she will caucus with Senate Democrats, she has stated explicitly she would not caucus with Republicans. Senator Sinema has also indicated, and Leader Chuck Schumer (D-NY) has confirmed, that she will keep her current committee assignments. As Punchbowl put it, by keeping her committee assignments, “Sinema is effectively caucusing with the Democrats,” even if she does not describe it that way.

The other two Senate Independents, Senators Angus King (I-ME) and Bernie Sanders (I-ME), both consistently vote, caucus with, and hold committee positions with Senate Democrats. At the same time, Senator Sinema has said—unlike Senators King and Sanders—she won’t attend weekly Democratic Caucus meetings (which she rarely did anyway), and isn’t sure whether her desk will remain on the Democratic side of the Senate floor.

Senator Sinema is known for bucking her party and frequently allies with Republicans on various legislative efforts. She is currently engaged in last-minute bipartisan talks with Senator Thom Tillis (R-N) on an immigration deal that she hopes could pass in the lame duck session.

Nevertheless, a review of her voting record on the Bipartisan Safer Communities Act, the CHIPS and Science Act, the Respect for Marriage Act, and other legislation shows she is farther to the left than the Republican Party on social issues, even if she is farther to the right of Democrats on economic issues. For instance, Senator Sinema has voted with the Democratic Party 93% of the time, and has publicly stated she doesn’t expect her voting record to change after her switch to become an Independent.

Moreover, Senator Sinema has supported every one of President Biden’s judicial nominees—an unlikely position for a Senate Republican—not to mention voting to impeach then-President Donald Trump twice. Underscoring this, a top aide to Minority Leader Mitch McConnell (R-KY) sent a note to lobbyists and supporters after the party switch highlighting Senator Sinema’s liberal voting record.

With Senator Sinema keeping her committee assignments, the day-to-day operation of the Senate is not expected to change. Following Senator Warnock’s reelection in the Georgia runoff, Democrats will hold a majority in the Senate beginning on January 3, 2023, and that will not change. Likewise, even with Senator Sinema’s switch, Democrats will be a majority on Senate committees—unlike in the current Congress, in which committees are tied. This means Senate Democrats will be able to move nominations more quickly, advance party legislative priorities out of committees with greater ease, and issue subpoenas without Republican support. Moreover, the Vice President will be needed less often to break tie votes.

_______________________________

[1] Senator Sinema’s 2018 victory was particularly noteworthy in a midterm Senate cycle that saw the end of much of the caucus’s moderate wing—Senators Joe Donnelly (D-IN), Heidi Heitkamp (D-ND), and Claire McCaskill (D-MO) each lost their seats after multiple terms in the Senate.

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The following Gibson Dunn attorneys assisted in preparing this client update: Michael D. Bopp, Roscoe Jones, Jr., Daniel P. Smith, Amanda Neely, Wynne Leahy, and Alex Boudreau.

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 or the following lawyers in the firm’s Congressional Investigations or Public Policy practice groups:

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

Roscoe Jones, Jr. – Co-Chair, Public Policy Group, 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]) 

*Daniel P. Smith is admitted only in Illinois; practicing under the supervision of members of the District of Columbia Bar under D.C. App. R. 49.

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Please join us for this 60-minute program. The panel covers key developments to be aware of headed into the 2022 Form 10-K reporting season, including recent SEC rulemaking and comment letters, disclosure trends and other developments.

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PANELISTS:

Thomas J. Kim is a partner in the Washington D.C. office of Gibson, Dunn & Crutcher, LLP, where he is a member of the firm’s Securities Regulation and Corporate Governance Practice Group. Mr. Kim focuses his practice on a broad range of SEC disclosure and regulatory matters, including capital raising and tender offer transactions and shareholder activist situations, as well as corporate governance, environmental social governance and compliance issues. He also advises clients on SEC enforcement investigations – as well as boards of directors and independent board committees on internal investigations – involving disclosure, registration, corporate governance and auditor independence issues.

Mike Titera is a partner in the Orange County office of Gibson, Dunn & Crutcher and a member of the Firm’s Securities Regulation and Corporate Governance Practice Group. His practice focuses on advising public companies regarding securities disclosure and compliance matters, financial reporting, and corporate governance. Mr. Titera often advises clients on accounting and auditing matters and the use of non-GAAP financial measures. He also has represented clients in investigations conducted by the Securities and Exchange Commission and the Financial Industry Regulatory Authority. Mr. Titera’s clients range from large-cap companies with global operations to small-cap companies in the pre-revenue phase. His clients operate in a range of sectors, including the retail, technology, pharmaceutical, hospitality, and financial services sectors.

David Korvin is a corporate associate in the Washington, D.C. office of Gibson, Dunn & Crutcher, where he currently practices in the firm’s Securities Regulation and Corporate Governance Practice Group. Mr. Korvin advises public companies and their boards with respect to corporate governance, federal securities, financial reporting and accounting, insider trading, stock exchange, shareholder engagement, ESG and executive compensation matters. Prior to joining Gibson Dunn, Mr. Korvin was an attorney at the Securities and Exchange Commission in the Division of Corporation Finance, where he handled the legal review of Securities Act and Exchange Act filings and served as a member of the Shareholder Proposal Taskforce.

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Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

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On December 7, 2022, President Biden signed into law the “Speak Out Act” (S.B. 4524), which prohibits the enforcement of pre-dispute non-disclosure and non-disparagement clauses in disputes relating to claims of sexual assault or sexual harassment.  Among other things, the Act is intended to combat sexual harassment and assault in the workplace by ensuring that “victims and survivors have the freedom to report and publicly disclose their abuse” so that perpetrators may be held accountable and workplaces may be “safer and more productive for everyone.”  S.B. 4524 § 2.  The Act applies only to non-disclosure and non-disparagement clauses signed before a dispute arises, meaning that it does not prohibit such provisions in settlement or severance agreements.

In light of Congress’s findings that non-disclosure and non-disparagement provisions “can perpetuate illegal conduct by silencing those who are survivors of illegal sexual harassment and assault or illegal retaliation” and “shielding perpetrators and enabling them to continue their abuse,” the Speak Out Act makes such clauses judicially unenforceable in sexual assault or sexual harassment disputes where the conduct is alleged to have violated federal, state, or tribal law.  S.B. 4524 §§ 4(a), 1(6).  The Act applies to disputes alleging nonconsensual sexual acts, nonconsensual sexual contact, or sexual harassment.  Id. §§ 4(a), 1(3)–(4).

A non-disclosure clause is defined as “a provision in a contract or agreement that requires the parties to the contract or agreement not to disclose or discuss conduct, the existence of a settlement involving conduct, or information covered by the terms and conditions of the contract or agreement.”  S.B. 4524 § 3(1).  A non-disparagement clause is defined as “provision in a contract or agreement that requires 1 or more parties to the contract or agreement not to make a negative statement about another party that relates to the contract, agreement, claim, or case.”  S.B. 4524 § 3(2).

The law does not impact an employer’s right to protect trade secrets or proprietary information.  S.B. 4524 § 4(d).  The Act also does not impact the applicability of state laws governing pre-dispute non-disclosure and non-disparagement clauses to the extent they provide the same or greater protections than the Speak Out Act.  S.B. 4524 § 4(c).

The Speak Out Act follows legislation limiting the enforcement of arbitration clauses in employment agreements for sexual assault and discrimination cases.  The Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act of 2021, enacted in March of 2022, prohibits the enforcement of pre-dispute agreements requiring employees to arbitrate sexual assault or harassment claims.

Notes for Employers

1. Does Not Prohibit Non-Disclosure and Non-Disparagement Clauses. The Act does not prohibit employers from entering into non-disclosure and non-disparagement provisions with their employees, nor does it prevent employers from enforcing such clauses in most circumstances.  The Act only prevents the enforcement of non-disclosure and non-disparagement provisions in connection with disputes relating to sexual harassment and sexual assault.  (Other federal and state laws and regulations, such as the Defend Trade Secrets Act and SEC Rule 21F-17, may require or provide for carve-outs from such clauses for certain protected whistleblowing activities.)
2. No Effect On Settlement Agreements. The Act only applies to non-disclosure and non-disparagement agreements “agreed to before the dispute arises.”  S.B. 4524 § 4(a).  The Act therefore does not place any limitations on non-disclosure and non-disparagement agreements reached as part of a settlement of sexual harassment and sexual assault claims.  Note, however, that many states have laws, such as California’s Silenced No More Act (Cal. S.B. 331) and Section 5-336 of the New York General Obligations Law (N.Y. Gen. Oblig. § 5-336), that place limitations on the use of non-disclosure and non-disparagement provisions in settlement agreements.
3. Not Retroactive. The Act only applies to claims filed after its enactment, and does not affect the enforceability of non-disclosure and non-disparagement clauses in connection with disputes filed before December 7, 2022.  S.B. 4524 § 5.

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The following Gibson Dunn attorneys assisted in preparing this client update: Gabrielle Levin and Kelley Pettus.

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 practice group, or the following:

Gabrielle Levin – New York (+1 212-351-3901, [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])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Orange County partner Thomas Manakides and associate Mark Tomaier are the authors of “Calif. EV Battery Recycling Plans Could Set National Trend” [PDF] published by Law360 on December 8, 2022.

On December 7, 2022, the Legislative Council (“LegCo’) of the Hong Kong Special Administrative Region (“HKSAR”) passed the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022 (“Amended AMLO”) into law. On the same day, the LegCo’s Bills Committee also published a report (“Report”), providing clarification on certain concepts under the Amended AMLO, and explained the postponed timeline for the commencement of the licensing regime for virtual asset service providers (“VASPs”).[1]

In our previous client alert[2], we explained the proposal by the Government of the HKSAR (“Government”) to introduce a licensing regime for VASPs by amending the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615) (“AMLO”). In this client alert, we explain and provide our views on the additional clarification provided on the licensing regime for VASPs, the updated timeline for the commencement of the licensing regime, and next steps.

I. Recap on the Key Proposals Under the Amended AMLO

The Amended AMLO introduces a licensing regime for VASPs, and imposes statutory anti-money laundering and counter-terrorist financing (“AML/CTF”) obligations on VASPs in Hong Kong. Some of the key takeaways are as follows:

• The operation of a virtual asset (“VA”) service will become a “regulated function”, such that VASPs will, in the future, be required to apply for a licence from the Securities and Futures Commission (“SFC”), before they can operate in Hong Kong.
• The licensing regime for VASPs is primarily intended to capture the operation of a VA exchange. However, the Government could expand the scope of “VA service” to cover other forms of VA activities, when the Government considers it necessary to do so in the future.
• The licensing requirements to be imposed on VASPs is likely to be modelled on existing requirements for the SFC’s licensing of regulated activities under the Securities and Futures Ordinance. This includes the fitness and properness requirements, and the requirement for a licensed VASP to have at least two responsible officers.
• The SFC has discretion to impose a range of licensing conditions on a VASP licensee, including conditions relating to financial resources, risk management policies and procedures, management of client assets, virtual asset listing and trading policies, prevention of market manipulation and abusive activities, avoidance of conflicts of interest, among other requirements that can be imposed by the SFC as a licence condition.
• Licensed VASPs will be required to comply with existing requirements under the AMLO on customer due diligence and record-keeping requirements, which will be comparable to traditional financial institutions.
• A new enforcement regime applicable to VASPs will be introduced. Under the Amended AMLO it will be a criminal offence to carry on a business of providing VA service without a VASP licence and to issue advertisements relating to an unlicensed person’s provision of VA service. It will also become a criminal offence to make fraudulent or reckless misrepresentations with the intention to induce others to invest in VAs and an offence to employ deceptive or fraudulent device, scheme or act, directly or indirectly, in a transaction involving VAs (which is likely to capture market manipulation activities).
• Relevantly, the offences of making fraudulent or reckless misrepresentations or employing deceptive or fraudulent devices, schemes or acts, are not limited to transactions on licensed VASPs and as such will capture all individuals and/or firms engaging in this type of conduct with a substantial nexus to Hong Kong.
• The SFC will be granted a significant range of supervisory powers over licensed VASPs. This includes the power to enter the business premise of a licensed VASPs to conduct routine inspections of business records, request production of documents and other records, and to investigate non-compliance and impose disciplinary sanctions against licensed VASPs in contravention.

II. The Applicability of the VASP Regime to Non-Fungible Tokens

Under the Amended AMLO, “VA” generally captures a cryptographically secured digital representation value that:

• is expressed as a unit of account or a store of economic value;
• either:
  
  • functions (or is intended to function) as a medium of exchange accepted by the public as payment for goods or services, or for the discharge of debt, or for investment purposes; or
  • provides rights, eligibility or access to vote on the management, administration or governance of the affairs in connection with any cryptographically secured digital representation of value;
• can be transferred, stored or traded electronically; and
• satisfies other characteristics prescribed by the SFC.

In our previous alert, we noted that the proposed definition of “VA” did not capture non-fungible tokens (“NFTs”). This point was picked up during the LegCo meetings. The SFC has clarified that the assessment of whether an NFT is a VA needs to take into account its terms and features. In most cases, NFTs which merely represent a “genuine digital representation of a collectable” is unlikely to be captured by the definition of “VA” under the Amended AMLO; however where the NFT go beyond the scope of a collectable, for example where it contains fungible elements or allows holders to vote on its arrangement, then this may cause the NFT to be “a medium of exchange accepted by the public” or “a digital representation of value that providers holders with rights, eligibility or access to vote”, and therefore it will fall under the ambit of a VA.[3]

The Government further explains that if a specific NFT is seen to be a VA, persons trading that specific NFT will require a licence if those dealings amount to a “VA service”, i.e., if the specific NFT is traded through the operation of an exchange. In other words, if the trading occurs on a peer-to-peer basis, the persons would not be deemed as operating an exchange and their activities would not fall within the scope of a “VA service”, and therefore a VASP licence is not required.[4]

III. The Requirement of Providing VA Services to Professional Investors Only

In our previous client alert, we noted the proposal that, in order to promote investor protection, the licensing regime for VASPs will, at the initial stage, stipulate that VASPs can only provide services to professional investors (“PI Restriction”), and that this restriction will be imposed by the SFC as a licence condition. At that time, we observed that the use of the phrase “initial stage” and the proposal to impose the PI Restriction by way of a licensing condition, rather than in the legislation itself, suggested that the SFC may possibly allow expansion of VASP services to retail investors down the track when VA markets become more mature and regulated.

It appears that the Government recognises that VA markets have become more mature since the licensing regime for VASPs was first proposed. On October 31, 2022, the Government issued its policy statement on the development of VAs in Hong Kong[5] (“Policy Statement”), where the Government stated that it recognised the increasing acceptance of VA as a vehicle for investment allocation by global investors, be they institutional or individual. It was noted in the Policy Statement that the SFC would be conducting a public consultation on how retail investors may be given a suitable degree of access to VA under the new licensing regime for VASPs, while being careful and cautious about the risks to retail investors, including by enhancing investor education and ensuring that suitable regulatory arrangements are in place.

The Report provides further clarification on the Government’s position on the PI Restriction requirement, and notes that the PI Requirement will be imposed on licensed VASPs as a licensing condition at the initial stage. However it further states that the SFC will conduct a consultation on the detailed regulatory requirements on the new VASP regime; and during the consultation the SFC will consider whether to allow non-professional investors (i.e. retail investors) to partake in VA transactions with licensed VASPs, provided that additional investor protection measures are in place.[6]

The SFC’s thinking on the investor protection measures to allow retail investors to trade VAs with licensed VASPs will likely become clearer after the SFC publishes its consultation paper on the regulatory requirements under the new VASP regime.

IV. Postponement to the Commencement of the Amended AMLO and the Licensing Regime for VASPs

In the Report, the Government proposed to postpone the commencement of the Amended AMLO and the licensing regime for VASPs. Set out below is a summary of the original timeline and the new timeline for the commencement of the Amended AMLO and the licensing regime for VASPs, as well as the timing implications for the transitional period and the deadline to submit an application to the SFC under the licensing regime for VASPs.

Event	Original timeline	New timeline
Commencement date of the Amended AMLO. Note that the criminal offences for fraudulent or reckless misrepresentations, or employing deceptive or fraudulent devices, schemes or acts, in relation to VA transactions, commences from this date.	January 1, 2023	April 1, 2023
Commencement date of the licensing regime for VASPs (“VASP Regime Commencement Date”).	March 1, 2023	June 1, 2023
Start date for the 12 months transitional period (“Transitional Period Start Date”) for any corporation that has been carrying on the business of providing a VA service in Hong Kong immediately before the VASP Regime Commencement Date (“Existing VASPs”), during which time the Existing VASP can carry on VA service in Hong Kong without a VASP licence.	Starting from March 1, 2023	Starting from June 1, 2023
Deadline of the 9 months period for Existing VASPs to file an application to the SFC for a licence under the licensing regime for VASPs, in order to be deemed to be licensed from the day after the expiry of the 12 months’ transitional period (“Application Deadline”).	By no later than December 1, 2023	By no later than March 1, 2024

Existing VASPs that file an application to the SFC by the Application Deadline will be deemed to be a licensed VASP from the day after the expiry of 12 months from the Transitional Period Start Date (i.e. June 2, 2024) until the SFC has made a decision to either approve or reject their licence application, or the licence applicant withdraws their application.

The Report notes that the postponement is intended to provide the Government and the SFC more time to work out the implementation details of the new regulatory regime, including public consultation work by the SFC on the regulatory requirements for licensed VASPs. The postponement is also intended to allow more time for the VASPs sector to prepare for the introduction of the licensing regime.

We will continue to closely monitor developments in this area, and will provide a more detailed update when the SFC publishes its public consultations on the regulatory regimes for licensed VASPs.

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[1] “Report of the Bills Committee on Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Bill 2022”, LC Paper No. CB(1)855/2022 (December 7, 2022), published by the Legislative Council, available at https://www.legco.gov.hk/yr2022/english/bc/bc05/reports/bc0520221207cb1-855-e.pdf

[2] Hong Kong Introduces Licensing Regime for Virtual Asset Services Providers (June 30, 2022), published by Gibson, Dunn & Crutcher LLP, available at https://www.gibsondunn.com/hong-kong-introduces-licensing-regime-for-virtual-asset-services-providers/

[3] Paragraph 13 of the Report

[4] Paragraph 14 of the Report.

[5] “Policy Statement on Development of Virtual Assets in Hong Kong”, published by the Financial Services and the Treasury Bureau on October 31, 2022, available at https://gia.info.gov.hk/general/202210/31/P2022103000454_404805_1_1667173469522.pdf

[6] Paragraph 27 of the Report.

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

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

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

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

New York partner J. Alan Bannister, Houston partner Hillary Holmes and Orange County partner James Moloney are the authors of “Parsing SEC’s Rule Extension For Fixed-Income Issuers” [PDF] published by Law360 on December 5, 2022.

I.   Introduction

Over the last few months, several European Union (“EU”) Member States have announced that they intend to withdraw from the Energy Charter Treaty (the “ECT”).  At the time of writing, Germany, Slovenia, Poland, the Netherlands, France, Spain and Luxembourg have made such announcements.

The timing of these announcements preceded the expected vote by the Contracting Parties to the ECT regarding amendments to the text of the 1994 ECT (the “Modernised ECT”).  The vote was scheduled to take place on 22 November 2022.  However, reportedly due to a failure by the European Commission to gain the consensus of EU Member States—a majority of which are Contracting Parties to the ECT—the vote was called off at the eleventh hour.  It has now been postponed until April 2023.  If adopted in April 2023, the Modernised ECT will enter into force 90 days after its ratification by three-fourths of the treaty’s Contracting Parties.  The Modernised ECT, if adopted, contains notable changes to the scope of investment protection afforded by the treaty.

We provide a summary of these developments and their potential impact on international arbitration claims brought by investors in ECT Contracting Parties.

II.   The ECT

The ECT is a multilateral investment treaty, that entered into force in 1998, which establishes a legal framework in order to promote long-term international cooperation in the energy sector.

The ECT obliges the states who are Contracting Parties to the treaty to encourage and create stable, equitable, favourable, and transparent conditions for investors of other Contracting Parties.[1]  In order to qualify for the protection afforded by the ECT, investments must be associated with “Economic Activity in the Energy Sector”.  In practice, this includes activities such as inter alia (i) oil and gas exploration, (ii) construction and operation of power generation facilities, including those powered by renewable energy sources such as wind, solar, and hydro, and (iii) decommissioning of energy related facilities, including oil rigs, oil refineries and power generating plants.[2]

Each Contracting Party gives its unconditional consent to the submission of disputes between a Contracting Party and an investor of another Contracting Party relating to an investment to international arbitration.[3]

III.   Amendments to the ECT

Since 2017, discussions have been underway regarding efforts to negotiate and agree a modernised text of the ECT.  On 24 June 2022, it was announced that the Contracting Parties reached an agreement in principle on the modernised text.  The Modernised ECT contains certain notable changes.

As explained by the Energy Charter Secretariat, the proposed changes include:

1. Alignment between the ECT and the Paris Agreement, which is a legally binding international treaty on climate change.[4] For example, the EU and the UK have opted to carve-out fossil fuel related investments from investment protection under the ECT, including for existing investments after 10 years (instead of 20 years under the current ECT).[5]
2. A provision stating that an investor from a Contracting Party that is part of a regional economic integration organisation (“REIO”), such as the EU, cannot bring an investor-state arbitral claim against another Contracting Party member of the same REIO—i.e., prohibiting what is referred to as “intra-EU arbitration”.[6]
3. A narrowed definition of a qualifying “investment” and “investor” under the treaty. An “investment” must fulfil a list of characteristics, such as the commitment of capital, the expectation of gain or profit, be made for a certain duration or involve the assumption of risk.  An “investor” cannot hold the nationality—or permanent residency—in the Contracting Party hosting the investment, and must demonstrate that it carries on substantial business activity in the host state.[7]
4. Provision for a list of measures that constitute a violation of the ECT’s fair and equitable treatment (“FET”) standard, including a description of the circumstances that give rise to an investors’ legitimate expectations.[8]
5. Clarification that the treaty’s expropriation provision covers indirect expropriations, identifying in this context the types of measures that cannot be considered an indirect expropriation.[9]
6. Provision that the treaty’s observance of undertakings clause—i.e., umbrella clause—only applies to breaches of specific written commitments made through the exercise of governmental authority.[10]

As noted, it is anticipated that the ECT Contracting Parties will vote in April 2023 on whether to formally adopt the Modernised ECT.  If adopted, the Modernised ECT will enter into force 90 days after its ratification by three-fourths of the treaty’s Contracting Parties.

IV.   Announced Intention by Contracting Parties to Withdraw from the ECT

In parallel to these developments, several ECT Contracting Parties—that are also EU Member States—have announced that they intend to withdraw from the ECT.  At the time of writing, Germany, Slovenia, Poland, the Netherlands, France, Spain and Luxembourg have made such announcements.  It is reported that Austria is also considering withdrawal.

These Contracting Parties have cited various reasons for their intention to withdraw.  The reasons appear generally to centre around complaints that the ECT impedes their ability to tackle climate change.  Relatedly, there are around a billion Euros’ worth of outstanding ECT arbitral awards rendered against EU Member States—a figure which continues to grow, and which EU Member States may be keen to limit insofar as possible.

Withdrawal, however, does not take immediate effect.  Rather, Article 47 of the ECT (Withdrawal) contains what is referred to as a “sunset clause”, which provides that, following formal notification of a Contracting Party’s withdrawal from the ECT, the withdrawal shall take effect one year after the notification is given.[11]  Further, the protections afforded by the ECT shall continue to apply to pre-existing investments made in the territory of a Contracting Party for a period of 20 years after the withdrawal has taken effect—i.e., “the sunset period”.

Additionally, in the face of the announcements regarding withdrawal, the Energy Charter Secretariat, which provides the Energy Charter Conference “with all necessary assistance for performance of its duties,”[12] issued a Guidance Note explaining that withdrawal from the ECT may need to conform with Article 62 on the Vienna Convention on the Law of Treaties[13] (the “VCLT”).

Article 62 of the VCLT only allows a state—as a matter of general international law—to withdraw from a treaty due to “fundamental changes of circumstances” that were “essential” for the decision to enter into the treaty, and which “radically” transform the obligations created by the treaty so that its further implementation becomes unduly burdensome.[14]  In addition, the change of circumstance relied on as the reason for withdrawal must have been unforeseen by the contracting parties to that treaty.

The Energy Charter Secretariat also observed that the International Court of Justice, in Gabčíkovo-Nagymaros Project (Hungary/Slovakia), did “not consider that new developments in the state of environmental knowledge and of environmental law can be said to have been completely unforeseen.”[15]

As a result, the analysis as to whether an ECT Contracting Party can validly withdraw from the ECT is not straightforward.  And the issue of withdrawal may be subject to challenge, for example by investors bringing claims in international arbitration against Contracting Parties that have purported to withdraw from the ECT.

Against this backdrop, the European Parliament passed a resolution on 24 November 2022, “urg[ing] the Commission to initiate immediately the process towards a coordinated exit of the EU from the ECT and calls on the Council to support such a proposal”.[16]  Although this resolution is not binding on the European Commission, it is an indication of the EU’s intention as regards the ECT.  For the EU to withdraw from the ECT, the Council of the EU—which is one of the EU’s legislative bodies and is comprised of representatives from the EU Member States—would need to formally approve a withdrawal from the ECT by the EU.  This is a very recent development, so precise details as to the path ahead are not yet clear.

V.   Implications for Potential Claims by Investors Against ECT Contracting Parties

The developments outlined above carry several implications, some of which overlap:

1. Investors in ECT Contracting Parties may seek to submit claims to international arbitration before a vote is passed and the Modernised ECT becomes effective, because they will presumably want their claims to come under the current ECT’s standards of investment protection.
2. A Contracting Party’s attempt to withdraw from the ECT altogether may not impact an investor’s ability to commence international arbitration in the short-to-medium term, given the ECT’s 20-year sunset clause.
3. Withdrawal is likely to become a contested issue in individual cases. The Energy Charter Secretariat suggested that Article 62 of the VCLT would apply to any attempt to withdraw from the ECT.  In this context, the reasons given by a Contracting Party for its withdrawal may need to be assessed against Article 62’s criteria on an individualised basis.  As a result, international arbitration tribunals confronted with claims by investors against a state that has purported to withdraw from the ECT may have to rule on the validity of that withdrawal as a jurisdictional issue.
4. If the Modernised ECT is adopted next year, an ECT Contracting Party can choose both to ratify the Modernised ECT and pursue withdrawal in parallel, since these are independent issues. Indeed, a Contracting Party wishing to minimise international arbitration claims against itself may well choose to vote for and ratify the Modernised ECT—with its narrower investor protections—and pursue withdrawal on a longer timeline.
5. Finally, it is worth noting that if the Modernised ECT is not adopted at the vote scheduled for April 2023, the scope of investment protection offered under the current ECT will continue to remain in force for Contracting Parties.

____________________________

[1]     ECT, Article 10.

[2]     ECT, Article 1(5).

[3]     ECT, Article 26(3)(a).

[4]     It was adopted by 196 Parties at COP 21 in Paris, on 12 December 2015, and entered into force on 4 November 2016.  See UNFCC, The Paris Agreement, available here.

[5]     See Energy Charter Secretariat, Public Communication explaining the main changes contained in the agreement in principle, 24 June 2022, 1. Definitions – Pillar 2: Flexibility, available here.

[6]     Id., 6. Regional Economic Integration Organisation (REIO).

[7]     Id., 2. Investment Protection – Definitions of Investment and Investor.

[8]     Id., 2. Investment Protection – Definition of Fair and Equitable Treatment.

[9]     Id., 2. Investment Protection – Definition of Indirect Expropriation.

[10]   Id., 2. Investment Protection – Umbrella clause.

[11]    ECT, Article 47(2).

[12]    ECT, Article 35.

[13]    VCLT, Article 62.

[14]    Energy Charter Secretariat, Sunset Clause (Article 47 of the ECT) in relation to Article 62 of the Vienna Convention on the Law of Treaties (VCLT), 3 November 2022, available here.

[15]     Ibid.

[16]     European Parliament resolution of 24 November 2022 on the outcome of the modernisation of the Energy Charter Treaty (2022/2934(RSP)), at 20, available here.

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The following Gibson Dunn lawyers assisted in the preparation of this client update: Jeff Sullivan KC, E Jin Lee, and Theo Tyrrell.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues.  Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s International Arbitration, Judgment and Arbitral Award Enforcement or Transnational Litigation practice groups, or any of the following:

Jeff Sullivan KC – London (+44 (0) 20 7071 4231, [email protected])
Cyrus Benson – London (+44 (0) 20 7071 4239, [email protected])
Penny Madden KC – London (+44 (0) 20 7071 4226, [email protected])
E Jin Lee – New York (+1 212 351 5327, [email protected])
Theo Tyrrell – London (+44 (0) 20 7071 4016, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Join us for a 30-minute briefing covering a wide range of M&A practice topics. The goal of the program is to provide quick insights into recent market trends and practical advice on how to manage common M&A problems.

Topics discussed:

• Jonathan Whalen and Matthew Wiener discuss recent developments in the representation and warranty insurance markets
• Kristen Poole and David Wilf discuss how to choose among different efforts standards when drafting and negotiating covenants
• Cassandra Gaedt-Sheckter and Alexander Southwell discuss practice pointers on assessing and managing cybersecurity and privacy risk in M&A transactions

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PANELISTS:

Cassandra Gaedt-Sheckter is a partner in Gibson, Dunn & Crutcher’s Palo Alto office, lead of the firm’s State Privacy Law Task Force, and a Co-Chair of the firm’s Artificial Intelligence and Automated Systems Practice Group. She is an award-winning practitioner, and just in 2022, has been featured as 40 under 40 in Silicon Valley by the Silicon Valley Business Journal, Woman Leader in Tech Law by The Recorder, and Best Lawyers’ One to Watch for Technology Law for her work. Her practice focuses on data privacy, cybersecurity, AI, and data regulatory enforcement, transactional, and product and compliance counseling representations. She has significant experience advising companies on legal and regulatory compliance, diligence, and risks in transactions, particularly with respect to California’s CCPA and CPRA, and other federal and state laws and regulations.

Kristen P. Poole is a corporate partner in Gibson, Dunn & Crutcher’s New York office, where her practice focuses on mergers and acquisitions and private equity. Ms. Poole represents both public and private companies, as well as financial sponsors, in connection with mergers, acquisitions, divestitures, minority investments, restructurings, and other complex corporate transactions. She also advises clients with respect to general corporate governance matters and shareholder activism matters.

Alexander Southwell is a partner in Gibson, Dunn & Crutcher’s New York office, and he is a Co-Chair of the firm’s Privacy, Cybersecurity and Data Innovation Practice Group. He is a Chambers-ranked former federal prosecutor and was named a “Cybersecurity and Data Privacy Trailblazer” by The National Law Journal. Mr. Southwell’s practice focuses on privacy, information technology, data breach, theft of trade secrets and intellectual property, computer fraud, national security, and network and data security issues, including handling investigations, enforcement defense, and litigation. He regularly advises companies and private equity firms on privacy and cybersecurity diligence and compliance.

Jonathan Whalen is a partner in Gibson, Dunn & Crutcher’s Dallas office, and he is a member of the firm’s Mergers and Acquisitions Practice Group. Chambers USA named Mr. Whalen an Up and Coming Corporate/M&A attorney in their 2022 publication. Mr. Whalen’s practice focuses on a wide range of corporate and securities transactions, including mergers and acquisitions, private equity investments, and public and private capital markets transactions.

David Wilf is a partner in Gibson, Dunn & Crutcher’s New York office, and he is Co-Chair of Gibson Dunn’s Transportation and Space Practice Group. Mr. Wilf is recognized as a leading M&A attorney by the International Financial Law Review. His practice focuses on mergers and acquisitions, joint ventures, strategic alliances and general corporate matters, including strategic complex corporate contracts. Mr. Wilf has represented United States entities in Europe, Asia, Latin America, and Africa in acquisitions, divestitures and joint ventures, and non-U.S. entities in similar types of domestic and international transactions, in addition to his general domestic U.S. practice.

Matthew Wiener is a Managing Director, M&A and Transaction Solutions in the Houston office of Aon. He is the co-practice leader for Aon’s Transaction Solutions team. In this role, Mr. Wiener is responsible for the development and implementation of transactional-based risk solutions, including the deployment of insurance capital for M&A transactions through representations and warranties, litigation, tax and other contingent liabilities insurance. Prior to joining the Aon Transaction Solutions team, Matthew was an attorney at Vinson & Elkins LLP, where he specialized in corporate finance and securities law matters, including mergers and acquisitions, private equity, public and private securities offerings, divestitures, and general corporate representation.

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MCLE CREDIT INFORMATION:

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 0.5 credit hour, of which 0.5 credit hour may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit.

Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 0.5 hour.

California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.

Washington, D.C. partner Michael Diamant and associate Nicole Lee are the authors of “Some more carrots, and definitely more sticks: DOJ corporate criminal enforcement” [PDF] published by Financier Worldwide in its December 2022 issue.

As discussed in our November 21 Client Alert, following a recent interpretation by the SEC Staff regarding the application of Exchange Act Rule 15c2-11 to fixed income securities initially offered and sold by private companies, such issuers will be required to publicly disclose specified current financial and other information if they wish to allow US broker-dealers to publish quotations on their securities.  Based on a December 2021 no action letter (referenced in our client alert), this interpretation was scheduled to be phased in over time, with “Phase Two” taking effect as of January 3, 2023, which would have affected trading in securities offered by non-reporting issuers in Rule 144A offerings.

On November 30, 2022, however, the SEC issued a no-action letter that delayed implementation of  Phase Two until January 4, 2025 to provide non-reporting issuers and US broker-dealers more time to implement compliance systems to meet the demands of the rule.  While various industry groups are expected to continue to engage with the Commission on the application of the Rule to fixed income securities, a further change in Commission policy remains uncertain.

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The following Gibson Dunn lawyers prepared this client update: Alan Bannister and James Moloney.

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Capital Markets or Securities Regulation and Corporate Governance practice groups:

Capital Markets Group:
J. Alan Bannister – New York (+1 212-351-2310, [email protected])
Andrew L. Fabens – New York (+1 212-351-4034, [email protected])
Hillary H. Holmes – Houston (+1 346-718-6602, [email protected])
Douglas S. Horowitz – New York (+1 212-351-3817, [email protected])
Stewart L. McDowell – San Francisco (+1 415-393-8322, [email protected])
Peter W. Wardle – Los Angeles (+1 213-229-7242, [email protected])

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
James J. Moloney – Orange County (+1 949-451-4343, [email protected])
Lori Zyskowski – New York (+1 212-351-2309, [email protected])

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

The U.S. Treasury Department recently issued proposed regulations[1] to address certain concerns raised by taxpayers and other stakeholders in response to final foreign tax credit regulations published in January 2022[2].  Although the proposed regulations do not grapple with some of the more fundamental problems previously identified by commentators, they do offer taxpayers relief in certain narrow circumstances.  In general, the proposed regulations are proposed to apply to tax years ending on or after November 18, 2022 (i.e., starting immediately in 2022 for calendar-year taxpayers).  Once the proposed regulations are finalized, taxpayers may choose to apply “some or all of the final regulations to earlier taxable years, subject to certain conditions” described in detail in the notice of proposed rulemaking.  Until the effective date of final regulations, taxpayers may rely on the proposed regulations.  If a taxpayer chooses to rely on a portion of the proposed regulations, taxpayers must consistently follow all proposed rules for that portion of the regulations for all years until final regulations are effective.[3]

Royalties

One of the primary areas of concern for taxpayers after the publication of the January 2022 final foreign tax credit regulations was the introduction of a source-based attribution requirement (described in earlier iterations of the regulations as the “jurisdictional nexus” requirement) that compares foreign laws governing the source of income with United States income tax laws to determine if a foreign tax should be creditable in the United States.  Under the source-based attribution requirement in Treas. Reg. § 1.901-2(b)(5)(i)(B), a foreign tax imposed on a nonresident’s income meets the attribution requirement only if the foreign tax law’s sourcing rules are reasonably similar to the United States sourcing rules.

In the case of gross income arising from royalties, the foreign tax law must impose tax on the royalties consistent with the manner in which the Internal Revenue Code (the “Code”) sources royalty income:  i.e., based on the place of use or the right to use the licensed intangible property.[4]  In this regard, the United States’ place-of-use rule for sourcing royalties is far from representative of a global consensus.  Other jurisdictions source royalties in a manner that does not fall neatly into that category, such as the United Kingdom, where a multi-factor approach is used to source royalties.  As a result, in those countries where withholding taxes on royalties are imposed on the basis of some other approach, royalty withholding taxes would not be creditable against the recipient’s U.S. tax liability even if the licensed intangible property is in fact used within the territory of the taxing jurisdiction.[5]

Complicating this inquiry is the lack of certainty that often arises when determining the location where intangible property is used.  Although it may be easy to identify where certain manufacturing-related intangibles are used (e.g., at a multinational enterprise’s manufacturing facility), it is more difficult in other situations, such as where employees in one jurisdiction use intangibles to generate sales through social media to customers residing in another jurisdiction.

The proposed regulations provide a limited exception to the source-based attribution requirement of the January 2022 regulations for situations in which the taxpayer can show that a withholding tax is imposed on royalties received in exchange for the right to use intangible property pursuant to a single-country license within the territory of the taxing jurisdiction.  For this purpose, a payment is made pursuant to a single-country license if the terms of the license agreement under which the payment is made characterize the payment as a royalty and limit the territory of the license to the country imposing the withholding tax.  Therefore, U.S. taxpayers may need to revise existing license agreements to qualify for the single-country license exception.

Cost Recovery Requirement

The proposed regulations also provide further insight into the net gain requirements that foreign income taxes must meet to give rise to U.S. foreign tax credits.  The final regulations require generally that significant items of expense—including capital expenditures, interest, rents, royalties, wages and research and experimentation—must be recovered against income, but the proposed regulations permit a foreign tax to disallow significant costs and expenses if the disallowance is consistent with any principle underlying disallowances required under the Code.

For taxpayers determining whether a disallowance is consistent with Code-based principles, the proposed regulations provide helpful guidance.  Treas. Reg. § 1.901-2(b)(4)(iv)(J), Example 10, makes clear that taxpayers would be permitted to claim foreign tax credits in respect of taxes paid to foreign taxing jurisdictions that do not allow any deductions for stock based compensation because the Code “contain[s] targeted disallowances or limits on the deductibility of certain items of compensation in particular circumstances based on non-tax public policy reasons, including to influence the amount or use of a certain type of compensation in the labor market,” citing sections 162(m) and 280G.  Without the inclusion of Example 10 in the proposed regulations, it would not otherwise have been obvious that a complete disallowance of deductions for stock-based compensation would be considered to be consistent with (or resemble) the limitations in sections 162(m) and 280G.

For taxpayers analyzing whether any other type of disallowance under foreign tax law resembles a Code-based disallowance, the example and its principles should provide helpful authority in determining whether the net gain requirement is satisfied.

Summary

While the recently released proposed regulations do not address many substantive issues raised by taxpayers and other stakeholders in response to the January 2022 regulations, they do represent an effort to answer narrower problems identified by taxpayers, and they are designed in a way that allows taxpayers the opportunity to make broad arguments in other areas by analogy to these narrow rules.  Given the relief provided in response to high profile comments from the technology and other sectors on royalty withholding issues in particular, interested parties with other specific issues should consider communicating those issues to the Treasury Department and the IRS with proposals for relief or clarification.

Please contact any Gibson Dunn tax lawyer for updates on this issue.

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[1] 87 Fed. Reg. 71,271, 71,275 (Nov. 22, 2022).

[2] T.D. 9959, 87 Fed. Reg. 276 (Jan. 4, 2022).

[3] Until the effective date of final regulations, taxpayers may rely on the proposed regulations. If a taxpayer chooses to rely on a portion of the proposed regulations, taxpayers must consistently follow all proposed rules for that portion of the regulations for all years until final regulations are effective.  87 Fed. Reg. 71,271, 71,277 (Nov. 22, 2022).

[4] Sections 861(a)(4) and 862(a)(4) of the Code.

[5] Foreign tax on royalties can often be eliminated altogether under United States income tax treaties that eliminate royalty withholding tax, in which case there is no need to claim a foreign tax credit.  But foreign taxes on royalties are a significant focus of many U.S. taxpayers, as other U.S. treaties only reduce the royalty withholding tax, and many substantial U.S. trading partners, including Brazil, Singapore, and Hong Kong, do not enjoy tax treaties with the United States.  We also note that in determining the availability of a deemed paid credit to a U.S. shareholder of a CFC, the IRS and Treasury have taken the position in the January 2022 regulations that a U.S. taxpayer may not rely on a U.S. treaty provision that a country’s royalty withholding tax is creditable in a context where withholding taxes are imposed on royalties paid by one CFC to another CFC.

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This alert was prepared by Jeffrey M. Trinklein, Anne Devereaux, John F. Craig III, Michael A. Benison, Eric Sloan, Sandy Bhogal, Jérôme Delaurière, and Hans Martin Schmid.

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 and Global Tax Controversy and Litigation 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])
Brian R. Hamano – Los Angeles (+1 310-551-8805, [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])
John-Paul Vojtisek – New York (+1 212-351-2320, [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])

Global Tax Controversy and Litigation Group:
Michael J. Desmond – Co-Chair, Los Angeles/Washington, D.C. (+1 213-229-7531, [email protected])
Saul Mezei – Washington, D.C. (+1 202-955-8693, [email protected])
Sanford W. Stark – Co-Chair, Washington, D.C. (+1 202-887-3650, [email protected])
C. Terrell Ussing – Washington, D.C. (+1 202-887-3612, [email protected])

*Anne Devereaux is an of counsel working in the firm’s Los Angeles office who is admitted only in Washington, D.C.

© 2022 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On November 28, 2022, the European Council formally adopted the Corporate Sustainability Reporting Directive (“CSRD”), following adoption by the European Parliament on November 10, 2022. The CSRD is now due to be signed and published in the European Union (“EU”) Official Journal and will come into force 20 days after publication.[1]

The CSRD will replace and significantly broaden the scope of the existing sustainability reporting requirements under the EU’s current sustainability reporting rules, which are set out in a suite of directives and regulations, including the Non-Financial Reporting Directive[2] (“NFRD”).  The NFRD currently requires that “public interest” entities, including large EU listed entities, credit institutions, insurance companies, and other entities designated as such by an EU member state, report certain sustainability information on an annual basis. While still subject to further implementation (as discussed below), the CSRD will also have important implications for non-EU groups with significant EU operations, as it will impose substantive and expanded disclosure requirements on those groups, with a resulting increase in costs. It will also likely lead to increased regulatory complexity and compliance risks.

Overview of the CSRD

The CSRD is intended to revise and strengthen the rules introduced by the NFRD by promoting relevant, comparable, reliable, and accessible sustainability information for investors and stakeholders.[3] The CSRD reporting requirements will complement and be aligned to other key EU sustainable finance initiatives that are directed principally at companies in the financial services and capital markets sectors, including the Sustainable Finance Disclosure Regulation (“SFDR”) (effective as of March 10, 2021)[4] and the EU Taxonomy Regulation (partially effective as of January 1, 2022, and fully effective as of January 1, 2023).[5]

As discussed in detail below, the CSRD will materially broaden the scope of sustainability information disclosed to stakeholders, increase the number of entities required to report such information, and introduce a new limited audit assurance requirement prior to October 1, 2026 and a new reasonable assurance requirement prior to October 1, 2028. The CSRD will apply to all large EU undertakings, both public and private. This expanded scope will apply the CSRD to, among others, U.S. entities with significant EU operations. Under the CSRD, small and medium enterprises (“SMEs”) will have delayed compliance requirements, and micro-undertakings will be excluded from compliance altogether.

Entities Covered by the CSRD and Exemptions

Entities covered by the CSRD include:

1. all undertakings with securities listed on EU regulated markets (other than listed micro-undertakings);
2. all “large undertakings” (whether listed or not), being an EU undertaking or an EU subsidiary of a non-EU entity that satisfies at least two of the three following criteria as of the relevant balance sheet date:

• 1. a balance sheet total exceeding €20,000,000;
  2. a net turnover[6] exceeding €40,000,000; and
  3. in excess of 250 employees on average during the financial year.

3. all parent undertakings of “large groups” (whether listed or not), being groups which on a consolidated basis satisfy two of the three criteria set out at a. through c. above; and
4. as of January 1, 2026 (with the ability to opt-out until 2028), “small” and “medium-sized enterprises” with transferable securities on an EU regulated market.[7]

Note that certain EU subsidiaries of non-EU entities, as well as any non-EU entities with transferable securities listed on an EU regulated market, accordingly will be subject to the CSRD.

From financial years starting on or after January 1, 2028, the CSRD will also apply to non-EU undertakings (labelled “third country undertakings”) that generate a net turnover of more than €150,000,000 in the EU and have: (i) an EU branch office with a net turnover of at least €40,000,000 in the EU; or (ii) a large or listed EU subsidiary.[8] The subsidiary or branch will be responsible for preparing a sustainability report for the third country undertaking at a consolidated level. These sustainability reports will need to be prepared according to: (i) separate standards to be adopted by the European Commission (“Commission”) by June 30, 2024; (ii) the standards applicable to EU undertakings; or (iii) standards which are deemed equivalent by the Commission. These sustainability reports of third country undertakings need to be published with an assurance opinion by a firm authorized to give such an opinion under the national law of the third country undertaking or of a member state.

A subsidiary undertaking will be exempt from reporting if that entity and its subsidiaries (if applicable) were included in the consolidated management report of the parent undertaking, provided that the parent’s report is compliant with the CSRD. This exemption would also apply where a subsidiary undertaking (and its subsidiaries) were included in the consolidated management report of a non-EU parent undertaking and that parent’s sustainability disclosures were determined to be “equivalent” to EU sustainability reporting standards. At this time, there is ambiguity on the equivalence protocol and likely outcomes of allowing non-EU parents to produce compliant consolidated reporting. Because it is not clear how this “equivalence test” will be applied (or indeed which non-EU countries will be treated as having equivalent sustainability reporting standards), non-EU entities must keep abreast of regulatory developments in this regard. While a parent in a non-EU country will be able to voluntarily choose to publish compliant consolidated management reports containing the relevant sustainability information mandated by the CSRD, this will not automatically exempt any of its EU subsidiary undertakings that fall within the scope of the CSRD.

For U.S. companies, the “equivalence” analysis adds another element of regulatory complexity, especially given that the U.S. Securities and Exchange Commission (“SEC”) has separately proposed new rules for climate change disclosure requirements for both U.S. public companies and foreign private issuers on March 21, 2022[9] (as discussed in further detail in our webcast here and our previous client alert here). There is no guarantee that those rules or any final SEC sustainability rules will be determined to be “equivalent” by the Commission for purposes of CSRD compliance,[10] and notably the proposed SEC rules deal with disclosures only for climate-related matters while disclosures under the CSRD include climate-related matters as well as other ESG-related matters.

For UK groups with substantial European operations, post-Brexit, a similar question will arise in relation to “equivalence”. The UK has arguably been leading the global landscape in relation to mandatory climate reporting pursuant to the Task Force on Climate-related Financial Disclosures (“TCFD”) and there exists a suite of specific ESG-related reporting requirements (e.g. in relation to modern slavery, consideration of broader stakeholder considerations and gender pay gap information). Nonetheless, the UK has yet to introduce a comprehensive set of mandatory non-climate related reporting requirements of the type envisaged by the CSRD.

As a practical matter, this means that EU large undertakings with non-EU parents could have to report consolidated sustainability information on a subsidiary-by-subsidiary basis if equivalence with the non-EU country’s sustainability reporting requirements is not determined. This could have wide-reaching implications for non-EU parent entities with significant subsidiary operations in the EU, not just in relation to the compliance burden of increased reporting costs across multiple entities, but also the compliance challenge and associated risks of ensuring relevance, accuracy and consistency across multiple reports.

Scope of Matters to be Reported and Relevant Reporting Standards

The CSRD will require reporting of forward-looking, retrospective, qualitative and quantitative information necessary to understand an undertaking’s impacts on sustainability matters and, from the “opposite” lens, the information necessary to understand how sustainability matters affect an undertaking’s development, performance, and position (i.e., “double materiality” reporting). The principle of double materiality requires that entities look inward to evaluate how sustainability issues affect the entity and look outward to understand how the entity impacts people and the environment.

The CSRD clarifies that entities will need to report on both elements of materiality for compliance with the reporting requirements. In particular, CSRD reporting entities will need to disclose:[11]

1. Strategy: Their business model and strategy, including:

• • the resilience of their business model and strategy to risks related to sustainability matters;
  • their opportunities related to sustainability matters;
  • their plans to ensure that their business model and strategy are compatible with the transition to a sustainable economy and with the limiting of global warming to 1.5°C in line with the Paris Agreement and the objective of achieving climate neutrality by 2050;
  • their business model and strategy take account of the interests of their stakeholders and of their impact on sustainability matters; and
  • how their strategy has been implemented with regard to sustainability matters.

2. Targets: The sustainability targets set and the progress made towards achieving them.
3. Governance: The role of the administrative, management and governance bodies in relation to sustainability factors.
4. Policies: Their policies in relation to sustainability matters.
5. Incentives: Information about the existence of sustainability-linked incentive schemes offered to members of the administrative, management and supervisory bodies.
6. Due Diligence: The due diligence process implemented with regard to sustainability matters.
7. Impacts: Their most significant negative impacts on sustainability factors.
8. Remedial Actions: Any actions taken, and the results of such actions, to prevent, mitigate, remediate or bring an end to actual or potential adverse impacts.
9. Risks: Their principal risks related to sustainability matters, including their principal dependencies on such matters, and how those risks are managed.
10. Reporting Scope: The manner in which they identified the information on which the report.

Time horizons: The CSRD will also require that qualitative and quantitative, forward-looking and retrospective information be disclosed, taking into account short, medium and long-term time horizons.

Value chains: Where appropriate, undertakings will also be required to disclose information regarding their own operations as well as their value chains, including products and services, business relationships and supply chains.

Sustainability Standards: Disclosures will need to be reported in accordance with the European Sustainability Reporting Standards (“ESRS”) currently being developed by the European Financial Reporting Advisory Group (“EFRAG”), a public-private partnership tasked to advise the Commission on the adoption of international financial reporting standards into EU law. By June 30, 2023, the Commission must adopt the first set of standards and by June 30, 2024, the Commission must adopt further complementary information requirements with regards to sustainability matters, separate standards for third country undertakings and SMEs, and sector-specific standards.[12] The Commission has noted that sector-specific standards are particularly important for sectors associated with high sustainability risks and/or impacts on the environment, human rights and governance.

The standards are required to specify the information that should be disclosed regarding the following sustainability matters:

• Environmental: (i) climate change mitigation; (ii) climate change adaptation; (iii) water and marine resources; (iv) resource use and circular economy; (v) pollution; and (vi) biodiversity and ecosystems (with reference to natural capital accounting to effectively monetize and quantify the cost/benefit of natural resources);
• Social: (i) equal treatment and opportunities, including gender equality and equal pay for equal work, training and skills development, employment and inclusion of people with disabilities, measures against violence and harassment in the workplace, and diversity; (ii) working conditions, including secure employment, working time, adequate wages, social dialogue, freedom of association, existence of work councils, collective bargaining, the information, consultation and participation rights of workers, work-life balance and health and safety; and (iii) respect for human rights, fundamental freedoms, democratic principles and standards established in the International Bill of Human Rights and other core UN human rights conventions, the International Labor Organization’s Declaration on Fundamental Principles and Rights at Work and the ILO fundamental conventions, the European Convention of Human Rights, the revised European Social Charter, and the Charter of Fundamental Rights of the European Union; and
• Governance: (i) the role of the undertaking’s administrative, management and supervisory bodies with regard to sustainability matters, and their composition, and their expertise and skills to fulfil this role or access to such expertise and skills; (ii) the main features of the undertaking’s internal control and risk management systems in relation to the sustainability reporting process; (iii) business ethics and corporate culture, including anticorruption and anti-bribery, the protection of whistle-blowers and animal welfare; (iv) engagement of the undertaking to exert its political influence, including its lobbying activities; (v) the management and quality of relationships with customers, suppliers and communities affected by the activities of the undertaking, including payment practices, especially with regard to late payment to SMEs; and (vi) the main features of the undertaking’s internal control and risk management systems, in relation to the sustainability reporting and decision-making process.

While the Commission has flagged the need for the standards to be consistent with other European legislation (i.e., EU Taxonomy Regulation and SFDR), the proposal does not point towards any one international standard or framework as a model or foundation. Instead, the proposal refers to the broad objective of taking into account existing standards and frameworks such as the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board, TCFD, the Climate Disclosure Standards Board, International Integrated Reporting Council, International Accounting Standards Board and any standards developed under the auspices of the IFRS Foundation.[13]

Audit Assurance: To help prevent greenwashing, the CSRD will also introduce a general EU-wide audit assurance requirement for reported sustainability information.[14] Previously, under the NFRD, audit assurance was optional. Under the CSRD, the Commission must adopt legislation to provide for a “limited assurance” requirement by October 1, 2026, and subsequently adopt further legislation to provide for a higher “reasonable assurance” requirement by October 1, 2028. EU member states will have the power to authorize independent assurance service providers to carry out this sustainability assurance work, which will broaden the choice of assurance providers beyond statutory auditors or audit firms.

Where to Report and Format of Reporting

The CSRD requires sustainability information to be published in an entity’s management report and not a separate, standalone report. To aid in the access, review, and comparability of sustainability information, the financial statements and management reports of CSRD reporting entities will be required to be published in a digital file format. Note that U.S. entities will likely include the management report as part of the Annual Report on Form 10-K since a separate, standalone ESG report will not comply with the CSRD.

CSRD Regulatory Approval Process

In connection with the CSRD rulemaking, the Commission carried out an Impact Assessment, including a public consultation. On April 21, 2021, the Commission adopted a proposal for the CSRD, and the proposal was open for public feedback until July 14, 2021. On June 21, 2022, the member states in the European Council and the European Parliament reached a provisional political agreement on the CSRD. On November 10, 2022, The European Parliament adopted a final legislative text based on the Commission’s proposal on November 10, 2022, which was then adopted by the European Council on November 28, 2022.  The CSRD is now due to be signed by the President of the European Parliament and the President of the European Council, after which it will be published in the EU Official Journal, and enter into force 20 days thereafter. Following this, member states must incorporate the CSRD into their local law within 18 months.[15]

In parallel, EFRAG set up a task force to lead the development of the sustainability standards applicable under the CSRD – the Project Task Force Non-Financial Reporting Standards (“PTF-NFRS”). The PTF-NFRS published a report in March 2021 outlining its proposed roadmap for development of a comprehensive set of EU sustainability standards. Elaboration of draft standards in project mode commenced in June 2021 and, significantly, on July 8, 2021, the EFRAG task force announced a Statement of Cooperation with the GRI. The GRI standards are currently the most commonly used sustainability reporting standards amongst EU entities.

EFRAG launched a public consultation on the ESRS exposure drafts in April 2022, with the consultation period closing on August 8, 2022. These exposure drafts corresponded to the first set of standards required under the CSRD and covered environmental, social and governance matters (described as “topical” standards) as well as cross-cutting standards (such as general principles, strategy, governance and materiality assessment disclosure requirements). On November 22, 2022, EFRAG submitted a set of twelve draft ESRS to the Commission, which take into consideration the results of the public consultation. The Commission will now consult with other EU bodies and member states on the draft ESRS, and is expected to adopt a set of final standards in June 2023. EFRAG is expected to release a second set of draft ESRS in the coming months, with a focus on sector-specific and SME standards.

The CSRD will apply to entities that are already subject to NFRD for financial years starting on or after January 1, 2024 with the new disclosures therefore appearing in reports published in 2025. In scope entities that are not already subject to NFRD will be required to apply CSRD for financial years starting on or after January 1, 2025. Reporting will be delayed for SMEs whose securities are admitted to trading on an EU regulated market until financial years starting on or after January 1, 2026 (subject to an opt-out until 2028) and for third country undertakings until financial years starting on or after January 1, 2028.[16]

Note that once adopted, the CSRD requires member state implementation into local law. Thus, it is possible that there may be divergences on both the timing of implementation and the approach between member states.

Key Takeaways

The reporting obligations arising from the CSRD are significant compared to the NFRD. In addition, the CSRD’s scope is much broader given the breadth and relative sizes of many U.S., UK and non-EU entities with significant operations in various EU jurisdictions. As a result, the CSRD may lead to a marked increase in additional substantive disclosures (and increased costs), including multiple subsidiary-level reporting obligations, and the associated risks of divergent reporting. With the CSRD’s adoption, the SEC’s proposed expanded climate change requirements in the U.S., and the UK Government and relevant agencies rolling out mandatory TCFD-aligned climate disclosure requirements while also pushing for enhanced non-climate related disclosures, it will be important for U.S. and UK companies with significant EU operations to start compiling and developing standards and procedures to confirm the accuracy of sustainability information.

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   [1]   Council of the European Union, Press Release, Council gives final green light to corporate sustainability reporting directive (November 28, 2022), available at https://www.consilium.europa.eu/en/press/press-releases/2022/11/28/council-gives-final-green-light-to-corporate-sustainability-reporting-directive/.

   [2]   The key rules and regulations are set out in the Accounting Directive (Directive 2013/34/EU) (which was amended by the NFRD), the Transparency Directive (Directive 2004/109/EC), the Audit Directive (2006/43/EC) and the Audit Regulation (Regulation (EU) 537/2014.

   [3]   Executive Summary of the Impact Assessment, European Commission (April 21, 2021), available at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52021SC0151&from=EN.

   [4]   The SFDR complements corporate disclosures by providing a comprehensive reporting framework for financial products and financial entities. FAQ: what is the EU Taxonomy and how will it work in practice?, European Commission, (April 21, 2021) at page 3, available here.

   [5]   The EU Taxonomy Regulation is a green classification system that translates the EU’s climate and environmental objectives into criteria for specific economic activities for investment purposes and provides a common understanding of economic activities that make a substantial contribution to the EU’s environmental goals. Id at page 1.

   [6]   The definition of “net turnover” is “the amounts derived from the sale of products and the provision of services after deducting sales rebates and value added tax and other taxes directly linked to turnover” as defined in the Accounting Directive (see footnote 2 above).

  [7]   Listed micro-undertakings (those that do not satisfy two of the three following criteria: (i) a balance sheet total exceeding €350,000; (ii) a net turnover exceeding €700,000; and (iii) in excess of ten employees) will be exempt from the CSRD.

   [8]   Corporate Sustainability Reporting Directive (November 10, 2022), at point (14) of Article 1 (introducing Article 40a to the Accounting Directive) and point (2) of Article 5, available at https://www.europarl.europa.eu/doceo/document/TA-9-2022-0380_EN.pdf

   [9]   Securities and Exchange Commission, The Enhancement and Standardization of Climate-Related Disclosures for Investors, available at https://www.sec.gov/rules/proposed/2022/33-11042.pdf.

  [10]   “Equivalence” will be determined pursuant to the formal mechanisms established by the European Commission as envisaged under Article 23(4)(i) of Directive 2004/109/EC, available here.

  [11]   Corporate Sustainability Reporting Directive (November 10, 2022), at point (4) of Article 1 (replacing Article 19a of the Accounting Directive), available at https://www.europarl.europa.eu/doceo/document/TA-9-2022-0380_EN.pdf.

  [12]   Id. at point (8) of Article 1 (inserting Articles 29b and 29c into the Accounting Directive) and point (14) of Article 1 (inserting Article 40b into the Accounting Directive).

  [13]   In March 2021 the IFRS Foundation announced creation of a working group to accelerate convergence in global sustainability reporting standards focused on enterprise value and to undertake technical preparation for a potential international sustainability reporting standards board under the governance of the IFRS Foundation. Press Release, IFRS, IFRS Foundation Trustees announce working group to accelerate convergence in global sustainability reporting standards focused on enterprise value (March 22, 2021), available here.

  [14]   Corporate Sustainability Reporting Directive (November 10, 2022), at point (13) of Article 1 (amending Article 34 of the Accounting Directive), available at https://www.europarl.europa.eu/doceo/document/TA-9-2022-0380_EN.pdf.

  [15]   Id. at point (1) of Article 5.

  [16]   Id. at point (2) of Article 5.