On April 27, 2021, a federal court in the Northern District of California dismissed federal and state law claims brought derivatively on behalf of The Gap, Inc., holding that the California proceedings were foreclosed by a forum selection bylaw designating the Delaware Court of Chancery as the exclusive forum for derivative suits (the “Forum Bylaw”). See Lee v. Fisher, Case No. 20-cv-06163-SK, ECF No. 59. This decision strikes a blow against what has become a new tactic of the plaintiff’s bar: asserting violations of the federal securities laws in the guise of shareholder derivative claims. This ruling furthers the purpose of exclusive forum bylaws to prevent duplicative litigation in multiple forums, and highlights the benefits these bylaws may achieve for companies.

The plaintiff in Fisher brought derivative claims purportedly on behalf of Gap against certain directors and officers based on their alleged failure to promote diversity at Gap and for allegedly making misleading statements about Gap’s commitment to diversity. The plaintiff asserted both state law claims (like breach of fiduciary duty) and a federal securities law claim for violation of Section 14(a) of the Securities Exchange Act.

Defendants moved to dismiss on forum non conveniens grounds pursuant to the Forum Bylaw. Plaintiff argued that the court could not enforce the Forum Bylaw as to the federal Section 14(a) claim because (1) that claim was subject to exclusive federal jurisdiction and could not be asserted in the Delaware Court of Chancery, and (2) enforcing the Forum Bylaw would violate the Exchange Act provision that prohibits waiving compliance with the Exchange Act (the “anti-waiver” provision).

The court rejected plaintiff’s arguments and enforced the Forum Bylaw, effectively precluding the plaintiff from asserting a Section 14(a) claim in any forum. First, the court noted the strong policy in favor of enforcing forum selection clauses, which the Ninth Circuit has held supersedes anti-waiver provisions like those in the Exchange Act. See Yei A. Sun v. Advanced China Healthcare, Inc., 901 F.3d 1081 (9th Cir. 2018). Second, relying on the Ninth Circuit’s holding in Sun that a forum selection clause should be enforced unless the forum “affords the plaintiffs no remedies whatsoever,” the court held that the Forum Bylaw was enforceable because the plaintiff could file a separate state law derivative action in Delaware, even if that action could not include federal securities law claims.

This ruling is notable because other federal courts confronted with a similar argument have decided to enforce these bylaws only as to state law claims, and to keep the federal claims in federal court. The result of those rulings, though, is that derivative actions involving the same alleged misconduct could proceed in two forums—actions in federal court involving federal law claims, and actions in state court involving state law claims. This result undermines the purpose of exclusive forum bylaws to prevent duplicative litigation in multiple forums.

The Fisher decision, as well as a similar ruling reached in Seafarers Pension Plan v. Bradway, 2020 WL 3246326 (N.D. Ill. June 8, 2020), should help establish that exclusive forum bylaws require all derivative actions to proceed in a single forum. When drafting and (later) enforcing exclusive forum bylaws, companies should have these recent decisions top of mind to make sure that these bylaws achieve their goal of efficiently litigating disputes in one forum only.

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

Brian M. Lutz – San Francisco/New York (+1 415-393-8379/+1 212-351-3881, [email protected])
Jason J. Mendro – Washington, D.C. (+1 202-887-3726, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
Michael J. Kahn – San Francisco (+1 415-393-8316, [email protected])

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

Securities Litigation Group:
Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, [email protected])
Brian M. Lutz – Co-Chair, San Francisco/New York (+1 415-393-8379/+1 212-351-3881, [email protected])
Robert F. Serio – Co-Chair, New York (+1 212-351-3917, [email protected])
Craig Varnen – Co-Chair, Los Angeles (+1 213-229-7922, [email protected])
Jefferson Bell – New York (+1 212-351-2395, [email protected])
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Paul J. Collins – Palo Alto (+1 650-849-5309, [email protected])
Jennifer L. Conn – New York (+1 212-351-4086, [email protected])
Thad A. Davis – San Francisco (+1 415-393-8251, [email protected])
Mark A. Kirsch – New York (+1 212-351-2662, [email protected])
Jason J. Mendro – Washington, D.C. (+1 202-887-3726, [email protected])
Alex Mircheff – Los Angeles (+1 213-229-7307, [email protected])
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Securities Regulation and Corporate Governance Group:
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Lori Zyskowski – Co-Chair, 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])
Michael A. Titera – Orange County, CA (+1 949-451-4365, [email protected])

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

On April 28, 2021, the U.S. Senate approved a resolution to repeal EPA’s 2020 policy amendments to regulations of upstream and midstream oil and gas operations. Under the 2020 policy amendments, the Trump Administration had declined to regulate oil and gas transmission and storage operations or set methane emission limits under Section 111 of the Clean Air Act’s (“CAA”) New Source Performance Standards (“NSPS”). If the U.S. House of Representatives approves the resolution and it is signed by the President, then the 2020 policy amendments would no longer be in effect, thus restoring key aspects of an earlier rule from the Obama Administration regulating methane from production and processing facilities at upstream oil and gas facilities as well as transmission and storage operations.

Key Takeaways:

The recent Senate resolution targets the last Administration’s rulemaking declining to regulate methane emissions from production and processing operations at oil and gas facilities. The soon-to-be repealed rule also declined to regulate associated transmission and storage operations.
Once the House of Representatives passes the same resolution and it is signed into law by President Biden, EPA will be able to quickly commence regulation of methane emissions for this sector as well as volatile organic compounds (“VOC”) and methane emissions for transmission and storage operations.
Impacted sources in the sector should begin evaluating compliance with the 2016 Obama Administration rules governing methane from production and processing operations as well as transmission and storage operations.
For production and processing operations, compliance with methane requirements should complement existing VOC compliance programs under NSPS Subpart OOOOa, although additional requirements could attach for operations in areas of ozone nonattainment.
The 2020 technical amendments to the NSPS Subpart OOOOa program governing production and processing operations remain unaffected.

Detailed Analysis: Beginning in 2012 and again in 2016, the Obama administration promulgated new regulations of the oil and gas industry under the CAA’s NSPS (“2016 NSPS”). Pursuant to the 2016 NSPS, the transmission and storage segment of the oil and gas industry was included in the NSPS regulated source category.[1] This applied the NSPS standards to storage tanks, compressors, equipment leaks, and pneumatic controllers, among other sources in the transmission and storage segment.[2] The 2016 NSPS also added methane emission limits for the same segment.[3]

In 2020, EPA repealed these changes, issuing final policy amendments that removed the transmission and storage segment sources from the NSPS source category.[4] Further, EPA rescinded the separate methane emission limits for the production and processing segments of the source category while retaining limits for VOCs, and EPA also interpreted the CAA to require a “significant contribution finding” for any particular air pollutant before setting performance standards for that pollutant unless EPA addressed the pollutant when first listing or regulating the source category.[5] This latter requirement was significant, among other reasons, because the EPA did not consider methane emissions at the time it initially listed the oil and gas source category in 1979, and would thus require “significant contribution finding” for methane.[6]

In a separate rulemaking also finalized in 2020, EPA made a number of separate technical amendments to the 2016 NSPS.[7] This final rule was not cited in the resolution that passed the Senate.

This week, Congress began the process of reversing course. The Senate passed a resolution, S.J. RES. 14,[8] which disapproved of the EPA’s 2020 policy amendments. The Senate voted by a 52-42 margin, with three Republicans voting in the majority, to repeal the 2020 policy amendments pursuant to its authority under the Congressional Review Act (“CRA”). Pursuant to the CRA, certain agency rules must be reported to Congress and the Government Accountability Office.[9] After receiving the report, Congress is authorized to disapprove of the promulgated rule within 60 session days.[10] Significantly, when certain criteria are met, a joint resolution of disapproval cannot be filibustered in the Senate.[11] Moreover, disapproval carries with it longer term effects: the CRA prohibits a rule in “substantially the same form” as the disapproved rule from being subsequently promulgated (unless so authorized by a subsequent law).

Although the Senate resolution is a significant step towards repeal of the 2020 policy amendments, the 2016 NSPS are not yet back in effect. In order to repeal the 2020 rule and reinstate the 2016 NSPS (subject to the technical changes finalized in 2020 that are unaffected by the CRA resolution), the House of Representatives will also need to pass the same resolution, which it is expected to vote on in the coming weeks.[12] Disapproval renders the 2020 rule “as though such rule had never taken effect.”[13] Questions remain as to whether this repeal will reignite past litigation challenging the 2012 and 2016 NSPS rulemakings.

Affected facilities in the transmission and storage segments of the source category that will soon be subject to the NSPS should prepare for compliance. Furthermore, all facilities in the source category subject to NSPS, including in the production and processing segments, should ensure that they have adequate controls to meet the 2016 NSPS requirements for methane emissions. The practical impact of this reversion is uncertain, particularly given EPA’s findings in 2020 that separate methane limitations for these segments of the industry are redundant because controls used to reduce VOC emissions also reduce methane. Moreover, given the uncertainty created by the CRA’s language that a disapproved rule is rendered not only ineffective moving forward but also “as though such rule had never taken effect,” EPA likely will need to issue guidance to regulated entities in order to explain its expectations for compliance and the timing thereof. EPA likely also will need to promulgate a ministerial rule restoring the applicable regulatory text from the 2016 NSPS in the Code of Federal Regulations.

Litigation over the 2012 and 2016 rulemakings, currently held in abeyance, likely will resume in the wake of this resolution. In addition, EPA will once again be responsible for issuing an existing source rule for this source category. Because EPA rescinded methane limits for the source category, EPA was no longer required to issue emission guidelines to address existing sources. This will change after the CRA resolution is approved.

_____________________

[1] EPA Issues Final Policy Amendments to the 2012 and 2016 New Source Performance Standards for the Oil and Natural Gas Industry: Fact Sheet, epa.gov (Aug. 13, 2020), https://www.epa.gov/sites/production/files/2020-08/documents/og_policy_amendments.fact_sheet._final_8.13.2020_.pdf.

[2] EPA’s Policy Amendments to the New Source Performance Standards for the Oil and Gas Industry, epa.gov (Aug. 2020), here.

[3] Supra note 1. For additional analysis of the previous standard, see S. Fletcher and D. Schnitzer, “Inside EPA’s Plan for Reducing Methane Emissions,” Law360 (Aug. 20, 2015), available at https://www.gibsondunn.com/wp-content/uploads/documents/publications/Fletcher-Schnitzer-Inside-EPAs-Plan-For-Reducing-Methane-Emissions-Law360-08-20-2015.pdf; “Client Alert: EPA Announces Program Addressing Methane Emissions from Oil and Gas Production,” (Jan. 15, 2015), available at https://www.gibsondunn.com/epa-announces-program-addressing-methane-emissions-from-oil-and-gas-production/

[4] Supra note 1.

[5] Id.

[6] See id.

[7] Id.

[8] A joint resolution providing for congressional disapproval under chapter 8 of title 5, United States Code, of the rule submitted by the Environmental Protection Agency relating to “Oil and Natural Gas Sector: Emission Standards for New, Reconstructed, and Modified Sources Review”, S.J.Res.14, 117th Cong. (2021).

[9] 5 U.S.C. §801(a)(1)(A).

[10] See 5 U.S.C. §802.

[11] See 5 U.S.C. §802(d).

[12] Jeff Brady, Senate Votes To Restore Regulations On Climate-Warming Methane Emissions, NPR (Apr. 28, 2021), https://www.npr.org/2021/04/28/991635101/senate-votes-to-restore-regulations-on-climate-warming-methane-emissions.

[13] 5 U.S.C. §801(f).

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 Environmental Litigation and Mass Tort practice group, or the following authors:

Stacie B. Fletcher – Washington, D.C. (+1 202-887-3627, [email protected])
David Fotouhi – Washington, D.C. (+1 202-955-8502, [email protected])
Mark Tomaier – Orange County, CA (+1 949-451-4034, [email protected])

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

Environmental Litigation and Mass Tort Group:
Stacie B. Fletcher – Washington, D.C. (+1 202-887-3627, [email protected])
Daniel W. Nelson – Washington, D.C. (+1 202-887-3687, [email protected])

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

This edition of Gibson Dunn’s Federal Circuit Update summarizes a new petition for certiorari in a case originating in the Federal Circuit concerning the Kessler preclusion doctrine, it addresses the Federal Circuit’s announcement that Judge Moore will become Chief Judge on May 22, 2021, and it discusses recent Federal Circuit decisions concerning self-enabling references, Article III standing, patent eligibility, and more Western District of Texas venue issues.

Federal Circuit News

Supreme Court:

This month, the Supreme Court did not add any new cases originating at the Federal Circuit. As we summarized in our January and February updates, the Court has two such cases pending: United States v. Arthrex, Inc. (U.S. Nos. 19-1434, 19-1452, 19-1458) and Minerva Surgical Inc. v. Hologic Inc. (U.S. No. 20-440).

The Court heard argument on the doctrine of assignor estoppel on Wednesday, April 21, 2021, in Minerva v. Hologic.

Noteworthy Petitions for a Writ of Certiorari:

There is one new potentially impactful certiorari petition that is currently before the Supreme Court:

PersonalWeb Technologies, LLC v. Patreon, Inc. (U.S. No. 20-1394): 1. Whether the Federal Circuit correctly interpreted Kessler v. Eldred, 206 U.S. 285 (1907), to create a freestanding preclusion doctrine that may apply even when claim and issue preclusion do not. 2. Whether the Federal Circuit properly extended its Kessler doctrine to cases where the prior judgment was a voluntary dismissal.

Other updates include:

On April 1, the Court requested a response in Warsaw Orthopedic v. Sasso (U.S. No. 20-1284) concerning state versus federal court jurisdiction.

As of April 26, the cert-stage briefing is complete in Sandoz v. Immunex (U.S. No. 20-1110), which concerns obviousness-type double patenting. Association for Accessible Medicines has filed an amicus brief in support of Sandoz and the Court has distributed this case for its May 13 conference.

On April 19, Illumina filed its brief in opposition in Ariosa Diagnostics, Inc. v. Illumina, Inc. (U.S. No. 20-892) concerning patent eligibility under 35 U.S.C. § 101.

American Axle & Manufacturing, Inc. v. Neapco Holdings LLC (U.S. No. 20-891), also concerning patent eligibility under 35 U.S.C. § 101, is scheduled for the Court’s April 30 conference.

Other Federal Circuit News:

The Federal Circuit announced that, on May 22, 2021, the Honorable Kimberly A. Moore will become Chief Judge. She will succeed the Honorable Sharon Prost who has served as Chief Judge since May 31, 2014, and has served as Circuit Judge since September 24, 2001. Judge Moore has served as Circuit Judge on the Federal Circuit since September 8, 2006.

Upcoming Oral Argument Calendar

The list of upcoming arguments at the Federal Circuit are available on the court’s website.

Live streaming audio is available on the Federal Circuit’s new YouTube channel. Connection information is posted on the court’s website.

Key Case Summaries (April 2021)

Raytheon Technologies Corp. v. General Electric Co. (Fed. Cir. No. 20-1755): Raytheon appealed a final inter partes review decision from the PTAB determining that certain claims of the asserted patent unpatentable as obvious. Raytheon argued before the Board that the prior art reference, Knip, failed to enable a skilled artisan to make the claimed invention because Knip relied on “revolutionary” materials unavailable as of the priority date of the asserted patent. The Board found that Knip was “enabling,” because it provided enough information to allow a skilled artisan to calculate the power density of Knip’s advanced engine, which fell within the claimed density range. The Board thus concluded that Knip rendered the challenged claims obvious.

The Federal Circuit (Chen, J., joined by Lourie, J. and Hughes, J.) reversed. The court agreed with Raytheon that the Board legally erred it in its prior art enablement analysis. To render a claim obvious, the prior art must enable a skilled artisan to make and use the claimed invention. The Board, rather than determining whether Knip enabled a skilled artisan to make and use the claimed invention, focused only on whether a skilled artisan was provided with sufficient parameters in Knip to determine the claimed power density without undue experimentation. The Board defended its position by noting that the claims did not require the advanced materials disclosed in Knip. However, Raytheon had presented unrebutted testimony that Knip fails to enable a skilled artisan to physically make Knip’s engine given the unavailability of the revolutionary composite material contemplated by Knip. The court thus concluded that the Board’s finding that Knip is “enabling” was legal error, because without a physical working engine, a skilled artisan could not achieve the claimed power density.

Apple Inc. v. Qualcomm Inc. (Fed. Cir. No. 20-1561): Apple appealed two PTAB inter partes review final written decisions holding that Apple did not prove several claims of two patents were obvious. These two patents were also asserted against Apple in district court. However, before Apple filed its appeal to the Federal Circuit, Apple and Qualcomm settled all litigation between the companies. Based on that settlement, the district court action was dismissed with prejudiced at the parties’ request.

The Federal Circuit (Moore, J., joined by Reyna, J. and Hughes, J.) dismissed Apple’s appeal for lack of standing. As a preliminary matter, the court stated that Apple should have addressed arguments and evidence establishing its standing in its opening brief. The court declined to apply waiver, however, and addressed the merits of the standing issue. The court rejected Apple’s argument that its ongoing payment obligations provides standing because Apple did not provide evidence that the validity of any single patent, including the two patents at issue, would impact its ongoing payment obligations. The court also found Apple’s argument that Qualcomm could later sue for infringement after the settlement agreement expires was too speculative to confer standing. Finally, the court explained that any injury based on the inter partes review estoppel’s provision was also too speculative to provide standing, especially where Apple did not show that it will likely be practicing the patent claims.

In Re: Board of Trustees of the Leland Stanford Junior University (Fed. Cir. No. 20-1288): The PTAB affirmed an examiner’s final rejection of claims directed to “computerized statistical methods for determining haplotype phase,” on the basis that the claims were not patent-eligible under 35 U.S.C. § 101. Haplotype phasing “is a process for determining the parent from whom alleles—i.e., versions of a gene—are inherited.” The PTAB held that the claims were directed to two abstract mental processes: (1) “the step of ‘imputing an initial haplotype phase for each individual in the plurality of individuals based on a statistical model’”; and (2) “the step of automatically replacing an imputed haplotype phase with a randomly modified haplotype phase when the latter is more likely correct than the former.” The PTAB also held that the claims lacked an inventive concept, as they “recited generic steps of receiving and storing genotype data in a computer memory, extracting the predicted haplotype phase from the data structure, and storing it in a computer memory.”

The Federal Circuit (Reyna, J., joined by Prost, C.J. and Lourie, J.) affirmed. At step one, the court held that the claims were directed to the abstract idea of “the use of mathematical calculations and statistical modeling.” The court rejected the applicant’s argument that the claims provided a technological improvement by allowing for “more accurate haplotype predictions.” The court explained that “[t]he different use of a mathematical calculation, even one that yields different or better results, does not render patent eligible subject matter.” At step two, the court held that the claims lacked an inventive concept because the “the recited steps of receiving, extracting, and storing data amount to well-known, routine, and conventional steps taken when executing a mathematical algorithm on a regular computer.”

In Re TracFone Wireless (Fed. Cir. No. 21-136) (nonprecedential): As discussed in our March update, the Federal Circuit granted TracFone’s first mandamus petition, ordering Judge Albright to “issue [his] ruling on the motion to transfer within 30 days from the issuance of this order, and to provide a reasoned basis for its ruling that is capable of meaningful appellate review.” On April 20, the court granted mandamus for a second time, holding that Judge Albright “clearly abused” his discretion in denying transfer under § 1404(a) by relying on a “rigid and formulaic” application of the Fifth Circuit’s 100-mile rule.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Federal Circuit. Please contact the Gibson Dunn lawyer with whom you usually work or the authors of this alert:

Blaine H. Evanson – Orange County (+1 949-451-3805, [email protected])
Jessica A. Hudak – Orange County (+1 949-451-3837, [email protected])

Please also feel free to contact any of the following practice group co-chairs or any member of the firm’s Appellate and Constitutional Law or Intellectual Property practice groups:

Appellate and Constitutional Law Group:
Allyson N. Ho – Dallas (+1 214-698-3233, [email protected])
Mark A. Perry – Washington, D.C. (+1 202-887-3667, [email protected])

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Wayne Barsky – Los Angeles (+1 310-552-8500, [email protected])
Josh Krevitt – New York (+1 212-351-4000, [email protected])
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Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Los Angeles partner Maurice Suh and of counsel Daniel Weiss are the authors of “NCAA under scrutiny in grant-in-aid cap antitrust litigation,” [PDF] published by the Daily Journal on April 26, 2021.

On April 26, 2021, in McMorris v. Carlos Lopez & Associates, LLC,[1] Judges Calabresi, Katzmann, and Sullivan of the Second Circuit entered the muddy waters at the intersection of data privacy and constitutional law in addressing when a plaintiff in a data breach case has suffered a sufficient injury to establish standing to bring a lawsuit in federal court under Article III of the United States Constitution based on an increased risk of future identity theft. This question presented a matter of first impression for the Second Circuit, which sought to harmonize the divergent approaches taken by its sister circuits on this pressing—and oft-recurring—issue by articulating a non-exhaustive three-factor test to aid courts’ future adjudication of these highly fact-specific disputes. Applying this test, the Second Circuit affirmed the district court’s dismissal for lack of standing because the plaintiffs had failed to plead a sufficient risk of future identity fraud.

I. Article III Standing and Data Privacy

Under Article III of the United States Constitution, “federal courts lack jurisdiction if no named plaintiff has standing.”[2] To establish standing, plaintiffs must demonstrate that they have (1) “suffered an injury in fact” (2) that “was caused by the defendant,” and which (3) “would likely be redressed by the requested judicial relief.”[3] In turn, an injury in fact requires “‘an invasion of a legally protected interest’ that is ‘concrete and particularized’ and ‘actual or imminent, not conjectural or hypothetical.’”[4] While an alleged risk of future harm may suffice, a mere “possible future injury” or even an “objectively reasonable likelihood” of a future injury is not enough to meet the injury in fact requirement.[5] Instead, the future injury must be “certainly impending” or there must be “a substantial risk that the harm will occur.”[6]

Whether an injury in fact has been adequately pleaded is often a threshold issue raised at the motion to dismiss stage in litigation concerning data breaches. Despite the frequency with which this question arises, however, it is widely recognized that “courts have struggled” to answer it in a consistent manner[7] and the federal courts of appeals “are divided.”[8]

For instance, the D.C. Circuit has found it “at least plausible” that data breach victims “run a substantial risk of falling victim” to future identity theft, particularly where some plaintiffs “have already experienced some form of identity theft since the breaches.”[9] Similarly, the Ninth Circuit suggested that it was sufficient for standing purposes if hackers “accessed information that could be used to help commit identity fraud or identity theft” or had “the means” to access such information going forward in light of the data breach.[10]

On the other hand, the Third Circuit has long held that plaintiffs lack standing if “no misuse is alleged” and there is “no quantifiable risk of damage in the future.”[11] More recently, the Eighth Circuit similarly held that “a mere possibility” of future harm following hackers’ theft of financial information was not a constitutionally cognizable injury,[12] and earlier this year the Eleventh Circuit agreed that “a mere data breach does not, standing alone, satisfy the requirements of Article III standing.”[13]

II. Facts and Procedural History of McMorris

In June 2018, an employee at Carlos Lopez & Associates, LLP (“CLA”) accidentally sent a spreadsheet containing the Social Security numbers, home addresses, dates of birth, telephone numbers, hiring dates, and other personal information for approximately 130 current and former CLA employees to all of the company’s then-current employees.[14] Three individuals whose personally identifiable information was disclosed filed a class-action complaint against CLA, asserting various state-law claims and alleging two distinct injuries.[15] First, they claimed that the disclosure put them “‘at imminent risk of suffering identity theft’ and becoming the victims of ‘unknown but certainly impending future crimes.’”[16] Second, they alleged they were injured “in the form of the time and money spent monitoring or changing their financial information and accounts.”[17] Notably, however, they never alleged that their personal information was actually shared outside of CLA or misused by anyone.

Although the parties reached a proposed class settlement, Judge Furman of the United States District Court for the Southern District of New York declined to approve the settlement and instead dismissed the matter sua sponte for lack of subject-matter jurisdiction.[18] In doing so, he held, that the plaintiffs’ alleged increased risk of future identity theft was not sufficiently concrete to support standing.[19] With no allegations that CLA’s release of personal information was intentional, involved malicious third parties, or had caused any actual misuse of data, Judge Furman found the plaintiffs’ injury too speculative and attenuated to qualify as an injury in fact.[20] He also rejected their theory of injury based on the actual costs they had incurred as a result of the disclosure of their personal information, reasoning that plaintiffs “cannot manufacture standing merely by inflicting harm on themselves based on their fears of hypothetical future harm that is not certainly impending.”[21] Since the possibility of identity theft was speculative, any costs taken to avoid it did not qualify as injuries in fact.

III. The Second Circuit’s Legal Analysis

In an opinion written by Judge Sullivan, the Second Circuit affirmed the district court’s dismissal of the claims against CLA for lack of standing.

While it recognized that other circuits had wrestled with the question of “whether a plaintiff may establish standing based on a risk of future identity theft or fraud stemming from the unauthorized disclosure of that plaintiff’s data,”[22] the Second Circuit sought to bridge the apparent divide. Its reading of its sister circuits’ decisions was that none had “explicitly foreclosed” a future-harm theory.[23] Instead, Judge Sullivan reasoned that the Third, Eighth, and Eleventh Circuits had only “declined to find standing on the facts of a particular case.”[24] The Second Circuit therefore characterized itself as “join[ing] all of [its] sister circuits that have specifically addressed the issue in holding that plaintiffs may establish standing based on an increased risk of identity theft or fraud following the unauthorized disclosure of their data.”[25]

However, the Second Circuit did not hold that any such allegation was sufficient to plead an injury in fact. Instead, it endorsed three non-dispositive and non-exhaustive factors that, it said, other appellate courts have “consistently addressed in the context of data breaches and other data exposure incidents” as providing “helpful guidance” in assessing the presence or absence of constitutional standing: “(1) whether the plaintiffs’ data has been exposed as the result of a targeted attempt to obtain that data; (2) whether any portion of the dataset has already been misused, even if the plaintiffs themselves have not yet experienced identity theft or fraud; and (3) whether the type of data that has been exposed is sensitive such that there is a high risk of identity theft or fraud.”[26]

Applying these factors to CLA’s data disclosure, the Second Circuit held that the plaintiffs had failed to plead a sufficient risk of future identity theft or fraud to establish Article III standing. The first two factors weighed in favor of dismissal in McMorris because the case “merely involve[d] the inadvertent disclosure of [personal information] due to an errant email,”[27] not a targeted or malicious attempt to obtain data, and the plaintiffs never alleged that any of “the exposed dataset was compromised.”[28] Although the third factor weighed in favor of finding that the court had Article III jurisdiction because the disclosed data “included the sort of [personally identifiable information] that might put Plaintiffs at a substantial risk of identity theft or fraud, in the absence of any other facts suggesting that the [data] was intentionally taken by an unauthorized third party or otherwise misused,” the Second Circuit held that “this factor alone does not establish an injury in fact.”[29] As such, the first two factors proved fatal to plaintiffs’ claimed standing based on a risk of future harm. And, as a result, the plaintiffs’ claims based on their protective-measures theory also failed because absent “a substantial risk of future identity theft,” any efforts “protecting . . . against [a] speculative threat cannot create an injury.[30]

IV. Conclusion

Whether McMorris effectively synthesized the federal judiciary’s “disarray about the applicability of [the] ‘increased risk’ theory in data privacy cases”[31] or only (inadvertently) highlighted the stark differences among the courts of appeal remains an open question. But, regardless, it is now binding law in the Second Circuit, and its adoption of guiding non-dispositive factors should provide a roadmap for the resolution of similar litigation going forward. Such future developments may also be influenced by the Supreme Court’s highly anticipated upcoming decision in TransUnion LLC v. Ramirez,[32] in which oral argument was held on March 30, 2021, addressing the closely related question of whether Article III or Federal Rule of Civil Procedure 23 permit a damages class action where the majority of the putative class did not suffer an actual injury. As always, Gibson Dunn remains available to help its clients in navigating this evolving area of the law.

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[1] — F.3d —-, 2021 WL 1603808 (2d Cir. Apr. 26, 2021).

[2] Frank v. Gaos, 139 S. Ct. 1041, 1046 (2019).

[3] Thole v. U.S. Bank N.A., 140 S. Ct. 1615, 1618 (2020).

[4] Spokeo, Inc. v. Robins, 136 S. Ct. 1540, 1548 (quoting Lujan v. Defs. of Wildlife, 504 U.S. 555, 560 (1992)).

[5] Clapper v. Amnesty Int’l USA, 568 U.S. 398, 409–10 (2013).

[6] Susan B. Anthony List v. Driehaus, 573 U.S. 149, 158 (2014) (internal quotation marks omitted).

[7] Allison Grande, High Court FCRA Case Could Shake Up Class Action Standing, Law360.com (Mar. 26, 2011), available at https://www.law360.com/articles/1368905/high-court-fcra-case-could-shake-up-class-action-standing.

[8] Tsao v. Captiva MVP Rest. Partners, LLC, 986 F.3d 1332, 1340 (11th Cir. 2021); Beck. v.McDonald, 848 F.3d 262, 273 (4th Cir. 2017).

[9] In re U.S. Off. of Pers. Mgmt. Data Sec. Breach Litig., 928 F.3d 42, 59 (D.C. Cir. 2019).

[10] In re Zappos.com, Inc., 888 F.3d 1020, 1027–28 (9th Cir. 2018) (emphasis added).

[11] Reilly v. Ceridian Corp., 664 F.3d 38, 45 (3d Cir. 2011).

[12] In re SuperValu, Inc., 870 F.3d 763, 771 (8th Cir. 2017).

[13] Tsao, 986 F.3d at 1344.

[14] Steven v. Carlos Lopez & Assocs., LLC, 422 F. Supp. 3d 801, 802 (S.D.N.Y. 2019).

[15] McMorris, 2021 WL 1603808, at *1.

[16] Id. at *1 (quoting Amended Complaint ¶¶ 6, 34).

[17] Steven, 422 F. Supp. 3d at 807.

[18] Id. at 803.

[19] Id. at 804.

[20] Id. at 804–07.

[21] Id. at 807 (quoting Clapper, 568 U.S. at 416).

[22] McMorris, 2021 WL 1603808, at *3.

[23] Id. .

[24] Id. at *3 & n.2.

[25] Id.

[26] Id. at *5.

[27] Id.

[28] Id. at *6.

[29] Id.

[30] Id. at *6 n.7 (quoting SuperValu, 870 F.3d at 771).

[31] Katz v. Pershing, LLC, 672 F.3d 64, 80 (1st Cir. 2012).

[32] No. 20-297.

The following Gibson Dunn lawyers assisted in the preparation of this alert: Alexander H. Southwell, Akiva Shapiro, Jeremy S. Smith, Michael Nadler, and Eric Hornbeck.

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 of the following members of the firm’s Privacy, Cybersecurity and Data Innovation practice group, or the following authors:

Alexander H. Southwell – New York (+1 212-351-3981, [email protected])
Akiva Shapiro – New York (+1 212-351-3830, [email protected])

United States
Alexander H. Southwell – Co-Chair, PCDI Practice, New York (+1 212-351-3981, [email protected])
S. Ashlie Beringer – Co-Chair, PCDI Practice, Palo Alto (+1 650-849-5327, [email protected])
Debra Wong Yang – Los Angeles (+1 213-229-7472, [email protected])
Matthew Benjamin – New York (+1 212-351-4079, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, [email protected])
Kristin A. Linsley – San Francisco (+1 415-393-8395, [email protected])
H. Mark Lyon – Palo Alto (+1 650-849-5307, [email protected])
Karl G. Nelson – Dallas (+1 214-698-3203, [email protected])
Ashley Rogers – Dallas (+1 214-698-3316, [email protected])
Deborah L. Stein – Los Angeles (+1 213-229-7164, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
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Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, [email protected])
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Europe
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Bernard Grinspan – Paris (+33 (0)1 56 43 13 00, [email protected])
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Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Washington, D.C. partner David Fotouhi and associates Andrew Wilhelm and Amalia Reiss are the authors of “Water Rule Reinstatement Shows Specific Objections Are Key,” [PDF] published by Law360 on April 28, 2021.

Shareholder lawsuits are not only complicated to litigate, but due to the high financial stakes, these actions can be among the most threatening to a company and its directors and officers. It has been twenty-six years since Congress enacted the Private Securities Litigation Reform Act of 1995, and since that time, private actions under the federal securities laws have continued to be filed at a steady pace. Over the last decade, the U.S. Supreme Court and the State Supreme Courts have issued multiple decisions impacting the way shareholder actions are litigated and decided. This one-hour briefing will highlight recent developments and trends in this constantly evolving and complex area of the law.

We will discuss:

Shareholder actions filing and settlement trends, including COVID-19-related shareholder action trends
The potential impact on class certification in stockholder class actions from the U.S. Supreme Court’s pending decision in Goldman Sachs Group Inc. v. Arkansas Teacher Retirement System
The proliferation of parallel federal and state securities class action lawsuits since the U.S. Supreme Court’s 2018 ruling in Cyan v. Beaver County Employees Retirement Fund, and the effectiveness of companies’ response through the adoption of federal forum provisions in their corporate charters

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PANELISTS:

Jennifer L. Conn is a partner in the New York office of Gibson, Dunn & Crutcher. Ms. Conn is a co-author of PLI’s Securities Litigation: A Practitioner’s Guide, Second Edition. She has extensive experience in a wide range of complex commercial litigation matters, including those involving securities, financial services, accounting malpractice, antitrust, contracts, insurance and information technology. She is also a member of Gibson Dunn’s General Commercial Litigation, Securities Litigation, Appellate, and Privacy, Cybersecurity and Data Innovation Practice Groups. In addition, Ms. Conn is an Adjunct Professor of Law at Columbia University School of Law, lecturing on securities litigation.

Alexander K. Mircheff is a partner in the Los Angeles office of Gibson, Dunn & Crutcher. Mr. Mircheff is a co-author of PLI’s Securities Litigation: A Practitioner’s Guide, Second Edition. His practice emphasizes securities and appellate litigation, and he has substantial experience representing issuers, officers, directors, and underwriters in class action and shareholder derivative matters. Mr. Mircheff has handled matters across a variety of industries, including biotech, financial services, accounting, real estate, entertainment, engineering, manufacturing, and consumer products. He is also a member of Gibson Dunn’s Securities Litigation, Appellate, Class Actions, Labor and Employment and Litigation Practice Groups.

Robert F. Serio is a partner in the New York office of Gibson, Dunn & Crutcher and a Co-Chair of Gibson Dunn’s Securities Litigation Practice Group. Mr. Serio is also a co-author of PLI’s Securities Litigation: A Practitioner’s Guide, Second Edition. His practice involves complex commercial and business litigation, with an emphasis on securities class actions, shareholder derivative litigation, SEC enforcement matters and corporate investigations. He is also a member of the Appellate, Class Actions, FCPA, and White Collar Defense and Investigations Practice Groups.

MCLE CREDIT INFORMATION:

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

This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact [email protected] to request the MCLE form.

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

This update provides an overview and summary of key class action developments during the first quarter of 2021.

Part I discusses appellate decisions in the Ninth, Seventh, and Eleventh Circuits about predominance, numerosity, and administrative feasibility.

Part II covers two decisions from several circuit courts of appeals relating to the evidentiary standards at the class-certification stage.

Part III reports on a decision from the Eleventh Circuit discussing Article III standing and data breach class actions.

_____________________

I. Class Certification Requirements: The Ninth Circuit on Predominance; the Seventh Circuit on Numerosity; and the Eleventh Circuit on Administrative Feasibility

The Ninth, Seventh, and Eleventh Circuits issued important opinions regarding predominance, numerosity, and administrative feasibility.

Predominance. In Olean Wholesale Grocery Cooperative, Inc. v. Bumble Bee Foods LLC, 993 F.3d 774, 2021 WL 1257845 (9th Cir. Apr. 6, 2021), a case involving an alleged tuna price fixing conspiracy, the Ninth Circuit clarified a district court’s obligations when assessing predominance, particularly where there is a dispute over whether all class members have suffered injury. Olean contains three key holdings:

First, it held for the first time that a district court must find that plaintiffs have established predominance by “a preponderance of the evidence,” joining the rule followed by the First, Second, Third, Fifth, and Seventh Circuits. at *4. The Ninth Circuit explicitly rejected the use of a “no reasonable juror” test outside of the wage-and-hour context. Id. at *5 & n.4.
Second, it held that plaintiffs in an antitrust price-fixing action can establish predominance using statistical evidence, but a district court must scrutinize—“with care and vigor”—the reliability of that evidence before certifying a class. at *5. Specifically, if the parties offer competing expert evidence regarding the number of uninjured class members, the district court must “resolve the competing expert claims” in order to determine whether predominance has been established. Id. at *10.
Finally, the court held that although there is no “threshold” percentage of uninjured class members that would defeat predominance, “it must be de minimis,” suggesting “that 5% to 6% constitutes the outer limits of a de minimis number”—and at the very least, 28% “would be out-of-bounds.” at *11. It also noted that the presence of uninjured class members presents “serious standing implications under Article III,” but did not reach the issue because class certification failed under Rule 23(b)(3). Id. at *10 n.7.

Numerosity. The Seventh Circuit affirmed a district court’s determination that a proposed class of 37 seasonal employees failed to satisfy Rule 23’s numerosity requirement in Anderson v. Weinert Enterprises, Inc., 986 F.3d 773 (7th Cir. 2021). In its decision, the court acknowledged that its cases “have recognized that ‘a forty-member class is often regarded as sufficient to meet the numerosity requirement.’” Id. at 777 (citation omitted). But the court also noted that the “[t]he key numerosity inquiry under Rule 23(a)(1) is not the number of class members alone but the practicability of joinder.” Id. To that end, the Seventh Circuit determined that the district court did not abuse its discretion in finding that the factors it considered—including the class’s geographic dispersion, overall size, and small dollar amounts involved with each individual claim—all “weighed against certifying the class.” Id.

Administrative feasibility. In Cherry v. Dometic Corp., 986 F.3d 1296 (11th Cir. 2021), the Eleventh Circuit held that an “administratively feasible” method to identify absent class members is not required to certify a class. It further held that denying certification does not divest a federal court of CAFA jurisdiction.

In the district court, plaintiffs had proposed a class of individuals who purchased allegedly defective refrigerators between 1997 and 2016. Defendant contended that the class representatives failed to show that the class was “ascertainable” because they “provided no evidence that their proposed method of identification would be workable.” Id. at 1300. The district court agreed with defendant and denied certification.

The Eleventh Circuit reversed. First, it held that administrative feasibility is not required for class certification, though it remains relevant to whether a proposed class may proceed under Rule 23(b)(3). Recognizing a circuit split on this issue (in fact, calling it “[o]ne of the most hotly contested issues in class action practice today”), the court reasoned that Rule 23(a) says nothing about administrative feasibility, which bears only on “how the district court can locate the remainder of the class after certification.” Id. at 1301, 1303. As such, it concluded, “administrative difficulties—whether in class-member identification or otherwise—do not alone doom a motion for certification.” Id. at 1304. Second, the court held that because CAFA jurisdiction does not depend on certification, a district court retains jurisdiction even after it denies certification in a CAFA action. Id. at 1305.

II. Several Circuits Clarify the Standards for Assessing the Admissibility of Evidence at the Class-Certification Stage

The Supreme Court has made clear that Rule 23 “does not set forth a mere pleading standard” and that a plaintiff “must be prepared to prove” that Rule 23’s requirements are “in fact” satisfied. Wal-Mart Stores, Inc. v. Dukes, 564 U.S. 338, 350 (2011) (emphasis in original). The need to assess actual evidence at the class-certification stage raises an important question: does such evidence need to be admissible? The Fifth and Sixth Circuits issued important decisions this past quarter that take divergent approaches to that question.

The Fifth Circuit in Prantil v. Arkema Inc., 986 F.3d 570 (5th Cir. 2021), held that the Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993), standard for admissibility of expert evidence applies at the class-certification stage when scientific evidence is relevant to the certification decision. 986 F.3d at 575 & n.12. The Fifth Circuit explained that applying Daubert at the certification stage was a natural extension of the Supreme Court’s admonition that courts conduct a “rigorous analysis” of the proposed class’s conformity with Rule 23. Id. at 575. The Fifth Circuit thus joined the Third, Seventh, and Eleventh Circuits in holding that “the Daubert hurdle must be cleared when scientific evidence is relevant to the decision to certify,” and declaring that the district court’s “hesitation to apply Daubert’s reliability standard with full force” was error. Id. at 575–76. The Fifth Circuit’s holding is consistent with the Ninth Circuit’s recent admonition in Olean, where it made clear that district courts must resolve competing expert claims on the reliability of evidence to support class certification. 2021 WL 1257845, at *10.

The Sixth Circuit took a slightly different approach—this time, with nonexpert evidence—in Lyngaas v. Curaden AG, 992 F.3d 412 (6th Cir. 2021). Lyngaas held that nonexpert evidence need not be admissible in order to be considered at class certification. Id. at 428–29. The district court certified a class of individuals who purportedly received unsolicited faxes from defendants and offered summary report logs as proof. The court rejected the defendants’ assertion that the logs had not been properly authenticated and therefore plaintiff had failed to support his motion with admissible evidence. Id. at 418–19.

On appeal, the Sixth Circuit held as a matter of first impression that a district court is not required to “decide conclusively at the class-certification stage what evidence will ultimately be admissible at trial.” Id. at 428. In so holding, the court adopted the reasoning of the Eighth and Ninth Circuits to conclude that the “evidentiary proof” required at class certification “need not amount to admissible evidence, at least with respect to nonexpert evidence.” Id. at 428–29. Rather, because of the “differences between Rule 23, summary judgment, and trial,” parties should be afforded “greater evidentiary freedom at the class certification stage.” Id. at 429 (quoting Sali v. Corona Reg’l Med. Ctr., 909 F.3d 996, 1005 (9th Cir. 2018)). Therefore, reliance on non-authenticated summary-report logs satisfied the district court’s obligation to conduct a “rigorous analysis” at class certification. Id. at 430.

III. The Eleventh Circuit Addresses Article III Standing in Data Breach Class Actions

As discussed in prior updates, federal courts at all levels have continued to ponder and opine on the role Article III standing plays in class actions. The Eleventh Circuit weighed in this quarter in Tsao v. Captiva MVP Restaurant Partners, LLC, 986 F.3d 1332 (11th Cir. 2021), holding that absent class members lacked standing following a data breach when the only injuries alleged were (a) a future risk of identity theft and (b) costs incurred to mitigate the risk of identity theft.

In Tsao, the plaintiff filed a putative data-breach class action after a restaurant chain announced a data breach involving its point-of-sale systems. The district court dismissed the case for lack of Article III standing, holding “[e]vidence of a data breach, without more, [is] insufficient to satisfy injury in fact under Article III standing.” Id. at 1337. The Eleventh Circuit affirmed, rejecting both of plaintiff’s argument that the data breach established standing.

First, the Eleventh Circuit held that an elevated threat of identity theft is not sufficient to establish Article III standing. Citing the Supreme Court’s opinion in Clapper v. Amnesty International USA, 568 U.S. 398 (2013), the court explained “a plaintiff alleging a threat of harm does not have Article III standing unless the hypothetical harm alleged is either ‘certainly impending’ or there is a ‘substantial risk’ of such harm.” Id. at 1339. An “increased risk of identity theft,” without more, was not sufficient to meet these requirements. Id. at 1344. Thus, it determined that absent “specific evidence of some misuse of class members’ data, a named plaintiff’s burden to plausibly plead factual allegations sufficient to show that the threatened harm of future identify theft was ‘certainly impending’—or that there was a ‘substantial risk’ of such harm—will be difficult to meet.” Id. (emphasis in original).

Second, the court rejected plaintiff’s argument that his efforts to mitigate the risk of identity theft—such as by cancelling his credit cards—could create an injury in fact. Where a hypothetical harm is not “certainly impending,” “a plaintiff cannot conjure standing by inflicting some direct harm on itself to mitigate a perceived risk.” Id. at 1339. Were it otherwise, “an enterprising plaintiff” could “secure a lower standard for Article III standing simply by making an expenditure based on a nonparanoid fear,” which is “not permit[ted]” by the law. Id. at 1345.

While the role of Article III standing in class actions continues to be hotly debated issue, some additional clarity may be on its way. On March 30, 2021, the Supreme Court heard argument in TransUnion LLC v. Ramirez. As noted in our prior class action update, the question presented in this case is “whether either Article III or Rule 23 permits a damages class action where the vast majority of the class suffered no actual injury, let alone an injury anything like what the class representative suffered.” During argument, the Justices probed this issue further, asking whether the majority of the class members—whose information had never been disclosed to third parties—possessed Article III standing, and whether the representative’s claims were typical of those of the absent class members. A decision is expected by summer.

The following Gibson Dunn lawyers contributed to this client update: Christopher Chorba, Theane Evangelis, Kahn Scolnick, Bradley Hamburger, Lauren Blas, Wesley Sze, Emily Riff, Andrew Kasabian, and Tim Kolesk.

Gibson Dunn attorneys are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Class Actions or Appellate and Constitutional Law practice groups, or any of the following lawyers:

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

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

Join Gibson Dunn panelists Michelle Kirschner and Matthew Nunan for a discussion of:

Recent FCA criminal prosecutions;
Lessons for board governance from the Aviva plc Final Notice;
Update on the Investment Firms Prudential Regime (IFPR) and remuneration;
Crystal ball gazing

View Slides (PDF)

Michelle M Kirschner: A partner in the London office. She advises a broad range of financial institutions, including investment managers, integrated investment banks, corporate finance boutiques, private fund managers and private wealth managers at the most senior level.

Matthew Nunan: A partner in the London office. He specializes in financial services regulation and enforcement, investigations and white collar defense.

Martin Coombes: An associate in the London office and a member of the Financial Institutions group. He specialises in advising on UK and EU financial services regulation. This includes a wide range of financial services and compliance issues including advice on UK and EU regulatory developments, the regulatory aspects of corporate transactions and the on-going compliance obligations of financial services firms.

Chris Hickey: An associate in the London office and a member of the firm’s Financial Institutions group. He advises on a range of UK and EU financial services regulatory matters. This includes the regulatory elements of corporate transactions, regulatory change management and ongoing compliance requirements to which firms are subject.

CPD TRAINING/MCLE CREDIT INFORMATION:

Gibson, Dunn & Crutcher LLP is authorized by the Solicitors Regulation Authority to provide in-house CPD training. This program is approved for CPD credit in the amount of 1.0 hour. Regulated by the Solicitors Regulation Authority (Number 324652).

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

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

On his first day in office, President Biden signed an Executive Order that directed his administration to focus on addressing climate change, and issued a mandate that certain agencies immediately review a number of agency actions from the previous administration regarding greenhouse gas (GHG) emissions.[1] In keeping with that directive, the National Highway Traffic Safety Administration (NHTSA) and the U.S. Environmental Protection Agency (EPA) have formally announced their intent to reconsider the 2019 Safer Affordable Fuel-Efficient Vehicles Rule Part One: One National Program (SAFE 1),[2] which curtailed California’s ability to establish and enforce more stringent GHG emission standards and a Zero Emission Vehicle (ZEV) sales mandate.[3] These steps are consistent with the Biden administration’s efforts to move swiftly to reexamine—and possibly to revoke—environmental regulations promulgated under the Trump administration, and could serve as a prime example of the shifting regulatory landscape for industries subject to GHG regulations.

Through SAFE 1, EPA withdrew the portions of California’s waiver under Section 209(b)(1) of the Clean Air Act (CAA) that allowed California to establish its own GHG emission standards and establish a mandate for the sale of ZEVs.[4] EPA went on to interpret the CAA as preventing other states from adopting California’s GHG standards, as well.[5] In the same action, NHTSA similarly cut back on California’s independent regulatory powers by concluding that NHTSA’s authority to regulate fuel economy under the Energy Policy and Conservation Act (EPCA) preempted all state and local regulations “related to” fuel economy.[6]

On April 22 and April 23, 2021, respectively, NHTSA and EPA formally announced that they are reconsidering this action, and will be soliciting public comment on the agencies’ separate proposed paths forward.

NHTSA

On April 22, 2021, NHTSA issued a notice of proposed rulemaking that would repeal those portions of SAFE 1 (including the regulatory text and interpretive statements in the preamble) that found California’s GHG and ZEV mandates preempted by EPCA.[7] In particular, NHTSA proposes to conclude that it lacks legislative rulemaking authority to issue a preemption regulation. The notice does not take a position on the substance of EPCA preemption. Rather, NHTSA says merely that it seeks to restore a “clean slate”—i.e., to take no formal agency position on express preemption by EPCA.[8]

The notice goes on to state, however, that even if NHTSA had legislative rulemaking authority, it would nonetheless repeal SAFE 1 because “NHTSA now has significant doubts about the validity of its preemption analysis as applied to the specific state programs discussed in SAFE 1,”[9] including federalism concerns and concerns with the “categorical” manner of the analysis taken in SAFE 1.[10]

NHTSA’s notice of proposed rulemaking includes a comment period of 30 days after publication in the Federal Register, which is expected in the coming days.

EPA

One day after NHTSA issued its notice, EPA announced its parallel action on SAFE 1. In its notice, EPA takes no new positions on the Agency’s authority to withdraw a previously granted waiver or the statutory interpretation of CAA Section 209.[11] Rather, EPA’s notice merely summarizes its past positions and tees up these issues, along with issues raised in administrative petitions, for public comment as part of a reconsideration. The notice states that the Agency now believes that there are “significant issues” with the positions taken in SAFE 1 and that “there is merit in reviewing issues that petitioners have raised” in the reconsideration petitions submitted to EPA.[12] However, the notice does not propose to take any specific alternative interpretation.

Notably, EPA has not initiated a rulemaking proceeding, but rather describes this as an informal adjudication.[13] The Agency also states that for waiver decisions, “EPA traditionally publishes a notice of opportunity for public hearing and comment and then, after the comment period has closed, publishes a notice of its decision in the Federal Register. EPA believes it is appropriate to use the same procedures for reconsidering SAFE 1.”[14]

A virtual public hearing will take place on June 2, 2021, and EPA will accept comments until July 6, 2021.[15]

Conclusion

In announcing the reconsideration of SAFE 1, EPA Administrator Michael Regan stated, “Today, we are delivering on President Biden’s clear direction to tackle the climate crisis by taking a major step forward to restore state leadership and advance EPA’s greenhouse gas pollution reduction goals.”[16] Final agency actions resulting from these reconsiderations are still months away, but EPA’s and NHTSA’s announcements signal the agencies’ continuing focus on GHG emissions and revisiting regulations issued by the previous administration. As executive branch agencies continue to carry out the directives in President Biden’s Executive Orders related to climate change, the landscape for regulated industries will remain in flux.

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[1] Exec. Order No. 13990, 86 Fed. Reg. 7037, 7041 (Jan. 25, 2021) (issued Jan. 20, 2021).

[2] 84 Fed. Reg. 51310 (Sept. 27, 2019). The SAFE 1 Rule was challenged in a series of consolidated cases before the U.S. Court of Appeals for the D.C. Circuit, where Gibson Dunn represented a coalition of automotive industry members as Intervenors in support of the rule. See Union of Concerned Scientists v. NHTSA, No. 19-1230 (D.C. Cir.). That matter has been held in abeyance at the request of the United States pending further review of the SAFE 1 rulemaking by EPA and NHTSA.

[3] Press Release, U.S. Dep’t of Transp., NHTSA, NHTSA Advances Biden-Harris Administration’s Climate & Jobs Goals (Apr. 22, 2021), here; U.S. EPA, Notice of Reconsideration of a Previous Withdrawal of a Waiver for California’s Advanced Clean Car Program (Light-Duty Vehicle Greenhouse Gas Emission Standards and Zero Emission Vehicle Requirements), here.

[4] 84 Fed. Reg. at 51328.

[5] Id. at 51350.

[6] Id. at 51313.

[7] U.S. Dep’t of Transp., NHTSA, Notice of Proposed Rulemaking (prepublication version), Corporate Average Fuel Economy (CAFE) Preemption (Apr. 22, 2021), here.

[8] Id. at 12.

[9] Id. at 13.

[10] Id. at 37.

[11] U.S. EPA, Notice of Reconsideration (prepublication version), California State Motor Vehicle Pollution Control Standards; Advanced Clean Car Program; Reconsideration of a Previous Withdrawal of a Waiver of Preemption; Opportunity for Public Hearing and Public Comment (Apr. 23, 2021), here.

[12] Id. at 7.

[13] Id. at 27.

[14] Id.

[15] Id. at 2.

[16] Press Release, U.S. EPA, EPA Reconsiders Previous Administration’s Withdrawal of California’s Waiver to Enforce Greenhouse Gas Standards for Cars and Light Trucks (Apr. 26, 2021), here.

The following Gibson Dunn lawyers assisted in preparing this client update: Ray Ludwiszewski, Stacie Fletcher, David Fotouhi, Rachel Corley, and Veronica Till Goodson.

Stacie B. Fletcher – Co-Chair (+1 202-887-3627, [email protected])
David Fotouhi (+1 202-955-8502, [email protected])
Raymond B. Ludwiszewski (+1 202-955-8665, [email protected])
Daniel W. Nelson – Co-Chair (+1 202-887-3687, [email protected])
Rachel Levick Corley (+1 202-887-3574, [email protected])
Veronica Till Goodson (+1 202-887-3719, [email protected])

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

Regulatory and policy developments during the first quarter of 2021 reflect a global tipping point toward serious regulation of artificial intelligence (“AI”) in the U.S. and European Union (“EU”), with far-reaching consequences for technology companies and government agencies.[1] In late April 2021, the EU released its long-anticipated draft regulation for the use of AI, banning some “unacceptable” uses altogether and mandating strict guardrails such as documentary “proof” of safety and human oversight to ensure AI technology is “trustworthy.”

While these efforts to aggressively police the use of AI will surprise no one who has followed policy developments over the past several years, the EU is no longer alone in pushing for tougher oversight at this juncture. As the United States’ national AI policy continues to take shape, it has thus far focused on ensuring international competitiveness and bolstering national security capabilities. However, as the states move ahead with regulations seeking accountability for unfair or biased algorithms, it also appears that federal regulators—spearheaded by the Federal Trade Commission (“FTC”)—are positioning themselves as enforcers in the field of algorithmic fairness and bias.

Our 1Q21 Artificial Intelligence and Automated Systems Legal Update focuses on these critical regulatory efforts, and also examines other key developments within the U.S. and Europe that may be of interest to domestic and international companies alike. As a result of several significant developments in April, and to avoid the need for multiple alerts, this 1Q21 update also include a number of matters from April, the beginning of 2Q21.

________________________

I. U.S. NATIONAL POLICY & REGULATORY DEVELOPMENTS

A.         U.S. National AI Strategy
B.         National Security & Trade
C.         Algorithmic Accountability & Consumer Safety
D.         FDA’s Action Plan for AI Medical Devices
E.         Intellectual Property Updates
F.         U.S. Regulators Seek Input on Use of AI in Financial Services

II. EU POLICY & REGULATORY DEVELOPMENTS

A.         EC Publishes Draft Legislation for EU-wide AI Regulation
B.         CAHAI Feasibility Study on AI Legal Standards
C.         EU Council Proposes ePrivacy Regulation
D.         Cybersecurity Report on the Use of AI in Autonomous Vehicles
E.         Proposed German Legislation on Autonomous Driving

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I. U.S. NATIONAL POLICY & REGULATORY DEVELOPMENTS

A. U.S. National AI Strategy

The U.S. federal government’s national AI strategy continues to take shape, bridging the old and new administrations. Pursuant to the National AI Initiative Act of 2020, which was passed on January 1 as part of the National Defense Authorization Act of 2021 (“NDAA”),[2] the White House Office of Science and Technology Policy (“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.[3]

Further, on January 27, 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. The President designated the OSTP to constitute an interagency Task Force to carry out the review,[4] which must be completed within 120 days of appointment of the Task Force members[5] and is expected to “generate important insights and best practices including transparency and accountability….”[6] On the same day, the President also signed an executive order to formally reconstitute the President’s Council of Advisors on Science and Technology.[7]

B. National Security & Trade

1. New House Subcommittee on Cyber, Innovative Technologies, and Information Systems

In February 2021, the House Armed Services Committee created a new Subcommittee on Cyber, Innovative Technologies, and Information Systems (“CITI”) out of the former Intelligence and Emerging Threats and Capabilities Subcommittee.[8] CITI will provide focused oversight on technology matters, including cybersecurity, IT policy, AI, electronic warfare and software acquisition, and shift non-technical topics, such as special operations and counter-proliferation of weapons of mass destruction, to other lawmakers. On March 12, the Subcommittee held a joint hearing with the House Committee on Oversight and Reform’s Subcommittee on National Security to receive testimony from the National Security Commission on Artificial Intelligence on the Commission’s final report (discussed in more detail below).[9]

2. 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.”[10] 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.[11]

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.[12] The Commission explains:

The United States should invest what it takes to maintain its innovation leadership, to responsibly use AI to defend free people and free societies, and to advance the frontiers of science for the benefit of all humanity. AI is going to reorganize the world.

America must lead the charge.

The more than 700-page report consists of two parts: Part I, “Defending America in the AI Era,” makes recommendations on how the U.S. government can responsibly develop and use AI technologies to address emerging national security threats, focusing on AI in warfare and the use of autonomous weapons, AI in intelligence gathering, and “upholding democratic values in AI.” The report’s recommendations identify 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.

Part II, “Winning the Technology Competition,” 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. The report highlights how stringent patent eligibility requirements in U.S. courts, particularly with respect to computer-implemented and biotech-related inventions, and a lack of explicit legal protections for data have created uncertainty in IP protection for AI innovations, discouraging the pursuit of AI inventions and hindering innovation and collaboration. NSCAI also notes that China’s significant number of patent application filings have created a vast reservoir of “prior art” and caused the USPTO’s patent examination process increasingly difficult. As such, the report recommends that the President issue an executive order to recognize IP as a national priority, and develop a comprehensive plan to reform IP policies to incentivize and protect AI and other emerging technologies.[13]

The NSCAI report may provide opportunity for legislative reform, which would spur investments in AI technologies and accelerate government adoption of AI technologies in national security. The report’s recommendations with respect to transparency and explainability may also have significant implications for potential oversight and regulation of AI in the private sector.

3. Executive Order on U.S. Supply Chains

At the end of February, the Biden Administration issued a sweeping executive order launching a year-long, multi-agency review of several sectors, including several that will be critical to maintaining U.S. leadership in the development of AI and associated technologies. The purpose of the “America’s Supply Chains” Executive Order 14017, as President Biden puts it, is to “help address the vulnerabilities in our supply chains across . . . critical sectors of our economy so that the American people are prepared to withstand any crisis.” The Executive Order has put into motion 100-day reviews of four types of products by four different federal agencies: (1) semiconductors (Commerce); (2) high-capacity batteries, including electric-vehicle batteries (Energy); (3) critical minerals and strategic materials, such as rare earth elements (Defense); and (4) pharmaceuticals and their active ingredients (Health and Human Services). Executive Branch work to implement the E.O. is being coordinated by the Assistant to the President for National Security Affairs (APNSA) and the Assistant to the President for Economic Policy (APEP). By February 24, 2022, the Secretaries of Defense, Health and Human Services, Commerce and Homeland Security, Energy, Transportation, and Agriculture are to provide the President with broader and deeper assessments of the defense industrial base, the public health and biological preparedness industrial base, the information and communications industrial base, energy sector industrial base, transportation industrial base, and agricultural commodities and food products industrial base, respectively.

The Biden Administration’s prioritization of semiconductors and critical minerals and strategic materials in the 100-day review was expected; they are critical links in many supply chains and either already are or could be in short supply to the United States for a range of reasons. Both are of specific relevance to the raw materials and manufacturing supply chains that support AI development and applications. Especially in light of ongoing geopolitical and economic tensions between the United States and China, the potential inability of the U.S. to access supply of critical minerals from China and many U.S. companies’ dependence on only a small handful of advanced semiconductor manufacturers based in Austria, Germany, Japan, The Netherlands, South Korea, Taiwan and the United States for critical links in their supply chains makes the advanced semiconductor supply chain especially prone to disruption.

Agency action has already begun with respect to the 100-day review of semiconductors. On March 11, the Commerce Department’s Bureau of Industry and Security (BIS) issued a notice seeking public comment on risks in the semiconductor manufacturing and advanced packaging supply chains. The notice requested information on a range of supply issues including the critical and essential goods and materials required for semiconductor manufacturing and advanced packaging support chain, manufacturing capabilities, and key skill sets and personnel necessary to sustain the U.S. semiconductor ecosystem. BIS also sought comments on how a failure to sustain the semiconductor supply chain might impact “key downstream capabilities,” including artificial intelligence applications. BIS received 34 comments by the comment due date of April 5 from a range of private sector companies, trade associations, universities, and individuals. In addition to the written comments, BIS also convened a virtual public forum inviting speakers to provide further input on the questions presented in its notice on April 8.

Although the focus of the America’s Supply Chain EO is on executive agency reporting, we expect the EO to provide U.S. private and non-governmental sectors significant opportunities for agency engagement. To state the obvious, the U.S. does not have a centralized planned economy, and U.S. Executive Branch agencies often lack the visibility required to produce reports that accurately reflect the state of play in many international supply chains. Especially because identified gaps and weak links in strategic supply chains are likely to be a focus of targeted infrastructure spending, tax incentives, export controls, immigration reform, and other regulatory action during the Biden Administration, many of our clients could find it well worth the effort to participate in agency information gathering like BIS’s public comment process, either directly or indirectly through trade associations.

Scrutiny on semiconductor supply chains has not been limited to the Executive Branch, however, and a recent request from Congress illustrates how even individual transactions involving specific links in the semiconductor supply may become subject to regulatory action as Commerce and other U.S. agencies develop a deeper understanding of supply chain dynamics. On March 19, 2021, two Republican lawmakers sent a letter to the Commerce Secretary to prevent ASML Holdings NV, a Dutch technology firm, from supplying critical systems to Semiconductor Manufacturing International Corp. (“SMIC”), a Chinese chipmaker. Sen. Marco Rubio (R-FL) and Rep. Michael McCaul (R-Texas) said that the U.S. should exercise its diplomatic leverage to weaken China’s foothold in the semiconductor industry. The lawmakers also asked Commerce Secretary Raimondo to add SMIC to the Commerce Department’s Entity List, which would limit SMIC’s ability to source materials even for those that are not manufactured in the United States. The two lawmakers proposed that a presumption of denial apply in the export licensing process to any China-facing export “capable of producing” chips smaller than 16 nanometers, which would broaden the scope of the products subject to the presumption of denial. The Commerce Secretary has not responded to the letter or issued any statement regarding the letter to date.

4. Interim Final Rule “Securing the Information and Communications Technology and Services (“ICTS”) Supply Chain”

The Department of Commerce also has taken the next step in implementing another Executive Order, this time from the Trump Administration, focused on the ICTS Supply Chain. An Interim Final Rule implementing the EO became effective on March 22, 2021.[14] The ICTS EO is an effort to protect against threats posed on the use of hardware, software and services designed, developed, manufactured or supplied by companies owned by, controlled by, or subject to the direction or control of China and other “foreign adversary” countries, but has been the target of consternation by commentators since its issuance on May 15, 2019.

The Interim Final Rule implements the Secretary of Commerce’s new power to prohibit transactions which involve the acquisition, importation, transfer, installation, dealing in, or usage of certain ICTS.[15] Transactions subject to the Secretary of Commerce’s review and prohibition include those involving managed services, data transmission, software updates, repairs, or the platforming or data hosting of applications for consumer download. Any of these actions can be prohibited or subject to licensing driven mitigation when the services, equipment, or software is designed, developed, manufactured, or supplied by companies owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary, and poses an undue or unacceptable risk.[16]

Many different AI-related transactions could be impacted by the ICTS transaction review. Not only does the Interim Final Rule specifically include ICTS infrastructure that is integral to AI and machine learning technologies among the transactions it deems ICTS transactions, but it also includes other kinds of transactions that are necessary to support AI development or deployment, including certain software, hardware, or any other product or services integral to data hosting or computing services, and certain ICTS products, such as internet-enabled sensors, webcams, routers, modems, drones, or any other end-point surveillance or monitoring device, home networking device, or aerial system. Thus, companies in the U.S. seeking to store training data or use the processing power of cloud services to develop or host AI applications could see their access to China-based or China company-owned or controlled cloud service providers now subject to Department of Commerce licensing. Similarly, companies already deploying devices that make use of AI could find their ability to source cheap parts and components from foreign advisory companies limited by a transaction review.

C. Algorithmic Accountability and Consumer Safety

Companies using algorithms, automated processes, and/or AI-enabled applications are now squarely on the radar of both federal and state regulators and lawmakers. In 2020, a number of draft federal bills and policy measures addressing algorithmic accountability and transparency had hinted at a sea change amid growing public awareness of AI’s potential to pose a risk to consumers, including by creating harmful bias. While no AI-specific federal legislation has been enacted to date, federal regulators, including the FTC, have now signaled that they will not wait to bring enforcement actions. Moreover, a steady increase in state privacy laws has placed increasing focus on governance of the biometric data utilized by facial recognition technologies. The past quarter saw a number of developments that suggest companies using facial recognition technology may be subject to stricter regulation and enforcement with respect to the use and retention of biometric identifiers extracted from facial images at both federal and state level.[17]

1. Algorithmic Fairness

a) FTC Statement Announces Intent to Take Enforcement Action Against “Biased” Algorithms

On April 19, the FTC published a blog post, “Aiming for truth, fairness, and equity in your company’s use of AI,” announcing the Commission’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.[18] 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 FTC also provides some 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 its 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 warns 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 comes on the heels of remarks by 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.[19] It also follows the FTC’s informal guidance last year outlining principles and best practices surrounding transparency, explainability, bias, and robust data models.[20]

The FTC’s stance has bipartisan support in the Senate, where FTC Commissioner Rohit Chopra provided a statement on April 20, noting that “Congress and the Commission must implement major changes when it comes to stopping repeat offenders” and that “since the Commission has shown it often lacks the will to enforce agency orders, Congress should allow victims and state attorneys general to seek injunctive relief in court to halt violations of FTC orders.”[21]

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[22] and impose obligations to delete algorithms, models or data (a potential new remedial obligation that is addressed in more detail below).

b) Bipartisan U.S. Lawmakers Introduce Bill Banning Law Enforcement Agencies from Accessing Illegally Obtained User Data

On April 21, a bipartisan group of lawmakers introduced a bill banning law enforcement agencies from buying access to user data from “data brokers,” including companies that “illegitimately obtained” their records.[23] The bill, titled “The Fourth Amendment Is Not For Sale Act,” is sponsored by a bipartisan group including Sen. Ron Wyden (D-OR), Sen. Rand Paul (R-KY) and 18 other members of the Senate, and purports to close “major loopholes in federal privacy law.”[24] The bill would force law enforcement agencies to obtain a court order before accessing users’ personal information through third-party brokers—companies that aggregate and sell personal data like detailed user location—and prevents law enforcement and intelligence agencies buying data that was “obtained from a user’s account or device, or via deception, hacking, violations of a contract, privacy policy, or terms of service.”[25] Reps. Jerry Nadler (D-NY) and Zoe Lofgren (D-CA) introduced a companion bill in the House.

c) 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,[26] state lawmakers and civil rights advocates proposed new rules to prohibit discrimination arising out of automated decision-making by public agencies.[27] 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.[28] If enacted, public agencies in Washington state would be prohibited from using automated decision 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. The bill has been referred to Ways & Means.

2. Facial Recognition

a) FTC Enforcement

In January 2021, the Federal Trade Commission (“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.[29] 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.[30] We will carefully monitor any further enforcement action by the FTC (and other regulators), 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 robust AI diligence and risk-assessment process for third-party AI applications.

b) Virginia Passes Ban on Law Enforcement Use of Facial Recognition Technology, 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.[31] The law will take 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.[32]

c) BIPA

i. Litigation

On March 15, 2021, Judge James L. Robart of the U.S. District Court for the Western District of Washington declined to dismiss two putative class action suits accusing two technology companies of violating Illinois residents’ privacy rights under BIPA.[33] The nearly identical complaints alleged that the companies violated BIPA by using a data set compiled by IBM containing geometric scans of their faces without their permission. The court found that plaintiffs’ claims could proceed under Sections 15(b) and 15(c) of BIPA.

On March 16, 2021, Illinois District Judge Sara L. Ellis dismissed proposed class claims against Clarifai, Inc., a facial recognition software maker, under BIPA.[34] The Complaint alleged that Clarifai was harvesting facial data from OkCupid dating profile photos without obtaining consent from users or making disclosures required under BIPA. The Court found that the plaintiff failed to allege sufficient contacts to show that Clarifai directly targeted Illinois and to establish personal jurisdiction.

ii. Illinois Bill Seeks to Limit BIPA

On March 22, the Illinois state legislature sent proposed amendments to BIPA (H.B. 559) to the chamber floor.[35] The draft bill contains provisions that would impose significant limitations on the scope and impact of BIPA, including a 30-day cure period, a one-year deadline to sue, and a proposal to replace statutory damages with actual damages.[36] BIPA suits have proliferated after the Illinois Supreme Court and some federal courts allowed plaintiffs to sue based on statutory violations.

D. FDA’s Action Plan for AI Medical Devices

On January 12, 2021, the U.S. Food and Drug Administration (“FDA”) released the agency’s first “Artificial Intelligence/Machine Learning (“AI/ML”)-Based Software as a Medical Device (SaMD) Action Plan,” which describes a multi-pronged approach to advance the FDA’s oversight of AI/ML-based medical software.[37] The AI/ML Action Plan is a response to stakeholder feedback received in relation to the April 2019 discussion paper, “Proposed Regulatory Framework for Modifications to Artificial Intelligence/Machine Learning-Based Software as a Medical Device (SaMD),” which described the foundation for a potential approach to premarket review for AI and ML software modifications.[38] For a detailed analysis of the discussion paper and proposed regulatory approach, please see our previous 2Q19 Legal Update.[39]

The FDA’s “Action Plan” outlines five next steps:

Further developing the proposed regulatory framework, including through issuance of draft guidance on a predetermined change control plan (for software’s learning over time). The SaMD Pre-Specifications (“SPS”) describe “what” aspects the manufacturer intends to change through learning, and the Algorithm Change Protocol (“ACP”) explains “how” the algorithm will learn and change while remaining safe and effective. The FDA intends to draft guidance which includes include a proposal of what should be included in an SPS and ACP to support the safety and effectiveness of AI/ML SaMD algorithms;
Supporting the development of good machine learning practices to evaluate and improve machine learning algorithms;
Fostering a patient-centered approach, including device transparency to users. Promoting transparency is a key aspect of a patient-centered approach, and numerous stakeholders have expressed the unique challenges of labeling for AI/ML-based devices and the need for manufacturers to clearly describe, for example, the data that were used to train the algorithm or “the role intended to be served by its output.”[40] The FDA intends to identify types of information a manufacturer should include in the labeling of AI/ML based medical devices to support transparency to users.
Developing methods to evaluate and improve machine learning algorithms, which includes methods for the identification and elimination of bias; and
Advancing real-world performance monitoring pilots on a voluntary basis.

The FDA welcomes continued feedback in this area and intends to hold public workshops to share learnings and elicit additional input from stakeholders. While the FDA has not yet expressed a substantive view on the specific contents of a draft regulation, it seems clear that it will involve a commitment from manufacturers on transparency and real-world performance monitoring for AI and machine learning-based software as a medical device, as well as periodic updates to the FDA on what changes were implemented as part of approved pre-specifications and the ACP. Depending on the scope of the draft regulatory framework, some of the proposed requirements could be highly significant and onerous: for example, requiring a manufacturer to include in the labeling of AI/ML-based devices a “description” of training data. We will continue to monitor developments, and expect that companies operating in this space will want to have a voice in the process leading up to the regulations, particularly with respect to implementing transparency requirements.

E. Intellectual Property Updates

1. USPTO Files Motion for Summary Judgment Arguing that AI Machines Can’t Invent

On February 24, the U.S. Patent and Trademark Office (“USPTO”) filed a motion for summary judgment in Virginia federal court with respect to a lawsuit challenging its finding that patents cannot cover inventions by AI machines, arguing that the Patent Act defines an inventor as an “individual” who must be human.[41]

The plaintiff, Stephen Thaler, is a physicist who created the AI, called DABUS, behind potential patents for a beverage container and a flashing beacon for search-and-rescue missions. The USPTO had denied the patent applications as incomplete because they were missing an inventor’s name, and it refused a petition to reconsider in April 2020, noting that the courts and the law have made clear that only humans can be inventors. Thaler then sued the USPTO in August 2020, alleging it violated the Administrative Procedure Act when it added a patentability requirement that is “contrary to existing law and at odds with the policy underlying the patent system,” and that by refusing to let AI machines be inventors, the agency is undermining the patent system.

In January 2021, Thaler filed a motion for summary judgment, arguing that the USPTO’s finding was arbitrary, capricious, an abuse of discretion and not supported by the law or substantial evidence, and that all of the cases the USPTO cites to support its finding involve inventions that courts concluded humans could do, but not creations that only a machine could invent. At a motion hearing on April 6, U.S. District Judge Leonie Brinkema did not make a bench ruling, but indicated that current legislation restricts the definition of “inventor” in the Patent Act to humans.[42] As previously reported, the European Patent Office has also denied Thaler’s patent applications with respect to DABUS.[43]

2. Google LLC v. Oracle America, Inc. — Supreme Court Rules for Google in Oracle Copyright Dispute

On April 5, 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 API’s to build its Android smartphone platform.[44] Notably, the Court did not rule on whether Oracle’s API’s 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.”[45] 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.”[46] 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.[47]

While the ruling appears to turn on this particular case, it will likely have repercussions for AI and platform creators.[48] 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.

F. U.S. Regulators Seek Input on AI Use in Financial Services

Five federal agencies, including the Federal Reserve Board and the Consumer Financial Protection Bureau, are seeking public input on financial institutions’ use of AI. The notice “Request for Information and Comment on Financial Institutions’ Use of Artificial Intelligence, including Machine Learning” (“RFI”) was published in the Federal Register on March 31.[49]

The federal agencies are aiming to better understand the use of AI and its governance, risk management and controls as well as challenges in developing, implementing and managing the technology. The RFI also solicits respondents’ views on “the use of AI in financial services to assist in determining whether any clarifications from the agencies would be helpful for financial institutions’ use of AI in a safe and sound manner and in compliance with applicable laws and regulations, including those related to consumer protection.” Financial institutions, trade associations, consumer groups and other stakeholders have until June 1, 2021 to submit their comments.

III. EU POLICY & REGULATORY DEVELOPMENTS

A. EC Publishes 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”).[50] 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[51] 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”[52], 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.

1. Summary of Key Provisions

The most relevant and noteworthy provisions contained in the Artificial Intelligence Act include:

Scope of the Artificial Intelligence Act – The proposed Artificial Intelligence Act not only covers “providers”[53] based in the EU, but also “providers” of AI systems based in third countries, placing on the market or putting into service AI systems in the EU, and also “users”[54] of AI systems located within the EU.[55] However, the proposed scope of the Artificial Intelligence Act goes even further to include also “providers” and “users” of AI systems located in third countries, where the output produced by the AI system is used in the EU.[56] The EC does not provide concrete examples for these use cases, but explains that the logic behind this is to prevent the circumvention of the Artificial Intelligence Act by transferring data lawfully collected in the EU to a third country and subject it to an AI system, which is located there.[57] Conversely, the Artificial Intelligence Act would not apply to AI systems developed or used exclusively for military purposes.[58]
Definition of an AI system – While the Artificial Intelligence Act provides a definition of an AI system[59], the EC emphasizes that the definition aims to be as technology neutral and future-proof as possible. Thus, the definition can and likely will be adapted by the EC as needed.
Prohibition of certain AI practices – Following a risk-based approach, which differentiates between uses of AI that create (i) an unacceptable risk, (ii) a high risk and (iii) low or minimal risk, the EC proposes to enact a strict ban on AI systems that are considered to create an “unacceptable risk.” The Artificial Intelligence Act lists four types of AI systems bearing an unacceptable risk, including AI systems that deploy “subliminal techniques beyond a person’s consciousness in order to materially distort a person’s behavior in a manner that causes or is likely to cause that person or another person physical or psychological harm.”[60] Since the draft legislation itself and the accompanying materials do not offer any further definitions or explanations for key terms, the exact application and impact of this prohibition in practice remains unclear. Further prohibited practices include the use of “social scoring” AI systems by public authorities[61] and the deployment of “real-time remote biometric identification systems” in publicly available spaces for the purpose of law enforcement (unless certain narrowly defined exceptions apply).[62]
Mandatory requirements for “high-risk AI systems” – The Artificial Intelligence Act contains specific requirements for so-called “high-risk AI systems”. AI systems are considered “high-risk” if they are either (i) intended to be used as a safety component of a product (embedded AI) or are themselves a product, which is covered by certain EU product safety legislation (g. medical devices, personal protective equipment, toys or machinery)[63] or (ii) listed in an enumerative catalogue,[64] which may be expanded by the EC through the application of a specific risk assessment methodology. The latter includes, inter alia, biometric identification and categorization of natural persons, management and operation of critical infrastructure (e.g. supply of water, gas, heating and electricity), employment (e.g. AI systems for screening applications), access to and enjoyment of essential private services and public services and benefits (e.g. AI systems for evaluating credit scores), law enforcement (e.g. predictive AI systems intended for the evaluation of occurrence or reoccurrence of a criminal offence) and administration of justice and democratic processes (e.g. AI systems for researching and interpreting facts and the law). Conspicuously, the health-care sector is missing from that list. General requirements for the development and deployment of such “high-risk AI systems” include the establishment and maintenance of a risk management system, the use of appropriate training, validation and testing data in the development phase, the achievement of an appropriate level of accuracy, robustness and cybersecurity in light of the intended use, the drawing up of specific technical documentation, designing of logging capabilities within the AI system, providing of comprehensive instructions for use and enabling human oversight of the AI system.[65] Notably, Article 10 of the draft regulation requires that the training, validation and testing data sets are “relevant, representative, free of errors and complete” and take into account the characteristics or elements particular to the specific geographical, behavioral or functional setting of the system’s intended use; the draft regulation carves out higher penalties for non-compliance with these data and data governance requirements in comparison to other cases of infringement.[66] Providers of “high-risk AI systems” also have specific obligations, which include ensuring that high-risk AI systems undergo a “conformity assessment procedure” prior to placing on the market or putting into service.[67] This “conformity assessment procedure” is modelled after the procedures, which are required before introducing other products, such as medical devices, into the EU market. For certain “high-risk AI systems” the provider only needs to perform internal controls. However, for AI systems which enable biometric identification and categorization of natural persons, the providers must involve an outside entity in the assessment procedure (a so-called “notified body”).[68] For “high-risk AI systems” covered by existing EU product safety legislation, already applicable conformity assessment procedures should be followed. Further, providers of “high-risk AI systems” must register the system in a publicly available EU database that is provided for under the Act.[69]
Post-market monitoring obligations for “high-risk AI systems” – In addition to the provisions relating to the development and placing on the market of “high-risk AI systems”, the proposed Artificial Intelligence Act also provides for mandatory post-market monitoring obligations for providers of such systems.[70] This includes obligations to report any serious incident or any malfunctioning of the AI system, which would constitute a breach of obligations under EU laws intended to protect fundamental rights. “High-risk AI systems” also have to be withdrawn or recalled, if the provider considers that an AI system that was placed on the market or put into service violates the Artificial Intelligence Act.
Provisions relating to “non-high-risk AI systems” – Other AI systems which do not qualify as prohibited or “high-risk AI systems” are not subject to any specific requirements. In order to facilitate the development of “trustworthy AI”, the EC stipulates that providers of “non-high-risk AI systems” should be encouraged to develop codes of conduct intended to foster the voluntary application of the mandatory requirements applicable to “high-risk AI systems”.[71] However, AI systems which are intended to interact with natural persons must be designed and developed in such a way that users are informed they are interacting with an AI system, unless it is “obvious from the circumstances and the context of use.”[72] The EC also proposes a disclosure obligation for so-called “deep fakes”.[73] In addition, the EC points out that such “non-high-risk AI systems” nevertheless have to comply with general product safety requirements.[74]
Enforcement and penalties for non-compliance – The draft Artificial Intelligence Act creates a governance and enforcement structure within which EU Member States would designate one or more national competent authorities at the national level, as well as a top-level national supervisory authority. At the EU level, the EC proposes establishing a European Artificial Intelligence Board, which would be responsible for providing advice and assistance to the EC. Finally, the proposal also includes various enforcement instruments and hefty penalties for non-compliance. In case of non-compliance with regards to the prohibitions on specific AI systems under Article 5 and AI system requirements relating to data and data governance under Article 10, companies would face fines of up to EUR 30 million (approx. $36 million total global annual turnover, whichever is higher.[75] Cases of non-compliance with the remaining requirements and obligations under the draft regulation would subject the company to administrative fines of up to EUR 20 million (approx. $24 million) or up to 4% of the company’s total worldwide annual turnover for the preceding financial year, whichever is higher.[76] Additionally, the supply of incorrect, incomplete or misleading information to notified bodies and national competent authorities in reply to a request may result in administrative fines of up to EUR 10 million (approx. $12 million) or up to 2% of the company’s total worldwide annual turnover for the preceding financial year, whichever is higher.[77]

2. Comparison with U.S. Legislative Proposals

Although the draft EC regulation is more comprehensive than existing legal frameworks that govern AI, there are marked similarities to recent legislation introduced in the U.S. For example, as noted above, a growing number of legislative bodies in the U.S. have passed laws restricting or banning the use of facial recognition technology, sharing the EC’s concerns regarding remote biometric identification systems, especially in the context of law enforcement.[78]

Additionally, like the draft regulation, state legislation relating to AI systems has called for increased transparency and stronger oversight. For example, the California Privacy Rights Act of 2020 requires that responses to access requests regarding automated decision-making technology “include meaningful information about the logic involved in such decision-making processes, as well as a description of the likely outcome of the process with respect to the consumer”, similar to the technical documentation requirements in the draft regulation which require providers to report “the general logic of the AI system and of the algorithms” along with the “main classification choices” with regards to the persons on which the system is to be used.[79] Also, like the supervising authority access requirements in the Artificial Intelligence Act, Washington state’s “Act Relating to the use of facial recognition services”, requires that providers of facial recognition services to state or local agencies “make available an application programming interface or other technical capability, chosen by the provider, to enable legitimate, independent, and reasonable tests of those facial recognition services for accuracy and unfair performance differences across distinct subpopulations.”[80]

Notably, the transparency and technical documentation requirements in the EC’s Artificial Intelligence Act are far more extensive than those outlined in existing legislation within the U.S. Specifically, under the EC regulation, authorities would be granted full access to the AI system provider’s training, validation and testing datasets, and upon reasoned request, the source code itself.[81] While a court in New Jersey recently granted a criminal defendant access to the source code of a probabilistic genotyping software used to match the defendant’s DNA to a crime scene, access to source code is generally not required by legislation or demanded by courts with respect to automated-decisions in the United States.[82] The extensive required disclosures may cause concern over intellectual property protection; information and data would be protected by confidentiality requirements, however the Commission and Member States are permitted to exchange confidential information with regulatory authorities of third countries where confidentiality agreements are in place.[83] Currently, United States legislative and regulatory bodies are not asking for the same degree of transparency, but are still taking steps to curb the potential discriminatory impact of AI systems, as discussed above.[84]

3. Next Steps

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.[85] Therefore, we expect that the proposed rules will not be significantly diluted, and could even be further tightened, as some advocacy groups have called for.[86] 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.

B. CAHAI Feasibility Study on AI Legal Standards

On December 17, 2020, the Ad Hoc Committee on Artificial Intelligence (“CAHAI”) of the Council of Europe (the “CoE”), adopted a feasibility study on a legal framework on AI design, development and application based on the CoE’s standards.[87] CAHAI was mandated by the CoE in 2019 to examine, on the basis of broad multi-stakeholder consultations, the feasibility of such a legal framework and take into account the CoE’s relevant standards in the fields of human rights, democracy and the rule of law as well as the relevant existing universal and regional international legal instruments.

At the outset, CAHAI points out that there is no single definition of AI and that the term “AI” is used as a blanket term for “various computer applications based on different techniques, which exhibit capabilities commonly and currently associated with human intelligence.” Accordingly, CAHAI highlights the need to approach AI systems in a technologically neutral way.

CAHAI expressly recognizes the opportunities and benefits arising from AI—such as contributing to achieving the UN Sustainable Development Goals and helping to mitigate the effect of climate change—but also addresses the potential challenges of certain AI use cases, such as the use of AI systems to predict recidivism and AI-based tracking techniques, as well as the risks arising out of biased training data. In light of these concerns, CAHAI recommends that a potential CoE legal framework on AI should pursue a risk-based approach that targets the specific application context. In its concluding comments, CAHAI notes that “no international legal instrument specifically tailored to the challenges posed by AI exists, and that there are gaps in the current level of protection provided by existing international and national instruments.”

On March 30, 2021, the CoE announced that CAHAI is now preparing a legal framework on AI.[88] CAHAI has launched a multi-stakeholder consultation until April 29, 2021.[89]

C. 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 [90] and published an updated proposal for a new ePrivacy Regulation.[91] 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[92] 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.[93]

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.

D. Cybersecurity Report on the Use of AI in Autonomous Vehicles

On February 11, 2021, the European Union Agency for Cybersecurity (“ENISA”) and the European Commission’s Joint Research Centre (“JRC”) published a joint report on cybersecurity risks connected to the use of AI in autonomous vehicles and provided recommendations for mitigating them (the “Cybersecurity Report”).[94]

The Cybersecurity Report emphasized the vulnerability of AI systems in autonomous vehicles with respect to intentional attacks that aim to interfere with the AI system. Even simple measures, such as paint markings on the road, could interfere with system navigation tools using AI technologies and could have a significant impact on safety and reliability.

In order to prevent or mitigate such risks, the Cybersecurity Report recommends several measures, such as the systematic security validation of AI models and data early on in the development process of AI systems used in autonomous vehicles. Further, the automotive industry should adopt a holistic “security by design” approach, creating an “AI cybersecurity culture” across the production ecosystem. The Cybersecurity Report identifies the absence of sufficient security knowledge and expertise among developers and system designers as a major roadblock towards cybersecurity awareness in the industry.

E. Proposed German Legislation on Autonomous Driving

On March 15, 2021, the German Federal Government (“Bundesregierung”) submitted a draft law on fully automated driving (SAE level 4) to the German Parliament (“Bundestag”) for legislative debate.[95] The draft law aims to establish uniform conditions for testing new technologies, such as driverless cars with SAE level 4, throughout Germany. Pursuant to the draft law, autonomous vehicles will be permitted to drive in regular operation without a driver being physically present, limited—for now—to certain locally defined operating areas, for the time being. If the draft law is passed by the Bundestag, Germany expects to be the first country in the world to permit fully automated vehicles in regular operation across the country by 2022 (subject to local operating areas to be defined by the respective German state authorities). As an example of fields of operation for such automated vehicles, the Bundesregierung mentions shuttle services, Hub2Hub and Dual-Mode-Vehicles, such as “automated valet parking.” Currently, autonomous vehicles can only be operated in Germany with special permits granted by state authorities.

The draft law also includes framework provisions on liability, which reflect the status quo under German liability law: if a person is injured or an object damaged while operating a car, the motor insurance of the car’s owner compensates for the damage. However, the draft law also introduces a new concept: “technical supervision,” defined as the ability to deactivate the autonomous vehicle during operation and enable driving maneuvers for the autonomous vehicle. In principle, the owner of the car is responsible for “technical supervision,” but can also entrust another person with the performance of these tasks. Nonetheless, the owner is still liable for any possible liability of the person entrusted with “technical supervision.”

There remains disagreement within the Bundesregierung regarding the provisions on data protection contained in the draft law.[96] Open items will be discussed in the upcoming legislative procedure. The Bundesregierung is aiming to adopt the new law before the parliamentary summer break (and before the German Federal Elections in September 2021).[97]

__________________________

[1] This Legal Update focuses on recent U.S. and EU regulatory efforts, but we note that there are numerous other examples of increasingly stringent worldwide regulation of algorithmic accountability and fairness. For example, on February 22, the UK Government published its response to the December 2020 Report by the House of Lords Select Committee on Artificial Intelligence, “AI in the UK: No Room for Complacency,” discussed in more detail in our Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems. The House of Lords’ report recommended action by the Government and called for it to “better coordinate its [AI] policy and the use of data and technology” on a national and local level, and “lead the way on making ethical AI a reality.” In its response, the UK Government acknowledged that it is crucial to develop the public’s understanding and trust in AI, stating that the National Data Strategy is actively ensuring members of the public become “responsible data citizens”. Moreover, the Centre for Data Ethics and Innovation’s (“CDEI”) future role will include AI monitoring and testing potential interventions in the tech landscape.

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

[3] 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/.

[4] 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/.

[5] Government Executive, New Task Force Will Conduct Sweeping Review of Scientific Integrity Policies (March 30, 2021), available at https://www.govexec.com/management/2021/03/new-task-force-will-conduct-sweeping-review-scientific-integrity-policies/173020/.

[6] 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.

[7] 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/.

[8] House Armed Services Committee, Subcommittee on Cyber, Innovative Technologies, and Information Systems, available at https://armedservices.house.gov/cyber-innovative-technologies-and-information-systems.

[9] House Armed Services Committee, Subcommittee on Cyber, Innovative Technologies, and Information Systems and the House Committee on Oversight & Reform’s Subcommittee on National Security Joint Hearing: “Final Recommendations of the National Security Commission on Artificial Intelligence” (Mar. 12, 2021), available at https://armedservices.house.gov/hearings?ID=32A667CD-578C-4F65-9F4F-1E26EE8F389A.

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

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

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

[13] Some of these concerns echo prior actions by the USPTO. For example, the USPTO issued the 2019 Revised Patent-Eligibility Guidance, which reportedly resulted in a 44% decrease in uncertainty of patent examination subject matter. However, the guidance has not been broadly applied by courts and leads to mixed results. Additionally, the USPTO in October 2020 issued a report on Public Views on Artificial Intelligence and Intellectual Property Policy, observing that commentators “were nearly equally divided between the view that new intellectual property rights were necessary to address AI inventions and the belief that the current U.S. IP framework was adequate to address AI inventions.” As discussed below, however, the USPTO continues to hold the view that an inventor to a patent must be a natural person.

[14] Securing the Information and Communications Technology and Services Supply Chain, 86 FR 4909 (Jan. 19, 2021), available at https://www.federalregister.gov/documents/2021/01/19/2021-01234/securing-the-information-and-communications-technology-and-services-supply-chain.

[15] 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”).

[16] Interim Final Rule, § 7.1.

[17] Further, on February 3, Canada’s Privacy Commissioners stated that Clearview AI’s app—which has been used widely by law enforcement agencies across Canada—was “illegal” and akin to putting all of society “continually in a police lineup.”) (Link to PIPEDA report)

[18] 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.

[19] 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.

[20] 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.

[21] FTC, Prepared Opening Statement of Commissioner Rohit Chopra, U.S. Senate Committee on Commerce, Science, and Transportation Hearing on “Strengthening the Federal Trade Commission’s Authority to Protect Consumers,” (April 20, 2021), available at https://www.ftc.gov/system/files/documents/public_statements/1589172/final_chopra_opening_statement_for_senate_commerce_committee_20210420.pdf.

[22] While a recent Supreme Court ruling curtailed the FTC’s ability to seek equitable monetary penalties such as restitution or disgorgement (AMG Capital Management, LLC, et al. v. Federal Trade Commission, No. 19-508 (U.S. April 22, 2021), Congress is considering legislation to remedy the decision. The House Energy and Commerce Committee has scheduled a hearing on whether the FTC needs new authority to seek consumer redress. See further Christopher Cole, Supreme Court Rolls Back FTC Restitution Power, Law360 (April 22, 2021), available at https://www.law360.com/articles/1377854.

[23] S. ___, 117^th Congress (2021), available at https://www.wyden.senate.gov/imo/media/doc/The%20Fourth%20Amendment%20Is%20Not%20For%20Sale%20Act%20of%202021%20Bill%20Text.pdf.

[24] Statement of Sen. Ron Wyden (D-OR), The Fourth Amendment Is Not For Sale Act (April 21, 2021), available at https://www.wyden.senate.gov/imo/media/doc/The%20Fourth%20Amendment%20Is%20Not%20For%20Sale%20Act%20of%202021%20One%20Pager.pdf.

[25] Id.

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

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

[28] 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/.

[29] 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.

[30] 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.

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

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

[33] Order, Steven Vance et al. v. Microsoft Corp., No. 2:20-cv-01082, (W.D. Wash. March 15, 2021, ) 2021 WL 963485

[34] Order, Stein et al. v. Clarifai Inc., No. 1:20-cv-01937, (N.D. Ill. March 16, 2021), 2021 WL 1020997

[35] H.B. 559, 102^nd Gen. Assembly, available at https://www.ilga.gov/legislation/BillStatus.asp?DocNum=559&GAID=16&DocTypeID=HB&SessionID=110&GA=102.

[36] Lauraann Wood, Illinois Bill Seeks To File Down Biometric Law’s Sharp Teeth, Law360 (March 22, 2021), available at https://www.law360.com/cybersecurity-privacy/articles/1367329/illinois-bill-seeks-to-file-down-biometric-law-s-sharp-teeth?nl_pk=4e5e4fee-ca5f-4d2e-90db-5680f7e17547&utm_source=newsletter&utm_medium=email&utm_campaign=cybersecurity-privacy.

[37] U.S. Food & Drug Administration, News Release, FDA Releases Artificial Intelligence/Machine Learning Action Plan (Jan. 12, 2021), available at https://www.fda.gov/news-events/press-announcements/fda-releases-artificial-intelligencemachine-learning-action-plan.

[38] U.S. Food & Drug Administration, Proposed Regulatory Framework for Modifications to Artificial Intelligence/Machine Learning-Based Software as a Medical Device (SaMD) (April 2019), available at https://www.fda.gov/media/122535/download.

[39] 2Q19 Artificial Intelligence and Autonomous Systems Legal Update, III.A. FDA Releases White Paper Outlining a Potential Regulatory Framework for Software as a Medical Device (SaMD) That Leverages AI.

[40] Supra, n.16 at 5.

[41] Stephen Thaler v. Andrew Hirshfeld et al., No. 1:20-cv-00903 (E.D. Va. Feb. 24, 2021).

[42] Cara Salvatore, Giving AI Inventorship Would Be A Bridge Too Far, Judge Says, Law360 (April 6, 2021), available at https://www.law360.com/articles/1354993.

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

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

[45] Id., at *3.

[46] Id. at *20.

[47] See id.

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

[49] 86 Fed. Reg. 16837.

[50] 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.

[51] 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.

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

[53] “Providers” are defined as a natural or legal person, public authority, agency or other body that develops an AI system or that has an AI system developed with a view to placing it on the market or putting it into service under its own name or trademark, whether for payment or free of charge (see Art. 3 no. 2 of the Artificial Intelligence Act).

[54] “Users” are defined as any natural or legal person, public authority, agency or other body using an AI system under its authority, except where the AI system is used in the course of a personal non-professional activity (see Art. 3 no. 4 of the Artificial Intelligence Act).

[55] Certain obligations also apply to “importers” and “distributors”.

[56] See Art. 2 para. 1 point (c) of the Artificial Intelligence Act.

[57] See Recital (11) of the Artificial Intelligence Act.

[58] See Art. 2 para. 3 of the Artificial Intelligence Act.

[59] “AI system” is defined as software that is developed with one or more of the techniques and approaches listed in an Annex (such as machine learning approaches incl. deep learning, logic- and knowledge-based approaches and statistical approaches) and can, for a given set of human-defined objectives, generate outputs such as content, predictions, recommendations, or decisions influencing the environment the interact with (see Art. 3 no. 1 of the Artificial Intelligence Act).

[60] See Art. 5 para. 1 point (a) of the Artificial Intelligence Act.

[61] See Art. 5 para. 1 point (c) of the Artificial Intelligence Act.

[62] See Art. 5 para. 1 point (d) of the Artificial Intelligence Act.

[63] See Art. 6 para. 1 of the Artificial Intelligence Act.

[64] See Art. 6 para. 2 in connection with Annex III of the Artificial Intelligence Act.

[65] See Art. 8 et seqq. of the Artificial Intelligence Act.

[66] See Art. 10 and 71 of the Artificial Intelligence Act.

[67] See Art. 16 points (a) and (e) of the Artificial Intelligence Act.

[68] See Art. 43 of the Artificial Intelligence Act.

[69] See Art. 16 point (f), 51 and 60 of the Artificial Intelligence Act.

[70] See Art. 61 et seq. of the Artificial Intelligence Act.

[71] See Recital (81) and Art. 69 of the Artificial Intelligence Act.

[72] See Art. 52 para. 1 of the Artificial Intelligence Act.

[73] See Art. 52 para. 3 of the Artificial Intelligence Act.

[74] See Recital (82) of the Artificial Intelligence Act.

[75] See Art. 71 of the Artificial Intelligence Act.

[76] See Id.

[77] See Id.

[78] See e.g., Portland Ordinance No. 190114, “Prohibit the use of Face Recognition Technologies by private entities in places of public accommodation in the City”, effective Jan. 1, 2021 (banning private entities from using Face Recognition Technologies in Places of Public Accommodation within the boundaries of the City of Portland); San Francisco Ordinance No. 103-19, the “Stop Secret Surveillance” ordinance, effective 31 May 2019 (banning the use of facial recognition software by public departments within San Francisco, California); Somerville Ordinance No. 2019-16, the “Face Surveillance Full Ban Ordinance,” effective 27 June 2019 (banning use of facial recognition by the City of Somerville, Massachusetts or any of its officials); Oakland Ordinance No. 18-1891, “Ordinance Amending Oakland Municipal Code Chapter 9.65 to Prohibit the City of Oakland from Acquiring and/or Using Real-Time Face Recognition Technology”, preliminary approval 16 July 2019, final approval 17 September 2019 (bans use by city of Oakland, California and public officials of real-time facial recognition). For more information, see our U.S. Cybersecurity and Data Privacy Outlook and Review – 2021 and Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems.

[79] See Art. 6 para. 1 in connection with Annex IV of the Artificial Intelligence Act; CPRA Section 14, adding Cal. Civ. Code § 1798.140(z). For more detail see our alert regarding “The Potential Impact of the Upcoming Voter Initiative, the California Privacy Rights Act”.

[80] See Art. 64 of the Artificial Intelligence Act; An Act Relating to the use of facial recognition services, S.B. 6280, 66th Leg., Reg. Sess. (Wash. 2020), available at http://lawfilesext.leg.wa.gov/biennium/2019-20/Pdf/Bills/Session%20Laws/Senate/6280-S.SL.pdf?q=20201214093740.

[81] See Art. 64 of the Artificial Intelligence Act.

[82] See State v. Pickett, No. A-4207-19T4, 2021 WL 357765, at *2 (N.J. Super. Ct. App. Div. Feb. 3, 2021); see e.g., Houston Fed’n of Tchrs., Loc. 2415 v. Houston Indep. Sch. Dist., 251 F. Supp. 3d 1168, 1179 (S.D. Tex. 2017) (stating that “[w]hen a public agency adopts a policy of making high stakes employment decisions based on secret algorithms incompatible with minimum due process, the proper remedy is to overturn the policy, while leaving the trade secrets intact”); An Act Relating to the use of facial recognition services, S.B. 6280, 66th Leg., Reg. Sess. (Wash. 2020), available at http://lawfilesext.leg.wa.gov/biennium/2019-20/Pdf/Bills/Session%20Laws/Senate/6280-S.SL.pdf?q=20201214093740 (stating that “[m]aking an application programming interface or other technical capability [to enable review] does not require providers to do so in a manner that would increase the risk of cyberattacks or to disclose proprietary data.”).

[83] See Art. 70 of the Artificial Intelligence Act.

[84] Supra at I.C.

[85] 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”.

[86] The New York Times, Europe Proposes Strict Rules for Artificial Intelligence (April 21, 2021), available at https://www.nytimes.com/2021/04/16/business/artificial-intelligence-regulation.html.

[87] Council of Europe – Ad Hoc Committee on Artificial Intelligence, Feasibility Study (Dec. 17, 2020), available at https://rm.coe.int/cahai-2020-23-final-eng-feasibility-study-/1680a0c6da.

[88] Press release, Launch of the CAHAI Multi-stakeholder Consultation (March 30, 2021), available at https://www.coe.int/en/web/artificial-intelligence/-/lauch-of-the-cahai-multi-stakeholder-consultation.

[89] The CAHAI consultation is accessible here: https://www.coe.int/en/web/artificial-intelligence/cahai-multi-stakeholder-consultation.

[90] Press release, Confidentiality of electronic communications: Council agrees its position on ePrivacy rules (Feb. 10, 2021), available at https://www.consilium.europa.eu/en/press/press-releases/2021/02/10/confidentiality-of-electronic-communications-council-agrees-its-position-on-eprivacy-rules/.

[91] EU Council, Proposal for a Regulation of the European Parliament and of the Council concerning the respect for private life and the protection of personal data in electronic communications and repealing Directive 2002/58/EC (Regulation on Privacy and Electronic Communications) (Feb. 10, 2021), available at https://data.consilium.europa.eu/doc/document/ST-6087-2021-INIT/en/pdf.

[92] Directive 2002/58/EC of the European Parliament and of the Council of 12 July 2002 concerning the processing of personal data and the protection of privacy in the electronic communications sector, available at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32002L0058&from=EN.

[93] See EU Commission, Proposal for a Regulation on Privacy and Electronic Communications (Jan. 10, 2017), available at https://digital-strategy.ec.europa.eu/en/library/proposal-regulation-privacy-and-electronic-communications.

[94] Press release, Cybersecurity Challenges in the Uptake of Artificial Intelligence in Autonomous Driving (Feb. 11, 2021), available at https://www.enisa.europa.eu/news/enisa-news/cybersecurity-challenges-in-the-uptake-of-artificial-intelligence-in-autonomous-driving. The Cybersecurity Report is available for download at https://www.enisa.europa.eu/publications/enisa-jrc-cybersecurity-challenges-in-the-uptake-of-artificial-intelligence-in-autonomous-driving/.

[95] Draft law of the Bundesregierung, Entwurf eines Gesetzes zur Änderung des Straßenverkehrsgesetzes und des Pflichtversicherungsgesetzes – Gesetz zum autonomen Fahren, Drucksache 19/27439 (March 15, 2021), available at https://dip21.bundestag.de/dip21/btd/19/274/1927439.pdf.

[96] For example, it has been reported that the Federal Ministry of Justice has raised concerns in relation to the question whether data such as driving routes can be transmitted to the Federal Criminal Police Office (the German equivalent to the FBI) upon request.

[97] Bundesregierung, Antwort der Bundesregierung auf die Kleine Anfrage der Abgeordneten Oliver Luksic, Frank Sitta, Bernd Reuther, weiterer Abgeordneter und der Fraktion der FDP, Drucksache 19/24851 (Dec. 28, 2020), available at https://dip21.bundestag.de/dip21/btd/19/256/1925626.pdf.

The following Gibson Dunn lawyers prepared this client update: H. Mark Lyon, Michael Walther, Kai Gesing, Christopher Timura, Frances Waldmann, Selina Grün, Prachi Mistry, and Derik Rao.

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:

H. Mark Lyon – Palo Alto (+1 650-849-5307, [email protected])
Frances A. Waldmann – Los Angeles (+1 213-229-7914,[email protected])

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

Artificial Intelligence and Automated Systems Group:
H. Mark Lyon – Chair, Palo Alto (+1 650-849-5307, [email protected])
J. Alan Bannister – New York (+1 212-351-2310, [email protected])
Patrick Doris – London (+44 (0)20 7071 4276, [email protected])
Kai Gesing – Munich (+49 89 189 33 180, [email protected])
Ari Lanin – Los Angeles (+1 310-552-8581, [email protected])
Robson Lee – Singapore (+65 6507 3684, [email protected])
Carrie M. LeRoy – Palo Alto (+1 650-849-5337, [email protected])
Alexander H. Southwell – New York (+1 212-351-3981, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
Michael Walther – Munich (+49 89 189 33 180, [email protected])

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Decided April 22, 2021

AMG Capital Management v. FTC, No. 19-508

Today, the Supreme Court held 9-0 that Section 13(b) of the Federal Trade Commission Act, which authorizes federal courts to issue “permanent injunction[s]” in FTC enforcement actions, does not include the power to award equitable monetary relief such as restitution.

Background:
Scott Tucker owned several businesses that provided high-interest, short-term loans over the Internet. The Federal Trade Commission sued Tucker and his businesses under Section 5 of the Federal Trade Commission Act, which prohibits “unfair or deceptive acts or practices.” The FTC sought a “permanent injunction” under Section 13(b) of the Act, as well restitution and disgorgement of Tucker’s monetary gains. The district court granted the FTC’s requested relief, and the Ninth Circuit affirmed, relying on its precedent holding that Section 13(b) “empowers district courts to grant any ancillary relief necessary to accomplish complete justice, including restitution.”

Issue:
Whether the authorization of a “permanent injunction” in Section 13(b) of the Act also authorizes federal courts to award equitable monetary relief such as restitution and disgorgement.

Court’s Holding:
Section 13(b) does not authorize federal courts to award equitable monetary relief, because a “permanent injunction” is distinct from equitable monetary relief and other sections of the Act expressly authorize the FTC to seek monetary relief if it follows certain procedures not required under Section 13(b).

“The question presented is whether th[e] statutory language authorizes the Commission to seek, and a court to award, equitable monetary relief such as restitution or disgorgement. We conclude that it does not.”

Justice Breyer, writing for the Court

What It Means:

The Court’s decision significantly cabins the FTC’s historically broad authority under Section 13(b) in consumer protection and antitrust matters. The FTC has used Section 13(b) “to win equitable monetary relief directly in court with great frequency.” Until the Seventh Circuit rejected the FTC’s authority to seek such relief in a 2019 decision, all eight federal courts of appeals to address the issue had upheld the FTC’s authority to seek such relief under the Act.
The Court’s decision does not preclude the FTC from seeking monetary relief in all cases. Under Sections 5 and 19 of the Act, the FTC may seek monetary relief on behalf of consumers when the FTC has engaged in administrative proceedings and issued cease and desist orders.
The Court explained that the FTC is “free to ask Congress to grant it further remedial authority” if Sections 5 and 19 are “too cumbersome or otherwise inadequate.” In fact, the FTC has recently asked Congress for broader authority, and it remains to be seen whether Congress will grant the FTC’s request in light of the Court’s decision.

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
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Mark A. Perry
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Lucas C. Townsend
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Bradley J. Hamburger
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Related Practice: Antitrust and Competition

Stephen Weissman
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Rachel S. Brass
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Scott D. Hammond
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Daniel G. Swanson
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Related Practice: Privacy, Cybersecurity and Data Innovation

Alexander H. Southwell
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S. Ashlie Beringer
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Ashley Rogers
+1 214.698.3316
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Ryan T. Bergsieker
+1 303.298.5774
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Washington, D.C. partner David Fotouhi and associate Trenton Van Oss are the authors of “What DC Circ.’s Finality Test Means For Biden Enviro Policies,” [PDF] published by Law360 on April 20, 2021.

On April 7, 2021, the new regulation of the New York Department of Financial Services (NYDFS) governing confidential supervisory information (CSI) became effective in final form. NYDFS has thus joined the Board of Governors of the Federal Reserve System (Federal Reserve) in making recent amendments to its approach to CSI.[1] The final regulation (Final Rule) makes certain improvements over the rule proposal most recently put out by NYDFS in September 2020. New York now has, for the first time, a CSI regulation in addition to the pre-existing statutory provision, Section 36.10 of the Banking Law.

A. Scope of CSI

The Final Rule defines CSI as “any information that is covered by Section 36.10 of the [New York] Banking Law.”[2] Section 36.10, in turn, refers to “reports of examinations and investigations [of any NYDFS-supervised institution and affiliates], correspondence and memoranda concerning or arising out of such examination and investigations, including any duly authenticated copy or copies thereof,” and includes any confidential materials shared by NYDFS with any governmental agency or unit.[3]

B. Disclosure to Affiliates

Under Section 36.10 and the Final Rule, the default standard for disclosure of any CSI is the prior written approval of NYDFS.[4] The Final Rule contains an exception to the prior written approval requirement for disclosure by a NYDFS-regulated entity of CSI to the regulated entity’s affiliates and their directors, officers and employees when “necessary and appropriate for business purposes” and “on the condition that such persons maintain the confidentiality of such information.”[5]

C. Disclosure to Legal Counsel and Independent Auditors

The Final Rule eases current restrictions on NYDFS-regulated entities’ disclosure of CSI to certain advisors. It provides a “limited exception” for disclosure by such entities to “legal counsel or an independent auditor that has been retained or engaged by such regulated entity pursuant to an engagement letter or written agreement.”[6]

In an improvement from the September 2020 proposal, there is no requirement that the applicable engagement letter or written agreement contain burdensome acknowledgements by the legal counsel or independent auditor, including that the information will be used solely to provide “legal representation or auditing services,” that the information will be disclosed to legal counsel’s or the auditor’s employees, directors, or officers only “to the extent necessary and appropriate for business purposes,” and that legal counsel or the auditor agree “to return or certify the destruction of the confidential supervisory information or, in the case of electronic files, render the files effectively inaccessible through access control measures or other means, at the conclusion of the engagement.”[7]

Rather, all that the Final Rule requires is that legal counsel or independent auditor acknowledge, “in writing,” that any disclosed information is CSI under Section 36.10 of the Banking Law, and agree, “in writing,” to abide by the prohibition on the dissemination of CSI contained in the Final Rule.[8]

Unlike the September 2020 proposal, there is also an exception for “Client Acceptance of New or Continuing Engagement of Independent Auditors.” Under this exception, a NYDFS-regulated entity may disclose CSI to independent auditors “as part of the independent auditor’s acceptance of a new client engagement or the continuation of an existing annual audit engagement.” The condition to this exception is that the regulated entity receive the written acknowledgement and agreement from the independent auditor described above.[9]

Unlike the Federal Reserve’s regulation, the Final Rule does not contain an exception for third-party vendors to legal counsel and external auditors, which NYDFS had previously characterized as “broad” and not contained in the OCC’s regulation.[10]

D. Disclosure to Other Regulators

With respect to the disclosure by NYDFS-regulated entities of CSI to other state and federal regulators “having direct supervisory authority over” such regulated entities, the Final Rule requires the prior written approval of both the Senior Deputy Superintendent of NYDFS for Banking and the NYDFS General Counsel, or their respective delegates, prior to disclosure.[11]

E. Duty to Notify NYDFS of Requests for CSI

The Final Rule requires each NYDFS-regulated entity, affiliate of a NYDFS-regulated entity, legal counsel, and independent auditor that is served with a request, subpoena, motion to compel or other judicial or administrative process to provide CSI to notify the NYDFS Office of the General Counsel of the request immediately so that NYDFS will be able to intervene in the action as appropriate.[12] In addition, the Final Rule mandates that a CSI holder both inform the requester of the substance of the New York regulation and the holder’s obligation to maintain the confidentiality of the CSI, and, “at the appropriate time,” inform the relevant tribunal of the substance of Section 36.10 of the New York Banking Law and the New York regulation.[13]

Conclusion

The Final Rule is a welcome development. It largely harmonizes the New York CSI rules with federal analogues and should reduce the inefficiencies created by Section 36.10 of the New York Banking Law, particularly for legal counsel and independent auditors. Outside of the Final Rule’s exceptions, however, the overriding traditional principle of CSI law and regulation – that the regulators consider CSI their property, to be disclosed only upon their specific consent – remains a key feature of the NYDFS regime, and one that can result in severe sanctions if it is ignored.

______________________

[1] See https://www.gibsondunn.com/wp-content/uploads/2020/09/developments-in-us-banking-regulators-treatment-of-confidential-supervisory-information.pdf.

[2] 3 N.Y.C.R.R. § 7.1(a).

[3] New York Banking Law, Section 36.10.

[4] Id.; 3 N.Y.C.R.R. § 7.2(a).

[5] 3 N.Y.C.R.R. § 7.2(d).

[6] Id. § 7.2(b).

[7] 3 N.Y.C.R.R. § 7.2(b) (proposed 2020).

[8] 3 N.Y.C.R.R. § 7.2(b).

[9] Id. § 7.2(c).

[10] NYS Register, page 12 (Sept. 9, 2020), available at https://www.dos.ny.gov/info/register/2020/090920.pdf.

[11] 3 N.Y.C.R.R. § 7.2(g).

[12] Id. § 7.2(e).

[13] Id.

The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long and Matthew Biben.

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, the authors, or any of the following members of the firm’s Financial Institutions practice group:

Matthew L. Biben – New York (+1 212-351-6300, [email protected])
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, [email protected])
M. Kendall Day – Washington, D.C. (+1 202-955-8220, [email protected])
Mylan L. Denerstein – New York (+1 212-351- 3850, [email protected])
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Matthew Nunan – London (+44 (0) 20 7071 4201, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [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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Andrew L. Fabens is a partner in the New York office of Gibson, Dunn & Crutcher. Mr. Fabens is Co-Chair of Gibson Dunn’s Capital Markets Practice Group and is a member of Gibson Dunn’s Securities Regulation and Corporate Governance Practice Group. Mr. Fabens advises companies on long-term and strategic capital planning, disclosure and reporting obligations under U.S. federal securities laws, corporate governance issues and stock exchange listing obligations. He represents issuers and underwriters in public and private corporate finance transactions, both in the United States and internationally. His experience encompasses initial public offerings, follow-on equity offerings, investment grade, high-yield and convertible debt offerings (including green and SLB bonds) and offerings of preferred, hybrid and derivative securities. In addition, he regularly advises companies and investment banks on corporate and securities law issues, including M&A financing, spinoff transactions and liability management programs.

Hillary Holmes is a partner in the Houston office of Gibson, Dunn & Crutcher, Co-Chair of the firm’s Capital Markets practice group, and a member of the firm’s Securities Regulation and Corporate Governance, Energy and Infrastructure, Oil and Gas, M&A and Private Equity practice groups. Ms. Holmes’ practice focuses on capital markets, securities regulation, and corporate governance, primarily in the energy industry. Ms. Holmes represents public companies and private companies of all sizes, MLPs, investment banks, management teams, and private equity in all forms of capital raising transactions, including IPOs, registered offerings of debt or equity, private placements, 144A offerings of debt or equity, joint ventures, structured investments, de-SPAC transactions, direct listings, sustainable financings, and spin-offs. Ms. Holmes provides regular counseling regarding securities laws, SEC reporting, ESG issues and governance matters. Ms. Holmes also frequently advises boards of directors, special committees and financial advisors in complex M&A transactions, conflicts of interest, and special situations.

Perlette Jura is a partner in Gibson Dunn’s Los Angeles office. Her practice focuses on complex trial and appellate litigation. She co-chairs the firm’s Transnational Litigation Group and its Environmental Social Governance practice. She has played a key role in a number of the firm’s most high-profile transnational, environmental and technology-driven matters. Ms. Jura has extensive experience working with the food and beverage, agricultural, aerospace, automotive, emerging technology and energy industries. In 2021, Ms. Jura was named among the Lawdragon Global Litigation 500, which recognizes those who specialize in international arbitration, public international law and advise leading corporations. She was recognized by Benchmark Litigation as one of the “Top 250 Women in Litigation” in 2020 and 2019. The Los Angeles Business Journal named Ms. Jura to its list of “Most Influential Women Lawyers” in Los Angeles, featuring 50 of the most accomplished female attorneys working in the region. In 2020, BTI Consulting Group honored Ms. Jura a Client Service All-Star, an attorney “who stand[s] above all the others in delivering the absolute best in client service.”

Michael A. Mencher is a corporate associate in the San Francisco office of Gibson, Dunn & Crutcher. He is a member of the Firm’s Capital Markets, Securities Regulation & Corporate Governance and ESG practice groups. His practice focuses on advising technology, life sciences and other public and pre-public companies on governance, ESG and sustainability, investor relations and SEC reporting and compliance matters and representing issuers in a wide variety of capital markets transactions, including initial public offerings and follow-on equity financings, sustainable finance transactions, private placements and debt financings.

Yair Y. Galil is of counsel in the New York office of Gibson Dunn, where he is a member of Gibson Dunn’s Global Finance, Business Restructuring and ESG Practice Groups. His experience includes representation of sponsors, issuers, financial institutions and investment funds in complex financing transactions. The business contexts for these transactions have ranged from corporate finance (including sustainability-linked credit facilities), to leveraged acquisitions and dividend recaps, to debt buybacks and other out-of-court capital restructuring transactions, to debtor-in-possession and bankruptcy exit financings. He also frequently performs credit analyses on a borrower’s debt instruments, and advises on vulnerabilities and potential restructuring approaches.

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This April 2021 edition of Gibson Dunn’s Aerospace and Related Technologies Update discusses newsworthy developments, trends, and key decisions from 2020 and early 2021 that are of interest to companies in the aerospace, space, defense, satellite, and drone sectors as well as the financial, technological, and other institutions that support them.

This update addresses the following subjects: (1) commercial unmanned aircraft systems, or drones; (2) recent government contracts decisions involving companies in the aerospace and defense industry; and (3) the commercial space sector.

___________________

I. Unmanned Aircraft Systems

A. New Rules Remote ID
B. Flight Over People, Over Vehicles, or at Night
C. Continued Lack of Clarity on Airspace
D. Newsworthy FAA Approvals
E. COVID-19 and Use of Drones

II. Government Contracts

III. Space

A. First Private Human Space Launch
B. Noteworthy Space Achievements in Countries Other than the United States
C. Other Noteworthy Space Developments
D. NASA’s Perseverance Rover, Past Updates, and Future Plans
E. Record-Setting Private investment
F. Satellite Internet Constellations
G. Expected Impact of Biden Administration

___________________

I. Unmanned Aircraft Systems

A. New Rules Remote ID

On December 28, 2020, the FAA released final rules regarding the Remote Identification of Unmanned Aircraft (“Remote ID”) and operations at night.[1] These rules, published in the Federal Register on January 15, 2021,[2] require that certain unmanned aircraft (“drones”) broadcast their identification and location during operation. The final rules reflect the FAA’s attempt to balance the competing interests in the federal airspace between commercial operators, hobbyists, law enforcement, and the general public.

The FAA received significant feedback on the Remote ID rules following its initial December 31, 2019 Notice of Proposed Rulemaking (“NPRM”), accumulating over 53,000 comments from manufacturers, organizations, state and local governments, and a significant number of individual recreational pilots.[3] In a departure from the original proposal, under the final rule, drones must broadcast the required Remote ID information “using radio frequency spectrum compatible with personal wireless devices” rather than over the internet to a third-party service provider.[4] The FAA received substantial feedback criticizing the original proposal as expensive and requiring additional hardware and a data plan from a wireless carrier, depending on internet connectivity.[5] But with drones now required to broadcast Remote ID information over ranges that can be received by cell phones, members of law enforcement and the general public will be able to receive the broadcasts and determine flight information about drones flying in their vicinity without special receiving technology.[6]

Compliance with Remote ID Rules

The rules create three ways in which operators and manufacturers can comply with the Remote ID rules: (1) a drone containing “Standard Remote ID,” (2) a drone retrofitted with a “broadcast module,” and (3) a drone without Remote ID operating recreationally in specified areas.[7] The rules include an exception for drones weighing less than 0.55 pounds (250 grams), which are not subject to the Remote ID rules if flown recreationally.[8]

Standard Remote ID

The primary form of compliance is “Standard Remote ID.”[9] Standard Remote ID is built into a drone at the time of manufacturing and tested for compliance via FAA-approved methods. It requires the most robust broadcast, including the location of both the drone and its operator, along with certain flight parameters, a unique ID assigned to the drone and registered by the operator, and an emergency status indication. Additionally, Standard Remote ID drones must be configured to prevent takeoff if the Remote ID equipment is not functional.

Remote ID Broadcast Module

The second form of compliance involves the installation on a drone of a Remote ID “broadcast module.”[10] This allows drones not manufactured with Standard Remote ID, including those currently in use, to comply with the Remote ID rules. The broadcast module’s transmission is similar to Standard Remote ID, except that it broadcasts the takeoff location rather than the location of the operator. Furthermore, drones outfitted with a broadcast module are not required to send an emergency status indication, and need not prevent the drone from taking off if the module is not functional. Unlike Standard Remote ID drones, those fitted with a Remote ID broadcast module are expressly limited to operation within visual line of sight.

Manufacturers should not rely on the Remote ID broadcast module moving forward. Starting eighteen months after the final rule becomes effective, manufacturers must meet the Remote ID standard in their production of drones. Restrictions on operation of noncompliant drones will take effect thirty months after the final rule becomes effective. As of now, the FAA has delayed implementation of the rule until April 21, 2021 as part of the Biden administration’s regulatory freeze.[11]

FAA-Recognized Identification Areas

Lastly, the new rules create FAA-Recognized Identification Areas (“FRIAs”) in which drones can be operated recreationally without complying with the Remote ID rules.[12] FRIAs are fixed locations where drones can be flown safely, thus preserving minimally regulated operations at hobbyist airfields, such as those maintained by the Academy of Model Aeronautics. In a departure from the proposed rules in the NPRM, which limited applicants to community-based organizations, the new rules expanded the list of potential FRIA applicants to include educational institutions.

Addressing Concerns Regarding Improper Use

The commercial drone industry has faced questions and concerns that drones will be operated in an unprofessional manner or used by malicious individuals to obtain data for nefarious purposes.[13] Law enforcement and government agencies have also shared concerns related to illegal operations, such as interference with manned aircraft.[14] The Remote ID rules will help address those concerns by allowing these organizations to identify the drone owner or determine if the drone is not equipped with Remote ID and not legally operating. Addressing these concerns will minimize some of the resistance the industry has faced. Further, Remote ID helps lay a foundation for an ecosystem in which tens of thousands of drones operate autonomously beyond visual line of sight on a daily basis. Although the current rules may be modified and more technology-developed, transmitting basic identification and location information will be a pillar of future large-scale autonomous operations. These rules are an important early step on the path to an integrated regime for regulating a rapidly growing body of unmanned aeronautical operations.

B. Flight Over People, Over Vehicles, or at Night

On December 28, 2020, the FAA released final rules impacting drone operations over people, over moving vehicles, or at night.[15] Prior to the new rules, Part 107 of the FAA regulations required commercial drone operators to receive a waiver in order to fly over people, over moving vehicles, or at night. In early 2019, the FAA and the Department of Transportation shared an NPRM, proposing alterations to Part 107 to make the operation of small unmanned aircraft over people or at night legal, under certain circumstances, without a waiver. On January 15, 2021, the final rule was published in the Federal Register.[16] The rule is scheduled to take effect on April 21, 2021.[17]

Drone Operations Over People

The new law permits commercial drone operations over people under certain conditions based on four categories of drones operating under Part 107. Category One, Two, and Four drones must be compliant with Remote ID rules discussed above to have sustained flight over open-air assemblies, but Category Three drones may never operate over open-air assemblies.

Category One is the most lenient category, consisting of drones that are both under 0.55 pounds (250 grams) and lack any exposed rotating parts that would cause lacerations.[18] Due to the weight restrictions, the drones in this Category will most likely initially be limited to photography and videography drones, but these restrictions may result in innovation of new lightweight sensors for expanded operations within Category One.

Categories Two and Three cover drones greater than 0.55 pounds and less than 55 pounds.[19] These categories allow drones to be flown over people only if the manufacturer has proven that a resulting injury to a person would be under a specified severity threshold. Category Two aircraft will need to demonstrate a certain injury threshold, and Category Three aircraft will have a higher injury threshold with additional operating limitations. Category Three drones can only operate over people (1) in a restricted access site in which all individuals on the ground have notice, or (2) without maintaining any sustained flight over people unless they are participating in the operations or protected by a structure.[20]

The new rules also created a fourth category that was not included under the proposed rules, but clarifies that specific drones for which the FAA has issued an airworthiness certificate under Part 21 can conduct operations over people unless prohibited under its operating limitations.[21]

Drone Operations Over Moving Vehicles

Although the proposed rule did not allow operations over moving vehicles, the final rule does allow such operations under two circumstances: (1) if in a restricted access site and the people in the vehicle are on notice, or (2) when the drone does not maintain sustained flight over moving vehicles.[22] This addition is a welcome change for all drone operators who no longer have to cancel, delay, or change an operation due to an unexpected vehicle or nearby traffic.

Drone Operations at Night

The rule also allows operations at night under two conditions: (1) the remote pilot in command must complete an updated initial knowledge test or online recurrent training, and (2) the drone must have proper anti-collision lighting that is visible for at least three statute miles.[23] Operators will be pleased with this change because it removes the need for nighttime waivers and delays associated with obtaining such waivers.

Looking Ahead

The Part 107 changes are steps in the right direction for increased commercial use of drones. Operating over people, moving vehicles, and at night expands the applications and timing of operations available to commercial operators. The additions to the proposed rules, such as permitting operations over moving vehicles, are an indication that the FAA is listening to the drone community and working to advance this industry.

C. Continued Lack of Clarity on Airspace

While new rules for Remote ID and operations over people, over moving vehicles, and at night are helpful to move the industry forward, they do not address the most challenging legal issue that remains for the commercial drone industry: control of low-altitude airspace. It remains unclear as to how much, if any, airspace is owned by private landowners and whether states and municipalities have any jurisdiction over low-altitude airspace. Furthermore, a legislative solution on this issue is increasingly improbable, and it will instead likely be decided by the courts years in the future.

In a nutshell, the confusion regarding low-altitude operations stems from the FAA’s claim that it controls the airspace “from the ground up” and that the claim that it does not control all the airspace below 400 feet is a “myth.”[24] However, many local governments and property owners do not agree with the FAA’s interpretation. While the FAA has jurisdiction over “navigable airspace,” many assert that the boundary of where that airspace ends and begins is far from clear.[25]

To date, this boundary has not been directly addressed by a court in the context of drones. The closest that federal courts have come to addressing this issue was in July 2016 when U.S. District Judge Jeffrey Meyer, of the District of Connecticut, questioned the FAA’s position: “[T]he FAA believes it has regulatory sovereignty over every cubic inch of outdoor air in the United States . . . . [T]hat ambition may be difficult to reconcile with the terms of the FAA’s statute that refer to ‘navigable airspace.’”[26] The dicta raised the question of where the FAA’s authority begins, but noted that the “case does not yet require an answer to that question.”[27] In time a case will require such an answer.

The legal uncertainty surrounding low-altitude operations remains one of the most significant barriers to large-scale commercial operations, and it is likely to be one of the most important issues for the industry for years to come.

D. Newsworthy FAA Approvals

This past year saw several groundbreaking approvals of new uses for unmanned aircraft systems, specifically in operations beyond the visual line of sight and in the agricultural context. The industry also saw progress in setting airworthiness standards.

Beyond the Visual Line-of-Sight Approvals

Perhaps the most well-known approval occurred in August 2020, when, according to public filings, the FAA approved Amazon’s use of a fleet of Prime Air delivery drones, allowing the company to expand its unmanned package delivery operations.[28] The FAA issued this authorization under Part 135 of its Unmanned Aircraft Systems regulations, which govern the use of drones beyond the visual line of sight (“BVLOS”) of the operator.[29] Although the Prime Air fleet is not yet fully scaled, this authorization enables the company to soon be able to deliver packages weighing five pounds or less in areas with relatively low population density.[30]

Further expanding the boundaries of BVLOS drone use, the FAA gave its first-ever approval of a company’s use of automated drones without a human operator on site earlier this year.[31] In January 2021, the FAA authorized American Robotics, a Boston-based drone systems developer that specializes in operating in rugged environments, to begin such automated operations.[32] Obtaining this approval required a four-year testing program in which the company ran up to ten automated drone flights per day.[33] While only beginning to be fully understood, the automated use of drones without the need for on-site human personnel could have enormous ramifications for the agricultural, energy, and infrastructure industries.[34]

Agricultural Use Approvals

The agricultural industry may experience additional aerospace innovation after the FAA approved the Iowa-based startup Rantizo’s use of drone swarms to spray crops.[35] The company received approval in July 2020 to operate three-drone swarms, which move in concert with one another with the help of one drone operator and one visual observer.[36] The approval will allow the company to cover between 40 and 60 acres of farmland per hour.[37]

Rantizo was not the only company to receive approval to operate drone swarms. In October 2020, the company DroneSeed obtained FAA approval to use five-drone swarms of heavy-lift drones beyond the visual line of sight for reforestation efforts in Arizona, California, Colorado, Montana, New Mexico, and Nevada.[38] Each of the company’s drones can carry up to a 57-pound payload, and reports suggest that the company may focus its reforestation efforts on areas ravaged by wildfires.[39]

Creation of Airworthiness Standards

Lastly, in September 2020, the FAA opened for public comment its first-ever set of type-certification airworthiness standards relating to drones, with the goal of streamlining the certification of certain classes of drones.[40] Whereas the FAA has airworthiness standards in place for most types of manned aircraft, allowing companies seeking approval of such vehicles to avoid a cumbersome, case-by-case process, no such process previously existed for drones. The creation of a standard airworthiness certificate for drones as a class of aircraft could significantly shorten the drone approval process, potentially accelerating innovation in the aerospace industry.

E. COVID-19 and Use of Drones

As discussed in last year’s update, many expected the global COVID-19 pandemic to usher in a new era of drone applications. In the early months of the pandemic, governments began using drones in novel ways: spraying disinfectant across large areas, developing disease detection mechanisms, and even enforcing social distancing requirements. Though these initial reports of drone usage in the age of COVID-19 dealt mostly with disease control efforts, corporations soon shifted their focus to the socially distant environment, turning to drones to facilitate deliveries to consumers and medical providers alike and provide services in a safer way.

Consumer Deliveries

For years, corporations have been hoping to facilitate deliveries via drone, and the pandemic amplified consumer interest. With more and more people looking to avoid crowds and stay at home, demand for drone delivery of consumer goods increased, and many companies deployed their technology to facilitate deliveries via drone.

Wing (Alphabet’s drone delivery company) launched a pilot program in October 2019, partnering with several local retailers to deliver certain products to people in Christiansburg, Virginia.[41] Since the pandemic, it has expanded its program by adding new products and new retailers, and deliveries have more than doubled.[42]

In North Dakota, Flytrex, an airborne delivery service company, launched a program allowing customers to order from a selection of 200 Walmart items.[43] The two companies recently introduced a partnership in North Dakota for grocery deliveries.[44] The company also delivers snacks to golfers at King’s Walk course in North Dakota.[45]

In addition to consumer goods, food delivery via drone has also increased since the pandemic. In fact, Flytrex has begun testing drone delivery of food and drink items in North Carolina.[46] And in Alabama, the company Deuce Drone has partnered with some restaurants for drone doorstep delivery.[47]

As discussed above, in August 2020, Amazon received FAA approval under Part 135 of FAA regulations to “safely and efficiently deliver packages to customers.”[48] This allows Amazon to transport property on small drones “beyond the visual line of sight.”[49] Amazon, which began testing drones in 2013, is continuing to test the technology and has not yet deployed drones at scale.[50]

Medical Supplies Deliveries

Drones also delivered medical supplies in 2020. In May, Zipline, a company that has been using drones to deliver blood in Rwanda since 2016, began delivering medical supplies and personal protective equipment via drones to a medical center in North Carolina.[51]

In November 2020, Wal-Mart received approval to deliver COVID-19 test kits to El Paso, Texas residents.[52] A few months later, Nevada-based Flirtey announced: “that it has successfully conducted multiple deliveries of at-home COVID-19 test kits in Northern Nevada during the initial phase of its test program.”[53] Drone delivery of COVID-19 test kits is more efficient and more convenient, and it reduces exposure risks.[54]

Remote Service Providers

Beyond deliveries, the pandemic also drove up demand for remote services as companies adapted to social distancing guidelines that made providing in-person services more difficult. Since the pandemic started, flights by construction-related companies are up 70%.[55] DroneDeploy, a startup that “has a program that analyzes drone footage of farmers’ fields and helps make recommendations about when to apply pesticides” has reported that these agriculture flights have tripled during the first several months of the pandemic.[56] The company also reported significant increases in flights using its energy app, which helps solar panel installers calculate where best to place the panels.[57]

Lasting Impact?

Though there has certainly been an expansion of drone services in the U.S., this expansion is not widespread. Many of the examples discussed above are limited to small geographic areas and it is still unclear when mass adoption will occur. While the pandemic appears to have pushed forward the adoption of drone delivery and service programs, it is unclear if that mentality will change after societies are no longer quarantined at home. Will there be as much of a demand for drone deliveries and services once there is no longer a pandemic-driven crisis?

Despite these uncertainties, many are optimistic about the future of drone deliveries. Technologies are improving, and most of the elements needed for the widespread adoption of drones are already available in the market.[58]

II. Government Contracts

In this update, we summarize select recent government contracts decisions that involve companies in the aerospace and defense industry, as well as decisions that may be of interest to them, from the tribunals that hear government contracts disputes. These cases address a wide range of issues with which government contractors in the aerospace and defense industry should be familiar.

DFARS 252.227-7103(f) Does Not Prohibit Markings On Noncommercial Technical Data That Restrict Third-Party Rights

In The Boeing Co. v. Sec’y of the Air Force, 983 F.3d 1321 (Fed. Cir. 2020), the Federal Circuit considered whether Defense Federal Acquisition Regulation Supplement 252.227-7103(f) (“DFARS 252.227-7103(f)”) applies to legends that restrict only the rights of third parties but do not restrict the rights of the Government. Boeing applied a legend to its technical data that stated, “NON-U.S. GOVERNMENT ENTITIES MAY USE AND DISCLOSE ONLY AS PERMITTED IN WRITING BY BOEING OR THE U.S. GOVERNMENT.” The Government rejected Boeing’s data deliverables because the legend allegedly did not conform to DFARS 252.227‑7103(f), which stated that the contractor could “only assert restrictions on the Government’s rights,” and specified the legends authorized under the contract. The Armed Services Board of Contract Appeals’ (“ASBCA”) decisions below found in favor of the Government. On appeal, Boeing argued that its legend conformed to the requirements of DFARS 252.227-7103(f) because the clause is applicable only to legends that assert restrictions on the Government’s rights, and is silent on legends that assert restrictions on the rights of third parties. The Federal Circuit agreed with Boeing that DFARS 252.227-7103(f) applies only to legends that assert restrictions to the Government’s rights in the data, and is silent on legends that restrict the rights of third parties. The Federal Circuit remanded the decision to the ASBCA to decide whether, as a matter of fact, Boeing’s legend asserted rights that restricted the Government’s rights in the data on which the legend was included.

ASBCA Declines To Decide Whether Fly America Act Applies To Indirect Costs

In Lockheed Martin Corp., ASBCA No. 62377 (Jan. 7, 2021), the ASBCA did not reach the question of whether the Fly America Act, 49 U.S.C.A. § 40118, as implemented by Federal Acquisition Regulation 52.247-63, Preference for U.S.-Flag Air Carriers, applies to a contractor’s indirect costs because there was no “live dispute” between the parties. FAR 52.247-63, “requires that all . . .Government contractors and subcontractors use U.S.-flag air carriers for U.S. Government-financed international air transportation of personnel (and their personal effects) or property, to the extent that service by those carriers is available.” It further requires that “[i]f available, the Contractor, in performing work under this contract, shall use U.S.-flag carriers for international air transportation of personnel (and their personal effects) or property.”

In 1997, Lockheed Martin Corporation and the Government entered into a memorandum of understanding (“MOU”) that the Fly America Act applied only to direct costs. However, in 2019, the corporate administrative contracting officer (“CACO”) withdrew the MOU on the purported basis that the MOU had misinterpreted FAR 52.247-63, and issued a final decision asserting the interpretation that FAR 52.247-63 applies to indirect costs. The ASBCA did not address the merits of the issue, finding that because Lockheed had not changed its practices as a result of the Government’s withdrawal of the MOU or the CACO’s final decision, there was no evidence that there was a live dispute to decide.

ASBCA Clarifies Types Of Activities That Are Not Unallowable Costs Under The FAR

In Raytheon Co. & Raytheon Missile Sys., ASBCA Nos. 59435 et al., (Feb. 1, 2021), the ASBCA issued a lengthy decision on the allowability of various types of costs incurred by Raytheon Company and its business segment Raytheon Missile Systems (“Raytheon”). The ASBCA sustained all but $18,109 of Raytheon’s appeals of the Government’s $11.8 million claims. The types of costs addressed in the decision include costs for Raytheon’s Government relations group, costs for Raytheon’s corporate development group, and airfare costs.

Government Relations Costs. In 2007 and 2008, Raytheon included Government relations group costs as indirect costs in its incurred cost submissions, but withdrew a portion of those costs as unallowable lobbying costs in accordance with FAR 31.205-22, Lobbying and political activity costs, which requires that contractors “maintain adequate records to demonstrate that the certification of costs as being allowable or unallowable…pursuant to this subsection complies with the requirements of this subsection.” The Government disagreed with Raytheon’s practice and disallowed 100 percent of the costs incurred by Raytheon’s Government relations group as expressly unallowable costs.

The ASBCA held that the Government had the burden to prove that the costs were expressly unallowable and that there was no basis to shift the burden to the contractor. The ASBCA further held that the Government did not meet its burden of proving that any of the Government relations costs included in Raytheon’s incurred costs submissions were unallowable, and that Raytheon’s method of removing unallowable lobbying costs was proper based on its disclosed accounting practice.

Corporate Development Costs. Raytheon included a portion of corporate development group costs as indirect costs in its incurred cost submission in 2007 and 2008, but withdrew a portion of the costs as unallowable organizational costs under FAR 32.205-27, Organization Costs. Raytheon implemented a “bright line” rule for its employees to determine the difference between costs for allowable activities under FAR 31.205-12, Economic Planning Costs, and FAR 31.205-38, Selling costs, and costs for unallowable activities under FAR 31.205-27. The Board found Raytheon’s corporate development employees kept track of their time in accordance with the bright line rule, that the allowable costs for the corporate development group were supported by documentation and credible witness testimony, and that the Defense Contract Management Agency (“DCMA”) did not meet its burden of proving that the corporate development costs were unallowable organization costs under FAR 31.205-27.

Airfare Costs. With respect to airfare costs, the ASBCA addressed two distinct issues: (1) whether the pre-Jan. 11, 2010 version of FAR 31.205-46(b) required Raytheon to take into account its corporate discounts in determining its allowable airfare; and (2) whether Raytheon’s policy of allowing business class travel for trans-oceanic flights in excess of 10 hours was reasonable and consistent with FAR 31.205-46(b). Prior to Jan. 11, 2010, FAR 31.205-46(b) stated:

Airfare costs in excess of the lowest customary standard, coach, or equivalent airfare offered during normal business hours are unallowable except when such accommodations require circuitous routing, require travel during unreasonable hours, excessively prolong travel, result in increased cost that would offset transportation savings, are not reasonably adequate for the physical or medical needs of the traveler, or are not reasonably available to meet mission requirements. However, in order for airfare costs in excess of the above standard airfare to be allowable, the applicable condition(s) set forth in this paragraph must be documented and justified.

(Emphasis added.) Effective Jan. 11, 2010, FAR 31.205-46(b) was amended to read: “Airfare costs in excess of the lowest priced airfare available to the contractor during normal business hours are unallowable except …” (emphasis added).

The ASBCA concluded that prior to Jan. 11, 2010, contractors were not required to factor in any negotiated corporate discounts when determining the allowable amounts of airfare costs. The ASBCA also held that Raytheon’s travel policy “documented and justified premium airfare,” as required by FAR 31.205-46(b), and that there is no requirement that premium airfare be “documented and justified” on an individual, flight-by-flight basis. Moreover, the ASBCA held that the CO acted within the scope of his authority when he determined that Raytheon’s travel policy complied with FAR 31.205-46(b), and that his determination was binding on DCMA.

ASBCA Rules That Government Shares Liability for Contractor’s Underfunded Pension Plan

In Appeal of Northrop Grumman Corp., ASBCA No. 61775 (Oct. 7, 2020), the ASBCA found that Northrop Grumman (“NG”)’s valuation of a nonqualified defined benefits pension plan adopted in 2003 and frozen in 2014 was compliant with the Cost Accounting Standards despite the Government’s objections to the company’s valuation methodology. During the plan’s existence, NG allocated its costs to numerous government contracts, all of which included FAR 52.215-15, Pension Adjustments and Asset Reversions; FAR 52.230-2, Cost Accounting Standards; and FAR 52.233-1, Disputes.

When the plan was frozen, NG calculated that the plan’s liabilities exceeded its market value and requested that the Government pay its pro rata share to NG to “true-up” the plan under CAS 413. The Government argued, inter alia, that NG’s reduction to its calculation of investment income to account for taxes on such income was non-compliant with CAS 412. Although the Board disagreed with NG’s approach of reducing its investment rate of return by the marginal tax rate, the Board found that roughly the same outcome would have been achieved had NG accounted for taxes as an administrative expense. Because FAR 30.602(c)(1) provides that the Government should make no adjustment to the contract when there is no material cost difference due to the alleged CAS violation, the Board sustained NG’s appeal and remanded to the parties to calculate the amount due and owing from the Government to NG.

Contractor’s REAs Were Not Contract Disputes Act (“CDA”) Claims Subject to the CDA Statute of Limitations

In Appeal of BAE Sys. Ordnance Sys., Inc., ASBCA No. 62416 (Feb. 10, 2021), the Board considered whether BAE’s requests for equitable adjustment (“REAs”) constituted claims in light of the Federal Circuit’s recent decision in Hejran Hejrat Co. Ltd v. United States Army Corps of Engineers, 930 F.3d 1354 (Fed. Cir. 2019). In Hejran Hejrat, the Federal Circuit ruled that, under certain circumstances, an REA can actually constitute an implicit request for a final decision.

BAE submitted three REAs seeking reimbursement for state-issued fines it received as a result of environmental conditions at the plant. The contracting officer (“CO”) replied that he would “entertain reimbursement” of a portion of the state fines, but later issued a “final determination” rejecting the REAs entirely. Subsequently, BAE submitted a CDA claim to which the Government failed to respond. BAE appealed the deemed denial of its claim to the Board. The Army then moved to dismiss the appeal asserting that BAE’s challenge to the CO’s decision was untimely because the REAs were, in fact, CDA claims, and the CO’s final determination upon them was thus a CO’s Final Decision. In denying the government’s motion to dismiss the appeal for lack of jurisdiction as outside of the CDA’s statute of limitations, the Board found that “BAE did all that it could to keep its REAs from falling within the realm of being also considered CDA claims by carefully avoiding making a request — explicit or implicit — for a [contracting officer]’s final decision.” Therefore, the Board found that BAE’s claims were timely filed and denied the government’s motion to dismiss.

III. Space

A. First Private Human Space Launch

On November 15, 2020, the launch of SpaceX’s Resilience marked the first “NASA-certified commercial human spacecraft system.”[59] The mission is the first of six crewed missions NASA and SpaceX plan to fly as part of the Commercial Crew Program, a program designed to provide “safe, reliable, and cost-effective transportation to and from the International Space System from the United States.”[60] The crew is comprised of four members, including three NASA astronauts and one member of the Japan Aerospace Exploration Agency.[61]

Resilience autonomously docked at the International Space Station on November 16, 2020 for a sixth-month stay, making it the longest space mission launched from the United States. During the mission, the crew is conducting various science and research investigations, including a “study using chips with tissue that mimics the structure and function of human organs to understand the role of microgravity on human health and diseases.”[62] The crew will also conduct various space walks, encounter several uncrewed spacecraft, and welcome crews from the Russian Soyuz vehicle and the next SpaceX Crew Dragon.[63] At the end of the mission, Resilience will autonomously undock and return to Earth.

B. Noteworthy Space Achievements in Countries Other than the United States

Countries and private companies are racing to the Moon, Mars, and even asteroids. This space race involves countries that are both newcomers to space and those that seek a return to the unknown.

China

Chang’e-5’s Lunar Exploration Mission

Following the Chang’e-4’s successful lunar exploration mission in 2019,[64] China reached the Moon again in 2020. On November 23, 2020, Chang’e-5 lifted off from Wenchang Space Launch Center on Hainan Island, China and went into the Moon’s orbit on November 28, 2020.[65] The descender craft separated from the orbiter on November 29, 2020 and landed on the Mons Rümker region of Oceanus Procellarum on December 1, 2020.[66] Once on the Moon’s surface, the lander system used a scoop and drill to dig up lunar samples.[67] After collection and storage, Chang’e-5 made its return to Earth on December 16, 2020, landing in the Siziwang Banner grassland of the autonomous region of Inner Mongolia in northern China.[68] The successful mission retrieved about 1,731 g (61.1 oz.) of lunar samples.[69] Chang’e-5 was China’s first successful lunar sample return mission,[70] and the first in the world in over four decades since the Soviet Union’s Luna-24 in 1976.[71]

The Chang’e-5 venture demonstrates China’s increasing capability in space, and is part of a broader effort under the Chinese National Space Administration Chang’e Lunar Exploration Program.[72] The Chang’e-6, expected to launch in 2023, will be China’s next lunar sample-return mission.[73]

Tianwen-1 Reaches Mars’s Orbit

China’s first independent interplanetary mission is well underway with the launch of the Tianwen-1 spacecraft on July 23, 2020.[74] After a 202-day, 295-million-mile journey through space, it arrived in orbit around Mars on February 10, 2021.[75] The first phase of Tianwen-1’s mission is to circle Mars’s orbit and map the planet’s morphology and geology, while allowing the orbiter to find a secure landing zone.[76]

About three months after arrival into orbit, in May 2021, the craft’s lander is expected to detach from its orbiter and descend onto Mars’s surface in a region known as Utopia Planitia.[77] Once on the surface, the lander will unveil a rover carrying a panoramic camera.[78] The solar-powered rover will also investigate surface soil characteristics for potential water-ice distribution with a ground-penetrating radar.[79] Tianwen-1 comes on the heels of several successful lunar missions for China’s space program.[80]

China’s Ambitious Plans for a Space Station

China has ambitious plans for a new space station.[81] Tianhe, the station’s core module, is expected to launch sometime in 2021.[82] The module is 59 feet (18 meters) long, weighs about 24 tons (22 metric tons), and will provide living space and life support for astronauts and house the outpost’s power and propulsion elements.[83] Tianhe’s launch will be one of eleven total liftoffs that will be required to build the space station, which China wants to finish by the end of 2022.[84]

China’s iSpace Fails to Reach Orbit During Second Attempt

China’s iSpace, also known as Beijing Interstellar Glory Space Technology Ltd. (a different company than the Japanese lunar startup ispace) was the first Chinese private company to reach orbit when it successfully launched its Hyperbola-1 rocket on July 25, 2019.[85] On February 1, 2021, iSpace’s four-stage Hyperbola-1 rocket failed to reach orbit during its second attempt to go to space.[86]

Despite its failed launch, iSpace is a prominent name in the Chinese private space industry, having raised $173 million in Series B funding for the Hyperbola rocket line. The company has indicated plans for a potential IPO and is in the midst of creating its Hyberbola-2 rocket.[87] Other private Chinese companies, including Galactic Energy, One Space, and Deep Blue Aerospace, are planning launches later this year.[88]

Japan

Hayabusa2’s Samples From Asteroid Ryugu

After spending over a year collecting and storing samples on a near-Earth asteroid named Ryugu,[89] Japan’s Hayabusa2 spacecraft started its journey back towards Earth in November 2019.[90] It completed its yearlong journey to return the asteroid samples back to Earth on December 5, 2020.[91] The return capsule landed in South Australia, carrying with it samples from the asteroid’s surface and interior.[92] From the samples, scientists hope to learn more about the composition of Ryugu’s minerals, as well as the origin and evolution of the solar system.[93]

Hayabusa2 was originally launched in 2014,[94] and its mission is far from over.[95] The Hayabusa2’s main craft separated from the return capsule just two days before the delivery of Ryugu’s samples was complete and retreated back to work on an extended mission.[96] Hayabusa2’s extended mission will feature visits to two more asteroids, one in 2026 and another in 2031.[97]

Japanese Startup Is Targeting the Moon in 2021

A Japanese startup, ispace (a different company than China’s iSpace), is targeting the Moon.[98] On August 22, 2020, company representatives stated ispace intends to go to the lunar surface on a stationary lander in 2021.[99] The company is also planning a second mission in 2023, in which it will deploy a rover for surface exploration.[100] These two missions will ride as secondary payloads on SpaceX Falcon 9 rockets, and together make up ispace’s Hakuto-Reboot program.[101]

United Arab Emirates

Hope Arrives on Mars

On February 9, 2021, the UAE’s Hope orbiter entered into Mars’s orbit,[102] making the UAE the fifth country to visit the Red Planet (China became the sixth the next day with its Tianwen-1 mission),[103] and the first Arab nation in history to do so.[104] Hope will take up a near-equatorial orbit as it observes the planet’s atmosphere, weather, and climate systems.[105] Hope also aims to study the leakage of hydrogen and oxygen into space, which scientists suspect is a contributing factor to Mars missing the once-abundant water that previously occupied its surface.[106]

Russia

Expected Launch of Luna-25 in October 2021

After a nearly half-century hiatus for its space program,[107] Russia is gearing up for a launch to the Moon.[108] Russia’s Luna-25 spacecraft will be the first Russian or Soviet Moon mission since 1976,[109] and will mark the reactivation of Russia’s Moon exploration program.[110] The Luna-25 lander will include scientific instruments to research the composition and structure around the Moon’s south pole.[111] Luna-25 is expected to launch in October 2021.[112]

Looking Ahead

As more countries join the space race, the global community benefits from all of research, technology, and discoveries resulting from outer space exploration. With upcoming missions to the Moon, Mars, and the development of a space station, the upcoming year is sure to result in tremendous advancement in our understanding of space.

C. Other Noteworthy Space Developments

The last year featured a number of developments in space technology, including from SpaceX, which became the first private company to launch astronauts to space, made progress on its Starship design, and launched a public beta program of its Starlink satellite internet service.

Crewed Flights

On May 30, 2020, SpaceX became the first private company to launch astronauts into orbit.[113] The mission marked the first launch of NASA astronauts from the U.S. since the space shuttles were retired in 2011.[114] The Falcon 9 Rocket carried a Crew Dragon capsule, an upgraded version of SpaceX’s Dragon capsule, which has been used to carry cargo to the space station.[115] While on board, the astronauts, tested all of the systems and verified that they performed as designed.[116] The astronauts arrived at the International Space Station on May 31, 2020,[117] and returned safely to Earth on August 2, 2020.[118]

Just five and a half months later, SpaceX sent astronauts to space again. As discussed above, on November 15, 2020, NASA’s SpaceX Crew-1 mission lifted off—the first of six crewed missions NASA and SpaceX plan to fly as part of the Commercial Crew Program, a program designed to provide safe, reliable, and cost-effective transportation between the ISS and the U.S.[119] The mission marked many firsts, including “the first flight of the NASA-certified commercial system designed for crew transportation.”[120] In contrast to the May launch, the Crew-1 mission transported four astronauts (three NASA astronauts and one from the Japan Aerospace Exploration Agency) to the International Space Station for a six-month science mission.[121] The crew arrived safely on November 16, and will eventually reboard Crew Dragon for transport back to Earth.[122]

Starship SN Flights

Following the successful launch of its first astronaut mission in May, SpaceX shifted gears to focus on the Starship, the rocket designed to launch cargo and up to 100 passengers at a time on missions to the Moon and Mars.[123] CEO Elon Musk acknowledged that the rocket has many milestones to reach before people can fly in it.[124]

After multiple launches of several starship prototypes failed, on August 4, 2020, SpaceX flew the Starship SN5 test vehicle for the first time ever.[125] Though the SN5 was only in the air for about 40 seconds, the short hop allowed SpaceX to gather valuable data necessary to analyze and smooth out the launch process.[126]

Just several weeks later, SpaceX launched SN6, which rose to nearly 500 feet above the ground before touching down near the launchpad.[127] Similar to the SN5 launch, the launch of the SN6 prototype was used to help SpaceX understand the technologies needed for a fully reusable launch system for deep space missions.[128]

On December 9, 2020, SpaceX launched Starship SN8 to 40,000 feet above its facility in Boca Chica, Texas.[129] After completing several objectives, including testing its aerodynamics and flipping to prepare for landing, the rocket exploded on impact as it attempted to land.[130] SpaceX declared the launch a success; despite the fiery landing, the nearly seven-minute flight provided helpful information to improve the probability of success in the future.[131]

Other Updates

SpaceX launched many satellites into orbit in 2020. Throughout the year, SpaceX launched satellites for the U.S. Space Force[132] and foreign militaries.[133] SpaceX also began to launch satellites for its Starlink mega-constellation, an infrastructure project designed to provide global broadband coverage to people in rural and remote areas.[134] As of January 29, 2021, SpaceX had deployed 1,023 satellites over the course of 18 launches.[135] In October, SpaceX began a public beta program of the Starlink satellite internet service in the northern U.S., Canada, and the U.K.[136] By February 2021, the Starlink satellite internet service had over 10,000 users.[137]

SpaceX had a monumental fundraising year. In May, SpaceX raised more than $346 million.[138] In August, the company reported its largest single fundraising round to date: $1.9 billion in new funding.[139] SpaceX also sold an additional $165 million in common stock.[140] In December, SpaceX began discussing another funding round with investors. This round will likely value the company at a minimum of $60 billion and possibly as high as $92 billion.[141]

D. NASA’s Perseverance Rover, Past Updates, and Future Plans

Two of NASA’s biggest accomplishments this year were the successful landing of the Perseverance Rover on Mars and the publication of the Artemis Plan, a document that outlines NASA’s intention to return a human to the Moon.

Perseverance Rover

On February 18, 2021, NASA’s Perseverance Rover landed safely in an area known as Jezero Crater on Mars.[142] Perseverance’s mission is to search for signs of ancient life and collect samples of rock and regolith for a return to Earth.[143] The Perseverance Rover will examine Martian dirt and rock with a variety of sophisticated scientific gear, including an instrument called SuperCam, which will zap rocks with a laser and gauge the composition of the resulting vapor.[144] The Rover will also utilize its drill and long robotic arm to collect samples and seal them into special tubes, and these samples will be brought back to Earth, perhaps as early as 2031.[145] Once returned, these samples will be analyzed and studied by scientists for decades to come.[146]

Artemis Plan

The United States is pushing forward on its plans to return to the Moon, with NASA publishing its comprehensive Artemis Plan in September 2020.[147] Under the Artemis Plan, the United States plans to send the next man and first woman to the Moon by 2024, and establish a sustained human presence on the Moon by 2028.[148] However, Congress is only providing $850 million for work on the Human Landing System to support NASA’s Artemis mission, well short of the requested $3.37 billion on the project.[149] This shortfall is the biggest risk to the ambitious goals and timing of the Artemis Plan.[150]

The Artemis I Mission

Artemis I is set to be the first mission under the Artemis Plan, and it is currently scheduled for launch on November 2021.[151] It will be an uncrewed mission from NASA’s Kennedy Space Station in Florida.[152] This mission will allow NASA to test its powerful new Space Launch System and Orion spacecraft.[153]

Commercial Lunar Payload Services

Under the Artemis Plan, NASA established the Commercial Lunar Payload Services initiative (“CLPS”) to partner with the U.S. commercial space industry to introduce new lander technologies and deliver payloads to the surface of the Moon.[154] As of February 2021, NASA had 14 companies on contract through CLPS to bid on delivery science experiments and technology demonstrations to the lunar surface.[155] Most recently, NASA awarded Firefly Aerospace of Cedar, Texas approximately $93.3 million to deliver a suite of ten science investigations and technology demonstrations to the Moon in 2023.[156]

Lunar Orbital Platform Gateway

The Lunar Orbital Platform Gateway is instrumental to NASA’s goal of sustaining a human presence on the Moon.[157] The Gateway will be a station orbiting the Moon that will serve as a holding area for astronaut expeditions and science investigations, as well as a port for deep space transportations.[158] NASA has selected SpaceX to provide launch services for the first two Gateway modules, the Power and Propulsion Element (“PPE”) and Habitation and Logistics Outpost (“HALO”), which are targeted to launch together no earlier than May 2024.[159]

Human Landing System

NASA’s Human Landing System Program (“HLS”) is tasked with developing a lander that will haul two astronauts to the Moon in 2024, and then safely return them to lunar orbit before their trip back to Earth.[160] Three companies have been selected to begin development work for the HLS: Blue Origin (of Kent, Washington), Dynetics, a Leidos company (of Huntsville, Alabama), and SpaceX (of Hawthorne, CA).[161] HLS is also charged with developing a sustainable, long-term presence on and around the Moon.[162]

E. Record-Setting Private investment

Over the past several years, there has been increased interest in investing in pure aerospace companies, and more recently, space and space-satellite-based companies have become the focus of special-purpose acquisition companies (“SPACs”).[163] Numerous milestones are driving the rise of space stocks traded on exchanges. For example, companies such as Virgin Galactic have been developing, and are on the cusp of starting, a commercial space tourism service; AstraSpace is entering the public market through a blank-check merger with Holicity; and Momentus is going public via Stable Road Capital, among others.[164] In addition to the above, exchange traded funds (“ETF”) have been rising in popularity as well.

To further illustrate the above, one only has to look to ETFs such as Procure Space ETF, a space-related fund launched in 2019, which has holdings in various space stocks.[165] In January, Cathie Wood’s Ark Investment Management announced in a filing that it was looking to start the ARK Space Exploration ETF.[166] This ETF would focus on exposure to “companies involved in space-related businesses like reusable rockets, satellites, drones, and other orbital and sub-orbital aircrafts.”[167]

In terms of SPACs, the aerospace industry has shown a significant amount of growth. SPACs are among the trendiest, high-growth investment opportunities in the finance world at the moment.[168]A SPAC raises money through an IPO to acquire an existing operating company. In the past, we have seen successful SPACs such as when Virgin Galactic merged with Social Capital Hedosophia, or when Momentus Space merged with Stable Road Acquisition Corp.[169] Another company considering a merger with a SPAC is Kraus Hamdani Aerospace, whose aircraft can “safely carry satellite payloads within the stratosphere, providing a lower cost alternative to satellites with zero carbon footprint[.]”[170] It appears that SPACs can provide a beneficial pathway for aerospace companies to obtain important access to capital.

There are other companies to watch for as well in the near term. Firefly Aerospace is a “small launch vehicle developer” that is increasingly nearing its first orbital launch attempt, and it is looking to raise $350 million to “scale up production and work on a new, larger vehicle.”[171] This is after Relativity Space, a similar launch vehicle developer, raised $500 million in November of 2020.[172]

In viewing the industry, it seems clear that the rise in space and space-related development is leading to more and more opportunities for small to large companies to expand into the public markets in order to raise the capital necessary to further expand these companies’ operations. Moreover, with the similar rise in ETFs and SPACs, access to equity in space companies, which may have been limited to a select few in years prior, is now more available to the general public than ever before. As such, the space industry market should be one to follow and watch for in the coming years.

F. Satellite Internet Constellations

The space industry, which includes the consumer broadband sector, saw record private investment in 2020.[173] One area of investment was in the continued development of satellite constellations that provide internet access across the globe. These new technologies offer great business potential and provide internet access to underserved remote populations. In fact, federal agencies are encouraging more private investment in the space economy, including internet satellite constellations.[174]

In December 2020, the FCC awarded $9.2 billion in funding to bidders as part of the Phase I Auction from its Rural Digital Opportunity Fund (“Fund”). The Fund, established in 2019 with $20 billion in funding, is to be used for providing internet access to the millions of Americans without internet access, particularly in rural and remote areas.[175] The funding is estimated to provide high-speed broadband internet service to 5.22 million users[176]— Former FCC Chairman Ajit Pai described it as the “single largest step ever taken to bridge the digital divide.”[177] According to Pai, the awards would bring “welcome news to millions of unconnected rural Americans who for too long have been on the wrong side of the digital divide. They now stand to gain access to high-speed, high-quality broadband service.”[178]

On January 19, 2021, over 150 members of Congress wrote a letter urging the FCC “to thoroughly vet the winning bidders to ensure that they are capable” and to “consider opportunities for public input on the applications.”[179] Among other requirements, winning bidders must deliver financial statements, coverage maps, and certify to the FCC that their network is able to deliver “to at least 95% of the required number of locations in each relevant state.”[180]

Multiple companies developing satellite constellations that provide internet access from low earth orbit are creating many opportunities, but these projects have also led to some concern. The U.S. National Oceanic and Atmospheric Administration projected that the number of active satellites in orbit could increase by 50% or more in 2021.[181] The injection of more satellites into low earth orbit increases the risk of collisions between man-made objects, which could create orbital debris that itself might collide with other space objects, thus resulting in greater accumulations of “space junk.”[182] According to Morgan Stanley, some government agencies now struggle to track this orbital debris, creating potential demand for private companies to track and maintain this potentially catastrophic threat.[183]

The rapidly developing breakthroughs in satellite broadband internet access will bridge the gap in the digital divide, and be the driving force in a projected trillion-dollar industry. Morgan Stanley projects that the global space economy could generate more than $1 trillion in revenue by 2040, with satellite broadband accounting for 50-70% of the projected growth.[184]

G. Expected Impact of Biden Administration

The inauguration of President Biden on January 20, 2020 signaled the beginning of significant changes to policies of the Trump administration in many key areas, but thus far President Trump’s space-related policies have generally proven a uniquely bipartisan area of continuity during this latest transition of power.

Having inherited a global pandemic, among other issues, President Biden’s first priorities have primarily been more terrestrial in focus, and insight into future policy decisions generally have to be gleaned from statements made on the campaign trail. However, the administration’s early remarks regarding Trump-era ventures like the Space Force and NASA’s Project Artemis have given those with their eyes turned skyward reasons for optimism, which has only been bolstered by President Biden’s symbolic decoration of the Oval Office with a moon rock collected during the Apollo 17 mission of 1972.[185]

Space Force

On December 20, 2019, President Trump signed the National Defense Authorization Act for Fiscal Year 2020 (“NDAA”) establishing the United States Space Force as the sixth branch of the United States military, and the first new military service in more than 70 years.[186] Its duties are to “(1) protect the interests of the United States in space; (2) deter aggression in, from, and to space; and (3) conduct space operations.”[187] Since its establishment, about 2,400 service members have officially transferred into the Space Force service, with plans to grow to 6,400 active-duty troops and add a reserve component in 2021.[188]

Despite earlier speculation to the contrary, White House spokeswoman Jen Psaki recently affirmed that the Space Force “absolutely has full support of the Biden administration.”[189] In response, the Chief of Space Operations Gen. John Raymond emphasized that the White House’s unambiguous statement of support for the Space Force makes it “really clear that this is not a political issue, it’s an issue of national security.”[190] That same sentiment is also reflected in Congress among bipartisan lawmakers who view the new branch as integral to ensuring the military puts enough focus on space to counter China and Russia.[191] Although President Biden has not yet publicly detailed his plans for the future of the Space Force, it does appear to be here to stay.

Space Exploration

In early February 2021, the White House also announced support for Project Artemis, NASA’s effort to return astronauts to the lunar surface. President Biden’s endorsement of the Artemis program means it will become the first major deep space human exploration effort with funding to survive a change in presidents since Apollo, after several fitful efforts to send astronauts back to the moon and beyond ultimately went nowhere.[192]

The Trump administration embraced exploration and directed NASA to speed up its moon campaign, directing it to land another man, and the first woman, on the lunar surface by 2024, but the time frame of this goal appears to be stifled by budgetary constraints, safety concerns, and other matters of national priority like COVID-19 relief.[193] For example, NASA requested a total of $25.2 billion for FY2021, a 12 percent increase over FY2020, in order to pay for Artemis. Although Congress had been steadily adding money to NASA’s budget for several prior years, in this case it provided less, $23.3 billion, suggesting there are limits to what it will allocate.[194]

Additionally, speculation remains that the Biden administration may instead prioritize NASA missions focused on increasing earth-observation capabilities, rather than space exploration. Lori Garver, the NASA deputy administrator during the Obama administration, was a key speaker at the SpaceVision 2020 convention on November 7 and 8, 2020. She noted, “[m]anaging the Earth’s ability to sustain human life and biodiversity will likely, in my view, dominate a civil space agenda for a Biden-Harris administration.”[195] However, eleven Democratic senators have already sent a letter to President Biden urging greater funding for Project Artemis, stressing that other NASA programs should not be cannibalized to pay for it.[196] As such, the first explicit insight into President Biden’s support for human spaceflight, and the timeline at which it can proceed, will likely be the FY2022 budget request that the President will send to Congress in the coming months.

Nevertheless, space exploration remains an overwhelmingly popular and bipartisan goal among Americans. Polls taken last year showed, for example, that 80% of Americans believed space travel supports scientific discovery; 78% had a favorable impression of NASA; 73% said NASA contributes to pride and patriotism; and 71% said NASA is not just a desirable agency, but a necessary one.[197] Such uniquely bipartisan support in this area cannot go unnoticed by the administration. Indeed, it appears that even if delayed for now, the question of landing another man or woman on the moon—or beyond—is a matter of when, not if, for the Biden Administration.

________________________

[1] Press Release – U.S. Department of Transportation Issues Two Much-Anticipated Drone Rules to Advance Safety and Innovation in the United States, Fed. Aviation Admin. (Dec. 28, 2020), available at https://www.faa.gov/news/press_releases/news_story.cfm?newsId=25541.

[2] Fed. Aviation Admin., Final Rule on Remote Identification of Unmanned Aircraft (Jan. 15, 2021), available at https://www.federalregister.gov/documents/2021/01/15/2020-28948/remote-identification-of-unmanned-aircraft.

[3] Id. at 4396.

[4] Id. at 4507–08.

[5] Id. at 4406.

[6] See id. at 4428.

[7] Id. at 4391.

[8] Id. at 4447.

[9] Id. at 4507.

[10] Id. at 4507–08.

[11] Fed. Aviation Admin., Operation of Small Unmanned Aircraft Systems Over People; Delay; Withdrawal; Correction (Mar. 10, 2021), available at https://public-inspection.federalregister.gov/2021-04881.pdf.

[12] Fed. Aviation Admin., supra note 2 at 4511–12.

[13] See James Roger, The dark side of our drone future, The Bulletin (Oct. 4, 2019), available at https://thebulletin.org/2019/10/the-dark-side-of-our-drone-future/.

[14] See Office of the Attorney General, Guidance Regarding Department Activities to Protect Certain Facilities or Assets from Unmanned Aircraft and Unmanned Aircraft Systems (Apr. 13, 2020), available at https://www.justice.gov/archives/ag/page/file/1268401/download.

[15] Fed. Aviation Admin., Operations Over People General Overview (Jan. 4, 2021), available at https://www.faa.gov/uas/commercial_operators/operations_over_people/.

[16] Operation of Small Unmanned Aircraft Systems Over People, 86 Fed. Reg. 4,314 – 4,387 (14 CFR 11, 21, 43, 107) (Jan. 15, 2021), available at https://www.federalregister.gov/documents/2021/01/15/2020-28947/operation-of-small-unmanned-aircraft-systems-over-people.

[17] Fed. Aviation Admin., Operation of Small Unmanned Aircraft Systems Over People; Delay; Withdrawal; Correction (Mar. 10, 2021), available at https://public-inspection.federalregister.gov/2021-04881.pdf.

[18] Id. at 4315

[19] Id. at 4315-16

[20] Id.

[21] Id. 4316-17

[22] Fed. Aviation Admin., Executive Summary Final Rule on Operation of Small Unmanned Aircraft Systems Over People (Dec. 28, 2020), available at https://www.faa.gov/news/media/attachments/OOP_Executive_Summary.pdf.

[23] Id.

[24] Fed. Aviation Admin., Busting Myths about the FAA and Unmanned Aircraft (Mar. 7, 2014), available at https://www.faa.gov/news/updates/?newsId=76240.

[25] 49 U.S.C. § 40103(b)(1); 49 U.S.C. § 40102(32); 14 C.F.R. § 91.119(b)(c).

[26] Huerta v. Haughwout, No. 3:16-cv-358, Dkt. No. 30 (D. Conn. July 18, 2016).

[27] Id.

[28] Annie Palmer, Amazon wins FAA approval for Prime Air drone delivery fleet, CNBC (Aug. 31, 2020), available at https://www.cnbc.com/2020/08/31/amazon-prime-now-drone-delivery-fleet-gets-faa-approval.html.

[29] Id.

[30] Id.

[31] Flying robots get FAA approval in first for drone sector, ZDNet (Jan. 20, 2021), available at https://www.zdnet.com/article/flying-robots-get-faa-approval-in-first-for-drone-sector/.

[32] Id.

[33] Id.

[34] Id.

[35] Rantizo receives FAA approval to operate drone swarms, Clay and Milk (July 7, 2020), available at https://clayandmilk.com/2020/07/07/rantizo-receives-faa-approval-to-operate-drone-swarms/.

[36] Id.

[37] Id.

[38] DroneSeed is first in U.S. to receive approval from FAA for post-wildfire reforestation in California and five other states, PR Newswire (Oct. 6, 2020), available at https://www.prnewswire.com/news-releases/droneseed-is-first-in-us-to-receive-approval-from-faa-for-post-wildfire-reforestation-in-california-and-five-other-states-301146779.html.

[39] Id.

[40] Fed. Aviation Admin., Notice of Proposed Rulemaking on Type Certification of Certain Unmanned Aircraft Systems (Sept. 18, 2020), available at https://www.federalregister.gov/documents/2020/09/18/2020-17882/type-certification-of-certain-unmanned-aircraft-systems.

[41] Alan Levin, Alphabet’s Drone Delivery Service in Virginia Sees Surge During Pandemic, Transport Topics (Apr. 8, 2020), available at https://www.ttnews.com/articles/alphabets-drone-delivery-service-virginia-sees-surge-during-pandemic.

[42] Id.

[43] Aaron Pressman, Drone industry flies higher as COVID-19 fuels demand for remote services, Fortune (July 13, 2020), available at https://fortune.com/2020/07/13/coronavirus-drones-dji-wing-flytrex-covid-19-pandemic/.

[44] Id.

[45] Ryan Duffy, A Q&A with Flytrex CEO and Cofounder Yariv Bash, Emerging Tech Brew (Feb. 22, 2021), available at https://www.morningbrew.com/emerging-tech/stories/2021/02/22/qa-flytrex-ceo-cofounder-yariv-bash.

[46] Brian Straight, If drones can deliver Starbucks, what’s taking so long for packages?, Modern Shipper (Feb. 15, 2021), available at https://www.freightwaves.com/news/if-drones-can-deliver-starbucks-whats-taking-so-long-for-packages.

[47] Tyler Fingert, The future of doorstep delivery being tested in Mobile; Drones could soon deliver orders in minutes, Fox 10 News (Aug. 5, 2020), available at https://www.fox10tv.com/news/mobile_county/the-future-of-doorstep-delivery-being-tested-in-mobile-drones-could-soon-deliver-orders-in/article_93138836-d786-11ea-872e-536e9c4176b9.html.

[48] Palmer, supra note 28.

[49] Id.

[50] Id.

[51] John Porter, Zipline’s drones are delivering medical supplies and PPE in North Carolina, The Verge (May 27, 2020), available at https://www.theverge.com/2020/5/27/21270351/zipline-drones-novant-health-medical-center-hospital-supplies-ppe.

[52] Walmart using drones to deliver Covid-19 test kits to El Paso homes, ABC-7 KVIA (Nov. 16, 2020), available at https://kvia.com/news/business-technology/2020/11/16/walmart-to-start-using-drones-to-delivery-covid-19-test-kits-to-homes-in-el-paso/.

[53] Kaleb Roedel, Flirtey successfully conducts drone deliveries of COVID test kits, Nevada Appeal (Feb. 19, 2021), available at https://www.nevadaappeal.com/news/2021/feb/22/flirtey-successfully-conducts-drone-deliveries-cov/.

[54] Id.

[55] Aaron Pressman, Drone industry flies higher as COVID-19 fuels demand for remote services, Fortune (July 13, 2020), available at https://fortune.com/2020/07/13/coronavirus-drones-dji-wing-flytrex-covid-19-pandemic/.

[56] Id.

[57] Id.

[58] Bijan Khosravi, How The Global Pandemic Became An Inflection Point for Drones, Forbes (Dec. 6, 2020), available at https://www.forbes.com/sites/bijankhosravi/2020/12/06/how-the-global-pandemic-became-an-inflection-point-for-drones/?sh=1fa1ddb01870.

[59] NASA’s SpaceX Crew-1 Astronauts Headed to International Space Station, NASA (Nov. 15, 2020), available at https://www.nasa.gov/press-release/nasa-s-spacex-crew-1-astronauts-headed-to-international-space-station.

[60] Id.

[61] Id.

[62] Id.

[63] Id.

[64] See Adam Mann, China’s Chang’e Program: Missions to the Moon, Space.com (Feb. 1, 2019), available at https://www.space.com/43199-chang-e-program.html.

[65] NASA Space Science Data Coordinated Archive, Chang’e 5, NASA, available at https://nssdc.gsfc.nasa.gov/nmc/spacecraft/display.action?id=2020-087A.

[66] Id.

[67] Jonathan Amos, China’s Chang’e-5 mission returns Moon samples, BBC (Dec. 16, 2020), available at https://www.bbc.com/news/science-environment-55323176.

[68] Id.

[69] NASA, supra note 65.

[70] Adam Mann, China’s Chang’e 5 mission: Sampling the lunar surface, Space.com (Dec. 10, 2020), available at https://www.space.com/change-5-mission.html.

[71] Id.

[72] See Mann, supra note 64.

[73] Dr. David R. Williams, Future Chinese Lunar Missions, NASA (Dec. 21, 2020), available at https://nssdc.gsfc.nasa.gov/planetary/lunar/cnsa_moon_future.html.

[74] Andrew Jones, China’s Tianwen-1Mars probe captures epic video of Red Planet during orbital arrival, Space.com (Feb. 12, 2021), available at https://www.space.com/tianwen-1.html.

[75] Id.

[76] Vicky Stein, Tianwen-1: China’s first Mars mission, Space.com (Feb. 8, 2021), available at https://www.space.com/tianwen-1.html.

[77] Id.

[78] Jones, supra note 74.

[79] Id.

[80] See Mann, supra note 64.

[81] See Mike Wall, China plans to launch core module of space station this year, Space.com (Jan. 7, 2021), available at https://www.space.com/china-space-station-core-module-launch-spring-2021.

[82] Id.

[83] Id.

[84] Id.

[85] Elizabeth Howell, China’s ispace fails to reach orbit in 2nd launch attempt, Space.com (Feb. 4, 2021), available at https://www.space.com/chinese-startup-ispace-rocket-launch-failure.

[86] Id.

[87] Id.

[88] Id.

[89] Smriti Mallapaty, Asteroid dust recovered from Japan’s daring Hayabusa2 mission, Nature.com (Dec. 15, 2020), available at https://www.nature.com/articles/d41586-020-03451-6.

[90] Meghan Bartels, Samples of asteroid Ryugu arrive in Japan after successful Hayabusa2 capsule landing, Space.com (Dec. 8, 2020), available at https://www.space.com/hayabusa2-asteroid-ryugu-samples-arrive-in-japan.

[91] Id.

[92] Id.

[93] Mallapaty, supra note 89.

[94] Bartels, supra note 90.

[95] See Doris E. Urrutia, Japan’s asteroid sample-return spacecraft Hayabusa2 gets extended mission, Space.com (Sept. 30, 2020), available at https://www.space.com/japan-asteroid-mission-hayabusa2-extended.

[96] Bartels, supra note 90.

[97] Urrutia, supra note 95.

[98] Mike Wall, Japanese Company ispace Now Targeting 2021 Moon Landing for 1st Mission, Space.com (Aug. 23, 2019), available at https://www.space.com/japan-ispace-first-moon-mission-2021.html.

[99] Id.

[100] Id.

[101] Id.

[102] Jonathan Amos, UAE Hope mission returns first image of Mars, BBC (Feb. 14, 2021), available at https://www.bbc.com/news/science-environment-56060890.

[103] Meghan Bartels, Behold! See the 1st Mars closeup from UAE’s Hope orbiter (photo), Space.com (Feb. 16, 2021), available at https://www.space.com/uae-hope-mars-spacecraft-first-close-photo.

[104] Natasha Turak and Dan Murphy, United Arab Emirates becomes first Arab country to reach Mars, CNBC (Feb. 10, 2021), available at https://www.cnbc.com/2021/02/09/mars-probe-uae-attempts-to-become-first-arab-country-to-reach-mars-with-hope-probe.html.

[105] Jonathan Amos, Hope probe: UAE launches historic first mission to Mars, BBC (July 19, 2020), available at https://www.bbc.com/news/science-environment-53394737.

[106] Id.

[107] Leonard David, Luna-25 Lander Renew Russian Moon Rush, Scientific American (Aug. 27, 2020), available at https://www.scientificamerican.com/article/luna-25-lander-renews-russian-moon-rush/.

[108] Id.

[109] Leonard David, Russia gearing up to launch moon mission in 2021, Space.com (Aug. 7, 2020), available at https://www.space.com/russia-moon-mission-luna-25.html.

[110] Id.

[111] Id.

[112] Id.

[113] Kenneth Chang et al., SpaceX Launch: Highlights from NASA Astronauts’ Trip to Orbit, The New York Times (May 30, 2020), available at https://www.nytimes.com/2020/05/30/science/spacex-launch-nasa.html.

[114] Id.

[115] Id.

[116] Id.

[117] Meghan Bartels, Space X’s 1st Crew Dragon with astronauts docks at space station in historic rendezvous, Space.com (May 31, 2020), available at https://www.space.com/spacex-crew-dragon-demo-2-docking-success.html.

[118] Mike Wall, SpaceX Crew Dragon makes historic 1st splashdown to return NASA astronauts home, Space.com (Aug. 2, 2020), available at https://www.space.com/spacex-crew-dragon-demo-2-splashdown.html.

[119] NASA’s SpaceX Crew-1 Astronauts Headed to International Space Station, NASA (Nov. 15, 2020), available at https://www.nasa.gov/press-release/nasa-s-spacex-crew-1-astronauts-headed-to-international-space-station.

[120] Id.

[121] Id.

[122] Id.

[123] Michael Sheetz, SpaceX launches and lands another Starship prototype, the second flight test in under a month, CNBC (Sep. 3, 2020), available at https://www.cnbc.com/2020/09/03/spacex-launches-and-lands-starship-sn6-prototype-in-flight-test.html.

[124] Id.

[125] Mike Wall, SpaceX’s Starship SN5 prototype soars on 1st test flight! ‘Mars is looking real,’ Elon Musk says, Space.com (Aug. 5, 2020), available at https://www.space.com/spacex-starship-sn5-prototype-1st-test-flight.html.

[126] Id.

[127] Sheetz, supra note 123.

[128] Tariq Malik, SpaceX launches Starship SN6 prototype test flight on heels of Starlink mission, Space.com (Sep. 3, 2020), available at https://www.space.com/spacex-starship-sn6-first-test-flight.html.

[129] Michael Sheetz, SpaceX’s prototype Starship rocket reaches highest altitude yet but lands explosively on return attempt, CNBC (Dec. 9, 2020), available at https://www.cnbc.com/2020/12/09/spacex-starship-rocket-sn8-explodes-after-high-altitude-test-flight-.html.

[130] Id.

[131] Id.

[132] Amy Thompson, SpaceX launches advanced GPS satellite for US Space Force, sticks rocket landing, Space.com (June 30, 2020), available at https://www.space.com/spacex-space-force-gps-3-sv03-launch-success.html.

[133] Amy Thompson, SpaceX launches South Korea’s 1st military satellite, nails rocket landing at sea, Space.com (July 20, 2020), available at https://www.space.com/spacex-launches-south-korean-military-satellite-anasis-2-lands-rocket.html.

[134] Amy Thompson, SpaceX launches 60 Starlink internet satellites, sticks rocket landing, Space.com (Sep. 3, 2020), available at https://www.space.com/spacex-starlink-11-satellites-launch-september-2020.html.

[135] Michael Sheetz, SpaceX looks to build next-generation Starlink internet satellites after launching 1,000 so far, CNBC (Jan. 29, 2021), available at https://www.cnbc.com/2021/01/28/spacex-plans-next-generation-starlink-satellites-with-1000-launched.html.

[136] Id.

[137] Michael Sheetz, SpaceX says its Starlink satellite internet service now has over 10,000 users, CNBC (Feb. 4, 2021), available at https://www.cnbc.com/2021/02/04/spacex-starlink-satellite-internet-service-has-over-10000-users.html?recirc=taboolainternal.

[138] Samantha Mathewson, SpaceX raises $1.9 billion in latest funding round: report, Space.com (Aug. 21, 2020), available at https://www.space.com/spacex-raises-1.9-billion-funding-round.html.

[139] Id.

[140] Id.

[141] Reuters, Wire Service Content, SpaceX Valuation to Hit at Least $60 Billion in New Funding Round – Business Insider, U.S. News (Jan. 28, 2021), available at https://www.usnews.com/news/technology/articles/2021-01-28/spacex-finalizing-new-funding-round-at-minimum-valuation-of-60-bln-business-insider.

[142] Mike Wall, Touchdown! NASA’s Perseverance rover lands on Mars to begin hunt for signs of ancient life, Space.com (Feb. 18, 2021), available at https://www.space.com/perseverance-mars-rover-landing-success.

[143] Id.

[144] Id.

[145] Id.

[146] Id.

[147] See NASA, The Artemis Plan (2020), available at https://www.nasa.gov/sites/default/files/atoms/files/artemis_plan-20200921.pdf.

[148] Thalia Patrinos, Artemis Moon Program Advances – The Story So Far, NASA (Oct. 7, 2019), available at https://www.nasa.gov/artemis-moon-program-advances.

[149] Id.

[150] See Elizabeth Howell, NASA receives $23.3 billion for 2021 fiscal year in Congress’ omnibus spending bill: report, Space.com (Dec. 22, 2020), available at https://www.space.com/nasa-2021-budget-congress-omnibus-spending-bill.

[151] Lia Rovira and Deborah Byrd, NASA’s moon program – Artemis – boosted at White House press briefing, EarthSky (Feb. 6, 2021), available at https://earthsky.org/space/what-is-nasas-artemis-program-moon.

[152] Id.

[153] Id.

[154] Commercial Lunar Payload Services, NASA (Feb. 9, 2021), available at https://www.nasa.gov/content/commercial-lunar-payload-services-overview.

[155] Id.

[156] Sean Potter, NASA Selects Firefly Aerospace for Artemis Commercial Moon Delivery in 2023, NASA (Feb. 4, 2021), available at https://www.nasa.gov/press-release/nasa-selects-firefly-aerospace-for-artemis-commercial-moon-delivery-in-2023.

[157] See Adam Mann, NASA’s Artemis Program, NASA (July 3, 2019), available at https://www.space.com/artemis-program.html.

[158] Kelli Mars, Gateway, NASA (Feb. 11, 2021), available at https://www.nasa.gov/gateway.

[159] Sean Potter, NASA Awards Contract to Launch Initial Elements for Lunar Outpost, NASA (Feb. 10, 2021), available at https://www.nasa.gov/press-release/nasa-awards-contract-to-launch-initial-elements-for-lunar-outpost.

[160] Leonard David, NASA’s 2024 Moon Goal: Q&A with Human Landing System Chief Lisa Watson-Morgan, NASA (Oct. 7, 2019), available at https://www.space.com/nasa-2024-moon-human-landing-system-chief-interview.html.

[161] Sean Potter, NASA Names Companies to Develop Human Landers for Artemis Moon Mission, NASA (Jan. 4, 2021), available at https://www.nasa.gov/press-release/nasa-names-companies-to-develop-human-landers-for-artemis-moon-missions.

[162] See Mike Wall, NASA picks SpaceX, Dynetics and Blue Origin-led team to develop Artemis moon landers, Space.com (Apr. 30, 2020), available at https://www.space.com/nasa-artemis-moon-landers-spacex-blue-origin-dynetics-selection.html.

[163] Gillian Rich, First Space Stock of its Kind Faces SpaceX Threat, Crowded Field, Investors.com (Feb. 2, 2021), available at https://www.investors.com/news/space-stocks-astra-space-to-go-public-but-faces-spacex-threat-crowded-field/.

[164] Gillian Rich, You Can’t Buy SpaceX Yet But These Space Stocks Are Up For Grabs, Investors.com (Mar. 25, 2021), available at https://www.investors.com/news/space-stocks-upstart-space-companies-moon-mars/.

[165] Id.

[166] ARK ETF Trust, Registration Statement Under The Securities Act of 1933 Amendment No. 31, Securities and Exchange Commission (Jan. 13, 2021), available at https://www.sec.gov/Archives/edgar/data/0001579982/000110465921003837/tm212832d1_485apos.htm.

[167] Ark Invest, Space Exploration, Ark-Invest.com (2021), available at https://ark-invest.com/strategy/space-exploration/.

[168] Mike Bellin, Alan Jones, and Eric Watson, How special purpose acquisition companies (SPACs) work, PWC (accessed Apr. 2, 2021), available at https://www.pwc.com/us/en/services/audit-assurance/accounting-advisory/spac-merger.html.

[169] Rich, supra note 164.

[170] Melissa Rowley, How SPACs Are Changing The Investment Landscape For Space Exploration And Beyond, Forbes (Feb. 9, 2021), available at https://www.forbes.com/sites/melissarowley/2021/02/09/how-spacs-are-changing-the-investment-landscape-for-space-exploration-and-beyond/?sh=5a2ba29435c4.

[171] Rich, supra note 164.

[172] Id.

[173] 5 Key Themes in the New Space Economy, Morgan Stanley (Feb. 4, 2021), available at https://www.morganstanley.com/ideas/space-economy-themes-2021.

[174] Id.

[175] Michael Sheetz and Magdalena Petrova, Why in the Next Decade Companies Will Launch Thousands More Satellites Than in all of History, CNBC (Dec. 15, 2019), available at https://www.cnbc.com/2019/12/14/spacex-oneweb-and-amazon-to-launch-thousands-more-satellites-in-2020s.html; Federal Communications Commission, 2020 BROADBAND DEPLOYMENT, 5 FCC Rcd 8986 (11) (Apr. 20, 2020), available at https://docs.fcc.gov/public/attachments/FCC-20-50A1.pdf.

[176] David Shepardson, FCC Awards $9.2 Billion to Deploy Broadband to 5.2 Million U.S. Homes, Businesses U.S. (2020), available at https://www.reuters.com/article/us-usa-internet-fcc/fcc-awards-9-2-billion-to-deploy-broadband-to-5-2-million-u-s-homes-businesses-idUSKBN28H2V1.

[177] Christopher Davenport, FCC Announces Billions of Dollars in Awards to Provide Rural Areas with Broadband Access, Washington Post (Dec. 7, 2020), available at https://www.washingtonpost.com/technology/2020/12/07/fcc-digital-divide-spacex-broadband/.

[178] Id.

[179] Ryan Tracy, Elon Musk’s SpaceX Riles Its Rivals for Broadband Subsidies, The Wall Street Journal (Jan. 31 2021), available at www.wsj.com/articles/elon-musks-spacex-riles-its-rivals-for-broadband-subsidies-11612108801.

[180] Public Notice: Rural Digital Opportunity Fund Phase I Auction (Auction 904) Closes; Winning Bidders Announced; FCC Form 683 Due January 29, 2021, Federal Communications Commission (Dec. 7, 2020), available at https://docs.fcc.gov/public/attachments/DA-20-1422A1.pdf.

[181] Morgan Stanley, supra note 173.

[182] The Economist, It’s time to tidy up space, The Economist (Jan. 16, 2021), available at https://www.economist.com/leaders/2021/01/14/its-time-to-tidy-up-space.

[183] Morgan Stanley, supra note 173.

[184] Space: Investing in the Final Frontier | Morgan Stanley, Morgan Stanley (July 24, 2020), available at https://www.morganstanley.com/ideas/investing-in-space.

[185] Jeffrey Kluger, The Biden Presidency Could Fundamentally Change the U.S. Space Program, Time (Jan. 29, 2021), available at https://time.com/5933447/biden-space-nasa/.

[186] Sec’y of the Air Force Public Affairs, With the Stroke of a Pen, U.S. Space Force Becomes a Reality (Dec. 20, 2019), available at https://www.spaceforce.mil/News/Article/2046055/with-the-stroke-of-a-pen-us-space-force-becomes-a-reality.

[187] National Defense Authorization Act for Fiscal Year 2020, S. 1790, 116th Cong. § 952 b(4) (as passed by Senate, June 27, 2019), available at https://www.congress.gov/116/bills/s1790/BILLS-116s1790enr.pdf‌.

[188] Rebecca Kheel, Space Force Expected To Live On Past Trump Era, The Hill (Dec. 19, 2021), available at https://thehill.com/policy/technology/530936-space-force-expected-to-live-on-past-trump-era.

[189] Reuters, Biden Decides to Stick with Space Force as Branch of U.S. Military, Reuters (Feb. 3, 2021), available at https://www.reuters.com/article/us-usa-biden-spaceforce/biden-decides-to-stick-with-space-force-as-branch-of-u-s-military-idUSKBN2A32Z6.

[190] Sandra Erwin, Raymond: Space Force ‘Not a Political Issue’, Space News (Mar. 3, 2021), available at https://spacenews.com/raymond-space-force-not-a-political-issue/.

[191] Kheel, supra note 199.

[192] Christian Davenport, The Biden Administration Has Set Out To Dismantle Trump’s Legacy, Except In One Area: Space, The Washington Post (Mar. 2, 2021), available at https://www.washingtonpost.com/technology/2021/03/02/biden-space-artemis-moon-trump/.

[193] Marcia Smith, Biden Administration “Certainly” Supports Artemis Program, Space Policy Online (Feb. 4, 2021), available at https://spacepolicyonline.com/news/biden-administration-certainly-supports-artemis-program/.

[194] Id.

[195] Lia Rovira, How Will the U.S. Space Program Fare Under Joe Biden?, EarthSky, (Jan. 10, 2021), available at https://earthsky.org/human-world/how-will-the-u-s-space-program-fare-under-joe-biden.

[196] Smith, supra note 204.

[197] Kluger, supra note 196.

The following Gibson Dunn lawyers assisted in preparing this client update: Dhananjay Manthripragda, Jared Greenberg, Lindsay Paulin, Sarah Ediger, Macey Olave, Andrew Blythe, Jacob Rierson, Sarah Scharf, Casper Yen, Alayna Monroe, Zak Baron, and Christopher Wang.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding the issues discussed above. Please contact the Gibson Dunn lawyer with whom you usually work, any of the following in the Aerospace and Related Technologies practice group:

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Each month, Gibson Dunn’s Media, Entertainment and Technology Practice Group highlights notable developments and rulings that may impact future litigation in this area. This month we focus on the increasingly popular digital asset known as non-fungible tokens or “NFTs” and related issues in the entertainment space and beyond.

Issue: Non-Fungible Tokens (NFTs)

Summary: NFTs have gone mainstream in what some have called a new “gold rush.” An NFT sold for almost $70 million at a Christie’s auction last month, NFTs of basketball video highlights have generated hundreds of millions of dollars in sales on the NBA Top Shot platform, and NFTs even were the subject of a skit on a recent episode of Saturday Night Live. Some consider them a fad or a bubble, citing the almost $600,000 sale of an image of an animated flying cat with a pop-tart body that anyone can download from the internet for free. But in one form or another, NFTs are here to stay. Even if the market matures and interest wanes in some unconventional pieces of digital art, NFTs will continue to offer a significant potential revenue stream for artists and entities in the film and television, music, and online gaming industries, among many others. We highlight below some of the emerging legal and policy issues related to NFTs, which include intellectual property law, profit participation issues, securities law, and even climate change.

What do the music group Megadeth, former University of Iowa basketball player Luka Garza, and New York City track and field center The Armory have in common? In the span of 24 hours earlier this month, each of them entered the rapidly expanding NFT market. They joined a number of artists and entertainers who have led the charge in selling NFTs. As film studios and other entities with large content libraries consider following suit, they will need to consider a number of deeply rooted legal issues against a relatively new technological backdrop.

I. Background

There are widely varied understandings of NFTs and related issues concerning tokens and blockchain technology. While many of our readers are familiar with these terms, a brief introduction is helpful to frame the issues that follow.

A. What are NFTs and What is the Blockchain?

An NFT, or “non-fungible token,” is a unique unit of data stored on a public ledger of transactions called a blockchain. The unique data could represent an image, an electronic deed to a piece of property, or a digital ticket for a particular seat at a sporting event. In contrast to these “non-fungible” tokens, cryptocurrencies such as Bitcoin and Ether—just like U.S. dollars, British pounds and other “fiat” government-issued currencies—are fungible; one penny in your pocket has the same intrinsic value as the penny under your couch cushion.

Today, NFTs generally reside on the Ethereum blockchain, which also supports, among other things, the cryptocurrency Ether—the second largest cryptocurrency in terms of market capitalization and volume after Bitcoin. While other blockchains can have their own versions of NFTs, right now Ethereum is the most widely used (though NBA Top Shot uses the Flow blockchain).

But what is a blockchain? As noted above, it is an electronic database or ledger showing a history of transactions. Each transaction is represented by an entry into the electronic ledger and multiple ledger entries are ordered in data batches known as “blocks” to await verification on the network. New blocks are added after the current block reaches its data limit. The blocks are connected using cryptography: each block contains a “hash” (a sort of coded electronic signature linking it to the previous block), which is how the blockchain gets its name.

A key feature of the Ethereum blockchain that distinguishes it from a database one might have at a business or law firm is that the blockchain is decentralized across a community of servers. Data is not stored in any one location or managed by any particular body. Rather, it exists on multiple computers simultaneously, with network participants holding identical copies of the ledger reflecting the encrypted transactions.

That is why blockchains are touted as both verifiable and secure. It is similar to the tracking details showing each step in a package’s journey from the shipper to its final delivery destination. Unlike the tracking details provided by a shipping company, however, on the blockchain no one person can alter that record to change the encrypted data without the network’s users noticing and rejecting the fraudulent version. And if any one computer system fails, there are duplicate images of the tracking details on the blockchain ledger available on other computers around the world.

B. What Do You Get When You Buy An NFT?

While an NFT is unique, it is important to keep in mind what that unique digital item actually is. In most cases the NFT is a digital identifier recording ownership, not—to borrow an example from the above—the actual image of the pop-tart cat. What amounts to your “receipt” is reflected in the blockchain, but the image file itself resides elsewhere.

This has to do with blockchain storage limitations and costs. The digital image itself theoretically can be stored in metadata on the blockchain, but in the vast majority of cases it is hosted on a regular website or the decentralized InterPlanetary File System (IPFS). The identifier is logged on the blockchain, but if the image is taken down from its non-blockchain location—say, because it violates someone’s copyright—the NFT could end up being a unique digital path to a closed door (even if there may be seemingly identical “copies” of the digital asset elsewhere). The immutable purchase record would remain on the blockchain, but the original image might not be viewable.

Almost uniformly, the NFT transfer conveys an interest in a licensed copy while copyright ownership of the underlying image or song is not transferred. The NFT may be in a limited edition and it may have some additional perceived value because it is officially authorized by the copyright holder or originated from the address of the copyright holder. But while the underlying copyright can be transferred when the NFT is sold or licensed, typically it isn’t. The terms and conditions of an NFT platform may reveal the limits of what actually is being transferred and how it might be used.

Under NBA Top Shot’s terms, for example, the purchaser who obtains a license to a “Moment” cannot use it for a commercial purpose, modify it, or use the image alongside anything the NBA considers offensive or hateful. An NFT platform that controls the image file is able to remove that file from its platform.

* * *

Monetization strategies for NFTs are constantly evolving, so one cannot generalize and say that all NFTs fall in one legal bucket or another. An NFT can be fair use of a copyright or it can violate it. An NFT likewise could be a simple collectible or it may be offered in such a way to convert it into a security subject to myriad regulations and disclosure requirements. It depends on the NFT. But as the market evolves, complicated questions will need to be answered by NFT creators, platforms, and, potentially, courts.

II. Intellectual Property

Any NFT platform must be particularly focused on the intellectual property rights underlying the NFTs stored, sold, or licensed on the platform. A single NFT may include various copyrightable elements, including a video clip and any accompanying music. Whereas the platform may be able to invoke a statutory liability protection with respect to some potential claims—like defamation—certain intellectual property claims are not precluded.

Specifically, Section 230 of the Communications Decency Act of 1996 shields certain online service providers from liability for hosting content that someone else created. In particular, Section 230(c)(1) states that “No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.”

To the extent Section 230 applies to a particular NFT platform, the law’s broad protection still has carve-outs. Among other things, it does not apply to “any law pertaining to intellectual property.” Courts have different interpretations of the scope of Section 230’s reference to “intellectual property.” In Perfect 10 v. CCBill, 488 F.3d 1102 (9th Cir. 2007), the Ninth Circuit ruled that Section 230 permitted claims under federal intellectual property laws but preempted state intellectual property claims alleging a violation of the plaintiff’s right of publicity. In Atlantic Recording Corp. v. Project Playlist, Inc., 603 F. Supp. 2d 690 (S.D.N.Y. 2009), a Southern District of New York court reached the opposite conclusion, holding that the “intellectual property” carve-out extended beyond intellectual property claims under federal law to include state-law claims.

Whether or not an NFT platform would be subject to potential liability for violating someone’s state-law right in her or his name and likeness, federal intellectual property law still would apply. And offering an NFT that potentially infringes a copyright could result in liability for the platform if, for example, it does not take the necessary steps under the Digital Millennium Copyright Act. That risk is heightened for some platforms given how easy it is to tokenize someone else’s work. Speculators can turn any digital image into an NFT that they can then try to sell, even if the original creator does not agree to that use or even know about it.

Studios and other intellectual property rights holders will need to be especially vigilant in protecting their intellectual property—and NFT platforms likewise will need to promptly remove content if a copyright owner notifies it of an infringement—as the market for small pieces of content expands.

III. Profit Participations

Especially in the current NFT environment, it is not difficult to imagine the potential value of tokenized iconic moments from movies and television. Of course, there would be a number of contractual issues for a rightsholder to navigate, which would vary from deal to deal. Valuable clips might come from movies dating back long before the advent of NFTs, the internet, or even computers. The relevant agreements certainly would not address NFTs, but even analogous provisions might be difficult to identify. Agreements may refer to “clips,” for example, but typically a clip is used to promote the full program or film rather than to be monetized on its own.

Depending on what it depicts, an NFT might not be a “clip” at all. Again using NBA Top Shot as an example, a “Moment” is not just a short video excerpt showing a pass or dunk; it is a package of on-court video, still photographs, digital artwork, and game information. Contracts would need to be analyzed to determine if the NFT should be categorized as a clip, a derivative production, merchandising, promotional material, or something else, with potential consequences on the calculation of gross receipts and any corresponding rights to profit participations or Guild royalties.

Exclusivity provisions in film or television licenses to third parties might bar or limit a studio from “minting” an NFT from a work in its library. Other considerations might also limit a rightsholder’s willingness to enter the NFT space. With vast libraries of well-known and high‑quality content, however, studios are better positioned than most to take advantage of the increased interest and marketability of discrete portions of a film or program.

IV. Securities Law

Particularly in light of the SEC’s increased focus on cryptocurrencies, including its recent lawsuit accusing Ripple Labs Inc. and two of its executives of engaging in an unregistered “digital asset securities offering,” anyone involved in marketing an NFT should give careful consideration to whether the NFT is a security under U.S. law.

This should be of particular concern to the celebrities marketing their own NFTs. Several years ago, in response to celebrity endorsements for cryptocurrency Initial Coin Offerings (ICOs), the SEC warned that “[a]ny celebrity or other individual who promotes a virtual token or coin that is a security must disclose the nature, scope, and amount of compensation received in exchange for the promotion.”[1] A failure to do so would be “a violation of the anti-touting provisions of the federal securities laws.”[2] The same principle would apply to NFTs, with the key question being whether an NFT is a security. This issue has significant bearing on the NFT platform as well. If an NFT is a security, the offeror must follow securities law disclosure requirements and restrictions on who may invest.

The term “security” in U.S. securities laws includes an “investment contract” as well as other instruments like stocks and bonds. Both the SEC and federal courts often use the “investment contract” analysis to determine whether unique instruments, such as digital assets, are securities subject to federal securities laws.

To determine whether a digital asset has the characteristics of an investment contract, courts apply a test derived from the U.S. Supreme Court’s decision in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Under that Howey test, federal securities laws apply where

there is an investment of money or some other consideration,
in a common enterprise,
with a reasonable expectation of profits,
to be derived from the efforts of others.

Again, it would depend on the NFT, but transactions that resemble a fan buying a collectible likely would not be securities under this test. The notion that an NFT is non-fungible also makes it less likely to be a security.

Nevertheless, the NFT market is a creative one. Many NFTs, for example, are configured through the “smart contracts”—which are essentially computer programs—to automatically pay out royalties to the digital artwork’s original creator with every future sale of the NFT on that platform; the artist could package those royalty rights for sale to potential investors.

NFT issuers also can sell fractional interests in NFTs or groups of NFTs. As prices for some NFTs climb into the stratosphere, this approach becomes more appealing to potential buyers who want a piece of the NFT but are unwilling or unable to pay for the whole thing. According to recent statements by SEC Commissioner Hester Peirce, however, doing so increases the likelihood that the NFT would be deemed a security under the Howey test.[3] That likelihood grows where the NFT issuer or a third party claim to be able to help increase the NFT’s value.

V. Climate Change

A major issue that has arisen related to NFTs— and cryptocurrency generally—is their believed effect on the environment. Articles abound comparing the energy consumption of the Ethereum blockchain to entire countries. An analysis by Cambridge University asserts that what it calls the “Bitcoin network” uses more energy than Argentina.[4] NFTs thus have proven somewhat controversial, with one online marketplace for digital artists dropping its plans to launch an NFT platform after backlash that included an artist labeling NFTs an “ecological nightmare pyramid scheme.”[5]

Some contend that these ecological concerns are exaggerated and misleading, noting that NFTs themselves do not cause carbon emissions. As one platform wrote in a recent blog post, “Ethereum has a fixed energy consumption at a given point of time.”[6] The carbon footprint of the Ethereum blockchain would be the same if people minted more NFTs or stopped minting them altogether. But even the post acknowledges that “[i]t is true that Ethereum is energy intensive.”[7]

The crypto energy consumption issue relates to how blockchain technology currently operates. To validate a transaction—and engender trust in a system that is not backed by any central bank or other government authority—the blockchain network relies on a method called “Proof of Work.” The hashing function described above that allows the blocks to be chained together requires complex mathematical equations that only powerful computers can solve. “Miners” must solve these equations to add a new block to the chain. As incentive to solve the mathematical puzzles, the miner receives a reward of new tokens or transaction fees.

The energy costs to complete the hash functions under the Proof of Work model can be high, with miners using entire data centers to compete to solve the puzzles first and garner the reward. To mitigate any environmental effects, mining sites may increasingly rely on renewable energy and “stranded” energy, which is surplus energy created, for example, by excess power that some hyrdroelectric dams around the world generate during rainy seasons.

Another option, at least for the Ethereum blockchain, is moving to a “Proof of Stake” model. Rather than relying on miners using significant amounts of electricity in a race to solve an equation the fastest, the Proof of Stake model involves validators of transactions who are assigned randomly via an algorithm. These validators also have to commit some of their own cryptocurrency, giving them a “stake” in keeping the blockchain accurate.

Reports indicate that Ethereum may move to the Proof of Stake model as soon as this year.[8] Doing so would decrease energy consumption associated with NFTs, allow more transactions per second than in the Proof of Work model, and seemingly remove (or at least mitigate) an apparent drag on the willingness of some to embrace NFTs.

At the same time, one recent article noted what a crypto-mining finance company executive called the “‘inherent security issue of using the native tokens of a blockchain to decide the future of those tokens or the blockchain.’”[9] If the value of the tokens fall, the value of a validator’s stake falls along with it. The validator then has less to lose if they decide to propose an incorrect transaction or otherwise misbehave.

VI. Conclusion

NFTs present significant opportunities for content creators and owners, but they also present novel legal and policy issues across a wide range of areas as the technology continues to evolve. Beyond those listed here, areas of potential concern include Commodities/Derivatives, Tax, Data Privacy, and Cross-Border Transactions. Understanding the potential complications of moving into the NFT space is a necessity in anticipation of the regulatory scrutiny and litigation that often follow similar explosions of interest and investment.

_______________________

[1] https://www.sec.gov/news/public-statement/statement-potentially-unlawful-promotion-icos (Nov. 1, 2017).

[2] Id.

[3] https://cointelegraph.com/news/sec-s-crypto-mom-warns-selling-fractionalized-nfts-could-break-the-law (Mar. 26, 2021).

[4] https://www.bbc.com/news/technology-56012952 (Feb. 10, 2021).

[5] https://www.theverge.com/2021/3/15/22328203/nft-cryptoart-ethereum-blockchain-climate-change (Mar. 15, 2021).

[6] https://medium.com/superrare/no-cryptoartists-arent-harming-the-planet-43182f72fc61 (Mar. 2, 2021).

[7] Id.

[8] https://www.coindesk.com/ethereum-proof-of-stake-sooner-than-you-think (Mar. 17, 2021).

[9] https://cryptonews.com/exclusives/proof-of-disagreement-bitcoin-s-work-vs-ethereum-s-planned-s-9788.htm (Apr. 3, 2021).

The following Gibson Dunn lawyers assisted in the preparation of this client update: Michael Dore and Jeffrey Steiner.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or the following leaders and members of the firm’s Media, Entertainment & Technology Practice Group:

Scott A. Edelman – Co-Chair, Media, Entertainment & Technology Practice, Los Angeles (+1 310-557-8061, [email protected])
Kevin Masuda – Co-Chair, Media, Entertainment & Technology Practice, Los Angeles (+1 213-229-7872, [email protected])
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Los Angeles partner Christopher Dusseault is the author of “High court to consider when AGs can intervene,” [PDF] published by the Daily Journal on April 15, 2021.

On April 15, 2021, the United States announced a significant expansion of sanctions on Russia, including new restrictions on the ability of U.S. financial institutions to deal in Russian sovereign debt and the designation of more than 40 individuals and entities for supporting the Kremlin’s malign activities abroad. As part of a sprawling package of measures, the Biden administration imposed sectoral sanctions on some of Russia’s most economically consequential institutions—including the country’s central bank, finance ministry, and sovereign wealth fund. The administration also blacklisted an array of individuals and entities implicated in Russia’s annexation of Crimea, foreign election interference, and the SolarWinds cyberattack. Most of the sanctions authorities included in newly issued Executive Order (“E.O.”) 14024 were already in force across a range of earlier Executive Orders and actions promulgated to respond to Russia’s initial incursion into Crimea in 2014, Moscow’s malicious cyber activities, election interference, chemical weapons attacks, and human rights abuses. This new initiative, however, suggests that the Biden administration is prepared to move aggressively to deter Moscow from further engaging in destabilizing activities. Moreover, we assess that this new initiative by the Biden administration is designed, at least in part, to elicit multilateral support, principally from the United Kingdom and the European Union. Whether Washington’s transatlantic allies take up the call (London is apparently poised to follow soon) and whether these measures ultimately change Russia’s behavior remains to be seen. In the meantime, the already frosty relationship between the West and Moscow appears likely to further deteriorate, which could have significant repercussions for multinational companies active in both jurisdictions.

Executive Order 14024

E.O. 14024 authorizes blocking sanctions against, among others, (1) persons determined to operate in certain sectors of the Russian economy; (2) those determined to be responsible for or complicit in certain activities on behalf of the Russian Government such as malicious cyber activities, foreign election interference, and transnational corruption; (3) Russian Government officials; and (4) Russian Government political subdivisions, agencies, and instrumentalities. As noted above, many of these bases for designation already exist under earlier Executive Orders. The duplication of these authorities suggests that the Biden administration may be looking both to put its own stamp on U.S. sanctions policy and to have a single, consolidated sanctions tool that it can use to target the full range of Russian malign behavior. E.O. 14024 also expands upon some of those earlier authorities, for example, by authorizing the imposition of sanctions against the spouse and adult children of individuals sanctioned pursuant to the new E.O. This is a somewhat uncommon provision apparently designed to prevent sanctions evasion by those who may seek to shift assets to close relatives—a strategy that the United States has seen in its implementation and enforcement of Russian sanctions, especially with respect to oligarchs.

Restrictions on Russian Sovereign Debt

While the 46 individual and entity designations (discussed more fully below) are potentially impactful on the specific parties targeted, the most systemically important component of E.O. 14024 comes in the form of a new Directive issued by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”). Such directives have in the past only been issued in the context of sectoral sanctions imposed against Russia. This latest Directive prohibits U.S. financial institutions, as of June 14, 2021, from either (1) participating in the primary market for “new” ruble and non-ruble denominated bonds issued by the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation (Russia’s principal sovereign wealth fund), or the Ministry of Finance of the Russian Federation, or (2) lending ruble or non-ruble denominated funds to those three entities. Modeled on earlier sectoral sanctions targeting major actors in Russia’s financial services, energy, defense, and oil sectors, the new Directive prohibits U.S. financial institutions from engaging only in certain narrow categories of transactions involving the targeted entities. Absent some other prohibition, U.S. banks may continue engaging in all other lawful dealings with the named entities. This reflects the delicate balance that President Biden and earlier administrations have attempted to strike by imposing meaningful consequences on large, globally significant actors without at the same time roiling global markets or imposing unpalatable collateral consequences on U.S. allies. Notably, the Biden administration stopped far short of more draconian measures such as blacklisting Russia’s sovereign wealth fund, or the Russian Government itself (as the Trump administration did in Venezuela).

The sectoral sanctions on Russia’s central bank, sovereign wealth fund, and finance ministry are further circumscribed in several key respects. First, they do not become effective until 60 days after the issuance of the Directive. Second, they are one of the rare instances in which OFAC’s Fifty Percent Rule does not apply, meaning that the Directive’s restrictions extend only to bonds issued by, and loans made to, the three named Russian Government entities and not to any other entities in which they may own a direct or indirect majority interest. Third, the Directive also does not prohibit U.S. financial institutions from participating in the secondary market for Russian sovereign bonds—a potentially wide loophole under which U.S. banks may continue to purchase such debt, just not directly from the three targeted entities. This is a loophole that could be significantly closed if the United Kingdom and European Union adopted similar measures—further supporting our assessment that the administration designed these restrictions in part to be imposed alongside similar restrictions promulgated by London and Brussels.

Particularly in light of existing restrictions on U.S. banks’ ability to participate in the primary market for non-ruble denominated Russian sovereign bonds, and from lending non-ruble denominated funds to the Russian sovereign, the Directive’s main significance is that it will make it more difficult for the Russian Government, starting on June 14, 2021, to borrow new funds in local currency. From a policy perspective, the Directive therefore appears calculated to further restrict potential sources of financing for the Russian state—in effect, penalizing the Kremlin by driving up its borrowing costs. Such a seemingly narrow expansion of restricted activities also leaves room to further strengthen measures if the Kremlin’s malign activities continue.

Sanctions Targeting Russia’s Other Troubling Activities

In addition to imposing restrictions on Russian sovereign debt, the Biden administration also designated dozens of individuals and entities to OFAC’s Specially Designated Nationals and Blocked Persons (“SDN”) List for their involvement in Russia’s destabilizing operations abroad. As a result of these designations, U.S. persons are generally prohibited from engaging in transactions involving the targeted individuals and entities and any property and interests in property of the targeted persons that come within U.S. jurisdiction are frozen. Underscoring the scope of the Biden administration’s concerns, these sanctions designations target an accumulation of Russian activities during the preceding months, including efforts to cement Russian control of the Crimea region of Ukraine, foreign election interference, and the SolarWinds cyberattack.

Among those targeted were eight individuals and entities involved in Russia’s annexation of Crimea. In particular, OFAC designated various persons involved in constructing the Kerch Strait Bridge, which connects the Crimean peninsula by rail to the Russian mainland. These designations also targeted Russian and local government officials for attempting to exercise control over Crimea, as well as a detention facility in the Crimean city of Simferopol that has been implicated in human rights abuses. Through these actions—which come amid reports of Russian troops massing on the eastern Ukrainian border—the United States appears to be signaling its continuing commitment to the territorial integrity of Ukraine.

In a second batch of designations, OFAC added a further 32 individuals and entities to the SDN List for attempting to influence democratic elections in the United States and Africa at the behest of the Russian state. Notably, these designations include a network of Russian intelligence-linked websites that allegedly engaged in a campaign of disinformation and election interference. OFAC also targeted associates and enablers of Yevgeniy Prigozhin, the principal financial backer of the Russia-based Internet Research Agency, as well as the Russian political consultant Konstantin Kilimnik. This set of sanctions targets not only Russian actors engaged in disinformation on behalf of the Russian government, but also those that facilitate this harmful behavior—adding a new layer of accountability to the extensive disinformation-related sanctions put in place over the last five years.

Finally, the Biden administration announced a long-awaited group of designations targeting six companies in the Russian technology sector in response to last year’s high-profile SolarWinds cyberattack on government and private networks—which the United States for the first time definitively attributed to Russia’s intelligence services. These technology companies, which were the first to be designated pursuant to E.O. 14024, were targeted because they are funded and operated by the Russian Ministry of Defense and allegedly helped research and develop malicious cyber operations for Russia’s three main intelligence agencies.

Taken together, these actions targeting a broad spectrum of disruptive activities beyond Russia’s borders mark a significant escalation of U.S. pressure on Moscow. U.S. Secretary of the Treasury Janet Yellen in a statement described the measures as “the start of a new U.S. campaign against Russian malign behavior,” implying that additional designations may be on the horizon. For example, a fresh round of sanctions could soon be announced if further harm were to come to the jailed Russian dissident Alexey Navalny.

Next Steps Between Washington and Moscow

This week’s wide-ranging sanctions on Moscow suggest that President Biden is likely to continue using sanctions and other instruments of economic coercion to deter and impose costs on the Kremlin. As for what this latest development means for foreign investors and multinational companies, the answer depends in part on how Russia ultimately responds. By reportedly holding out the possibility of a U.S.-Russia summit in a recent call with Russia’s President Vladimir Putin, as well as refraining from imposing more biting sanctions, President Biden appears to have left open the possibility of limited retaliation by Russia and an eventual de-escalation of tensions between Washington and Moscow. The Kremlin’s public response so far has been muted, including the expulsion of a handful of U.S. diplomats and the imposition of sanctions against eight senior U.S. officials. However, if Russia were to respond more forcefully—such as by launching an incursion further into Ukraine or through renewed cyberattacks against the United States and allied nations—the imposition of more severe sanctions barring U.S. persons from participating in the secondary market for Russian bonds or the designation of a major enterprise in the country’s energy sector could occur. At a minimum, the sanctions announced this past week are likely to further increase the risks, and the yield, associated with new issuance of Russian sovereign debt—marking the beginning of a new chapter in U.S. Government efforts to change the Russian Government’s behavior, or at least impose significant costs if the Kremlin refuses to alter course.

The following Gibson Dunn lawyers assisted in preparing this client update: Scott Toussaint, Judith Alison Lee, Adam Smith, Stephanie Connor, Christopher Timura and Laura Cole.

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:

United States:
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, [email protected])
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, [email protected])
Jose W. Fernandez – New York (+1 212-351-2376, [email protected])
Nicola T. Hanna – Los Angeles (+1 213-229-7269, [email protected])
Marcellus A. McRae – Los Angeles (+1 213-229-7675, [email protected])
Adam M. Smith – Washington, D.C. (+1 202-887-3547, [email protected])
Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, [email protected])
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, [email protected])
Laura R. Cole – Washington, D.C. (+1 202-887-3787, [email protected])
R.L. Pratt – Washington, D.C. (+1 202-887-3785, [email protected])
Samantha Sewall – Washington, D.C. (+1 202-887-3509, [email protected])
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, [email protected])
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, [email protected])
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, [email protected])

Asia:
Kelly Austin – Hong Kong (+852 2214 3788, [email protected])
Fang Xue – Beijing (+86 10 6502 8687, [email protected])
Qi Yue – Beijing – (+86 10 6502 8534, [email protected])

Europe:
Attila Borsos – Brussels (+32 2 554 72 10, [email protected])
Nicolas Autet – Paris (+33 1 56 43 13 00, [email protected])
Susy Bullock – London (+44 (0)20 7071 4283, [email protected])
Patrick Doris – London (+44 (0)207 071 4276, [email protected])
Sacha Harber-Kelly – London (+44 20 7071 4205, [email protected])
Penny Madden – London (+44 (0)20 7071 4226, [email protected])
Steve Melrose – London (+44 (0)20 7071 4219, [email protected])
Matt Aleksic – London (+44 (0)20 7071 4042, [email protected])
Benno Schwarz – Munich (+49 89 189 33 110, [email protected])
Michael Walther – Munich (+49 89 189 33-180, [email protected])
Richard W. Roeder – Munich (+49 89 189 33-160, [email protected])

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

New York partner Matthew Biben is the author of “The New Anti-Money Laundering Act: Issues for Financial Institutions,” [PDF] published by the New York Law Journal on April 16, 2021. New York associates Lee Crain and Lavi Ben Dor contributed to the article.

Federal Circuit News

Upcoming Oral Argument Calendar

Key Case Summaries (April 2021)

I. Class Certification Requirements: The Ninth Circuit on Predominance; the Seventh Circuit on Numerosity; and the Eleventh Circuit on Administrative Feasibility

II. Several Circuits Clarify the Standards for Assessing the Admissibility of Evidence at the Class-Certification Stage

III. The Eleventh Circuit Addresses Article III Standing in Data Breach Class Actions

Table of Contents

I. U.S. NATIONAL POLICY & REGULATORY DEVELOPMENTS

II. EU POLICY & REGULATORY DEVELOPMENTS

I. U.S. NATIONAL POLICY & REGULATORY DEVELOPMENTS

A. U.S. National AI Strategy

B. National Security & Trade

C. Algorithmic Accountability and Consumer Safety

D. FDA’s Action Plan for AI Medical Devices

E. Intellectual Property Updates

F. U.S. Regulators Seek Input on AI Use in Financial Services

III. EU POLICY & REGULATORY DEVELOPMENTS

A. EC Publishes Draft Legislation for EU-wide AI Regulation

B. CAHAI Feasibility Study on AI Legal Standards

C. EU Council Proposes ePrivacy Regulation

D. Cybersecurity Report on the Use of AI in Autonomous Vehicles

E. Proposed German Legislation on Autonomous Driving

A. Scope of CSI

B. Disclosure to Affiliates

C. Disclosure to Legal Counsel and Independent Auditors

D. Disclosure to Other Regulators

E. Duty to Notify NYDFS of Requests for CSI

Conclusion

TABLE OF CONTENTS

I. Unmanned Aircraft Systems

A. New Rules Remote ID

B. Flight Over People, Over Vehicles, or at Night

C. Continued Lack of Clarity on Airspace

D. Newsworthy FAA Approvals

E. COVID-19 and Use of Drones

II. Government Contracts

III. Space

A. First Private Human Space Launch

B. Noteworthy Space Achievements in Countries Other than the United States

C. Other Noteworthy Space Developments

D. NASA’s Perseverance Rover, Past Updates, and Future Plans

E. Record-Setting Private investment

F. Satellite Internet Constellations

G. Expected Impact of Biden Administration

I. Background

A. What are NFTs and What is the Blockchain?

B. What Do You Get When You Buy An NFT?

II. Intellectual Property

III. Profit Participations

IV. Securities Law

V. Climate Change

VI. Conclusion