BlackRock, Vanguard and State Street Global Advisors (“State Street”) recently issued their voting policy updates for 2022, as well as guidance about their 2022 priorities for their portfolio companies. On January 18, 2022, BlackRock’s CEO issued his annual “Letter to CEOs” (available here), following closely on the heels of State Street’s CEO, who issued his annual letter to public company directors (available here) on January 12.

These pronouncements from the “Big Three” asset managers reflect a number of common themes, including an emphasis on climate and the transition to a Net Zero economy, diversity at the board level and throughout the workforce, and effective human capital management. Links to the BlackRock and Vanguard voting policies for 2022 are below. State Street’s voting policy updates span several documents that provide guidance on areas that State Street views as focal points for the coming year. Links to these documents are also below.

BlackRock Proxy Voting Guidelines for U.S. Securities (effective as of January 2022)

Vanguard Proxy Voting Policy for U.S. Companies (effective as of March 1, 2022)

State Street

1. BlackRock

2022 Letter to CEOs

In his 2022 letter titled “The Power of Capitalism,” BlackRock CEO Larry Fink encourages companies to focus on their purpose and put that purpose at the foundation of their relationships with stakeholders, in order to be valued by their stakeholders and deliver long-term value for their shareholders. The letter urges companies to think about whether they are creating an environment that helps their employee-stakeholders navigate the new world of work that has emerged from the pandemic. The letter observes that most stakeholders now expect companies to play a role in moving toward a Net Zero global economy and discusses BlackRock’s approach to climate and sustainability. This is a priority area for BlackRock because of its need, as a capitalist and fiduciary to its clients, to understand how companies are adjusting their business to massive changes in the economy. Mr. Fink also emphasizes that divesting from entire sectors, or simply passing carbon-intensive assets from public to private markets, will not move the world to Net Zero. BlackRock does not pursue divestment from oil and gas companies as a policy, but believes that action by “foresighted companies” in a variety of carbon-intensive industries is a critical part of the transition to a greener economy. Government participation on the policy, regulatory and disclosure fronts is also critical because, Mr. Fink notes, “businesses can’t do this alone, and they cannot be the climate police.”

The letter concludes with a reminder that BlackRock has built a stewardship team so it can understand companies’ progress throughout the year, and not just during proxy season. BlackRock previously announced an initiative to give more of its clients the option to vote their own holdings, rather than BlackRock casting votes on their behalf. The letter notes that this option is now available to certain institutional clients, including pension funds that support 60 million people. The letter also commits to expanding that universe as BlackRock is committed to a future where every investor, including individual investors, have the option to participate in the proxy voting process.

2022 BlackRock Voting Policy Updates

30% Target on Board Diversity

BlackRock believes boards should aspire to 30% diversity, and encourages companies to have at least two directors who identify as female and at least one who identifies as being from an “underrepresented group.” The definition of “underrepresented group” is broad and includes individuals who identify as racial or ethnic minorities, LGBTQ+, underrepresented based on national, Indigenous, religious or cultural identity, individuals with disabilities and veterans. Although the wording of the policy is aspirational, insufficient board diversity was a top reason BlackRock opposed the election of directors in 2021.

Board Diversity Disclosure

BlackRock updated its expectations for disclosure about board diversity. It asks that companies disclose how the diversity characteristics of the board, in aggregate, are aligned with a company’s long-term strategy and business model, and whether a diverse slate of nominees is considered for all available board seats.

Votes on Compensation Committee Members

BlackRock appears to be strengthening its position on votes for compensation committee members where there is a lack of alignment between pay and performance. In that situation, BlackRock will vote “against” the say-on-pay proposal and relevant compensation committee members (rather than simply “considering” negative votes for committee members).

Sustainability Reporting

BlackRock will continue to ask that companies report in accordance with the Task Force on Climate-related Financial Disclosure (“TCFD”) framework. In recognition of continuing advances in sustainability reporting standards, the 2022 voting guidelines recognize that in addition to TCFD, many companies report using industry-specific metrics other than those developed by the Sustainability Accounting Standards Board (“SASB”). For those companies, BlackRock asks that they highlight metrics that are industry- or company- specific. It also recommends that companies disclose any multinational standards they have adopted, any industry initiatives in which they participate, any peer group benchmarking undertaken, and any assurance processes to help investors understand their approach to sustainable and responsible business conduct.

Climate Risk

BlackRock continues to ask companies to disclose Net Zero-aligned business plans that are consistent with their business model and sector. For 2022, it is encouraging companies to: (1) demonstrate that their plans are resilient under likely decarbonization pathways and the global aspiration to limit warming to 1.5°C; and (2) disclose how considerations related to having a reliable energy supply and a “just transition” (that protects the most vulnerable from energy price shocks and economic dislocation) affect their plans. BlackRock also updated its voting policies to reflect its existing approach of signaling concerns about a company’s plans or disclosures in its votes on directors, particularly at companies facing material climate risks. In determining how to vote, it will continue to assess whether a company’s disclosures are aligned with the TCFD and provide short-, medium-, and long-term reduction targets for Scope 1 and 2 emissions.

ESG Performance Metrics

BlackRock does not have a position on the use of ESG performance metrics, but it believes that where companies choose to use them, they should be relevant to the company’s business and strategy, clearly articulated, and appropriately rigorous, like other financial and non-financial performance metrics.

Votes on Committee Members at Controlled Companies

BlackRock may vote “against,” or “withhold” votes from, directors serving on “key” committees (audit, compensation, nominating/governance), that it does not consider to be independent, including at controlled companies. Previously, this policy was limited to votes on insiders or affiliates serving on the audit committee, and did not extend to other committees.

2. Vanguard

Vanguard’s voting policy updates address several of the same areas as BlackRock’s, including oversight of climate risk, and board diversity and related disclosures. The introduction to the voting policies also contains more explicit language emphasizing that proposals often require fact-intensive analyses based on an expansive set of factors, and that proposals are voted case-by-case at the direction of the boards of individual Vanguard funds.

Climate Risk Oversight “Failures”

Vanguard’s voting policies outline certain situations in which funds will oppose the re-election of directors on “accountability” grounds—that is, “because of governance failings or as a means to escalate other issues that remain unaddressed by a company.” Under Vanguard’s current policies, funds will consider votes “against,” or “withhold” votes from, directors or a committee for governance or material risk oversight failures.

For 2022, Vanguard has updated this policy to clarify that in cases where there is a risk oversight “failure,” funds will generally vote “against,” or “withhold” votes from, the chair of the committee responsible for overseeing a particular material risk (or the lead independent director and board chair, if a risk does not fall under the purview of a specific committee). The policy has also been updated to reflect that it covers material social and environmental risks, including climate change. On the subject of climate change, the updated policy lists factors that funds will consider in evaluating whether board oversight of climate risk is appropriate, including: (1) the materiality of the risk; (2) the effectiveness of disclosures to enable the market to understand and price the risk; (3) whether a company has disclosed business strategies, including reasonable risk mitigation plans in the context of anticipated regulatory requirements and changes in market activity, in line with the Paris Agreement or subsequent agreements; and (4) company specific-context, regulations and expectations. Funds will also consider the board’s overall governance of climate risk and the effectiveness of its independent oversight of this area.

Board Diversity and Qualifications

For 2022, Vanguard has clarified its expectations on disclosure about board diversity and qualifications. The policy states that boards can inform shareholders about the board’s current composition and related strategy by disclosing at least: (1) statements about the board’s intended composition strategy, including expectations for year-over-year progress, from the nominating/governance committee or other relevant directors; (2) policies for promoting progress toward greater board diversity; and (3) current attributes of the board’s composition. The policy states that board diversity disclosure should cover, at a minimum, the genders, races, ethnicities, tenures, skills and experience that are represented on the board. While disclosure about self-identified personal characteristics such as race and ethnicity can be presented at the aggregate or individual level, Vanguard expects to see disclosure about tenure, skills and experience at the individual level.

Under its policy on board “accountability” votes, a lack of progress on board diversity and/or disclosures about board diversity may lead to votes “against,” or “withhold” votes from, the chair of the nominating/governance committee. Vanguard has updated this policy for 2022 to reflect its expectations about the various dimensions of diversity (gender, race, etc.) that should be represented on boards and about companies’ disclosures. The policy includes a reminder that “many boards still have an opportunity to increase diversity across different dimensions,” and that these boards “should demonstrate how they intend to continue making progress.”

Director Overboarding

Vanguard has clarified how its overboarding policy applies to directors who are named executive officers (NEOs). Although Vanguard’s limit of two public company boards remains in place, the policy updates clarify that the two boards could consist of either the NEO’s own board and one outside board, or two outside boards if an NEO does not sit on the board at their own company. Vanguard funds will generally oppose the election of directors who exceed this limit at their outside board(s), but not at the company where they are an NEO.

For other directors, Vanguard’s existing limit of four public company boards is unchanged.

Vanguard funds will also look for companies to have good governance practices on director commitments, including adopting a policy on outside board service and disclosure about how the board oversees the policy.

Unilateral Board Adoption of Exclusive Forum Provisions

Vanguard has updated its voting policy on board “accountability” votes where a company adopts policies limiting shareholder rights. Under this policy, Vanguard funds will generally oppose the election of the independent board chair or lead director, and the members of the nominating/governance committee, in response to unilateral board actions that “meaningfully limit” shareholder rights. For 2022, this policy has been updated to specify that these board actions may include the adoption of an exclusive forum provision without shareholder approval.

Proposals on Virtual and Hybrid Shareholder Meetings

According to Vanguard, data show that virtual meetings can increase shareholder participation and reduce costs. Vanguard funds will consider supporting proposals on virtual meetings if meeting procedures and requirements are disclosed ahead of time, there is a formal process for shareholders to submit questions, real-time video footage is available, shareholders can call into the meeting or send recorded messages, and shareholder rights are not unreasonably curtailed.

3. State Street

In his letter, State Street CEO Cyrus Taraporevala announces that in 2022, State Street’s main focus “will be to support the acceleration of the systemic transformations underway in climate change and the diversity of boards and workforces.” To that end, the letter attaches three guidance documents outlining State Street’s expectations and voting policies for the 2022 proxy season in the areas of climate change and diversity, equity and inclusion. State Street has also published other guidance documents on director overboarding/time commitments and human capital for the 2022 proxy season.

The guidance documents are worth reading in their entirety because they provide detailed information about the practices and disclosures State Street expects to see from its portfolio companies in both 2022 and 2023, and about State Street’s related voting policies. A summary of the key highlights is below.

Corporate Climate Disclosures

General

State Street expects all companies in its portfolio to provide disclosures in accordance with the four pillars of the TCFD framework: governance, strategy, risk management, and metrics and targets. In approaching its disclosure expectations, State Street will begin by engaging with companies. The guidance document includes a list of questions (organized by the four TCFD pillars) that State Street may ask companies as part of its engagement efforts.

For companies that it believes are not making sufficient progress after engagement, State Street will consider taking action through its votes on directors and/or shareholder proposals. Starting in 2022, at S&P 500 companies, State Street may vote against the independent board leader if a company fails to provide sufficient disclosure in accordance with the TCFD framework, including about board oversight of climate-related risks and opportunities, total Scope 1 and Scope 2 greenhouse gas (“GHG”) emissions, and targets for reducing GHG emissions.

Companies in “Carbon-Intensive Sectors”

For several years, State Street has had specific disclosure expectations for companies in “carbon-intensive sectors” (oil and gas, utilities and mining), and the guidance document outlines what State Street expects to see beginning in 2022. Disclosures are expected to address: (1) interim GHG emissions reductions targets to accompany long-term climate ambitions; (2) discussion of the impacts of scenario-planning on strategy and financial planning; (3) use of carbon pricing in capital allocation decisions; and (4) Scope 1, Scope 2 and material categories of Scope 3 emissions.

Climate Change Shareholder Proposals

State Street will evaluate climate-related shareholder proposals on a case-by-case basis, taking into account factors that include the reasonableness of a proposal, alignment with the TCFD framework and SASB standards where relevant, emergent market and industry trends, peer performance, and dialogue with the board, management and other stakeholders. For companies in carbon-intensive sectors, State Street will consider alignment with its disclosure expectations specific to these companies. The guidance also addresses specific factors State Street will consider in assessing climate-related lobbying proposals.

Climate Transition Plan Disclosures

Related to the broader subject of climate disclosures, State Street has also issued guidance specific to disclosures about companies’ climate transition plans. In the guidance, State Street notes that there is no one-size-fits-all approach to reaching Net Zero, and that climate-related risks and opportunities are highly nuanced across and within industries. It plans to continue developing its disclosure expectations over time, including taking into account any disclosures mandated by regulators. In his letter, State Street CEO Cyrus Taraporevala emphasizes that what State Street is seeking from climate transition plans, as a long-term investor, “is not purity but pragmatic clarity around how and why a particular transition plan helps a company make meaningful progress.” Mr. Taraporevala also emphasizes the need to take a big-picture look at whether the climate commitments individual companies make have the effect of reducing climate impacts at the aggregate level. In this regard, he observes that so-called “brown-spinning” (public companies selling off their highest-emitting assets to private equity or other market participants), “reduces disclosure, shields polluters, and allows the publicly-traded company to appear more ‘green,’ without any overall reduction in the level of emissions on the planet.” State Street recognizes that in the near term, additional investments in light fossil fuels may be necessary to propel the transition to Net Zero.

In light of these considerations, State Street intends its guidance document on climate transition plans as a “first step” to provide transparency about the core criteria State Street expects companies to address in developing their plans. These criteria are organized into ten categories that generally align with those found in two external frameworks: the Institutional Investors Group on Climate Change (IIGCC) Net Zero Investment Framework and Climate Action 100+ Net-Zero Company Benchmark. The criteria include decarbonization strategy, capital allocation, climate governance, climate policy and stakeholder engagement.

As a companion to its 2022 policy on holding independent board leaders accountable for climate disclosures (discussed above), this year, State Street plans to launch an engagement campaign on climate transition plan disclosure targeted at “significant emitters in carbon-intensive sectors.” Starting in 2023, it will hold directors at these companies accountable if their company fails to show adequate progress in meeting its climate transition disclosure expectations.

Diversity Disclosures

State Street’s guidance document lists five topics it expects all of its portfolio companies to address in their diversity disclosures:

Board oversight—How the board oversees the company’s diversity, equity and inclusion efforts, including the potential impacts of products and services on diverse communities;
Strategy—The company’s timebound and specific diversity goals (related to gender, race and ethnicity at a minimum), the policies and programs in place to meet these goals, and how they are measured, managed and progressing;
Goals—Same as Strategy.
Metrics—Measures of the diversity of the company’s global workforce and board. For employees, this should include diversity by gender, race and ethnicity (at a minimum) where permitted by law, broken down by industry-relevant employment categories or seniority levels, for all full-time employees. In the U.S., companies are expected to use the disclosure framework from the EEO-1 at a minimum. For the board, disclosures should be provided by gender, race and ethnicity (at a minimum), and can be on an aggregate or individual level; and
Board diversity—Efforts to achieve diversity at the board level, including how the nominating/governance committee ensures diverse candidates are considered as part of the recruitment process.

State Street also encourages companies to consider providing disclosures about other dimensions of diversity (LGBTQ+, disabilities, etc.), as it views these attributes as furthering the overarching goal of contributing to the diversity of thought on boards and in the workforce.

Diversity and Proxy Voting

State Street will consider disclosures about board diversity in deciding how to vote on directors, as follows:

Racial/Ethnic Diversity – S&P 500 Companies

In 2022, State Street will vote “against,” or “withhold” votes from:

The chair of the nominating/ governance committee if the company does not disclose the racial and ethnic composition of its board, either at the aggregate or individual level;
The chair of the nominating/ governance committee if the company does not have at least one director from “an underrepresented racial or ethnic community”; and
The chair of the compensation committee, if the company does not disclose its EEO-1 report, with acceptable disclosure including the original report, or the exact content of the report translated into custom graphics.

Gender Diversity

State Street may vote “against,” or “withhold” votes from, the chair of the nominating/governance committee:

Beginning in 2022, for companies in all markets, if there is not at least one female director on the board; and
Beginning in 2023, at Russell 3000 companies, if the board does not have at least 30% female directors. State Street may waive this policy if a company engages with it and provides a specific, timebound plan for reaching 30%.

If a company fails to meet the gender diversity expectations for three consecutive years, State Street may vote against all incumbent nominating/governance committee members.

The guidance also outlines State Street’s approach to voting on diversity-related shareholder proposals, including specific criteria relating to proposals seeking reporting on diversity, “pay gap” proposals, and proposals seeking racial equity audits.

State Street notes that its voting policies currently focus on increasing board diversity, but that in coming years it intends to shift its focus to the workforce and executive levels. Related to the subject of workforce diversity, the guidance previews ten recommended areas of focus for boards in overseeing racial and ethnic diversity. These are addressed in more detail in a publication issued by State Street in partnership with Russell Reynolds and the Ford Foundation.

Director Overboarding

For 2022, State Street is moving toward an approach that relies more heavily on nominating/governance committee oversight (and enhanced disclosures) about whether directors have enough time to fulfill their commitments. The updated approach is designed to ensure that nominating/governance committees are evaluating directors’ time commitments, regularly assessing director effectiveness, and providing disclosure about their policies and efforts. State Street cites two factors as the key drivers of these updates: its own research showing that boards with overcommitted directors have been slower to adopt leading governance practices and provide robust shareholder rights, and concerns about “tokenism” (nominating already-overcommitted diverse directors) and the need to broaden the candidate pools of diverse directors. The policy updates also address service on SPAC boards.

As a result of the policy updates, beginning in March 2022, State Street will apply the following overboarding limits to directors:

For board chairs or lead directors, three public company boards; and
Other director nominees who are not public company NEOs, four public company boards.

State Street may consider waiving these limits and support a director’s election if the company discloses its policy on outside board seats. This policy (or the related disclosure) must include:

A numerical limit on public company board seats that does not exceed State Street policies by more than one;
Consideration of public company board leadership positions;
An affirmation that all directors are currently in compliance with the policy; and
A description of the nominating/governance committee’s annual process for review outside board commitments.

This waiver policy will not apply to public company NEOs, who remain subject to State Street’s existing limit of two public company boards.

In calculating outside boards, State Street will not count mutual fund boards or SPAC boards, but it expects the nominating/governance committee to consider these boards in evaluating directors’ time commitments.

Human Capital Management (HCM) Disclosures and Practices

State Street’s guidance document lists the five topics it expects companies to address in their HCM disclosures: (1) board oversight; (2) strategy (specifically, how a company’s approach to HCM advances its overall long-term business strategy); (3) compensation, and how it helps to attract and retain employees and incentivize contributions to an effective HCM strategy; (4) “voice” (how companies solicit and act on employee feedback, and how the workforce is engaged in the organization); and (5) how the company advances diversity, equity and inclusion.

State Street emphasizes that it expects companies to provide specificity on these subjects. For example, rather than disclosing that employees are surveyed regularly, State Street suggests that companies disclose survey frequency, examples of questions asked, and relevant examples of actions taken in response to employee feedback. State Street also encourages companies to consider emerging disclosure frameworks, such as the framework outlined by the Human Capital Management Coalition, which includes 35 institutional investors representing over $6.6 trillion in assets.

State Street will approach HCM issues by starting with engagement, focusing on the companies and industries with the greatest HCM risks and opportunities. For companies that it believes are not making sufficient progress after engagement, State Street will consider taking action through its votes on directors and/or shareholder proposals. It will consider supporting shareholder proposals at companies whose HCM disclosures are not sufficiently aligned with State Street’s disclosure expectations.

The following Gibson Dunn lawyers assisted in the preparation of this client update: Elizabeth Ising and Lori Zyskowski.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work in the Securities Regulation and Corporate Governance and Executive Compensation and Employee Benefits practice groups, or any of the following practice leaders and members:

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Lori Zyskowski – New York, NY (+1 212-351-2309, [email protected])
Ron Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, [email protected])
Mike Titera – Orange County, CA (+1 949-451-4365, [email protected])
Aaron Briggs – San Francisco, CA (+1 415-393-8297, [email protected])
Julia Lapitskaya – New York, NY (+1 212-351-2354, [email protected])
Cassandra Tillinghast – Washington, D.C. (+1 202-887-3524, [email protected])

Executive Compensation and Employee Benefits Group:
Stephen W. Fackler – Palo Alto/New York (+1 650-849-5385/+1 212-351-2392, [email protected])
Sean C. Feller – Los Angeles (+1 310-551-8746, [email protected])
Krista Hanvey – Dallas (+ 214-698-3425, [email protected])

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Decided January 24, 2022

April Hughes, et al. v. Northwestern University, et al., No. 19-1401

On Monday, January 24, 2022, the Supreme Court held 8-0 that offering inexpensive investment options, together with other allegedly high-cost options, in a defined-contribution retirement plan does not itself categorically foreclose a claim for breach of ERISA’s duty of prudence.

Background:

The Employee Retirement Income Security Act (“ERISA”) imposes a duty of prudence on fiduciaries’ management of employees’ retirement plans. See 29 U.S.C. § 1104(a)(1)(B). Administrators of defined-contribution plans, which feature a “menu” of investment options into which employees may direct their contributions, are subject to the fiduciary duties set forth in ERISA. Petitioners, who are former and current employees of respondent Northwestern University, alleged that Northwestern violated its duty of prudence by providing employees with a menu of investment options that caused employees to incur excessive fees, both because too many options were offered and because of the high fees associated with a number of the available options. The Seventh Circuit affirmed the dismissal of petitioners’ claims for failure to plausibly allege a breach of fiduciary duty. It held in relevant part that Northwestern had complied with its duty of prudence by offering a menu of investment options that included petitioners’ preferred type of low-cost investments, along with other higher-cost options.

Issue:

Whether participants in a defined-contribution retirement plan may state a claim for breach of ERISA’s fiduciary duty of prudence on the theory that investment options offered in the plan were too numerous and that many of the options were too costly, notwithstanding that the plan’s fiduciaries offered low-cost investment options in the plan as well.

Court’s Holding:

Relying on Tibble v. Edison Int’l, 575 U.S. 523 (2015), the Supreme Court held that the Seventh Circuit erred in dismissing the plaintiffs’ claims without making a “context-specific inquiry” that “take[s] into account [a fiduciary’s] duty to monitor all plan investments and remove any imprudent ones.”

“[E]ven in a defined-contribution plan where participants choose their investments, plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options.”

Justice Sotomayor, writing for the Court

What It Means:

The Court’s short, unanimous decision (with Justice Barrett recused) requires the Seventh Circuit to reevaluate the plaintiffs’ claims under Tibble. The decision does not purport to break new legal ground, does not decide whether plaintiffs stated a viable claim, and does not address what allegations would be sufficient to plead a viable claim under plaintiffs’ theories (including theories focused on recordkeeping fees).
Citing Tibble, the Court stated that the mere availability of adequate investment options does not categorically prevent ERISA plaintiffs from stating a plausible claim for breach of the duty of prudence, and that “[i]f the fiduciaries fail to remove an imprudent investment from the plan within a reasonable time, they breach their duty.”
In evaluating whether the plan participants’ allegations were sufficient to survive a motion to dismiss, the Court applied well-settled pleading rules and did not adopt an ERISA-specific standard.
In concluding its opinion, the Court emphasized that “[a]t times, the circumstances facing an ERISA fiduciary will implicate difficult tradeoffs, and courts must give due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise.”

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]
Bradley J. Hamburger +1 213.229.7658 [email protected]

Related Practice: Executive Compensation and Employee Benefits:

Stephen W. Fackler
+1 650.849.5385
[email protected]

Sean C. Feller
+1 310.551.8746
[email protected]

Krista P. Hanvey
+1 214.698.3425
[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]

Washington, D.C. partners Saul Mezei and Terrell Ussing are the authors of “How Justices May Interpret Statutory Time Bar In Tax Context,” [PDF] published by Law360 Tax Authority on January 21, 2022.

Washington, D.C. partner Patrick Stokes and Denver partner John Partridge and associate Eva Michaels are the authors of “Safe Harbors (and Other Strategies) for Life Sciences and Healthcare Companies in the International Anti-Corruption Storm” [PDF] published by the American Bar Association in the December 2021 issue of The Health Lawyer.

This presentation will explore the ethical, legal, and practical principles implicated by parallel investigations by multiple government authorities. The presentation will discuss the ever-increasing rise in parallel investigations (whether by different agencies within the federal government, across state lines, or between the state and federal governments), and will discuss the specific issues that may be posed by such investigations.

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PANELISTS:

Winston Y. Chan is a litigation partner in Gibson, Dunn & Crutcher’s San Francisco office. He has particular experience leading matters involving government enforcement defense, internal investigations and compliance counseling, and regularly represents clients before and in litigation against federal, state and local agencies, including the U.S. Department of Justice, Securities and Exchange Commission and State Attorneys General. Mr. Chan is Co-Chair of the firm’s False Claims Act/Qui Tam Defense practice group.

Diana M. Feinstein is a partner in the Los Angeles office of Gibson, Dunn & Crutcher. She is a member of the firm’s Securities Litigation and White Collar Defense and Investigations Practice Groups.Ms. Feinstein’s practice focuses on complex litigation, including securities litigation and high-value commercial litigation.She also focuses on white collar defense and investigations. She has handled matters across a variety of industries, including financial services, technology, entertainment, insurance, healthcare, transportation, real estate, manufacturing, and consumer products.Ms. Feinstein has represented clients in a variety of matters across the United States in cases involving breach of contract, shareholder disputes, breach of fiduciary duty claims, fraud claims, securities law violations, employment disputes and other matters.

Douglas M. Fuchs is a partner in Gibson, Dunn & Crutcher’s Los Angeles office. Mr. Fuchs is the co-chair of the firm’s Los Angeles Litigation Department. He also is a member of the firm’s White Collar Defense and Investigations, Securities Enforcement and Securities Litigation Practice Groups. Mr. Fuchs has a special expertise in representing corporations and individuals in white collar criminal, SEC and other regulatory enforcement matters, including cases involving allegations of securities fraud, environmental violations, public corruption, antitrust violations, economic espionage and government contracting fraud. Mr. Fuchs has also conducted sensitive internal investigations, been retained by companies that have been victimized by fraud, and developed compliance programs, including compliance with the Foreign Corrupt Practices Act. Mr. Fuchs additionally has experience handling a broad range of civil litigation, including cases stemming from the same facts giving rise to criminal, SEC, and regulatory investigations.

James L. Zelenay is a partner in the Los Angeles office of Gibson, Dunn & Crutcher where he practices in the firm’s Litigation Department. Mr. Zelenay has extensive experience in defending clients involved in white collar investigations, assisting clients in responding to government subpoenas, and in government civil fraud litigation. Mr. Zelenay has represented clients in connection with alleged violations of environmental regulations, regulations governing trade with sanctioned countries, Department of Education rules and regulations, Food and Drug Administration regulations, Federal Emergency Management Agency regulations, government construction contracting matters, patent and telecommunication proceedings, and other administrative matters. Mr. Zelenay also has substantial experience with the federal and state False Claims Acts and whistleblower litigation.

MCLE CREDIT INFORMATION:

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

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Neither the Connecticut Judicial Branch nor the Commission on Minimum Continuing Legal Education approve or accredit CLE providers or activities. It is the opinion of this provider that this activity qualifies for up to 1 hour toward your annual CLE requirement in Connecticut, including 0 hour(s) of ethics/professionalism.

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

The shift to remote work since early 2020 has presented a number of challenges to those in the legal industry, both as outside and in-house counsel. This presentation will discuss issues posed by remote work that may affect an attorney’s ability to practice competently, including the effect on an attorney’s mental health, their ability to connect with management, those they supervise, or with clients, and their ability to maintain confidentiality, and will cover what employers and firms can do to address these issues, as well as what we should be mindful of as we move towards a return to offices or a hybrid work structure.

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PANELISTS:

Megan Cooney is a Partner in the Orange County office of Gibson, Dunn & Crutcher. She is a member of the firm’s Labor and Employment, Class Actions, and Litigation Practice Groups. Ms. Cooney’s practice focuses on employment and class action litigation. She has represented employers in class actions, collective actions under the Fair Labor Standards Act, representative actions under the California Private Attorneys General Act, and individual actions in state and federal court alleging wage and hour violations, discrimination, retaliation, wrongful denial of benefits, harassment, and employment misclassification. Ms. Cooney has also represented clients in complex business litigation, including derivative lawsuits.

Tiffany Phan is a litigation Partner in the Los Angeles office of Gibson, Dunn & Crutcher. Her practice focuses on labor and employment matters with experience in class action defense and complex employment litigation at both the trial and appellate levels. She has extensive experience litigating wage and hour class actions involving exemptions, pay equity, harassment, discrimination, meal and rest breaks, and employee reimbursements. She has also conducted many internal investigations into complaints regarding executive employees. She has experience in matters before the NLRB and spends significant time counseling and advising employers on preventive planning.

MCLE CREDIT INFORMATION:

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

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

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

The panel will cover key developments to be aware of headed into the 2022 reporting and proxy season, including recent and upcoming SEC rulemaking and comment letters, proxy season trends, investor and proxy advisor updates, and regulatory developments on topics such as board diversity and director duties.

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PANELISTS:

Daniela L. Stolman is a partner in Gibson Dunn’s Century City office and a member of the firm’s Private Equity, Mergers and Acquisitions, Capital Markets and Securities Regulation and Corporate Governance practice groups. She advises companies and private equity firms across a wide range of industries, focusing on public and private merger transactions, stock and asset sales, and public and private capital-raising transactions. Ms. Stolman also advises public companies with respect to securities regulation and corporate governance matters, including periodic reporting and disclosure matters, Section 16, Rule 144, and insider trading.

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

Aaron Briggs is a Parnter in Gibson Dunn’s San Francisco office, where he works in the firm’s Securities Regulation and Corporate Governance Practice Group. Mr. Briggs’ practice focuses on advising public companies of all sizes (from pre-IPO to mega-cap), with a focus on technology and life sciences companies, on a wide range of securities and governance matters, including SEC compliance, corporate governance, ESG and sustainability, investor engagement, annual meeting, shareholder activism and executive compensation matters. Mr. Briggs previously served for five years as Executive Counsel – Corporate, Securities & Finance, at General Electric Company.

MCLE CREDIT INFORMATION:

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

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

As we do each year, we offer our observations on new developments and recommended practices for calendar-year filers to consider in preparing their Form 10-K. This alert reviews the recent amendments to Regulation S-K adopted by the U.S. Securities and Exchange Commission (“SEC”) and discusses how public companies are reacting to these new requirements. In addition, it discusses other disclosure topics, including Environmental, Social, and Governance (“ESG”) issues such as human capital management, climate change, and cybersecurity, that, in light of increasing investor focus and forthcoming rulemaking, continue to be a top priority for public companies.

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The following Gibson Dunn attorneys assisted in preparing this client update: Mike Titera, Justine Robinson, Andrew Fabens, Hillary Holmes, Elizabeth Ising, Thomas Kim, David Korvin, Ron Mueller, Jim Moloney, and Victor Twu.

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

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

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

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

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Adding to the growing list of jurisdictions that have passed pay transparency laws, effective May 15, 2022, employers in New York City will be required to include salary ranges in job postings.

Brief Summary

The new pay transparency law makes it an “unlawful discriminatory practice” under the New York City Human Rights Law (“NYCHRL”) for an employer to advertise a job, promotion, or transfer opportunity without stating the position’s minimum and maximum salary in the advertisement.

The salary range may include the lowest and highest salaries that the employer believes in “good faith” that it would pay for the job, promotion, or transfer at the time of the posting.

Notably, the law does not define “advertise” and it does not differentiate between jobs that are posted externally versus internally. The law also does not define a “salary,” nor does it clarify the requirements for non-salaried positions.

Covered Employers

The law applies to all employers with at least four employees in New York City, and independent contractors are counted towards that threshold. Significantly, however, the law does not apply to temporary positions advertised by temporary staffing agencies.

Enforcement and Penalties

The New York City Commission on Human Rights is authorized to take action to implement the law, including, among other things, through the promulgation of rules and/or imposition of civil penalties under the NYCHRL.

Growing Trend of Pay Transparency Laws

New York City’s pay transparency law is part of a growing trend in the United States.

In 2021, Colorado enacted a law that requires employers to disclose, among other things, the compensation or range of possible compensation in job postings. Of note, Colorado’s law is more expansive than New York City’s in that it requires employers with even one employee based in Colorado to post such salary information in any job postings for remote work (i.e., work that is performable anywhere, including Colorado).

Last year, Connecticut and Nevada enacted similar pay transparency laws, and Rhode Island passed a law (effective January 1, 2023) which will require employers to provide wage or salary range information to applicants and employees under certain conditions.

California, Maryland, and Washington also have laws requiring salary disclosure, but only upon the request of an applicant or employee, and each law’s disclosure requirements vary slightly. Maryland, for example, requires disclosure of a position’s wage range upon request of any applicant. In comparison, California requires disclosure upon request from applicants who have completed an initial interview and Washington requires disclosure upon request from applicants who have received an offer.

This trend appears poised to continue as other state legislatures, including Massachusetts and South Carolina, are considering pay transparency bills.

Similar to laws banning questions related to an applicant’s salary history during the hiring process, these pay transparency laws are aimed at promoting equal pay. Where state or local law provide for a private right of action, employers may face “tag-along” claims alleging pay disclosure non-compliance in addition to claims of workplace discrimination and/or retaliation.

Takeaway

All covered employers in New York City should take steps to ensure compliance with these new pay transparency requirements effective May 2022. And, employers operating in multiple jurisdictions should carefully monitor the ever-growing patchwork of pay transparency laws in order to ensure compliance wherever located.

The following Gibson Dunn attorneys assisted in preparing this client update: Danielle Moss, Harris Mufson, Gabby Levin, and Meika Freeman.

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

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

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

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

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

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

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

Gibson Dunn lawyers provide an overview of the ongoing and still unfolding humanitarian crisis in Afghanistan. The session covers the latest updates on the legal landscape for Afghan refugees, the various mechanisms for providing immigration relief to Afghan refugees in the United States, and a look at how the legal profession has and can help close the justice gap for these deserving families.

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PANELISTS:

Katherine Marquart is a partner in Gibson Dunn’s New York office and is the Firm’s Pro Bono Chair. In this role, Ms. Marquart manages and coordinates the Firm’s pro bono efforts globally. She also maintains a substantive practice in many areas of public interest law. Ms. Marquart previously spent seven years as a litigation associate at the Firm, where her practice focused on complex business litigation, transnational litigation, and internal investigations and regulatory inquiries.

Sara Ghalandari is Of Counsel in the San Francisco office of Gibson, Dunn & Crutcher. She is a member of the firm’s Real Estate Group. Ms. Ghalandari’s practice encompasses a wide-array of land use/development matters and real estate transactions, including zoning, planning, the California Environmental Quality Act (CEQA), public private partnerships, and matters regarding construction access, underpinning and shoring. The primary focus of her practice is the processing of entitlements, supervising the preparation and approval of environmental documentation, and negotiating transactional documents associated with land use, project development, and construction, including agreements between private and public entities (including local governments and public agencies).

Lauren Traina is an associate in the Los Angeles office of Gibson, Dunn & Crutcher. She currently practices in the firm’s Real EstatePractice Group. Ms. Traina’s practice focuses on land use and real estate matters, with an emphasis on energy transactions, including project development, acquisitions, financings and restructurings. She has significant expertise in wind power, solar power and other renewable energy technology, and has represented both developers and tax equity investors in connection with these transactions. Ms. Traina also has notable experience in corporate mergers and acquisitions, capital markets, and securities regulation.

MCLE CREDIT INFORMATION:

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

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

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

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2021 was a busy year for policy proposals and lawmaking related to artificial intelligence (“AI”) and automated technologies. The OECD identified 700 AI policy initiatives in 60 countries, and many domestic legal frameworks are taking shape. With the new Artificial Intelligence Act, which is expected to be finalized in 2022, it is likely that high-risk AI systems will be explicitly and comprehensively regulated in the EU. While there have been various AI legislative proposals introduced in Congress, the United States has not embraced a comprehensive approach to AI regulation as proposed by the European Commission, instead focusing on defense and infrastructure investment to harness the growth of AI.

Nonetheless —mirroring recent developments in data privacy laws—there are some tentative signs of convergence in US and European policymaking, emphasizing a risk-based approach to regulation and a growing focus on ethics and “trustworthy” AI, as well as enforcement avenues for consumers. In the U.S., President Biden’s administration announced the development of an “AI bill of rights.” Moreover, the U.S. Federal Trade Commission (“FTC”) has signaled a particular zeal in regulating consumer products and services involving automated technologies and large data volumes, and appears poised to ramp up both rulemaking and enforcement activity in the coming year. Additionally, the new California Privacy Protection Agency will likely be charged with issuing regulations governing AI by 2023, which can be expected to have far-reaching impact. Finally, governance principles and technical standards for ensuring trustworthy AI and ML are beginning to emerge, although it remains to be seen to what extent global regulators will reach consensus on key benchmarks across national borders.

I. U.S. NATIONAL POLICY, LEGISLATIVE EFFORTS, & ENFORCEMENT

A. U.S. National Policy

1. National AI Strategy

Almost three years after President Trump issued an Executive Order “Maintaining American Leadership in Artificial Intelligence” to launch the “American AI Initiative” and seek to accelerate AI development and regulation with the goal of securing the United States’ place as a global leader in AI technologies, we have seen a significant increase in AI-related legislative and policy measures in the U.S., bridging the old and new administrations. As was true a year ago, the U.S. federal government has been active in coordinating cross-agency leadership and encouraging the continued research and development of AI technologies for government use. To that end, a number of key legislative and executive actions have been directed at increasing the growth and development of such technologies for federal agency, national security and military applications. U.S. lawmakers also continued a dialogue with their EU counterparts, pledging to work together during an EU parliamentary hearing on March 1.[1] Rep. Robin Kelly (D-Ill.) testified at a hearing before the EU’s Special Committee on AI, noting that “[n]ations that do not share our commitment to democratic values are racing to be the leaders in AI and set the rules for the world,” .[2] She urged Europe to take a “narrow and flexible” approach to regulation while working with the U.S.[3]

a) National AI Initiative Act of 2020 (part of the National Defense Authorization Act of 2021 (“NDAA”)) and National AI Initiative Office

Pursuant to the National AI Initiative Act of 2020, which was passed on January 1, 2021 as part of the National Defense Authorization Act of 2021 (“NDAA”),[4] the OSTP formally established the National AI Initiative Office (the “Office”) on January 12. The Office—one of several new federal offices mandated by the NDAA—will be responsible for overseeing and implementing a national AI strategy and acting as a central hub for coordination and collaboration by federal agencies and outside stakeholders across government, industry and academia in AI research and policymaking.[5] The Act also established the National AI Research Resource Task Force (the “Task Force”), convening a group of technical experts across academia, government and industry to assess and provide recommendations on the feasibility and advisability of establishing a National AI Research Resource (“NAIRR”).[6] The Task Force will develop a coordinated roadmap and implementation plan for establishing and sustaining a NAIRR, a national research cloud to provide researchers with access to computational resources, high-quality data sets, educational tools and user support to facilitate opportunities for AI research and development. The Task Force will submit two reports to Congress to present its findings, conclusions and recommendations—an interim report in May 2022 and a final report in November 2022.

On January 27, 2021, President Biden signed a memorandum titled “Restoring trust in government through science and integrity and evidence-based policy making,” setting in motion a broad review of federal scientific integrity policies and directing agencies to bolster their efforts to support evidence-based decision making[7] which is expected to “generate important insights and best practices including transparency and accountability….”[8] The President also signed an executive order to formally reconstitute the President’s Council of Advisors on Science and Technology,[9] and announced the establishment of the National AI Advisory Committee, which is tasked with providing recommendations on various topics related to AI, including the current state of U.S. economic competitiveness and leadership, research and development, and commercial application.[10]

b) Innovation and Competition Act (S. 1260)

On June 8, 2021, the U.S. Senate voted 68-32 to approve the U.S. Innovation and Competition Act (S. 1260), intended to boost the country’s ability to compete with Chinese technology by investing more than $200 billion into U.S. scientific and technological innovation over the next five years, listing artificial intelligence, machine learning, and autonomy as “key technology focus areas.”[11] $80 billion is earmarked for research into AI, robotics, and biotechnology. Among various other programs and activities, the bill establishes a Directorate for Technology and Innovation in the National Science Foundation (“NSF”) and bolsters scientific research, development pipelines, creates grants, and aims to foster agreements between private companies and research universities to encourage technological breakthroughs.

The Act also includes provisions labelled as the “Advancing American AI Act,”[12] intended to “encourage agency artificial intelligence-related programs and initiatives that enhance the competitiveness of the United States” while ensuring AI deployment “align[s] with the values of the United States, including the protection of privacy, civil rights, and civil liberties.”[13] The AI-specific provisions mandate that the Director of the Office for Management and Budget (“OMB”) shall develop principles and policies for the use of AI in government, taking into consideration the NSCAI report, the December 3, 2020 Executive Order “Promoting the Use of Trustworthy Artificial Intelligence in the Federal Government,” and the input of various interagency councils and experts.[14]

c) Algorithmic Governance

We have also seen new initiatives taking shape at the federal level focused on algorithmic governance, culminating in the White House Office of Science and Technology Policy’s (“OSTP”) announcement in November 10, 2021, that it would launch a series of listening sessions and events the following week to engage the American public in the process of developing a Bill of Rights for an Automated Society.[15] According to OSTP Director Eric, the bill will need “teeth” in the form of procurement enforcement.[16] In a parallel action, the Director of the National AI Initiative Office, Lynne Parker made comments indicating that the United States should have a vision for the regulation of AI similar to the EU’s General Data Protection Regulation (“GDPR”).[17] Moreover, in October 2021, the White House’s Office of Science and Technology Policy (“OSTP”) published an RFI requesting feedback on how biometric technologies have performed in organizations and how they affect individuals emotionally and mentally.[18]

In June 2021, the U.S. Government Accountability Office (“GAO”) published a report identifying key practices to help ensure accountability and responsible AI use by federal agencies and other entities involved in the design, development, deployment, and continuous monitoring of AI systems.[19] The report identified four key focus areas: (1) organization and algorithmic governance; (2) system performance; (3) documenting and analyzing the data used to develop and operate an AI system; and (4) continuous monitoring and assessment of the system to ensure reliability and relevance over time.[20]

Finally, the National Institute of Standards and Technology (“NIST”), tasked by the Trump administration to develop standards and measures for AI, released its report of how to measure and enhance user trust, and identify and manage biases, in AI technology.[21] NIST received sixty-five comments on the document, and the authors plan to synthesize and use the public’s responses to develop the next version of the report and to help shape the agenda of several collaborative virtual events NIST will hold in coming months.[22]

2. National Security

a) NSCAI Final Report

The National Defense Authorization Act of 2019 created a 15-member National Security Commission on Artificial Intelligence (“NSCAI”), and directed that the NSCAI “review and advise on the competitiveness of the United States in artificial intelligence, machine learning, and other associated technologies, including matters related to national security, defense, public-private partnerships, and investments.”[23] Over the past two years, NSCAI has issued multiple reports, including interim reports in November 2019 and October 2020, two additional quarterly memorandums, and a series of special reports in response to the COVID-19 pandemic.[24]

On March 1, 2021, the NSCAI submitted its Final Report to Congress and to the President. At the outset, the report makes an urgent call to action, warning that the U.S. government is presently not sufficiently organized or resourced to compete successfully with other nations with respect to emerging technologies, nor prepared to defend against AI-enabled threats or to rapidly adopt AI applications for national security purposes. Against that backdrop, the report outlines a strategy to get the United States “AI-ready” by 2025[25] and identifies specific steps to improve public transparency and protect privacy, civil liberties and civil rights when the government is deploying AI systems. NSCAI specifically endorses the use of tools to improve transparency and explainability: AI risk and impact assessments; audits and testing of AI systems; and mechanisms for providing due process and redress to individuals adversely affected by AI systems used in government. The report also recommends establishing governance and oversight policies for AI development, which should include “auditing and reporting requirements,” a review system for “high-risk” AI systems, and an appeals process for those affected. These recommendations may have significant implications for potential oversight and regulation of AI in the private sector. The report also outlines urgent actions the government must take to promote AI innovation to improve national competitiveness, secure talent, and protect critical U.S. advantages, including IP rights.

b) DOD’s Defense Innovation Unit (DIU) released its “Responsible AI Guidelines”

On November 14, 2021, the Department of Defense’s Defense Innovation Unit (“DIU”) released “Responsible AI Guidelines” that provide step-by-step guidance for third party developers to use when building AI for military use. These guidelines include procedures for identifying who might use the technology, who might be harmed by it, what those harms might be, and how they might be avoided—both before the system is built and once it is up and running.[26]

c) Artificial Intelligence Capabilities and Transparency (“AICT”) Act

On May 19, 2021, Senators Rob Portman (R-OH) and Martin Heinrich (D-NM), introduced the bipartisan Artificial Intelligence Capabilities and Transparency (“AICT”) Act.[27] AICT would provide increased transparency for the government’s AI systems, and is based primarily on recommendations promulgated by the National Security Commission on AI (“NSCAI”) in April 2021.[28] AICT was accompanied by the Artificial Intelligence for the Military (AIM) Act.[29] The AICT Act would establish a pilot AI development and prototyping fund within the Department of Defense aimed at developing AI-enabled technologies for the military’s operational needs, and would develop a resourcing plan for the DOD to enable development, testing, fielding, and updating of AI-powered applications.[30] Both bills were passed as part of the Fiscal Year 2022 National Defense Authorization Act.[31]

B. Consumer Protection, Privacy & Algorithmic Fairness

1. FTC Focuses on Algorithmic Transparency and Fairness

On April 19, 2021, the FTC issued guidance highlighting its intention to enforce principles of transparency and fairness with respect to algorithmic decision-making impacting consumers. The blog post, “Aiming for truth, fairness, and equity in your company’s use of AI,” announced the FTC’s intent to bring enforcement actions related to “biased algorithms” under section 5 of the FTC Act, the Fair Credit Reporting Act, and the Equal Credit Opportunity Act.[32] Notably, the statement expressly notes that “ the sale or use of—for example—racially biased algorithms” falls within the scope of the prohibition of unfair or deceptive business practices. The blog post provided concrete guidance on “using AI truthfully, fairly, and equitably,” indicating that it expects companies to “do more good than harm” by auditing its training data and, if necessary, “limit[ing] where or how [they] use the model;” testing their algorithms for improper bias before and during deployment; employing transparency frameworks and independent standards; and being transparent with consumers and seeking appropriate consent to use consumer data. The guidance also warned companies against making statements to consumers that “overpromise” or misrepresent the capabilities of a product, noting that biased outcomes may be considered deceptive and lead to FTC enforcement actions.

This statement of intent came on the heels of remarks by former Acting FTC Chairwoman Rebecca Kelly Slaughter on February 10 at the Future of Privacy Forum, previewing enforcement priorities under the Biden Administration and specifically tying the FTC’s role in addressing systemic racism to the digital divide, exacerbated by COVID-19, AI and algorithmic decision-making, facial recognition technology, and use of location data from mobile apps.[33] It also follows the FTC’s informal guidance last year outlining principles and best practices surrounding transparency, explainability, bias, and robust data models.[34]

These regulatory priorities continue to gather pace under new FTC Chair Lina Khan, who in November 2021 announced several new additions to the FTC’s Office of Policy Planning, including three “Advisors on Artificial Intelligence,” Meredith Whittaker, Ambak Kak, and Sarah Meyers West—all formerly at NYU’s AI Now Institute and experts in various AI topics including algorithmic accountability and the political economy of AI.[35]

The FTC has also taken steps to strengthen its enforcement powers, passing a series of measures to allow for quicker investigations into potential violations, including issues regarding bias in algorithms and biometrics.[36] Moreover, on July 27, 2021, the FTC’s chief technologist Erie Meyer commented that the agency envisions requiring companies that engage in illegal data uses to “not just disgorge data and money,” but also “algorithms that were juiced by ill-gotten data.”[37] Sen. Mike Lee, R-Utah, subsequently introduced a bill on December 15, 2021 that would give the FTC the authority to seek restitution in federal district court, after the U.S. Supreme Court ruled in April that the agency’s power to seek injunctions from a federal judge does not include the ability to request restitution or disgorgement of ill-gotten gains.[38] The proposed Consumer Protection and Due Process Act would amend Section 13(b) of the Federal Trade Commission Act to give the FTC the explicit authority to ask a federal judge to let it recover money from scammers and antitrust violators.[39]

The FTC also identified “dark patterns” as a growing concern and enforcement focal point. Dark patterns may be loosely defined as techniques to manipulate a consumer into taking an unintended course of action using novel uses of technology (including AI), particularly user experience (UX) design—for example, a customer service bot, unwanted warranty, or a trial subscription that converts to paid.[40] At an FTC virtual workshop to examine dark patterns, the Acting Director of the Bureau of Consumer Protection, Daniel Kaufman, suggested that companies can expect aggressive FTC enforcement in this area and that the FTC will use Section 5 of the FTC Act and the Restoring Online Shoppers’ Confidence Act to exercise its authority by enacting new rules, policy statements, or enforcement guidance.[41]

We recommend that companies developing or deploying automated decision-making adopt an “ethics by design” approach and review and strengthen internal governance, diligence and compliance policies. Companies should also stay abreast of developments concerning the FTC’s ability to seek restitution and monetary penalties and impose obligations to delete algorithms, models or data.

2. Consumer Financial Protection Bureau

The CFPB, now headed by former FTC Commissioner Rohit Chopra, suggested that it may use the Fair Credit Reporting Act (FCRA) to exercise jurisdiction over large technology companies and their business practices.[42] The FCRA has traditionally regulated the activities of credit bureaus, background check companies, and tenant screening services, but Chopra has made several statements that the underlying data used by technology giants may be triggering obligations under the FCRA. The FCRA defines a consumer reporting agency fairly broadly to include companies assembling, evaluating, and selling data to third parties that use the data in making eligibility decisions about consumers. The CFPB may seek to make an inquiry into large technology companies in order to learn whether data is, in fact, being sold to third parties and how it may be used further downstream.

In November, the CFPB issued an advisory opinion affirming that consumer reporting companies, including tenant and employment screening companies, are violating the law if they engage in careless name-matching procedures.[43] The CFPB is particularly concerned by the algorithms of background screening companies assigning a false identity to applicants for jobs and housing due to error-ridden background screening reports that may disproportionately impact communities of color. The advisory opinion reaffirms the obligations and requirements of consumer reporting companies to use reasonable procedures to ensure the maximum possible accuracy.

3. U.S. Equal Employment Opportunity Commission

The U.S. Equal Employment Opportunity Commission plans to review how AI tools and technology are being applied to employment decisions.[44] The EEOC’s initiative will examine more closely how technology is fundamentally changing the way employment decisions are made. It aims to guide applicants, employees, employers, and technology vendors in ensuring that these technologies are used fairly, consistent with federal equal employment opportunity laws.

4. Facial Recognition and Biometric Technologies

a) Enforcement

In January 2021, the FTC announced its settlement with Everalbum, Inc. in relation to its “Ever App,” a photo and video storage app that used facial recognition technology to automatically sort and “tag” users’ photographs.[45] The FTC alleged that Everalbum made misrepresentations to consumers about its use of facial recognition technology and its retention of the photos and videos of users who deactivated their accounts in violation of Section 5(a) of the FTC Act. Pursuant to the settlement agreement, Everalbum must delete models and algorithms that it developed using users’ uploaded photos and videos and obtain express consent from its users prior to applying facial recognition technology, underscoring the emergence of deletion as a potential enforcement measure. A requirement to delete data, models, and algorithms developed by using data collected without express consent could represent a significant remedial obligation with broader implications for AI developers.

Signaling the potential for increasing regulation and enforcement in this area, FTC Commissioner Rohit Chopra issued an accompanying statement describing the settlement as a “course correction,” commenting that facial recognition technology is “fundamentally flawed and reinforces harmful biases” while highlighting the importance of “efforts to enact moratoria or otherwise severely restrict its use.” However, the Commissioner also cautioned against “broad federal preemption” on data protection and noted that the authority to regulate data rights should remain at state-level.[46] We will carefully monitor any further enforcement action by the FTC (and other regulators), as well as the slate of pending lawsuits alleging the illicit collection of biometric data used by automated technologies pursuant to a growing number of state privacy laws—such as Illinois’ Biometric Information Privacy Act (“BIPA”)[47]—and recommend that companies developing or using facial recognition technologies seek specific legal advice with respect to consent requirements around biometric data as well as develop robust AI diligence and risk-assessment processes for third-party AI applications.

b) Legislation

Facial recognition technology also attracted renewed attention from federal and state lawmakers in 2021. On June 15, 2021, a group of Democratic senators reintroduced the Facial Recognition and Biometric Technology Moratorium Act, which would prohibit agencies from using facial recognition technology and other biometric tech—including voice recognition, gate recognition, and recognition of other immutable physical characteristics—by federal entities, and block federal funds for biometric surveillance systems.[48] A similar bill was introduced in both houses in the previous Congress but did not progress out of committee.[49] The legislation, which is endorsed by the ACLU and numerous other civil rights organizations, also provides a private right of action for individuals whose biometric data is used in violation of the Act (enforced by state Attorneys General), and seeks to limit local entities’ use of biometric technologies by tying receipt of federal grant funding to localized bans on biometric technology. Any biometric data collected in violation of the bill’s provisions would also be banned from use in judicial proceedings.

At the state level, Virginia passed a ban on the use of facial recognition technology by law enforcement (H.B. 2031). The legislation, which won broad bipartisan support, prohibits all local law enforcement agencies and campus police departments from purchasing or using facial recognition technology unless it is expressly authorized by the state legislature.[50] The law took effect on July 1, 2021. Virginia joins California, as well as numerous cities across the U.S., in restricting the use of facial recognition technology by law enforcement.[51]

5. Algorithmic Accountability

a) Algorithmic Justice and Online Platform Transparency Act of 2021 (S. 1896)

On May 27, 2021, Senator Edward J. Markey (D-Mass.) and Congresswoman Doris Matsui (CA-06) introduced the Algorithmic Justice and Online Platform Transparency Act of 2021 to prohibit harmful algorithms, increase transparency into websites’ content amplification and moderation practices, and commission a cross-government investigation into discriminatory algorithmic processes across the national economy.[52] The Act would prohibit algorithmic processes on online platforms that discriminate on the basis of race, age, gender, ability, and other protected characteristics. In addition, it would establish a safety and effectiveness standard for algorithms and require online platforms to describe algorithmic processes in plain language to users and maintain detailed records of these processes for review by the FTC.

b) Consumer Safety Technology Act, or AI for Consumer Product Safety Act (H.R. 3723)

On June 22, 2021, the House voted 325-103 to approve the Consumer Safety Technology Act, or AI for Consumer Product Safety Act (H.R. 3723), which requires the Consumer Product Safety Commission to create a pilot program that uses AI to explore consumer safety questions such as injury trends, product hazards, recalled products, or products that should not be imported into the U.S.[53] This is the second time the Consumer Safety Technology Act has passed the House. Last year, after clearing the House, the bill did not progress in the Senate after being referred to the Committee on Commerce, Science and Transportation.[54]

c) Data Protection Act of 2021 (S. 2134)

In June 2021, Senator Kirsten Gillibrand (D-NY) introduced the Data Protection Act of 2021, which would create an independent federal agency to protect consumer data and privacy.[55] The main focus of the agency would be to protect individuals’ privacy related to the collection, use, and processing of personal data.[56] The bill defines “automated decisions system” as “a computational process, including one derived from machine learning, statistics, or other data processing or artificial intelligence techniques, that makes a decision, or facilitates human decision making.”[57] Moreover, using “automated decision system processing” is a “high-risk data practice” requiring an impact evaluation after deployment and a risk assessment on the system’s development and design, including a detailed description of the practice including design, methodology, training data, and purpose, as well as any disparate impacts and privacy harms.[58]

d) Filter Bubble Transparency Act

On November 9, 2021, a bipartisan group of House lawmakers introduced legislation that would give people more control over the algorithms that shape their online experience.[59] If passed, the Filter Bubble Transparency Act would require companies like Meta to offer a version of their platforms that runs on an “input-transparent” algorithm that doesn’t pull on user data to generate recommendations—in other words, provide users with an option to opt out of algorithmic content feeds based on personal data. This House legislation is a companion bill to Senate legislation introduced in June 2021.

e) Deepfake Task Force Act

On July 29, Senators Gary Peters (D-Mich.) and Rob Portman (R-Ohio) introduced bipartisan legislation which would create a task force within the Department of Homeland Security (DHS) tasked with producing a plan to reduce the spread and impact of deepfakes, digitally manipulated images and video nearly indistinguishable from authentic footage.[60] The bill would build on previous legislation, which passed the Senate last year, requiring DHS to conduct an annual study of deepfakes.

6. State and City Regulations

a) Washington State Lawmakers Introduce a Bill to Regulate AI, S.B. 5116

On the heels of Washington’s landmark facial recognition bill (S.B. 6280) enacted last year,[61] state lawmakers and civil rights advocates proposed new rules to prohibit discrimination arising out of automated decision-making by public agencies.[62] The bill, which is sponsored by Sen. Bob Hasegawa (D-Beacon Hill), would establish new regulations for government departments that use “automated decisions systems,” a category that includes any algorithm that analyzes data to make or support government decisions.[63] If enacted, public agencies in Washington state would be prohibited from using automated decisions systems that discriminate against different groups or make final decisions that impact the constitutional or legal rights of a Washington resident. The bill also bans government agencies from using AI-enabled profiling in public spaces. Publicly available accountability reports ensuring that the technology is not discriminatory would be required before an agency can use an automated decision system.

b) New York City Council Bill Passed to Ban Employers from Using Automated Hiring Tools without Yearly Audit to Determine Discriminatory Impact

On November 10, 2021, the New York City Council passed a bill barring AI hiring systems that do not pass annual audits checking for race- or gender-based discrimination.[64] The bill would require the developers of such AI tools to disclose more information about the workings of their tool and would provide candidates the option of choosing an alternative process to review their application. The legislation would impose fines on employers or employment agencies of up to $1,500 per violation.

C. Intellectual Property

1. Thaler v. Hirshfeld

Intellectual property has historically offered uncertain protection to AI works. Authorship and inventorship requirements are perpetual stumbling blocks for AI-created works and inventions. For example, in the United States, patent law has rejected the notion of a non-human inventor.[65] The Federal Circuit has consistently maintained this approach.[66] This year, the Artificial Inventor Project made several noteworthy challenges to the paradigm. First, the team created DABUS, the “Device for the Autonomous Bootstrapping of Unified Sentience”—an AI system that has created several inventions.[67] The project then partnered with attorneys to lodge test cases in the United States, Australia, the EU, and the UK.[68] These ambitious cases reaped mixed results, likely to further diverge as AI inventorship proliferates.

In the United States, DABUS was listed as the “sole inventor” in two patent applications.[69] In response, the USPTO issued a Notice to File Missing Parts of Non-Provisional Application because the “application data sheet or inventor’s oath or declaration d[id] not identify each inventor or his or her legal name” and stressed that the law required that inventorship “must be performed by a natural person.”[70] The patent applicants sought review in the Eastern District of Virginia, which agreed with the USPTO.[71] The Artificial Inventor Project faced comparable setbacks in Europe. The European Patent Office (“EPO”) rebuffed similar patent applications, holding that the legal framework of the European patent system leads to the conclusion that the law requires human inventorship.[72] The Legal Board of Appeal similarly held that under the European Patent Convention, patents require human inventorship.[73] DABUS fared no better in UK patent courts, which held that the Patents Act requires that an inventor be a person.[74] Conversely, South Africa’s patent office granted the first patent for an AI inventor.[75] A leader of the legal team explained the differential outcome: in the UK, the patent application was “deemed withdrawn” for failure to comply associated with filing the patent forms; however, “South Africa does carry out formalities examination, and issued it, as required, on the basis of the designation in the international (Patent Cooperation Treaty [PCT]) application, which was previously accepted by WIPO.”[76] Weeks later, the Federal Court of Australia also held that AI inventorship was not an obstacle to patentability.[77] But it is worth noting that Australia’s patent system does not employ a substantive patent examination system.

While developments in South Africa and Australia offer encouragement to AI inventors, there is no promise for harmonization. Instead a patchwork approach is more likely. The United States and Europe are likely to maintain the view that AI is an inventor’s tool, but not an inventor.

2. Google LLC v. Oracle America, Inc.

On April 5, 2021, the U.S. Supreme Court ruled in favor of Google in a multibillion-dollar copyright lawsuit filed by Oracle, holding that Google did not infringe Oracle’s copyrights under the fair use doctrine when it used material from Oracle’s APIs to build its Android smartphone platform.[78] Notably, the Court did not rule on whether Oracle’s APIs declaring code could be copyrighted, but held that, assuming for argument’s sake the material was copyrightable, “the copying here at issue nonetheless constituted a fair use.”[79] Specifically, the Court stated that “where Google reimplemented a user interface, taking only what was needed to allow users to put their accrued talents to work in a new and transformative program, Google’s copying of the Sun Java API was a fair use of that material as a matter of law.”[80] The Court focused on Google’s transformative use of the Sun Java API and distinguished declaring code from other types of computer code in finding that all four guiding factors set forth in the Copyright Act’s fair use provision weighed in favor of fair use.[81]

While the ruling appears to turn on this particular case, it will likely have repercussions for AI and platform creators.[82] The Court’s application of fair use could offer an avenue for companies to argue for the copying of organizational labels without a license. Notably, the Court stated that commercial use does not necessarily tip the scales against fair use, particularly when the use of the copied material is transformative. This could assist companies looking to use content to train their algorithms at a lower cost, putting aside potential privacy considerations (such as under BIPA). Meanwhile, companies may also find it more challenging to govern and oversee competitive programs that use their API code for compatibility with their platforms.

D. Healthcare

1. FDA’s Action Plan for AI Medical Devices

In January 2021, the U.S. Food and Drug Administration (FDA) presented its first five-part Action Plan focused on Artificial Intelligence/Machine Learning (AI/ML)-based Software as a Medical Device (SaMD). The Action Plan is a multi-pronged approach to advance the FDA’s oversight of AI/ML-based SaMD, developed in response to stakeholder feedback received from the April 2019 discussion paper, “Proposed Regulatory Framework for Modifications to Artificial Intelligence/Machine Learning-Based Software as a Medical Device.”[83] The FDA’s stated vision is that “with appropriately tailored total product lifecycle-based regulatory oversight” AI/ML-based SaMD “will deliver safe and effective software functionality that improves the quality of care that patients receive.”[84]

As proposed in the FDA’s January 2021 Action Plan, in October 2021 the FDA held a public workshop on how information sharing about a device supports transparency to all users of AI/ML-enabled medical devices.[85] The stated purpose of the workshop was twofold: (1) to “identify unique considerations in achieving transparency for users of AI/ML-enabled medical devices and ways in which transparency might enhance the safety and effectiveness of these devices;” and (2) “gather input from various stakeholders on the types of information that would be helpful for a manufacturer to include in the labeling of and public facing information of AI/ML-enabled medical devices, as well as other potential mechanisms for information sharing.”[86]

The workshop had three main modules on (1) the meaning and role of transparency; (2) how to promote transparency; and (3) a session for open public comments.[87] Specific panels covered topics such as patient impressions and physician perspectives on AI transparency, the FDA’s role in promoting transparency and transparency promotion from a developer’s perspective.[88] After the workshop, the FDA solicited public comments regarding the workshop by November 15, 2021, to be taken into consideration going forward.[89]

2. FDA Launches List of AI and Machine Learning-Enabled Medical Devices

On September 22, 2021, the FDA shared its preliminary list of AI/ML-based SaMDs that are legally marketed in the U.S. via 510(k) clearance, De Novo authorization, or Premarket (PMA) approval.[90] The agency developed this list to increase transparency and access to information on AI/ML-based SaMDs, and to act “as a resource to the public regarding these devices and the FDA’s work in the space.”[91] The effort comes alongside the growing interest in developing such products to contribute to a wide variety of clinical spheres, and the increasing number of companies seeking to incorporate AI/ML technology into medical devices. The FDA noted that one of “the greatest potential benefits of ML resides in its ability to create new and important insights from the vast amount of data generated during the delivery of health care every day.”[92]

E. Autonomous Vehicles (“AVs”)

1. U.S. Federal Developments

In June 2021, Representative Bob Latta (R-OH-5) again re-introduced the Safely Ensuring Lives Future Deployment and Research Act (“SELF DRIVE Act”) (H.R. 3711), which would create a federal framework to assist agencies and industries to deploy AVs around the country and establish a Highly Automated Vehicle Advisory Council within the National Highway Traffic Safety Administration (“NHTSA”). Representative Latta had previously introduced the bill in September 23, 2020, and in previous sessions.[93]

Also in June 2021, The Department of Transportation (“DOT”) released its “Spring Regulatory Agenda,” and proposed that NHTSA establish rigorous testing standards for AVs as well as a national incident database to document crashes involving AVs.[94] The DOT indicated that there will be opportunities for public comment on the proposals.

On June 29, 2021, NHTSA issued a Standing General Order requiring manufacturers and operators of vehicles with advanced driver assistance systems (ADAS) or automated driving systems (ADS) to report crashes.[95] ADAS is an increasingly common feature in new vehicles where the vehicle is able to control certain aspects of steering and speed. ADS-equipped vehicles are what are more colloquially called “self-driving vehicles,” and are not currently on the market. The Order requires that companies must report crashes within one day of learning of the crash if the crash involved a “a hospital-treated injury, a fatality, a vehicle tow-away, an air bag deployment, or a vulnerable road user such as a pedestrian or bicyclist.”[96] An updated report is also due 10 days after the company learned of the crash.[97] The order also requires companies to report all other crashes involving an ADS-equipped vehicle that involve an injury or property damage on a monthly basis.[98] All reports submitted to NHTSA must be updated monthly with new or additional information.[99]

NHTSA also requested public comments in response to its Advance Notice of Proposed Rulemaking (“ANPRM”), “Framework for Automated Driving System Safety,” through the first quarter of 2021.[100] The ANPRM acknowledged that NHTSA’s previous AV-related regulatory notices “have focused more on the design of the vehicles that may be equipped with an ADS—not necessarily on the performance of the ADS itself.”[101] To that end, NHTSA sought input on how to approach a performance evaluation of ADS through a safety framework, and specifically whether any test procedure for any Federal Motor Vehicle Safety Standard (“FMVSS”) should be replaced, repealed, or modified, for reasons other than for considerations relevant only to ADS. NHTSA noted that “[a]lthough the establishment of an FMVSS for ADS may be premature, it is appropriate to begin to consider how NHTSA may properly use its regulatory authority to encourage a focus on safety as ADS technology continues to develop,” emphasizing that its approach will focus on flexible “performance-oriented approaches and metrics” over rule-specific design characteristics or other technical requirements.[102]

2. Iowa’s Automated Vehicle Legislation

In 2019, the Iowa legislature approved a law allowing driverless-capable vehicles to operate on the public highways of Iowa without a driver, if the vehicle meets certain conditions including that the vehicle must be capable of attaining minimal risk if the automated driving system malfunctions. It also requires the vehicle’s system to comply with Iowa’s traffic laws, and the manufacturer must certify that a manufacturer be in compliance with all applicable federal motor vehicle safety standards.[103] In August 2021, the Iowa Transportation Commission approved rules for automated vehicles. These regulations include requirements that a “manufacturer or entity shall not test driverless-capable vehicles in Iowa without a valid permit,” and imposes restrictions on who may qualify for a driverless-capable vehicle permit.[104] It also provides authority to the department to restrict operation of the vehicle “based on a specific functional highway classification, weather conditions, days of the week, times of day, and other elements of operational design while the automated driving system is engaged.”[105]

F. Financial Services

Amid the increasing adoption of AI in the financial services space, the year also brought a renewed push to regulate such technological advances. Federal agencies led the charge issuing numerous new regulations and previewing more to come in 2022.

The Federal Deposit Insurance Corporation (FDIC), the Board of Governors of the Federal Reserve System, and the Office of the Comptroller of the Currency teamed up to issue a new cybersecurity reporting rule.[106] The rule applies to all Banking Organizations[107] governed by the agency and compels Banking Organizations to notify their primary Federal regulators within 36 hours of any sufficiently serious “computer-security incident.”[108] The rule takes effect in April 1, 2022 and all regulated entities must comply by May 1, 2022.[109]

In addition to newly issued regulations, numerous agencies signaled their desire to regulate technological advances in financial services as soon as early 2022. Five Agencies jointly held an open comment period on “Financial Institutions’ Use of Artificial Intelligence” from March 31, 2021, until July 1, 2021, to “understand respondents’ views on the use of AI by financial institutions in their provision of services to customers.”[110] Kevin Greenfield, Deputy Comptroller for operational risk policy with the OCC, noted that the RFI would specifically shed light on the issue of AI potentially violating consumer protection laws by disparately impacting a protected class, among other issues.[111] This flurry of activity by regulators indicates an active 2022 that might feature several notable new regulations governing the use of advanced technology by various forms of financial services entities.

III. EU POLICY & REGULATORY DEVELOPMENTS

A. European Union

1. EC Draft Legislation for EU-Wide AI Regulation

On April 21, 2021, the European Commission (“EC”) presented its much anticipated comprehensive draft of an AI Regulation (also referred to as the “Artificial Intelligence Act”).[112] As highlighted in our client alert “EU Proposal on Artificial Intelligence Regulation Released“ and in our “3Q20 Artificial Intelligence and Automated Systems Legal Update“, the draft comes on the heels of a variety of publications and policy efforts in the field of AI with the aim of placing the EU at the forefront of both AI regulation and innovation. The proposed Artificial Intelligence Act delivers on the EC president’s promise to put forward legislation for a coordinated European approach on the human and ethical implications of AI[113] and would be applicable and binding in all 27 EU Member States.

In order to “achieve the twin objective of promoting the uptake of AI and of addressing the risks associated with certain uses of such technology”[114], the EC generally opts for a risk-based approach rather than a blanket technology ban. However, the Artificial Intelligence Act also contains outright prohibitions of certain “AI practices” and some very far-reaching provisions aimed at “high-risk AI systems”, which are somewhat reminiscent of the regulatory approach under the EU’s General Data Protection Regulation (“GDPR”); i.e. broad extra-territorial reach and hefty penalties, and will likely give rise to controversy and debate in the upcoming legislative procedure.

As the EC writes in its explanatory memorandum to the Artificial Intelligence Act, the proposed framework covers the following specific objectives:

Ensuring that AI systems available in the EU are safe and respect EU laws and values;
Ensuring legal certainty to facilitate investment and innovation in AI;
Enhancing governance and effective enforcement of existing laws applicable to AI (such as product safety legislation); and
Facilitating the development of a single market for AI and prevent market fragmentation within the EU.

While it is uncertain when and in which form the Artificial Intelligence Act will come into force, the EC has set the tone for upcoming policy debates with this ambitious new proposal. While certain provisions and obligations may not be carried over to the final legislation, it is worth noting that the EU Parliament has already urged the EC to prioritize ethical principles in its regulatory framework.[115] Therefore, we expect that the proposed rules will not be significantly diluted, and could even be further tightened. Companies developing or using AI systems, whether based in the EU or abroad, should keep a close eye on further developments with regard to the Artificial Intelligence Act, and in particular the scope of the prohibited “unacceptable” and “high-risk” use cases, which, as drafted, could potentially apply to a very wide range of products and applications.

We stand ready to assist clients with navigating the potential issues raised by the proposed EU regulations as we continue to closely monitoring developments in that regard, as well as public reaction. We can and will help advise any clients desiring to have a voice in the process.

2. EU Parliament AI Draft Report

On November 2, 2021, the EU’s Special Committee released its Draft Report on AI in a Digital Age for the European Parliament, which highlights the benefits of use of AI such as fighting climate change and pandemics, and also various ethical and legal challenges.[116] According to the draft report, the EU should not regulate AI as a technology; instead, the type, intensity and timing of regulatory intervention should solely depend on the type of risk associated with a particular use of an AI system. The draft report also highlights the challenge of reaching a consensus within the global community on minimum standards for the responsible use of AI, and concerns about military research and technological developments in weapon systems without human oversight.

3. EU Council Proposes ePrivacy Regulation

On February 10, 2021, the Council of the European Union (the “EU Council”), the institution representing EU Member States’ governments, provided a negotiating mandate with regard to a revision of the ePrivacy Directive and published an updated proposal for a new ePrivacy Regulation. Contrary to the current ePrivacy Directive, the new ePrivacy Regulation would not have to be implemented into national law, but would apply directly in all EU Member States without transposition.

The ePrivacy Directive contains rules related to the privacy and confidentiality in connection with the use of electronic communications services. However, an update of these rules is seen as critical given the sweeping and rapid technological advancement that has taken place since it was adopted in 2002. The new ePrivacy Regulation, which would repeal and replace the ePrivacy Directive, has been under discussion for several years now.

Pursuant to the EU Council’s proposal, the ePrivacy Regulation will also cover machine-to-machine data transmitted via a public network, which might create restrictions on the use of data by companies developing AI-based products and other data-driven technologies. As a general rule, all electronic communications data will be considered confidential, except when processing or other usage is expressly permitted by the ePrivacy Regulation. Similar to the European General Data Protection Regulation (“GDPR”), the ePrivacy Regulation would also apply to processing that takes place outside of the EU and/or to service providers established outside the EU, provided that the end users of the electronic communications services, whose data is being processed, are located in the EU.

However, unlike GDPR, the ePrivacy Regulation would cover all communications content transmitted using publicly available electronic communications services and networks, and not only personal data. Further, metadata (such as location and time of receipt of the communication) also falls within the scope of the ePrivacy Regulation.

It is expected that the draft proposal will undergo further changes during negotiations with the European Parliament. Therefore, it remains to be seen whether the particular needs of highly innovative data-driven technologies will be taken into account—by creating clear and unambiguous legal grounds other than user consent for processing of communications content and metadata for the purpose of developing, improving and offering AI-based products and applications. If the negotiations between the EU Council and the EU Parliament proceed without any further delays, the new ePrivacy Regulation could enter into force in 2023, at the earliest.

4. EDPB & EDPS Call for Ban on Use of AI for Facial Recognition in Publicly Accessible Spaces

On June 21, 2021, the European Data Protection Board (“EDPB”) and European Data Protection Supervisor (“EDPS”) published a joint Opinion calling for a general ban on “any use of AI for automated recognition of human features in publicly accessible spaces, such as recognition of faces, gait, fingerprints, DNA, voice, keystrokes and other biometric or behavioral signals, in any context.”[117]

In their Opinion, the EDPB and the EDPS welcomed the risk-based approach underpinning the EC’s proposed AI Regulation and emphasized that it has important data protection implications. The Opinion also notes the role of the EDPS—designated by the EC’s AI Regulation as the competent authority and the market surveillance authority for the supervision of the EU institutions—should be further clarified.[118] Notably, the Opinion also recommended “a ban on AI systems using biometrics to categorize individuals into clusters based on ethnicity, gender, political or sexual orientation, or other grounds on which discrimination is prohibited under Article 21 of the Charter of Fundamental Rights.”

Further, the EDPB and the EDPS noted that they “consider that the use of AI to infer emotions of a natural person is highly undesirable and should be prohibited, except for very specified cases, such as some health purposes, where the patient emotion recognition is important, and that the use of AI for any type of social scoring should be prohibited.”

IV. UK POLICY & REGULATORY DEVELOPMENTS

A. UK Launches National AI Strategy

On September 22, 2021, the UK Government published its ‘National AI Strategy’ (the “Strategy”)[119]. According to the Parliamentary Under Secretary of State at the Department for Digital, Culture, Media and Sport, Chris Philip MP, the aim of the Strategy is to outline “the foundations for the next ten years’ growth” to help the UK seize “the potential of artificial intelligence” and to allow it to shape “the way the world governs it”[120]. The Strategy has three pillars: (1) investing in the long-term needs of the AI ecosystems; (2) ensuring AI benefits all sectors and regions; and (3) governing AI effectively.

To that end, the UK aims to attract global talent to develop AI technologies by continuing to support existing academia-related interventions, as well as broadening the routes that talented AI researchers and individuals can work in the UK (for example, by introducing new VISA routes). The UK also seeks to adopt a new approach to research, development and innovation in AI, by, for example, launching a National AI Research and Innovation (R&I) Programme, and also collaborate internationally on shared challenges in research and development (for example, by implementing the US UK Declaration on Cooperation in AI Research and Development.

The Strategy also highlights that effective, pro-innovation governance of AI means that, amongst other things, the UK has a clear, proportionate and effective framework for regulating AI that supports innovation while addressing actual risks and harms. Currently, the UK’s regulations for AI are arranged sector by sector ranging from competition to data protection. However, the Strategy acknowledges that this approach can lead to issues including inconsistent approaches across sectors and overlaps between regulatory mandates. To address this, the third pillar outlines key upcoming initiatives to improve AI governance: the Office for AI will publish a White Paper in early 2022, which will outline the Government’s position on the potential risks and harms posed by AI systems. The Government will also take other actions including piloting an AI Standards Hub to coordinate UK engagement in establishing AI rules globally, and collaborating with the Alan Turing Institute to provide updated guidance on the ethical and safety issues concerning AI.

B. UK Government Publishes Ethics, Transparency and Accountability Framework for Automated Decision Making

On May 13, 2021, the UK Government published a framework setting out how public sector bodies can deploy automated decision-making technology ethically and sustainably (the “Framework”).[121] The Framework segregates automated decision making into two categories: (1) solely automated decision making – decisions that are “fully automated with no human judgment” ; and (2) automated assisted decision making – when “automated or algorithmic systems assist human judgment and decision making.” The Framework applies to both types and sets out a seven-step process to follow when using automated decision-making: (1) test to avoid any unintended outcomes or consequences; (2) deliver fair services for all users and citizens; (3) be clear who is responsible; (4) handle data safely and protect citizens’ interests; (5) help users and citizens understand how it impacts them; (6) ensure compliance with the law, including data protection laws, the Equality Act 2010 and the Public Sector Equality Duty; and (7) ensure algorithms or systems are continuously monitored and mitigate against unintended consequences.

C. UK Government Publishes Standard for Algorithmic Transparency

Algorithmic transparency refers to openness about how algorithmic tools support decisions. The Cabinet Office’s Central Digital and Data Office (the “CDDO”) developed an algorithmic transparency standard for Government departments and public sector bodies, which was published on November 29, 2021[122] (the “Standard”). This makes the UK one of the first countries in the world to produce a national standard for algorithmic transparency. The Standard is in a piloting phase, following which the CDDO will review the Standard based on feedback gathered and seek formal endorsement from the Data Standards Authority in 2022.

D. ICO Offers Insight on its Policy Around the Use of Live Facial Recognition in the UK

On June 18, 2021, the Information Commissioner’s Office (“ICO”) published a Commissioner’s Opinion on the use of live facial recognition (“LFR”) in the UK (“the Opinion”).[123] Facial recognition is the process by which a person can be identified or otherwise recognized from a digital facial image. LFR is a type of facial recognition technology that often involves the automatic collection of biometric data. The Commissioner previously published an opinion in 2019 on the use of LFR in a law enforcement context, concluding that data protection law sets “high standards” for the use of LFR to be lawful when used in public spaces. The Opinion builds on this work by focusing on the use of LFR in public spaces—defined as any physical space outside a domestic setting, whether publicly or privately owned—outside of law enforcement. The Opinion makes clear that first and foremost, controllers seeking to use LFR must comply with the UK General Data Protection Regulation (“UK GDPR”) and the Data Protection Act 2018.

In terms of enforcement, the ICO announced on 29 November 2021 its intention to impose a potential fine of over just £17 million on Clearview AI Inc for allegedly gathering images of a substantial number of people from the UK without their knowledge, in breach of the UK’s data protection laws. The ICO also issued a provisional notice to the company to stop further processing the personal data of people in the UK and to delete it. The ICO’s preliminary view is that Clearview AI appears to have failed to comply with UK data protection laws in several ways including by failing to have a lawful reason for collecting the information and failing to meet the higher data protection standards required for biometric data under the UK GDPR. Clearview AI Inc will now have the opportunity to make representations in respect of the alleged breaches, following which the ICO is expected to make a final decision. This action taken by the ICO highlights the importance of ensuring that companies are compliant with UK data protection laws prior to processing and deploying biometric data.

E. UK Financial Regulator Vows to Boost Use of AI in Oversight

The UK’s Prudential Regulation Authority (“PRA”) intends to make greater use of AI, according to its Business Plan for 2021/22.[124] The focus on AI is part of the PRA’s aim to follow through on commitments set out in its response to the Future of Finance report (published in 2019) to develop further their RegTech strategy. The Future of Finance report recommended that supervisors take advantage of the ongoing developments in data science and processing power, including AI and machine learning, that automate data collection and processing.[125]

F. Consultation on the Future Regulation of Medical Devices in the UK

On September 16, 2021, the Medicines & Healthcare products Regulatory Agency (“MHRA”) published a “Consultation on the future regulation of medical devices in the United Kingdom”, which ran until November 25, 2021 (the “Consultation”).[126] The Consultation invited members of the public to provide their views on possible changes to the regulatory framework for medical devices in the UK, with the aim of developing a future regime for medical devices which enables (i) improved patient and public safety; (ii) greater transparency of regulatory decision making and medical device information; (iii) close alignment with international best practice and (iv) more flexible, responsive and proportionate regulation of medical devices.

The Consultation set out proposed changes for Software as a medical device (“SaMD”) including AI as a medical device (“AIaMD”), noting that current medical device regulations contain few provisions specifically aimed at regulating SaMD or AIaMD. The MHRA’s proposals therefore include amending UK medical devices regulations in order to both protect patients and support responsible innovation in digital health. Some of the possible changes put forward by the MHRA in the Consultation include (amongst others) defining ‘software’, clarifying or adding to the requirements for selling SaMD via electronic means, changing the classification of SaMD to ensure the scrutiny applied to these medical devices is more commensurate with their level of risk and more closely harmonised with international practice. The MHRA intends that any amendments to the UK medical device framework will come into force in July 2023.

The MHRA also separately published an extensive work programme on software and AI as a medical device to deliver bold change to provide a regulatory framework that provides a high degree of protection for patients and public, but also to ensure that the UK is the home of responsible innovation for medical device software.[127] Any legislative change proposed by the work programme will build upon wider reforms to medical device regulation brought about by the Consultation.

________________________

[1] Steven Overly & Melissa Heikkilä, “China wants to dominate AI. The U.S. and Europe need each other to tame it.,” Politico (Mar. 2, 2021), available at https://www.politico.com/news/2021/03/02/china-us-europe-ai-regulation-472120.

[2] Id.

[3] Id.

[4] For more detail, see our Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems.

[5] The White House, Press Release (Archived), The White House Launches the National Artificial Intelligence Initiative Office (Jan. 12, 2021), available at https://trumpwhitehouse.archives.gov/briefings-statements/white-house-launches-national-artificial-intelligence-initiative-office/.

[6] Id.

[7] The White House, Memorandum on Restoring Trust in Government Through Scientific Integrity and Evidence-Based Policymaking (Jan. 27, 2021), available at https://www.whitehouse.gov/briefing-room/presidential-actions/2021/01/27/memorandum-on-restoring-trust-in-government-through-scientific-integrity-and-evidence-based-policymaking/.

[8] Letter from Deputy Director Jane Lubchenco and Deputy Director Alondra Nelson, OSTP to all federal agencies (March 29, 2021), available at https://int.nyt.com/data/documenttools/si-task-force-nomination-cover-letter-and-call-for-nominations-ostp/ecb33203eb5b175b/full.pdf.

[9] The White House, Executive Order on the President’s Council of Advisors on Science and Technology (Jan. 27, 2021), available at https://www.whitehouse.gov/briefing-room/presidential-actions/2021/01/27/executive-order-on-presidents-council-of-advisors-on-science-and-technology/.

[10] Dan Reilly, “White House A.I. director says U.S. should model Europe’s approach to regulation,” Fortune (Nov. 10, 2021), available at https://fortune.com/2021/11/10/white-house-a-i-director-regulation/.

[11] S. 1260, 117th Cong. (2021).

[12] Id., §§4201-4207.

[13] Id., §4202.

[14] Id., §4204. For more details on the NSCAI report and 2020 Executive Order, please see our Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems.

[15] White House, “Join the Effort to Create a Bill of Rights for an Automated Society” (Nov. 10, 2021), available at https://www.whitehouse.gov/ostp/news-updates/2021/11/10/join-the-effort-to-create-a-bill-of-rights-for-an-automated-society/.

[16] Dave Nyczepir, “White House technology policy chief says AI bill of rights needs ‘teeth,’” FedScoop (Nov.10, 2021), available at https://www.fedscoop.com/ai-bill-of-rights-teeth/.

[17] Id.

[18] Office of Science and Technology Policy, Notice of Request for Information (RFI) on Public and Private Sector Uses of Biometric Technologies (Oct. 8, 2021), available at https://www.federalregister.gov/documents/2021/10/08/2021-21975/notice-of-request-for-information-rfi-on-public-and-private-sector-uses-of-biometric-technologies.

[19] U.S. Government Accountability Office, Artificial Intelligence: An Accountability Framework for Federal Agencies and Other Entities, Highlights of GAO-21-519SP, available at https://www.gao.gov/assets/gao-21-519sp-highlights.pdf.

[20] The key monitoring practices identified by the GAO are particularly relevant to organizations and companies seeking to implement governance and compliance programs for AI-based systems and develop metrics for assessing the performance of the system. The GAO report notes that monitoring is a critical tool for several reasons: first, it is necessary to continually analyze the performance of an AI model and document findings to determine whether the results are as expected, and second, monitoring is key where a system is either being scaled or expanded, or where applicable laws, programmatic objectives, and the operational environment change over time.

[21] Draft NIST Special Publication 1270, A Proposal for Identifying and Managing Bias in Artificial Intelligence (June 2021), available at https://nvlpubs.nist.gov/nistpubs/SpecialPublications/NIST.SP.1270-draft.pdf?_sm_au_=iHVbf0FFbP1SMrKRFcVTvKQkcK8MG.

[22] National Institute of Science and Technology, Comments Received on A Proposal for Identifying and Managing Bias in Artificial Intelligence (SP 1270), available at https://www.nist.gov/artificial-intelligence/comments-received-proposal-identifying-and-managing-bias-artificial.

[23] H.R. 5515, 115th Congress (2017-18).

[24] The National Security Commission on Artificial Intelligence, Previous Reports, available at https://www.nscai.gov/previous-reports/.

[25] NSCAI, The Final Report (March 1, 2021), available at https://www.nscai.gov/wp-content/uploads/2021/03/Full-Report-Digital-1.pdf.

[26] Defense Innovation Unit, Responsible AI Guidelines: Operationalizing DoD’s Ethical Principles for AI (Nov. 14, 2021), available at https://www.diu.mil/responsible-ai-guidelines.

[27] Securing the Information and Communications Technology and Services Supply Chain, U.S. Department of Commerce, 86 Fed. Reg. 4923 (Jan. 19, 2021) (hereinafter “Interim Final Rule”).

[28] For more information, please see our Artificial Intelligence and Automated Systems Legal Update (1Q21).

[29] S. 1776, 117th Cong. (2021).

[30] S. 1705, 117th Cong. (2021).

[31] Portman, Heinrich Announce Bipartisan Artificial Intelligence Bills Included in FY 2022 National Defense Authorization Act, Office of Sen. Rob Portman (Dec. 15, 2021), available at https://www.portman.senate.gov/newsroom/press-releases/portman-heinrich-announce-bipartisan-artificial-intelligence-bills-included.

[32] FTC, Business Blog, Elisa Jillson, Aiming for truth, fairness, and equity in your company’s use of AI (April 19, 2021), available at https://www.ftc.gov/news-events/blogs/business-blog/2021/04/aiming-truth-fairness-equity-your-companys-use-ai.

[33] FTC, Protecting Consumer Privacy in a Time of Crisis, Remarks of Acting Chairwoman Rebecca Kelly Slaughter, Future of Privacy Forum (Feb. 10, 2021), available at https://www.ftc.gov/system/files/documents/public_statements/1587283/fpf_opening_remarks_210_.pdf.

[34] FTC, Using Artificial Intelligence and Algorithms (April 8, 2020), available at https://www.ftc.gov/news-events/blogs/business-blog/2020/04/using-artificial-intelligence-algorithms.

[35] FTC, FTC Chair Lina M. Khan Announces New Appointments in Agency Leadership Positions (Nov. 19, 2021), available at https://www.ftc.gov/news-events/press-releases/2021/11/ftc-chair-lina-m-khan-announces-new-appointments-agency.

[36] FTC, Resolution Directing Use of Compulsory Process Regarding Abuse of Intellectual Property (Sept. 2, 2021), available at https://www.law360.com/articles/1422050/attachments/0. These resolutions were passed by the Democratic commissioners on a 3-2 party line vote. The GOP commissioners issued a dissenting statement, arguing that blanket authorizations remove commission oversight while doing nothing to make investigations more effective.

[37] Ben Brody, FTC official warns of seizing algorithms ‘juiced by ill-gotten data’ (July 27, 2021), available at https://www.protocol.com/bulletins/ftc-seize-algorithms-ill-gotten?_sm_au_=iHV5LNM5WjmJt5JpFcVTvKQkcK8MG.

[38] The FTC had previously relied on Section 13(b) to pursue disgorgement via injunctive relief, mostly concerning consumer protection violations. The Supreme Court found, however, that the injunction provision authorized the FTC only to seek a court order halting the illegal activity and did not give it the power to ask a court to impose monetary sanctions. A similar bill, which was introduced the week of the Supreme Court ruling and was endorsed by 25 state attorneys general and President Joe Biden, passed the House over the summer in a nearly party-line vote, but hasn’t yet been moved through the Senate. Republicans opposed that initiative over concerns about due process and the bill’s 10-year statute of limitations. The new bill, on the other hand, includes a three-year statute of limitations and wording that requires the commission to prove that the company accused of breaking the law did so intentionally.

[39] S. _ 117th Cong. (2022-2023) https://www.law360.com/cybersecurity-privacy/articles/1449355/gop-sen-floats-bill-to-restore-ftc-s-restitution-powers?nl_pk=4e5e4fee-ca5f-4d2e-90db-5680f7e17547&utm_source=newsletter&utm_medium=email&utm_campaign=cybersecurity-privacy

[40] Harry Brignull, the PhD who coined the term “dark patterns” has developed a taxonomy, which may include: trick questions; sneak into basket (in an online purchase, last minute items are added to the basket, without the user’s involvement); roach motel (services are easily entered into but difficult to cancel); privacy over-disclosure (users are tricked into sharing or making public more information than intended); price comparison prevention (websites make it difficult to compare prices from other providers); misdirection; hidden costs; bait and switch; confirmshaming (users are guilted into something or a decline option is phrased to shame the users, e.g. “No, I don’t want to save money”); disguised ads; forced continuity (free trial unexpectedly turns into a paid subscription); and friend spam (user contact list is used to send unwanted messages from the user). See Harry Brignull, Types of Dark Pattern, Dark Patterns, available at https://www.darkpatterns.org/types-of-dark-pattern.

[41] Bringing Dark Patterns to Light: An FTC Workshop, Federal Trade Commission, April 29, 2021, available at https://www.ftc.gov/news-events/events-calendar/bringing-dark-patterns-light-ftc-workshop.

[42] Jon Hill, CFPB’s Newest Hook On Big Tech May Be 1970s Data Law, Law360 (Nov. 16, 2021), available at https://www.law360.com/technology/articles/1439641/cfpb-s-newest-hook-on-big-tech-may-be-1970s-data-law?nl_pk=0d08c9f5-462a-4ad6-9d20-292663da6d5e&utm_source=newsletter&utm_medium=email&utm_campaign=technology.

[43] CFPB, CFPB Takes Action to Stop False Identification by Background Screeners (Nov. 4, 2021), available at https://www.consumerfinance.gov/about-us/newsroom/cfpb-takes-action-to-stop-false-identification-by-background-screeners/?_sm_au_=iHVFR9tfrf49TNNMFcVTvKQkcK8MG.

[44] EEOC, EEOC Launches Initiative on Artificial Intelligence and Algorithmic Fairness (Oct. 28, 2021), available at https://www.eeoc.gov/newsroom/eeoc-launches-initiative-artificial-intelligence-and-algorithmic-fairness?_sm_au_=iHV5LNM5WjmJt5JpFcVTvKQkcK8MG.

[45] FTC, In the Matter of Everalbum, Inc. and Paravision, Commission File No. 1923172 (Jan. 11, 2021), available at https://www.ftc.gov/enforcement/cases-proceedings/1923172/everalbum-inc-matter.

[46] FTC, Statement of Commissioner Rohit Chopra, In the Matter of Everalbum and Paravision, Commission File No. 1923172 (Jan. 8, 2021), available at https://www.ftc.gov/system/files/documents/public_statements/1585858/updated_final_chopra_statement_on_everalbum_for_circulation.pdf.

[47] See, e.g., Vance v. Amazon, 2:20-cv-01084-JLR (W.D. Wash. Oct. 7, 2021); Vernita Miracle-Pond et al. v. Shutterfly Inc., No. 2019-CH-07050, (Ill. Cir. Ct. of Cook County); Carpenter v. McDonald’s Corp., No. 2021-CH-02014 (Ill. Cir. Ct. May 28, 2021); Rivera v. Google, Inc., No. 1:16-cv-02714 (N.D. Ill. Aug. 30, 2021); Pena v. Microsoft Corp., No. 2021-CH-02338 (Ill. Cir. Ct. May 12, 2021); B.H. v. Amazon.com Inc., No. 2021-CH-02330 (Ill. Cir. Ct. May 12, 2021), Pruden v. Lemonade, Inc., No. 1:21-cv-07070 (S.D.N.Y. Aug. 20, 2021).

[48] S. _, 117th Cong. (2021); see also Press Release, Senators Markey, Merkley Lead Colleagues on Legislation to Ban Government Use of Facial Recognition, Other Biometric Technology (June 15, 2021), available at https://www.markey.senate.gov/news/press-releases/senators-markey-merkley-lead-colleagues-on-legislation-to-ban-government-use-of-facial-recognition-other-biometric-technology.

[49] For more details, please see our previous alerts: Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems.

[50] H.B. 2031, Reg. Session (2020-2021).

[51] For more details, see our Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems.

[52] S. 1896, 117th Cong. (2021); see also Press Release, Senator Markey, Rep. Matsui Introduce Legislation to Combat Harmful Algorithms and Create New Online Transparency Regime (May 27, 2021), available at https://www.markey.senate.gov/news/press-releases/senator-markey-rep-matsui-introduce-legislation-to-combat-harmful-algorithms-and-create-new-online-transparency-regime.

[53] H.R. 3723, 117th Cong. (2021).

[54] Elise Hansen, House Clears Bill To Study Crypto And Consumer Protection, Law360 (June 23, 2021), available at https://www.law360.com/articles/1396110/house-clears-bill-to-study-crypto-and-consumer-protection.

[55] S. 2134, 117th Cong. (2021); see also Press Release, Office of U.S. Senator Kirsten Gillibrand, Press Release, Gillibrand Introduces New And Improved Consumer Watchdog Agency To Give Americans Control Over Their Data (June 17, 2021), available at https://www.gillibrand.senate.gov/news/press/release/gillibrand-introduces-new-and-improved-consumer-watchdog-agency-to-give-americans-control-over-their-data.

[56] Under the proposed legislation, “personal data” is defined as “electronic data that, alone or in combination with other data—(A) identifies, relates to, describes, is capable of being associated with, or could reasonably be linked, directly or indirectly, with a particular individual, household, or device; or (B) could be used to determine that an individual or household is part of a protected class.” Data Protection Act of 2021, S. 2134, 117th Cong. § 2(16) (2021).

[57] Id., § 2(3) (2021).

[58] Id., § 2(11)-(13) (2021).

[59] H.R. 5921 (2021), available at https://www.congress.gov/bill/117th-congress/house-bill/5921/cosponsors?s=1&r=90&overview=closed; S.B. 2024 (2021), available at https://www.congress.gov/bill/117th-congress/senate-bill/2024/text.

[60] U.S. Senate Committee on Homeland Security & Governmental Affairs, Tech Leaders Support Portman’s Bipartisan Deepfake Task Force Act to Create Task Force at DHS to Combat Deepfakes (July 30, 2021), available at https://www.hsgac.senate.gov/media/minority-media/tech-leaders-support-portmans-bipartisan-deepfake-task-force-act-to-create-task-force-at-dhs-to-combat-deepfakes.

[61] For more details, see our Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems.

[62] S.B. 5116, Reg. Session (2021-22).

[63] Monica Nickelsburg, Washington state lawmakers seek to ban government from using discriminatory AI tech, GeewWire (Feb. 13, 2021), available at https://www.geekwire.com/2021/washington-state-lawmakers-seek-ban-government-using-ai-tech-discriminates/.

[64] N.Y.C., No. 1894-2020A (Nov. 11, 2021), available at https://legistar.council.nyc.gov/LegislationDetail.aspx?ID=4344524&GUID=B051915D-A9AC-451E-81F8-6596032FA3F9.

[65] See Thaler v. Hirshfeld, No. 120CV903LMBTCB, 2021 WL 3934803, at *8 (E.D. Va. Sept. 2, 2021) (noting “overwhelming evidence that Congress intended to limit the definition of ‘inventor’ to natural persons.”).

[66] See, e.g., Univ. of Utah v. Max-Planck-Gesellschaft, 734 F.3d 1315, 1323 (Fed. Cir. 2013); Beech Aircraft Corp. v. EDO Corp., 990 F.2d 1237, 1248 (Fed. Cir. 1993).

[67] The Artificial Inventor Project ambitiously describes DABUS as an advanced AI system. DABUS is a “creative neural system” that is “chaotically stimulated to generate potential ideas, as one or more nets render an opinion about candidate concepts” and “may be considered ‘sentient’ in that any chain-based concept launches a series of memories (i.e., affect chains) that sometimes terminate in critical recollections, thereby launching a tide of artificial molecules.” Ryan Abbott, The Artificial Inventor behind this project, available at https://artificialinventor.com/dabus/.

[68] Ryan Abbott, The Artificial Inventor Project, available at https://artificialinventor.com/frequently-asked-questions/.

[69] Thaler v. Hirshfeld, 2021 WL 3934803, at *2.

[70] Id. at *2.

[71] Id. at *8.

[72] The European Patent Office, EPO publishes grounds for its decision to refuse two patent applications naming a machine as inventor, Jan. 28, 2020, available at https://www.epo.org/news-events/news/2020/20200128.html.

[73] Dani Kass, EPO Appeal Board Affirms Only Humans Can Be Inventors, Law360, Dec. 21, 2021.

[74] Thomas Kirby, UK court dismisses DABUS – an AI machine cannot be an inventor, Lexology, Dec. 14, 2021.

[75] World’s first patent awarded for an invention made by an AI could have seismic implications on IP law, University of Surrey, July 28, 2021.

[76] Gene Quinn, DABUS Gets Its First Patent in South Africa Under Formalities Examination, IP Watchdog, July 29, 2021, available at https://www.ipwatchdog.com/2021/07/29/dabus-gets-first-patent-south-africa-formalities-examination/id=136116/.

[77] Thaler v Commissioner of Patents [2021] FCA 879.

[78] Google LLC v. Oracle Am., Inc., No. 18-956, 2021 WL 1240906, (U.S. Apr. 5, 2021).

[79] Id., at *3.

[80] Id. at *20.

[81] See id.

[82] Bill Donahue, Supreme Court Rules For Google In Oracle Copyright Fight, Law360 (April 5, 2021), available at https://www.law360.com/ip/articles/1336521.

[83] See U.S. Food & Drug Admin., Artificial Intelligence/Machine Learning (AI-ML)-Based Software as a Medical Device (SaMD) Action Plan 1-2 (2021), https://www.fda.gov/media/145022/download [hereinafter FDA AI Action Plan]; U.S. Food & Drug Admin., FDA Releases Artificial Intelligence/Machine Learning Action Plan (Jan. 12, 2021), https://www.fda.gov/news-events/press-announcements/fda-releases-artificial-intelligencemachine-learning-action-plan. See also U.S. Food & Drug Admin., Proposed Regulatory Framework for Modifications to Artificial Intelligence/Machine Learning (AI/ML)-Based Software as a Medical Device (SaMD) Discussion Paper and Request for Feedback (2019), https://www.fda.gov/media/122535/download.

[84] FDA AI Action Plan, supra note 1, at 1.

[85] U.S. Food & Drug Admin., Virtual Public Workshop – Transparency of Artificial Intelligence/Machine Learning-enabled Medical Devices (last updated Nov. 26, 2021) https://www.fda.gov/medical-devices/workshops-conferences-medical-devices/virtual-public-workshop-transparency-artificial-intelligencemachine-learning-enabled-medical-devices.

[86] Id.

[87] Id.

[88] Id.

[89] Id.

[90] U.S. Food & Drug Admin., Artificial Intelligence and Machine Learning (AI/ML)-Enabled Medical Devices (last updated Sept. 22, 2021), https://www.fda.gov/medical-devices/software-medical-device-samd/artificial-intelligence-and-machine-learning-aiml-enabled-medical-devices.

[91] Id.

[92] Id.

[93] As we addressed in previous legal updates, the House previously passed the SELF DRIVE Act (H.R. 3388) by voice vote in September 2017, but its companion bill (the American Vision for Safer Transportation through Advancement of Revolutionary Technologies (“AV START”) Act (S. 1885)) stalled in the Senate. For more details, see our Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems.

[94] U.S. Dep’t of Transp., Press Release, U.S. Department of Transportation Releases Spring Regulatory Agenda (June 11, 2021), available at https://www.transportation.gov/briefing-room/us-department-transportation-releases-spring-regulatory-agenda.

[95] U.S. Dep’t of Transp., NHTSA Orders Crash Reporting for Vehicles Equipped with Advanced Driver Assistance Systems and Automated Driving Systems, available at https://www.nhtsa.gov/press-releases/nhtsa-orders-crash-reporting-vehicles-equipped-advanced-driver-assistance-systems

[96] Id.

[97] Id.

[98] Id.

[99] Id.

[100] 49 CFR 571, available at https://www.nhtsa.gov/sites/nhtsa.gov/files/documents/ads_safety_principles_anprm_website_version.pdf

[101] Id., at 6.

[102] Id., at 7-8.

[103] SF 302, Reg. Session (2019-2020).

[104] ARC 5621C, Notice of Intended Action, available at https://rules.iowa.gov/Notice/Details/5621C.

[105] Id.

[106] Carly Page, US Banks Must Soon Report Significant Cybersecurity Incidents Within 36 Hours, (Nov. 19, 2021), available at https://techcrunch.com/2021/11/19/us-banks-report-cybersecurity-incidents/?guccounter=1.

[107] “Banking Organizations” is a defined term in the rule and applies to a slightly different mix of entities with respect to each agency.

[108] 86 Fed. Reg. 66424.

[109] Id. at 66438.

[110] 86 Fed. Reg. 16837.

[111] Al Barbarino, Bank Regulators Eye Updated Guidance to Fight Bias in AI (Oct. 21, 2021), available at https://www.law360.com/cybersecurity-privacy/articles/1433299/.

[112] EC, Proposal for a Regulation of the European Parliament and of the Council laying down Harmonised Rules on Artificial Intelligence and amending certain Union Legislative Acts (Artificial Intelligence Act), COM(2021) 206 (April 21, 2021), available at https://digital-strategy.ec.europa.eu/en/library/proposal-regulation-european-approach-artificial-intelligence.

[113] Ursula von der Leyen, A Union that strives for more: My agenda for Europe, available at https://ec.europa.eu/commission/sites/beta-political/files/political-guidelines-next-commission_en.pdf.

[114] Supra, note 39, p. 1.

[115] European Parliament, Resolution of 20 October 2020 with recommendations to the Commission on a framework of ethical aspects of artificial intelligence, robotics and related technologies (2020/2012 (INL)) (Oct. 20, 2020), available at https://www.europarl.europa.eu/doceo/document/TA-9-2020-0275_EN.pdf. For more detail, see our “3Q20 Artificial Intelligence and Automated Systems Legal Update“.

[116] Draft Report on AI in a Digital Age for the European Parliament (Nov. 2, 2021), available at https://www.europarl.europa.eu/meetdocs/2014_2019/plmrep/COMMITTEES/AIDA/PR/2021/11-09/1224166EN.pdf

[117] Joint Opinion 5/2021 on the proposal for a Regulation of the European Parliament and of the Council laying down harmonised rules on artificial intelligence, available at https://edpb.europa.eu/system/files/2021-06/edpb-edps_joint_opinion_ai_regulation_en.pdf.

[118] EDPS, Press Release, EDPB & EDPS Call For Ban on Use of AI For Automated Recognition of Human Features in Publicly Accessible Spaces, and Some Other Uses of AI That Can Lead to Unfair Discrimination (June 21, 2021), available at https://edps.europa.eu/press-publications/press-news/press-releases/2021/edpb-edps-call-ban-use-ai-automated-recognition_en?_sm_au_=iHVWn7njFDrbjJK3FcVTvKQkcK8MG.

[119] UK Government, National AI Strategy (22 September 2021), available at https://www.gov.uk/government/publications/national-ai-strategy.

[120] UK Government, New ten-year plan to make the UK a global AI superpower (22 September 2021), available at https://www.gov.uk/government/news/new-ten-year-plan-to-make-britain-a-global-ai-superpower.

[121] UK Government, Ethics, Transparency and Accountability Framework for Automated Decision-Making (13 May 2021), available at https://www.gov.uk/government/publications/ethics-transparency-and-accountability-framework-for-automated-decision-making.

[122] UK Government, UK government publishes pioneering standard for algorithmic transparency (November 29, 2021), available at https://www.gov.uk/government/news/uk-government-publishes-pioneering-standard-for-algorithmic-transparency–2.

[123] UK Government, Information Commissioner’s Office, The use of live facial recognition technology in public places (June 18, 2021), available at https://ico.org.uk/media/for-organisations/documents/2619985/ico-opinion-the-use-of-lfr-in-public-places-20210618.pdf.

[124] UK Gov’t, Prudential Regulation Authority Business Plan 2021/22 (May 24, 2021), available at https://www.bankofengland.co.uk/prudential-regulation/publication/2021/may/pra-business-plan-2021-22.

[125] UK Gov’t, Future of Finance, Bank of England (June 2019), available at https://www.bankofengland.co.uk/-/media/boe/files/report/2019/future-of-finance-report.pdf?la=en&hash=59CEFAEF01C71AA551E7182262E933A699E952FC.

[126] UK Gov’t, Consultation on the future regulation of medical devices in the United Kingdom (Sept. 16, 2021), available at https://www.gov.uk/government/consultations/consultation-on-the-future-regulation-of-medical-devices-in-the-united-kingdom.

[127] UK Gov’t, Software and AI as a Medical Device Change Programme (Sept. 16, 2021), available at https://www.gov.uk/government/publications/software-and-ai-as-a-medical-device-change-programme.

The following Gibson Dunn lawyers prepared this client update: H. Mark Lyon, Frances Waldmann, Emily Lamm, Tony Bedel, Kevin Kim, Brendan Krimsky, Prachi Mistry, Samantha Abrams-Widdicombe, Leon Freyermuth, Iman Charania, and Kanchana Harendran.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Artificial Intelligence and Automated Systems Group, or the following authors:

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Frances A. Waldmann – Los Angeles (+1 213-229-7914,[email protected])

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On January 18, 2022, the U.S. Federal Trade Commission (“FTC”) and the Department of Justice’s Antitrust Division (“DOJ”) held a press conference to announce a joint public inquiry aimed at revising the agencies’ merger guidelines. The agencies’ Horizontal Merger Guidelines, previously revised in 2010, reflect the framework the agencies use to evaluate whether M&A transactions between actual and potential competitors violate the antitrust laws. The 2020 Vertical Merger Guidelines—which the FTC previously announced it will no longer follow—address combinations of companies at different levels of a supply chain (e.g., manufacturers and their customers.

FTC Chair Lina Khan and Assistant Attorney General (“AAG”) Jonathan Kanter opened the conference with remarks about the agencies’ decision to undertake a review of the merger guidelines, along with details about the accompanying Request for Information (“RFI”). The theme of their remarks was a shared desire to strengthen the “joint merger guidelines to meet the challenges and realities of the modern economy.”[1]

The RFI addresses fifteen topics associated with merger review,[2] but Chair Khan and AAG Kanter focused their remarks on a handful of priorities:

Monopolies: The agencies plan to review how the merger guidelines should more specifically address transactions that might create or strengthen dominant firms, taking into account a range of “business strategies and incentives” that might drive acquisitions by such firms. For example, the agencies’ RFI asks how the guidelines should address “serial” and “rollup” acquisitions of competitors by large companies and private equity firms—and whether such transactions collectively might “tend to create a monopoly” in violation of Section 7 of the Clayton Act.
Labor Issues: The agencies seek comment and information on whether the guidelines should specifically address the possible effects of mergers on employees and workers. In doing so, the agencies signal that they may consider factors such as the impact of a merger on wages, salaries, and other forms of compensation. They will also seek information on whether the guidelines should treat the elimination of jobs as a cognizable efficiency of a merger.
Evidence of Anticompetitive Effects: The agencies seek information as to whether the current guidelines and agency merger analysis are unduly limited in their focus on price effects of a merger. Specifically, the agencies will consider whether other indicia of anticompetitive effects, such as head-to-head competition between the merging parties, should be given more weight, and whether such evidence is more appropriate to analyzing mergers in certain industries.
Accounting for “Market Realities:” The agencies seek comment as to whether, in a “dynamic and multi-dimensional economy,” defining markets is a reliable tool for assessing the potential harm of mergers. They further seek information on how to capture dynamism in the market and whether the guidelines should consider competition in terms of “stacks” or “clusters” of component products and services that drive digital and physical supply chains.
Convergence of Horizontal and Vertical Merger Analysis: The agencies seek input as to whether the traditional separation of horizontal and vertical merger analysis accurately reflects the realities of the modern economy. They will assess, in general, whether rigid categories accurately capture complex and dynamic business relationships, particularly in technology markets.

Focus on Digital Markets

The above concerns reflect the agencies’ leadership’s view that the current merger guidelines fail to fully account for the types of competitive harms mergers present in today’s technology markets generally, and digital markets in particular. Indeed, AAG Kanter stated that “[o]ur country depends on competition to drive progress, innovation and prosperity . . . [and for that reason] [w]e need to understand why so many industries have too few competitors, and to think carefully about how to ensure our merger enforcement tools are fit for purpose in the modern economy.” The RFI calls out digital markets specifically. Agency officials explained they want to establish an analytical roadmap for assessing digital markets because such markets raise “different issues” like tipping, zero price issues, and data aggregation.

Statement of Commissioners Noah Joshua Phillips and Christine S. Wilson

Following the announcement, FTC Commissioners Noah Joshua Phillips and Christine S. Wilson issued a joint statement endorsing the effort to seek public comment on the guidelines because “it reflects [the FTC’s] posture of continual learning.” Their comments also highlight that the 2010 Horizontal Merger Guidelines have largely been accepted by the courts because they are based on a consensus framework developed over decades. They noted that the 2010 Guidelines succeeded in providing transparency and predictability to the business community. Any revisions to the guidelines must reflect the administrability, transparency, and predictability considerations that made the 2010 guidelines successful. In order to fully account for these considerations, Commissioners Phillips and Wilson encourage the public to submit comments and concerns on both the legal and economic issues presented in the RFI, as well as the assumptions that underlie those particular questions.

Next Steps and Implications

Chair Khan remarked that “[t]his inquiry . . . is designed to ensure that [the agencies’] merger guidelines accurately reflect modern market realities and equip [the agencies] to forcefully enforce the law against unlawful deals.” [3] As many expected, the FTC and DOJ under the Biden Administration are proceeding with revisions to the federal merger guidelines that will reflect the Administration’s goal of strengthening antitrust enforcement. It remains to be seen whether and how the revised guidelines address this broad range of topics, and whether they will be adopted by the courts. Commissioners Phillips and Wilson observed that the existing guidelines embraced well-established legal and economic principles and enhanced transparency for merging parties. For new guidelines to have the same impact, they will need to reflect a similar approach.

Companies concerned about the forthcoming guidelines should begin making plans now to ensure those concerns are amply documented before the agency. As Commissioners Wilson and Philips emphasized, substantial, evidence-based comments—whether submitted directly by a company, or by a trade association—have historically driven guidelines the reflect a consensus framework. Businesses and the agencies alike share an interest in a merger review framework that results in necessary enforcement while avoiding over deterrence in merger and acquisition activity.

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[1] Statement of AAG Jonathan Kanter (Jan. 18, 2022).

[2] The full list of topics are as follows: Purpose, Harms, and Scope, Types and Sources of Evidence, Coordinate Effects, Unilateral Effects, Presumptions, Market Definition, Potential and Nascent Competition, Remedies, Monopsony Power and Labor Markets, Innovation and IP, Digital Markets, Special Characteristics Markets, Barriers to Firm Entry and Grown, Efficiencies, and Failing and Flailing Firms.

[3] Statement of Chair Lina Khan (Jan. 18, 2022).

The following Gibson Dunn lawyers prepared this client alert: Adam Di Vincenzo, Rachel Brass, and Kareem Ramadan.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please feel free to contact the Gibson Dunn attorney with whom you usually work in the firm’s Antitrust and Competition Practice Group, the authors, or any of the following:

Rachel S. Brass – San Francisco (+1 415-393-8293, [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])
Richard G. Parker – Washington, D.C. (+1 202-955-8503, [email protected])
Michael J. Perry – Washington, D.C. (+1 202-887-3558, [email protected])
Stephen Weissman – Washington, D.C. (+1 202-955-8678, [email protected])

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

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I. Introduction: Themes and Notable Developments

A. A New Administration Leverages a Traditional Playbook

With the confirmation of Chair Gary Gensler in April and the appointment of Enforcement Division Director Gurbir Grewal in June, the latter half of 2021 provided greater insight into the ways in which heightened enforcement under this Administration will impact market participants and the implications for clients going forward. In speeches in the latter half of 2021, Director Grewal and Chair Gensler outlined their enforcement priorities. While many of their themes echo the messages of prior Democratic administrations, certain points this Commission has chosen to emphasize could have outsized impact on public companies, SEC-registered firms and their executives and outside professionals.

Remedies – Director Grewal expressed the intention to escalate the sanctions the Commission would demand in both negotiated resolutions and litigated enforcement actions. While the remedies are not new, the focus on expanding the magnitude and frequency of sanctions reflects not just desire to increase the amount of particular sanctions, but also the breadth of parties and circumstances that would trigger a demand for certain sanctions.
- Penalties – Picking up on a theme articulated by then-Acting Chair Caroline Crenshaw earlier this year (and discussed in our Mid-Year Alert [link: https://www.gibsondunn.com/2021-mid-year-securities-enforcement-update/]), Director Grewal warned of the likelihood of increased penalties generally, and in particular, in circumstances where, in the Commission’s view, penalties have been insufficient to deter perceived misconduct based in part on previous enforcement actions against other actors in the same industry. Director Grewal was particularly pointed on the diminished relevance of prior settlements when negotiating current settlements. As Director Grewal bluntly stated, “You should not expect comparable cases to be the beginning and end of our analysis.”[1]
- Bars – Director Grewal has also signaled an intention to pursue officer and director bars, including in cases in which an individual defendant was not an officer or director of a public company. As Grewal explained, in determining whether to recommend pursuing a bar, the Enforcement Division would consider whether the individual is simply “likely to have an opportunity to become an officer and director of a public company in the future.”[2] In at least one recent example, in a litigated enforcement case, the Commission is seeking officer and director bars against individuals who are, according to the complaint, not employed by public companies.[3]
- Admissions – In Director Grewal’s words, “When it comes to accountability, few things rival the magnitude of wrongdoers admitting that they broke the law. . . . Admissions, given their attention-getting nature, also serve as a clarion call to other market participants to stamp out and self-report the misconduct to the extent it is occurring in their firm.”[4] Not long after that speech, the Commission announced a settled enforcement action that contained admissions to regulatory recordkeeping violations.[5] Notably, violation of such regulatory provisions does not give rise to private rights of action. It will remain to be seen to what extent the Commission seeks admissions in other circumstances.
Recidivism – Director Grewal emphasized that “recidivism” would be a potentially significant factor in the assessment of appropriate resolutions. In Grewal’s words, “When a firm repeatedly violates our laws or rules, they should expect to be penalized more harshly than a first-time offender might be for the same conduct.”[6] As discussed below, this position raises significant concerns about the applicability of the term “recidivist” in the context of securities enforcement.
Gatekeepers – In separate speeches, both Chair Gensler and Director Grewal emphasized a focus on gatekeepers – lawyers, auditors, accountants, bankers and investment advisers – who play a variety of roles in the securities industry, capital markets, and public company financial reporting and disclosure. As Chair Gensler articulated his perspective in a message to such gatekeepers, “You occupy positions of trust. Though you represent your clients, you also have an important role in upholding the law, which protects investors and our markets. You can often be the first lines of defense. That’s particularly true when a client is getting close to crossing the line.”[7] Director Grewal made a similar point in separate remarks, “Encouraging your clients to play in the grey areas or walk right up to the line creates significant risk. It’s when companies start testing those lines that problems emerge and rules are broken. . . . That’s why gatekeepers will remain a significant focus for the Enforcement Division, as evidenced by some of our recent actions.”[8]

Our Take – It is not surprising that the Enforcement Division under this Administration would emphasize seeking greater sanctions, particularly penalties, in enforcement actions. Perhaps notable is that this Administration has not articulated new remedies, just more of the existing ones without any guiding principles. The lack of transparency regarding when admissions will be demanded, whether voluntary disclosure or cooperation will impact that determination, or even why admissions are needed, is notable. An absence of guidelines may very well lead to a lack of consistency. It remains to be seen whether the Enforcement Division is able to execute on such vision if the demand for such sanctions also results in an increase in the Commission’s litigation caseload. While remedies such as penalties can often be negotiated to a resolution, other remedies, such as bars and admissions, can be far more consequential for individuals and entities. As a result, an effort to flex a regulatory muscle by demanding greater remedies may ultimately run up against a resource constraint on the ability to litigate cases.

Arguably of greater potential impact is the emphasis on conceptual themes, such as recidivism and gatekeepers. The concept of recidivism, for example, can easily be misapplied in the regulatory context. In any large, diversified enterprise with thousands of employees engaged in a highly regulated business, it is almost inevitable that over time a number of securities law violations will occur, often comprised of unintentional mistakes. Violations can arise for an unlimited number of different reasons, including individual misconduct, growth and diversification of the business, prevailing industry practice, emerging risks, acquisitions, and evolving regulatory interpretations and standards of enforcement. Trying to apply a label such as “recidivist” in this context can not only be inappropriate, but also leave parties exposed to the rhetorical judgments of regulators as to what constitutes recidivism.

Similarly, defining a wide range of professionals as “gatekeepers” and then cautioning them on the risks of advising clients acting in the “grey areas” suggests a vision of advisers (lawyers, accountants, financial advisers) that is inconsistent with their roles. Many areas of the law are grey, especially those subject to agency discretion and interpretation, and it is precisely in the grey areas that clients should be reaching out to their advisers and most need advice. The Commission has long articulated a position of not pursuing enforcement actions against professional advisers, particularly counsel, on the basis of advice, but rather only for participation in misconduct that rises to the level of a direct or secondary violation. One hopes that the recent rhetoric about the focus on gatekeepers does not signal a departure from decades of Commission practice in this area.

B. A Look at – and Behind – the Numbers

The enforcement statistics for fiscal 2021 reflected a 7% year-over-year increase in standalone actions, from 405 in 2020 to 434 in 2021. However, to put this number in perspective, 2020 saw a substantial decrease in enforcement actions due to the pandemic. Thus, the 434 standalone enforcement actions for fiscal 2021 represented a decline of more than 17% from the 526 enforcement actions in 2019. The distribution of actions was consistent with prior years, with the majority of cases involving broker-dealers and investment advisers, securities offerings, and public company financial reporting. Financial remedies ordered in fiscal 2021 represented an increase in penalties (from $1.09 billion in 2020 to $1.46 billion in 2021), but a decrease in disgorgement ordered (from $3.59 billion in 2020 to $2.40 in 2021).[9]

One must always exercise caution when drawing conclusions about enforcement trends from such metrics, particularly in light of the pandemic and in a year of transition in administrations. In particular, given the close of the fiscal year on September 30 and the extended pipeline through which enforcement actions ultimately receive formal approval, the impact of this administration on metrics such as the number of cases and size of financial remedies are more likely to be measurable in future years. With that in mind, below are graphical representations of the metrics over recent years.

C. SPACs

The SEC continued its focus on Special Purpose Acquisition Companies (“SPACs”) in the second half of 2021. Multiple enforcement actions came on the heels of pronouncements by senior SEC officials earlier last year concerning the risks posed by the explosion of SPAC initial public offerings, including a potential misalignment of interests and incentives between SPAC sponsors and shareholders. For example, in July, the SEC announced a partially settled enforcement action against a SPAC, the SPAC sponsor, and the CEO of the SPAC, as well as the proposed merger target and the former CEO of the target for misstatements in a registration statement and amendments concerning the target’s technology and business risks.[10] Please see our prior client alert [link: https://www.gibsondunn.com/sec-fires-shot-across-the-bow-of-spacs/] on this subject for an analysis of the lessons learned from the matter.

In December, the SEC also provided an update to an action originally filed in July[11] against a publicly traded company’s founder and former CEO.[12] The Commission’s complaint filed in July alleged that the company’s former CEO encouraged investors to follow him on social media to get “accurate information” about the company “faster than anywhere else,” but, instead, he allegedly misled investors about the company’s technological advancements, products, in-house production capabilities, and commercial achievements. In its December update, the SEC announced that the company agreed to settle the action. Without admitting or denying the SEC’s findings, the company agreed to cease and desist from future violations, to certain voluntary undertakings, to pay $125 million in penalties, and to continue cooperating with the SEC’s ongoing litigation and investigation.

D. Commissioner and Senior Staffing Update

In the waning days of 2021, one of the two Republican-appointed members of the Commission, Commissioner Elad Roisman, announced that he would leave the SEC by the end of January 2022.[13] The departure will reduce the normally five-member Commission to four members until a replacement is appointed, and will leave Commissioner Hester Peirce as the lone Republican-appointed Commissioner for the time being. Commissioners Roisman and Peirce have been reliable dissenting voices at the Commission in the last year, and we would expect to see continued dissent from Commissioner Peirce notwithstanding the loss of her fellow-Republican Commissioner ally.

In the second half of 2021, Chair Gensler and Enforcement Director Grewal continued building out the senior staff of the Commission. Notable appointments included:

In July, Daniel Kahl was appointed Acting Director of the Division of Examinations, succeeding Peter Driscoll.[14] Kahl joined the SEC in 2001 as a staff attorney, and most recently served as Deputy Director for Division of Examinations. He also served as an attorney for FINRA, the Investment Adviser Association, and the North American Securities Administrators Association.
In August, Sanjay Wadhwa was named Deputy Director of the Division of Enforcement.[15] Wadhwa has worked for the SEC for 18 years, most recently as the Senior Associate Director of Enforcement for the New York Regional Office.
In September, Dan Berkovitz was appointed SEC General Counsel, succeeding John Coates.[16] Berkovitz was previously a Commissioner of the Commodity Futures Trading Commission (CFTC). Mr. Berkovitz has previous experience in private practice and an extensive public service career, including as General Counsel for the CFTC, a senior staff attorney for the U.S. Senate Permanent Subcommittee on Investigations, and Deputy Assistant Secretary in the Department of Energy’s Office of Environmental Management.
In early November, Nicole Creola Kelly was named Chief of the SEC Office of the Whistleblower.[17] Kelly is a 20-year veteran of the SEC, most recently serving as Senior Special Counsel in the Office of General Counsel. She was also previously Counsel to SEC Chair Mary Jo White and former SEC Commissioner Kara M. Stein.
In November, Daniel Gregus was appointed Director of the Chicago Regional Office.[18] He had previously served as acting co-director of the Chicago office. Gregus has spent 28 years with the SEC in varying roles, including as Associate Director of the National Clearance and Settlement Examination Program and Associate Regional Director for the Broker-Dealer and Exchange Examination Program in the Chicago office. Prior to joining the SEC, Mr. Gregus was in private practice.
Also in November, the SEC announced the appointment of Haoxiang Zhu as Director of Division of Trading and Markets.[19] Zhu joins the SEC from academia, most recently holding the post of Professor at the MIT Sloan School of Management. He also previously served as an academic expert for the CFTC and Bank for International Settlements. Mr. Zhu is a member of the Federal Reserve Bank of Chicago’s Working Group on financial markets.
In December, Judge James Grimes was named the SEC’s Chief Administrative Law Judge, succeeding Brenda Murray.[20] Judge Grimes previously spent 13 years at the Department of Justice, serving as a trial attorney and senior litigation counsel in the Civil Division. He previously served with the Navy Judge Advocate General (JAG) Corps, representing service members in courts-martial and representing the government before military appellate courts.
Also in December, William Birdthistle was appointed Director of Division of Investment Management.[21] Before joining the SEC, Mr. Birdthistle was a Professor of Law at Chicago-Kent College of Law, where his research focused on investment funds, securities regulation, and corporate governance. He also previously worked in private practice as a corporate associate for five years.

E. Whistleblower Awards

The SEC’s whistleblower program remains a significant source of incoming information for the SEC and, as has been true for many years, the significant recovery associated with whistleblower awards continues to grow. As of year-end 2021, the SEC has awarded approximately $1.2 billion to 236 individuals since issuing its first award in 2012.

In August, Chair Gensler responded to criticism regarding amendments to the whistleblower rules that were previously adopted in September 2020 and acknowledged that there were concerns regarding whether the amendments would have the effect of chilling whistleblowers from coming forward.[22] In response, Chair Gensler directed his staff to prepare potential revisions to the rules to address those concerns. Interim rules were instituted in order to ensure that whistleblowers “with claims pending” while the amended rules are being considered “are not disadvantaged.”[23] In response, Commissioners Peirce and Roisman issued a strongly worded statement disagreeing with the Commission’s action to “substantively ignore [Commission rules] while proposed amendments are formulated and considered,” calling the course of action “unwise and . . . a troubling and counterproductive precedent.”[24] As of the end of 2021, the interim rules remain in place and the Commission is moving forward with proposed revisions to the whistleblower rules.

Also in the second half of the year, the Commission announced that not all tips are good tips. In September, the SEC barred two individuals from the whistleblower award program, each of whom had filed hundreds of award applications that the SEC described as “frivolous” and did not contribute to any successful enforcement action.[25] The bars were issued pursuant to the 2020 amendments to the Whistleblower Program Rules, which were designed to allow the whistleblower program to operate more effectively and efficiently and to focus on good faith whistleblower submissions.

Significant whistleblower awards granted during the second half of this year included:

Two awards in July, including a payment of more than $1 million to a whistleblower who provided “valuable” information and ongoing assistance, which led to an SEC enforcement action;[26] and an award of nearly $3 million to a whistleblower who alerted the SEC to previously unknown conduct and then provided “substantial” additional assistance, which led to a successful enforcement action.[27]
Four awards in August, including awards totaling more than $4 million to four whistleblowers in two separate enforcement proceedings, each of whom were described as providing “high-quality information that made an important contribution” to the success of the underlying enforcement action;[28] awards totaling more than $3.5 million to three individuals in two separate enforcement proceedings, one of whom was awarded approximately $2 million for alerting SEC staff to an ongoing fraud, prompting the opening of an investigation;[29] awards of nearly $6 million to two whistleblowers in separate enforcement proceedings, one of whom was awarded more than $3.5 million for reporting new information that caused the SEC to expand an existing investigation into a new geographic area, while the other whistleblower was awarded more than $2.4 million for alerting the SEC to previously unknown conduct, prompting the opening of the investigation;[30] and awards totaling approximately $2.6 million to five whistleblowers in three separate enforcement proceedings who provided information, developed either from the whistleblower’s independent knowledge or the whistleblower’s independent analysis, which “substantially” contributed to a successful enforcement action.[31]
Three awards in September—including a notable award of approximately $110 million, consisting of an approximately $40 million award in connection with an SEC case and an approximately $70 million award arising out of related actions by another agency—for providing “significant” independent analysis that “substantially advanced” the investigations.[32] This award stands as the second-highest award in the program’s history, following the over $114 million whistleblower award the SEC issued in October 2020. Additional awards in September included payments totaling approximately $11.5 million to two whistleblowers, one of whom was awarded nearly $7 million in recognition of the fact that the whistleblower was the initial source that caused the staff to open the investigation into hard-to-detect violations and thereafter provided substantial assistance, while the second whistleblower, by comparison, submitted information after the investigation was already underway and had delayed reporting for several years after becoming aware of the wrongdoing;[33] and an award of approximately $36 million to a whistleblower who provided what the SEC described as “crucial information” on an illegal scheme, which “significantly” contributed to the success of an SEC enforcement action, as well as actions by another federal agency.[34]
Two awards in October, including awards totaling approximately $40 million to two whistleblowers, one of whom received approximately $32 million for providing information that caused the opening of the investigation and exposed difficult-to-detect violations, as well as ongoing assistance, while the other whistleblower received approximately $8 million for providing new information during the course of the investigation, but waited several years to report to the Commission;[35] and a payment of more than $2 million to a whistleblower who provided information that led to a successful related action by the U.S. Department of Justice.[36]
Two awards in November, including awards totaling more than $15 million to two whistleblowers, one of whom received more than $12.5 million for alerting Commission staff to a fraudulent scheme and prompted the opening of an investigation;[37] and awards totaling approximately $10.4 million to seven whistleblowers who provided information and assistance in three separate covered actions.[38]
An award in December of nearly $5 million to a whistleblower who provided information and assistance that led to the success of a covered action, resulting in the return of millions of dollars to investors.[39]

II. Public Company Accounting, Financial Reporting, and Disclosure Cases

Public company accounting and disclosure cases continued to comprise a significant portion of the SEC’s cases in the latter half of 2021, and included a range of actions concerning earnings management, revenue recognition, impairments, internal controls, and disclosures concerning financial performance.

A. Financial Reporting Cases

In July, the SEC announced a complaint against the former CEO and CFO of a network infrastructure company for alleged accounting fraud.[40] From January 2017 to January 2019, the SEC alleged that the executives secretly caused the company to issue nearly $23 million in convertible notes, each of which required complex analyses under GAAP, but instead masked the convertible notes as conventional promissory notes by creating fake copies and forging board signatures to mislead internal and external auditors. Additionally, from early 2016 to November 2018, the executives allegedly inflated company revenues more than 100% by recording revenues from purportedly completed construction projects for which the infrastructure company had yet to complete the work. The SEC also alleged that the executives misappropriated $5.4 million from the company for personal use, including salary increases, luxury cars, private jet services, and unauthorized cash payments. The litigation is ongoing, and the SEC is seeking permanent injunctions, penalties, and officer and director bars against the executives. The U.S. Attorney’s Office for the Southern District of New York also brought criminal charges against the two executives.

Also in July, the SEC announced a settled action against a specialty leather retailer and its former CEO for accounting, reporting, and control failures related to the retailer’s inventory tracking system which could not accurately support the retailer’s inventory accounting methodology.[41] The SEC alleged that the inventory tracking system resulted in misleading financial statements which, for years, impacted the company’s calculations for income, profits, and inventory. According to the SEC, the CEO was aware of the inventory tracking system’s shortcomings and did not adequately remedy them, nor institute additional proper accounting controls to ensure that inventory was recorded in accordance with GAAP. Without admitting or denying the allegations, the retailer and the CEO agreed to cease and desist from future violations and pay a combined penalty of $225,000.

In September, the SEC instituted a settled action against a multinational food company and two former employees for negligently misreporting the company’s financial results.[42] The SEC alleged that, for multiple years, the food company’s procurement division caused the company to prematurely recognize discounts from suppliers, which reduced the company’s reported cost of goods sold. The SEC further alleged that the food company’s internal controls relating to accounting for supplier contracts were ineffective, and it alleged that the individual respondents, who had overseen the procurement division, should have known about the accounting misstatements. Without admitting or denying the allegations, the food company agreed to pay a $62 million civil penalty, which recognized the company’s cooperation and remedial control improvements; one employee consented to a cease-and-desist order and paid disgorgement and a $300,000 civil penalty; and the other employee consented to a permanent injunction, a $100,000 civil penalty, and a five-year ban from serving as an officer or director of a public company.

In December, the SEC instituted a settled action against a dialysis provider and three former executives for improperly calculating and reporting revenue adjustments related to actual and expected payments from patients’ health insurance providers.[43] The SEC alleged that, from 2017 to 2018, the company manipulated its revenues through accounting adjustments of the difference between what the company anticipated a patient’s insurance might pay for medical treatment and the actual payment received. The three executives were alleged to have orchestrated a scheme to determine these adjustments not based on the actual difference between expected and received payment for each patient, but rather, based on mathematical calculations to achieve pre-determined revenue figures in any given period. Furthermore, the adjustments were not reported until they were needed to meet financial targets. The executives were also alleged to have misled the company’s outside auditor in order to conceal this accounting practice. Without admitting or denying wrongdoing, the company agreed to resolve the action in a judgment with a permanent injunction and a $2 million fine. Litigation against the executives remains ongoing, and also includes an allegation of making false statements to the company’s auditors.

B. Disclosure Cases

In June, the SEC instituted a settled action against a publicly traded provider of title and escrow services, alleging disclosure controls violations related to a cybersecurity vulnerability that exposed sensitive customer information.[44] The SEC alleged that the issuer’s information security personnel discovered a vulnerability that exposed a large number of customers’ personally identifiable information, but waited several months to escalate and remediate it. Because information about the incident had not been escalated to senior management, the issuer filed an inaccurate Form 8-K about the incident. According to the SEC, the issuer failed to maintain adequate disclosure controls designed to ensure that all available, relevant information concerning the vulnerability was analyzed for disclosure. Without admitting or denying the findings, the issuer agreed to a cease-and-desist order and to pay approximately $490,000 in civil penalties.

In July, the SEC announced settled actions against a medical diagnostics company and two executives related to allegedly misleading statements regarding the company’s ability to produce COVID-19 tests and personal protective equipment (“PPE”) in order to boost its declining stock price.[45] The SEC alleged that the company issued a series of press releases touting the immediate availability of PPE for sale, and that it would be developing a COVID-19 test which would be “available soon.” The SEC alleged that, in fact, the company was insolvent, and this prevented it both from developing the COVID-19 test and purchasing or importing PPE for retail sale. Without admitting or denying the findings, the company and executives consented to a permanent injunction from future violations and combined penalties of $185,000. The two executives also consented to officer and director bars for three and five years each.

In August, the SEC announced a complaint against the former CEO of a private technology company, alleging that the CEO inaccurately claimed that the company had achieved strong and consistent revenue and customer growth in order to push it to a “unicorn” valuation of over $1 billion.[46] According to the SEC, the CEO misrepresented the value of numerous customer deals to investors and altered or created invoices to make it appear that customers had been billed at higher amounts than they actually had. The SEC’s litigation against the former CEO remains ongoing, and the U.S. Attorney’s Office for the Northern District of California announced criminal charges against the CEO stemming from the same conduct.

Also in August, the SEC instituted a settled action against a U.K.-based company that provides publishing and other services to schools and universities, alleging that the company made misleading statements and omissions to investors about a cyber breach.[47] The order alleged that, in 2018, the company experienced a breach that resulted in the theft of millions of student records, including email addresses and dates of birth. According to the Commission, the company’s disclosures referred to a data privacy incident as a mere hypothetical risk, when, in fact, the breach had already occurred. Moreover, the company issued a media statement that misstated or omitted certain details about the breach. The SEC alleged that the company failed to maintain disclosure controls and procedures designed to ensure that those responsible for making disclosure determinations were adequately informed about the breach. Without admitting or denying the SEC’s findings, the publisher agreed to cease and desist from future violations and to pay a $1 million civil penalty.

In September, the SEC filed a complaint against the principals of a subprime automobile finance company for allegedly misleading investors about the loans which backed its $100 million offering.[48] The SEC alleged that the principals inflated the value of these asset-backed securities by including loans that were not eligible in the securitization vehicle, extending loan repayment dates without borrower knowledge to adjust the performance of the securitization vehicle, and forgiving payments from delinquent borrowers without disclosing this fact to investors. The SEC is seeking permanent injunctions, officer and director bars, disgorgement, and civil penalties, and the litigation against the principals remains ongoing.

In November, the SEC announced a settled action against an oilfield services company and its former CEO for allegedly failing to properly disclose the CEO’s executive perks and stock pledges.[49] The SEC alleged that the CEO caused the company to incur over $380,000 worth of personal and travel expenses and failed to disclose to company personnel that he had pledged all his company stock in private real estate transactions. The company also failed to properly disclose over $47,000 in unpaid perks to the CEO. The CEO agreed to pay over $195,000 in civil fines, and both the CEO and the company agreed to cease and desist from further violations, without admitting or denying any wrongdoing.

Also in November, the SEC instituted a settled action against an exchange-traded product (“ETP”), which seeks to track the changes in the spot price of crude oil, and its general partner, a commodity pool operator, alleging that they misled investors about limitations imposed by the ETP’s sole futures commission merchant and broker.[50] In the wake of the April 2020 shake-up of the oil market brought on by pandemic-related lockdowns, the ETP received record investor inflows while the ETP’s sole futures broker informed the ETP that it would not execute any new oil futures positions. The SEC alleged that the ETP and its general partner did not fully disclose the character and nature of this limitation to investors until one month after it was first imposed. Without admitting or denying the SEC’s findings, the ETP and its general partner agreed to pay a $2.5 million fine to settle the SEC action and a parallel action brought by the CFTC.

C. Auditor Independence

In August, the SEC instituted a settled action against a Big Four accounting firm and three of its current or former audit partners for conduct which allegedly violated auditor independence rules in connection with the accounting firm’s pursuit to serve as the independent auditor for a public company.[51] The SEC also instituted a settled action against the public company’s then-Chief Accounting Officer for his role in the alleged misconduct. The SEC alleged that the accounting firm partners solicited and received confidential competitive intelligence regarding the public company’s audit committee and independent auditor selection process from the public company’s then-Chief Accounting Officer. This information allegedly caused both the public company and the accounting firm to commit reporting violations because the accounting firm would no longer be able to exercise objective and impartial judgment after the audit engagement began. Without admitting or denying the findings, the accounting firm and its current and former partners agreed to cease and desist from future violations. Additionally, the accounting firm agreed to pay a $10 million civil fine and institute controls to prevent future violations, including regular reporting to the SEC. The individual partners agreed to monetary penalties between $15,000 and $50,000, and agreed to a suspension from appearing or practicing before the SEC for periods of one to three years. The Chief Accounting Officer, without admitting or denying the allegations, agreed to a civil fine of $51,000 and a two-year suspension from appearing or practicing before the SEC.

III. Investment Advisers

In the second half of 2020, the SEC instituted a number of actions against investment advisers. We discuss notable cases below.

A. Complex Products

The SEC, in connection with the SEC’s Exchange Traded Product (“ETP”) initiative, filed a settled action in July against a dual-registered broker-dealer and investment adviser,, alleging historic compliance failures related to the sale of a volatility-linked ETP.[52] According to the SEC, the ETP was designed to track short-term volatility expectations in the market, and the product’s issuer told the company that it was not appropriate to hold the product for an extended period. The SEC alleged that while the company prohibited the solicitation of the product entirely for brokerage accounts, it allowed more experienced financial advisors who managed client portfolios on a discretionary basis to buy the ETP after mandatory training. Further, the SEC alleged that although the registrant had adopted a concentration limit on volatility-linked ETPs, it did not implement a system to monitor or enforce that limit. Finally, the SEC alleged that certain financial advisers misunderstood the appropriate use of the ETP, failed to take sufficient steps to understand the risks of holding onto the ETP for an extended period, and ended up holding the product too long. Without admitting or denying the SEC’s findings, the company agreed to a cease-and-desist order, censure, disgorgement of $112,000, and a civil penalty of $8 million.

B. Material Misrepresentations

In July, the SEC announced a settled action against the subsidiary of an association which keeps records for employer-sponsored retirement plans (“ESPs”) and advises clients on whether to roll over their ESPs into individually managed accounts.[53] The SEC and the New York Attorney General’s Office brought parallel actions that were simultaneously settled in July. According to the SEC, the subsidiary made inaccurate and misleading statements to its clients by representing that its advisers acted in the client’s best interest and as fiduciaries. Further, the SEC alleged that the subsidiary and its employees failed to adequately disclose their conflicts of interest when they made certain recommendations to the clients. Without admitting or denying the SEC’s findings, the subsidiary agreed to a cease-and-desist order, to be censured, disgorgement, and a civil penalty totaling $97 million.

In September, the SEC announced a settled action against the CEO and chief portfolio manager of an advisory firm based on allegations of misrepresentations of the performance of funds managed by the firm.[54] According to the SEC, the executives inflated net asset values and the performance of funds by recording non-binding transactions and fraudulent fees in books and records. The SEC further alleged that the CEO waived monthly management fees owed to the firm to make it seem as if the funds were achieving better results. These allegedly inflated results were then used in promotional materials sent to investors. Without admitting or denying the SEC’s allegations, the CEO agreed to be barred from the securities industry and to pay over $5 million in disgorgement, and a penalty of almost $300,000. The chief portfolio manager, also without admitting or denying the allegations, agreed to a limitation on activities in the securities industry for at least three years, and to pay a penalty of $50,000.

In November, the SEC announced that it prevailed in a jury trial against a hedge fund adviser and his investment firm for allegedly reaping profits from making false statements to drive down the price of a pharmaceutical company.[55] The SEC alleged that the hedge fund had established a short position in the pharmaceutical company, and then made a series of false statements to shake investor confidence in the company and lower its stock price. These statements included that the pharmaceutical company’s investor relations firm had told the hedge fund adviser that the company’s most profitable drug was nearly obsolete and that the pharmaceutical company had engaged in a risky transaction with an unaudited shell company in an effort to reduce the size of its balance sheet. These statements and the ultimate decline in stock price allegedly resulted in more than $1.3 million in profits from the short position. The jury found the hedge fund and its adviser guilty of fraudulent misrepresentations; remedies will be determined at a later date.

In December, the SEC announced a settled action against an investment adviser regarding improper calculation of management fees, which is an area the SEC continues to be focused on, and appears to be expanding into the private fund adviser space.[56] According to the SEC, the investment adviser failed to adequately offset portfolio company fees against management fees paid to the company, despite promising clients it would do so in the relevant governing documents. This allegedly led to clients overpaying millions in additional management fees. The SEC also claimed the adviser made inconsistent statements to clients about how management fees would be calculated. Without admitting or denying the SEC’s allegations, the investment adviser agreed to pay a $4.5 million penalty to settle the action.

C. Misuse of Client Funds

In July, the SEC filed an action against an individual trader at an asset management firm. According to the SEC, from January 2015 through April 2021, the individual traded stock in his family members’ accounts before or during the time periods when his employer’s advisory clients were executing large orders for the same stock.[57] The SEC alleges that the trader would then close out the just-established positions in his relatives’ accounts before the client accounts completed their executions. The SEC alleged the individual conducted a front-running scheme that violated the antifraud provisions of the federal securities laws and is seeking disgorgement, penalties, and injunctive relief. The U.S. Attorney’s Office for the Southern District of New York also brought criminal charges against the trader. Litigation remains ongoing.

The SEC also filed an action in July against the CEO of several real estate investment trusts (“REITs”) and his wholly-owned investment advisory firm.[58] The SEC alleged that the CEO took money from two REITs he founded, put it into a third REIT he had founded, and later caused the same two REITs to enter into money-losing transactions with the third REIT to benefit himself and the third REIT. According to the SEC, the CEO also made misrepresentations to the boards of the two REITs that resulted in a payment to him, and he also misled investors by causing those REITs to make false and misleading statements in their public filings. The SEC alleged violations by the CEO of various federal antifraud provisions and is seeking disgorgement, penalties, permanent injunctions, and industry, penny stock, and officer and director bars against the CEO.

In October, the SEC filed am action against a former New Jersey-based financial adviser, alleging that he misappropriated several million dollars from client accounts.[59] According to the SEC, the adviser used those funds to pay off balances in credit card accounts held by his wife and parents, caused checks to be drawn on his clients’ and customers’ accounts, and used client funds to purchase gold coins and other precious metals, buy luxury goods, and make electronic fund transfers to himself. The SEC’s complaint alleged violations of the antifraud provisions of the federal securities laws and is seeking injunctive relief, disgorgement, and civil penalties. The U.S. Attorney’s Office for the District of New Jersey has also filed criminal charges against him.

D. Implementation of Form CRS

In July, the SEC announced settled actions against 21 investment adviser firms and 6 broker-dealer firms based on allegations that the firms failed to timely file and deliver their client or customer relationship summaries (Form CRS) to their retail investors.[60] In June 2019, the SEC adopted Form CRS and required SEC-registered investment adviser and broker-dealer firms to take the following actions: file these forms with the SEC, begin delivering them to prospective and new retail investors by June 2020, deliver them to existing retail investor clients or customers by July 2020, and prominently post the form on their websites. The SEC alleged that these 27 firms missed the regulatory deadlines and did not comply until they were reminded at least twice over the course of several months by the appropriate regulatory authority. Without admitting or denying the SEC’s findings, the firms all agreed to be censured, to a cease-and-desist order, and to pay civil penalties varying from $10,000 to $97,523.

E. Ineffective Information Barriers

In November, the SEC announced a settled action against a management consulting firm’s wholly-owned registered investment adviser.[61] The adviser’s advisory clients were limited to current and former employees of the consulting firm. According to the SEC, the adviser directed the purchase and sale of securities in companies that the consulting firm previously had advised, or currently was advising. The SEC alleged that the adviser did not maintain adequate policies and procedures to prevent investment decisions from utilizing material nonpublic information obtained through the firm’s consulting work. Without admitting or denying the SEC’s findings, the affiliate agreed to a cease-and-desist order and to pay $18 million to settle the action.

IV. Broker-Dealers

Although not as numerous as prior years, there were nevertheless notable cases involving the conduct of broker-dealers in the latter half of 2021.

A. Financial Reporting and Recordkeeping

In August, the SEC announced a settled action against an investment firm, its principal, and its trader for allegedly providing erroneous order-marking information on sale orders, causing the fund’s brokers to mismark the sales as “long,” and failing to borrow or locate shares prior to executing the sales.[62] The firm and its personnel also allegedly engaged in dealer activity without registering with the SEC. Without admitting or denying the findings, the parties each agreed to cease-and-desist orders, disgorgement fees, and penalties totaling $7.9 million.

In September, the SEC instituted an action against a school district and its former Chief Financial Officer, alleging that they misled investors who purchased $28 million in municipal bonds.[63] According to the SEC’s complaint and order, the district and CFO provided investors with misleading budget projections indicating the district could cover its costs and would end the fiscal year with a general fund balance of approximately $19.5 million, when in fact the district ended the year with a negative balance of several million dollars. The CFO agreed to pay a $28,000 penalty. The district also agreed to settle with the SEC and consented, without admitting or denying any findings, to engage an independent consultant to evaluate its policies and procedures related to its municipal securities disclosures.

B. Unfair Dealings

In August, the SEC instituted a settled action against a broker-dealer and its former CEO for allegedly engaging in unfair dealing in connection with a municipal bond tender offer.[64] The SEC’s orders alleged that the broker-dealer recommended to a county that it attempt to reduce the amount of its outstanding debt service expense through a tender offer for bonds it had issued years earlier. According to the orders, the broker-dealer allegedly purchased millions of dollars of the county’s outstanding bonds, sold them to an affiliated entity, and tendered the bonds back to the county at a price that the broker-dealer recommended without disclosing to the county that the affiliate had acquired bonds to be tendered, or the resulting conflict of interest. Without admitting or denying the SEC’s findings, the broker-dealer and CEO agreed to pay nearly $400,000 in disgorgement and civil penalties.

In September, and as a continuing part of an industry-wide series of investigations originating nearly five years ago, the SEC announced that a broker-dealer agreed to resolve allegations that it engaged in unfair dealing in municipal bond offerings.[65] According to the SEC’s order, the broker-dealer allegedly allocated bonds intended for institutional customers and dealers to parties known in the industry as “flippers,” who then resold the bonds to other broker-dealers at a profit. In addition, the SEC alleged that where an issuer had instructed the broker-dealer to place retail customer orders first, it violated those instructions by allocating bonds to flippers ahead of orders for retail customers, and improperly obtained bonds for its own inventory. Without admitting or denying the findings, the broker-dealer consented to pay more than $800,000 in penalties and disgorgement. Among multiple agreements, two employees consented to pay civil penalties of $25,000 and $30,000.

In September, the SEC brought an action against a municipal adviser and its two principals, alleging that they violated their duties by engaging in unregistered municipal advisory activities.[66] According to the SEC, these actions are the first-ever SEC cases enforcing Municipal Securities Rulemaking Board (“MSRB”) Rule G-42 on the duties of non-solicitor municipal advisers. The SEC’s complaint specifically alleged that the principals entered into an impermissible fee-splitting arrangement with their former employer and did not adequately disclose to their clients the conflicts of interest associated with the illicit arrangement or their relationship with the underwriting firm. The SEC also alleged that all three parties engaged in municipal advisory activities when they were not registered with the SEC or MSRB. One principal consented, without admitting or denying any findings, to pay a $26,000 penalty. The SEC has not announced a settlement with respect to the other two principals.

Also in September, the SEC brought an action against a former managing director and head of fixed income trading at a broker-dealer, alleging that the individual engaged in unauthorized trading in fixed income securities and illegally obtained fictitious commission income.[67] The conduct came to light after the allegedly illegal trading resulted in the broker-dealer’s bankruptcy in 2019. The SEC’s complaint alleged that the individual engaged in unauthorized speculative trading in U.S. Treasury securities; incurred millions of dollars in losses for the firm; and obtained commission income based on fictitious commission payments from fabricated customers. The individual agreed to settle the SEC’s action by consenting to a permanent injunction and to pay disgorgement and a civil penalty in amounts to be determined at a later date. In a parallel action, the U.S. Attorney’s Office announced criminal charges for related misconduct.

In October, the SEC announced an order alleging that a financial services group raised funds on behalf of state-owned entities in Mozambique through two bond offerings and a syndicated loan, and that these proceeds were used to fund a hidden debt scheme, pay kickbacks to investment bankers along with their intermediaries, and bribe foreign government officials.[68] The SEC’s order also alleged that the company failed to properly address significant and known risks concerning bribery. The SEC announced that the financial services group agreed to pay $475 million in disgorgement and penalties.

Relatedly, a London-based subsidiary of a Russian bank also agreed to settle SEC allegations in October related to its alleged role in misleading investors in the second bond offering.[69] According to the SEC’s order, the Russian bank and financial services group’s offering materials failed to disclose Mozambique’s debt and the risk of default on bonds. The financial services group agreed to pay nearly $100 million in disgorgement and penalties, and the U.S. Department of Justice imposed a $247 million criminal fine. Without admitting or denying the findings, the Russian bank agreed to pay $6.4 million in disgorgement and penalties.

C. Internal Policies and Procedures

In August, the SEC instituted three settled actions against eight investment advisers and broker-dealers, alleging that the firms failed to create and maintain adequate cybersecurity policies and procedures in violation of the Safeguards Rule of Regulation S-P.[70] In all three cases, unauthorized third parties gained access to email accounts, resulting in the exposure of customer data for periods of more than one year. The Commission alleged that, in two of the cases, the firms violated the Safeguards Rule by failing to adopt and implement enhanced data security measures in a timely manner after discovering the account-takeovers. In the press release announcing the actions, the SEC stressed that “[i]t is not enough to write a policy requiring enhanced security measures if those requirements are not implemented or are only partially implemented, especially in the face of known attacks.” Without admitting or denying the SEC’s allegations, each firm agreed to cease and desist from future violations, to be censured, and to pay financial penalties totaling $750,000 (across all firms).

In October, the SEC announced a conclusion to its allegations that a clearing agency did not have adequate risk management policies within its Government Securities Division.[71] In an order, the SEC alleged that the agency failed to comply with rules requiring it to have reasonably designed policies and procedures for holding sufficient qualifying liquid resources to meet the financial obligations created by the potential failure of a large participant. According to the order, the agency did not conduct a required analysis of the reliability of its liquidity arrangements, failed to conduct required due diligence of its liquidity providers, and failed to adhere to rules requiring it to have reasonably designed policies and procedures for maintaining and periodically reviewing its margin coverage. The clearing agency agreed to pay an $8 million penalty to settle the SEC’s allegations.

In December, the SEC announced a settled action against a broker-dealer subsidiary of a financial services company, alleging failures by the broker-dealer and its employees to maintain and preserve written communications.[72] The company admitted that its employees, managing directors and other senior supervisors had communicated about securities business matters on their personal devices, using text messages, WhatsApp, and personal email accounts, and that the majority of these records were not surveilled nor preserved by the firm as required by the federal securities laws. The company also acknowledged that its failure to capture and retain these records deprived the SEC staff of timely access to evidence and potential sources of information in other investigations. The company admitted certain facts set forth in the SEC’s order and agreed to pay a $125 million penalty and implement improvements to its compliance policies and procedures. The CFTC brought a parallel proceeding against the firm and related entities, similarly alleging that the firms’ recordkeeping violated CFTC requirements.[73] The firm agreed to pay a $75 million penalty and implement remedial measures.

V. Cryptocurrency and Other Digital Assets

The Commission continued to bring enforcement actions in the area of digital assets throughout 2021. As in 2020, these actions were based primarily on alleged failures to comply with the requirement to register an offering of assets deemed to be securities or allegations of fraud in the offer and sale of digital assets. Significant uncertainty remains around exactly how the Commission will approach the regulation of crypto assets going forward.

A. Significant Developments

As has been true for several years, the Commission has continued to struggle with how to define the ever-expanding collection of products in the digital asset space. Emblematic of that question is an enforcement action from this summer, along with a follow-on statement from two Commissioners.

In July, the SEC instituted a settled action against the U.K.-based operator of a website for failing to disclose compensation it received from issuers of the digital assets it profiled.[74] Each profile included links to the token issuer’s websites and a “trust score” that the website stated reflected its evaluation of the “credibility” and “operational risk” for each digital token offering. In the press release announcing the action, the SEC noted that many of the profiles were published after the Commission issued a 2017 advisory warning that promoters of virtual tokens classified as securities must disclose any compensation received in exchange for the promotion.[75] Without admitting or denying the SEC’s findings, the operator of the website agreed to pay $43,000 in disgorgement and a penalty of approximately $155,000.

Interestingly, Commissioners Peirce and Roisman took the unusual step of issuing a public statement after the above-described action, concurring in the result, but expressing their continued disappointment that the settlement with the operator “did not explain which digital assets touted by [the operator] were securities, an omission which is symptomatic of our reluctance to provide additional guidance about how to determine whether a token is being sold as part of a securities offering or which tokens are securities.”[76] They continued that “[t]here is a decided lack of clarity for market participants around the application of securities laws to digital assets and their trading . . . [and that despite some guidance m]arket participants have difficulty getting a lawyer to sign off that something is not a securities offering or does not implicate the securities laws; they also cannot get a clear answer, backed by a clear Commission-level statement, that something is a securities offering.”[77] One proposal put forth by the two Commissioners, which was previously proposed by Commissioner Peirce,[78] is to offer a safe harbor of sorts, which would allow for token offerings to occur subject to a set of tailored protections for token purchasers.

While clarity on this issue is still forthcoming, there remains a groundswell of support from the digital asset community for further clarification on digital asset topics outside anecdotal and incremental progress toward regulatory standards posed by each new enforcement matter.

B. Registration Cases

In August, the SEC instituted a settled action against a company for operating a web-based trading platform that facilitated the buying and selling of digital assets without registering as a national securities exchange.[79] The order alleged that the company’s internal communications expressed a desire to be “aggressive” in making new digital assets available for trade, including assets that might be considered securities under the Howey test. The SEC determined that some of these digital assets were investment contracts, thereby constituting securities. Without admitting or denying the SEC’s findings, the company agreed to the entry of a cease-and-desist order and agreed to pay disgorgement of approximately $8.5 million and a civil penalty of $1.5 million.

In September, the Commission instituted a settled action against two U.S. media companies that conducted both an unregistered offering of common stock and an unregistered offering of digital coins, as well as a third company that participated only in the stock offering.[80] The SEC alleged that the two companies involved in the coin offering promoted the coins to the general public through their websites and social media platforms. Because the coins were allegedly marketed as an investment opportunity with a likelihood of significant returns, the Commission alleged that they constituted securities. Without admitting or denying the findings, these two companies agreed to a cease-and-desist order, to pay disgorgement of over $434 million on a joint and several basis, and to each pay a civil penalty of $15 million. The third company agreed to a cease-and-desist order, to pay disgorgement of more than $52 million, and to pay a civil penalty of $5 million. The companies also agreed not to participate in any offering of a digital asset security, to assist SEC staff in the administration of a distribution plan, and to publish notice of the SEC’s order on their public websites and social media channels.

The SEC’s enforcement activities extended beyond unregistered offerings to consider the substance of attempted registrations of digital assets deemed securities. In November, the Commission instituted proceedings against a Wyoming-based company in connection with allegedly incomplete and misleading registration forms.[81] The effectiveness of the company’s registration of two digital tokens as securities remains stayed pending the completion of the proceedings. The order alleged that the “Form 10” registration forms submitted by the company lacked material information about the tokens and about the company’s business practices, including audited financial statements. The SEC further alleged that certain inconsistent statements rendered the Form 10 misleading. In the press release announcing the action, the SEC stressed that all issuers of securities “must provide the information necessary for investors to make informed decisions.”

C. Fraud Cases

In August, the SEC instituted a settled action against two Florida men and their Cayman Islands decentralized finance (“DeFi”) company in connection with their unregistered sales of two types of digital tokens.[82] In offering and selling the tokens, the company stated that it would use investor assets to purchase income-generating “real world” assets, such as car loans. The order alleged that the company misrepresented its business practices by claiming to have purchased these loans. The SEC alleged that, although the men controlled another company that owned car loans, the DeFi company never acquired any ownership interest in those loans. Instead, the Commission alleged that the men used personal funds and funds from the other company they controlled to make principal and interest payments for the DeFi company. The respondents, without admitting or denying the findings, consented to a cease-and-desist order that included over $12 million in disgorgement and $125,000 penalties for each of the men. Additionally, prior to the order, the respondents funded contracts that allowed those who held tokens to redeem their tokens and receive all principal and interest owed.

In September, the SEC filed an action against an online cryptocurrency lending platform, its founder, its top U.S. promoter, and the promoter’s affiliated company in connection with approximately $2 billion of unregistered sales of investments in their “Lending Program.”[83] The lending platform, with the help of its promoter, allegedly represented that it would generate high returns on its customers’ investments by using a proprietary “volatility software trading bot.” Instead, the complaint alleged, the company transferred investor funds to digital wallets controlled by the company, its founder, its promoter, and others. The complaint further alleged that the company misled investors by failing to disclose commissions paid to promoters around the world. The SEC previously reached settlements with two individuals in a related action for promoting the lending program, and the company’s top U.S. promoter pled guilty to criminal charges brought by the Department of Justice. The litigation remains ongoing.

In November, the SEC filed an action against a California individual for allegedly conducting two unregistered securities offerings and misappropriating investor funds.[84] The SEC found that he had raised over $3.6 million in Bitcoin from these offerings by promising an extremely high rate of return on the investments through, among other activities, fulfillment of social media marketing orders and “cryptocurrency trading and advertising arbitrage.” The complaint alleges that he used at least $1 million of investor funds to pay personal expenses and, despite representations to the contrary, prevented investors from withdrawing their funds. The U.S. Attorney’s Office for the Northern District of California has also brought criminal charges against the individual. The litigation remains ongoing.

In December, the SEC filed an action against a Latvian citizen for allegedly conducting two fraudulent offerings, one involving the sale of unregistered digital tokens as part of an ICO and the other involving the investment of digital assets in a cloud mining company.[85] In the former, the individual claimed users of the token could store their digital assets in a secure digital wallet and then spend them “like any other debit card,” but the complaint alleges that all of these claimed products and services were fictitious. In the latter, the individual claimed that investors would receive a daily “automatic payout” from a cloud mining program, but the complaint similarly alleges that these services never existed. The complaint alleges that the individual used fictitious names, phone numbers, addresses, and online profiles to market both offerings and misappropriated nearly all funds raised from each. The litigation remains ongoing.

VI. Insider Trading

In addition to a significant uptick in insider trading enforcement actions in the second half of 2021, an indication that the SEC has reinvigorated its focus on insider trading cases, the SEC suffered a rare trial loss (after the alleged tipper defendant settled[86]) in a previously discussed insider trading case.

In December 2020, the SEC brought a case against a mortgage broker accused of being tipped by his brother-in-law, who was corporate controller at an IT company whose stock and options were traded by the broker.[87] The case went to trial in late 2021, and after the close of the SEC’s case, the defense moved, as is typical, for a Rule 50 Judgment as a Matter of Law. Surprisingly, and without the defense presenting any portion of its case, the court granted the defense’s motion and dismissed the case.[88] The SEC’s case was built around circumstantial evidence of what it characterized as “highly suspicious trading,” but the judge concluded that neither the timing nor the manner of the trading nor the communications between the brothers-in-law were suspicious. Despite surviving all pre-trial motions to dismiss the case, the judge concluded that he was having trouble finding “any circumstantial evidence that would justify a finding that [the broker] got insider information and took some action on it.” Whether the SEC will file an appeal remains an open question, but as of yet, no appeal has been filed.

Below is an overview of insider trading enforcement actions brought in the second half of 2021. Of particular note are two cases alleging insider trading against corporate outsiders who obtained material nonpublic information through unauthorized computer systems access.

A. Cases Arising from Unauthorized Computer Systems Access

In July, the SEC filed an action against a foreign national who was allegedly selling stolen “insider trading tips” to individual investors on the dark web.[89] According to the SEC’s complaint, beginning in December 2016, the individual obtained stolen order-book data from a securities trading firm as well as pre-release earnings reports of publicly traded companies and subsequently sold that information to investors. The SEC’s complaint is seeking injunctive relief, disgorgement, and civil penalties. The U.S. Attorney’s Office for the Southern District of New York filed parallel criminal charges against the individual.

In December, the SEC filed an action against five Russian nationals for allegedly trading based on stolen corporate earnings announcements obtained by hacking into the systems of two U.S.-based filing agent companies.[90] According to the allegations in the SEC’s complaint, one of the individuals hacked into the filing agents’ systems and fed the earnings information to his associates, who then used 20 different brokerage accounts located around the world to make trades before over 500 corporate earnings announcements. According to the SEC, the trades occurred between 2018 and 2020 and netted at least $82 million in profits. The SEC complaint further alleged that the defendants shared the profits by funneling them through a Russian information technology company in which some of the individuals were involved as founders and directors. The SEC’s complaint seeks civil penalties, disgorgement, and injunctive relief. The U.S. Attorney’s Office for the District of Massachusetts filed parallel criminal charges against all five individuals and announced that one of the individuals has been extradited to the United States from Switzerland.

B. Other Insider Trading Cases

In July, the SEC filed an action against three individuals with insider trading related to stock purchases in advance of an announcement by a beverage company that it was pivoting its business to focus on blockchain technology.[91] The SEC’s complaint alleged that an insider at the company provided confidential information related to the planned changes to his friend, who then subsequently passed that information on to another friend, who ultimately purchased 35,000 shares that resulted in profits of over $160,000 when the information was made public. The SEC’s complaint seeks permanent injunctions and civil penalties against all three individuals, and an officer and director ban for the company insider. The SEC also revoked the registration of the company’s securities as part of the action. Two of the individuals involved in the case are currently in litigation with the SEC over an alleged market manipulation scheme. The two individuals pled guilty to criminal charges in a parallel action brought in relation to the alleged market manipulation scheme.

In August, the SEC filed an action against a former employee of a biopharmaceutical company with insider trading based on trades made in advance of the company’s announcement that it would be acquired by a major pharmaceutical company.[92] The SEC’s complaint alleged that the former employee, then the head of business development at the biopharmaceutical company, purchased short-term, out-of-the-money options of a similar pharmaceutical company after learning that his company was getting acquired by a large pharmaceutical company at a significant premium. The SEC’s complaint alleged that the employee made the purchase just minutes after learning that the investment bankers had listed the similar company as a comparable company in their discussions with his company over valuations. The SEC’s complaint alleged that the trading netted the former employee profits of just over $100,000, and seeks injunctive relief, a civil penalty, and an officer and director bar for the employee. A motion to dismiss in the case was recently denied, and litigation is ongoing.[93]

Also in August, the SEC filed an action against three former software engineers and two of their associates with insider trading.[94] The SEC alleged that a former employee and two associates made trades based on confidential, nonpublic information about subscriber growth at the former employee’s streaming media company. The SEC’s complaint alleges that the former employees had passed along confidential information about subscriber growth, which was a key metric reported alongside their company’s quarterly earnings, to their close acquaintances, who traded the stock in advance of the key earnings releases. The SEC’s complaint alleged that the trades netted approximately $3 million in profits. All five individuals consented to judgments that impose various injunctive relief and civil penalties, including, for one of the software engineers, an officer and director ban. The U.S. Attorney’s Office for the Western District of Washington filed parallel criminal charges against two of the software engineers and the two associates.

In September, the SEC announced a settlement with a leading alternative data provider company and its co-founder based on allegations that it engaged in deceptive practices and made material misrepresentations about how its alternative data was derived.[95] The SEC alleged that the co-founder, in order to induce companies to share their data, made assurances to those companies that their data would be aggregated and anonymized prior to being fed into a statistical model. However, the SEC alleged that for approximately four years, the company used non-aggregated and non-anonymized data to alter its model-generated estimates of app performance to make them more valuable to the trading firms that it sold the estimates to. The SEC also alleged that the company further misrepresented to their trading firm customers that it generated the estimates in a way that was consistent with the consents they obtained from their data-providing clients and that they had effective internal controls to prevent the misuse of confidential data and to ensure compliance with federal securities laws. The SEC alleged that the company and its co-founder were aware that the trading firm customers were making investment decisions based on the estimates, and in fact touted how closely their data correlated with the companies’ true performance and provided guidance to the trading firms as to how they could use the estimates to trade ahead of upcoming earnings announcements. As part of the settlement agreement, neither the company nor the co-founder admitted any wrongdoing. However, both consented to a cease-and-desist order that included a $10 million penalty for the company and a $300,000 penalty for the co-founder. The settlement also included a three-year public company officer and director ban for the co-founder.

Also in September, the SEC brought an action against a former IT manager at a pharmaceutical company with insider trading based on four trades made just prior to public announcements that were allegedly based on material nonpublic information shared with him by a former colleague at the company.[96] The SEC’s complaint alleged that the manager used nonpublic information on the company’s earnings, drug approvals, and a pending merger with a major pharmaceutical company to place highly profitable options trades. The SEC alleged that the manager made over $8 million in combined profits and avoided losses, and shared some of his profit with the former colleague in the form of overseas cash payments. The manager consented to a judgment which enjoined him from violating the alleged provisions and barred him from acting as an officer or director of a public company, with civil penalties in an amount to be determined by the court. The U.S. Department of Justice, Fraud Section, announced parallel criminal charges against the manager.

In September, the SEC brought an action against a quantitative analyst who worked at two prominent asset management firms for allegedly perpetuating a years-long front-running scheme that generated at least $8.5 million in profits.[97] The SEC alleged that the analyst used information he had about his firm’s securities orders to place similar orders just before the firm on nearly 3,000 occasions, taking advantage of the price movements caused by the firm’s trades. The SEC’s complaint alleges that the analyst utilized his wife’s brokerage account to make the trades. The SEC’s complaint seeks disgorgement plus interest, civil penalties, and injunctive relief. The U.S. Attorney’s Office for the Southern District of New York filed parallel criminal charges against the analyst.

Also in September, the SEC brought an action against a compliance analyst, who was a foreign national working at an overseas office of an investment bank, for allegedly placing trades in advance of corporate events involving the investment bank’s clients.[98] The SEC’s complaint alleges that the individual used his position as a compliance analyst to place trades in advance of at least 45 events involving the investment bank’s clients. The SEC alleged that the individual took steps to avoid detection, including only placing relatively small trades and using multiple U.S.-based brokerage accounts held in his parent’s name. The SEC obtained an emergency court freezing the individual’s assets. The trades allegedly generated more than $471,000 in gains. The SEC is seeking injunctive relief, disgorgement, and a civil penalty, and has also named the individual’s parents as relief defendants in the action.

In November, the SEC brought an action against a partner at a global management consulting firm for insider trading.[99] The SEC alleged that the partner purchased out-of-the-money call options of a company after he learned that one of the consulting firm’s clients would be acquiring the company. According to the SEC’s complaint, the partner sold the options the morning of the acquisition announcement, just days before they were set to expire, for profits totaling over $450,000. The SEC also alleged that the partner violated his firm’s policies by failing to pre-clear the trades. The SEC’s complaint seeks injunctive relief and a civil penalty. The U.S. Attorney’s Office for the Southern District of New York filed parallel criminal charges against the partner.

In December, the SEC brought an action against a medical school alleging insider trading in the securities of a biotechnology company in advance of that company’s announcement of positive drug trial results for its flagship drug candidate.[100] The SEC alleged that the professor entered into a consulting relationship with the biotechnology company to serve as its lead clinical investigator for the drug trial, and that, through his role, he learned material nonpublic information about the drug trial results. The complaint alleged that upon learning of the positive results, the professor purchased over 8,000 shares of the company’s stock, which, upon release of the drug trial results, rose approximately 300% and generating gains of over $130,000. The SEC reached a settlement with the professor that, if approved by the court, provides for a permanent injunction and a civil penalty in an amount to be determined by the court at a later date. The U.S. Attorney’s Office for the Northern District of Illinois announced parallel criminal charges against the professor.

VII. Market Manipulation

There were three alleged market manipulation schemes that were the focus of SEC enforcement actions during the second half of 2021.

In September, the SEC, in two separate complaints, commenced actions against four people and five entities in an allegedly fraudulent microcap operation that generated more than $10 million in profits.[101] The SEC also sought an order to freeze the assets of seven of the defendants and one relief defendant. According to the SEC’s first complaint, one of the individuals and his son allegedly acquired millions of shares in U.S. publicly traded microcap companies, disguised their control over the companies, and then dumped their shares into the public markets in violation of the securities laws. The SEC alleged that, while concealing their holdings in the companies, they allegedly engaged in manipulative trading and generated artificial demand for the stock by making misleading statements to investors. According to the SEC’s second complaint, two associates of the individual and his son allegedly used their roles as officers or majority shareholders at several of the microcap companies to hide the individual’s control, while simultaneously helping him and his son acquire and then sell millions of the companies’ shares. The SEC also alleged that one of the associates made false and misleading statements in response to subpoenas issued by the SEC and during a subsequent interview. The SEC is seeking injunctive relief, disgorgement and civil penalties against all of the parties. The SEC is also seeking penny stock bars against three of the non-entity defendants, conduct-based injunctions against the individual and his son, and officer and director bars against the two company-insider associates.

Also in September, the SEC brought an action against an individual and his friend for allegedly engaging in a coordinated operation to collect liquidity rebates from exchanges by wash trading put options of certain “meme stocks” in early 2021.[102] The SEC’s complaint alleged that the individual was able to generate at least $668,000 in profits from approximately 11,400 trades made in a way that took advantage of a certain brokerage firms’ maker-taker rebate programs. The friend generated approximately $51,000 in profits as a result of approximately 2,300 trades. The SEC alleged that the individual placed initial orders on one side of the market utilizing brokerage accounts that passed rebates back to their customers and then placed opposite orders in brokerage accounts that did not charge trading fees, thereby essentially trading with himself and retaining the rebates. The SEC alleged that the practice impacted the market by skewing the volume in certain option contracts and induced other traders to place trades in otherwise illiquid option contracts. Litigation against the individual is ongoing. The friend, without admitting or denying the allegations, consented to a judgment providing for injunctive relief, disgorgement and a civil monetary penalty of $25,000.

In October, the SEC brought an action against a webcast host for allegedly making more than 100 false statements regarding public companies.[103] According to the SEC’s complaint, the host received advance notice of companies about which another individual allegedly planned to spread false statements, after which the host shared the names of those companies with his subscribers. The SEC alleged that the conduct led to temporary increases in the companies’ stock prices and netted the host more than $347,000 in profits. The SEC alleged that the host was working as part of a broader group; the complaint follows a similar complaint against a different individual allegedly involved in the scheme. The host agreed to cooperate with the SEC and has consented to the entry of a judgment that provides for injunctive relief, disgorgement, a civil penalty in an amount to be determined by the court, a penny stock bar and a bar from the securities industry generally. The host also pleaded guilty to criminal charges brought in a parallel action by the U.S. Attorney’s Office for the Northern District of Georgia.

Also in October, the SEC filed an emergency action and obtained an injunction and asset freeze against an individual, alleging that he used his Twitter handle to encourage his followers to buy stocks in which the individual had holdings.[104] According to the SEC, the individual encouraged his followers to invest in the stock and then sold his own stock at inflated prices while continuing to recommend on Twitter that people purchase the stock. The SEC has alleged violations of the antifraud provisions of the federal securities laws and seeks a permanent injunction, disgorgement, civil penalties, and the asset freeze already granted by the court.

VIII. Offering Frauds

The SEC continued to bring numerous offering fraud cases, which often allege violations by individuals and companies that target particular groups of investors, sometimes referred to as affinity frauds.

A. Penny Stock Schemes

In August, the SEC brought an action against a company, its CEO, and several other entities and individuals with participating in an alleged penny stock fraud scheme.[105] According to the SEC, the company bought shares of another company’s stock with the understanding that the offering proceeds would be used to secretly finance stock promotions. Those involved then allegedly misled investors about how offering proceeds would be used and the promotional activities undertaken to boost the value of the stock. The SEC has alleged violations of the antifraud provisions of the federal securities laws and seeks disgorgement of ill-gotten gains, civil penalties, permanent injunctive relief, and penny stock bar, and officer and director bars.

In August, the SEC brought an emergency action against a public company’s chairman, several of his associates, and several clients of the company.[106] The SEC alleged that the chairman and his associates masterminded and implemented a scheme that allowed the clients—who controlled microcap companies—to conceal their control and ownership of those companies through a network of offshore shell companies. According to the SEC, the clients used this system to dump their stock while hiding their control positions from investors. In December, the SEC alleged violations by three more clients for activity stemming from the same alleged scheme.[107] In both complaints, the SEC seeks permanent injunctions, conduct based injunctions, disgorgement, civil penalties and penny stock bars.

B. Frauds Targeting Senior Citizens and Retirees

In August, the SEC filed several actions based on different Ponzi-like schemes. In one, the SEC brought an emergency action and obtained temporary relief against a Minnesota couple and various entities they controlled. According to the SEC, the couple raised almost $17.6 million by promising friends and family—including many elderly retirees—that investments would be used to trade foreign currencies.[108] The SEC’s complaint alleged that, in fact, funds were used to pay returns to existing investors and to support other businesses. The SEC is seeking preliminary and permanent injunctions, disgorgement, civil penalties, and an asset freeze.

Also in August, the SEC brought an emergency action against an individual along with the investment adviser with which he was associated, and an investment fund he controlled.[109] The SEC alleged that he—and persons directed by him—raised more than $110 million from investors—including many elderly retirees—for his investment fund and then used money from new investors to pay earlier investors. The SEC is seeking preliminary and permanent injunctions, disgorgement, civil penalties, an asset freeze, and the appointment of a receiver.

In a similar case, the SEC brought an emergency action, and obtained an asset freeze and temporary relief, against an individual who allegedly used an investment adviser to solicit over $10 million in investments from clients—many of whom were elderly—into an investment fund, only to use the funds for Ponzi-like payments.[110] The SEC is seeking preliminary and permanent injunctions, disgorgement, and civil penalties.

C. Frauds Targeting Affinity Groups

In September, the SEC brought an action against a payday loan company and its CEO for an alleged Ponzi-like scheme targeting South Florida’s Venezuelan-American community.[111] According to the SEC’s complaint, the CEO raised at least $66 million by telling investors that their money would be used to make payday loans, but in reality, he misappropriated the funds for personal use and to make payments to other investors. The SEC seeks permanent injunctions, disgorgement, and civil penalties from each of the defendants and an officer and director bar against the CEO.

D. Frauds Related to Natural Resource Offerings

In September, the SEC announced a settled action against two individuals and the entities they controlled for making misrepresentations in connection with unregistered oil and gas securities offerings.[112] The two individuals—acting as unregistered brokers—allegedly made material misstatements regarding debt and equity securities in oil and gas wells they sold to retail investors. Without admitting or denying the SEC’s allegations, the two entities each agreed to pay a civil penalty of $225,000, and the individuals each agreed to pay a civil penalty of $75,000, and further agreed to prohibitions on future undertakings related to offerings.

Also in September, the SEC brought an action against a mining company and its two managing members for their participation in an unregistered offering related to a Columbian mining venture.[113] According to the SEC’s complaint, the two individuals raised approximately $2.7 million by misrepresenting to investors that they could share in the profits of a Columbian gold mining operation and that all the necessary permits had been obtained. The SEC is seeking permanent injunctions, disgorgement, and civil penalties. To date, one of the managing members has offered to settle with the SEC for a permanent injunction, disgorgement, and penalties totaling approximately $820,000.

E. Misuse of Investor Funds

In July, the SEC filed an emergency action and sought and received a temporary restraining order and asset freeze against an investment firm and two individuals associated with the firm.[114] According to the SEC’s complaint, the firm represented to investors that their money would be invested according to recommendations made by an artificial intelligence supercomputer that consistently provided large returns for investors. The SEC alleged that defendants then misused investor money for personal use and for paying other investors. The complaint alleged the firm and two individuals violated the antifraud provisions of the federal securities laws. Further, the complaint alleged that one individual acted as the control person under the Exchange Act. The SEC is seeking permanent injunctions, disgorgement, and civil penalties.

Also in July, the SEC filed a settled action against an individual in connection with his involvement in two companies.[115] According to the SEC, he misappropriated investor funds and used those funds for personal use, secretly sold stock while paying promoters to recommend the same stock to retail investors, failed to provide the required disclosures in connection with his stock trading, and made material misrepresentations to investors regarding one company’s products. The SEC sought injunctive relief, an officer and director bar, a penny stock bar, disgorgement, and civil penalties. Without admitting or denying the allegations, the individual consented to a settlement that included an injunction, an officer and director bar and penny stock bars, and disgorgement and civil penalty in excess of $1.3 million.

In August, the SEC brought an emergency action and obtained temporary relief against two entities and the individual who controlled them to stop an alleged Ponzi scheme.[116] The SEC alleged that the individual told investors that offering proceeds would be used to fund small business loans. According to the SEC, only a small portion of the $70 million raised was used for such small business loans; instead, the rest was used to pay returns to prior investors and to pay sales agents who promoted the investments. The SEC complaint seeks preliminary and permanent injunctions, disgorgement, and civil penalties, as well as an officer and director bar against the individual.

In September, the SEC brought an emergency action and obtained an asset freeze against a real estate company and its president for alleged securities fraud in connection with EB-5 offerings tied to two development projects.[117] According to the SEC, the president raised more than $229 million by misrepresenting the source of financing for the projects, the scope of the projects, and the experience of the development and construction teams in offering materials, then misappropriated millions of dollars for unauthorized purposes. The complaint requests a permanent injunction, disgorgement, civil penalties, an asset freeze, and the appointment of a monitor.

F. Misleading Statements to Investors

In July, the SEC filed an emergency action against an individual, alleging that he made misleading statement to encourage investors to invest in several microcap companies.[118] According to the SEC, the individual and others he worked with encouraged investors to make such investments during high pressure sales calls or email promotions and the individual received money from the stock sale proceeds of one of the microcap companies. The SEC is seeking an asset freeze, permanent injunctions, disgorgement, civil penalties, and penny stock and officer and director bars.

The SEC filed an emergency action in July against an investment company and its director.[119] According to the SEC, the company and its director raised money from investors by falsely representing that the company had sufficient funds to acquire three Italian cycling companies and that the director had invested his own money in the offerings. The SEC alleged that the director misappropriated the funds for personal use and hid from investors the fact that the company had failed to acquire the cycling companies. The complaint seeks emergency relief, permanent injunctions, disgorgement, civil penalties, and a conduct-based injunction, and an officer and director bar against the director.

The SEC also filed an action in July against an individual, alleging that he made misrepresentations to investors, created false documents, misappropriated investor funds, and acted as an unregistered broker-dealer.[120] According to the SEC, the individual falsely represented to investors that he was a licensed securities professional, provided false documents showing that he was associated with a licensed broker-dealer, and further provided false account statements and trading data to make it appear that his trading on their behalf was generating more value than it was. The SEC alleges violations of the antifraud provisions and broker-dealer registration provisions of the federal securities laws. The complaint seeks an injunction, disgorgement, and a civil penalty.

In September, the SEC brought an action against three individuals—as well as a funding portal and its CEO—for their roles in selling nearly $2 million of unregistered securities through crowdfunding offerings.[121] According to the SEC, the three individuals misrepresented information in their crowdfunding offering, which they conducted through two cannabis and hemp companies. Specifically, one of the individuals hid his involvement in the offerings due to concerns about a prior criminal conviction. The SEC also brought an action against the registered funding portal and its CEO that hosted the offerings for allegedly failing to address red flags—such as the prior criminal conviction—associated with the offerings. The complaint seeks injunctions, disgorgement, and civil penalties.

In October, the SEC filed an action against a hemp company and its co-founders for allegedly making misrepresentations to investors.[122] According to the SEC, the company misrepresented that it was a fully integrated company processing its own hemp, misstated historical revenue numbers, and provided unsupported projections for future revenues. Further, the SEC alleges that the co-founders misappropriated several million dollars from the company for personal use. The SEC seeks permanent injunctions, disgorgement, civil penalties, and officer and director and penny stock bars against the co-founders. The U.S. Attorney’s Office for the Southern District of New York filed criminal charges against the individual co-founders.

The SEC also filed an action in October against a real estate investment company and its co-founders.[123] According to the SEC, the company and its co-founders made misrepresentations to investors about the source of investor returns and paid investors using funds raised from other investors. Further, one of the co-founders allegedly made representations to investors about his education in finance and his investment experience without disclosing that he had been barred by FINRA from affiliating with any FINRA-member firm. The SEC’s complaint alleged the company and its co-founders violated the antifraud and securities offering and broker-dealer registration provisions of the federal securities laws. The complaint is seeking permanent injunctions, disgorgement, and civil penalties.

In November, the SEC brought an emergency action and obtained temporary relief against a claims aggregator—a firm that submits claims to administrators tasked with returning settlement funds to harmed investors—and its three principals in federal court.[124] According to the SEC, these individuals, and the entities they control, stole at least $40 million from 400 distribution funds by submitting false claims to settlement fund administrators. The U.S. Attorney’s Office for the Eastern District of Pennsylvania filed parallel criminal charges against the three principals. In addition to the asset freeze and temporary restraining order granted by the court, the SEC is seeking disgorgement and civil penalties.

__________________________

[1] SEC Speech, PLI Broker/Dealer Regulation and Enforcement 2021, Gurbir Grewal, Division of Enforcement (Oct. 6, 2021), available at https://www.sec.gov/news/speech/grewal-pli-broker-dealer-regulation-and-enforcement-100621.

[2] SEC Speech, Remarks at SEC Speaks 2021, Gurbir Grewal, Director, Division of Enforcement (Oct. 13, 2021), available at https://www.sec.gov/news/speech/grewal-sec-speaks-101321.

[3] SEC Press Release, SEC Charges Dialysis Provider and Three Former Senior Executives with Revenue Manipulation Scheme (December 6, 2021), available at https://www.sec.gov/news/press-release/2021-252.

[4] SEC Speech, Remarks at SEC Speaks 2021, Gurbir Grewal, Director, Division of Enforcement (Oct. 13, 2021), available at https://www.sec.gov/news/speech/grewal-sec-speaks-101321.

[5] SEC Press Release, JPMorgan Admits to Widespread Recordkeeping Failures and Agrees to Pay $125 Million Penalty to Resolve SEC Charges (December 17, 2021), available at https://www.sec.gov/news/press-release/2021-262.

[6] SEC Speech, Remarks at SEC Speaks 2021, Gurbir Grewal, Director, Division of Enforcement (Oct. 13, 2021), available at https://www.sec.gov/news/speech/grewal-sec-speaks-101321.

[7] SEC Speech, Prepared Remarks at the Securities Enforcement Forum, Chair Gary Gensler (Nov. 4, 2021), available at https://www.sec.gov/news/speech/gensler-securities-enforcement-forum-20211104.

[8] SEC Speech, Remarks at SEC Speaks 2021, Gurbir Grewal, Director, Division of Enforcement (Oct. 13, 2021), available at https://www.sec.gov/news/speech/grewal-sec-speaks-101321.

[9] SEC Press Release, SEC Announces Enforcement Results for FY 2021 (Nov. 18, 2021), available at https://www.sec.gov/news/press-release/2021-238.

[10] SEC Press Release, SEC Charges SPAC, Sponsor, Merger Target, and CEOs for Misleading Disclosures Ahead of Proposed Business Combination (July 13, 2021), https://www.sec.gov/news/press-release/2021-124.

[11] SEC Press Release, Nikola Corporation to Pay $125 Million to Resolve Fraud Charges (Dec. 21, 2021), available at https://www.sec.gov/news/press-release/2021-267.

[12] SEC Press Release, SEC Charges Founder of Nikola Corp. With Fraud (July 29, 2021), available at https://www.sec.gov/news/press-release/2021-141.

[13] SEC Statement, Statement of Commissioner Elad L. Roisman (Dec. 20, 2021), available at https://www.sec.gov/news/statement/roisman-20211220.

[14] SEC Press Release, Daniel S. Kahl Appointed Acting Director of the Division of Examinations; Peter B. Driscoll to Depart Agency (July 14, 2021), available at https://www.sec.gov/news/press-release/2021-126.

[15] SEC Press Release, Sanjay Wadhwa Named Deputy Director of Enforcement Division (Aug. 18, 2021), available at https://www.sec.gov/news/press-release/2021-157.

16] SEC Press Release, Dan Berkovitz Named SEC General Counsel; John Coates to Leave SEC (Sept. 28, 2021), available at https://www.sec.gov/news/press-release/2021-198.

[17] SEC Press Release, Nicole Creola Kelly Named Chief of SEC Whistleblower Office (Nov. 5, 2021), available at https://www.sec.gov/news/press-release/2021-225.

[18] SEC Press Release, Daniel R. Gregus Named Director of Chicago Office (Nov. 15, 2021), available at https://www.sec.gov/news/press-release/2021-234.

[19] SEC Press Release, SEC Appoints Haoxiang Zhu Director of Division of Trading and Markets (Nov. 19, 2021), available at https://www.sec.gov/news/press-release/2021-242.

[20] SEC Press Release, James E. Grimes Named Chief Administrative Law Judge at SEC (Dec. 17, 2021), available at https://www.sec.gov/news/press-release/2021-263.

[21] SEC Press Release, William Birdthistle Named Director of Division of Investment Management (Dec. 21, 2021), available at https://www.sec.gov/news/press-release/2021-268.

[22] SEC Public Statement, Statement in Connection with the SEC’s Whistleblower Program (Aug. 2, 2021), available at https://www.sec.gov/news/public-statement/gensler-sec-whistleblower-program-2021-08-02.

[23] SEC Rules Release, Procedures for the Commission’s Use of Certain Authorities Under Rule 21F-3(B)(3) and Rule 21F-6 of the Securities Exchange Act of 1934, available at https://www.sec.gov/rules/policy/2021/34-92565.pdf.

[24] SEC Public Statement, Statement on the Commission’s Action to Disregard Recently-Amended Whistleblower Rules (Aug. 5, 2021), available at https://www.sec.gov/news/public-statement/peirce-roisman-whistleblower-procedures-2021-08-05.

[25] SEC Press Release, SEC Bars Two Individuals from Whistleblower Award Program (Sept. 28, 2021), available at https://www.sec.gov/news/press-release/2021-199.

[26] SEC Press Release, SEC Awards More Than $1 Million to Whistleblower (July 15, 2021), available at https://www.sec.gov/news/press-release/2021-128.

[27] SEC Press Release, SEC Awards Nearly $3 Million to Whistleblower (July 21, 2021), available at https://www.sec.gov/news/press-release/2021-134.

[28] SEC Press Release, SEC Issues Whistleblower Awards Totaling More Than $4 Million (Aug. 2, 2021), available at https://www.sec.gov/news/press-release/2021-143.

[29] SEC Press Release, SEC Awards $3.5 Million to Whistleblowers in Two Enforcement Actions (Aug. 6, 2021), available at https://www.sec.gov/news/press-release/2021-146.

[30] SEC Press Release, SEC Issues Nearly $6 Million in Whistleblower Awards (Aug. 10, 2021), available at https://www.sec.gov/news/press-release/2021-149.

[31] SEC Press Release, SEC Issues Whistleblower Awards Totaling $2.6 Million (Aug. 27, 2021), available at https://www.sec.gov/news/press-release/2021-168.

[32] SEC Press Release, SEC Surpasses $1 Billion in Awards to Whistleblowers with Two Awards Totaling $114 Million (Sept. 15, 2021), available at https://www.sec.gov/news/press-release/2021-177.

[33] SEC Press Release, SEC Awards $11.5 Million to Two Whistleblowers (Sept. 17, 2021), available at https://www.sec.gov/news/press-release/2021-180.

[34] SEC Press Release, SEC Awards Approximately $36 Million to Whistleblower (Sept. 24, 2021), available at https://www.sec.gov/news/press-release/2021-192.

[35] SEC Press Release, SEC Awards $40 Million to Two Whistleblowers (Oct. 15, 2021), available at https://www.sec.gov/news/press-release/2021-211.

[36] SEC Press Release, SEC Awards More Than $2 Million to Whistleblower for Successful Related Action (Oct. 29, 2021), available at https://www.sec.gov/news/press-release/2021-220.

[37] SEC Press Release, SEC Issues Awards Totaling More Than $15 Million to Two Whistleblowers (Nov. 10, 2021), available at https://www.sec.gov/news/press-release/2021-232.

[38] SEC Press Release, SEC Issues Whistleblower Awards Totaling Approximately $10.4 Million (Nov. 22, 2021), available at https://www.sec.gov/news/press-release/2021-243.

[39] SEC Press Release, SEC Issues Whistleblower Nearly $5 Million Award (Dec. 7, 2021), available at https://www.sec.gov/news/press-release/2021-253.

[40] SEC Press Release, SEC Charges Executives of Network Infrastructure Company with Accounting Fraud (July 15, 2021), available at https://www.sec.gov/news/press-release/2021-127.

[41] SEC Press Release, SEC Charges Retailer and Former CEO for Accounting, Reporting, and Control Failures (July 21, 2021), available at https://www.sec.gov/news/press-release/2021-133.

[42] SEC Press Release, SEC Charges The Kraft Heinz Company and Two Former Executives for Engaging in Years-Long Accounting Scheme (Sept. 3, 2021), available at https://www.sec.gov/news/press-release/2021-174.

[43] SEC Press Release, SEC Charges Dialysis Provider and Three Former Senior Executives with Revenue Manipulation Scheme (Dec. 6, 2021), available at https://www.sec.gov/news/press-release/2021-252.

[44] SEC Press Release, SEC Charges Issuer with Cybersecurity Disclosure Controls Failures (Jun. 15, 2021), available at https://www.sec.gov/news/press-release/2021-102.

[45] SEC Press Release, SEC Charges Company and Two Executives for Misleading COVID-19 Disclosures (July 7, 2021), available at https://www.sec.gov/news/press-release/2021-120.

[46] SEC Press Release, SEC Charges Former CEO of Technology Company with $80 Million Fraud (Aug. 25, 2021), available at https://www.sec.gov/news/press-release/2021-164.

[47] SEC Press Release, SEC Charges Pearson plc for Misleading Investors About Cyber Breach (Aug. 16, 2021), available at https://www.sec.gov/news/press-release/2021-154.

[48] SEC Press Release, SEC Charges Principals of Subprime Automobile Finance Company with Fraud (Sept. 23, 2021), available at https://www.sec.gov/news/press-release/2021-189.

[49] SEC Press Release, SEC Charges Oilfield Services Company and Former CEO With Failing to Disclose Executive Perks and Stock Pledges (Nov. 22, 2021), available at https://www.sec.gov/news/press-release/2021-244.

[50] SEC Press Release, SEC Charges Exchange-Traded Product and Its General Partner With Disclosure Failures (Nov. 8, 2021), available at https://www.sec.gov/news/press-release/2021-229.

[51] SEC Press Release, SEC Charges Ernst & Young, Three Audit Partners, and Former public Company CAO with Audit Independence Misconduct (Aug. 2, 2021), available at https://www.sec.gov/news/press-release/2021-144.

[52] SEC Press Release, UBS Settles Charges Related to Investments in Complex Exchange-Traded Product (July 19, 2021), available at https://www.sec.gov/news/press-release/2021-130.

[53] SEC Press Release, SEC Announces $97 Million Enforcement Action Against TIAA Subsidiary for Violations in Retirement Rollover Recommendations (July 13, 2021), available at https://www.sec.gov/news/press-release/2021-123.

[54] SEC Press Release, SEC Charges Former Executives of Registered Investment Advisor with Fraud (Sept. 30, 2021), available at https://www.sec.gov/news/press-release/2021-204.

[55] SEC Press Release, SEC Wins Jury Trial: Hedge Fund Adviser Found Liable for Securities Fraud (Nov. 5, 2021), available at https://www.sec.gov/news/press-release/2021-224.

[56] SEC Press Release, SEC Charges Private Equity Fund Advisor with Fee and Expense Disclosure Failures (Dec. 20, 2021), available at https://www.sec.gov/news/press-release/2021-266.

[57] SEC Press Release, SEC Charges Hedge Fund Trader in Lucrative Front-Running Scheme (July 2, 2021), available at https://www.sec.gov/news/press-release/2021-118.

[58] SEC Press Release, SEC Charges Real Estate CEO with Defrauding Investors (July 30, 2021), available at https://www.sec.gov/news/press-release/2021-142.

[59] SEC Press Release, SEC Charges Financial Advisor With Stealing Investor Funds to Pay Off Credit Cards, Buy Gold Coins (Oct. 28, 2021), available at https://www.sec.gov/news/press-release/2021-217.

[60] SEC Press Release, SEC Charges 27 Financial Firms for Form CRS Filing and Delivery Failures (July 26, 2021), available at https://www.sec.gov/news/press-release/2021-139.

[61] SEC Press Release, McKinsey Affiliate to Pay $18 Million for Compliance Failures in Handling Nonpublic Information (Nov. 19, 2021), available at https://www.sec.gov/news/press-release/2021-241.

[62] SEC Press Release, SEC Charges Investment Adviser and Associated Individuals with Causing Violations of Regulation SHO (Aug. 17, 2021), available at https://www.sec.gov/news/press-release/2021-156.

[63] SEC Press Release, SEC Charges School District and Former Executive with Misleading Investors in Bond Offering (Sept. 16, 2021), available at https://www.sec.gov/news/press-release/2021-178.

[64] SEC Press Release, SEC Charges Underwriter and Its Former CEO With Misconduct In Muni Bond Tender Offer (Aug. 26, 2021), available at https://www.sec.gov/news/press-release/2021-166.

[65] SEC Press Release, RBC Charged With Failing to Give Priority to Retail and Institutional Investors in Municipal Offerings (Sept. 17, 2021), available at https://www.sec.gov/news/press-release/2021-179.

[66] SEC Press Release, SEC Charges Firm and Two Principals in First-Ever Actions Enforcing Rule on Duties of Municipal Advisors (Sept. 23, 2021), available at https://www.sec.gov/news/press-release/2021-188.

[67] SEC Press Release, SEC Charges Rogue Trader Who Bankrupted His Firm (Sept. 30, 2021), available at https://www.sec.gov/news/press-release/2021-205.

[68] SEC Press Release, Credit Suisse to Pay Nearly $475 Million to U.S. and U.K. Authorities to Resolve Charges in Connection with Mozambican Bond Offerings (Oct. 19, 2021), available at https://www.sec.gov/news/press-release/2021-213.

[69] Id.

[70] SEC Press Release, SEC Announces Three Actions Charging Deficient Cybersecurity Procedures (Aug. 30, 2021), available at https://www.sec.gov/news/press-release/2021-169.

[71] SEC Press Release, SEC Charges Fixed Income Clearing Corp. With Having Inadequate Risk Management Policies (Oct. 29, 2021), available at https://www.sec.gov/news/press-release/2021-219.

[72] SEC Press Release, JPMorgan Admits to Widespread Recordkeeping Failures and Agrees to Pay $125 Million Penalty to Resolve SEC Charges (Dec. 17, 2021), available at https://www.sec.gov/news/press-release/2021-262.

[73] CFTC Press Release, CFTC Orders JPMorgan to Pay $75 Million for Widespread Use by Employees of Unapproved Communication Methods and Related Recordkeeping and Supervision Failures (Dec. 17, 2021), available at https://www.cftc.gov/PressRoom/PressReleases/8470-21.

[74] SEC Press Release, ICO “Listing” Website Charged with Unlawfully Touting Digital Asset Securities (Jul. 14, 2021), available at https://www.sec.gov/news/press-release/2021-125.

[75] See SEC Statement, SEC Statement Urging Caution Around Celebrity Backed ICOs (Nov. 1, 2017), available at https://www.sec.gov/news/public-statement/statement-potentially-unlawful-promotion-icos.

[76] SEC Statement, In the Matter of Coinschedule by Commissioners Peirce and Roisman (July 14, 2021), available at https://www.sec.gov/news/public-statement/peirce-roisman-coinschedule.

[77] Id.

[78] Hester Peirce, Commissioner, SEC, Token Safe Harbor Proposal 2.0 (Apr. 13, 2021), available at https://www.sec.gov/news/public-statement/peirce-statement-token-safe-harbor-proposal-2.0.

[79] SEC Press Release, SEC Charges Poloniex for Operating Unregistered Digital Asset Exchange (Aug. 9, 2021), available at https://www.sec.gov/news/press-release/2021-147.

[80] SEC Press Release, SEC Charges Three Media Companies with Illegal Offerings of Stock and Digital Assets (Sep. 13, 2021), available at https://www.sec.gov/news/press-release/2021-175.

[81] SEC Press Release, Registration of Two Digital Tokens Halted (Nov. 10, 2021), available at https://www.sec.gov/news/press-release/2021-231.

[82] SEC Press Release, SEC Charges Decentralized Finance Lender and Top Executives for Raising $30 Million Through Fraudulent Offerings (Aug. 6, 2021), available at https://www.sec.gov/news/press-release/2021-145.

[83] SEC Press Release, SEC Charges Global Crypto Lending Platform and Top Executives in $2 Billion Fraud (Sep. 1, 2021), available at https://www.sec.gov/news/press-release/2021-172.

[84] SEC Press Release, SEC Charges Promoter with Conducting Cryptocurrency Investment Scams (Nov. 18, 2021), available at https://www.sec.gov/news/press-release/2021-237.

[85] SEC Press Release, SEC Charges Latvian Citizen with Digital Asset Fraud (Dec. 2, 2021), available at https://www.sec.gov/news/press-release/2021-248.

[86] The alleged tipper settled for a permanent injunction, a $240,000 fine, and a two-year officer and director bar, as well as a two-year bar under a parallel Rule 102(e) forbidding practice before the SEC. See SEC Litigation Release, SEC Obtains Judgment Against Former Corporate Controller for Tipping Brother-in-Law Ahead of Merger Announcement (Nov. 15, 2021), available at https://www.sec.gov/litigation/litreleases/2021/lr25264.htm.

[87] SEC Litigation Release, SEC Charges Corporate Controller and His Brother-In-Law with Insider Trading Ahead of Merger Announcement (Dec. 11, 2020), available at https://www.sec.gov/litigation/litreleases/2020/lr24982.htm.

[88] Dean Seal, SEC Handed Rare Midtrial Defeat in Insider Trading Case (Dec. 14, 2021), available at https://www.law360.com/articles/1448811/sec-handed-rare-midtrial-defeat-in-insider-trading-case.

[89] SEC Press Release, SEC Charges TheBull with Selling “Insider Trading Tips” on the Dark Web (Jul. 9, 2021), available at https://www.sec.gov/news/press-release/2021-122.

[90] SEC Press Release, SEC Charges Five Russians in $80 Million Hacking and Trading Scheme (Dec. 20, 2021), available at https://www.sec.gov/news/press-release/2021-265.

[91] SEC Press Release, SEC Charges Three Individuals with Insider Trading (Jul. 9, 2021), available at https://www.sec.gov/news/press-release/2021-121.

[92] SEC Press Release, SEC Charges Biopharmaceutical Company Employee with Insider Trading (Aug. 17, 2021), available at https://www.sec.gov/news/press-release/2021-155.

[93] Order Denying Motion to Dismiss, S.E.C. v. Panuwat, No. 3:21-cv-06322 (N.D. Cal. Jan. 14, 2022) ECF No. 26.

[94] SEC Press Release, SEC Charges Netflix Insider Trading Ring (Aug. 18, 2021), available at https://www.sec.gov/news/press-release/2021-158.

[95] SEC Press Release, SEC Charges App Annie and its Founder with Securities Fraud (Sept. 14, 2021), available at https://www.sec.gov/news/press-release/2021-176.

[96] SEC Press Release, SEC Charges Former Pharmaceutical Global IT Manager in $8 Million Insider Trading Scheme (Sept. 17, 2021), available at https://www.sec.gov/news/press-release/2021-181.

[97] SEC Press Release, SEC Charges Quant Analyst in Multimillion Dollar Front-Running Scheme (Sept. 23, 2021), available at https://www.sec.gov/news/press-release/2021-186.

[98] SEC Press Release, SEC Charges Investment Bank Compliance Analyst with Insider Trading in Parents’ Accounts and Obtains Asset Freeze (Sept. 29, 2021), available at https://www.sec.gov/news/press-release/2021-203.

[99] SEC Press Release, SEC Charges Partner at Global Consulting Firm With Insider Trading (Nov. 10, 2021), available at https://www.sec.gov/news/press-release/2021-230.

[100] SEC Press Release, SEC Charges Clinical Drug Trial Investigator with Insider Trading (Dec. 20, 2021), available at https://www.sec.gov/news/press-release/2021-264.

[101] SEC Press Release, SEC Charges U.K.-Based Father and Son, and Two Others in Transatlantic Microcap Fraud Scheme (Sept. 23, 2021), available at https://www.sec.gov/news/press-release/2021-187.

[102] SEC Press Release, SEC Charges Two Individuals for Wash Trading Scheme Involving Options of “Meme Stocks” (Sept. 27, 2021), available at https://www.sec.gov/news/press-release/2021-195.

[103] SEC Press Release, SEC Charges Webcast Host for Role in Market Manipulation Scheme (Oct. 1, 2021), available at https://www.sec.gov/news/press-release/2021-206.

[104] SEC Press Release, SEC Obtains Asset Freeze and Other Relief in Halting Penny Stock Scheme on Twitter (Oct. 26, 2021), available at https://www.sec.gov/news/press-release/2021-214.

[105] SEC Press Release, SEC Charges Penny Stock Company, CEO and Others with Multi-Million Dollar Fraud (Aug. 16, 2021), available at https://www.sec.gov/news/press-release/2021-153.

[106] SEC Press Release, SEC Charges International Microcap Fraud Scheme Participants (Aug. 9, 2021), available at https://www.sec.gov/news/press-release/2021-148.

[107] SEC Press Release, SEC Charges Three Canadian Citizens in Fraudulent Penny Stock Scheme (Dec. 10, 2021), available at https://www.sec.gov/news/press-release/2021-255.

[108] SEC Press Release, SEC Obtains Emergency Relief, Charges Couple Who Operated $18 Million Ponzi Scheme (Aug. 31, 2021), available at https://www.sec.gov/news/press-release/2021-170.

[109] SEC Press Release, SEC Obtains Emergency Relief, Charges Investment Adviser and its Principal with Operating $110 Million Ponzi Scheme (Aug. 25, 2021), available at https://www.sec.gov/news/press-release/2021-163.

[110] SEC Press Release, SEC Obtains Court Order to Stop Investment Adviser’s Alleged Ongoing Offering Fraud (Aug. 13, 2021), available at https://www.sec.gov/news/press-release/2021-150.

[111] SEC Press Release, SEC Charges Florida Payday Lender and CEO with Affinity Fraud Targeting the Venezuelan-American Community (Sept. 27, 2021), available at https://www.sec.gov/news/press-release/2021-196.

[112] SEC Press Release, SEC Charges Two Companies and Their Principals with Misleading Investors in More Than a Dozen Oil and Gas Securities Offerings (Sept. 24, 2021), available at https://www.sec.gov/news/press-release/2021-193.

[113] SEC Press Release, SEC Charges Puerto Rican Company and Managing Members with Fraud (Sept. 21, 2021), available at https://www.sec.gov/news/press-release/2021-185.

[114] SEC Press Release, SEC Shuts Down Fraudulent Mother-Son Offering Involving Purported Supercomputer (July 19, 2021), available at https://www.sec.gov/news/press-release/2021-131.

[115] SEC Press Release, SEC Files Charges in Multi-Million Dollar Fraud Involving Two Companies (July 19, 2021), available at https://www.sec.gov/news/press-release/2021-132.

[116] SEC Press Release, SEC Obtains Emergency Relief, Charges Two Florida Companies and Their Principal Officer with Operating a Ponzi Scheme (Aug. 13, 2021), available at https://www.sec.gov/news/press-release/2021-151.

[117] SEC Press Release, SEC Obtains Emergency Relief Against New York Real Estate Developer Charged with EB-5 Securities Fraud (Sept. 28, 2021), available at https://www.sec.gov/news/press-release/2021-200.

[118] SEC Press Release, SEC Charges California Resident in Microcap Fraud Scheme Targeting Retail Investors (July 22, 2021), available at https://www.sec.gov/news/press-release/2021-135.

[119] SEC Press Release, SEC Halts Alleged Ongoing Offering Fraud Involving Cycling Companies (July 22, 2021), available at https://www.sec.gov/news/press-release/2021-136.

[120] SEC Press Release, SEC Charges Unlicensed Broker with Defrauding Investors (July 28, 2021), available at https://www.sec.gov/news/press-release/2021-140.

[121] SEC Press Release, SEC Charges Crowdfunding Portal, Issuer, and Related Individuals for Fraudulent Offerings (Sept. 20, 2021), available at https://www.sec.gov/news/press-release/2021-182.

[122] SEC Press Release, SEC Charges Hemp Company and Co-Founders with Fraud (Oct. 5, 2021), available at https://www.sec.gov/news/press-release/2021-208.

[123] SEC Press Release, SEC Charges Newport Beach Company and its Principals with Operating a $13.5 Million Ponzi-Like Scheme (Oct. 29, 2021), available at https://www.sec.gov/news/press-release/2021-221.

[124] SEC Press Release, SEC Obtains Emergency Relief in Case Charging Claims Aggregator and Principals with Multi-Million Dollar Fraud (Nov. 4, 2021), available at https://www.sec.gov/news/press-release/2021-222.

The following Gibson Dunn lawyers assisted in the preparation of this client update: Mark Schonfeld, Richard Grime, Barry Goldsmith, David Ware, Timothy Zimmerman, Lindsey Geher, Jeff Meyers, Ben Gibson, Kate Googins, Caelin Moriarty Miltko*, Sean Brennan*, and Jimmy Pinchak*.

Gibson Dunn is one of the nation’s leading law firms in representing companies and individuals who face enforcement investigations by the Securities and Exchange Commission, the Department of Justice, the Commodities Futures Trading Commission, the New York and other state attorneys general and regulators, the Public Company Accounting Oversight Board (PCAOB), the Financial Industry Regulatory Authority (FINRA), the New York Stock Exchange, and federal and state banking regulators.

Our Securities Enforcement Group offers broad and deep experience. Our partners include the former Director of the SEC’s New York Regional Office, the former head of FINRA’s Department of Enforcement, the former United States Attorneys for the Central and Eastern Districts of California and the District of Maryland, and former Assistant United States Attorneys from federal prosecutors’ offices in New York, Los Angeles, San Francisco and Washington, D.C., including the Securities and Commodities Fraud Task Force.

Securities enforcement investigations are often one aspect of a problem facing our clients. Our securities enforcement lawyers work closely with lawyers from our Securities Regulation and Corporate Governance Group to provide expertise regarding parallel corporate governance, securities regulation, and securities trading issues, our Securities Litigation Group, and our White Collar Defense Group.

Securities Enforcement Practice Group Leaders:
Richard W. Grime – Washington, D.C. (+1 202-955-8219, [email protected])
Mark K. Schonfeld – New York (+1 212-351-2433, [email protected])

Please also feel free to contact any of the following practice group members:

Washington, D.C.
Stephanie L. Brooker (+1 202-887-3502, [email protected])
Daniel P. Chung (+1 202-887-3729, [email protected])
M. Kendall Day (+1 202-955-8220, [email protected])
Jeffrey L. Steiner (+1 202-887-3632, [email protected])
Patrick F. Stokes (+1 202-955-8504, [email protected])
F. Joseph Warin (+1 202-887-3609, [email protected])

San Francisco
Winston Y. Chan (+1 415-393-8362, [email protected])
Thad A. Davis (+1 415-393-8251, [email protected])
Charles J. Stevens (+1 415-393-8391, [email protected])
Michael Li-Ming Wong (+1 415-393-8234, [email protected])

Palo Alto
Michael D. Celio (+1 650-849-5326, [email protected])
Paul J. Collins (+1 650-849-5309, [email protected])
Benjamin B. Wagner (+1 650-849-5395, [email protected])

Denver
Robert C. Blume (+1 303-298-5758, [email protected])
Monica K. Loseman (+1 303-298-5784, [email protected])

Los Angeles
Michael M. Farhang (+1 213-229-7005, [email protected])
Douglas M. Fuchs (+1 213-229-7605, [email protected])
Nicola T. Hanna (+1 213-229-7269, [email protected])
Debra Wong Yang (+1 213-229-7472, [email protected])

* Caelin Moriarty Miltko, Sean Brennan, and Jimmy Pinchak are recent law graduates working in the firm’s Washington, D.C., Denver and New York offices, respectively, and not yet admitted to practice law.

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

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California has seen a flurry of legislative activity over the last couple of years focused on protecting the rights of employees entering separation or settlement agreements with employers. Employers who have not updated their separation or severance agreement templates in the last few years should consider whether updates to their agreements are needed. This is especially true in light of SB 331 which Governor Gavin Newsom signed into law on October 7, 2021. SB 331, or the “Silenced No More Act,” introduces additional restrictions on settlement agreements, non-disparagement agreements and separation agreements executed with employees in California after January 1, 2022.

Background – Recent Legal Developments

California has made a number of changes to requirements for separation and settlement agreements over the past few years, including but not limited to:

SB 1431, effective January 1, 2019, which amended the language of Section 1542 of the California Civil Code, often cited in settlement agreements, to read as follows: “A general release does not extend to claims that the creditor or releasing party does not know or suspect to exist in his or her favor at the time of executing the release and that, if known by him or her, would have materially affected his or her settlement with the debtor or released party.”
SB 820 which prohibits provisions in settlement agreements entered into after January 1, 2019 that prevent the disclosure of facts related to sexual assault, harassment, and discrimination claims “filed in a civil action” or in “a complaint filed in an administrative action.” SB 820 did not prohibit provisions requiring confidentiality of a settlement payment amount, and the law included an exception for provisions protecting the identity of the claimant where requested by the claimant.
SB 1300, effective January 1, 2019, amended California’s Fair Employment and Housing Act to prohibit employers from requiring employees to agree to a non-disparagement agreement or other document limiting the disclosure of information about unlawful workplace acts in exchange for a raise or bonus, or as a condition of employment or continued employment. SB 1300 further prohibited employers from requiring, in exchange for a raise or bonus or as a condition of employment or continued employment, that an individual “execute a statement that he or she does not possess any claim or injury against the employer” or release “a right to file and pursue a civil action or complaint with, or otherwise notify, a state agency, other public prosecutor, law enforcement agency, or any court or other governmental entity.” Under the law, any such agreement is contrary to public policy and unenforceable. That said, negotiated settlement agreements of civil claims supported by valuable consideration were exempted from these prohibitions.
AB 749 went into effect on January 1, 2020 and further impacted settlement agreements by limiting the inclusion of “no-rehire” provisions in agreements that settle employment disputes. AB 749 created Code of Civil Procedure Section 1002.5, which prohibits an agreement to settle an employment dispute from containing “a provision prohibiting, preventing, or otherwise restricting a settling party that is an aggrieved person from obtaining future employment with the employer against which the aggrieved person has filed a claim, or any parent company, subsidiary, division, affiliate, or contractor of the employer.” AB 749 defined an “aggrieved person” as “a person who has filed a claim against the person’s employer in court, before an administrative agency, in an alternative dispute resolution forum, or through the employer’s internal complaint process.” Notably, AB 749 continued to allow a “no-rehire” provision in a settlement agreement with an employee whom the employer, in good faith, determined engaged in sexual harassment or sexual assault. AB 749 did not restrict the execution of a severance agreement that is unrelated to a claim filed by the employee against the employer.
AB 2143, which took effect January 1, 2021, modified the provisions enacted by AB 749 to further clarify and expand when employers can include a “no-rehire” provision in separation or settlement agreements. Specifically, AB 2143 amended Code of Civil Procedure Section 1002.5 to also allow a “no-rehire” provision if the aggrieved party has engaged in “any criminal conduct.” AB 2143 also clarified that in order to include a “no-rehire” provision in a separation or settlement agreement, an employer must have made and documented a good-faith determination that such individual engaged in sexual harassment, sexual assault, or any criminal conduct before the aggrieved employee raised his or her claim. Finally, AB 2143 also made clear that the restriction on “no-rehire” provisions set forth in Code of Civil Procedure Section 1002.5 applies only to employees whose claims were filed in “good faith.”

SB 331 – Key Changes

Against this legal backdrop, SB 331 has introduced additional restrictions that employers should keep in mind when entering into settlement or separation agreements with employees in California.

Settlement Agreements

Building on the protections included in SB 820, SB 331 expanded SB 820’s prohibition on provisions that prevent the disclosure of facts to include all facts related to all forms of harassment, discrimination, and retaliation—not just those related to sexual assault, sexual harassment, or sex discrimination. Just as with SB 820, parties can agree to prevent the disclosure of the settlement payment amount, and the identity of the claimant can be protected where requested by the claimant.

Non-Disparagement Covenants and Separation Agreements

Consistent with SB 1300, SB 331 prohibits an employer from requiring an employee to agree to a non-disparagement agreement or other document limiting the disclosure of “information about unlawful acts in the workplace” in exchange for a raise or bonus, or as a condition of employment or continued employment. SB 331 also prohibits an employer from including in any separation agreement with an employee or former employee any provision that prevents the disclosure of “information about unlawful acts in the workplace” which includes, but is not limited to, information pertaining to harassment or discrimination or any other conduct that the employee has reasonable cause to believe is unlawful.

Effective January 1, 2022, any non-disparagement or other contractual provision that restricts an employee’s ability to disclose information related to conditions in the workplace must include, in substantial form, the following language: “Nothing in this agreement prevents you from discussing or disclosing information about unlawful acts in the workplace, such as harassment or discrimination or any other conduct that you have reason to believe is unlawful.”

Finally, SB 331 also provides that any separation agreement with an employee or former employee related to an employee’s separation from employment that includes a release of claims must provide: (i) notice that the employee has the right to consult an attorney regarding the agreement and (ii) a reasonable time period of at least five (5) business days in which to consult with an attorney. An employee may sign the agreement before the end of such reasonable time period so long as such employee’s decision is “knowing and voluntary” and is not induced by the employer through fraud, misrepresentation or a threat to withdraw or alter the offer prior to the expiration of such reasonable period of time or by providing different terms to the employees who sign such an agreement before the expiration of such time period. The SB 331 requirements do not apply to a negotiated agreement to resolve an underlying claim filed by an employee in court, before an administrative agency, in arbitration, or through an employer’s internal complaint process.

Conclusion and Next Steps

SB 331 represents the latest step taken by California intended to protect employees’ rights by restraining employers from preventing the disclosure of information regarding certain workplace conditions.

When evaluating separation or severance agreement templates, employers should consider whether the agreements:

Include language requiring that a settlement or severance amount be held in the strictest confidence by the employee or former employee.
Have the latest amended Section 1542 language.
Have the appropriate disclosures for any non-disparagement provisions.
Provide employees with sufficient disclosures and time to consider the separation agreement.
Include limitations on individuals which are now prohibited.

Employers should navigate these requirements with care. Compliance with California’s multifaceted legal protections for employees and former employees will require careful drafting. Employers should consider seeking the assistance of legal counsel to refresh templates prior to entering into settlement or separation agreements in California.

The following Gibson Dunn attorneys assisted in preparing this client update: Tiffany Phan, Florentino Salazar, Sean Feller, Jason Schwartz, and Katherine V.A. Smith.

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

Sean C. Feller – Co-Chair, Executive Compensation & Employee Benefits Group, Los Angeles
(+1 310-551-8746, [email protected])

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

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

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

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Following an unprecedented year for UK regulated firms in 2020, the UK Financial Conduct Authority used 2021 to advance a number of regulatory initiatives. This client alert assesses the regulatory landscape through the lens of three notable regulatory “hot topics”: environment, social and governance (“ESG”) developments; fintech and cryptoassets; and individual accountability and conduct risks.

ESG developments

“ESG matters are high on the regulatory agenda. If the financial sector is going to help support the transition to a more sustainable future, market participants and financial services firms need high quality information, a well-functioning ecosystem and clear standards. And consumers need to be able to rely on firms to take ESG seriously, avoid ‘greenwashing’ and deliver on their ESG promises.”[1]

(1) Overview

Over the last five years, sustainable investing and sustainable finance have come to the fore on the global stage, primarily as a result of the climate crisis and the resulting net zero commitments increasingly being given around the world. It reflects an acknowledgement of the real financial impacts of climate change and broader ESG-related issues.

In 2021, in particular, the focus on ESG has become even more intense in the UK, which further cemented its ESG credentials through the hosting of the 2021 United Nations Climate Change Conference (known as COP26) in November.

(2) Developments in 2021

A number of significant steps have been taken by both the UK FCA and UK government in this regard. 2021 saw, amongst other things:

the introduction of disclosure requirements aligned with the TCFD (or Taskforce on Climate-related Financial Disclosures) for all premium listed issuers (to be rolled out to a broader range of issuers);

a UK FCA policy statement on enhancing climate-related disclosures by asset managers, life insurers and FCA-regulated pension providers, with first disclosures required by 30 June 2023;

building on such work, proposals to introduce a UK “Green Taxonomy”, sustainability disclosure requirements for asset managers and FCA-regulated asset owners, as well as a comprehensive labelling system for sustainable investment products. The details of the UK Green Taxonomy and the sustainability disclosure requirements will closely track the EU’s Taxonomy Regulation[2] and the Sustainable Finance Disclosure Regulation[3] (“SFDR”) requirements; and

in more than just a symbolic move, in mid-2021 the UK FCA welcomed its first “Director of ESG”, Sacha Sadan. Mr Sadan’s mandate is to embed ESG considerations across the UK FCA’s functions, in a “golden thread” approach.

The focus to-date has largely been to focus on the “E” rather than the “S” or “G”. For instance, the UK FCA consultation on TCFD-aligned disclosure rules for asset managers referred to above is much more geared towards climate. This is not exclusively the case, however. For example, the UK FCA sourcebook containing such rules will be entitled the “ESG” sourcebook and the UK FCA has specifically said that it “anticipate[s] that the ESG sourcebook will expand over time to include new rules and guidance on other climate-related and wider ESG topics”[4]. Additionally, for the purposes of the UK Green Taxonomy proposals, in order for an economic activity to qualify as being sustainable it must meet a number of criteria, including complying with minimum safeguards based on certain human rights standards.

Challenges firms face

Firms face a number of challenges including:

operating multi-nationally and complying with different regulatory regimes;
dealing with investor requirements; and
supranational standards and disclosures.

It is clear that the current portfolio of proposals and initiatives is the starting place and not the finishing line.

(3) What to expect in 2022

The focus in the UK on ESG is by no means set to slow down. One such area in which there is encouragingly a lot of work being done is in attempting to bring some further clarity and coherence to ESG disclosures. On November 3, 2021, in recognition of international investors with global investment portfolios increasingly calling for high quality, transparent, reliable and comparable reporting by companies on climate and other ESG matters, the creation of a new standard setting board – the International Sustainability Standards Board – was announced. This was broadly welcomed by the industry and regulators alike. Indeed, in a speech on the same day as the announcement, the UK FCA CEO, Nikhil Rathi went so far as to refer to this as a “game changer”, noting also that the UK FCA “will work with IOSCO and others to promote adoption of the new Board’s global baseline sustainability reporting standards”[5].

Another area in which we may well see development is in relation to ESG data providers. As industry participants more fully integrate ESG into their activities and expand their ESG-focused product offerings, they are increasingly reliant on third-party ESG data services, as well as ESG ratings and benchmark indices. It is, therefore, increasingly important that these services are delivered in a fair, effective and transparent way. We are, therefore, likely to see proposals in relation to managing risks such as lack of transparency and manipulation coming out of supranational bodies such as IOSCO and also national legislators and regulators.

As the UK FCA explained in its ESG strategy statement[6], “[i]n the case of ESG ratings, different methodological choices result in a low correlation between different providers’ ratings. Consequently, without transparency of these methodologies, it may be difficult to interpret and compare outputs across providers, potentially leading to harms for consumers…it is important providers deliver ESG data and ratings transparently, and that they have strong governance and management of conflicts of interests. The Government is therefore considering bringing these firms into the scope of FCA authorisation and regulation”. In another example of the UK FCA demonstrating awareness that it is important to find a global solution to a global problem, it has (in parallel) contributed to the International Organization of Securities Commissions’ work on ESG data and ratings.

Fintech and cryptoassets

“It will take a great deal of careful thought to craft a regulatory regime which will be effective in the decentralised world of digital tokens. And it’s clear that legislators need to consider 3 issues: how to make it harder for digital tokens to be used for financial crime; how to support useful innovation; and the extent to which consumers should be free to buy unregulated, purely speculative tokens and to take the responsibility for their decisions to do so.”(Charles Randell, Chair of the FCA and PSR, September 2021)[7]

(1) Overview

As a general matter, over the last year or so we have seen cryptoassets explode into the mainstream. Cryptoasset firms have expanded in geographical reach and “traditional” financial institutions have increased their exposure to this asset class. FCA research indicated that 2.3 million adults in the UK hold cryptoassets, up from 1.9 million in 2020.[8] The UK looks for the most part at cryptoassets through the lens of traditional financial instruments under the Financial Services and Markets Act. Essentially, cryptoassets will fall within the regulatory perimeter where they constitute securities (e.g. shares, debentures, etc.), certain derivatives or collective investment schemes.

The FCA has issued warnings regarding companies offering cryptocurrency services in the UK without being properly registered, and not meeting the required standards under money laundering regulations. From the enforcement perspective, like elsewhere in the world it is an aggressive enforcement environment for cryptoasset firms in the UK. The FCA is very active in protecting the so-called regulatory perimeter. We have also seen the FCA (like its EU counterparts) ban the sale of crypto derivatives to retail investors.

The approach being taken in the UK by the government is risk-based and so we have not seen proposals for a bespoke regulatory regime for cryptoassets for the UK although there have been a good many initiatives, including the proposal to expand the scope of the financial promotions regime to unregulated cryptoassets and a more recent proposal to bring certain stablecoins within the regulatory perimeter.

In the UK, and elsewhere internationally, there has been a focus on tackling anti-money laundering in the cryptoassets space. The UK and EU now have cryptoasset firm registration procedures derived from the Fifth Money Laundering Directive (“MLD5”). The FCA has been particularly focus on undertaking a robust review of an the AML framework of firms seeking MLD5 registration.

(2) Developments in 2020

There have been a number of UK regulatory developments concerning fintech and cryptoassets in 2021.

Bringing “stable tokens” within the FCA’s regulatory perimeter

In January 2021, HM Treasury published another consultation paper setting out proposals to bring “stable tokens” within the FCA’s regulatory perimeter. Stable tokens are defined as those tokens that stabilise their value by referencing one or more assets, such as fiat currency or a commodity and could, therefore more reliably be used as a means of exchange or store of value. This regime would bring both.

Expanding the financial promotions regime

HM Treasury is also consulting on proposals to expand the perimeter of the financial promotion regime to bring the promotion of certain types of unregulated cryptoassets within its scope. The HM Treasury proposals identify the unregulated cryptoassets that will be covered as “controlled investments” by introducing “qualifying cryptoasset” as a new category of controlled investment. the tokens and associated activities into regulation.

Kalifa Review

In 2021, we also saw the publication of the Kalifa Review of UK Fintech (the “Review”). The Review stated that the UK has the potential to be a leading global centre for the issuance, clearing, settlement, trading and exchange of crypto and digital assets. The Review called for a bespoke regime for cryptoassets should adopt a functional and technology-neutral approach, in line with the principles of the current regulatory framework, as well as the concept of “same risk, same regulation”, while being tailored to the risks arising from cryptoasset activities.

Law Commission digital assets project

The Law Commission has been asked by Government to make recommendations for reform to ensure that the law is capable of accommodating both cryptoassets and other digital assets in a way which allows the possibilities of this technology to flourish. The Law Commission published an interim update paper on its digital assets project on 24 November 2021. The Law Commission anticipates publishing its digital assets consultation paper in mid-2022.

Extension of the Temporary Registrations Regime

From a practical perspective, the FCA extended the end date of the Temporary Registrations Regime (“TRR”) for existing cryptoasset businesses from 9 July 2021 to 31 March 2022. The TRR was established in 2020 to allow existing cryptoasset firms that applied for registration before 16 December 2020, and whose applications are still being assessed, to continue trading. The FCA noted that a significant number of businesses were not meeting the required standards under the Money Laundering Regulations. The extended date allows cryptoasset firms to continue to carry on business while the FCA continues with its assessment.

(3) What to expect in 2022

We will see the proposed changes coming in, including expansion of the scope of the financial promotions regime to include cryptoassets currently outside the regulatory perimeter and bringing certain stablecoins inside the regulatory perimeter. However, we do not consider that that will be the end of the story. We fully expect that we will continue to see new laws and regulations in the UK which will respond to the regulatory risks posed by cryptoassets. The FCA is also likely to continue to be an aggressive regulator in this space, especially in areas of perceived highest risk: anti-money laundering and defending the regulatory perimeter in order to protect investors.

Individual accountability and conduct risks

“We want firms to be clear about what we expect from them, including from their governance and culture.” (FCA Business plan 2021/2022)

(1) Overview

The UK regulators recognise that each firm’s culture is different. However, they consider that it is the responsibility of everyone in financial services to focus on culture, and they expect senior management in firms to manage the drivers of behaviour in their firms to create and maintain cultures which reduce the potential for harm.

Firm’s cultures have been a major root cause of conduct failures, and the regulator’s work supporting firms in delivering real and sustainable culture transformations will help prevent harm caused by inappropriate behaviours. Conduct and culture are inextricably linked to senior management accountability. In the UK, the vast majority of regulated firms are now subject to the Senior Managers and Certification Regime.

(2) Developments in 2021

“The focus on points of failure not only encourages greater awareness, it also promotes better calculations of judgement”(Mark Steward, FCA Executive Director of Enforcement and Market Oversight)[9]

Non-financial misconduct

As we noted in 2020[10], the regulatory direction of travel has been to push firms to think more broadly in terms of what types of misconduct they need to tackle with an increased focus on non-financial misconduct and how this reflects the culture of the firm.

In September 2021, the FCA banned director Jon Frensham from performing any regulated activity for non-financial misconduct. The decision was notable as the Upper Tribunal found that Frensham’s conviction for child sexual offences was not sufficient on its own to justify the imposition of a prohibition, as the FCA had not established a sufficiently strong factual or legal basis linking the conviction itself Frensham’s lack of personal integrity as was relevant to his specific financial services role. However, the Upper Tribunal did uphold the FCA’s prohibition order on alternative, narrower grounds. In assessing whether non-financial misconduct is relevant to an assessment of fitness and propriety, the FCA will need to establish that this has an impact on and is relevant to its standards and statutory objectives.

Diversity and inclusion

“We will increasingly be asking tough questions firms about representation across grades and whether their culture is open and inclusive and provides a safe space for colleagues at all levels of the organisation” (Nikhil Rathi, FCA CEO, March 2021)[11]

The FCA has previously developed its “5 conduct questions”[12] expressly to help firms implement more effective change programmes as well as helping the FCA to interrogate progress. The 5 conduct questions are addressed to firms and require self-reflective answers. The FCA has expressly noted that it is considering adding a sixth question in its future work which will interrogate firms on diversity and inclusion, another telling indicator of culture. The FCA’s Business plan stated that the FCA takes diversity and inclusion seriously and expects regulated firms and market participants to do the same.

In July 2021, the Prudential Regulation Authority, the Bank of England and the FCA issued a joint discussion paper to engage financial firms and other stakeholders in a discussion on how to accelerate the pace of meaningful change on diversity and inclusion in the sector. The discussion paper contains a number of potential policy issues including: (1) setting targets for board composition and succession planning; (2) extending diversity and inclusions into the Senior Managers and Certification Regime; (3) linking diversity and inclusion progress to remuneration; (4) setting targets for senior management and employees more broadly; and (5) the introduction of disclosures relating to diversity and inclusion. The discussion paper also raised the issue of extending guidance on “non-financial misconduct” to make it clear that this concept includes sexual harassment, bullying and discrimination based on someone’s protected (or otherwise) characteristics. Taking into account feedback on the discussion paper, the PRA and FCA intend to consult on more detailed proposals in Q1 2022 followed by a policy statement in Q3 2022.

(3) What to expect in 2022

We expect the UK regulators to continue their focus on individual accountability and conduct risks in 2022.

Whilst this will be more of a progression on previous years than a new development we expect the UK regulators to really focus on how conduct and culture are reflected in the new ESG products being developed, and in the new fintech firms and products coming to prominence.

Firms can expect to be challenged on whether their ESG products really have good consumer outcomes at their heart. Regulators are likely to really test governance systems to ensure firms can demonstrate commitment to products delivering on descriptions.

Similarly, firms involved in fintech or digital assets can expect to be targeted for supervisory or thematic visits as Regulators look to test whether the culture of firms is in line with regulatory expectations, and whether systems and controls offer enough comfort that consumers and the financial system as a whole will be adequately protected as new and innovative products are launched.

_________________________

[1] https://www.fca.org.uk/publications/corporate-documents/strategy-positive-change-our-esg-priorities

[2] Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment

[3] Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector

[4] FCA CP21/17: Enhancing climate-related disclosures by asset managers, life insurers and FCA-regulated pension providers (June 2021), paragraph 1.5

[5] https://www.fca.org.uk/news/speeches/strategy-positive-sustainable-change

[6] https://www.fca.org.uk/publications/corporate-documents/strategy-positive-change-our-esg-priorities

[7] https://www.fca.org.uk/news/speeches/risks-token-regulation

[8] https://www.fca.org.uk/publications/research/research-note-cryptoasset-consumer-research-2021

[9] https://www.fca.org.uk/news/speeches/compliance-culture-and-evolving-regulatory-expectations-mark-steward

[10] https://www.gibsondunn.com/the-challenge-of-addressing-non-financial-misconduct-in-uk-regulated-firms/

[11] https://www.fca.org.uk/news/speeches/why-diversity-and-inclusion-are-regulatory-issues

[12] https://www.fca.org.uk/firms/5-conduct-questions-programme

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

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

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

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Introduction

On 12 January 2022, the Hong Kong Monetary Authority (HKMA) released a Discussion Paper on the expansion of the Hong Kong regulatory framework to stablecoins (e.g. crypto-assets pegged to fiat currencies). The Paper considers the adequacy of the existing regulatory framework in light of the growing use of stablecoins and other types of crypto-assets in financial markets, and the challenges posed by this increase in their prevalence. It further poses eight questions for consideration by the industry, including the scope of a proposed new regulatory regime to cover what the HKMA describes as “payment-related stablecoins”.

This client alert provides an overview of the HKMA’s views on crypto-assets and stablecoins as outlined in the Paper, discusses the implications for players in the stablecoin ecosystem if the proposed changes are implemented, and suggested next steps for interested parties.

The HKMA has requested responses to the Paper by 31 March 2022, and has indicated that it intends to introduce this new stablecoin regulatory regime by 2023-2024.

HKMA’s views on crypto-assets and financial stability

The Paper provides a valuable insight into the HKMA’s views on crypto-assets in general, and stablecoins in particular, including their linkages to the traditional financial system and ramifications on financial stability.

In introducing its proposal to regulate payment related stablecoins, the HKMA has made it clear that while the current size and trading activity of crypto-assets globally may not pose an immediate threat to the stability of the global financial system from a systemic point of view, it does consider the increasing prevalence of crypto-assets to have the potential to impact financial stability. In particular, the HKMA has flagged that it considers the growing exposure of institutional investors, as well as certain segments of the retail public, to such assets as an alternative to, or to complement traditional asset classes, indicates growing interconnectedness with the mainstream financial system.

Further, as noted by the HKMA, it understands that while Hong Kong authorised banks (Authorised Institutions or AIs) currently undertake only limited activities in relation to crypto-assets, AIs are interested in pursuing these activities further, given that they face increasing demand from customers for crypto-related products and services. This is consistent with what we understand is a steady increase in high net wealth investors hungry for yield demanding access to crypto-assets through their private wealth managers, as well as an uptick in demand from retail investors in Hong Kong eager for the same exposure to upside. To this end, the HKMA has flagged that it will soon provide AIs with more detailed regulatory guidance in relation to their interface with and provision of services to customers in relation to crypto-assets.

Finally, the HKMA has also noted its concerns that the ease of anonymous transfer of crypto-assets may make them susceptible to the risk of illicit and money laundering / terrorist financing activities.

The HKMA’s views on stablecoins

The Paper also flags the HKMA’s view that stablecoins are increasingly viewed as a ‘widely acceptable means of payment’ and that this, alongside the actual increase in their use, has increased the potential for their incorporation into the mainstream financial system. In the HKMA’s opinion, this in turn raises broader monetary and financial stability implications and has resulted in the regulation of stablecoins becoming a key priority for the HKMA, which has stated in the Paper that it wishes to ensure that such coins “are appropriately regulated before they operate in Hong Kong or are marketed to the public of Hong Kong”.

The Paper goes on to identify a number of potential risks that may arise in relation to the use of stablecoins, including, in summary:

Payment integrity risks where stablecoins are commonly accepted as a means of payment and operational disruptions or failures occur in relation to the stablecoins;
Banking stability risks if banks were to increase their exposure to stablecoins, particularly if stablecoins were viewed as a substitute for bank deposits;
Monetary policy risks in relation to the issue and redemption of HKD-backed stablecoins, which could affect interbank HKD demand and supply; and
User protection risks where a user may have no or limited recourse in relation to operational disruptions or failures of a stablecoin.

Given these potential risks, the HKMA has stated in the Paper that it considers it appropriate to expand the regulatory perimeter to cover payment-related stablecoins in the first instance, although it has not ruled out the possibility of regulating other forms of stablecoins as well.

The HKMA’s discussion questions for industry consideration

The HKMA has noted in the Paper that it considers ‘the need to regulate [stablecoins] is well justified and the tool to regulate…[can] be decided at a later stage’. However, it has indicated that it wishes for feedback from the industry and the public on the scope of the regulatory regime applicable to stablecoins, and to this end has set out eight discussion questions for industry consideration. A summary of the key questions posed by the HKMA, as well as the HKMA’s views on those questions, is set out below.

Question 1: Should we regulate activities relating to all types of stablecoins or give priority to those payment-related stablecoins that pose higher risks to the monetary and financial systems while providing flexibility in the regime to make adjustments to the scope of stablecoins that may be subject to regulation as needed in the future?

In posing this question, the HKMA has noted that it intends to take a risk-based approach focused initially on payment-related stablecoins at this stage given their predominance in the market and higher potential to be incorporated into the mainstream financial market (as discussed above). However, the HKMA has noted that it intends to ensure that whatever regime is introduced is sufficiently flexible that it could extend to other types of stablecoins in the future. As such, issuers and traders of other types of stablecoins should not expect to avoid regulatory scrutiny forever.

Question 2: What types of stablecoin-related activities should fall under the regulatory ambit, e.g. issuance and redemption, custody and administration, reserves management?

The HKMA has proposed regulating a broad range of stablecoin-related activities, including:

Issuing, creating or destroying stablecoins;
Managing reserve assets to ensure stabilisation of stablecoin value;
Validating transactions and records;
Storing private keys used to provide access to stablecoins;
Facilitating the redemption of stablecoins;
Transmission of funds to settle transactions; and
Executing transactions in stablecoins.

This broad list is based on a list of activities in relation to stablecoins published by the Financial Stability Board[1] and as such may be viewed as in keeping with international standards. However, as discussed below in relation to Question 5, the breadth of this regime may raise concerns regarding the degree of overlap between this regime and others proposed by Hong Kong regulators, including the proposed VASP regime to be administered by the Securities and Futures Commission (SFC) (see our alert here).

Question 3: What kind of authorisation and regulatory requirements would be envisaged for those entities subject to the new licensing regime?

The HMKA has suggested that it considers that entities subject to the new stablecoin licensing regime would be subject to the following requirements:

authorisation and prudential requirements, including adequate financial resources and liquidity requirements;
fit and proper requirements in relation to both management and ownership;
requirements relating to the maintenance and management of reserves of backing assets; and systems; and
controls, governance and risk management requirements.

Further, given that it is common for multiple entities to be involved in different parts of a stablecoin arrangement, the HKMA has noted that such entities could be subject to part or all of the requirements, depending on the services they offer.

If requirements in relation to these matters are ultimately implemented by the HKMA, the stablecoin regime would cover some of the requirements of the proposed VASP regime, with the exception of requirements of reserves of backing assets, which will presumably only be applied to stablecoins given their nature.

Question 4: What is the intended coverage as to who needs a licence under the intended regulatory regime?

The HKMA has signalled that it believes that only entities incorporated in Hong Kong and holding a relevant licence granted by HKMA should carry out regulated activities, to enable the HKMA to exercise effective regulation on the relevant entities. As such, it has stated in the Paper that it expects that foreign companies / groups which intend to provide regulated activities in Hong Kong or actively market those activities in Hong Kong to incorporate a company in Hong Kong and apply for a licence to the HKMA under this regime.

If implemented, this would have significant ramifications for those global crypto-exchanges currently offering trading in stablecoins to Hong Kong users from offshore. These businesses would be faced with a choice between either incorporating in Hong Kong and seeking a licence, or discontinuing their trading for Hong Kong users.

Question 5: When will this new, risk-based regime on stablecoins be established, and would there be regulatory overlap with other financial regulatory regimes in Hong Kong, including but not limited to the SFC’s VASP regime, and the SVF licensing regime of the PSSVFO?

The HKMA has stated that it will collaborate and coordinate with other financial regulators when defining the scope of its oversight and will seek to avoid regulatory arbitrage, including in relation to areas which ‘may be subject to regulation by more than one local financial authority’.

However, an HKMA-administered regime of the breadth proposed above would create a situation in which an exchange undertaking transactions in non-stablecoin crypto-assets would be regulated by the SFC under its proposed new VASP regime while being regulated by both the SFC and the HKMA under its stablecoin regime. In this respect, we note that the proposed definition of ‘virtual asset’ under the proposed new VASP regime ‘applies equally to virtual coins that are stable (i.e. the so-called “stablecoins”)’.[2] While the HKMA and SFC share regulatory responsibility for Registered Institutions (i.e. Authorised Institutions which are separately licensed by the SFC to undertake securities and futures business), that shared regulatory responsibility concerns distinctly different types of activities. In contrast, we consider that from an exchange’s perspective, the act of executing transactions in stablecoins is substantially similar to executing transactions in non-stablecoin crypto-assets. As such, this approach may lead to unnecessary and undesirable regulatory inefficiencies if exchanges are required to be licensed under both the SFC and HKMA regimes to undertake transactions in crypto-assets.

Question 6: Stablecoins could be subject to run and become potential substitutes of bank deposits. Should the HKMA require stablecoin issuers to be AIs under the Banking Ordinance, similar to the recommendations in the Report on Stablecoins issued by the US President’s Working Group on Financial Markets?

While not expressly stating that it will not require stablecoin issuers to be regulated as AIs under the Banking Ordinance, the HKMA has indicated that it expects that the requirements applicable to stablecoin issuers will instead borrow from Hong Kong’s current regulatory framework for stored value facilities (SVF). However, the HKMA has signalled that certain stablecoin issuers may be subject to higher prudential requirements than SVF issuers where they issue stablecoins of systemic importance.

Question 7: [Does] the HKMA also have plan[s] to regulate unbacked crypto-assets given their growing linkage with the mainstream financial system and risk to financial stability?

The HKMA has not expressly ruled out regulating unbacked crypto-assets, and has stated that it is necessary to continue monitoring the risks posed by this asset class. In stating this, the HKMA has also pointed to the VASP regime, suggesting that the HKMA’s approach to this area is likely to depend on the success of that regime once implemented.

Question 8: For current or prospective parties and entities in the stablecoins ecosystem, what should they do before the HKMA’s regulatory regime is introduced?

The HKMA has advised current and prospective players in the stablecoin ecosystem to provide feedback on the proposals set out in the Discussion Paper, and has noted that in the interim, it will continue to supervise AIs’ activities in relation to crypto-assets and implement the SVF licensing regime pending implementation of this new regime.

Conclusion

The Discussion Paper provides a valuable insight into the HKMA’s plans for the future of stablecoin regulation in Hong Kong. While some concerns exist as to the potential overlap between the HKMA’s new proposed regime and the SFC’s VASP regime, it is clear that the HKMA intends to ensure that it is regarded as the primary regulator of stablecoins going forward, and that it sees the regulation of this asset class as closely linked to its key objective of ensuring financial stability.

____________________________

[1] See Financial Stability Board, Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements: Final Report and High-Level Recommendations, https://www.fsb.org/wp-content/uploads/P131020-3.pdf, page 10.

[2] See Financial Services and the Treasury Bureau, Public Consultation on Legislative Proposals to Enhance Anti-Money Laundering and Counter-Terrorist Financing Regulation in Hong Kong (Consultation Conclusions), https://www.fstb.gov.hk/fsb/en/publication/consult/doc/consult_conclu_amlo_e.pdf, paragraph 2.8.

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 Crypto Taskforce ([email protected]) or the Global Financial Regulatory team, including the following authors in Hong Kong:

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

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

SEC’s Dodd-Frank Whistleblower Program continued to break records in FY 2021. The Office of the Whistleblower (“OWB”) received over 12,200 whistleblower tips, by far the largest number of tips received since the beginning of the Program, from 99 foreign countries and every state in the Union. Additionally, the OWB handed out the largest whistleblower awards to date and processed the highest number of claims in FY 2021 since the Program began eleven years ago. The OWB also saw a change in leadership in FY 2021, with the longtime Chief Jane Norberg departing and with the new Acting Chief in office. Together, these trends and changes create the perfect storm for keeping in-house counsel and compliance professionals up at night.

Securities Docket is pleased to present its eleventh annual webcast on Dodd-Frank’s whistleblower provisions. This year’s panelists once again include leading practitioners in all aspects of Dodd-Frank whistleblower litigation and investigations, including F. Joseph Warin, John W.F. Chesley, Greta Williams, and Nicole Lee of Gibson Dunn, former SEC Office of the Whistleblower Chief Sean X. McKessy of Phillips & Cohen, and Jim Barratt of AlixPartners.

This free, 90-minute webcast will include a dynamic and participatory discussion on the statutory and regulatory framework of Dodd-Frank’s whistleblower provisions, their interpretation by the SEC Office of the Whistleblower and federal courts, and provide participants with practical tips for navigating the minefield of whistleblower complaints.

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On December 23, 2021, President Biden signed the Uyghur Forced Labor Prevention Act (the “UFLPA” or “Act”) into law.[1] The UFLPA, which received widespread bipartisan support in Congress, is the latest in a line of U.S. efforts to address the plight of Uyghurs and other persecuted minority groups in China’s Xinjiang Uyghur Autonomous Region (the “XUAR”).

A key feature of the Act is the creation of a rebuttable presumption that all goods manufactured even partially in the XUAR are the product of forced labor and therefore not entitled to entry at U.S. ports. The Act also builds on prior legislation, such as 2020’s Uyghur Human Rights Policy Act,[2] by expanding that Act’s authorization of sanctions to cover foreign individuals responsible for human rights abuses related to forced labor.

I. Background

In recent years, both the executive and legislative branches have demonstrated an increased interest in “lead[ing] the international community in ending forced labor practices wherever such practices occur,”[3] with a particular focus on the XUAR.

2020 saw a boom in efforts across agencies and the houses of Congress, beginning with the Department of Homeland Security’s January publication of a Department-wide strategy to combat forced labor in supply chains.[4] Later that year, DHS joined the U.S. Departments of State, Treasury and Commerce to issue a joint advisory warning of heightened risks of forced labor for businesses with supply chain exposure to the XUAR.[5]

The U.S. also emphasized eliminating forced labor in supply chains through its international obligations at this time. The 2020 United States-Mexico-Canada Agreement (“USMCA”) required each party to this free trade agreement to “prohibit the importation of goods into its territory from other sources produced in whole or in part by forced or compulsory labor.”[6] To carry out this obligation, President Trump issued an executive order in May 2020 establishing the Forced Labor Enforcement Task Force (“FLETF”), chaired by the Secretary of Homeland Security and including representatives from the Departments of State, Treasury, Justice, Labor, and the Office of the U.S. Trade Representative.[7] The implementing bill of the USMCA requires the FLETF to serve as the central hub for the U.S. government’s enforcement of the prohibition on imports made through forced labor.[8]

In Congress, Rep. James McGovern (D) and Sen. Marco Rubio (R) — co-chairs of the Congressional-Executive Commission on China — introduced the first versions of the UFLPA in the House of Representatives[9] and the Senate[10] in March 2020. The bill received unusual, wide bipartisan support, with co-sponsors among Congress’s most conservative and most liberal members.[11] Each bill passed in its respective house in early 2021, and a compromise bill — reconciling differences of timing and reporting processes between the two versions — was sent to the President in mid-December[12] before being signed into law.

II. Presumptive Ban on Imports from the XUAR

The UFLPA’s trade provisions are notable both for their expansive scope and the heightened evidentiary standard required to rebut the Act’s presumptive prohibition on all imports from the XUAR.

a. Scope of the Import Ban

The UFLPA’s scope is broad, instructing U.S. Customs and Border Protection (“CBP”) to presume that “any goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part in” the XUAR were made with forced labor and are therefore unfit for entry at any U.S. ports.[13]

This presumption extends also to goods, wares, articles, and merchandise produced by a variety of entities identified by the FLETF in its strategy to implement the Act. This includes entities that work with the XUAR government to recruit, transport, or receive forced labor from the XUAR,[14] as well as entities that participate in “poverty alleviation” and “pairing-assistance” programs[15] in the XUAR.[16]

CBP has traditionally had the authority to prevent the importation of “[a]ll goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part in any foreign country by . . . forced labor” through the issuance of Withhold Release Orders (“WROs”).[17] The UFLPA broadens this power by creating a rebuttable presumption that all articles produced in whole or in part in the XUAR or by entities that source material from persons involved in XUAR government forced labor schemes are automatically barred from entry into the United States, even absent a WRO or any specific showing of forced labor in the supply chain.

b. Exceptions to the Import Ban

Despite this broad prohibition, importers of goods covered by the UFLPA may still be able to rebut the presumption against importation. The Act specifies that the presumption will not be applied if the Commissioner of CBP determines that:

The importer of record has:
- Fully complied with all due diligence and evidentiary guidance established by the FLETF pursuant to the Act, along with any associated implementing regulations; and
- Completely and substantively responded to all CBP inquiries seeking to ascertain whether the goods were produced with forced labor; and
“Clear and convincing” evidence shows that the goods were not produced wholly or in part with forced labor.[18]

Each time the Commissioner determines that an exception to the import ban is warranted under the criteria above, the Commissioner must submit a report to Congress within 30 days, identifying the goods subject to the exception and the evidence upon which the determination is based.[19] The Commissioner must make all such reports available to the public.[20]

III. High-Priority Enforcement Sectors

As part of its enforcement strategy, the UFLPA instructs the Forced Labor Enforcement Task Force to prepare both a list of high-priority sectors subject to CBP enforcement, and a sector-specific enforcement plan for each of these high-priority sectors.[21] The Act mandates that cotton, tomatoes, and polysilicon must be among the high-priority sectors, building upon CBP’s existing WRO against all cotton and tomato products produced in the XUAR.[22]

The addition of polysilicon on this list of high-priority sectors directly impacts the U.S. solar energy industry: nearly half of the world’s polysilicon — a key material for the manufacture of solar panels — is produced in the XUAR.[23] Despite the dominance of Chinese polysilicon, however, solar industry groups have embraced the passage of the UFLPA and are encouraging solar companies to move their supply chains out of the XUAR.[24] Corporate responsibility concerns surrounding the sourcing of polysilicon from the XUAR have been circulating for at least a year, and the solar industry groups have acted proactively to create standards and procedures to trace and audit supply chains of this important resource. To further this industry-wide goal of eradicating forced labor from solar supply chains,[25] these industry groups recently published a “Solar Supply Chain Traceability Protocol.”[26]

IV. Sanctions

The UFLPA also amends the Uyghur Human Rights Policy Act of 2020 to underscore that sanctions may be imposed due to “[s]erious human rights abuses in connection with forced labor” related to the XUAR. Within 180 days of enactment, the President is required to submit an initial report to Congress identifying non-U.S. persons subject to sanctions under this new provision.[27] The sanctioned individuals will be subject to asset blocking, as provided under the International Emergency Economic Powers Act,[28] as well as the revocation or denial of visas to enter the United States. The President must submit additional reports at least annually identifying non-U.S. persons responsible for human rights violations in the XUAR, including with respect to forced labor, as provided under the Uyghur Human Rights Policy Act.[29]

V. Compliance Takeaways

a. Establishing “Clear and Convincing” Evidence

The Act does not specify what types of evidence might suffice to establish by clear and convincing evidence that goods are not the product of forced labor. Instead, the Act charges the FLETF with publishing an enforcement strategy containing, among other things, “[g]uidance to importers with respect to . . . the type, nature, and extent of evidence that demonstrates that goods originating in the People’s Republic of China . . . were not mined, produced, or manufactured wholly or in part with forced labor.”[30]

While the Act does not clarify what evidence would be necessary to meet the “clear and convincing” standard, CBP has issued guidance regarding the detailed evidence importers may need to provide to obtain the release of goods detained pursuant to certain WROs. A similar high bar of documentation — if not higher — will likely be required under the UFLPA. In addition to the required Certificate of Origin and importer’s detailed statement,[31] CBP has highlighted the following forms of evidence as helpful to importers seeking the release of shipments detained pursuant to a WRO:

An affidavit from the provider of the product;
Purchase orders, invoices, and proof of payment;
A list of production steps and records for the imported merchandise;
Transportation documents;
Daily manufacturing process reports;
Evidence regarding the importer’s anti-forced labor compliance program; and
Any other relevant information that the importer believes may show that the shipments are not subject to the import ban.[32]

The exact contours of any guidance to be issued by the Forced Labor Enforcement Task Force remains uncertain. However, companies with supply chain exposure to the XUAR should expect compliance with the UFLPA to require significant supply chain diligence and documentation obligations. These obligations may exceed the already high benchmarks on diligence established by the FLETF and CBP through years of sustained engagement with non-governmental organizations and other standard-setting stakeholders who are focused on eradicating forced labor from supply chains globally.

b. Due Diligence

The Act instructs the FLETF to issue guidance on “due diligence, effective supply chain tracing, and supply chain management measures” aimed at avoiding the importation of goods produced with forced labor in the XUAR within 180 days of the UFLPA’s enactment.[33]

Until the FLETF issues this guidance, companies importing goods into the U.S. should look to recognized international standards to conduct due diligence of their supply chains to identify potential ties to the XUAR. For example, the “Xinjiang Supply Chain Business Advisory” identifies the following standards as providing useful guidance on best practices for this due diligence:[34] the UN Guiding Principles on Business and Human Rights,[35] the OECD Guidelines on Multinational Enterprises,[36] and the ILO Tripartite Declaration of Principles Concerning Multinational Enterprises and Social Policy.[37] The Advisory warns, however, that third-party audits alone cannot guarantee credible information for due diligence purposes, both because of official harassment of auditors and because of workers’ fear of reprisals for speaking to these auditors.[38] To combat this information gap, the Advisory encourages businesses to collaborate within industry groups to share information and build relationships with Chinese suppliers.[39]

The unique circumstances of the forced labor crisis in the XUAR may render due diligence efforts insufficient, however. In 2020, the Congressional-Executive Commission on China warned that “due diligence in Xinjiang is not possible” because of official repression and harsh reprisals against whistle blowers, which is made possible by extensive state surveillance in the XUAR.[40] (Notably, this warning coincided with the introduction of the first versions of the bills that would later become the UFLPA.) Moreover, China enacted a series of “blocking statutes” in 2021 authorizing, inter alia, countersanctions and civil liability for Chinese nationals who comply with attempts to enforce foreign laws extraterritorially in China.[41] This threat of liability, coupled with the already-existing reprisals, limits the ability of companies to obtain reliable information about their supply chain activity in the XUAR.

VI. Timeline for Enforcement

The Act’s rebuttable presumption against the importation of goods produced in the XUAR or by entities identified by the FLETF is set to take effect 180 days after the UFLPA’s enactment, on June 21, 2022.

The Act provides that the process for developing the enforcement strategy will proceed as follows:

Within 30 days of enactment (by Jan. 22, 2022): The FLETF will publish a notice soliciting public comment on how best to ensure that goods mined or produced with forced labor in China — and particularly in the XUAR — are not imported into the United States.[42]
No less than 45 days after notice is given (by Mar. 8, 2022): The public, including private sector businesses and non-governmental organizations, will submit comments in response to the FLETF’s notice.[43]
Within 45 days of the public comment period closing (by Apr. 22, 2022): The FLETF will hold a public hearing, inviting witnesses to testify regarding measures that can be taken to trace supply chains for goods mined or produced in whole or in part with forced labor in China and to ensure that goods made with forced labor do not enter the United States.[44]
No later than 180 days after enactment (June 21, 2022): The FLETF, in consultation with the Secretary of Commerce and the Director of National Intelligence, must submit to Congress a strategy for supporting CBP’s processes for enforcing the Act. This strategy must include guidance to importers regarding due diligence and supply chain tracing, as well as the nature and extent of evidence required to show that goods originating in China were not mined or produced with forced labor.The Forced Labor Enforcement Task Force must thereafter submit an updated strategy to Congress annually.[45]

Notably, the FLETF’s enforcement strategy need only be submitted by the day the Act’s rebuttable presumption takes effect. Therefore, importers may have little or no advance notice as to what evidence they must submit to rebut the presumption against importation.

VII. Global Efforts to Address Forced Labor in the XUAR

The U.S. is far from the only country targeting forced labor through new executive and legislative actions. In the past year, jurisdictions around the globe have developed a variety of new strategies for eliminating the importation of goods produced with forced labor in the XUAR. These global efforts vary in scope, and many have not yet taken effect. Companies with supply chain exposure to the XUAR should, however, prepare for an increasingly complex international regulatory landscape in coming years.

a. The European Union (“EU”)

On September 15, 2021, the European Commission (“EC”) President Ursula von der Leyen announced plans for a ban on products made by forced labor to be proposed in 2022.[46] While the XUAR was not named, the proposed measure has been viewed to directly target forced labor in this region.[47] Recent reports, however, have highlighted disagreements within the EC as to which department is to spearhead the proposal due to trade sensitivities.[48] Therefore, little progress has been made. Most recently, in December 2021, the EU Executive Vice-President for Trade, Valdis Dombrovskis, warned the EC of the risks of a ban targeting only forced labor in the XUAR being deemed as “discriminatory”. He further noted that the UFLPA “cannot be automatically replicated in the EU,”[49] and argued instead that including the ban within the EU’s proposed Sustainable Corporate Governance Directive (“SCG Directive”) would be more effective.[50]

The EU has sought to address forced labor more generally via its proposal — in the form of the SCG Directive — for EU-based companies to undertake mandatory human rights due diligence to increase their accountability for human rights and environmental abuses in their supply chains. After lengthy delays, the EC’s proposal for the SCG Directive is now due in early 2022.[51]

At the moment, it remains unclear whether the EU will follow the U.S. in imposing a stand-alone ban on imports from the XUAR, or whether the proposed measures will be weakened by incorporating them into the SCG Directive proposal.

b. United Kingdom

The U.K. does not currently have legislation equivalent to the UFLPA. However, officials within the Foreign Office and the Department for International Trade have suggested that similar efforts to address imports made with forced labor in the XUAR may be imminent.[52] These efforts would build on the U.K.’s ongoing “review of export controls as they apply to Xinjiang . . . to prevent the exports of goods that may contribute to human rights abuses in the region.”[53]

c. Canada

In coordination with the United Kingdom and other international partners, the Canadian government released a statement in January 2021 addressing its concerns with the situation in the XUAR. The government announced that it would adopt a number of measures to combat the alleged human rights violations in the XUAR, including:[54]

Prohibition on Imports of Goods Produced by Forced Labor: On November 24, 2021, Sen. Housakos introduced Bill S-204, an act to amend the “Customs Tariff (goods from Xinjiang).”[55] Currently at the second reading stage in the Canadian Senate, this bill is intended to prevent the importation of goods believed to be produced through forced labor.[56] Consistent with Canada’s obligations under the USMCA, this prohibition would prevent the importation of goods believed to be produced using forced labor in the XUAR.
Xinjiang Integrity Declaration for Canadian Companies: Following the amendments made to the Customs Tariff, the Canadian Government established an Integrity Declaration on Doing Business with Xinjiang Entities to guide Canadian companies’ business practices in the region. The Integrity Declaration is mandatory for all Canadian companies that (i) source goods, directly or indirectly, from the XUAR or from entities that rely on Uyghur, (ii) are established in the XUAR, or (iii) seek to engage in the XUAR market. If any such company fails to sign the Integrity Declaration, they will be ineligible to receive support from the Trade Commissioner Service.[57]
Export Controls: The Canadian government stated that it will deny export licenses for the exportation of goods or technologies if it determines that there is a substantial risk that the export would result in a serious violation of human rights under the Export and Import Permits Act 1985.[58]

d. Australia

In June 2021, Sen. Patrick introduced the Customs Amendment (Banning Goods Produced by Forced Labour) Bill 2021 to the Australian Senate. The introduction of this bill follows the growing concerns in Australia that the Australian Modern Slavery Act 2018 does not adequately address the issue of state-sanctioned forced labor. Rather limited in its scope, the Modern Slavery Act 2018 requires certain companies to submit annual statements reporting on the risks of modern slavery in their operations and supply chains, as well as any steps they are taking to address such risks. Other entities based or operating in Australia may report this information voluntarily.[59]

Sen. Patrick’s bill would go a step further in combatting state-sanctioned forced labor by amending the Customs Act 1901 to prohibit the importation into Australia of goods that are produced in whole or in part by forced labor.[60] Although the bill makes no specific reference to China, human rights abuses in the XUAR were repeatedly cited as the proposal’s impetus during the Senate debate. Moreover, if passed, the bill would have the effect of banning the importation of goods made with Uyghur forced labor.[61] The bill was passed through the Australian Senate with cross-party support and the endorsement of the Australian Council of Trade Unions. The bill must now pass the House of Representatives to become law.[62]

e. New Zealand

New Zealand has taken a notably softer stance than the U.S. Although New Zealand’s parliament unanimously declared in May 2021 that severe human rights abuses against the Uyghur ethnic minority group were taking place in the XUAR, the motion merely expressed the parliament’s ‘grave concern’[63] over these human rights abuses. The Uyghur community in New Zealand have requested for parliament to take stronger action, such as declaring the oppression of Uyghurs in China a ‘genocide’ and placing a ban on the importation of products made by forced labor in the XUAR.[64]

_________________________

[1] Pub. L. 117-78 (2021).

[2] Pub. L. 116-145 (2020).

[3] Pub. L. 117-78, § 1(2) (2021).

[4] Department of Homeland Security Strategy to Combat Human Trafficking, the Importation of Goods Produced with Forced Labor, and Child Sexual Exploitation (Jan. 2020), U.S. DEPARTMENT OF HOMELAND SECURITY, https://www.dhs.gov/sites/default/files/publications/20_0115_plcy_human-trafficking-forced-labor-child-exploit-strategy.pdf.

[5] Xinjiang Supply Chain Business Advisory (Jul. 2, 2020, updated Jul. 13, 2021), U.S. Department of the Treasury, https://home.treasury.gov/system/files/126/20210713_xinjiang_advisory_0.pdf.

[6] United States-Mexico-Canada Agreement art. 23.6, Jul. 1, 2020, available at https://ustr.gov/trade-agreements/free-trade-agreements/united-states-mexico-canada-agreement.

[7] Exec. Order No. 13923, 85 Fed. Reg. 30587 (2020).

[8] 19 U.S.C. § 4681 (2020).

[9] Uyghur Forced Labor Prevention Act, H.R. 6210, 116th Cong. (2019–2020).

[10] Uyghur Forced Labor Prevention Act, S. 3471, 116th Cong. (2019–2020).

[11] Id. (House bill’s co-sponsors included Dan Crenshaw, Rashida Tlaib, and Ilhan Omar.). Uyghur Forced Labor Prevention Act, S. 3471, 116th Cong. (2019–2020). (Senate bill’s co-sponsors included Tom Cotton, Marsha Blackburn, Dick Durbin, and Elizabeth Warren.).

[12] Zachary Basu, House unanimously passes Uyghur forced labor bill, Axios (Dec. 15, 2021), https://www.axios.com/congress-uyghur-forced-labor-bill-d4699c95-16ea-4b42-bda4-eb5baa29326a.html.

[13] Pub. L. 117-78 § 3(a) (2021).

[14] Id. at § 2(d)(2)(B)(ii).

[15] The PRC government has established large-scale “mutual pairing assistance” programs, wherein companies from other provinces of China are incentivized to open satellite factories in the XUAR. See Xinjiang Supply Chain Business Advisory, supra note 5 at 6. The State Department has raised concerns that pairing-assistance programs and other poverty alleviation measures have served as a cover for forced labor and the transfer of Uyghurs and other persecuted minorities to other parts of the country. Forced Labor in China’s Xinjiang Region: Fact Sheet, U.S. Department of State (Jul. 1, 2020), available at https://www.state.gov/forced-labor-in-chinas-xinjiang-region/.

[16] Pub. L. 117-78 § 2(d)(2)(B)(v) (2021).

[17] 19 U.S.C. § 1307.

[18] Pub. L. 117-78 § 3(b) (2021).

[19] Id. at § 3(c).

[20] Id.

[21] Id. at § 2(d)(2)(B)(viii)–(ix).

[22] CBP Issues Region-Wide Withhold Release Order on Products Made by Slave Labor in Xinjiang, U.S. Customs and Border Protection (Jan. 13, 2021), https://www.cbp.gov/newsroom/national-media-release/cbp-issues-region-wide-withhold-release-order-products-made-slave.

[23] China Renewables: The Stretched Ethics of Solar Panels from Xinjiang, The Financial Times (Jan. 9, 2022), available at https://on.ft.com/3ndq1NE.

[24] Press Release, Solar Industry Statement on the Passage of the Uyghur Forced Labor Prevention Act, Solar Energy Industries Association (Dec. 16, 2021), available at https://www.seia.org/news/solar-industry-statement-passage-uyghur-forced-labor-prevention-act.

[25] Solar Industry Forced Labor Prevention Pledge, Solar Energy Industries Association (Nov. 23, 2021), available at https://www.seia.org/sites/default/files/Solar%20Industry%20Forced%20Labor%20Prevention%20Pledge%20Signatories.pdf.

[26] Solar Supply Chain Traceability Protocol 1.0: Industry Guidance, Solar Energy Industries Association (Apr. 2021), available at https://www.seia.org/sites/default/files/2021-04/SEIA-Supply-Chain-Traceability-Protocol-v1.0-April2021.pdf.

[27] Pub. L. 116-145 § 6(a)(1) (2020).

[28] 50 U.S.C. 1701 § 5(c)(1)(A) (1977).

[29] Pub. L. 116-145 § 6(a)(1) (2020).

[30] Pub. L. 117-78 § 2(d)(6) (2021).

[31] 19 C.F.R. § 12.43 (2017).

[32] See Hoshine Silicon Industry Co. Ltd Withhold Release Order Frequently Asked Questions, U.S. Customs and Border Protection (Nov. 10, 2021), https://www.cbp.gov/trade/programs-administration/forced-labor/hoshine-silicon-industry-co-ltd-withhold-release-order-frequently-asked-questions.

[33] Pub. L. 117-78 § 2(d)(6)(a) (2021).

[34] Xinjiang Supply Chain Business Advisory, supra note 5 at 7–8.

[35] Guiding Principles on Business and Human Rights, Office of the United Nations High Commissioner for Human Rights (2011), available at https://www.ohchr.org/Documents/Publications/GuidingPrinciplesBusinessHR_EN.pdf.

[36] OECD Guidelines for Multinational Enterprises, Organisation for Economic Co-operation and Development (2011), available at https://www.oecd.org/daf/inv/mne/48004323.pdf.

[37] Tripartite Declaration of Principles Concerning Multinational Enterprises and Social Policy, International Labour Organization (2017), available at https://www.ilo.org/wcmsp5/groups/public/—ed_emp/—emp_ent/—multi/documents/publication/wcms_094386.pdf.

[38] Xinjiang Supply Chain Business Advisory, supra note 5 at 9.

[39] Id.

[40] Staff of Cong.-Exec. Comm’n on China, Global Supply Chains, Forced Labor, and the Xinjiang Uyghur Autonomous Region (2020), https://www.cecc.gov/sites/chinacommission.house.gov/files/documents/CECC%20Staff%20Report%20March%202020%20-%20Global%20Supply%20Chains%2C%20Forced%20Labor%2C%20and%20the%20Xinjiang%20Uyghur%20Autonomous%20Region.pdf.

[41] See MOFCOM Order No. 1 of 2021 on Rules on Counteracting Unjustified Extra-territorial Application of Foreign Legislation and Other Measures, People’s Republic of China Ministry of Commerce (Jan. 9, 2021), available at http://english.mofcom.gov.cn/article/policyrelease/announcement/202101/20210103029708.shtml.

[42] Pub. L. 117-78 § 2(a)(1) (2021).

[43] Id. at § 2(a)(2).

[44] Id. at § 2(b)(1).

[45] Id. at § 2(c)–(e).

[46] 2021 State of the Union Address by President von der Leyen, European Commission (Sep. 15, 2021), available at https://ec.europa.eu/commission/presscorner/detail/en/SPEECH_21_4701.

[47] Coalition Statement on European Commission’s Proposed Ban on Products Made with Forced Labour, End Uyghur Forced Labour (Sep. 21, 2021), available at https://enduyghurforcedlabour.org/news/coalition-statement-on-european-commissions-proposed-ban-on-products-made-with-forced-labour/.

[48] Sarah Anne Aarup, Ban on Uyghur imports becomes EU’s hot potato, Politico (Oct. 15, 2021), https://www.politico.eu/article/uyghur-china-europe-ban-imports-europe-trade-hot-potato-forced-labor/; Mehreen Kahn, EU urges caution on any ban on imports made with forced labour, The Financial Times (Dec. 23, 2021), https://www.ft.com/content/748a837b-ac51-4f2e-9a5d-3af780ec8444.

[49] EU urges caution on any forced labor import ban, The Washington City Times (Dec. 23, 2021), https://thewashingtoncitytimes.com/2021/12/23/eu-urges-caution-on-any-forced-labor-import-ban/.

[50] Id.

[51] Legislative Proposal on Sustainable Corporate Governance, European Parliament, Legislative Train (Dec. 17, 2021), https://www.europarl.europa.eu/legislative-train/theme-an-economy-that-works-for-people/file-legislative-proposal-on-sustainable-corporate-governance; see also Sustainable Corporate Governance, About this initiative, European Commission, available at https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12548-Sustainable-corporate-governance_en.

[52] See Emilia Casalicchio, UK hints at banning Chinese imports with forced labor links, Politico (Dec. 20, 2021), https://www.politico.eu/article/uk-could-impose-chinese-forced-labor-import-ban/.

[53] Press Release, UK Government announces business measures over Xinjiang human rights abuses, U.K. Government (Jan. 12, 2021) (U.K.), https://www.gov.uk/government/news/uk-government-announces-business-measures-over-xinjiang-human-rights-abuses; see also Fifth Special Report, Never Again: The UK’s Responsibility to Act on Atrocities in Xinjiang and Beyond: Government’s Response to the Committee’s Second Report, U.K. Parliament (Nov. 1, 2021) (U.K.), available at https://publications.parliament.uk/pa/cm5802/cmselect/cmfaff/840/84002.htm.

[54] Canada Announces New Measures to Address Human Rights Abuses in Xinjiang, China, Government of Canada (2021) (Can.), available at https://www.canada.ca/en/global-affairs/news/2021/01/canada-announces-new-measures-to-address-human-rights-abuses-in-xinjiang-china.html.

[55] See s-204 An Act to amend the Customs Tariff (goods from Xinjiang), Parliament of Canada (Can.) (2021) https://www.parl.ca/legisinfo/en/bill/44-1/s-204.

[56] Integrity Declaration on Doing Business with Xinjiang Entities, Government of Canada (2021) (Can.), available at https://www.international.gc.ca/global-affairs-affaires-mondiales/news-nouvelles/2021/2021-01-12-xinjiang-declaration.aspx?lang=eng.

[57] Id.

[58] Global Affairs Canada advisory on doing business with Xinjiang-related entities, Government of Canada (2021) (Can.), available at https://www.international.gc.ca/global-affairs-affaires-mondiales/news-nouvelles/2021/2021-01-12-xinjiang-advisory-avis.aspx?lang=eng.

[59] See Modern Slavery Act 2018, Federal Register of Legislation (Austl.), https://www.legislation.gov.au/Details/C2018A00153.

[60] See Customs Amendment (Banning Goods Produced by Forced Labour) Bill 2021 (Austl.), https://www.aph.gov.au/Parliamentary_Business/Bills_Legislation/Bills_Search_Results/Result?bId=s1307

[61] Daniel Hurst, Australia Senate passes bill banning Imports made using Forced Labour, The Guardian, (Aug. 23, 2021), https://www.theguardian.com/australia-news/2021/aug/23/australian-senate-poised-to-pass-bill-banning-imports-made-using-forced-labour.

[62] Australian Senate Passes Forced Labour Bill, Freedom United (Aug. 23, 2021), https://www.freedomunited.org/news/australian-senate-passes-forced-labor-bill/.

[63] China slams New Zealand parliament’s motion on Uighur abuses, Al Jazeera (May 6, 2021), https://www.aljazeera.com/news/2021/5/6/china-slams-new-zealand-parliaments-uighur-concerns.

[64] Julia Hollingsworth, New Zealand is a Five Eyes outlier on China. It may have to pick a side, CNN (June 4, 2021), https://edition.cnn.com/2021/06/03/asia/new-zealand-xinjiang-china-intl-hnk-dst/index.html.

The following Gibson Dunn lawyers assisted in preparing this client update: Judith Alison Lee, Selina Sagayam, Susanne Bullock, Michael Murphy and Christopher Timura, with Sean Brennan, Ruby Taylor, Natalie Harris, and Freddie Batho, recent law graduates working in the firm’s London and Washington, D.C. offices who are not yet admitted to practice law.

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

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London partners Nicholas Tomlinson, Benjamin Fryer, Michelle Kirschner, Gregory Campbell, and Deirdre Taylor, associates Tamas Lorinczy, Joanne Hughes, Chris Hickey, Mairi McMartin, and Charlie Osborne, and of counsel James Visick are the authors of “Private Equity in the UK (England and Wales): Overview” [PDF] published in the Private Equity Global Guide by Thomson Reuters in December 2021.