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Compared to 2021’s record level deal activity, the first quarter of 2022 has registered a dip in global M&A. Analysts report that for January through March of 2022, global M&A is down by approximately one-fifth relative to the same period last year when measured by both deal value and volume metrics. The total value of pending and completed deals announced in Q1 2022 is the lowest since the second quarter of 2020. Big deals are still being signed, including a range of high profile deals in the largest mega-deal bracket (i.e., deals valued at $10B or more), a category that includes, among others, Microsoft/Activision Blizzard ($68B) and TD Bank/First Horizon ($13.4B). Yet, during the early months of 2022, large and mid-market deals—those valued between $1B and $5B—declined 40% relative to last year.

A host of complex factors influence M&A activity at any given time, from inflation to global conflicts to liquidity factors to prevailing regulatory dynamics. To be sure, the current regulatory climate around antitrust issues presents a challenge for deal makers. Progressive leadership at the Federal Trade Commission (FTC) and the Department of Justice Antitrust Division (DOJ) (together, the Agencies) have articulated and begun to execute a broad anti-consolidation agenda, increasing uncertainty and heightening risk associated with the U.S. merger clearance process. Similar trends are playing out across the global antitrust enforcement community. This shift has implications for the costs, timeline, and business disruption associated with the merger clearance process, particularly in light of the Agencies’ movement towards disfavoring settlements. But unlike many of the factors that contribute to M&A trends, which are exogenous and uncontrollable by deal parties, concerns about antitrust risk can be assessed and managed.

Gibson Dunn is working actively with clients to ensure that unpredictability around the merger control process under the Biden administration does not create unnecessary barriers to lawful M&A transactions. In this climate, the clear and certain allocation of risk and articulation of regulatory obligations in transaction agreements is paramount. Where appropriate, merging parties should prepare to defend their transactions through federal court litigation in the event that the Agencies adopt theories of harm that depart from standing law or are inconsistent with business realities. Finally, parties should give broad consideration to the implications of Agency non-merger enforcement activity (i.e., investigative studies, conduct enforcement actions, and rulemakings) on potential transactions, and vice versa.

Heightened Uncertainty and Risk Associated With Merger Clearance in the U.S. and Beyond

Since coming to leadership, FTC Chair Lina Khan and Assistant Attorney General Jonathan Kanter of the DOJ have pursued a top to bottom reconsideration of the antitrust agenda. Through rulemaking, promises of tougher enforcement activity, and rescission and (eventual) replacement of key policy documents, the Agencies are seeking to broaden antitrust enforcement and, in so doing, discourage M&A activity. These policies stem, in part, from the Agencies’ belief that corporate consolidation has “harmed open markets and fair competition” under overly permissive enforcement regimes in the past decades.

Among the Agencies’ most significant departures from past merger review practice is their reconsideration of the Horizontal Merger Guidelines and withdrawal of the Vertical Merger Guidelines, which they deemed “narrow and outdated.” Historically, agency staff, as well as deal makers and advisors interpreting the merger laws, have relied heavily on the Horizontal Merger Guidelines and, to a lesser extent (due to their recent revision and the less developed state of vertical merger enforcement), the Vertical Merger Guidelines. Now, the relevancy of the past guidelines is in doubt, but the content and scope of new guidelines is also unknown. What is clear from Agency commentary is that new guidelines are likely to substantially expand the scope of merger enforcement and very well may embrace novel and untested theories of harm, including greater scrutiny of “non-horizontal” transactions (e.g., conglomerate mergers and cross market mergers), examination of the incentives created by the involvement of investment firms, and a newfound emphasis on harm to workers and small businesses.

The Agencies’ shifting policy around merger remedies is another source of unpredictability and increased deal risk. In recent remarks, AAG Kanter expressed concern that the Agencies’ historical approach to merger remedies has been ineffective. He went on to say that under his leadership the DOJ may be less willing to resolve competitive concerns through divestitures, particularly when a deal involves “innovative markets” or “evolving business models.” Instead, when enforcers “conclude[] that a merger is likely to lessen competition, in most situations” the Agency “should seek a simple injunction to block the transaction,” rather than trying to cure the harm through divestitures. Accordingly, relative to past practice, merging parties may find the Agencies unreceptive to settlement negotiations. At the least, parties will face more resistance and likely need to offer broader divestiture packages. And even where merger settlements are available, the Agencies have revived the practice of including in consent decrees prior notice and approval requirements in respect of future transactions, with the effect of complicating settlement negotiations and burdening future deals.

Outside of the merger context, the Agencies are taking action that is likely to have second-order effects for M&A. For example, the FTC is actively deploying its Section 6(b) authority, which enables the agency to conduct wide-ranging studies without a specific law enforcement objective. Section 6(b) scrutiny of particularly industries or issues (such as non-reportable technology transactions or particular healthcare sectors) is likely to create obstacles for mergers that coincide with the area of FTC scrutiny. For example, enforcers may be inclined to look more closely at a transaction that relates to an area of active study in order to further their study objectives. In addition, political or PR concerns may enter into the Agencies’ calculus about clearing mergers in an industry that is under active 6(b) scrutiny. The same is true for mergers in industries that are being investigated or prosecuted for anticompetitive practices; such mergers may face more intense and searching scrutiny.

Once the new merger guidelines are issued and AAG Kanter and Chair Khan’s new policies develop a track record of implementation, we will have a more precise understanding of the operative analytical framework and its implications for M&A transactions. But the practical consequences of Chair Khan and AAG’s Kanter’s antitrust rewrite are already playing out and the trajectory is unlikely to change: merging parties are bearing more second request risk, broader and longer investigations, less opportunity to resolve competitive concerns with settlements, and greater risk of enforcement action.

Practical Considerations for Dealmakers and Advisors

In light of antitrust’s gating function, it is fair to question whether the current antitrust climate has to some extent played a role in the Q1 M&A dip. Yet dealmakers have a range of tools to accommodate and manage the risk engendered by the current regulatory environment. Antitrust considerations should be raised in the earliest phases of deal negotiations. As transaction agreements are negotiated, clear articulation of regulatory obligations and risk allocation remains critical in the effort to  keep merging parties aligned and ultimately hold deals together when Agency scrutiny comes to bear. Before agreeing to particular efforts standards in purchase agreements in respect of obtaining antitrust approvals, parties should appreciate the possibility that those efforts standards may ultimately require time-consuming and costly litigation.

In some transactions, merging parties are unwilling to carry on if a second request is issued and their agreement reflects that fact. The signal that such a contractual provision sends to the Agencies and the incentives that it creates should be weighed carefully.

Appreciating that merger reviews are likely to be more time consuming, onerous, and costly (whether because the Agencies require more engagement and advocacy during the first 30 days, require a pull-and-refile, or issue a broad second request), parties should consider building flexibility or extra time into transaction timetables. For cross-border deals that may be subject to scrutiny in jurisdictions that move slowly or, like the U.S., are broadening their approach to merger enforcement, a sophisticated multi-jurisdiction analysis should be conducted early on so that deal timing can be formulated accordingly. The likelihood of protracted reviews should also be contemplated during deal financing.

Transaction rationale and economics should take account of the Agencies’ heightened skepticism of merger remedies and the possibility of the FTC imposing a prior approval clause in those consents that are achievable. Transactions in which divestiture of a full business is feasible will have a better chance of resolving Agency concerns with a remedy, whereas transactions involving dynamic markets are expected to face more settlement resistance.

In light of the FTC’s new practice of warning merging parties that they may keep investigations open beyond the expiration of the HSR Act waiting period, contractual language formulating closing conditions based on the status of antitrust review should be worded precisely. Likewise, in the context of cross-border transactions that must be notified in ex-U.S. jurisdictions that do not have a statutory bar on closing before the review is complete, merging parties should agree as to whether they will close the deal during an ongoing review, with the buyer bearing the risk of future action by competition authorities.

Even deals that do not present any facial competitive issue may face an uncertain regulatory path if the parties do business in a sector that is the subject of Agency interest, as evinced by 6(b) studies, the Executive Order on Promoting Competition in the American Economy, conduct investigations or enforcement activity, or the Agencies’ political agenda. Parties doing deals in these industries should actively consider this layer of risk in consultation with antitrust counsel, so as to ensure that all possible risks are understood and mitigated.

Finally, where possible, merging parties should consider including commitments to litigate in their transaction agreement to signal to the Agencies that they are committed to closing and will not be backed off by onerous second requests or a protracted review. Ultimately, merger guidelines and other enforcement policy statements do not bind federal courts. In the event that the Agencies depart significantly from established law and economics, merging parties may have good prospects of vindicating their deals in federal court.

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

Antitrust and Competition Group:
Sophia A. Vandergrift – Washington, D.C. (+1 202-887-3625, [email protected])
Adam Di Vincenzo – Washington, D.C. (+1 202-887-3704, [email protected])
Kristen C. Limarzi – Washington, D.C. (+1 202-887-3518, [email protected])
Joshua Lipton – Washington, D.C. (+1 202-955-8226, [email protected])
Michael J. Perry – Washington, D.C. (+1 202-887-3558, [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])
Ali Nikpay – Co-Chair, London (+44 (0) 20 7071 4273, [email protected])
Christian Riis-Madsen – Co-Chair, Brussels (+32 2 554 72 05, [email protected])

Mergers and Acquisitions Group:
Eduardo Gallardo – Co-Chair, New York (+1 212-351-3847, [email protected])
Robert B. Little – Co-Chair, Dallas (+1 214-698-3260, [email protected])
Saee Muzumdar – Co-Chair, New York (+1 212-351-3966, [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.

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Decided April 21, 2022

City of Austin, Texas v. Reagan National Advertising of Austin, Inc., No. 20-1029

Today, the Supreme Court held that a regulation treating on-premises signs—those that contain advertisements for the place where the signs are located—differently from off-premises signs is content neutral and therefore not subject to strict scrutiny under the First Amendment.

Background: The Sign Code of Austin, Texas permits the new construction only of signs and billboards that advertise for the place where they are located, which are known as on-premises signs. The Code similarly permits only on-premises signs to be equipped with electronic controls that, for example, allow billboards to cycle through digital advertisements. Advertisers wishing to convert off-premises billboards to digitally changeable displays sued, claiming that the Code discriminates based on the content of their speech in violation of the First Amendment. The Fifth Circuit agreed, holding that because the on-premises/off-premises distinction could be applied only by a person who reads and interprets the sign’s message, the regulation was content-based and subject to strict scrutiny. Finding no compelling government justification, the Fifth Circuit found the Code’s distinction unconstitutional.

Issue: Whether the Sign Code’s distinction between on- and off-premises signs is a content-neutral regulation of speech.

Court’s Holding: The Sign Code’s distinction between on- and off-premises advertisements is facially content-neutral and subject to intermediate scrutiny under the First Amendment. The Court remanded the case to the Fifth Circuit to apply that test, rather than strict scrutiny.

“[H]old[ing] that a regulation cannot be content neutral if it requires reading the sign at issue[ ] is too extreme an interpretation of this Court’s precedent.”

Justice Sotomayor, writing for the Court

What It Means:

• The Court’s decision clarifies that its 2015 case, Reed v. Town of Gilbert, does not hold that restrictions are content-based every time they require an official to read a sign to determine whether it complies with a regulation.  According to the Court, Reed involved “a very different regulatory scheme” that placed stricter limitations on some types of signs compared to others—for instance, by placing more restrictions on advertisements for religious services than on political messages.  In this case, by contrast, the “sign’s substantive message is irrelevant to the application of” the on-premises/off-premises distinction.
• The Court noted that regulations like Austin’s Sign Code are common, including in provisions of the federal Highway Beautification Act.  It expressed reluctance to question these rules where authorities claim they are necessary to combat distracted driving and reduce blight, and where an “unbroken tradition of on-/off-premises distinctions counsels against” invalidating the rule.
• The decision subjects regulations like Austin’s to intermediate scrutiny, which requires the government to show that the rule does not excessively restrict speech and serves an important government interest.  The Court reserved judgment on whether the Code would satisfy that test.
• In a dissenting opinion joined by Justices Gorsuch and Barrett, Justice Thomas wrote that the Court had departed from Reed’s “clear and neutral rule” that regulation of signs is content-based whenever enforcing the rule requires determining whether a sign conveys a particular message.  He predicted that the departure from Reed’s “bright-line rule” will lead to future confusion.

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The Court’s opinion is available here.

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

Appellate and Constitutional Law Practice

Allyson N. Ho +1 214.698.3233 [email protected]	Thomas H. Dupree Jr. +1 202.955.8547 [email protected]	Julian W. Poon +1 213.229.7758 [email protected]
Lucas C. Townsend +1 202.887.3731 [email protected]	Bradley J. Hamburger +1 213.229.7658 [email protected]

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Decided April 21, 2022

Boechler, P.C. v. Commissioner of Internal Revenue, No. 20-1472

Today, the Supreme Court unanimously held that the Internal Revenue Code’s 30-day deadline for taxpayers to seek Tax Court review of “collection due process” determinations is a nonjurisdictional claims-processing rule that is subject to equitable tolling.

Background: When the IRS assesses a tax and the taxpayer doesn’t pay, the IRS can seize the taxpayer’s property to satisfy the outstanding amount. Since 1998, Congress has required the IRS to give advance notice to taxpayers before it levies their property to cover unpaid taxes. Taxpayers can challenge a proposed levy in an administrative hearing before the IRS’s Independent Office of Appeals, which issues the taxpayer a notice of determination stating its findings and decision. And the Internal Revenue Code provides that a taxpayer “may, within 30 days of a determination [from the Independent Office of Appeals], appeal such determination to the Tax Court (and the Tax Court shall have jurisdiction with respect to such matter).” 26 U.S.C. § 6330(d)(1).

Boechler, P.C. received an unfavorable determination from the IRS’s Independent Office of Appeals on a proposed levy but petitioned the Tax Court for review one day after the thirty-day deadline. The Eighth Circuit held that § 6330(d)(1)’s 30-day deadline is jurisdictional, meaning it could not be subject to equitable tolling.

Issue: Is § 6330(d)(1)’s 30-day deadline a jurisdictional requirement or a nonjurisdictional claims-processing rule? If it is a claims-processing rule, is it mandatory or subject to equitable tolling?

Court’s Holding: Section 6330(d)(1) is a nonjurisdictional claims-processing rule and is subject to equitable tolling.

“[The] 30-day time limit to file a petition for review of a collection due process determination is an ordinary, nonjurisdictional deadline subject to equitable tolling.”

Justice Barrett, writing for the Court

What It Means: 

• The Court’s decision reinforces the principle that filing deadlines are generally not jurisdictional unless the statute’s text or structure provides a clear statement to the contrary. In rejecting the Commissioner’s arguments, the Court reasoned that ambiguity in the text left “multiple plausible interpretations” and thus no clear statement of jurisdictional intent.
• The decision likewise confirms that nonjurisdictional filing deadlines are “presumptively subject to equitable tolling,” particularly where the statutory framework in question is likely to produce circumstances warranting exceptions to a statutory deadline—for instance, where the provision appears as part of a scheme in which unrepresented parties often initiate the process.
• The Court’s holding provides taxpayers with a limited opportunity to seek judicial review of unfavorable collection due process determinations even when they fail to petition the Tax Court for review within 30 days of the determination. That holding is consistent with the statute’s underlying purpose, which was to give taxpayers a way to seek administrative and judicial review before the IRS took the serious step of levying their property to satisfy unpaid taxes.
• The Court did not elaborate on the circumstances in which it would be appropriate for courts to toll § 6330(d)(1)’s 30-day deadline, leaving those arguments for further proceedings on remand. Lower courts are likely to encounter arguments for tolling featuring a wide variety of factual scenarios, including with respect to lower-income taxpayers, many of whom do not have counsel in collection due process proceedings.
• While the Court’s holding is limited to the deadline under § 6330(d)(1) for filing a collection due process case, the decision specifically calls into question a long line of cases holding that the 90-day deadline for invoking the Tax Court’s general deficiency jurisdiction under 26 U.S.C. § 6213(a) is jurisdictional. Section 6213(a) applies broadly when a taxpayer seeks to challenge an IRS audit determination or other income tax adjustment in Tax Court. Of the more than 150 million income tax returns filed each year, the IRS has historically issued far more than one million such adjustments, typically resulting in around 25,000 cases filed in Tax Court. If, following the Court’s holding, § 6213(a) is also found to be nonjurisdictional, it could open the door for a large number of taxpayers to argue for equitable tolling when they miss the 90-day general filing deadline.

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The Court’s opinion is available here.

Appellate and Constitutional Law Practice

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

Related Practice: Global Tax Controversy and Litigation

Michael J. Desmond +1 213.229.7531 [email protected]	Saul Mezei +1 202.955.8693 [email protected]	Sanford W. Stark +1 202.887.3650 [email protected]
C. Terrell Ussing +1 202.887.3612 [email protected]

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In March 2022, amidst an array of new proposals for sustainable products (including a proposed draft Regulation on Ecodesign for Sustainable Products) the European Commission announced an EU Strategy for Circular and Sustainable Textiles.

The Strategy envisages that “By 2030, textile products placed on the EU market are long-lived and recyclable, to a great extent made of recycled fibres, free of hazardous substances and produced in respect of social rights and the environment. Consumers benefit longer from high quality affordable textiles, fast fashion is out of fashion, and economically profitable re-use and repair services are widely available…..producers take responsibility for their products along the value chain, including when they become waste,…. incineration and landfilling of textiles is reduced to the minimum”.

The EC envisages numerous steps to achieve this strategy, including:

• Binding product-specific ecodesign requirements to increase durability, reusability, repairability and recyclability, and to address the unintentional release of microplastics in the environment.
• Development of criteria for safe and sustainable chemicals and materials- to reduce the presence of hazardous substances used in textile products.
• Introduction of a transparency obligation requiring large companies to publicly disclose the number of products they discard and destroy, including textiles.
• Introduction of a Digital Product Passport for textiles-based on mandatory information requirements on circularity and other key environmental aspects.
• Increased information and transparency for consumers at the point of sale, regarding the sustainability credentials of products.
• Extended producer responsibility requirements for textiles.

According to the EC’s Strategy Communication, the textiles and clothing sector comprises more than 160,000 companies and employs 1.5 million people, generating a turnover of EUR 162 billion in 2019. Global textile production has almost doubled between 2000 and 2015, with the consumption of clothing and footwear expected to increase by 63% by 2030, from 62 million tonnes now, to 102 million tonnes in 2030. The EC flags that in the EU, the consumption of textiles, most of which are imported, now accounts on average for the fourth highest negative impact on the environment and on climate change and third highest for water and land use from a global life cycle perspective. In circumstances where approximately 5.8 million tonnes of textiles are discarded every year in the EU, the impact of this Strategy could be significant.

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In the past year, the U.S. Federal Trade Commission (“FTC”) and Department of Justice’s Antitrust Division (“DOJ”) have put antitrust enforcement in the employment context at center stage.  Last week, those efforts were put to their first true test in trials in Texas and Colorado—where juries failed to convict any defendant of wage-fixing, unlawful no-poach agreements, or any other antitrust violation.  But employers should not rest easy; the DOJ has already confirmed that it is undaunted.  And both the DOJ and FTC appear ready to bring novel enforcement actions against agreements and consolidations that allegedly restrain competition in labor markets.[1]  These developments, should put employers on high-alert to ensure that their hiring, recruitment, non-compete, and employee classification and compensation policies and practices conform with antitrust laws.

Wage-Fixing, No-Hire, No-Poach, and Non-Solicit Agreements

For more than five years, following the DOJ and FTC’s 2016 “Antitrust Guidance for Human Resource Professionals,” the DOJ has been vocal about its intent to criminally prosecute “naked” wage-fixing and no-hire, no-poach and non-solicit agreements between horizontal competitors.[2]  This intention has become reality over the past 18 months, with a number of criminal indictments against both companies and individual executives for alleged wage-fixing, no-poach, and non-solicit agreements.  Those efforts have now been tested at trial.

Late last week, a jury in Texas returned its verdict after a eight-day trial of two health care staffing executives accused of fixing the rates paid to physical therapists and therapist assistants in the Dallas-Fort Worth area.  The jury acquitted the defendants of violating the Sherman Act, but did convict one defendant for obstructing a related FTC investigation.[3]  In response to the verdict, a DOJ official said, “In no way should the verdict today be taken as a referendum on the Antitrust Division’s commitment to prosecuting labor market collusion, or on our ability to prove these crimes at trial.”[4]  And late Friday, a Colorado jury acquitted defendants DaVita Inc. and its former CEO Kent Thiry of all charges after a nearly two-week trial regarding an alleged no-poach agreement.[5]

Still, the DOJ’s docket remains full of labor-related actions demonstrating that “commitment to prosecuting labor market collusion.”  In December 2021, for example, the DOJ announced indictments of six executives at companies in the aerospace industry for alleged no-poach and non-solicitation agreements.[6]  The DOJ currently has five pending criminal cases against both companies and individual executives for their alleged participation in wage-fixing, no-poach and non-solicit agreements.  These cases are expected to proceed toward trial throughout 2022.

Outside the criminal context, DOJ has also recently taken a harder line on whether certain no-poach and non-solicit agreements should be treated as per se violations—meaning that they would be deemed illegal irrespective of any inquiry into procompetitive justifications or anticompetitive effects—as opposed to being reviewed under the rule of reason standard, which requires such inquiry.  In particular:

• In November 2020, the DOJ filed an amicus brief in the Ninth Circuit arguing that no-poach provisions can be deemed “ancillary” to a procompetitive venture only upon a fairly demanding showing by the defendant that they are “reasonably necessary” to the overall agreement.[7] The Ninth Circuit rejected the DOJ’s arguments,[8] but if the DOJ’s position were adopted by other courts it would mean that companies would have to show that a no-poach or non-solicit agreement entered into in the context of a transaction, joint-venture, or other legitimate arrangement between competitors was “reasonably necessary” to the execution or implementation of that overall agreement, otherwise it could be considered per se
• In December 2021, the DOJ filed a statement of interest in a putative class action involving outpatient medical center employees in which it directly equated no-poach agreements with horizontal market allocation schemes, urging the court that “[t]he anticompetitive potential” of such market allocation schemes “justifies their facial invalidation even if procompetitive justifications are offered for some.”[9] The DOJ also argued that employers need not enter “quid pro quo” or “bilateral commitments” to allege an agreement in violation of the antitrust laws.
• In February 2022, the DOJ filed a motion for leave to file a statement of interest in a case involving alleged no-poach and non-solicit agreements in the franchise context.[10] The DOJ indicated that statements of interest it filed in franchise cases in 2019—in which the DOJ argued that the per se rule was unlikely to apply in the franchise context—”do not fully and accurately reflect the government’s current views.”  The court denied the DOJ’s motion, and thus how exactly the DOJ’s views in the franchise context have evolved remains unseen, although the other activity discussed above may provide some indication.

Mergers that Allegedly Reduce Competition for Labor

On January 18, 2022, in a joint press conference, the FTC and DOJ announced that they were launching a joint public inquiry aimed at strengthening enforcement against anticompetitive mergers.  FTC Chair Lina Khan took a “spotlight” to the effects of mergers in labor markets in particular, asking whether the agencies’ merger guidelines adequately assess whether mergers may lessen competition in labor markets, thereby harming workers.  That includes whether the guidelines should consider factors beyond wages, salaries, and financial compensation, and whether the cost savings derived from elimination of jobs are a cognizable efficiency.[11]

Likewise, labor market considerations in merger review was addressed as part of the December 2021 FTC and DOJ workshop on “Promoting Competition in Labor Markets.”  Chair Kahn and Jonathan Kanter, head of the DOJ’s Antitrust Division, reiterated that the current horizontal merger guidelines apply equally to labor markets and Tim Wu, Special Assistant to the President for Technology and Competition Policy, voiced the view that merger review has not focused sufficiently on the effects on workers.

The DOJ’s November 2021 lawsuit to block Penguin Random House’s acquisition of Simon & Schuster was perhaps a harbinger of things to come, focusing on the alleged harm the merger would have on workers—in that case, authors—who, according to the complaint, rely on competition between the major publishers to ensure they are fairly compensated for their work.[12]  The DOJ argued that the merger would reduce such competition, leading to less compensation for authors, and thus a declining quality and quantity of published books.

Employment Contracts, Including Non-Compete and Non-Disclosure Provisions

Antitrust enforcers have also signaled that they will more aggressively challenge employment contracts and agreements between employers that increase labor market frictions.

In February 2022, the DOJ submitted a statement of interest in a Nevada state court lawsuit filed by a group of anesthesiologists alleging that non-compete provisions in their employment agreements (with a contractor to sell their services to a hospital system) violate state law.[13]  The DOJ used the case as an opportunity to advance its position that such non-compete restrictions could be considered per se violations of Section 1 of the Sherman Act.  Notably, the DOJ argued that the non-compete restriction was not merely a vertical one (between employer and employee), but horizontal in so far as, at the time the agreement was made, the plaintiff anesthesiologists could sell their services directly to the hospital system at issue, in competition with the contractor who contracted with the hospital system on their behalf.  That is, in the DOJ’s view, the non-compete was akin to a horizontal no-hire agreement between competitors.  And even if the non-compete is considered a vertical agreement, the DOJ argued that it raises “significant concerns” because it can “effectively freeze” much of the local market for anesthesiology services.

Of course, no court has yet endorsed the unprecedented theory advanced by DOJ—that a unilateral decision to use a non-compete provision could be deemed per se unlawful—but the case illustrates the degree to which DOJ is continuing to aggressively push the boundaries of antitrust law in this area.

In addition, at the DOJ/FTC December 2021 workshop, speakers attacked mandatory arbitration agreements and class action waivers as anticompetitive, but they did not address how to reconcile a competition law focus on arbitration with the Federal Arbitration Act.  Panelists and enforcers also criticized agreements between employers which facilitate coordination (e.g., information sharing and benchmarking agreements) or reduce competition (e.g., no-poach agreements).  Enforcers recognized that these agreements can enhance competition in some cases, but also signaled that they may treat non-compete and information sharing agreements as presumptively illegal unless they are narrowly tailored to a facially obvious procompetitive business justification.  Enforcers also stated their intention to reconsider enforcement safe harbors.

Employee Misclassification

At the DOJ/FTC December 2021 workshop, FTC speakers discussed the possibility of challenging employee misclassification as an unfair method of competition under Section 5 of the FTC Act. This would reflect a significant shift in the law and an unprecedented expansion of the scope of the FTC Act.  Specifically, the FTC signaled that it considers an employer’s intentional misclassification of its employees as independent contractors to be an unfair method of competition because misclassification gives non-compliant employers a cost advantage over employers which follow labor guidelines.

The DOJ also voiced concerns that misclassification can lead to competitive harm in an amicus brief filed last month in an NLRB case in which the NLRB is considering whether to overturn its current independent-contractor standard.[14]  The DOJ brief argued that misclassification can lead to competitive harm in part because workers cannot “resist” unfavorable terms and conditions “without the organizing rights and protections provided by the NLRA.”  The DOJ further suggested that the existing independent contractor standard is “ambiguous” and that the ambiguity “encourage[s] employers to misclassify their workers.”  The DOJ then connected these concerns to the labor exemption from the antitrust laws, noting that, “[e]ven if the Antitrust Division were to exercise its prosecutorial discretion not to pursue action against workers whose status as employees is unclear, the threat of private antitrust lawsuits and treble damages might nonetheless substantially chill worker organizing, since employers and other interested parties would remain free to pursue antitrust litigation.”  In other words, the DOJ seems to be suggesting that the risk of private sector enforcement of the Sherman Act is chilling union organization, and that the NLRB should clarify the law to deprive employers of that potential claim in the context of independent contractor workers.

Executive Action and Administrative Rulemaking

President Biden’s July 2021 Executive Order on Promoting Competition in the American Economy specifically encouraged the FTC to engage in rulemaking “to curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”[15]  And the FTC has signaled it will act on the Executive Order’s instruction to prohibit or otherwise curtail non-compete agreements.[16]  While the FTC recently streamlined its rulemaking procedures and gave the Chair more control over the process,[17] rulemaking is a protracted process that often takes years.  To implement a rule, the FTC must develop a factual record; draft and issue a proposed rule; invite and consider the public’s comments on the proposal; and then revise and finalize the rule in light of those comments and the evidence in the record.  A rule that gives insufficient attention to important problems identified by commenters, such as the absence of statutory authority or constitutional problems, is legally vulnerable.  Thus, companies concerned about prohibitions against non-compete agreements and other potential rules should begin making plans to ensure those concerns are amply documented before the FTC when rulemaking proceedings begin.

President Biden’s Executive Order also tasked the Treasury Department, in consultation with the DOJ, the FTC, and the Department of Labor, to investigate the effects of an alleged lack of labor market competition on the U.S. labor market.  The Treasury Department’s report, issued last month, concluded that “a careful review of credible academic studies places the decrease in wages” relative to what they would have been in a “fully competitive market” at “roughly 20 percent.”[18]  The report further noted that employers’ “[w]age-setting power is also evident in the large number of workers who are subject to rules and agreements that limit their ability to switch jobs and occupations and, hence, their bargaining power.”  There is little doubt that enforcers (along with plaintiffs’ attorneys) will seize upon such language to support antitrust claims against employers.

Takeaways

After five years of looking for ways to use antitrust laws to improve mobility and competition in the labor markets, the FTC and DOJ appear ready to bring novel enforcement actions against agreements and consolidations that restrain competition in labor markets.  The potential antitrust risks associated with the labor practices discussed above run the gamut from civil DOJ, FTC or state AG investigations and lawsuits to, in some (potentially growing number of) instances, criminal prosecution, alongside the ever-present threat of private civil litigation.  In the merger context, companies have to consider potential second requests stemming from labor market concerns where there are otherwise no antitrust issues.

It is therefore now more important than ever that companies ensure that their hiring, employment, and compensation policies and practices conform with antitrust laws.  That includes:

• Consider labor market issues early in the M&A context. Expect heightened scrutiny not only where a transaction results in concentration or among parties with a history of collusion, but also where there is a history of attempted unionization, prior discrimination or wage and hour litigation, and or disputes about employee classification.  Scrutiny may also extend to non-competes, no-hire, and no-poach provisions within purchase agreements.  Consider the rationale for any such provision, and in particular whether it addresses a risk arising out the transaction.
• Check in on your employment agreements, and consider whether provisions that could be viewed as limiting employee mobility (such as non-competes) are state of the art. This includes considering the duration, scope, and purpose of those provisions, and whether the provision is tailored to achieve the company’s objectives.
• Be particularly mindful of enforcer interest in private equity acquisitions, agriculture, healthcare, technology, transportation, and shipping.
• Understand that the antitrust enforcers are equally interested in all categories of workers, from low-wage to highly trained workers.

_________________________

   [1]   Outside the U.S., European enforcers have also indicated that they intend to take a tougher enforcement stance with respect to no-poach and other labor market agreements.  See Client Alert: EU Competition Commissioner Signals Tougher Enforcement of No-Poach and Other Labor Market Agreements, Gibson, Dunn & Crutcher (Oct. 26, 2021).

   [2]   A “no-hire” agreement is one in which a company or individual agrees not to hire any employee from another company, while a “no-poach” or “non-solicit” agreement is one in which a company or individual agrees not to recruit or solicit employees from another company. The DOJ generally treats all of these types of agreements similarly.

   [3]   United States v. Jindal, United States v. Rodgers, Case No. 20-CR-358 (E.D. Tex. Apr. 14, 2022).

   [4]   Ben Penn, “DOJ’s First Criminal Wage-Fixing Case Ends Mostly in Defeat,” Bloomberg Law (Apr. 14, 2022).

   [5]   United States v. Da Vita Inc, Case No. 1:21-CR-00229 (D. Colo. Apr. 15, 2022).

   [6]   Department of Justice, Antitrust Division, Six Aerospace Executives and Managers Indicted for Leading Roles in Labor Market Conspiracy that Limited Workers’ Mobility and Career Prospects, Press Release (Dec. 16, 2021).

   [7]   Brief of Amicus United States of America in Support of Neither Party, Aya Healthcare Servs., Inc. v. AMN Healthcare, Inc. (9th Cir. Nov. 19, 2020).

   [8]   Aya Healthcare Servs., Inc. v. AMN Healthcare, Inc., 9 F.4th 1102 (9th Cir. 2021).

   [9]   Statement of Interest of the United States of America, In re Outpatient Medical Center Employee Antitrust Litig., Case No. 1:21-cv-00305 (N.D. Ill. Nov. 9, 2021).

  [10]   Motion for Leave to File Statement of Interest by United States of America, Deslandes v. McDonald’s USA, LLC, et al., Case No. 19-cv-05524 (N.D. Ill. Feb. 17, 2022).

  [11]   Federal Trade Commission, Remarks of Chair Lina M. Khan Regarding the Request for Information on Merger Enforcement (Jan. 18, 2022).

  [12]   Department of Justice, DOJ Sues to Block Penguin Random House’s Acquisition of Rival Publisher Simon & Schuster, Press Release (Nov. 2, 2021).

  [13]   Statement of Interest of the United States, Beck et al. v. Pickert Medical Group, P.C., et al., Case No. CV21-02092 (2d Jud. Dist. Nev. Feb. 25, 2022).

  [14]   See The Atlanta Opera, Inc. and Make-Up Artists & Hair Stylists Union, Case No. 10-RC-27692.

  [15]   See Client Alert: President Signs Executive Order Directing Agencies to Address Wide Range of Businesses’ Competitive Practices, Including Non-Compete Agreements, Gibson, Dunn & Crutcher (July 9, 2021).

  [16]   Chair Khan had also proposed banning non-compete agreements prior to her appointment. Rohit Chopra & Lina Khan, The Case for “Unfair Methods of Competition” Rulemaking, 87 U. Chi. L. Rev. 357, 373 (2020).

  [17]   Statement of FTC Commissioner Rebecca Kelly Slaughter (July 1, 2021).

  [18]   U.S. Department of the Treasury, The State of Labor Market Competition (Mar. 7, 2022).

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The following Gibson Dunn lawyers prepared this client alert: Rachel Brass, Caeli Higney, Kirsten Limarzi, Michael Holecek, Jeremy Robison, Nick Marquiss, Connie Lee, Chris Wilson, JeanAnn Tabbaa, and Logan Billman.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any leader or member of the firm’s Antitrust and Competition, Labor and Employment or Administrative Law and Regulatory practice groups:

Antitrust and Competition Group:
Rachel S. Brass – Co-Chair, San Francisco (+1 415-393-8293, [email protected])
Scott D. Hammond – Washington, D.C. (+1 202-887-3684, [email protected])
Caeli A. Higney – San Francisco (+1 415-393-8248, [email protected])
Kristen C. Limarzi – Washington, D.C. (+1 202-887-3518, [email protected])
Jeremy Robison – Washington, D.C. (+1 202-955-8518, [email protected])
Stephen Weissman – Co-Chair, Washington, D.C. (+1 202-955-8678, [email protected])
Ali Nikpay – Co-Chair, London (+44 (0) 20 7071 4273, [email protected])
Christian Riis-Madsen – Co-Chair, Brussels (+32 2 554 72 05, [email protected])

Labor and Employment Group:
Michael Holecek – Los Angeles (+1 213-229-7018, [email protected])
Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202-955-8242, [email protected])
Katherine V.A. Smith – Co-Chair, Los Angeles (+1 213-229-7107, [email protected])

Administrative Law and Regulatory Group:
Eugene Scalia – Co-Chair, Washington, D.C. (+1 202-955-8543, [email protected])
Lucas C. Townsend – Washington, D.C. (+1 202-887-3731, [email protected])
Helgi C. Walker – Co-Chair, Washington, D.C. (+1 202-887-3599, [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.

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This client alert provides an overview of, and our current perspectives on, the SEC’s recently proposed rules that would establish a new climate change reporting framework for U.S. public companies and foreign private issuers as well as practical recommendations on what companies should be doing now.

I. Overview

On March 21, 2022, the Securities and Exchange Commission (the “SEC” or “Commission”) proposed rules for climate change disclosure requirements for both U.S. public companies and foreign private​ issuers. The SEC posted a 500+ page Proposing Release (the “Proposing Release”) and issued a Press Release and a Fact Sheet summarizing notable provisions.

These disclosure requirements are mostly prescriptive rather than principles-based, and in many respects are derived from the Taskforce on Climate-related Financial Disclosures (“TCFD”) reporting framework and the Greenhouse Gas Protocol. The requirements would apply to annual reports on Forms 10-K and 20-F, with material changes to be reported quarterly on Form 10-Q. These requirements would also apply to IPO, spin-off and merger registration statements. Rather than creating a new stand-alone reporting form, as some corporate commenters had urged, the Commission has proposed amending Regulation S-K and Regulation S-X to create a climate change reporting framework within existing Securities Act and Exchange Act forms.

The proposed climate change reporting framework is extensive and detailed. For example, the text of the proposed Regulation S-K climate change reporting requirements comprise approximately 50% more words than the part of Regulation S-K requiring large public companies to describe their Business. In most cases where the proposed rules call for disclosure, the level of specificity and detail called for is virtually unprecedented in the SEC’s public company reporting rules.

Given the breadth and specificity of the proposed climate change reporting framework, compliance costs are expected to be significant. It is difficult to reasonably estimate the incremental costs of compliance given the absence of precedent for such disclosures. The Commission estimates that annual direct costs to comply with the proposed rules (including both internal and external resources) would range from $490,000 (smaller reporting companies) to $640,000 (non-smaller reporting companies) in the first year and $420,000 to $530,000 in subsequent years.^[1] In terms of the additional workload that would be necessary to prepare an annual report on Form 10-K, the Commission estimates this would be approximately 3,400 to 4,400 hours in the first year and 2,900 to 3,700 hours in years 2-6.^[2] While these estimates appear to include the incremental costs associated with the third-party attestation requirements, these estimates assume that companies already have the necessary internal personnel to support compliance and do not include transaction costs associated with hiring additional personnel or of implementing new processes, controls and procedures to satisfy the extensive reporting obligations.

The proposed rules would phase in over time, based on a company’s filer status.

II. Background

The SEC’s rule proposal comes amidst a backdrop of increasing focus on climate change by the investment community in recent years and follows on the heels of several initiatives and announcements throughout 2021 that signaled the Commission’s growing resolve to take action on the topic of climate change disclosure. The Commission had been mostly silent on these disclosure issues since its issuance of principles-based climate change disclosure guidance in 2010.[3]

• Request for public comment. In March 2021, in an effort to determine how and whether the Commission should further regulate the disclosure of this information, the Commission’s then-Acting Chair, Allison Herren Lee, requested public input regarding the need for climate change disclosure requirements.^[4] This solicitation generated 600 unique responses from a wide range of individuals, organizations, and institutions.^[5] Proponents of additional climate-related disclosure supported their position with arguments that “climate change poses significant financial risks to registrants and investors,” and that “current disclosure practice[s have] not produced consistent, comparable, reliable information for investors and their advisors.”^[6] Advocates opposed to additional climate-related disclosure argued that the existing principles-based disclosure framework under the securities laws, including the 2010 Climate Change Guidance, adequately provided for disclosure of climate-related risk when material.
• ESG Task Force. Also in March 2021, the SEC established a Climate and Environmental, Social, and Governance Task Force (the “ESG Task Force”) within the Commission’s Division of Enforcement. The initial focus of this task force was to “identify any material gaps or misstatements in issuers’ disclosure of climate risks under existing [Commission] rules.”[7] We are not yet aware of any publicly announced climate-related enforcement actions initiated by the ESG Task Force.
• Announced rulemaking priorities. In May 2021, shortly after his confirmation, SEC Chair Gary Gensler announced that information about climate risk “is one of my top priorities and will be an early focus during my tenure at the SEC.”[8] In June of that year, climate change disclosure rulemaking appeared on the SEC’s Spring 2021 Unified Agenda of Regulatory and Deregulatory Actions (“Reg-Flex Agenda”).[9]
• Wave of climate change comment letters. In the Summer and Fall of 2021, the Commission’s Division of Corporation Finance issued comment letters to dozens of companies on their fiscal 2020 Form 10-Ks relating exclusively to climate change disclosure issues. The comments, which were issued by a variety of the Division’s industry review groups, appeared to be based on the 2010 Climate Change Guidance.[10] In contrast, between 2010 and 2020, the SEC issued relatively few climate change-related comments.[11]

Chair Gensler had intended to propose climate change rules by the end of 2021, but the timing was reportedly delayed due to ongoing internal debate at the Commission on the scope of the proposed rules and continued refinement of the rule proposal.[12]

III. Summary of Proposed Reg. S-K Amendments

A. Overview

The proposed climate change disclosure requirements would amend Regulation S-K to require a new, separately captioned “Climate-Related Disclosure” section in applicable SEC filings, which would cover a range of climate-related information. In order to avoid duplicative disclosure, companies would have the flexibility to incorporate by reference into the new section relevant information included elsewhere in the document (e.g., Risk Factors, MD&A), subject to compliance with the SEC’s general rules on incorporation by reference.[13] The proposed disclosure requirements, which would be housed in new subpart 1500 of Regulation S-K and are discussed in more detail in the following sections, include:

• Risks. How any climate-related risks have had or are reasonably likely to have material impacts on a company’s business or consolidated financial statements.
• Impact on the company. How any climate-related risks have affected or are reasonably likely to affect a company’s strategy, business model and outlook.
• Risk management/oversight process. Processes for identifying, assessing and managing climate-related risks, as well as board governance of climate-related risks and relevant risk management processes.
• GHG emissions. Greenhouse gas (“GHG”) emissions metrics, which would include:
  • Scope 1 and Scope 2, which, for accelerated and large accelerated filers only, would be subject to assurance by an independent GHG emissions attestation provider.
  • For certain filers, Scope 3, but only if material or if the company has set a GHG emissions reduction target or goal that includes its Scope 3 emissions.
• Targets/goals. Information regarding climate-related targets, goals, and transition plans, if any.

B. Climate-Related Risks

Proposed Item 1502 of Reg. S-K would require companies to describe “climate-related risks reasonably likely to have a material impact on the registrant, including on its business or consolidated financial statements, which may manifest over the short, medium, and long term.” The detailed disclosures would include:

• Categorization of each risk as either a “physical risk” (e.g., related to the physical impacts of climate change, such as hurricanes, wildfires, floods) or “transition risk” (i.e., related to the transition to a lower-carbon economy).
• For physical risks, the nature of the risk, including whether it is acute (e.g., short-term or event-driven) or chronic (i.e., related to longer-term weather patterns); the location (by ZIP code or, for regions without ZIP codes, a similar subnational postal zone or geographic location) and nature of the properties/operations subject to the risk; and, to the extent the risk concerns flooding or drought conditions, additional information about the size/amount and location of assets.
• For transition risks, the nature of the risk, including whether it relates to regulatory, technological, market (including changing consumer, business counterparty, and investor preferences), liability, reputational or other transition-related factors, and how those factors impact the company.

A couple of aspects of the proposed rules would impact how companies assess the potential materiality of climate-related risks. First, companies would be required to consider various time horizons (short-, medium- and long-term). The proposed rules would provide flexibility for companies to determine how they define these time horizons, but companies would be required to disclose this determination as well as information about how such determination ties to the expected useful life of assets and climate-related planning processes and goals. Second, based on the proposed rules’ definition of “climate-related risks,” companies would need to consider not only the direct impacts of climate change on their financial statements and business, but also the indirect impacts on their “value chains” (i.e., upstream and downstream activities related to the company’s operations). This would encompass supply chain activities as well as product distribution and end use.

While the prescriptive requirements are largely focused on climate-related risks, the proposed rules make clear that companies also are permitted, but not required, to provide corresponding information about climate-related opportunities.

C. Climate-Related Impacts on Strategy, Business Model & Outlook

Proposed Item 1502 of Reg. S-K would also require companies to describe “the actual and potential impacts of any [identified] climate-related risks … on the registrant’s strategy, business model, and outlook.” The detailed disclosures would include:

• Nature of the impact, including on business operations (by type and location), products or services, value chain, activities to mitigate or adapt to climate-related risks, R&D expenditures and any other “significant changes or impacts.”
• Time horizon for each impact, e.g., short-, medium- or long-term.
• How each impact is integrated into the company’s business model and outlook, including with respect to strategy planning, financial planning, capital allocation and resources used for risk mitigation.
• How identified climate change metrics and targets are integrated into the business model and strategy, including the role of any carbon offsets or renewable energy credits or certificates (“RECs”) that the company utilizes.
• Financial statement impact, including whether and how identified climate-related risks have affected or are reasonably likely to affect the financial statements and considering any climate-related metrics required to be disclosed in the financials under the proposed rules (as discussed below).
• Business strategy resilience in light of potential changes in climate-related risks, on both a qualitative and quantitative basis and including any analytical tools used by the company to assess the impact of climate-related risks and support resiliency. Companies that use scenario analysis (e.g., a process for identifying and assessing a potential range of outcomes under various possible future climate scenarios, such as global surface temperature rise of 2 degrees Celsius above pre-industrial levels) would be required to disclose the specific scenarios considered along with parameters, assumptions, analytical choices and projected financial impacts under each scenario.

In addition to the above, for companies that have set an internal price on carbon (i.e., an estimate of the cost of carbon emissions for planning purposes), the proposed rules would require detailed disclosure about the price per unit and total price used, how the total price is estimated to change over time, calculation methodology, rationale for selecting the price used, and how the company uses that information to evaluate and manage climate-related risks. If the company uses more than one internal carbon price (i.e., for planning under various scenarios), then it would be required to provide disclosures for each price.

D. Climate-Related Risk Oversight & Management

Proposed Item 1501 of Reg. S-K would require companies to describe “the [board’s] oversight of climate-related risks” and “management’s role in assessing and managing climate-related risks.” The detailed disclosures would include:

• With respect to the board’s role, who, if any, on the board is responsible for climate risk oversight (e.g., full board, board committee, certain directors), whether any directors have “expertise in climate-related risks” (including supporting information to fully describe the nature of the expertise), the process by which the board is informed about climate risks and frequency of discussion, integration of climate risks into the strategy/risk/financial oversight processes, and the board’s establishment of and monitoring of climate-related targets or goals.
• With respect to management’s role, to the extent applicable, who in management is responsible for climate risk assessment and management (e.g., certain management positions or committees), relevant expertise of the position holders or committee members (including supporting information to fully describe the nature of the expertise), the process by which they are informed and monitor climate risks, and the frequency of reporting to the board/committee.

In addition, proposed Item 1503 of Reg. S-K would require companies to describe, if applicable, “any processes the registrant has for identifying, assessing, and managing climate-related risks.” The detailed disclosures would include:

• Risk identification and assessment process, including determination of relative significance of climate risks versus other risks, consideration of existing or likely regulatory requirements or policies, consideration of shifts in customer or counterparty preferences, technological changes or changes in market prices, and determination of materiality of climate risks.
• Risk management process, specifically the decision-making process for mitigating, accepting or adapting to particular risks, including risk prioritization and mitigation of high-priority risks.
• How these processes are integrated into overall risk management, including whether and how climate-related risks are integrated into the registrant’s overall risk management system or processes, and whether climate-focused board and management committees interact with the committees focused on overall risk management (if different).

Also, to the extent a company has adopted a transition plan as part of its climate risk management strategy, additional disclosures would be required. These disclosures would include, for example, a description of the plan, relevant metrics and targets used, annual updates about the transition plan (e.g., actions taken to meet goals) and how the company plans to mitigate or adapt to identified physical and transition risks.

Notably, the Commission did not include specific requirements addressing compensation practices tying executive pay to climate-related targets and goals, taking the position that the Compensation Discussion & Analysis rules already provide a framework for this disclosure.[14]

E. GHG Emissions Reporting

Proposed Item 1504 of Reg. S-K would require companies to disclose Scope 1, Scope 2 and, in some cases, Scope 3 “GHG emissions … for [their] most recently completed fiscal year, and for the historical fiscal years included in [their] consolidated financial statements in the filing, to the extent such historical GHG emissions data is reasonably available,” and Item 1505 of Reg. S-K would require certain companies to obtain external assurance of some of these disclosures.

The proposed rules define GHGs to include carbon dioxide (CO₂), methane (CH₄), nitrous oxide (N₂O), nitrogen trifluoride (NF₃), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs) and sulfur hexafluoride (SF₆), consistent with the Kyoto Protocol, the UN Framework Convention on Climate Change, the U.S. Energy Information Administration, and the U.S. Environmental Protection Agency. The proposed rules share basic concepts and vocabulary from the Greenhouse Gas Protocol, which is a widely accepted accounting and reporting standard for GHG emissions, in order to attempt to reduce the compliance burden on companies and promote comparability of reported data.[15] However, the SEC rules would require reporting to exclude the effects of offsets and RECs, and companies would not be required to follow the standards and guidance provided by the Greenhouse Gas Protocol in reporting their GHG emissions.

The proposed rules generally would require companies to provide GHG emissions data with respect to each year for which financial statements are included in the filing. For example, for a non-smaller reporting company, this would mean three years of GHG emissions data in an annual report on Form 10-K. Although data for the most recent fiscal year would always be required to be reported, the proposed rules contain an exception for prior years to the extent the data is not “reasonably available.” The proposing release explains that a company would be able to omit data for such years to the extent it “has not previously presented such metric for such fiscal year and the historical information necessary to calculate or estimate such metric is not reasonably available … without unreasonable effort or expense.” [16] As a result, we expect that companies that did not previously collect such data would be able to avail themselves of this exception on a scope-by-scope basis to “phase in” to full compliance (i.e., for a large accelerated filer, providing one year of data for the first year of compliance, two years of data for the next year, and three years of data beginning in the third year of compliance).

The proposed rules also include a limited safe harbor from liability for Scope 3 disclosures, providing that such disclosures will not be deemed fraudulent, “unless it is shown that such statement was made or reaffirmed without a reasonable basis or was disclosed other than in good faith.” However, the proposed safe harbor does little beyond defining the standard necessary to establish scienter for fraud-based claims, and provides only limited protection in the context of Securities Act liability standards provided it is shown that the company was not negligent.

The following table provides an overview of the detailed GHG emissions reporting requirements contained in the proposed rules, comparing applicable requirements for Scopes 1, 2 and 3:

	Scope 1	Scope 2	Scope 3
How this is defined	Direct emissions from operations owned or controlled by company (i.e., consolidated or accounted for as an equity method investment)	Indirect emissions from generation of purchased or acquired energy consumed by operations owned or controlled by company	All other indirect emissions not otherwise included in Scope 2 that occur in upstream and downstream activities of a company’s value chain
Who must report	All companies	Same as Scope 1	All companies (other than smaller reporting companies), but only if (a) material to the company, or (b) the company has set[17] a GHG emissions target that includes Scope 3
What must be reported: absolute GHG emissions	Aggregate amount in terms of metric tons of CO2e* Breakdown by constituent GHGs* *Excluding impact of purchased or generated offsets	Same as Scope 1	Same as Scope 1* plus breakdown by any significant categories of Scope 3 emissions *May choose to present as a range if company discloses reasons for doing so and underlying assumptions
What must be reported: GHG intensity	Sum of Scopes 1+2 emissions in terms of metric tons of: CO2e[18] per unit of total revenue (using company’s reporting currency), and CO2e per unit of production relevant to company’s industry (disclosing basis for unit used)* *Special rules apply for companies with no revenue or unit of production for a fiscal year or when voluntarily disclosing additional GHG intensity measures		Same as Scopes 1+2, but must be calculated and presented separately
What must be reported: description of methodology	Approach to categorizing emissions, including organizational & operational boundaries[19] (which must be consistent with financial reporting & as between Scopes 1/2/3) Reasonable estimates & material data gaps Calculation approach, including third-party data Material year-over-year changes in methodology	Same as Scope 1	Same as Scope 1 plus: Categories of included upstream and downstream activities Data sources used to calculate, including whether verified by company or third party Any significant overlap in categories producing Scope 3 emissions and how accounted for
Time period covered	Most recent fiscal year plus, if reasonably available, other years covered by financial statements in filing* *If full-year data not reasonably available for most recent year, can use actual data for Q1-Q3 plus reasonable estimate for Q4, but must promptly disclose any material difference between Q4 estimates and actuals	Same as Scope 1	Same as Scope 1
Subject to attestation requirements	Yes, for large accelerated filers and accelerated filers, subject to a stepped phase-in from limited assurance to reasonable assurance	Same as Scope 1	No
Subject to liability safe harbor	No	No	Yes, not deemed to be fraudulent unless it is shown that the disclosure was made without a reasonable basis or not in good faith

 

A key question for large accelerated filers and accelerated filers that have not yet set GHG emissions targets that encompass Scope 3 emissions will be whether such emissions are material to the company and, therefore, required to be disclosed. According to the Commission, Scope 3 emissions disclosure would be subject to a materiality qualifier in order to balance the “relative difficulty” for companies to collect this data and in acknowledgment of the fact that the impact of Scope 3 emissions can vary significantly across industries and companies.^[20] The Commission stated that this determination is based on traditional notions of materiality and that disclosure would be required “if there is a substantial likelihood that a reasonable investor would consider [Scope 3 emissions] important when making an investment or voting decision.”[21] The Commission added that this inherently is a company-specific determination that depends, in part, on a company’s industry and whether Scope 3 emissions represent a significant portion of a company’s total GHG emissions footprint.[22] Although the proposed rules would not explicitly require a company to disclose its basis for determining that Scope 3 emissions are not material, the proposing release notes that “it may be useful to investors to understand the basis for that determination.”[23] Moreover, the recent wave of SEC comment letters on climate change disclosures shows the Staff’s willingness to probe companies’ materiality determinations in this area.

F. Attestation of GHG Emissions

As noted above, proposed Item 1505 of Reg. S-K would require large accelerated filers and accelerated filers to obtain an attestation report from a GHG emissions attestation provider covering disclosure of Scope 1 and Scope 2 emissions. The detailed disclosures would include:

• Requirements for selecting a GHG emissions attestation provider, including that the person or firm is an expert in GHG emissions by virtue of having “significant experience,” and is “independent” from the company and its affiliates during the “attestation and professional engagement period” (as such terms are defined in the proposed rules), and the company would be required to disclose whether the attestation provider has a license to provide assurance (identifying any such licensing or accreditation body), is subject to any oversight inspection program (identifying any such program), and is subject to record-keeping requirements with respect to the engagement (identifying any such requirements and their duration).
• Form and content requirements for the report, including that the report contain information about its subject matter, evaluation time period, measurement criteria and attestation standard used (which must be publicly available at no cost and established by a group that has followed due process procedures), level of assurance provided, nature of engagement, description of the work performed if it is a limited assurance engagement, relative responsibilities of the company versus the attestation provider, independence of the attestation provider, any inherent limitations in the evaluation and conclusion of the attestation provider, among other technical form requirements.
• Phase-in of attestation requirements, under which filings with respect to the (1) first fiscal year after the compliance date would not require attestation, (2) second and third fiscal years after the compliance date would require, at a minimum, attestation at a “limited assurance” level, and (3) all years beginning with the fourth fiscal year after the compliance date would require attestation at a “reasonable assurance” level.[24]
• Voluntary attestation or verification would be permitted during the first fiscal year after the compliance date, but various disclosure requirements would apply, such as providing the identity of the attestation/verification provider and information about its independence, description of the standards used, level and scope of the attestation/verification provided, and a brief description of the results. Companies who voluntarily comply after the first fiscal year after the compliance date would be required to follow the full attestation requirements in the proposed rules.

The proposed rules would not require that the GHG emissions attestation provider be an independent, registered public accounting firm.[25] However, given the extensive qualification and disclosure requirements that would apply to the provider, as well as the expert liability that the provider would be subject to under the Securities Act of 1933 (the “Securities Act”),[26] we believe that many large public companies would engage their existing outside audit firm to provide these attestation services.[27] In this regard, registration statements that include an attestation report would be required to include as an exhibit a consent from the GHG emissions attestation provider, and, as a result, such provider would have a role in the diligence and comfort letter process for securities offerings.

G. Targets, Goals & Transition Plans

Proposed Item 1506 of Reg. S-K would require detailed disclosures if a company has “set any targets or goals related to the reduction of GHG emissions, or any other climate-related target or goal (e.g., regarding energy usage, water usage, conservation or ecosystem restoration, or revenues from low-carbon products) such as actual or anticipated regulatory requirements, market constraints, or other goals established by a climate-related treaty, law, regulation, policy, or organization.” The detailed disclosures would include:

• Scope and calculation of the target, including scope of activities and emissions included in the target, unit of measurement and whether absolute or intensity-based, time horizon for achievement (including whether it is consistent with an external standard), and baseline against which progress is measured (including a requirement to use a consistent base year for multiple targets).
• Progress achievement, including how the company intends to meet the target, any interim targets set by the company, and annual updates on progress achieved towards the target (including quantitative data and actions taken).
• Any use of carbon offsets or RECs, including the amount of carbon reduction represented by the offsets or amount of generated renewable energy from the RECs, description and location of the underlying projects, and information about the source, cost and authentication of the offsets or RECs.

IV. Summary of Proposed Reg. S-X Amendments

A. Overview

The proposed rules would amend Regulation S-X to require certain climate-related financial statement metrics and related disclosures in a separate footnote to companies’ annual audited financial statements. Specifically, the proposed disclosure requirements, which would be housed in new Article 14 of Regulation S-X, would require disclosure of three types of information: (1) financial impact metrics, (2) expenditure/cost metrics, and (3) financial estimates and assumptions.

As this information would be included in the financial statements, it would come within the scope of an independent, registered public accounting firm’s audit of the financials as well as a company’s internal control over financial reporting and related CEO and CFO certifications.

These disclosures, which are discussed in more detail below, would not be required to be included in filings that do not include audited financial statements (e.g., quarterly reports on Form 10-Q).

B. Generally Applicable Requirements

Proposed Rules 14-01 and 14-02 of Reg. S-X contain several requirements that would apply with respect to all of the climate-related financial metrics discussed below. The detailed disclosures would include:

• Disclosure thresholds. A particular metric would need to be disclosed if the absolute value of all climate-related impacts or expenditures/costs, as applicable, with respect to a corresponding financial statement line item represents at least 1% of that line item.
• Calculation methodology. The calculation of reported metrics must use financial information that is consistent with the scope of the rest of the financial statements and apply the same accounting principles utilized for the rest of the financial statements.
• Contextual information. For each reported metric, contextual information must be provided as to how it was derived, including significant inputs and assumptions, policy decisions (if applicable) and the impact of any climate-related risks identified pursuant to the new Regulation S-K requirements.

C. Financial Impact Metrics

Proposed Rule 14-02(c) and (d) of Reg. S-X would require companies to disclose, subject to the 1% line-item threshold, the financial impacts of severe weather events, other natural conditions and transition activities on any relevant line items in the company’s financial statements. The detailed disclosures would include:

• Presentation requirements, including that disclosure be presented, at a minimum, on an aggregated, line-by-line basis for all negative impacts and, separately, positive impacts.
• Scope of severe weather events and other natural conditions, including flooding, drought, wildfires, extreme temperatures and sea level rise, with potential impacts, including, for example, revenue and cost changes from business disruptions, asset impairment charges, changes in loss contingencies or reserves, and changes in total expected insured losses.
• Scope of covered transition activities, including efforts to reduce GHG emissions or mitigate exposure to transition risks, with potential impacts, including, for example, revenue and cost changes from new emissions pricing or regulations, cash flow changes from changes in upstream costs, changes in asset carrying amounts due to reduction in useful life, and changes to interest expense due to climate-linked bonds with variable interest rates based on achievement of climate targets.

D. Expenditure/Cost Metrics

Proposed Rule 14-02(e) and (f) of Reg. S-X would require companies to disclose, subject to the 1% threshold, expenditures and capitalized costs to mitigate the risks of severe weather events or other natural conditions and expenditures related to transition activities. The detailed disclosures would include:

• Presentation requirements, including that disclosure be presented on an aggregated basis for expenditures expensed and, separately, capitalized costs incurred.
• Scope of covered severe weather events and other natural conditions, including flooding, drought, wildfires, extreme temperatures and sea level rise (same as for financial impact metrics), with potential expenses/costs related to, for example, increasing business resilience, retiring or shortening the useful life of assets, relocating at-risk assets or operations, and otherwise reducing the future impact of severe weather events and other natural conditions on the business.
• Scope of covered transition activities, including efforts to reduce GHG emissions or mitigate exposure to transition risks (same as for financial impact metrics), with potential expenses/costs related to, for example, R&D for new technologies, purchase of assets, infrastructure or products to reduce GHG emissions, increase energy efficiency, offset emissions (e.g., energy credit purchases) or improve resource efficiency, and progress towards meeting disclosed climate-related targets or commitments.

E. Financial Estimates & Assumptions

Proposed Rule 14-02(g) and (h) of Reg. S-X would require companies to disclose whether estimates and assumptions underlying the amounts reported in the financial statements were impacted by risks and uncertainties associated with, or known impacts from, severe weather events and other natural conditions, the transition to a lower-carbon economy and any disclosed climate-related targets. To the extent there was an impact, qualitative disclosure would be required as to how the development of any such estimate or assumption was impacted.

F. Time Period Covered

Proposed Rule 14-01 of Reg. S-X would require the financial statement disclosures discussed above to be provided for a company’s most recently completed fiscal year and for each historical fiscal year included in the financial statements in the filing. As an example, a company that includes balance sheets as of the end of its two most recent fiscal years and three years of income and cash flow statements would be required to disclose two years of climate-related metrics that correspond to balance sheet line items and three years of climate-related metrics that correspond to income or cash flow statement line items.

Unlike the Reg. S-K disclosure requirements for GHG emissions, the Reg. S-X disclosure proposals do not contain an exemption for information that is not reasonably available with respect to historical periods.

V. Other Significant Aspects of the Proposed Rules

A. Applicability

The proposed rules would apply to companies with reporting obligations under the Securities Exchange Act of 1934 (the “Exchange Act”) pursuant to Section 13(a) or Section 15(d) and companies filing a registration statement under the Securities Act or Exchange Act. As a result, the proposed rules would apply to both U.S. public companies and foreign private issuers.

Once the rules are completely phased in (as discussed below), there generally would not be any filer-status-based exemptions from complying with the proposed rules. There would be limited exceptions for Scope 3 emissions disclosure (smaller reporting companies would be exempt) and GHG emissions attestation requirements (non-accelerated filers would be exempt). However, in contrast to some of the other SEC rules adopted in recent years, there would be no exemption for emerging growth companies.

The new disclosures would apply broadly to periodic filings as well as registration statements, including U.S. companies’ Forms S-1, S-3, S-4, S-11, 10, 10-Q and 10-K and foreign companies’ Forms F-1, F-3, F-4, 6-K and 20-F.[28] Although these forms generally would require the full panoply of disclosures in the proposed rules, quarterly reports on Form 10-Q would be required to disclose only material changes to the Regulation S-K-based climate change disclosures included in a company’s Form 10-K.

B. Liability Implications

The proposed rules would treat all climate-related disclosures as “filed” rather than “furnished” (other than those included in a foreign private issuer’s Form 6-K, which generally are “furnished”). This means that, in addition to general anti-fraud liability under Rule 10b-5 under the Exchange Act, such disclosures would be subject to incremental liability under Section 18 of the Exchange Act and, to the extent such disclosures are included or incorporated by reference into Securities Act Registration Statements, subject to liability under Sections 11 and 12 of the Securities Act. Importantly, claims under Section 11 of the Securities Act and Section 18 of the Exchange Act do not require a plaintiff to prove scienter or negligence, in contrast to claims under Rule 10b-5. As discussed above, there would be a limited safe-harbor from liability for Scope 3 emissions disclosures.

C. Safe Harbor for Forward-Looking Information

The proposed rules make clear that, to the extent that any of the climate-related disclosures are forward-looking (e.g., climate-related goals, emission reduction targets, transition plans, scenario analysis), they would be subject to the general safe-harbor protections under the Private Securities Litigation Reform Act (“PSLRA”), assuming that all of the required conditions under the PSLRA are met.[29] However, the PSLRA safe harbor would not be available for climate-related disclosures contained in the financial statement notes or in the context of initial public offerings. Also, compliance with the PSLRA safe harbor does not limit the Commission’s ability to bring enforcement actions.

D. Inline XBRL Data Tagging Requirements

The proposed rules would require all of the required disclosures to be tagged in Inline XBRL, including block text tagging and detail tagging of both qualitative and quantitative disclosures. According to the proposing release, this Inline XBRL tagging requirement is intended to “enable automated extraction and analysis of climate-related disclosures, allowing investors and other market participants to more efficiently perform large-scale analysis and comparison of climate-related disclosures across companies and time periods.”^[30]

VI. Commissioner Remarks and Potential Challenges

The Commission voted on party lines, three-to-one, in support of the proposed rule amendments. Chair Gensler supported the proposed rules, indicating that the rules would provide investors with “consistent, comparable, and decision-useful information for making their investment decisions and would provide consistent and clear reporting obligations to issuers.” He highlighted that the SEC has historically “stepped in when there’s a significant need for disclosure of information relevant to investors’ decisions.” Subsequent to the open meeting at which the rule proposal was approved, in response to a letter sent to the Commission by 40 Congressional Republicans asking the SEC to “immediately table” the rule on grounds that it would be “extremely burdensome,” Chair Gensler reiterated his view that the information sought by the proposed rules was “consistent with … concepts of decision-making and related materiality.”[31]

Commissioner Lee also supported the proposed rules, hailing their introduction as a “watershed moment for investors and financial markets.” In addition, Commissioner Lee noted that the majority of public comments received in last year’s request for public comment favored enhanced climate disclosure and that the proposed rules are responsive to those requests. Similarly, Commissioner Crenshaw supported the proposed rules, noting that they would “empower investors to make more informed decisions.”

Commissioner Peirce dissented and outlined several concerns she had regarding the proposed rules. In a dissent that may preview legal arguments that challengers would raise in litigation challenging the rule once finalized, Commissioner Peirce indicated that: (i) existing rules already cover material climate risks, (ii) the proposed rules would not apply a materiality threshold in some places (e.g., Scope 1 and Scope 2 required disclosures) and would distort materiality in other places (e.g., the Scope 3 disclosure requirements), (iii) the proposal would not lead to comparable, consistent, and reliable disclosures, (iv) the proposal exceeds the Commission’s statutory limits of authority, (v) the proposed rules would be expensive for companies to implement, and (vi) the proposal would hurt investors, the economy and the reputation of the SEC. Notably, Commissioner Peirce’s remarks also seemingly laid the framework for First Amendment challenges to the proposed rules based on limitations on compelled speech.

For the full text of the published statements of the Commissioners, please see the following links: Chair Gensler, Commissioner Peirce, Commissioner Lee and Commissioner Crenshaw.

VII. Effective Dates and Comment Period

The table below shows the phase-in schedule for the proposed rule requirements, assuming that final rules are adopted and effective by the end of 2022 (consistent with the proposing release’s assumption). This illustrative schedule would apply to companies with a December 31 or later fiscal year-end.^[32]

Disclosure Requirement	Large Accelerated Filers	Accelerated Filers	Non-Accelerated Filers	Smaller Reporting Companies
All disclosures other than Scope 3	Fiscal year 2023 (filed in 2024)	Fiscal year 2024 (filed in 2025)	Same as for Accelerated Filers	Fiscal year 2025 (filed in 2026)
Scope 3 emissions disclosures	Fiscal year 2024 (filed in 2025)	Fiscal year 2025 (filed in 2026)	Same as for Accelerated Filers	Exempt
Attestation for Scope 1 & Scope 2 emissions disclosures	Limited Assurance Fiscal year 2024 (filed in 2025) Reasonable Assurance Fiscal year 2026 (filed in 2027)	Limited Assurance Fiscal year 2025 (filed in 2026) Reasonable Assurance Fiscal year 2027 (filed in 2028)	Exempt	Same as for Accelerated Filers or Non-Accelerated Filers (as applicable)

The comment period ends on May 20, 2022, which is 60 days from when the SEC approved the rule proposal.

VIII. Key Takeaways and Action Items for Public Companies

In addition to their detailed and prescriptive approach to setting forth disclosure standards, several other aspects of the proposed rules are notable:

• Absence of materiality. The proposed disclosure standards largely eschew the use of a materiality standard; other than in the context of Form 10-Q updating, only the climate change risk disclosures, one of the two standards for requiring Scope 3 emissions disclosure, and certain details regarding emissions disclosures are predicated on materiality (and in the case of risk disclosures, the standard is “reasonably likely” to have a material impact). Notably, Chair Gensler stated that the definition of “materiality” applicable to the proposed rules is the one used under the U.S. securities laws, notwithstanding other “materiality” definitions used by various environmental, social and governance reporting frameworks,^[33] suggesting that company disclosures in sustainability reports may encompass topics not required to be addressed under the proposed rules.
• Inner workings disclosure. The proposed rules would require companies to disclose detailed underlying methodologies regarding climate-change issues to a degree that has few precedents in the SEC’s rules. For example, a company would not only have to disclose its GHG emissions, but would also have to provide a detailed description of its methodology, including significant inputs, calculation approach, and calculation tools. Thus, the rules would provide insights into key internal aspects of this one facet of a company’s business and operations to a greater degree than most other aspects of the company’s operations, potentially resulting in disclosure of proprietary business strategies and competitively sensitive information.
• Vague disclosure triggers based on company actions. In many cases, company actions can trigger disclosure under the proposed rules. For example, a company would have to provide Scope 3 emissions disclosure if the company “has set” a Scope 3 target or goal. Similarly, detailed disclosures would be required if a company “uses” a scenario analysis, “maintains” an internal carbon price, “has set” any climate-related target or goal, “has adopted” a transition plan. Moreover, once these disclosures are triggered, the proposed rules would prescribe detailed information that would have to be disclosed and would impose conditions on the disclosure that may differ from the company action that triggered the disclosure. For example, Scope 3 emissions disclosure would be required to be provided by constituent GHG, even if the target or goal that triggered the disclosure was not developed in that manner. Given the detailed reporting requirements that would be triggered by various company actions, the rules could disincentivize companies from taking such actions or from modifying or updating their planning around these types of actions and could lead to widely disparate disclosures among companies, largely without regard to the materiality of such actions or disclosures.

Although the rules have only been proposed and are subject to comment (which we believe will be significant) and any final rules could be challenged in court, it is not too early to start thinking about the potential implications of the proposed rules, if they are adopted as proposed, and assess what additional steps may be necessary to take in order to be well positioned to comply. The following planning suggestions should be tailored, as appropriate, to your company’s particular industry and size.

• Participate in the rulemaking. Under the Administrative Procedure Act, the SEC is required to consider and reasonably respond to public comments. Accordingly, companies concerned about aspects of the proposed rules should consider participating in the rulemaking proceedings, either by submitting their own comments or by working in conjunction with a trade association. Among other things, comments may address the expected costs of compliance with the proposed rules (including quantitative data, where available); requirements in the proposed rules that are unclear, impractical or unduly burdensome; and possible alternatives to provisions of potential concern.
• Conduct a gap analysis against any existing disclosures. Companies should start by taking stock of their existing climate-related disclosures—including in their SEC filings and on their websites (e.g., on an ESG webpage or stand-alone ESG report), as applicable—and assessing what additional disclosures would be needed to comply with the proposed climate-related risk disclosure framework. That will help focus and inform compliance and readiness efforts once final rules are issued.
• Assess sufficiency of internal and external climate change resources. Given their breadth and complexity, compliance with the proposed rules, if adopted, likely would require substantial internal and external resources. As a result, companies should begin to assess their internal resources’ expertise and external service providers. In assessing resource sufficiency, consideration should also be given to the timing for preparing these disclosures, since most will need to be finalized early the following year in time for the annual report on Form 10-K. This is an already busy time for internal legal and financial reporting teams and, for those companies that voluntarily publish an ESG report, this timing likely represents an acceleration of when similar disclosures otherwise would have been prepared as ESG reports are often published later in the year. Companies should start gathering information necessary for budgeting and organizational planning purposes.
• Evaluate disclosure controls and internal controls. Given that the proposed new disclosures would be included in SEC filings, companies should assess their existing disclosure controls and procedures, as well as internal control over financial reporting as it relates to the proposed Regulation S-X rules, to identify any necessary enhancements to cover the new climate-related disclosures. As a general matter, in light of the potential disclosure liability that attaches to these disclosures generally (even those included on company websites),^[34] it is important to have robust processes in place to collect and verify the underlying data and assumptions.
• Revisit climate-related risk oversight and management practices. As the proposed rules would require significant disclosure about climate-related risk oversight and management practices, companies should begin assessing their existing practices and considering whether any enhancements are warranted to how the board oversees climate-related risks (e.g., whether at the full board level or a committee, frequency for monitoring, etc.) and how these risks are managed internally before such practices are subject to disclosure.
• Reassess board composition, focusing on climate change expertise. As the proposed rules would require disclosure about any climate change expertise on the board of directors, companies should start assessing relevant qualifications of existing board members to consider what the potential disclosure would look like and evaluate whether it is appropriate (or not) to make climate change expertise a recruitment focus area for future board refreshment opportunities.
• Conduct a detailed materiality assessment of climate-related risks on the business. As a significant portion of the new Regulation S-K qualitative disclosure requirements would include a materiality qualifier, companies, would be well served by conducting a more detailed materiality assessment of climate change risks and opportunities on their business than they have done in the past.
• Begin considering potential significance of Scope 3 emissions for your company. As a threshold question for whether Scope 3 emissions disclosure would be required is whether they are material, companies should start to consider the potential significance of their Scope 3 emissions, including taking into account a company’s value chain. As this likely will require reliance on third-party data to some extent, companies should begin identifying potential data sources, including both industry resources and partners in their value chains.
• Discuss implications with your outside auditor. Companies should start discussing with their outside auditors the implications of both (1) the proposed financial statement disclosure requirements on the firm’s audit, and (2) the proposed disclosure requirements outside of the financial statements on the comfort letter process. Companies also should consider whether their outside auditors could be engaged to conduct the required GHG emissions attestation.

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[1]   See the Proposing Release, p. 386.

[2]   See the Proposing Release, p. 450.

[3]   See Commission Guidance Regarding Disclosure Related to Climate Change, Release No. 33-9106 (Feb. 2, 2010) (the “2010 Climate Change Guidance”), https://www.sec.gov/rules/interp/2010/33-9106.pdf.

[4]   See Acting Chair Allison Herren Lee, “Public Input Welcomed on Climate Change Disclosures” (Mar. 15, 2021), https://www.sec.gov/news/public-statement/lee-climate-change-disclosures.

[5]   See the Proposing Release, p. 19.

[6]   Id., pp. 19-20

[7]   See SEC Announces Enforcement Task Force Focused on Climate and ESG Issues, Press Release 2021-42 (Mar. 4, 2021), https://www.sec.gov/news/press-release/2021-42.

[8]   See Gensler Says Climate Disclosure Rules Among “Top Priorities,” Law360 (May 13, 2021), https://www.law360.com/articles/1384626.

[9]   See SEC Announces Annual Regulatory Agenda, Press Release 2021-99 (June 11, 2021), https://www.sec.gov/news/press-release/2021-99.

[10]   See SEC Staff Scrutiny of Climate Change Disclosures Has Arrived: What to Expect and How to Respond, Gibson, Dunn & Crutcher (Sep. 19, 2021), https://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=446. See also Sample Letter to Companies Regarding Climate Change Disclosures, (Last Modified Sept. 22, 2021), https://www.sec.gov/corpfin/sample-letter-climate-change-disclosures.

[11]   Based on Gibson Dunn’s review of the Intelligize database for the relevant time period.

[12]   See SEC Bogs Down on Climate Rule, Handing White House Fresh Setback, Robert Schmidt and Benjamin Bain, Bloomberg Green (Feb. 8, 2022), https://www.bloomberg.com/news/articles/2022-02-08/sec-bogs-down-on-climate-rule-saddling-biden-team-with-new-woe.

[13]   See the Proposing Release, p. 54.

[14]   See the Proposing Release, p. 102.

[15]   See the Proposing Release, p. 154.

[16]   See the Proposing Release, p. 192.

[17]   The proposed rules are not as clear on what it means to “set” a target, but we believe it makes sense to interpret this as meaning the company has publicly disclosed a target that includes Scope 3 emissions.

[18]   CO₂e refers to carbon dioxide equivalents and is a common unit of measurement that indicates global warming potential of each greenhouse gas. See the Proposing Release, p. 474.

[19]   Organizational boundaries refer to entities owned or controlled by the company, whereas operational boundaries define the direct and indirect emissions associated with the business. See the Proposing Release, p. 193.

[20]   See the Proposing Release, p. 169.

[21]   Id.

[22]   See the Proposing Release, pp. 169-173 (highlighting several industry dynamics that might lead a company to conclude that Scope 3 emissions are material).

[23]   See the Proposing Release, p. 174.

[24]    “Reasonable assurance” is the same level of assurance as a company’s financial statements in Form 10-K. It is an affirmative assurance that the GHG emissions disclosure is measured in accordance with the attestation provider’s standards. “Limited assurance” is a form of negative assurance and commonly referred to as “review,” and it is the same level of assurance provided to a company’s financial statements in a Form 10-Q.

[25]    See the Proposing Release, p. 47.

[26]    See the Proposing Release, pp. 252-253.

[27]    The Commission affirmed that fees paid to the outside auditor for GHG emissions attestation services would be considered “audit-related fees” for proxy disclosure purposes. See the Proposing Release, p. 252.

[28]   See the Proposing Release, p. 285-286.

[29]   See the Proposing Release, pp. 70-71.

[30]   Id. at 295.

[31]   See SEC Chief Doubles Down on Climate Plan Amid GOP Uproar, Law360 (Apr. 12, 2022), https://www.law360.com/securities/articles/1483445/sec-chief-doubles-down-on-climate-plan-amid-gop-uproar?nl_pk=a362658d-96a1-4200-b75b-8cd032e05259&utm_source=newsletter&utm_medium=email&utm_campaign=securities&utm_content=2022-04-13.

[32]   For companies with a fiscal year 2023 that commences before the adoption and effectiveness of the final rules, the proposing release makes clear that the time period for compliance would be one year later than illustrated above. See the Proposing Release, p. 225.

[33]   See Chair Gary Gensler, “Statement on Proposed Mandatory Climate Risk Disclosures,” Mar. 21, 2022, https://www.sec.gov/news/statement/gensler-climate-disclosure-20220321. Compare, for example, the Global Reporting Initiative, which uses an “impact materiality” standard based on whether information is important for reflecting an organization’s economic, environmental and social impacts, or the European Union’s Corporate Sustainability Reporting Directive, which uses a “double materiality” standard, based on both financial materiality and impact materiality concepts.

[34]   For a discussion about potential disclosure and other liability associated with ESG disclosures, see ESG Legal Update: What Corporate Governance and ESG Professionals Need to Know, Gibson, Dunn & Crutcher (June 2020), https://www.gibsondunn.com/wp-content/uploads/2020/10/Ising-Meltzer-McPhee-Percopo-Assaf-Holmes-ESG-Legal-Update-What-Corporate-Governance-and-ESG-Professionals-Need-to-Know-Society-for-Corporate-Governance-06-2020.pdf.

Los Angeles partner Michael Holecek and Washington, D.C. associates Andrew Kilberg and Logan Billman are the authors of “The FTC’s Foray Into Worker Classification Is Misguided and Unlawful” [PDF] published by The National Law Journal on April 12, 2022.

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On April 4, 2022, the U.S. Federal Trade Commission and U.S. Department of Justice (together, the “Agencies”) hosted international and state antitrust enforcers for panel discussions on current and emerging enforcement trends. U.S. agency leaders Assistant Attorney General (“AAG”) Jonathan Kanter and FTC Chair Lina M. Khan used the Summit to help showcase their policy objectives and enforcement priorities as part of President Biden’s efforts to harness antitrust as a tool to pursue his administration’s broader agenda.

A few key themes emerged from the Summit:

• The Agencies plan to substantively reform their approach to evaluating and challenging mergers in digital platform markets, markets where non-price competition is the predominant form of competition, and non-horizontal markets.
• The Agencies will continue their efforts to expand the reach of antitrust enforcement—including through the adoption of novel theories of harm and seldom used enforcement tools, such as challenging allegedly unfair methods of competition on a standalone basis under Section 5 of the FTC Act and criminally prosecuting alleged monopolization under Section 2 of the Sherman Act.

The Agencies are expected to substantively revise the Merger Guidelines

Throughout the Summit, state and international enforcers (together, the “enforcers”) celebrated merger control as the most important tool for preserving competition. Yet some enforcers bemoaned that the Agencies’ current Horizontal and Vertical Merger Guidelines inadequately prevent competitive harms in myriad industries. Noting the Agencies’ efforts to revise the current Merger Guidelines, enforcers discussed the current state of merger enforcement and identified areas where revisions may be appropriate. Among those concerns are:

• Structural Presumptions: Enforcers recognized that structural presumptions based on market shares are an essential starting place for merger analyses, but expressed concern that market share analysis alone does not necessarily paint an accurate picture of harm in dynamic markets, digital markets, and non-price markets.
• Digital and No-Marginal Cost Products: Enforcers expressed concern that traditional approaches to defining relevant markets and analyzing competitive effects do not apply to markets defined by non-price or negative price competition. For example, enforcers are particularly concerned with digital platforms that provide consumer facing services for “free” but monetize the service by selling advertisements. Enforcers suggested that the revised Guidelines could address this blind spot by adopting new economic tools, such as defining non-price markets through the “Small But Significant and non-Transitory Increase in Attention Costs” test. Enforces also suggested that the Agencies should place increased emphasis on ordinary course business documents.
• Non-Horizontal Mergers: Enforcers emphasized that antitrust should take a broad view of potential merger harms, including harms that may come from mergers that are neither strictly horizontal nor vertical, but are instead “non-horizontal” (i.e., conglomerate mergers, cross-market mergers, private equity acquisitions, and partial mergers). While the Agencies currently recognize that a broad range of non-horizontal transactions may be anticompetitive if they would enable a party to expand its monopoly power, or exclude rivals, through bundling, tying, and price discrimination, the enforcers suggested the Merger Guidelines could discuss these theories of harm in greater detail. Enforcers also suggested that the revised Merger Guidelines should provide a framework for analyzing transactions that might diminish or eliminate nascent competition, which often evade neat categorization into existing paradigms of vertical and horizontal harm.
• Remedies and Divestitures: International and local enforcers expressed agreement with the Agencies – and in particular AAG Kanter – that behavioral merger remedies inadequately address anticompetitive harms, and called on the Guidelines to expressly disfavor behavioral remedies.

While the precise scope, content, and timing of the revised Merger Guidelines remain unknown, signals from the Agencies suggest that they may substantially expand on and depart from the prior Guidelines, particularly with respect to issues surrounding digital platforms, non-price markets, non-horizontal mergers, and remedies. Ultimately, we expect that the regulatory environment for M&A transactions will continue to be unpredictable at best and at times more challenging than in the past; we expect the Agencies to probe novel or searching theories of harm during merger investigations.

The Agencies recommit to invigorating non-merger enforcement

In the non-merger context, the Agencies’ leadership signaled their intent to bring aggressive enforcement actions under novel legal and economic theories. For instance, the DOJ reiterated its commitment to criminally prosecute antitrust violations involving agreements in labor markets. DOJ staff celebrated recent court decisions that declined to dismiss indictments for employment-related violations under Section 1 of the Sherman Act and emphasized that labor market prosecutions will remain a priority. As the Agencies expand antitrust enforcement in labor markets, they also have been increasing their efforts to investigate whether a proposed transaction effects competition for workers.

AAG Kanter also reiterated that the DOJ will begin efforts to bring criminal charges for violations of Section 2 of the Sherman Act based on unilateral conduct of dominant firms. Not only is criminal prosecution for Section 2 violations unprecedented in the modern era, the DOJ historically has analyzed Section 2 cases under the rule of reason, which is an in-depth factual analysis unlike the “per se” rule, and prosecuted them only on a civil basis, reserving criminal enforcement for the most hardcore per se violations, such as agreements between competitors to fix prices or allocate markets. The DOJ has not prosecuted a Section 2 case criminally since 1981, and has brought only a handful of civil Section 2 cases in the past twenty years. Given the Supreme Court’s guidance that per se treatment should be used only for restraints with “manifestly anticompetitive effects” that “lack any redeeming virtue,” and per se treatment of single-firm conduct is rare, efforts to revive criminal Section 2 enforcement will likely face significant headwinds in the courts.

The DOJ and FTC further signaled increased civil enforcement actions, especially against interlocking directors involving competitors under Section 8 of the Clayton Act. And the FTC committed to challenging anticompetitive conduct that falls short of a Sherman Act violation under Section 5 of the FTC Act. Likewise, the FTC suggested it may regulate markets through its substantive rule-making authority. Previous workshops suggest that the FTC intends to target worker misclassification and other labor-related practices.

Concurrent with the Summit, the DOJ announced updates to its leniency program that foreshadow an era of criminal enforcement in which leniency applicants will face additional eligibility hurdles and heightened scrutiny. Under the revised policy, the DOJ will no longer grant leniency to companies that fail to promptly report cartel violations and will condition leniency on swift remediation of historic violations. These revisions to the DOJ’s leniency program create divergences from major international leniency programs that do not include these eligibility requirements.

In addition to a number of other changes, including with respect to civil litigation and Type B leniency, the leniency program’s frequently asked questions (“FAQs”) added compliance officers, alongside board members and legal counsel, as “authoritative representative[s] of the applicant for legal matters.” As a result, when any of these individuals discover collusive conduct, it will be attributed to the company and used to determine whether leniency was promptly sought.

Additionally, the FAQs do not define the meaning of “prompt.” Rather, the DOJ will base its determination of promptness on “the facts and circumstances of the illegal activity and the size and complexity of operations of the corporate applicant.” Importantly, it imposes on the applicant the “burden to prove that its self-reporting was prompt.”

The changes to the leniency program may create uncertainty as to leniency eligibility when companies make the determination whether to self-report. The drafting of the FAQs would have benefited from a consultation process with the private bar and the business community as is common in other jurisdictions.

While the Agencies’ expanded use of the federal antitrust laws, both through potential criminal enforcement (the mechanics of which remain unclear) and broader civil enforcement through Section 5 of the FTC Act, indicates novel challenges are likely, Article III courts ultimately determine whether conduct violates the antitrust laws. Where an Agency challenge departs from precedent and modern antitrust principles, parties should be prepared to vindicate their conduct through litigation before district and circuit courts, which tend to favor adherence to precedent instead of embracing novel and untested theories of liability.

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The following Gibson Dunn lawyers prepared this client alert: Rachel Brass, Stephen Weissman, Scott Hammond, Sophia Vandergrift, Jamie France, Chris Wilson, Caroline Ziser Smith, Logan Billman, and Harry Phillips.

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

Scott D. Hammond – Washington, D.C. (+1 202-887-3684, [email protected])

Sophia A. Vandergrift – Washington, D.C. (+1 202-887-3625, [email protected])

Jamie E. France – Washington, D.C. (+1 202-955-8218, [email protected])

Chris Wilson – Washington, D.C. (+1 202-955-8520, [email protected])

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

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

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

Christian Riis-Madsen – Co-Chair, Antitrust & Competition Group, Brussels (+32 2 554 72 05, [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.

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Since President Biden took office in January 2021, employers’ compensation and nondiscrimination practices have been under increasing scrutiny by the federal government.  For example, the recently issued Directive 2022-01—the Office of Federal Contract Compliance Programs (OFCCP) of the United States Department of Labor’s first directive since President Biden took office—directly underscores that pay equity is a priority of the new administration.[1]   This Directive, among other mandates, makes clear that OFCCP intends to challenge whether employers can rely on the attorney-client privilege and work product doctrine to protect internal pay equity audits from being produced when requested by OFCCP as part of its investigations into regulatory compliance.  As a result, companies should be particularly mindful of how they conduct internal pay equity analyses going forward.  This is especially important considering OFCCP Director Jenny Yang has recently declared that going forward, it is “redoubling its efforts to remove barriers to pay equity.”[2]

Recent Legal Developments

The Directive, which was issued on March 15, 2022, attempts to clarify federal contractor affirmative action obligations under 41 C.F.R. § 60-2.17(b)(3), which requires that federal contractors analyze their compensation systems for gender, race, or ethnicity-based disparities to ensure fair compensation policies and practices.  While the Directive does not create new legal rights or requirements, it is an example of the federal government’s increased attention to pay equity.  The Directive provides insight on how OFCCP will evaluate the “in-depth” pay equity audits required by federal affirmative action regulations.  According to the Directive, OFCCP can evaluate federal contractors’ compliance  during a “desk audit,” during which OFCCP will “look broadly at a contractor’s workforce (across job titles, levels, roles, positions, and functions) to identify patterns of segregation by race, ethnicity, and gender . . .  that drive pay disparities.”[3]  While the Directive does not make clear exactly what methods OFCCP will use in making this assessment, “where possible,” OFCCP will use “regression and other systemic analyses” to identify potential pay disparities in either patterns of assignment or in salary paid across similar functions and positions.[4]  If this audit reveals disparities in pay, OFCCP may seek additional information, such as additional compensation data, and conduct follow-up interviews.  OFCCP may also request additional information if the audit reveals employee complaints of pay discrimination, other anecdotal evidence of discrimination, or inconsistencies in how the contractor is applying its pay policies.

Importantly, the Directive makes clear that OFCCP can request production of the employer’s pay equity audit required under 41 C.F.R. § 60-2.17(b)(3), as well as any materials and communications related to that audit.  Employers often conduct privileged, internal audits on pay equity to proactively assess potential legal issues and to receive legal guidance.  Employers typically have resisted production of these privileged studies on attorney-client privilege and work product grounds.

The Directive emphasizes federal contractors “must maintain and make available to OFCCP documentation of their compliance with OFCCP regulations,” and that it “has the authority under its regulations to request the analyses the contractor has conducted to comply with OFCCP regulations.”[5]  OFCCP may also request information relating to the frequency of pay equity audits, the communication to management, and how the results were used to rectify disparities based on gender, race and/or ethnicity. The Directive takes the position that since federal contractors have an independent, regulatory duty to provide such information to OFCCP, they cannot withhold it on the basis of attorney-client privilege or pursuant to the attorney work product doctrine.[6]  OFCCP has made clear that its position is that this obligation “defeats any expectation” that the company’s pay equity audit findings and compliance records prepared by or with the assistance of counsel would remain confidential.  Id.

Notwithstanding this broad position, the Directive suggests that so long as federal contractors produce a pay equity audit and compliance records sufficient to comply with 41 C.F.R. § 60-2.17(b)(3), OFCCP “generally will not seek [production of] additional privileged analyses” conducted for any other purpose.[7]

While OFCCP’s application of this new position remains to be seen, it suggests that a prudent course for government contractor employers may be to conduct separate pay audits—one for the sole purpose of obtaining privileged legal advice, and a second, potentially non-privileged audit for demonstrating regulatory compliance.  Employers that conduct a single audit run a risk that OFCCP could challenge the audit as conducted, at least in part, for regulatory compliance purposes, making communications and other records regarding the exercise subject to disclosure.  Additionally, while it is unclear at this time how far OFCCP will go in contesting any privilege assertions over pay equity audit records, if OFCCP’s recent aggressive actions (such as its proposed changes to the pre-enforcement notice and conciliation procedures, see supra note 1)  serve as an indication, OFCPP could become more insistent on challenging an employer’s assertions of privilege.  If in fact OFCCP takes an aggressive approach towards challenging these privilege assertions, the boundaries of OFCCP’s position and the contours of privilege in this context will likely have to be resolved through litigation.  Employers should thus be prepared to vigorously defend any assertions of privilege in this context and to minimize risk of waiver.

Conclusion and Next Steps

In light of OFCCP’s increasing focus on pay equity, employers subject to OFCCP requirements should take care to ensure compliance with the pay equity obligations established by 41 C.F.R. § 60-2.17.  This means conducting regular audits of compensation systems, as well as implementing action-oriented programs designed to correct identified problem areas.  To the extent employers wish to conduct audits for the purposes of legal advice and to maintain privilege over such materials, it is important to establish clear separation between privileged audits conducted solely for the purpose of legal advice, and audits conducted for the purpose of complying with federal regulations.  Blurring the lines between those purposes could risk waiver of the privileged materials.  Furthermore, if employers choose to conduct separate pay equity audits, they should be mindful of potential  differences in the data utilized for the privileged and non-privileged audits as there could be inconsistent outcomes between audits.   Employers subject to OFCCP requirements should seek the advice of counsel to ensure appropriate processes and guardrails are in place to meet these federal obligations.

_______________________

 [1]   This is not the only evidence of the government’s recently increased scrutiny on nondiscrimination in general, however.  On March 21, 2022, OFCCP announced newly proposed amendments to its current rules governing its pursuit of potential discrimination violations.  OFCCP issued rules entitled “Nondiscrimination Obligations of Federal Contractors and Subcontractors: Procedures to Resolve Potential Employment Discrimination” on December 10, 2020.  The rules were purportedly designed to provide transparency into OFCCP’s process for evaluating nondiscrimination compliance and clarity for contractors in understanding the substantive requirements for OFCCP to issue discrimination findings.  However, OFCCP’s proposed amendments, if implemented, would have the effect of eliminating certain evidentiary and procedural safeguards that are currently in place (and which tend to protect contractors under a more flexible framework).  See Pre-Enforcement Notice and Conciliation Procedures, 87 Fed. Reg. 16138 (proposed March 22, 2022) (to be codified at 41 C.F.R. § 60).

 [2]   Press Release, U.S. Department of Labor, U.S. Department of Labor Announces Pay Equity Audit Directive for Federal Contractors to Identify Barriers to Equal Pay (Mar. 15, 2022), https://www.dol.gov/newsroom/releases/ofccp/ofccp20220315.

 [3]   Directive 2022-01.

 [4]   Id.

 [5]   Id.

 [6]   Id.

 [7]   Id.

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The following Gibson Dunn attorneys assisted in preparing this client update: Jason C. Schwartz, Karl G. Nelson, Dhananjay S. Manthripragada, Lindsay M. Paulin, Tiffany Phan, Lauren Fischer, and Virginia Baldwin.

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

Government Contracts Group:
Dhananjay S. Manthripragada – Co-Chair, Los Angeles (+1 213-229-366, [email protected])
Lindsay M. Paulin – Washington, D.C. (+1 202-887-3701, [email protected])

Labor and Employment Group:
Karl G. Nelson – Dallas (+1 214-698-3203, [email protected])
Tiffany Phan – Los Angeles (+1 213-229-7522, [email protected])
Eugene Scalia – Washington, D.C. (+1 202-955-8543, [email protected])
Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202-955-8242, [email protected])
Katherine V.A. Smith – Co-Chair, 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.

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On April 8, 2022, the Ninth Circuit released a significant en banc opinion in Olean Wholesale Grocery v. Bumble Bee Foods, — F.4th —, 2022 WL 1053459 (9th Cir. Apr. 8, 2022) (en banc), that addresses numerous key class certification issues, including the evidentiary burden for a plaintiff seeking class certification, the assessment of expert testimony at the class certification stage, and the interplay between Rule 23 and injury and Article III standing.

While the Ninth Circuit ultimately affirmed the granting of class certification in Olean, and rejected a per se ruling against certifying a class that contains more than a de minimis number of uninjured class members (a ruling which conflicts with decisions from the First and D.C. Circuits), the court’s opinion outlines a framework for class certification that creates significant hurdles for plaintiffs seeking to certify expansive classes, especially where proving injury at trial would require individualized adjudications.  And while Olean is an antitrust case involving claims of price fixing, its holdings are likely to impact all types of class actions, including consumer and employment cases.

Below, we outline the key holdings of Judge Ikuta’s lengthy opinion for the en banc Ninth Circuit:

• Evidentiary Burden—Preponderance. The Ninth Circuit joined other circuits in holding that the preponderance-of-the-evidence standard should be used to evaluate whether the proponent of class certification satisfied the prerequisites of Rule 23.  2022 WL 1053459 at *5.
• Admissible Evidence. The Ninth Circuit held that a plaintiff seeking class certification must satisfy its burden at class certification with admissible evidence.  Id. at *6.  This effectively overrules a prior Ninth Circuit panel decision, Sali v. Corona Regional Medical Center, 909 F.3d 996 (9th Cir. 2018), which had suggested that class certification could not be denied on the ground that the plaintiff’s evidence was inadmissible.
• Inquiry Into the Merits. The Ninth Circuit cautioned that a “district court is limited to resolving whether the evidence establishes that a common question is capable of class-wide resolution, not whether the evidence in fact establishes that plaintiffs would win at trial.”  Id. at *7.  But the court recognized that a “district court must also resolve disputes about historical facts if necessary to determine whether the plaintiffs evidence is capable of resolving a common issue central to the plaintiffs’ claims.”  Id. at *8.
• Scrutiny of Expert Testimony. The Ninth Circuit held that Daubert and Rule 702 of the Federal Rules of Evidence applies to expert testimony submitted at the class certification stage.  at *6, n.7.  But at the same time, the court emphasized that a district court cannot stop at simply evaluating whether expert testimony is admissible, as “[c]ourts have frequently found that expert evidence, while otherwise admissible under Daubert, was inadequate to satisfy the prerequisites of Rule 23.”  Id. at *7, n.9.  The Ninth Circuit then cataloged several examples of such inadequate expert testimony, including where “the evidence demonstrated nonsensical results such as false positives,” “where the evidence contained unsupported assumptions,” and “where the expert evidence was inadequate to prove an element of the claim for the entire class.”  Ibid.
• Uninjured Class Members. Breaking with the Olean panel decision—as well as the First Circuit’s decision in In re Asacol Antitrust Litig., 907 F.3d 42 (1st Cir. 2018), and the D.C. Circuit’s decision in In re Rail Freight Fuel Surcharge Antitrust Litig., 934 F.3d 619 (D.C. Cir. 2019)—the Ninth Circuit rejected a categorical rule precluding certification of a class that includes more than a de minimis number of uninjured class members.  Id. at *9.

But the Ninth Circuit did not hold that injury is irrelevant to the class certification calculus.  To the contrary, the court repeatedly emphasized that injury, both as an element of the underlying claim and as a requirement of Article III, is an essential issue in determining whether Rule 23(b)(3)’s predominance requirement is satisfied.

• • First, the court held that “[w]hen individualized questions relate to the injury status of class members, Rule 23(b)(3) requires that the court determine whether individualized inquiries about such matters would predominate over common questions.” at *9.  And “[b]ecause the Supreme Court has clarified that ‘[e]very class member must have Article III standing in order to recover individual damages,’ Rule 23 also requires a district court to determine whether individualized inquiries into this standing issue would predominate over common questions.”  Id. at *9, n.12 (quoting TransUnion LLC v. Ramirez, 141 S. Ct. 2190, 2208 (2021)).
  • Second, the court directed district courts to perform a “rigorous analysis” on a case-by-case basis, including analyzing “whether the possible presence of uninjured class members means that the class definition is fatally overbroad.” Id. at *10, n.14.
  • Third, while the court encouraged district courts to “redefine” overbroad classes rather than denying certification altogether, it expressly cautioned that courts cannot create “fail safe” classes designed to “include only those individuals who were injured by the allegedly unlawful conduct.” Ibid.
  • Finally, the court declined to address whether the “possible presence of a large number of uninjured class members raises an Article III issue,” as it concluded that the plaintiffs had demonstrated that all class members had standing.  Id. at *19.  The court did, however, expressly overrule its prior statement in Mazza v. American Honda Motor Co., 666 F.3d 581 (9th Cir. 2012), that “no class may be certified that contains members lacking Article III standing,” reasoning that this statement was wrong as applied to class actions seeking only injunctive or equitable relief, as opposed to damages.  2022 WL 1053459 at *19, n.32.

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The following Gibson Dunn lawyers contributed to this client update: Bradley Hamburger, Kahn Scolnick, Helen Avunjian, Christopher Chorba, Lauren Blas, Ariana Sañudo, and Wesley Sze.

Gibson Dunn attorneys 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 in the firm’s Class Actions, Labor and Employment, Antitrust and Constitutional, or Appellate and Constitutional Law practice groups, or any of the following lawyers:

Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, [email protected])
Christopher Chorba – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7396, [email protected])
Theane Evangelis – Co-Chair, Litigation Practice Group, Los Angeles (+1 213-229-7726, [email protected])
Kahn A. Scolnick – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7656, [email protected])
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, [email protected])
Lauren M. Blas – Los Angeles (+1 213-229-7503, [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.

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On 31 March 2022, the Hong Kong Securities and Futures Commission (“SFC”) released a new circular to licensed corporations (“LCs”) on the handling of client complaints,[1] alongside an Appendix setting out the SFC’s expected regulatory standards and suggested techniques and procedures for handling client complaints (collectively, the “Circular”).[2]

This client alert covers the key regulatory expectations imposed on LCs under the Circular and highlights suggested practices that LCs can adopt in order to meet these expectations. In particular, as discussed further below, the Circular continues the SFC’s increasing shift towards requiring LCs to allocate one or more of their Managers-in-Charge (“MIC”) with responsibility for a particular subject matter, by requiring the appointment of an MIC to oversee complaints handling. This follows the SFC’s October 2019 circular requiring LCs to appoint an MIC with specific responsibility for the use of external electronic data storage providers[3] and the June 2021 circular requiring LCs to appoint an MIC or responsible officer (“RO”) with specific responsibility for the operation of the LC’s bank accounts.[4] Further, by providing more granular and prescriptive guidance to LCs in relation to complaints handling, and in particular the expected timeframe for handling complaints, the Circular represents an important step towards alignment of regulatory standards in this area between LCs and authorized institutions which must comply with the HKMA’s Supervisory Policy Manual IC-4 (“SPM”).[5]

I. The SFC’s existing requirements for complaint handling

Paragraph 12.3 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code”)[6] sets out the standard of compliance expected of LCs with regards to complaint handling. In short, the Code requires LCs to handle complaints in a
“timely and appropriate manner”, to properly review the subject matter of the complaint, and to respond “promptly” to the complaints.

Similarly, Part V(5) of the Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the Securities and Futures Commission (the “Internal Control Guidelines”)[7] requires the management of LCs to establish, maintain and enforce “policies and procedures to ensure the proper handling of complaints from clients and that appropriate remedial action is promptly taken.”

The SFC’s new Circular supplements both the Code and Internal Control Guidelines, and provides important guidance and detail as to the SFC’s expectations of how LCs should adhere to the requirements set out in the Code and Internal Control Guidelines. In other words, compliance with the Circular is now required in order to ensure compliance with the Code and Internal Control Guidelines. As such, we strongly encourage LCs to adopt the suggested techniques and procedures laid out under the Circular as soon as practicable.

The Circular covers six key areas in relation to handling client complaints: (i) management oversight and complaint handling policies and procedures; (ii) disclosure of complaint handling procedures; (iii) identification and escalation of complaints; (iv) investigating complaints; (v) communicating outcomes with clients; and (vi) record keeping.

II. Responsibilities of senior management

The Circular emphasizes that senior management of LCs bear “primary responsibility” for ensuring appropriate standards of conduct and adherence to proper policies and procedures. As such, the SFC has indicated that LCs should designate a MIC to oversee complaint handling, including the setup, implementation and monitoring of complaint handling policies and process. Further, the Circular encourages LCs to ensure that regular reports on the progress of complaints handling are  made to senior management, with the SFC praising LCs which provided their senior management with reports on the types of complaints received, adherence to timelines, investigation results, remedial measures identified from investigations, and the implementation status thereof.

The SFC has also indicated that senior management should ensure that:

• LCs with large retail client bases dedicate sufficient resources to ensure proper governance over complaint handling, including through, for example, complaints committees staffed by MICs and ROs;
• at the conclusion of an investigation of a complaint, any remedial measures identified are promptly implemented so as to prevent the recurrence of similar issues; and
• regular training is provided to staff in relation to complaint handling techniques.

III. Complaint handling policies and procedures

The Internal Control Guidelines require LCs to set out their complaint handling policies and procedures in writing. The Circular supplements this by noting that LCs should ensure that their complaints handling policies set out:

• the expected timeframe for acknowledging the complaint upon receipt;
• responding to the complainant’s enquiries in relation to the complaint;
• providing a final response to the complaint.

Further, the Circular notes that while the timeframe required will vary depending on the nature of the complaint, as a rule of thumb, an acknowledgment of a complaint should be issued within seven days of receipt and a final response should be issued within two months. This is broadly consistent with the HKMA’s SPM which requires authorized institutions to provide an acknowledgment of receipt within seven days, and a final response within thirty days, or, if that is not possible, within a “reasonable period of time” (which the HKMA considers to be no longer than sixty days).

In order to preserve objectivity in investigations and to avoid potential conflict of interests, the SFC has also encouraged LCs to ensure that complaints are handled by compliance staff who are not directly involved in the subject matter of complaints.

IV. Disclosure of complaint handling procedures to clients in a clear, understandable manner

The Circular states that at a minimum, LCs should disclose key information about the different methods of lodging a complaint to the LC (for example, by email, telephone, letter, etc.); and the expected timeframe for processing the complaint under normal circumstances. However, the SFC has stopped short of mandating the manner in which this information must be conveyed, with the Circular noting that this standard of disclosure will be met as long as the required information is effectively conveyed to complainants. This may include, for example, posting the information in a prominent place on LC’s website, or to providing a leaflet with the necessary information to the client during account opening or upon receipt of their complaint.

V. Identification and escalation of complaints

The Code requires LCs to differentiate general enquiries from complaints for the purpose of ensuring compliance with the self-reporting requirements set out in para 12.5(a) of the Code. The Circular builds on this by:

• requiring the escalation of any serious or high-impact cases to senior management for prompt handling, including self-reporting to the SFC under para 12.5(a) where appropriate. The Circular suggests that this category of serious or high impact cases includes those involving fraud, staff misconduct, mass complaints involving multiple clients complaining about the same or similar issues, as well as those involving significant financial losses to clients or which may cause significant financial, operational and reputational risks for the LC; and
• recommending the provision of guidelines for staff to distinguish between the different nature and seriousness of complaints.

Further, the Circular also encourages LCs to regularly monitor feedback channels to ensure that all complaints are detected; for instance, by sample-checking tape recordings of telephone conversations between clients and customer service staff.

VI. Investigating complaints

The Circular notes that LCs should:

• properly review the subject matter of each complaint;
• maintain guidelines on when and how a complaint can be closed, including circumstances under which a complaint can be closed, and the approval procedures for different types of resolutions; and
• offer appropriate, consistent and fair resolutions to complainants; for example, where issues complained thereof are recurring or systematic, LCs should dig into the root causes of the problem rather than investigating at surface-level.

VII. Communicating outcomes to clients

LCs are expected to communicate their investigation results to complainants promptly and in doing so provide a clear description of the outcome of the investigation (i.e. whether the complaint is accepted or rejected, and any redress offered), alongside with an explanation of the outcome. The Circular further requires LCs to advise clients of any further steps which may be available to them where a complaint is not remedied promptly, including the right to refer a dispute to the Financial Dispute Resolution Centre.

VIII. Record keeping

The Internal Control Guidelines require LCs to keep proper records of all complainants and their complaints. The Circular extends this requirement by demanding LCs to review such records on a regular basis and to make them available to the SFC upon request during its ad hoc and routine reviews. While the Circular does provide LCs with some degree of flexibility by noting that LCs may adopt a pragmatic approach in deciding the level of detail to be retained in record-keeping, the Circular does also note that:

• complaint records will generally not be complete without details of the substance of the complaint and how it was resolved;
• details of follow up actions should be kept for any complaints relating to client assets; and
• a register of complaints should be made available to the SFC upon request.

IX. Conclusion

The Circular should be viewed as consistent with the SFC’s continued prioritization of senior management accountability as well as investor protection. As such LCs are encouraged to pay close attention to the SFC’s views and expectations as set out in the Circular and adopt appropriate implementation measures as soon as practicable.

________________________

   [1]   Circular to Licensed Corporations Handling of Client Complaints (31 March 2022), published by the Securities and Futures Commission, available at https://apps.sfc.hk/edistributionWeb/api/circular/openFile?lang=EN&refNo=22EC30.

   [2]   Expected Regulatory Standards and Suggested Techniques and Procedures for Handling Client Complaints (31 March 2022), published by the Securities and Futures Commission, available at https://apps.sfc.hk/edistributionWeb/api/circular/openAppendix?lang=EN&refNo=22EC30&appendix=0.

   [3]   Circular to Licensed Corporations – Use of external electronic data storage (31 Oct 2019), published by the Securities and Futures Commission, available at https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/intermediaries/supervision/doc?refNo=19EC59.

   [4]   Circular to licensed corporations Operation of bank accounts (28 June 2021), published by the Securities and Futures Commission, available at https://apps.sfc.hk/edistributionWeb/api/circular/openFile?lang=EN&refNo=21EC25.

   [5]   Supervisory Policy Manual IC-4 Complaints Handling Procedures (22 February 2002), published by the Hong Kong Monetary Authority, available at https://www.hkma.gov.hk/media/eng/doc/key-information/guidelines-and-circular/2002/IC-4.pdf.

   [6]   Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission, 27th edition (December 2020), published by the Securities and Futures Commission, available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-and-futures-commission/Code_of_conduct-Dec-2020_Eng.pdf.

   [7]   Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the Securities and Futures Commission (April 2003), published by the Securities and Futures Commission, available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/management-supervision-and-internal-control-gu/management-supervision-and-internal-control-guidelines-for-persons-licensed.pdf.

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

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

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

© 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.

Munich partner Mark Zimmer and associate Katharina Heinrich are the authors of “Anreize ohne Aktien – Virtuelle Mitarbeiterbeteiligung” [PDF] published in the April 2022 issue of the German publication Arbeit und Arbeitsrecht (AuA). The article discusses what limits an employer has to comply with when structuring phantom shares for employees, especially when the employees invest their own money.

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On March 30, 2022, the U.S. Securities and Exchange Commission (the “Commission”), by a three-to-one vote, issued a press release announcing proposed new rules (the “Proposal”) intended to enhance disclosure and investor protections in initial public offerings (“IPO”) by special purpose acquisition companies (“SPACs”) and in subsequent business combinations between SPACs and private operating companies (“de-SPAC transaction”).[1]

The Proposal provides a lengthy and comprehensive discussion that builds upon the Commission’s prior statements and actions regarding SPAC IPOs and de-SPAC transactions.[2] As noted by the Commission’s Chair, Gary Gensler, in the press release, the Proposal is intended to “help ensure” that “disclosure[,] standards for marketing practices[,] and gatekeeper and issuer obligations,” as applied in the traditional IPO context, also apply to SPACs.[3]  Chair Gensler further noted that “[f]unctionally, the SPAC target IPO is being used as an alternative means to conduct an IPO.”[4]

Overview

There are four key components of the Proposed Rules:

• Disclosure and Investor Protection. Proposes specific disclosure requirements with respect to, among other things, compensation paid to sponsors, potential conflicts of interest, dilution, and the fairness of the business combination, for both the SPAC IPOs and de‑SPAC transactions;
• Business Combinations Involving Shell Companies. Deems a business combination transaction involving a reporting shell company and a private operating company as a “sale” of securities under the Securities Act of 1933, as amended (the “Securities Act”), amends the financial statement requirements applicable to transactions involving shell companies, and amends the current “blank check company” definition to make clear that SPACs cannot rely on the safe harbor provision under the Private Securities Litigation Reform Act of 1995, as amended (the “PSLRA”) when marketing a de-SPAC transaction;
• Projections. Expands and updates the Commission’s guidance on the presentation of projections in filings with the Commission to address the reliability of such projections; and
• New Safe Harbor under the Investment Company Act of 1940. Proposes a safe harbor that SPACs may rely on to avoid being subject to registration as investment companies under the Investment Company Act of 1940, as amended (the “Investment Company Act”).  The safe harbor would (i) require SPACs to hold only assets comprising of cash, government securities, or certain money market funds; (ii) require the surviving entity to be engaged primarily in the business of the target company; and (iii) impose a time limit, from the SPAC IPO, of 18 months for the announcement (and 24 months for the completion) of the de-SPAC transaction.

We provide below our key takeaways, a summary of the Proposal, links to Commissioner statements regarding the Proposal, and a note regarding the comment period and process.

Key Takeaways

Below are the key takeaways from the Proposal:

• Timing. Although the proposed rules will not be in effect unless and until the Commission approves final rules after the public comment period and the Commission’s review process, existing SPACs and their targets should expect to receive comments from the Commission staff along the broader lines of the Proposal. SPACs and their targets also should consider the extent to which they will want to comply voluntarily with some of the proposed rules, especially those focused on financial statement requirements and enhanced disclosures.
• Conforming SPACs to Traditional IPOs. The Proposal goes to great lengths to contrast the current SPAC regulatory regime against the one applicable to traditional IPOs and to seek to “level” the playing field between the two.  Closer alignment of the two regimes may reduce some potential benefits of a de-SPAC transaction (e.g., availability of alternative financing sources and expedited path to becoming a public company) while also exposing the SPAC, its target and their advisors to additional liability.
• No PSLRA Protection. PSLRA safe harbor against a private right of action for forward-looking statements is not available in, among others, an offering by a blank check company or a “penny stock” issuer, or in an initial public offering.  Some market participants believe the PSLRA safe harbor is otherwise available in de-SPAC transactions when a SPAC is not a blank check company under Rule 419.  The Commission proposes to amend the current “blank check company” definition to remove the “penny stock” condition and make clear that SPACs may no longer rely on the safe harbor provision under the PSLRA as it relates to the use of projections and other forward-looking statements when marketing a de-SPAC transaction.  If the Proposal is adopted, it is unclear whether the lack of the PSLRA safe harbor, especially if coupled with proposed changes to regulations relating to projections, will lead to changes in the presentation of projections and assumptions, or the abandonment of projections.  If the latter, this could effectively eliminate the de-SPAC transaction as an alternative for target companies that do not have a lengthy operating history.
• Co-Registrant Liability. The Proposal would include target companies and their officers and directors as co-registrants under Form S-4 and Form F-4 filings, thus imposing Section 11 liability on such persons.  Liability will extend to both SPAC and target company disclosures contained in such filings.
• Extension of Current Disclosure Guidance (Projections, Dilution, Sponsor, Conflicts). Much of the Proposal is simply an extension of current guidance and practice by the Commission.  The Proposal does require additional information and specificity (in some cases, beyond current rules and guidance).  Nonetheless, some of the prescriptive rulemakings around enhanced disclosures—including the required financial statements, disclosure of sources of dilution, sponsor control and relationships, and potential conflicts of interest—are based on existing rules and guidance, and should not be particularly novel for practitioners.
• Fairness to Shareholders. The Proposal does not go as far as requiring a SPAC board to obtain a fairness opinion, although that seems the likely, practical outcome of the Proposal, since it requires more fulsome discussion of these matters and a determination by the board of directors of a SPAC regarding its reasonable belief as to the fairness of a de-SPAC transaction and related financings to the SPAC’s shareholders when approving a de-SPAC transaction.  Studies have indicated that only 15% of de-SPAC transactions disclose that they were supported by fairness opinions (compared to 85% of traditional mergers and acquisitions, excluding de-SPAC transactions).[5]  If the Proposal is adopted, a SPAC’s board of directors will need to consider obtaining a fairness opinion, and whether or not it obtains a fairness opinion, the bases for the SPAC’s reasonable belief as to the fairness of the transaction.
• Underwriter Liability. The Commission seeks to extend underwriter status (and resulting potential liability) in the de-SPAC transaction to those underwriters to SPAC IPOs involved, directly or indirectly, in the de-SPAC transaction (e.g., advisory services, placement agent services, and other activities related to the de-SPAC transaction would all be considered direct and indirect activities).  Underwriters to SPAC IPOs who participate in the de-SPAC transaction will need to consider whether to make changes to the typical de-SPAC transaction process, to ensure they have the benefit of their due diligence defense.
• SPAC Time Limits. In order to rely on a proposed safe harbor for SPACs under the Investment Company Act, SPACs would have a limited time period of no later than 18 months to announce a de-SPAC transaction (and no later than 24 months to complete a de-SPAC transaction) following the effective date of the SPAC’s registration statement for its IPO.  This would remove SPACs’ flexibility to seek extensions from its shareholders to their required liquidation date without running the risk of being considered to be an investment company subject to registration and regulation under the Investment Company Act.

Proposal Summary

New Subpart 1600 of Regulation S-K

The Proposal would create a new Subpart 1600 of Regulation S-K solely related to SPAC IPOs and de-SPAC transactions.  Among other things, this new Subpart 1600 would prescribe specific disclosure about the sponsor, potential conflicts of interest, and dilution.

Sponsor, Affiliates, and Promoters

To provide investors with a more complete understanding of the role of SPAC sponsors, affiliates, and promoters,[6] the Commission is proposing a new Item 1603(a) of Regulation S-K, to require:

• Experience. Description of the experience, material roles, and responsibilities of sponsors, affiliates, and promoters.
• Arrangements. Discussion of any agreement, arrangement, or understanding (i) between the sponsor and the SPAC, its executive officers, directors, or affiliates, in determining whether to proceed with a de-SPAC transaction and (ii) regarding the redemption of outstanding securities.
• Sponsor Control. Discussion of the controlling persons of the sponsor and any persons who have direct or indirect material interests in the sponsor, as well as an organizational chart that shows the relationship between the SPAC, the sponsor, and the sponsor’s affiliates.
• Lock-Ups. A table describing the material terms of any lock-up agreements with the sponsor and its affiliates.
• Compensation. Discussion of the nature and amounts of all compensation that has been or will be awarded to, earned by, or paid to the sponsor, its affiliates, and any promoters for all services rendered in all capacities to the SPAC and its affiliates, as well as the nature and amounts of any reimbursements to be paid to the sponsor, its affiliates, and any promoters upon the completion of a de-SPAC transaction.

Potential Conflicts of Interest

To provide investors with a more complete understanding of the potential conflicts of interest between (i) the sponsor or its affiliates or the SPAC’s officers, directors, or promoters, and (ii) unaffiliated security holders, the Commission is proposing a new Item 1603(b) of Regulation S-K.  This would include a discussion of conflicts arising as a result of a determination to proceed with a de-SPAC transaction and from the manner in which a SPAC compensates the sponsor or the SPAC’s executive officers and directors, or the manner in which the sponsor compensates its own executive officers and directors.

Relatedly, proposed Item 1603(c) of Regulation S-K would require disclosure of the fiduciary duties that each officer and director of a SPAC owes to other companies.

Sources of Dilution

In an effort to conform and enhance disclosure relating to dilution in SPAC IPOs and de-SPAC transactions, the Commission is proposing proposed Items 1602 and 1604 of Regulation S-K, respectively.

• IPO Dilution Disclosure. In providing disclosure pursuant to Item 506, SPACs currently provide prospective investors with estimates of dilution as a function of the difference between the initial public offering price and the pro forma net tangible book value per share after the offering, often including an assumption of the maximum number of shares eligible for redemption in a de-SPAC transaction.  The Proposal would require additional granularity on the prospectus cover page, requiring SPACs to present redemption scenarios in quartiles up to the maximum redemption scenario.  In addition to changes to the cover page, the Proposal would supplement Item 506 disclosure by requiring a description of material potential sources of future dilution following a SPAC’s initial public offering, as well as tabular disclosure of the amount of potential future dilution from the public offering price that will be absorbed by non-redeeming SPAC shareholders, to the extent quantifiable.
• De-SPAC Dilution Disclosure. In addition to disclosure at the IPO stage of a SPAC’s lifecycle, the Proposal would require additional disclosure regarding material potential sources of dilution as a result of the de-SPAC transaction.[7]  As seen in recent comment letters by the Commission, the Commission has requested additional granularity with respect to post-closing pro forma ownership disclosure, often requiring various redemption thresholds and the effects of potential sources of dilution.  The Proposal would codify this practice by requiring SPACs to affirmatively provide a sensitivity analysis in a tabular format that expresses the amount of potential dilution under a range of reasonably likely redemption levels.  The Proposal does not specify what are “reasonably likely” redemption levels, but looking at the proposed SPAC IPO dilution requirements (as discussed above), quartile disclosure up to the maximum redemption scenario may be acceptable.

Fairness of the De-SPAC Transaction and Related Financings

SPACs would be required to disclose whether their board of directors reasonably believes that the de-SPAC transaction and any related financing transaction are fair or unfair to the SPAC’s unaffiliated security holders, as well as a discussion of the bases for this statement.  Proposed Item 1606 of Regulation S-K would require a discussion, “in reasonable detail,” of the material factors upon which a reasonable belief regarding the fairness of a de-SPAC transaction and any related financing transaction is based, and, to the extent practicable, the weight assigned to each factor.  As noted by Commissioner Hester M. Peirce, “[w]hile this disclosure requirement technically does not require a SPAC board to hire third parties to conduct analyses and prepare a fairness opinion, the proposed rules clearly contemplate that this is the likely outcome of the new requirement.  For example, [proposed Item 1606] would require disclosure of whether ‘an unaffiliated representative’ has been retained to either negotiate the de-SPAC transaction or prepare a fairness opinion and [proposed Item 1607] would elicit disclosures about ‘any report, opinion, or appraisal from an outside party relating to . . . the fairness of the de-SPAC transaction.’”[8]

Relatedly, if any director voted against, or abstained from voting on, approval of the de-SPAC transaction or any related financing transaction, SPACs would be required to identify the director, and indicate, if known, after making reasonable inquiry, the reasons for the vote against the transaction or abstention.

Aligning De-SPAC Transactions with IPOs

Target Company as Co-Registrant

Under the current rules, only the SPAC and its officers and directors are required to sign the registration statement and are liable for material misstatements or omissions.  The Proposal would require the target company to be treated as a co-registrant with the SPAC when a Form S‑4 or Form F‑4 registration statement is filed by the SPAC in connection with a de-SPAC transaction.[9]  Registrant status for a target company and its officers and directors would result in such parties being liable for material misstatements or omissions pursuant to Section 11 of the Securities Act.  Under the Proposal, target companies and their officers and directors would be liable with respect to their own material misstatements or omissions, as well as any material misstatements or omissions made by the SPAC or its officers and directors.  As a result, the Proposal seeks to further incentivize target companies and SPACs to be diligent in monitoring each other’s disclosure.

Smaller Reporting Company Status

Currently, de-SPAC companies are able to avail themselves – as almost all SPACs have done since 2016[10] – of the smaller reporting company rules for at least a year following the de-SPAC transaction (and most SPACs would still retain this status at the time of the de-SPAC transaction when the SPAC is the legal acquirer of the target company).  The “smaller reporting company” status benefits the combined company after the de-SPAC transaction by availing it of scaled disclosure and other accommodations as it adjusts to being a public company.

Citing the disparate treatment between traditional IPO companies and de-SPAC companies (the former having to determine smaller reporting company status at the time it files its initial registration statement and the latter retaining the SPAC’s smaller reporting company status until the next annual determination date), the Proposal would require de-SPAC companies to determine compliance with the public float threshold (i.e., public float of (i) less than $250 million, or (ii) in addition to annual revenues less than $100 million, less than $700 million or no public float)[11] within four business days after the consummation of the de-SPAC transaction.

The revenue threshold would be determined by using the annual revenues of the target company as of the most recently completed fiscal year for which audited financial statements are available, and the de-SPAC company would then reflect this re-determination in its first periodic report following the closing of the de-SPAC transaction.

The Commission estimates that an average of 50 post-business combination companies following a de-SPAC transaction will no longer qualify as smaller reporting companies, when compared to current rules.[12]  Studies have indicated that the average size of a de-SPAC company has consistently remained north of $1 billion in 2021.[13]  Assuming this trend continues, there is an expectation that an increasing number of target companies will no longer qualify as smaller reporting companies after the de-SPAC transaction, and will need to adapt toward the enhanced public disclosure requirements.  This would include faster additional board and management training to prepare the post-de-SPAC company for additional disclosure requirements.

PSLRA Safe Harbor

The PSLRA provides a safe harbor for forward-looking statements under the Securities Act and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under which a company is protected from liability for forward-looking statements in any private right of action under the Securities Act or Exchange Act when, among other things, the forward-looking statement is identified as such and is accompanied by meaningful cautionary statements.

The safe harbor, however, is not available when the forward looking statement is made in connection with an offering by a “blank check company,” a company that is (i) a development stage company with no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies, or other entity or person, and (ii) is issuing “penny stock.”[14]

Because of the penny stock requirement, many practitioners have considered SPACs to be excluded from the definition of blank check company for purposes of the PSLRA safe harbor.  The Proposal seeks to amend the current definition of “blank check company” to remove the penny stock requirement, thus effectively removing a SPAC’s ability to qualify for the PSLRA safe harbor provision for the de-SPAC transaction.

This inability to rely on the PSLRA is coupled with the Proposal’s addition of new and modified projections disclosure requirements (as further discussed below).  If the Proposal is adopted, it remains unclear whether that will lead to changes in projections and assumptions (especially considering the current environment where market participants, investors, and financiers have come to expect detailed projections disclosure, similar to what is used in public merger and acquisitions (“M&A”) transactions), or the abandonment of projections. The latter could effectively eliminate the de-SPAC transaction as an alternative for target companies that do not have a lengthy operating history.

Underwriter Status and Liability

Historically, Section 11 and Section 12(a)(2) of the Securities Act[15] have imposed underwriter liability on underwriters of a SPAC’s IPO.  The Proposal takes a novel approach in arriving at the conclusion that a de-SPAC transaction would constitute a “distribution” under applicable underwriter regulations and seeks to extend such underwriter liability to a de-SPAC transaction.  Proposed Rule 140a would deem a SPAC IPO underwriter to be an underwriter in the de-SPAC transaction, provided that such party is engaged in certain de-SPAC activities or compensation arrangements.

Specifically, an underwriter in a SPAC’s IPO would be deemed an underwriter for purposes of a de-SPAC transaction if such person “takes steps to facilitate the de-SPAC transaction, or any related financing transaction, or otherwise participates (directly or indirectly) in the de-SPAC transaction,” including if such entities are (i) serving as financial advisor, (ii) identifying potential target companies, (iii) negotiating merger terms, or (iv) serving as a placement agent in private investments in public equity (“PIPE”) or other alternative financing transactions.

While Proposed Rule 140a only addresses “underwriter” status in de-SPAC transactions with respect to those serving as underwriters to the SPAC’s IPO, the Commission leaves open the door for subsequent determinations for finding additional “statutory underwriters” in a de-SPAC transaction, suggesting that “financial advisors, PIPE investors, or other advisors, depending on the circumstances, may be deemed statutory underwriters in connection with a de-SPAC transaction if they are purchasing from an issuer ‘with a view to’ distribution, are selling ‘for an issuer,’ and/or are ‘participating’ in a distribution.”[16]

In addition to the potential chilling effect that underwriter status may have on financial institutions’ participation in a de-SPAC transaction, the Commission’s statement that other “statutory underwriters” may be designated in the future, coupled with the traditional “due diligence” defenses of underwriters,[17] suggests that SPACs and target companies should expect extensive diligence requests from financial institutions, advisors, and their counsel in connection with a de-SPAC transaction and other related changes to the de-SPAC transaction process that add complexity, time, and cost.

Business Combinations Involving Shell Companies

The Commission’s concern related to private companies becoming U.S. public companies via de-SPAC transactions is substantially related to the opportunity for such private companies “to avoid the disclosure, liability, and other provisions applicable to traditional registered offerings.”[18]

Proposed Rule 145a

Based on the structure of certain de-SPAC transactions, the Commission expressed concern that, unlike investors in transaction structures in which the Securities Act applies (and a registration statement would be filed, absent an exemption), investors in reporting shell companies may not always receive the disclosures and other protection afforded by the Securities Act at the time the change in the nature of their investment occurs, due to the business combination involving another entity that is not a shell company.

Proposed Rule 145a intends to address the issue by deeming any direct or indirect business combination of a reporting shell company involving another entity that is not a shell company to involve “an offer, offer to sell, offer for sale, or sale within the meaning of section 2(a)(2) of the [Securities] Act.”[19]  By deeming such transaction to be a “sale” of securities for the purposes of the Securities Act, the Proposal is intended to address potential disparities in the disclosure and liability protections available to shareholders of reporting shell companies, depending on the transaction structure deployed.

Proposed Rule 145a defines a reporting shell company as a company (other than an asset-backed issuer as defined in Item 1101(b) of Regulation AB) that has:

1. no or nominal operations;
2. either:
   
   1. no or nominal assets;
   2. assets consisting solely of cash and cash equivalents; or
   3. assets consisting of any amount of cash and cash equivalents and nominal other assets; and
3. an obligation to file reports under Section 13 or Section 15(d) of the Exchange Act.

The Proposal notes that the sales covered by Proposed Rule 145a would not be covered by the exemption provided under Section 3(a)(9) of the Securities Act, because the exchange of securities would not be exclusively with the reporting shell company’s existing security holders, but also would include the private company’s existing security holders.

Financial Statement Requirements in Business Combination Transactions Involving Shell Companies

The Proposal amends the financial statements required to be provided in a business combination with an intention to bridge the gap between such financial statements and the financial statements required to be provided in an IPO.  The Commission views such Proposal as simply codifying “current staff guidance for transactions involving shell companies.”[20]

Number of Years of Financial Statements

Proposed Rule 15-01(b) would require a registration statement for a de-SPAC transaction where the target business will be a predecessor to the SPAC registrant to include the same financial statements for that business as would be required in a Securities Act registration statement for an IPO of that business.

Audit Requirements of Predecessor

Proposed Rule 15-01(a) would require the examination of the financial statements of a business that will be a predecessor to a shell company to be audited by an independent accountant in accordance with the standards of the Public Company Accounting Oversight Board (“PCAOB”) for the purpose of expressing an opinion, to the same extent as a registrant would be audited for an IPO, effectively codifying the staff’s existing guidance.[21]

Age of Financial Statements of the Predecessor

Proposed Rule 15-01(c) would provide for the age of the financial statements of a private operating company as predecessor to be based on whether such private company would qualify as a smaller reporting company in a traditional IPO process, ultimately aligning with the financial statement requirements in a traditional IPO.

Acquisitions of Businesses by a Shell Company Registrant or Its Predecessor That Are Not or Will Not Be the Predecessor

The Commission is proposing a series of rules intended to clarify when companies should disclose financial statements of businesses acquired by SPAC targets or where such business are probable of being acquired by SPAC targets.  Proposed Rule 15-01(d) would address situations where financial statements of other businesses (other than the predecessor) that have been acquired or are probable to be acquired should be included in a registration statement or proxy/information statement for a de-SPAC transaction.  The Proposal would require application of Rule 3-05, Rule 8-04 or Rule 3-14 (with respect to real estate operation) of Regulation S-X to acquisitions by the private target in the context of a de-SPAC transaction, which the staff views as codifying its existing guidance.

Proposed amendments to the significance tests in Rule 1-02(w) of Regulation S-X will require the significance of the acquisition target of the private target in a de-SPAC transaction to be calculated using the SPAC’s target’s financial information, rather than the SPAC’s financial information.

In addition, Proposed Rule 15-01(d)(2) would require the de-SPAC company to file the financial statements of a recently acquired business, that is not or will not be its predecessor pursuant to Rule 3-05(b)(4)(i) in an Item 2.01(f) of Form 8-K filed in connection with the closing of the de-SPAC transaction where such financial statements were omitted from the registration statement for the de-SPAC transaction, to the extent the significance of the acquisition is greater than 20% but less than 50%.

Financial Statements of a Shell Company Registrant after the Combination with Predecessor

Proposed Rule 15-01(e) allows a registrant to exclude the financial statements of a SPAC for the period prior to the de-SPAC transaction if (i) all financial statements of the SPAC have been filed for all required periods through the de-SPAC transaction, and (ii) the financial statements of the registrant include the period on which the de-SPAC transaction was consummated.  The Proposal eliminates any distinction between a de-SPAC structured as a forward acquisition or a reverse recapitalization.

Other Amendments

In addition, the Proposal is also addressing the following related amendments:

• amendment of Rule 11-01(d) of Regulation S-X to expressly state that a SPAC is a business for purposes of the rule, effectively requiring an issuer that is not a SPAC to file financial statements of the SPAC in a resale registration statement on Form S-1;
• amendment of Item 2.01(f) of Form 8-K to refer to “acquired business,” rather than “registrant,” to clarify that the information required to be provided “relates to the acquired business and for periods prior to consummation of the acquisition”;[22] and
• amendment of Rules 3-01, 8-02, and 10-01(a)(1) of Regulation S-X to expressly refer to the balance sheet of the predecessors, consistent with the provision regarding income statements.

Enhanced Projections Disclosure

Disclosure of financial projections is not expressly required by the U.S. federal securities laws; however, it has been common practice for SPACs to use projections of the target company and post-de-SPAC company in its assessment of a proposed de-SPAC transaction, its investor presentations, and soliciting material once a definitive agreement is executed.  The Proposal seeks to amend existing regulations regarding the use of projections as well as add new, supplemental disclosure requirements.

Amended Item 10(b) of Regulation S-K

Under Item 10(b) of Regulation S-K, management may present projections regarding a registrant’s future performance, provided that (i) there is a reasonable and good faith basis for such projections, and (ii) they include disclosure of the assumptions underlying the projections and the limitations of such projections, and the presentation and format of such projections.  Citing concerns of instances where target companies have disclosed projections that lack a reasonable basis,[23] the Proposal seeks to amend Item 10(b) of Regulation S-K as follows:

• Clarification of Applicability to Target Company. Item 10(b) of Regulation S-K currently refers to projections regarding the “registrant.”  Proposed amendments would modify the language to clarify that the guidance therein applies to any projections of “future economic performance of persons other than the registrant, such as the target company in a business combination transaction, that are included in the registrant’s Commission filings.” Application of the term “persons other than the registrant” suggests that it is likely that the proposed amended guidance also would apply to the use of projections in non-SPAC transactions.
• Historical Results. Disclosure of projected measures that are not based on historical financial results or operational history should be clearly distinguished from projected measures that are based on historical financial results or operational history.
• Prominence of Historical Results. Similar to non-GAAP presentation, the Commission would consider it misleading to present projections that are based on historical financial results or operational history without presenting such historical measure or operational history with equal or greater prominence.
• Non-GAAP Measures. Presentation of projections that include a non-GAAP financial measure should include a clear definition or explanation of the measure, a description of the GAAP financial measure to which it is most closely related, and an explanation why the non-GAAP financial measure was used instead of a GAAP measure.  The Proposal notes that the reference to the nearest GAAP measure called for by amended Item 10(b) would not require a reconciliation to that GAAP measure; however, the need to provide a GAAP reconciliation for any non-GAAP financial measures would continue to be governed by Regulation G and Item 10(e) of Regulation S-K.

Proposed Item 1609 of Regulation S-K

In light of the traditional SPAC sponsor compensation structure (i.e., compensation in the form of post-closing equity) and the potential incentives and overall dynamics of a de-SPAC transaction, the Commission has proposed a new rule specific to SPACs that would supplement the proposed amendments to Item 10(b) of Regulation S-K (as discussed above).  Specifically, the Commission is proposing a new Item 1609 of Regulation S-K that would require SPACs to provide the accompanying disclosures to financial projections:

• Purpose of Projections. Any projection disclosed by the registrant must include disclosure regarding (i) the purpose for which the projection was prepared, and (ii) the party that prepared the projection.
• Bases and Assumptions. Disclosure would include all material bases of the disclosed projections and all material assumptions underlying the projections, and any factors that may materially impact such assumptions.  This would include a discussion of any factors that may cause the assumptions to be no longer reasonable, material growth rates or discount multiples used in preparing the projections, and the reasons for selecting such growth rates or discount multiples.
• Views of Management and the Board. Disclosure must discuss whether the projections disclosed continue to reflect the views of the board and/or management of the SPAC or target company, as applicable, as of the date of the filing.  If the projections do not continue to reflect the views of the board and/or management, the SPAC should include a discussion of the purpose of disclosing the projections and the reasons for any continued reliance by the management or board on the projections.

Like the proposed amendments to Item 10(b), the first two requirements summarized above should not come as a particular surprise to existing SPACs and their counsel as projections disclosure has been a significant area of scrutiny by the Commission in the registration statement and proxy statement review process.

We note, however, that the requirement under Item 1609 to add disclosure as to management’s and/or the board’s current views may obligate additional disclosure beyond what has been typical market practice.  In particular, projections disclosure in a registration statement or proxy statement is often made in the context of a historical lookback to the projections in place at the time the board of directors of the SPAC assessed whether to enter into a de-SPAC transaction with the target company.  These projections typically are not updated with newer data during the pendency of the transaction since the purpose of such disclosure is to inform investors of the board’s rationale for approving the transaction.  Proposed Item 1609 does not explicitly require the updating of projections, but it does require the parties to disclose whether the included projections reflect the view of the SPAC and the target company as of the date of filing.  Moreover, the potential to provide revised projections, coupled with obligations to disclose management’s and board’s continuing views, may prove challenging disclosure to be made between the signing of a business combination agreement and the filing of a registration statement or proxy statement and during the review period for such registration statement or proxy statement.

Status of SPACs under the Investment Company Act of 1940

Section 3(a)(1)(A) of the Investment Company Act defines an “investment company” as any issuer that is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities.  Given that SPACs, prior to a de-SPAC transaction, are not engaged in any meaningful business other than investing its IPO proceeds held in trust, there is a potential for SPACs to be treated as an “investment company.”

In recognition of the fact that SPACs are generally formed to identify, acquire, and operate a target company through a business combination and not with a stated purpose of being an investment company, the Proposal seeks to clarify SPAC status by providing a safe harbor under Section 3(a)(1)(A) of the Investment Company Act (the “Subjective Test Safe Harbor”).[24]  To qualify under the Subjective Test Safe Harbor:

• SPAC Assets. The assets held by a SPAC must consist solely of government securities, government money market funds, and cash items prior to the completion of the de-SPAC transaction.  The Proposal further notes that (i) all proceeds obtained by the SPAC, including those from any SPAC offering, cash infusion from the sponsor, or any interest, dividend, distribution, or other such return derived from the SPAC’s underlying assets, would need to be held in these asset classes, and (ii) SPACs may not acquire interests in an operating company prior to a de-SPAC transaction.
• SPAC Asset Management. Assets listed above may not at any time be acquired or disposed of for the primary purpose of recognizing gains or decreasing losses resulting from market value changes.  The Proposal notes that this is not intended to prohibit SPACs the flexibility to hold their assets consistent with cash management practices.
• De-SPAC Transaction. The SPAC must seek to complete a single de-SPAC transaction[25] where the surviving public company, either directly or through a primarily controlled company,[26] will be primarily engaged in the business of the target company or companies, which is not that of an investment company.
• Board Action. The board of directors of the SPAC would need to adopt a resolution evidencing that the company is primarily engaged in the business of seeking to complete a single de-SPAC transaction.
• Primary Engagement. Activities of the SPAC’s officers, directors, and employees, its public representations of policies, and its historical development must evidence that the SPAC is primarily engaged in completing a de-SPAC transaction.  Other than a requirement that the board of directors of the SPAC adopt a resolution, the Proposal does not provide examples of other definitive actions as to how SPACs may properly evidence compliance, instead noting that a SPAC may not hold itself out as being primarily engaged in the business of investing, reinvesting, or trading in securities.
• Exchange Listing. The SPAC must have at least one class of securities listed for trading on a national securities exchange “by meeting initial listing standards just as any company seeking an exchange listing would have to do.”
• De-SPAC Transaction Time Limits. The SPAC would have 18 months from its IPO to enter into a de-SPAC transaction and no more than 24 months from its IPO to complete its de-SPAC transaction.

While most SPACs should not have an issue with qualifying for the Subjective Test Safe Harbor, the proposed time limits may prove problematic for existing SPACs seeking amendments to their governing documents to extend the time necessary to complete a de-SPAC transaction.  Typically, these amendments are either sought when (i) a SPAC has a definitive transaction agreement entered into and needs some time to consummate the transaction, and/or (ii) a sponsor is willing to compensate existing securities holders by contributing additional amounts into a trust that is disbursable to shareholders upon lapse of the extension.  Moreover, stock exchange rules require a SPAC to complete a de-SPAC transaction within 36 months from its IPO, and with its truncated time periods, the Proposal would significantly constrain some of this timing flexibility for SPACs that would like to comply with the Subjective Test Safe Harbor.

Admittedly, a SPAC does not need to comply with the Subjective Test Safe Harbor, but the alternative would be to make an assessment that the SPAC does not qualify as an investment company, notwithstanding its non-compliance with the time limits in the Subjective Test Safe Harbor, or to register as an “investment company,” and with it, comply with the regulatory regime of the Investment Company Act on top of seeking the consummation of a de-SPAC transaction.

Conclusions

As noted by Chair Gensler, much of the Proposal seeks to impose traditional IPO concepts and regulations on the SPAC IPO and de-SPAC transaction process, as well as codify existing Commission guidance and practice.

That said, there are some notable deviations and provisions in the Proposal that, if implemented, could significantly impact the SPAC marketplace.  We note that certain provisions in the Proposal may have consequences for the future of SPACs as an alternative vehicle to traditional IPOs.

In particular, proposals regarding underwriter liability in the de-SPAC transaction context, unavailability of the PSLRA, and liquidation timeframes contemplated by the proposed new Investment Company Act safe harbor, all would curtail SPAC flexibility and/or increase the complexity and cost of completing a de-SPAC transaction.

We continue to monitor further developments and will keep you apprised of the latest news regarding this Proposal.

Commissioner Statements

For the published statements of the Commissioners, please see the following links:

Chair Gary Gensler

Commissioner Allison Herren Lee

Commissioner Caroline A. Crenshaw

Commissioner Hester M. Peirce (Dissent)

Comment Period

The comment period ends on the later of 30 days after publication in the Federal Register or May 31, 2022 (which is 60 days from the date of the Proposal).  Comments may be submitted: (1) using the Commission’s comment form at https://www.sec.gov/rules/submitcomments.htm; (2) via e-mail to [email protected] (with “File Number S7‑13‑22” on the subject line); or (3) via mail to Vanessa A. Countryman, Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.  All submissions should refer to File Number S7‑13‑22.

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  [1]  U.S. Securities and Exchange Commission, Proposed Rule (RIN 3235-AM90), Special Purpose Acquisition Companies, Shell Companies, and Projections (March 30, 2022), available at https://www.sec.gov/rules/proposed/2022/33-11048.pdf (hereinafter, the “Proposed Rule”).

  [2]  See Gibson, Dunn & Crutcher LLP, SEC Staff Issues Cautionary Guidance Related to Business Combinations with SPACs (April 7, 2021), available at https://www.gibsondunn.com/sec-staff-issues-cautionary-guidance-related-to-business-combinations-with-spacs/ (addressing the statement of the staff of the Commission’s Division of Corporation Finance about certain accounting, financial reporting, and governance issues related to SPACs and the combined company following a de-SPAC transaction (see Division of Corporation Finance, Announcement: Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies (March 31, 2021), available at https://www.sec.gov/corpfin/announcement/staff-statement-spac-2021-03-31), see also Gibson, Dunn & Crutcher LLP, Back to the Future: SEC Chair Announces Spring 2021 Reg Flex Agenda (June 21, 2021), available at https://www.gibsondunn.com/back-to-the-future-sec-chair-announces-spring-2021-reg-flex-agenda/ (discussing the inclusion of SPACs in Chair Gensler’s Spring 2021 Unified Agenda of Regulatory and Deregulatory Actions announced on June 11, 2021 (see U.S. Securities and Exchange Commission, Press Release (2021-99), SEC Announces Annual Regulatory Agenda (June 11, 2021), available at https://www.sec.gov/news/press-release/2021-99), and Gibson, Dunn & Crutcher LLP, SEC Fires Shot Across the Bow of SPACs (July 14, 2021), available at https://www.gibsondunn.com/sec-fires-shot-across-the-bow-of-spacs/ (discussing a partially settled Commission enforcement action against a SPAC related to purported misstatements on the registration statement concerning the target’s technology and business risks).

  [3]  U.S. Securities and Exchange Commission, Press Release (2022-56), SEC Proposes Rules to Enhance Disclosure and Investor Protection Relating to Special Purpose Acquisition Companies, Shell Companies, and Projections (March 30, 2022), available at https://www.sec.gov/news/press-release/2022-56.

  [4]  Id.

  [5]  Proposed Rule, p. 195 (citing on fn. 432 Michael Levitt, Valerie Jacob, Sebastian Fain, Pamela Marcogliese, Paul Tiger, & Andrea Basham, 2021 De-SPAC Debrief, FRESHFIELDS (Jan. 24, 2022), available at https://blog.freshfields.us/post/102hgzy/2021-de-spacdebrief, and on fn. 433 Tingting Liu, The Wealth Effects of Fairness Opinions in Takeovers, 53 FIN. REV. 533 (2018)).

  [6]  The term “promoter” is defined in Securities Act Rule 405 and Exchange Act Rule 12b-2.

  [7]  Proposed Item 1604(c)(1) suggests the following potential sources: “the amount of compensation paid or to be paid to the SPAC sponsor, the terms of outstanding warrants and convertible securities, and underwriting and other fees.”  Proposed Rule, p. 336.

  [8]  Commission Hester M. Peirce, Statement:  Damning and Deeming: Dissenting Statement on Shell Companies, Projections, and SPACs Proposal (March 30, 2022), available at https://www.sec.gov/news/statement/peirce-statement-spac-proposal-033022.

  [9]  Under Section 6(a) of the Securities Act, each “issuer” must sign a Securities Act registration statement.  The Securities Act broadly defines the term “issuer” to include every person who issues or proposes to issue any securities.

  [10]  Proposed Rule, p. 195.

  [11]  17 CFR 229.10(f)(1).

  [12]  Proposed Rule, p. 302 and fn. 575 (explaining that the “estimate is based, in part, on [the Commission’s] estimate of the number of de-SPAC transactions in which the SPAC is the legal acquirer”).

  [13]  See Jamie Payne, Market Trends: De-SPAC Transactions, LexisNexis (March 5, 2022), available at https://www.lexisnexis.com/community/insights/legal/practical-guidance-journal/b/pa/posts/market-trends-de-spac-transactions (“The average size of de-SPAC transactions remained consistent between $2.2 billion and $2.8 billion in 2021 until a significant decline to $1.4 billion in the fourth quarter.  The largest SPAC merger announced and closed in 2021, between Altimeter Growth Corp. and Grab Holdings Inc., was valued at $39.6 billion.”).

  [14]  The term “penny stock” is defined in 17 CFR 240.3a51-1.

  [15]  Section 11 of the Securities Act imposes on underwriters, among other parties identified in Section 11(a), civil liability for any part of the registration statement, at effectiveness, which contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, to any person acquiring such security.  Further, Section 12(a)(2) imposes liability upon anyone, including underwriters, who offers or sells a security, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading, to any person purchasing such security from them.

  [16]  The Proposal further notes that “Federal courts and the Commission may find that other parties involved in securities distributions, including other parties that perform activities necessary to the successful completion of de-SPAC transactions, are ‘statutory underwriters’ within the definition of underwriter in Section 2(a)(11).”  Proposed Rule, p. 98.

  [17]  Although the Securities Act does not expressly require an underwriter to conduct a due diligence investigation, the Proposal reiterates the Commission’s long-standing view that underwriters nonetheless have an affirmative obligation to conduct reasonable due diligence.  Proposed Rule, fn. 184 (citing In re Charles E. Bailey & Co., 35 S.E.C. 33, at 41 (Mar. 25, 1953) (“[An underwriter] owe[s] a duty to the investing public to exercise a degree of care reasonable under the circumstances of th[e] offering to assure the substantial accuracy of representations made in the prospectus and other sales literature.”); In re Brown, Barton & Engel, 41 SEC 59, at 64 (June 8, 1962) (“[I]n undertaking a distribution . . . [the underwriter] had a responsibility to make a reasonable investigation to assure [itself] that there was a basis for the representations they made and that a fair picture, including adverse as well as favorable factors, was presented to investors.”); In the Matter of the Richmond Corp., infra note 185 (“It is a well-established practice, and a standard of the business, for underwriters to exercise diligence and care in examining into an issuer’s business and the accuracy and adequacy of the information contained in the registration statement . . .  The underwriter who does not make a reasonable investigation is derelict in his responsibilities to deal fairly with the investing public.”)).

  [18]  Proposed Rule, p. 104, citing SEC v. M & A W., Inc., 538 F.3d 1043, 1053 (9th Cir. 2008) (“[W]e are informed by the purpose of registration, which is ‘to protect investors by promoting full disclosure of information thought necessary to informed investment decisions.’  The express purpose of the reverse mergers at issue in this case was to transform a private corporation into a corporation selling stock shares to the public, without making the extensive public disclosures required in an initial offering.  Thus, the investing public had relatively little information about the former private corporation.  In such transactions, the investor protections provided by registration requirements are especially important.”).

  [19]  Id., p. 343.

  [20]  Id., p. 112 (citing the staff guidance under the Division of Corporation Finance’s Financial Reporting Manual).

  [21]  Id., p. 112 (citing the staff guidance under the Division of Corporation Finance’s Financial Reporting Manual at Section 4110.5).

  [22]  Id., p. 124.

  [23]  For example, the Commission cites to recent enforcement actions against SPACs, alleging the use of baseless or unsupported projections about future revenues and the use of materially misleading underlying financial projections.  See, e.g., In the Matter of Momentus, Inc., et al., Exch. Act Rel. No. 34-92391 (July 13, 2021); SEC vs. Hurgin, et al., Case No. 1:19-cv05705 (S.D.N.Y., filed June 18, 2019); In the Matter of Benjamin H. Gordon, Exch. Act Rel. No. 34-86164 (June 20, 2019); and SEC vs. Milton, Case No. 1:21-cv-6445 (S.D.N.Y., filed July 29, 2021).

  [24]  Proposed Rule 3a-10.  The Proposal does not provide a safe harbor under Section 3(a)(1)(C) of the Investment Company Act, with respect to issuers engaged or proposing to engage in certain securities activities.

  [25]  The de-SPAC transaction may involve the combination of multiple target companies, so long as intentions of the SPAC are disclosed and so long as closing with respect to all target companies occurs contemporaneously and within the required time limits (as described below).  Proposed Rule, p. 145.

  [26]  “Primary Control Company” means an issuer that (i) “[i]s controlled within the meaning of Section 2(a)(9) of the Investment Company Act by the surviving company following a de-SPAC transaction with a degree of control that is greater than that of any other person” and (ii) “is not an investment company.”  Proposed Rule 3a-10(b)(2).

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Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Capital Markets, Mergers and Acquisitions, Securities Enforcement, or Securities Regulation and Corporate Governance practice groups, or the following authors:

Evan M. D’Amico – Washington, D.C. (+1 202-887-3613, [email protected])
Gerry Spedale – Houston (+1 346-718-6888, [email protected])
Lori Zyskowski – New York (+1 212-351-2309, [email protected])
Julia Lapitskaya – New York (+1 212-351-2354, [email protected])
Gregory Merz – Washington, D.C. (+1 202-887-3637, [email protected])
Rodrigo Surcan – New York (+1 212-351-5329, [email protected])
James O. Springer – Washington, D.C. (+1 202-887-3516, [email protected])

Please also feel free to contact the following practice group leaders:

Mergers and Acquisitions Group:
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Capital Markets Group:
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Securities Regulation and Corporate Governance Group:
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Thomas J. Kim – Washington, D.C. (+1 202-887-3550, [email protected])
Mike Titera – Orange County (+1 949-451-4365, [email protected])
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The UK’s competition watchdog has prohibited a proposed merger that the European Commission had cleared little more than one month ago. On the same day, the US Department of Justice announced that it considered the deal problematic. These developments highlight the growing uncertainties that companies now face in getting global deals through and underline the need for careful, strategic planning to manage competition law risks.

Divergence is real and it can hurt

The assumption that UK competition laws and policies would largely continue to match those of the EU has been a key underpinning of the advice most practitioners have given since Brexit. Whilst still valid in most areas as a matter of law, the approach adopted by the UK Competition and Markets Authority (CMA) has, in fact, been diverging from that of the European Commission (EC) for some time in the field of merger control.

This spilt out when the CMA publicly expressed skepticism of the EC’s Google/Fitbit clearance in early 2021. However, many commentators argued that this divergence was limited to digital markets and would not affect more traditional industries. The CMA would, it was asserted, do everything it could to coordinate and adopt an approach consistent with the EC particularly in deals in which neither party was a UK company.

That assumption can no longer be made.

Earlier this week, parties to a proposed merger abandoned their deal, which was already cleared by the EC, following a prohibition by the CMA. The CMA concluded that that the divestiture package that had been accepted by the EC was not clear-cut enough to be effective.

The blocked Cargotec/Konecranes merger serves as a stark reminder to companies that following the UK’s exit from the EU’s one stop shop merger regime, divergence in approach between the two authorities is real, and may lead to deals literally falling apart.

In this note, we consider the implications for parties facing parallel merger review before the EU and UK authorities and offer some practical tips to achieve the best outcome. It is clear that parties to transactions facing dual review in the EU and the UK need to pay close attention to the practice of both authorities, particularly in relation to remedies. Timing and cooperative engagement are paramount.

A brief look at the present case

Cargotec and Konecranes are Finnish companies offering container handling equipment and services to port terminals and industrial customers worldwide. The companies announced their proposed US$5 billion merger in October 2020. The deal was notified in a number of jurisdictions, including the UK, EU, U.S., Australia, New Zealand, Singapore and Israel.

When the deal ran into trouble, the parties proposed a divestment remedy which involved carving out asset packages from within each of their existing businesses to be sold as a new combined business.

In February, the EC announced its approval of the deal subject to the divestiture remedy. The EC’s Executive Vice-President Margrethe Vestager said “[f]ollowing the remedies offered by the two companies, customers in Europe will continue to have sufficient choice of port equipment and will continue benefitting from competitive prices and a great choice of technology”.

Vestager doubled down on the justification for the EC’s clearance of the deal in a speech on 25 March 2022. She asserted that the EC had made sure that the remedies addressed the EC’s concerns through the divestiture of “viable standalone businesses”.

Four days later the CMA announced that it would block the merger. The CMA was not satisfied with the parties’ proposed remedies, stating that the asset packages “would not enable whoever bought them to compete as strongly as the merging businesses do at present” and that the process of carving out the assets and knitting them together “would be complex and risky”.

Two days from then, Vestager returned to the fray, reiterating her message that the EC had made sure that the proposed remedies addressed its concerns and that the market had given positive feedback on them.

A sign of things to come

We should be cautious in drawing too firm a conclusion from one case. The US, EU and UK authorities regularly communicate with one another and have a strong record of coordinating their actions.

But the CMA’s prohibition of the Cargotec/Konecranes merger – and the EC’s very public support for the stand it took – suggests greater challenges lie ahead for parallel track cases, in particular when it comes to remedies: what is “clear-cut” for one authority appears no longer to be clear-cut for another. The CMA’s public criticism of the EC’s Google/Fitbit remedies provides support for the latter.

On the other hand, in September last year the CMA unconditionally cleared the Meta/Kustomer merger in Phase I, whilst the deal went to Phase II in Europe (it was ultimately cleared with remedies in January 2022 by the EC).

Global considerations

There was a broader global dimension to Cargotec/Konecranes, beyond the UK-EU divergence. In particular, on the same day as the CMA’s prohibition, the U.S. Department of Justice announced that the deal would have led to an “illegal consolidation” and that it had informed the parties that the proposed remedy was insufficient.

The ACCC has discontinued its review following the abandonment of the transaction, but it noted in its press release that Australian customers had expressed strong concerns on the proposed remedy.

These elements underline the need for merging parties to factor in potentially different approaches across multiple jurisdictions, and the possibility that a tougher approach by one or several authorities may jeopardise the approval prospects of a deal that is cleared in other jurisdictions.

How do you get your deal through unscathed?

There are four main things that companies need to bear in mind:

• Should the UK be a condition precedent: the UK merger regime is voluntary and is non-suspensory. As a result many companies opt not to have UK clearance as a condition precedent. Whilst this often makes sense, much greater thought than in the past needs to go into the question. Cargotec/Konecranes not only underlines that the CMA is now one of the toughest regulators in the world but also that it is willing to go its own way on remedies, even in deals between two non-UK companies.
• Timing: Having a robust, well thought out strategy on the timing of deal announcement and engagement with the authorities is critical. The merger review timetables of the EC and CMA do not line up – the CMA’s review period is longer than that of the EC. Parties may want to stagger their submissions so that the CMA and EC are reviewing remedy packages at the same time. There is also a disconnect between the stage at which each authority may be willing to accept large, upfront remedy packages. The EC does, in certain circumstances, accept these in Phase 1, whereas the CMA typically requires an in-depth investigation to get comfortable. On the face of it, it appears that Cargotec and Konecranes may have simply run out of time to get the CMA comfortable with a revised divestiture package.
• Defining the right remedy package: In cases where remedies are on the cards, plan them early, discuss them early with the authority and make them as clear-cut as commercially possible. Cargotec/Konecranes confirms that it is difficult to persuade authorities to accept mix-and-match remedies. Parties should avoid remedies that could be difficult to implement and must take into account the remedy preference of each authority (a one-size-fits-all remedy package is no longer always an option).
• Facilitate cooperation between agencies: It is clear that cooperation between the EC and the CMA is not at its strongest. That means that the parties and their advisors will need to work much more closely and proactively with both authorities; “leave it to the authorities to sort things out between themselves” is no longer a viable strategy (if it ever was!).

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The following Gibson Dunn lawyers prepared this client alert: Ali Nikpay and Mairi McMartin.

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, any member of the firm’s Antitrust and Competition practice group, or the following:

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

Attila Borsos – Partner, Antitrust & Competition Group, Brussels (+32 2 554 72 11, [email protected])

Deirdre Taylor – Partner, Antitrust & Competition Group, London (+44 20 7071 4274, [email protected])

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

Nicholas Banasevic – Managing Director, Antitrust & Competition Group, Brussels (+32 2 554 72 40, [email protected])

Jessica Staples – Of Counsel, Antitrust & Competition Group, London (+44 (0) 20 7071 4155, [email protected])

Mairi McMartin – Associate, Antitrust & Competition Group, Brussels (+32 2 554 72 29, [email protected])

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

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

Please join our distinguished panelists for a recorded discussion about the U.S. Sentencing Guidelines and how they apply in corporate enforcement actions. They discuss issues arising in white collar matters and strategies that can impact the calculation of the Sentencing Guidelines fine range, including gain from the offense, corporate recidivism, and cooperation, among other issues. Another area of focus is how the Guidelines address corporate compliance programs and how organizations can position themselves for maximum credit.

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Decided March 31, 2022

Badgerow v. Walters, No. 20-1143

Today, the Supreme Court held 8-1 that federal jurisdiction to confirm or vacate an arbitral award under Sections 9 and 10 of the Federal Arbitration Act must exist independent of the underlying controversy—that is, courts cannot “look through” to the underlying dispute to establish federal subject-matter jurisdiction.

Background: Under the Federal Arbitration Act (FAA), a party to an arbitration agreement may ask a federal court to confirm or vacate an arbitral award. 9 U.S.C. §§ 9, 10. A Louisiana resident initiated an arbitration against her Louisiana employer, alleging unlawful termination under federal and state law. After the arbitrators dismissed the claims, the plaintiff sued in state court to vacate the arbitral award. The defendant removed the case to federal court based on the underlying federal employment claims and asked the court to confirm the arbitrators’ decision. The Fifth Circuit held that the federal court had jurisdiction by “looking through” the plaintiff’s petition to the underlying federal employment claims.

Issue: Do federal courts have subject-matter jurisdiction to confirm or vacate an arbitral award under Sections 9 and 10 of the Federal Arbitration Act when the only basis for jurisdiction is that the underlying dispute involved a federal question?

Court’s Holding: No. Federal jurisdiction to confirm or vacate an arbitration award must exist independent of the underlying controversy, and it is not sufficient for federal jurisdiction that the underlying claim the parties arbitrated arose under federal law.

“Congress has made its call. We will not impose uniformity on the statute’s non-uniform jurisdictional rules.”

Justice Kagan, writing for the Court

What It Means:

• Today’s decision resolves a circuit split over whether the Court’s decision in Vaden v. Discover Bank, 556 U.S. 49 (2009)—which held that federal courts should look through to the underlying claims to determine whether they have jurisdiction over a petition to compel arbitration under FAA Section 4—applies to petitions to confirm or vacate arbitral awards under FAA Sections 9 and 10.
• The Court ruled that Vaden’s “look through” approach was based on textual indicia unique to Section 4, which Congress did not include in Sections 9 and 10. Therefore, the Court declined to extend Vaden to Sections 9 and 10.
• The Court’s holding that the “look through” approach is limited to petitions under Section 4 means that federal courts will lack jurisdiction over many petitions under Sections 9 and 10. In practice, unless there is a federal question on the face of the petition, or complete diversity between the parties and the amount of the arbitral award exceeds $75,000, federal courts are not likely to have jurisdiction over petitions to confirm or vacate an arbitral award.
• The Court’s decision does not extend to the enforcement of international arbitration awards under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, because the FAA independently confers federal jurisdiction over those cases.
• The decision demonstrates the Court’s commitment to applying statutes as written. The Court refused to allow policy concerns to override the “evident congressional choice” to “respect the capacity of state courts to properly enforce arbitral awards.” In contrast, Justice Breyer, writing in dissent, acknowledged that he was looking beyond “the statute’s literal words” to its “purposes” and “the likely consequences” flowing from a non-uniform approach to assessing jurisdiction over petitions filed under the FAA.

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The Court’s opinion is available here.

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

Appellate and Constitutional Law Practice

Allyson N. Ho +1 214.698.3233 [email protected]	Mark A. Perry +1 202.887.3667 [email protected]	Lucas C. Townsend +1 202.887.3731 [email protected]
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Related Practice: Class Actions

Christopher Chorba +1 213.229.7396 [email protected]

Kahn A. Scolnick +1 213.229.7656 [email protected]

Related Practice: Labor and Employment

Jason C. Schwartz +1 202.955.8242 [email protected]

Katherine V.A. Smith +1 213.229.7107 [email protected]

Related Practice: Judgment and Arbitral Award Enforcement

Matthew D. McGill +1 202.887.3680 [email protected]

Robert L. Weigel +1 212.351.3845 [email protected]

Related Practice: International Arbitration

Rahim Moloo +1 212.351.2413 [email protected]

Hong Kong partner Sébastien Evrard and associates Felicia Chen and Hayley Smith are the authors of “Abuses of Dominance Involving Personal Information in China” [PDF] published by Competition Policy International on March 31, 2022.

New York partners Danielle Moss and Harris Mufson and Washington, D.C. associate Emily Lamm are the authors of “Medley Of State AI Laws Pose Employer Compliance Hurdles” [PDF] published by Law360 Employment Authority on March 30, 2022.

Hong Kong partners Sébastien Evrard and Connell O’Neill and associates Hayley Smith and Nick Hay are the authors of “The Intersection of Competition Law and Data Privacy in APAC” [PDF] published by Global Competition Review in its Asia-Pacific Antitrust Review 2022 in March 2022.

Orange County partner Thomas Manakides and associate Joseph Edmonds are the authors of “Calif. Cities’ Drilling Bans May Face Pushback In State Courts” [PDF] published by Law360 on March 28, 2022.