SEC Division of Examinations Risk Alert Provides a Useful Roadmap on Compliance Issues for Fund Managers

On Friday, April 9, 2021, the Securities and Exchange Commission (“SEC”) Division of Examinations (the “Division”), issued a Risk Alert detailing its observations of deficiencies and internal control weaknesses from examinations of investment advisers and funds regarding investing that incorporates environmental, social, and governance factors (“ESG investing”).[1]  This alert follows another recent announcement of the creation of a Climate and ESG Task Force within the Division of Enforcement to focus on ESG-related disclosures by public companies and ESG investment practices by investment funds.[2]

Key Takeaways

The Risk Alert provides useful guidance regarding the types of compliance issues the Staff is reviewing in its examinations of investment advisers, examples of deficiencies the Staff is finding, as well as instances in which the Staff has observed effective compliance practices.  Accordingly, the Risk Alert provides a useful roadmap to assist investment advisers in developing, testing and enhancing their compliance policies, procedures and practices.

On the heels of the Risk Alert, Commissioner Peirce issued a cautionary statement to express her view that the alert, “should not be interpreted as a sign that ESG investment strategies are unique in the eyes of examiners,” but simply that, as with any other investment strategy, “[f]irms claiming to be conducting ESG investing need to explain to investors what they mean by ESG and they need to do what they say they are doing.”[3]

In sum, the SEC’s focus on ESG investment strategies heightens the need for investment advisers to make sure their disclosures align with investment practices and that there is sufficient and knowledgeable oversight and review by compliance personnel to avoid a divergence between the two over time.

Concerns Identified by the Division

In the Division’s examination of investment advisers, registered investment companies, and private funds engaged in ESG investing, the Staff observed the following weaknesses:

  • Lack of adherence to global ESG frameworks where firms claimed such adherence.
  • Weakness in policies and procedures governing implementation and monitoring of ESG-related directives. For example, the Staff observed that advisers did not have adequate controls around implementation and monitoring of clients’ negative screens.
  • Inconsistency between public ESG-related proxy voting claims and internal voting policies and practices, including the dissemination of public statements that ESG-related proxy proposals would be independently evaluated on a case-by-case basis, while internal deadlines generally did not provide such case-by-case analysis.
  • Unsubstantiated or otherwise potentially misleading claims regarding ESG investing in marketing materials that touted favorable risk, return, and correlation metrics related to ESG investing, without disclosing material facts regarding the significant expense reimbursement received from the fund-sponsor, which inflated returns for those ESG-oriented funds.
  • Inadequate controls to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices, including lack of documentation of ESG investing decisions and issuer engagement efforts, as well as a failure to update marketing materials timely.
  • Limited knowledge by compliance personnel of relevant ESG-investment analyses or oversight over ESG-related disclosures and marketing decisions.

Guidance for ESG Investing Disclosures and Procedures

The Staff also observed policies, procedures, and practices which were reasonably designed to convey approaches to ESG investing.  The Division noted that the following practices may be helpful to address the compliance issues identified above:

  • Simple and clear disclosures regarding the firm’s approach to ESG investments in client-facing materials.
  • Explanations regarding how ESG investments are evaluated using goals established under global ESG frameworks on the firm’s website, client presentations, and annual reports.
  • Detailed, comprehensive investment policies and procedures regarding ESG investments and factors considered in specific investment decisions; when multiple ESG investing approaches are considered, specific written procedures, due diligence documentation, and separate specialized personnel who provide additional rigor to the portfolio management process.
  • Compliance personnel who are knowledgeable about the firm’s ESG approaches and practices. Firms with dedicated ESG compliance personnel were more likely to avoid materially misleading claims in their ESG-related marketing materials and other client/investor-facing documents.

Conclusion

In conclusion, the SEC’s Risk Alert reaffirms the need for firms involved in ESG investing to ensure that their disclosures accurately describe their ESG-related investment practices.  Periodic reviews of marketing materials and other investor disclosures against current investment strategy and adherence to stated ESG metrics will avoid the types of deficiencies the Staff has observed in recent inspections, and, in the worst cases, avoid even greater scrutiny from the Division of Enforcement.

_____________________

   [1]   Division of Examinations, Risk Alert, Securities and Exchange Commission (Apr. 9, 2021), https://www.sec.gov/files/esg-risk-alert.pdf.

   [2]   Press Release, U.S. Securities and Exchange Commission, SEC Announces Enforcement Task Force Focused on Climate and ESG Issues (Mar. 4, 2021), https://www.sec.gov/news/press-release/2021-42?_sm_au_=iHVN4cW7DnktSD5NFcVTvKQkcK8MG.

   [3]   Public Statement, Statement on the Staff ESG Risk Alert (Apr. 12, 2021), https://www.sec.gov/news/public-statement/peirce-statement-staff-esg-risk-alert.

Gibson, Dunn and Crutcher’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 Securities Enforcement practice group, or the following authors:

Mark K. Schonfeld – New York (+1 212-351-2433, [email protected])
Tina Samanta – New York (+1 212-351-2469, [email protected])
Lauren Myers – New York (+1 212-351-3946, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

The New York State Legislature, as part of its annual revenue bill, has authorized mobile sports wagering in New York, and the Governor is expected to sign that bill momentarily.  Through this landmark legislation, New Yorkers will soon be able to wager on sporting events online, just like millions of Americans who live in other states.

Although New York has long delayed legalizing various forms of sports wagering due to provisions of its State Constitution, the new mobile sports wagering law should pass constitutional muster.  As Gibson Dunn attorneys argued in a New York Law Journal article last year,[1] the Legislature has the authority to authorize mobile sports betting, consistent with the State Constitution, so long as the servers that effectively place the bets are physically housed “at” the casinos duly authorized under the State Constitution.  Through the new sports wagering law, the Legislature adopted Gibson Dunn’s constitutional interpretation:  The new law “deem[s]” “[a]ll mobile sports wagering initiated in this state” as “tak[ing] place at the licensed gaming facility where the server . . . is located.”[2]

I.  New York’s Online Sports Wagering Law Adopts Gibson Dunn’s Constitutional Interpretations and Will Likely Survive Constitutional Challenge

In 2013, New York State voters approved a constitutional amendment to allow the Legislature to authorize “casino gambling” “at” up to seven casinos in the State.[3]  Prior to this constitutional amendment, legal gambling in New York was limited to state-run lotteries and betting on horse races, as well as gambling allowed on Native American tribal lands under federal law.  The same constitutional amendment also conferred on the Legislature broad authority to regulate wagering in the State.

Pursuant to this constitutional authority, in 2019, the Legislature legalized “sports wagering” in New York State.[4]  The law then enacted provided that sports wagers may only be accepted “from persons physically present” “in a sports wagering lounge located at a casino.”[5]  In effect, the law prohibited online sports betting, since sports betters would only be permitted to make bets in person at an authorized casino.

But as Gibson Dunn attorneys argued in a 2020 New York Law Journal op-ed,[6] the Legislature had the authority to go further under the 2013 constitutional amendment.  As our attorneys explained, the Legislature could enact legislation legalizing online sports wagering for two reasons.  First, sports betting fits within the Constitution’s language empowering the legislature to legalize “casino gambling.”  Specifically, when the constitutional amendment was passed and adopted, “casino gambling” would have been understood to include sports betting.  Second, online sports wagering can be conducted “at” an authorized casino.  As our attorneys explained, a wager is nothing more than a contract, and under well-established New York law, a contract is made where the contractual offer is accepted.  When a mobile sports bettor in Manhattan, for instance, asks to place a wager by entering her bet into an app or website, that request constitutes a contractual offer.  So long as the acceptance of the Manhattanite’s bet and ultimate placement of the wager occurs at a server located at a duly authorized casino, online sports betting can be deemed to have occurred “at” a casino.

New York’s new online sports wagering law adopts Gibson Dunn’s constitutional reasoning.  The Legislature amended the 2019 law to state that “all sports wagers through electronic communication . . . are considered placed or otherwise made when and where received by the mobile sports wagering licensee on such mobile sports wagering licensee’s server . . . at a licensed gaming facility, regardless of the authorized sports bettor’s physical location within the state at the time the sports wager is placed.”[7]  The hypothetical sports bet requested by an app user in Manhattan, for example, therefore is deemed to occur “at” the casino that ultimately accepts and places the bet.  Additionally, the new law is based on a legislative declaration that “a sports wager that is made through virtual or electronic means from a location within New York state and is transmitted to and accepted by electronic equipment located at a licensed gaming facility . . . is a sports wager made at such licensed gaming facility.”[8]  Under well-established New York law, this legislative finding of fact will be considered presumptively valid, making it more likely that the law will survive a constitutional challenge.[9]

With our attorneys’ reasoning codified into law, New Yorkers across the State will be able to access online sports wagering websites and apps, and the State will begin to reap the economic benefits (including tax revenue) of these lucrative transactions.

II.  New York’s Detailed Regulatory Scheme for Mobile Sports Wagering

The new law includes a number of provisions regulating mobile sports wagering.  It clarifies that online sports betting is legal as long as the bettor is “physically present” in New York at the time of the transaction.[10]  By requiring the casino, bettor, and servers all to be located in New York, the law limits mobile sports wagering to intrastate transactions.  This allows the mobile sports betting industry to avoid problems that may arise from conducting interstate transactions, which are subject to federal regulations, including the federal Wire Act’s prohibition on using wires to transmit “bets or wagers on any sporting event or contest” if the state where the bet initiates has banned sports betting.[11]

The law‘s regulatory framework centers on the “platform providers” that will offer online sports betting services.  The law authorizes the State Gaming Commission to select two platform providers to become mobile sports wagering operators based on a competitive bidding process.[12]  The Commission may permit more than two mobile sports wagering operators if the Commission determines that doing so is “in the best interests of the state” and if the additional operators pay the same tax rate as the initial two licensees.[13]  Applicants must provide a range of information about their operations and predicted earnings.[14]  Additionally, all licensees must pay a one-time $25 million fee to the State, and the operator’s license will need to be renewed after ten years.[15]

One primary factor in assessing licensing applications will likely be the amount of tax on revenues that mobile sports wagering operators are willing to pay.  The law sets the minimum revenue tax on mobile sports wagering operators at 12%—with casinos to pay a 10% revenue tax only on in-person sports wagering.[16]  But the bidding process appears designed to reach a higher rate of taxation, explicitly stating that the ultimate tax percentage platform providers will pay “shall be determined pursuant to a competitive bidding process.”[17]  This revenue tax will be paid at least “monthly.”[18]

The new law requires any casino that offers mobile sports wagering, and each mobile sports wagering platform provider, to submit a detailed annual report to the Commission.  The report must include, among other information, the total amount of wagers placed and prizes awarded and the number of accounts established by sports bettors.[19]  New York law will also now empower the Commission to conduct financial audits of casinos and mobile sports wagering licensees and mandate that the Commission publish an annual report sharing the aggregate information that the Commission receives across all sports betting entities.[20]

Mobile sports wagering operators must satisfy a number of compliance requirements as “condition[s] of licensure.”[21]  For instance, they must limit sports bettors to a single account, take steps to ensure “to a reasonable degree of certainty” that individuals are only placing bets from within New York State, prevent minors from participating in any sports wagering, and avoid running advertisements that mislead players about the odds of winning on a bet.[22]

Conclusion

New York’s mobile sports wagering law stands on solid constitutional ground.  By deeming online bets to take place at the location of the servers housed on casinos’ premises, the new law follows the proposal made by Gibson Dunn attorneys last year and is consistent with the New York State Constitution.

___________________

   [1]   Mylan Denerstein, Akiva Shapiro & Lee R. Crain, The Constitutionality of Mobile Sports Betting in New York State, N.Y. L.J. (Jan. 31, 2020), https://www.law.com/newyorklawjournal/2020/01/31/
the-constitutionality-of-mobile-sports-wagering-in-new-york-state/.

   [2]   N.Y. Rac. Pari-Mut. Wag. & Breed. Law (PML) § 1367–a(4)(i) (post-2021 amend.).

   [3]   N.Y. Const. art. I, § 9.  These casinos authorized by the State Constitution do not include those that Native American tribes may operate pursuant to the Indian Gaming Regulatory Act, 18 U.S.C. §§ 1166–1168 and 25 U.S.C. §§ 2701 et seq.

   [4]   See PML § 1367 (pre-2021 amend.).

   [5]   Id. § 1367(3)(b), (d).

   [6]   Denerstein, Shapiro & Crain, supra note 1.

   [7]   PML § 1367–a(2)(d) (post-2021 amend.) (emphasis added).

   [8]   S.B. S2509, 2021 Leg., 2021–2022 Sess., Part Y, § 2 (N.Y. 2021) (emphasis added).

   [9]   See, e.g., All Am. Crane Serv. Inc. v. Omran, 58 A.D.3d 467, 467 (1st Dep’t 2009) (noting that laws are “presumed to be supported by facts known to the legislative body”).

  [10]   PML § 1367(1)(b) (post-2021 amend.).

  [11]   18 U.S.C. § 1084(a)–(b); cf. Murphy v. Nat’l Collegiate Athletic Ass’n, 138 S. Ct. 1461, 1483 (2018) (emphasizing that “federal policy” is to “respect the policy choices of the people of each State on the controversial issue of gambling”).

  [12]   PML § 1367–a(7) (post-2021 amend.).

  [13]   Id. § 1367–a(7)(d).

  [14]   Id. § 1367–a(7)(b).

  [15]   PML § 1367–a(2)(b), (3).

  [16]   Id. § 1367(7).

  [17]   Id.

  [18]   Id. § 1367(7)–(8).

  [19]   Id. § 1367(6).

  [20]   Id. § 1367(6), (9).

  [21]   Id. § 1367–a(4).

  [22]   Id.

The following Gibson Dunn lawyers prepared this client alert: Mylan Denerstein, Akiva Shapiro, Lee Crain, Michael Klurfeld, Grace Assaye* and Lavi Ben Dor*.

Gibson, Dunn & Crutcher’s lawyers are available to assist with any questions you may have regarding these issues. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, or the following authors in New York:

Mylan L. Denerstein – Co-Chair, Public Policy Practice (+1 212-351-3850, [email protected])
Akiva Shapiro (+1 212-351-3830, [email protected])
Lee R. Crain (+1 212-351-2454, [email protected])
Michael Klurfeld (+1 212-351-6370, [email protected])

*Ms. Assaye and Mr. Ben Dor are not yet admitted to practice law in New York and currently are practicing under the supervision of members of the New York Bar.

© 2021 Gibson, Dunn & Crutcher LLP

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

New York associate Alex Marcellesi is the author of “Evaluating Creditor Continuity of Interest: A 10-Step Process,” [PDF] published by Tax Notes Federal on March 15, 2021.

On April 6, 2021, New York Governor Andrew Cuomo signed into law Senate Bill 297B/Assembly Bill 164B (the “New York LIBOR Legislation”), the long anticipated New York State legislation addressing the cessation of U.S. Dollar (“USD”) LIBOR.[1]  The New York LIBOR Legislation generally tracks the legislation proposed by the Alternative Reference Rates Committee (“ARRC”).[2] It provides a statutory remedy for so-called “tough legacy contracts,” i.e., contracts that reference USD LIBOR as a benchmark interest rate but do not include effective fallback provisions in the event USD LIBOR is no longer published or is no longer representative, and that will remain in existence beyond June 30, 2023 in the case of the overnight, 1 month, 3 month, 6 month and 12 month tenors, or beyond December 31, 2021 in the case of the 1 week and 2 month tenors.[3]

Under the new law, if a contract governed by New York law (1) references USD LIBOR as a benchmark interest rate and (2) does not contain benchmark fallback provisions, or contains benchmark fallback provisions that would cause the benchmark rate to fall back to a rate that would continue to be based on USD LIBOR, then on the date USD LIBOR permanently ceases to be published, or is announced to no longer be representative, USD LIBOR will be deemed by operation of law to be replaced by the “recommended benchmark replacement.” The New York LIBOR Legislation provides that the “recommended benchmark replacement” shall be based on the Secured Overnight Financing Rate (“SOFR”) and shall have been selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York or the ARRC for the applicable type of contract, security or instrument. The recommended benchmark replacement will include any applicable spread adjustment[4] and any conforming changes selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York or the ARRC.

The New York LIBOR Legislation also establishes a safe harbor from liability for the selection and use of a recommended benchmark replacement and further provides that a party to a contract shall be prohibited from declaring a breach or refusing to perform as a result of another party’s selection or use of a recommended benchmark replacement.

It should be noted that the New York LIBOR Legislation does not affect contracts governed by jurisdictions other than New York, and that the parties to a contract governed by New York law remain free to agree to a fallback rate that is not based on USD LIBOR or SOFR; the new law does not override a fallback to a non-USD LIBOR based rate (e.g., the Prime rate) agreed to by the parties to a contract. Although this legislation provides crucial safeguards, it should not be viewed as a substitute for amending legacy USD LIBOR contracts where possible. Rather, it should be viewed as a backstop in the event that counterparties are unwilling or unable to agree to adequate fallback language prior to the cessation date or date of non-representativeness.

The ARRC, the Federal Reserve Board and several industry associations and groups have expressed their strong support for the new law.[5]

__________________

   [1]   See https://www.nysenate.gov/legislation/bills/2021/S297.

   [2]   See https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/libor-legislation-with-technical-amendments.

   [3]   We note that certain contracts, such as derivatives entered into under International Swaps and Derivatives Association (ISDA) standard documentation, provide for linear interpolation of the 1 week and 2 month USD LIBOR tenors until USD LIBOR ceases to exist for all tenors on June 30, 2023. The New York LIBOR Legislation provides that if the first fallback in a contract is linear interpolation, then, for the 1 week or 2 month tenor USD LIBOR contracts, the parties to the contract would continue to use linear interpolation for the period between December 31, 2021 and June 30, 2023. See the definition of “LIBOR Discontinuance Event” and “LIBOR Replacement Date” in the New York LIBOR Legislation.

   [4]   Note that the ICE Benchmark Administration Limited and the UK Financial Conduct Authority formally announced LIBOR cessation and non-representative dates for USD LIBOR on March 5, 2021. These announcements fixed the spread adjustment contemplated under certain industry-standard documents. See Gibson Dunn’s Client Alert: The End Is Near: LIBOR Cessation Dates Formally Announced, available at https://www.gibsondunn.com/the-end-is-near-libor-cessation-dates-formally-announced/.

   [5]   See “ARRC Welcomes Passage of LIBOR Legislation by the New York State Legislature,” ARRC (March 24, 2021, available at https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/20210324-arrc-press-release-passage-of-libor-legislation; see also, Randall Quarles, Keynote Address at the “The SOFR Symposium: The Final Year,” an event hosted by the Alternative Reference Rates Committee, New York, New York (March 22, 2021), available at https://www.federalreserve.gov/newsevents/speech/quarles20210322a.htm.

Gibson Dunn’s lawyers are available to answer questions about the LIBOR transition in general and these developments in particular. Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Capital Markets, Derivatives, Financial Institutions, Global Finance or Tax practice groups, or the following authors of this client alert:

Andrew L. Fabens – New York (+1 212-351-4034, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
John J. McDonnell – New York (+1 212-351-4004, [email protected])

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

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

Derivatives Group:
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
Darius Mehraban – New York (+1 212-351-2428, [email protected])
Erica N. Cushing – Denver (+1 303-298-5711, [email protected])

Financial Institutions Group:
Matthew L. Biben – New York (+1 212-351-6300, [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])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, [email protected])

Global Finance Group:
Aaron F. Adams – New York (+1 212 351 2494, [email protected])
Linda L. Curtis – Los Angeles (+1 213 229 7582, [email protected])
Ben Myers – London (+44 (0) 20 7071 4277, [email protected])
Michael Nicklin – Hong Kong (+852 2214 3809, [email protected])
Jamie Thomas – Singapore (+65 6507 3609, [email protected])

Tax Group:
Sandy Bhogal – London (+44 (0) 20 7071 4266, [email protected])
Benjamin Fryer – London (+44 (0) 20 7071 4232, [email protected])
Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224/+1 212-351-2344), [email protected])
Bridget English – London (+44 (0) 20 7071 4228, [email protected])
Alex Marcellesi – New York (+1 212-351-6222, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

On March 31st, 2021, New York became the 16th state to legalize marijuana for recreational use with the enactment of Senate Bill S854A. Under the new law, it is legal for individuals 21 and older to possess and purchase up to three ounces of marijuana.  At their place of residence, individuals are also permitted to possess up to five pounds of the drug.  While the law takes effect immediately, it is expected to take the state as long as two years to fully implement it, including setting up a system to license marijuana retailers.  The law also modifies the state’s existing medical marijuana program, in place since 2014, by expanding the types of medical conditions for which marijuana can be prescribed.

Restrictions on Employers’ Hiring and Disciplinary Policies

Of particular importance to employers, the law creates new restrictions on an employer’s ability to discipline or terminate employees for using marijuana, as well as limits on employers’ ability to refuse to hire a prospective employee for consuming the drug.  Specifically, it is now unlawful for employers to refuse to hire, employ or license, or to discharge from employment or otherwise discriminate against an individual in compensation, promotion, or terms, conditions or privileges of employment because that individual uses cannabis as permitted under state law.  N.Y. Lab. Law § 201-d(2).  However, the law allows employers to take action based on an employee’s or a prospective employee’s use of marijuana where required by federal or state law, or when an employee is impaired while on the job.  N.Y. Lab. Law § 201-d(4-a).

These restrictions build on existing provisions of New York’s medical marijuana law, which treats a person’s status as a certified user of medical marijuana as a disability that employers must accommodate where reasonably possible.  See N.Y. Pub. Health Law § 3369.  They also come on the heels of a law that took effect in New York City in May 2020, prohibiting employers from testing job applicants for marijuana usage.  See N.Y.C. Admin. Code § 8-107(31)(a).  New York City’s law exempts employers in certain cases, such as where the applicant is being considered for a safety-sensitive position.  N.Y.C. Admin. Code § 8-107(31)(b).

Trend in State and Local Laws

With the enactment of S854A, New York becomes the third state in 2021 to liberalize its laws governing marijuana use.  In February 2021, New Jersey also legalized recreational marijuana, and starting in July 2021 residents of South Dakota will be permitted to use marijuana for certain medical reasons.  Both New Jersey’s and South Dakota’s laws also place restrictions on when employers can take action based on an employee’s or job applicant’s marijuana use.  See N.J. Stat. § 24:6I-52(a); S.D. Codified Laws § 34-20G-22.

In total, 19 states and the District of Columbia now have laws restricting employers’ ability to take marijuana usage into account when making employment decisions.  These laws vary widely both in how extensively they limit employers’ actions, as well as in the number and types of exceptions they allow, creating a patchwork of different legal obligations across the country that employers must navigate.  New York’s new restrictions are among the most extensive in the nation, and will require many employers to make significant changes to longstanding drug testing and employment policies.

Takeaways for Employers

  • Employers in New York State should review their policies governing drug use among employees and job applicants to ensure they are in compliance with the new restrictions on basing employment decisions on a person’s consumption of marijuana.
  • Employers with operations in multiple states should closely examine applicable state and local laws to ensure they are in compliance with the unique limitations on how marijuana use is treated in the workplace in different jurisdictions. A uniform, one-size-fits-all policy on drug use is, in many cases, no longer feasible for employers with nationwide operations.
  • Employers should closely monitor developments in this area as states and cities adopt new laws. The rules governing how marijuana use is treated when making employment decisions are changing rapidly across the country, and employers may find that longstanding employment practices need to be adjusted as this trend continues.

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

Gabrielle Levin – New York (+1 212-351-3901, [email protected])
Blake Lanning* – Washington, D.C. (+1 202-887-3794, [email protected])

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

Labor and Employment Group:
Catherine A. Conway – Los Angeles (+1 213-229-7822, [email protected])
Jason C. Schwartz – Washington, D.C. (+1 202-955-8242, [email protected])

*Mr. Lanning is admitted only in Indiana, and is currently practicing under the supervision of members of the District of Columbia Bar.

© 2021 Gibson, Dunn & Crutcher LLP

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

Los Angeles partners James Zelenay Jr. and Nick Hanna and associate Sean Twomey are the authors of “COVID relief will spur False Claims Act enforcement,” [PDF] published by the Daily Journal on March 31, 2021.

There were more initial public offerings (“IPOs”) of special purpose acquisition companies (“SPACs”) in 2020 alone than in the entire period from 2009 until 2019 combined, and in the first three months of 2021, there have been more SPAC IPOs than there were in all of 2020. All of these newly public SPACs are looking for business combinations and many private companies are or will be considering a combination with a SPAC as a way to go public.

After an IPO, a SPAC has a limited amount of time to acquire a target company. Many of these business combinations move quickly and a private company becomes a public reporting company in a relatively short period of time. It is important for sponsors, target companies and investors to be aware of some of the special attributes of SPACs and the post-business combination public company.

On March 31, 2021, the staff of the Division of Corporation Finance (the “Staff”) of the Securities and Exchange Commission (the “SEC”) issued a statement addressing certain accounting, financial reporting and governance issues related to SPACs and the combined company following a SPAC business combination.

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The following Gibson Dunn attorneys assisted in preparing this update: Hillary Holmes, Peter Wardle, Gerald Spedale and Rodrigo Surcan.

This edition of Gibson Dunn’s Federal Circuit Update summarizes key petitions for certiorari in cases originating in the Federal Circuit, addresses the Federal Circuit’s announcement that Judge Wallach will be taking senior status and the court’s updated Rules of Practice, and discusses recent Federal Circuit decisions concerning issue preclusion, Section 101, appellate procedure for PTAB appeals, and the latest mandamus petitions on motions to transfer from the Western District of Texas.

Federal Circuit News

Supreme Court:

Today, the Court decided Google LLC v. Oracle America, Inc. (U.S. No. 18-956).  In a 6-2 decision, the Court held that because 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 Java API was a fair use of that material as a matter of law.  The Court did not decide the question whether the Copyright Act protects software interfaces.  “Given the rapidly changing technological, economic, and business-related circumstances,” the Court explained, “[the Court] should not answer more than is necessary to resolve the parties’ dispute.”  The Court therefore assumed, “purely for argument’s sake,” that the Java interface is protected by copyright.

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 will hear argument on the doctrine of assignor estoppel on Wednesday, April 21, 2021, in Minerva v. Hologic.

Noteworthy Petitions for a Writ of Certiorari:

There are three new potentially impactful certiorari petitions that are currently before the Supreme Court:

Ono Pharmaceutical v. Dana-Farber Cancer Institute (U.S. No. 20-1258):  “Whether the Federal Circuit erred in adopting a bright-line rule that the novelty and non-obviousness of an invention over alleged contributions that were already in the prior art are ‘not probative’ of whether those alleged contributions were significant to conception.”

Warsaw Orthopedic v. Sasso (U.S. No. 20-1284):  “Whether a federal court with exclusive jurisdiction over a claim may abstain in favor of a state court with no jurisdiction over that claim.”

Sandoz v. Immunex (U.S. No. 20-1110):  “May the patent owner avoid the rule against double patenting by buying all of the substantial rights to a second, later-expiring patent for essentially the same invention, so long as the seller retains nominal ownership and a theoretical secondary right to sue for infringement?”

The petitions in American Axle & Manufacturing, Inc. v. Neapco Holdings LLC (U.S. No. 20-891) and Ariosa Diagnostics, Inc. v. Illumina, Inc. (U.S. No. 20-892) are still pending.

After requesting a response, the Court denied Argentum’s petition in Argentum Pharmaceuticals LLC v. Novartis Pharmaceuticals Corporation (U.S. No. 20-779).  Gibson Dunn partners Mark Perry and Jane Love were counsel for Novartis.

Other Federal Circuit News:

Judge Wallach to Retire.  On March 16, 2021, the Federal Circuit announced that Judge Evan J. Wallach will retire from active service and assume senior status, effective May 31, 2021.  Judge Wallach served on the Federal Circuit for nearly 10 years and, prior to that, served on the U.S. Court of International Trade for 16 years.  Judge Wallach’s full biography is available on the court’s website.  On March 30, President Biden announced his intent to nominate Tiffany Cunningham for the empty seat.  Ms. Cunningham has been a partner in the Patent Litigation practice of Perkins Coie LLP since 2014, and serves on the 17-member Executive Committee of the firm.  She began her legal career as a law clerk to Judge Dyk.

Federal Circuit Practice Update

Updated Federal Circuit Rules.  Pursuant to the court’s December 9, 2020 public notice, the court has published an updated edition of the Federal Circuit Rules.  This edition incorporates the emergency amendment to Federal Circuit Rule 15(f) brought about by the court’s en banc decision in NOVA v. Secretary of Veterans Affairs (Fed. Cir. No. 20‑1321).

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.

Case of Interest:

New Vision Gaming & Development, Inc. v. SG Gaming, Inc. (Fed. Cir. No. 20‑1399):  This case concerns “[w]hether the unusual structure for instituting and funding AIA post-grant reviews violates the Due Process Clause in view of Tumey v. Ohio, 273 U.S. 510 (1927), and its progeny, which establish ‘structural bias’ as a violation of due process.”  It attracted an amicus brief from US Inventor in support of appellant, which argues that the administrative patent judges’ compensation and performance rating system affects their decision making.  Panel M will hear argument in New Vision Gaming on April 9, 2021, at 10:00 AM Eastern.

Key Case Summaries (March 2021)

SynQor, Inc. v. Vicor Corp. (Fed. Cir. No. 19-1704):  In an inter partes reexamination (“IPR”), the Patent Trial and Appeal Board (“PTAB”) found several claims of SynQor’s patent unpatentable over the prior art.  SynQor appealed, arguing that common law preclusion arising from a prior reexamination involving two related patents collaterally estopped the Board from finding a motivation to combine.

The Federal Circuit panel majority (Hughes, J., joined by Clevenger, J.) vacated and remanded, holding that common law issue preclusion can apply to IPRs.  Analyzing the statutory scheme, the majority determined that Congress did not intend to prevent application of common law estoppel.  Instead, the estoppel provisions of 35 U.S.C. §§ 315(c), 317(b) were more robust than common law collateral estoppel and fully consistent with allowing common law estoppel.  The majority also determined that IPRs satisfied the traditional elements of issue preclusion.  The majority explained that unlike an ex parte reexamination, Congress provided the third-party reexamination requestor the opportunity to fully participate in inter partes proceedings.  The majority also determined that inter partes reexaminations contained sufficient procedural elements necessary to invoke issue preclusion.  In an IPR, a party has the opportunity to respond to the other party’s evidence, challenge an expert’s credibility and submit its own expert opinions.  Thus, the majority found that the lack of cross-examination did not prevent common law issue preclusion from applying to IPRs.

Judge Dyk dissented, arguing that common law issue preclusion should not apply to inter partes reexaminations because of the lack of compulsory process and cross-examination.

In Re: Board of Trustees of the Leland Stanford Junior University (Fed. Cir. No. 20-1012):  The PTAB affirmed the examiner’s final rejection of Stanford’s claims directed to determining haplotype phase, on the basis that the claims were ineligible.  The process of haplotype phasing involves determining from which parent an allele was inherited.  The PTAB held that the claims were directed to “receiving and analyzing information,” which are “mental processes within the abstract idea category,” and that the claims lacked an inventive concept.

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 “mathematically calculating alleles’ haplotype phase.”  At step two, it held that the claims lacked an inventive concept, noting that the claims recited no steps that “practically apply the claimed mathematical algorithm.”  The court held that, instead, the claims merely stored the haplotype phase information, which could not transform the abstract idea into patent-eligible subject matter.  It further held that the dependent claims recited limitations amounting to no more than an instruction to apply that abstract idea.

Mylan Laboratories v. Janssen Pharmaceutica (Fed. Cir. No. 20-1071):  Mylan petitioned for IPR of Janssen’s patent.  Janssen opposed institution on the grounds that instituting the IPR would be an inefficient use of the PTAB’s resources because of two co-pending district court actions: one against Mylan and a second against Teva Pharmaceuticals that was set to go to trial soon after the institution decision.  The Board applied its six-factor standard articulated in Fintiv and denied institution.  Mylan appealed and requested mandamus relief; arguing that denying IPR based on litigation with a third party undermined Mylan’s constitutional and other due process rights, and that application of the six-factor standard violated congressional intent.

The Federal Circuit (Moore, J., joined by Newman, J. and Stoll, J.) granted Janssen’s motion to dismiss the appeal and denied Mylan’s petition for a writ of mandamus.  The court dismissed Mylan’s direct appeal and reiterated that the court lacks jurisdiction over appeals from decisions denying institution because Section 314(d) specifically makes institution decisions “nonappealable.”  The court noted that “judicial review [of institution decisions] is available in extraordinary circumstances by petition for mandamus,” even though “the mandamus standard will be especially difficult to satisfy” when challenging a decision denying institution of an IPR.  Indeed, the court noted that “it is difficult to imagine a mandamus petition that challenges a denial of institution and identifies a clear and indisputable right to relief.”  Considering the merits of Mylan’s petition, the court explained that “there is no reviewability of the Director’s exercise of his discretion to deny institution except for colorable constitutional claims,” which Mylan had failed to present.

Uniloc 2017 v. Facebook (Fed. Cir. No. 19-1688):  Uniloc appealed from a PTAB ruling that the petitioners were not estopped from challenging the claims and that the patents at issue were invalid as obvious.  Facebook filed two IPR petitions and then joined an IPR petition that had been previously filed by Apple, which challenged only a subset of the claims in the Facebook petitions.  LG then joined Facebook’s two petitions, but not Apple’s.  After instituting trial on Facebook’s two IPR petitions, the PTAB issued it final written decision in the Apple IPR, upholding the validity of Apple’s claims.  The PTAB determined that, as of the final written decision on the Apple IPR, Facebook was estopped from challenging the overlapping claims in its own IPR petitions under § 315 (e)(1).  LG, however, was not estopped from challenging the overlapping claims.

The Federal Circuit (Chen, J., joined by Lourie, J. and Wallach, J.) affirmed.  The panel first determined that it had jurisdiction to review the challenge because the final written decision in the Apple IPR did not issue until after the institution of trial on the Facebook petitions.  Next, the panel held that LG was not a real-party-at-interest or privy of Facebook because there was no evidence of any sort of preexisting, established relationship that indicates coordination related to the Apple IPR.  According to the panel, moreover, Facebook was not estopped from addressing the non-overlapping claims (even the claim that depended from an overlapping claim) because § 315 (e)(1) specifically applies to claims in a patent.  The panel then addressed the PTAB’s obviousness determination regarding the challenged claims and affirmed the Board’s obviousness findings as supported by substantial evidence.

In Re TracFone Wireless (Fed. Cir. No. 21-118): Precis Group sued TracFone in the Western District of Texas, alleging that venue was proper because TracFone has a store in San Antonio.  TracFone moved to transfer on the grounds that venue was inconvenient, as well as improper because it no longer has a branded store in the district.  For several months, the district court (Judge Albright) did not decide the motion, and instead kept the case moving towards trial.  After eight months, TracFone petitioned the Federal Circuit for a writ of mandamus.

In its decision granting mandamus, the Federal Circuit (Reyna, J., joined by Chen, J. and Hughes, J.) ordered Judge Albright to “issue its 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.”  It also ordered that all proceedings in the case be stayed until further notice.  Notably, the court explained “that any familiarity that [the district court] has gained with the underlying litigation due to the progress of the case since the filing of the complaint is irrelevant when considering the transfer motion and should not color its decision.”  Judge Albright denied the motion to transfer the day after the mandamus decision issued.

The Federal Circuit has recently denied two other petitions for mandamus involving cases before Judge Albright.  In In re Adtran, Inc. (Fed. Cir. No. 21-115), the court denied a petition for mandamus directing Judge Albright to stay all deadlines unrelated to venue pending a decision on transfer.  In In re True Chemical Solutions (Fed. Cir. No. 21-131), the court denied a petition for mandamus reversing Judge Albright’s grant of a motion for intra-division transfer.  Notably, Judge Albright now oversees 20% of new US patent cases (link).

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])

Intellectual Property Group:
Wayne Barsky – Los Angeles (+1 310-552-8500, [email protected])
Josh Krevitt – New York (+1 212-351-4000, [email protected])
Mark Reiter – Dallas (+1 214-698-3100, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

Decided April 5, 2021

Google LLC v. Oracle America, Inc., No. 18-956

Today, the Supreme Court held 6-2 that Google’s use of the Java interface in the Android platform falls within the fair use doctrine. 

Background:
Sun Microsystems launched the Java platform in the 1990s to allow software developers to write and run applications in the Java programming language. The Java platform includes pre-written code to perform a number of common functions (e.g., calculating an arithmetic mean), which software developers can incorporate directly into their own applications through the use of the Java software interface. By using Java’s software interface in their applications, developers avoid having to compose the underlying, functional code themselves.

Google launched its Android operating system in 2008. Like Java, Android includes pre-written code to perform certain common functions, making it easier for developers to create applications for Android. Although the code used by Android to perform these functions is entirely original, Android used portions of Java’s software interface. By doing so, Google allowed developers to create applications for Android using the same interface that they use to create applications for Java. In all, Android uses 11,330 lines (or 0.4 percent) of Java’s software interface.

After acquiring Java from Sun Microsystems, Oracle sued Google for copyright infringement based on Android’s use of the Java software interface. The district court concluded that copyright protection did not extend to the Java software interface, but the Federal Circuit reversed, concluding that Java’s software interface is protectable under copyright law and that the merger doctrine, which bars copyright protection when there are only a few ways to express a function, was inapplicable. On remand, a jury found that Google’s use of the Java software interface was protected under the fair use doctrine, but the Federal Circuit again reversed.

Issue:
Does the Copyright Act protect a software interface and, if so, does Android’s use of the Java software interface constitute fair use?

Court’s Holding:
The Court assumed, “purely for argument’s sake,” that the Java interface is protected by copyright, and held that Google’s use of that interface in the Android platform falls within the fair use doctrine.

“We reach the conclusion that in this case, 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.”

Justice Breyer, writing for the Court

What It Means:

  • The Court clarified that “fair use” is a mixed question of law and fact. Reviewing courts should appropriately defer to the jury’s findings of underlying facts, but the ultimate question whether those facts show a fair use is a legal question for judges to decide de novo.
  • The Court explained that the fair use doctrine is particularly important when applying copyright law to computer programs because they almost always serve functional purposes and are bound up with uncopyrightable material. “[F]air use can play an important role in determining the lawful scope of a computer program copyright” because it provides a context-based check that can help to keep a copyright monopoly within its lawful bound.
  • The application of fair use in this case does not undermine the general copyright protection Congress provided for computer programs because the declaring code at issue, “if copyrightable at all,” is further than most computer programs are from “the core of copyright.”  This is because, as part of a user interface, the declaring code’s use “is inherently bound together with uncopyrightable ideas (general task division and organization) and new creative expression (Android’s implementing code).”  Moreover, its value (1) derives from the value that computer programmers invest of their own time and effort to learn the API’s system and (2) lies in its efforts to encourage programmers to learn and to use that system so that they will use Sun-related implementing programs.
  • Despite Google having copied portions of the Java interface “precisely,” the Court held that its use was nonetheless “transformative” because Google used the code to “create a new platform that could be readily used by programmers.” Google’s use was therefore “consistent with that creative ‘progress’ that is the basic constitutional objective of copyright itself.”
  • Commercial use does not necessarily tip the scales against fair use. The Court explained that, even though Google’s use was a commercial endeavor, that is not dispositive of the “purpose and character of use” factor, particularly because Google’s use was transformative.
  • The Court’s fair use ruling will make it easier for platform developers to reuse software interfaces when creating new platforms. This may lead to the development of less-expensive competing versions of applications, but may also disincentivize research and development of new software platforms or languages.
  • The question whether the Copyright Act protects software interfaces remains unanswered. “Given the rapidly changing technological, economic, and business-related circumstances,” the Court explained, “[the Court] should not answer more than is necessary to resolve the parties’ dispute.” The Court therefore assumed, “purely for argument’s sake,” that the Java interface is protected by copyright.

The Court’s opinion is available here.

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

Appellate and Constitutional Law Practice

Allyson N. Ho
+1 214.698.3233
[email protected]		Mark A. Perry
+1 202.887.3667
[email protected]		Blaine H. Evanson
+1 949-451-3805
[email protected]
Lucas C. Townsend
+1 202.887.3731
[email protected]		Bradley J. Hamburger
+1 213.229.7658
[email protected]		 

Related Practice: Intellectual Property

Wayne Barsky
+1 310.552.8500
[email protected]		Josh Krevitt
+1 212.351.4000,
[email protected]		Mark Reiter
+1 214.698.3100
,[email protected]
Howard S. Hogan
+1 202.887.3640
[email protected]		  

On 25 March 2021, the Court of Justice of the EU (“CJEU”) confirmed the fines imposed in Europe on a number of pharmaceutical companies, including Xellia and Alpharma, for entering into anticompetitive ‘pay for delay’ settlement agreements.

One of the grounds of appeal rejected by the CJEU concerned the impact of the lengthy administrative procedure on Xellia’s and Alpharma’s rights of defence.  The CJEU found that Xellia and Alpharma had not proven that the Commission’s investigatory steps had taken so long as to impact their rights of defence.  In particular, Xellia and Alpharma could not blame the Commission for their own failure to preserve documents that could have assisted their defence.

The CJEU’s judgment sends a message to companies active in sectors under investigation.  Although there is no general obligation to preserve documents which would assist the Commission in the exercise of its investigatory powers in competition cases, companies are advised to preserve key documents and legal assessments for the purposes of their own defence – even when the investigation appears unconscionably dilatory.  Once aware of being a possible target of a Commission investigation, companies should preserve all relevant documents until they can be confident that no further action will be taken.  Given the recent practice of the Commission to make infringement findings against companies even where fines cannot be imposed for prescription reasons, that period of time may be very long indeed.

I. Background

In 2002, Lundbeck entered into settlement agreements with a number of generic pharmaceuticals manufacturers and resellers, including Alpharma.  The settlement agreement between Lundbeck and Alpharma was in effect until 30 June 2003.  For the period of the agreement, Alpharma generally committed not to sell generic citalopram in the EU, Norway and Switzerland, in exchange for payments from Lundbeck amounting US$ 12 million.

In October 2003, the Danish Competition Authority informed the Commission of the settlement agreements entered into by Lundbeck and the generics manufacturers and resellers.  In a press release issued on 28 January 2004, the Danish Competition Authority indicated that “the Commission [did] not wish to initiate proceedings against Lundbeck.”[1]  However, unbeknown to the public, between 2003 and 2006 the Commission conducted inspections (so-called ‘dawn raids’), primarily at Lundbeck’s premises in Europe.

In 2008 and 2009, the Commission conducted a formal inquiry into the pharmaceutical sector.  The Final Report of the Commission on the Pharmaceutical Sector Inquiry examined competition issues relevant to Lundbeck as well as Alpharma and Xellia, such as patent filing strategies (including related exchanges and litigation), as well as settlements and other related agreements.[2]

Some eight years after the Lundbeck settlement agreements, the Commission opened investigations into Lundbeck in 2010 and into Alpharma and Xellia in March 2010 and March 2011, respectively.  The Commission adopted an infringement decision in June 2013 imposing fines of approximately €146 million for ‘pay for delay’ anti-competitive agreements entered into by  Lundbeck, Alpharma, Xellia and other generic manufacturers and resellers.

On appeal before the General Court and the CJEU, Xellia and Alpharma argued that the Commission had infringed their rights of defence by failing to inform them in a timely manner of the existence of an inquiry concerning them, which allegedly caused them not to retain potentially exculpatory evidence.  In particular, Xellia and Alpharma referred to three categories of documents that had been lost due to the lapse of time: (i) drafts and comments relating to the agreements at issue, (ii) the business plans of Alpharma relating to citalopram, and (iii) the documents of external counsel.

At first instance, the General Court ruled that Xellia and Alpharma were under a duty of diligence, applicable to all investigated parties in EU antitrust proceedings, to retain all relevant documentation and evidence in order to safeguard their rights of defence.[3]  According to the General Court, the duty of diligence arose in this case due to the press release of the Danish Competition Authority of 28 January 2004, and the Commission’s Pharmaceutical Sector Inquiry of 2008-2009.[4]

The CJEU disagreed with the General Court’s reasoning.  It clarified that the duty of diligence exists but only applies to investigated companies once formal proceedings have been opened against them.  In the cases of Xellia and Alpharma, the duty did therefore not arise until 2010 and 2011, when the Commission formally opened investigations against them.  Somewhat inconsistently, the CJEU indicated that a “duty of care” should have led Xellia and Alpharma to preserve all relevant documentation as of the date of the opening of the Pharmaceutical Sector Inquiry, some four and a half years after the settlement agreements had expired.[5]

II. Obligation to Preserve Documents in EU Competition Cases

Document retention rules in Europe are generally covered by national legislation.  With regard to commercial negotiations and other business arrangements, companies are generally required under national law to preserve company books and records for a precautionary period of time (e.g., five years).

EU competition law does not impose any general obligation on companies to preserve documents that are or could be relevant to an antitrust investigation.  However, EU case law has established a general “duty of care” concerning companies and trade associations, to ensure the proper maintenance of information about their activities for evidentiary purposes.[6] Furthermore, when companies receive requests for information from the Commission, they are expected to act with greater diligence and to take all appropriate measures in order to preserve such evidence as might be reasonably available.[7]

Once an investigation is underway, companies have a general duty to cooperate in response to Commission requests for information and inspections.  In particular, the Commission has powers to request correct, accurate and complete information and documentation.[8]  Companies are also obliged to produce complete company books and records during dawn raids, and the duty of cooperation is increased when inspections have been authorised by decision.[9]

III. Deferred Detection and Lengthy Proceedings Do Not Excuse Document Losses or Short Retention Policies

General principles of EU law dictate that administrative procedures relating to competition policy must be conducted within a reasonable time.  EU Courts apply this principle by analysing the impact of lengthy investigations on the rights of defence of companies, and can reduce the amount of fines imposed where appropriate.[10]

The Commission’s failure to observe the duty to deal with a matter within a reasonable period of time normally has no effect on the validity of the administrative procedure under Regulation No. 1/2003.[11]  Limited exceptions to this general rule may be found in EU case law, for example, when the Commission fails to investigate a company for five consecutive years, thereby exceeding the statute of limitations set in Regulation No. 1/2003.[12] In order to argue successfully that their rights of defence have been infringed through the dilatoriness of the Commission’s investigation, companies must prove that they acted diligently during the different phases of an investigation and that specific and avoidable harm was caused to them.[13]

In the Alpharma and Xellia cases, the General Court considered that the Commission had carried out a number of relevant investigative steps in the period between the receipt by the Commission of the Lundbeck settlement agreements (October 2003) and the initiation of proceedings against Alpharma and Xellia (2010 and 2011, respectively).  Furthermore, the press release of the Danish Competition Authority of 28 January 2004 demonstrated that the Commission was taking an interest in Lundbeck’s settlement agreements.  Xellia and Alpharma ought to have been aware of the Commission’s likelihood of investigating ‘pay for delay’ agreements in the pharmaceutical sector, and should have acted with greater diligence to preserve any information that could be relevant for the investigation.[14]

The CJEU ultimately disagreed with the General Court on this point, considering that the “duty of diligence” did not apply during the pre-investigation phases (i.e., from 2003 to 2010-2011 in the case of Xellia and Alpharma).[15]  However, the application of the general principle of the “duty of care”, coupled with the relatively short period between the expiration of the Lundbeck settlement agreements and the Pharmaceutical Sector Inquiry (four and a half years), led the CJEU to the same conclusion as the General Court: Xellia and Alpharma could not blame the Commission for their respective failures to retain relevant evidence:

“a specific duty of care requiring [companies] to ensure that information enabling details of their activities to be retrieved is retained properly in their books or records, in order, in particular, that they have in their possession the necessary evidence in the event of subsequent administrative action or judicial proceedings. […] [A] well-informed and seasoned operator […] could not be unaware and […] take precautions against the loss, due to the passage of time, of evidence that might prove to be useful to them in the context of subsequent administrative procedures or judicial proceedings.”[16]

IV. Conclusion

Although EU legislation does not contain a formal duty to preserve documents that the Commission may seek or require to be produced during the course of an investigation, a failure to preserve information may weaken a firm’s ability to defend itself in subsequent proceedings.  In particular, the possibility of deferred enforcement or lengthy Commission investigations does not negate the fact that it is in the firm’s own interest to preserve relevant documents for the purposes of subsequent litigation.

Whilst this has always been recognised with respect to civil claims, it is now clear that firms would be well-advised to preserve potentially exculpatory materials, especially if they became aware that practices similar to those that they are engaging in have become the subject of an EU antitrust investigation.  This includes both cases against individuals firms and sector inquiries.

In practice, as a first step, such firms and their legal advisors should ensure that they have arranged appropriate document retention policies and practices for their emails, other internal documents and communications with actual or potential competitors.  As a second step, it is important to monitor legal developments affecting the sectors in which they operate, and to be aware of the different retention obligations they may face in different jurisdictions.  Finally, in taking these protective measures, companies should take into account the limited scope of legal professional privilege in EU competition cases, and to ensure that protected documents are clearly labelled as such and filed separately.

______________________

   [1]   See Case AT.39226 – Lundbeck, para. 728.

   [2]   See Pharmaceutical Sector Inquiry, Final Report, 8 July 2009, Section C.2.

   [3]   See Case T-471/13 Xellia and Alpharma v Commission, EU:T:2016:460, paras. 353 ff.

   [4]   See Case T-471/13 Xellia and Alpharma v Commission, EU:T:2016:460, para. 368.

   [5]   See Case C-611/16 P Xellia and Alpharma v Commission, EU:C:2021:245, paras. 135 ff.

   [6]   See Case T-240/07 Heineken v Commission, EU:T:2011:284, para. 301.

   [7]   See Case T-5 and 6/00 Neederlandse Federatieve Vereniging voor de Groothandel op Elektrotechnisch Gebied and Technische Unie v Commission, EU:T:2003:342, para. 87.

   [8]   See Regulation No 1/2003, Article 23(1).

   [9]   See Regulation No 1/2003, Article 23(1)(c).  Most inspections are authorised by formal Decision of the Commission. Per contra, most requests for information sent by the Commission are not made pursuant to a formal Decision (and in that sense responding may be considered to be a voluntary act).

  [10]   See Case C-445/11 P Bavaria v Commission, EU:C:2012:828, para. 77.

  [11]   See Case T-410/03 Hoechst v Commission, EU:T:2008:211, para. 227.

  [12]   See Case T-213/00 CMA CGM et al. v Commission, EU:T:2003:76, para. 482.

  [13]   See C 201/09 P and C 216/09 P ArcelorMittal Luxembourg et al. v Commission, EU:C:2011:190, para. 118; Case T-240/07 Heineken Nederland and Heineken v Commission, EU:T:2011:284, para. 300 ff;  Case T-410/03 Hoechst v Commission, EU:T:2008:211, para. 227.; and Case T-471/13 Xellia and Alpharma v Commission, EU:T:2016:460, paras. 357 and 358.

  [14]   See Case T-471/13 Xellia and Alpharma v Commission, EU:T:2016:460, paras. 353 ff.

  [15]   See Case C-611/16 P Xellia and Alpharma v Commission, EU:C:2021:245, paras.127-148.

  [16]   See Case C-611/16 P Xellia and Alpharma v Commission, EU:C:2021:245, paras.151-152.

The following Gibson Dunn lawyers prepared this client alert: Alejandro Guerrero and David Wood.

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

Antitrust and Competition Group:

Brussels
Attila Borsos (+32 2 554 72 11, [email protected])
Christian Riis-Madsen (+32 2 554 72 05, [email protected])
Lena Sandberg (+32 2 554 72 60, [email protected])
David Wood (+32 2 554 7210, [email protected])
Alejandro Guerrero (+32 2 554 7218, [email protected])

Frankfurt
Georg Weidenbach (+49 69 247 411 550, [email protected])

Munich
Michael Walther (+49 89 189 33 180, [email protected])
Kai Gesing (+49 89 189 33 180, [email protected])

London
Ali Nikpay (+44 20 7071 4273, [email protected])
Deirdre Taylor (+44 20 7071 4274, [email protected])
Philip Rocher (+44 20 7071 4202, [email protected])
Patrick Doris (+44 20 7071 4276, [email protected])
Charles Falconer (+44 20 7071 4270, [email protected])

Hong Kong
Kelly Austin (+852 2214 3788, [email protected])
Sébastien Evrard (+852 2214 3798, [email protected])

Washington, D.C.
Adam Di Vincenzo (+1 202-887-3704, [email protected])
Scott D. Hammond (+1 202-887-3684, [email protected])
Joseph Kattan (+1 202-955-8239, [email protected])
Kristen C. Limarzi (+1 202-887-3518, [email protected])
Joshua Lipton (+1 202-955-8226, [email protected])
Richard G. Parker (+1 202-955-8503, [email protected])
Michael J. Perry (+1 202-887-3558, [email protected])
Cynthia Richman (+1 202-955-8234, [email protected])
Jeremy Robison (+1 202-955-8518, [email protected])
Stephen Weissman (+1 202-955-8678, [email protected])
Andrew Cline (+1 202-887-3698, [email protected])
Chris Wilson (+1 202-955-8520, [email protected])

New York
Eric J. Stock (+1 212-351-2301, [email protected])
Lawrence J. Zweifach (+1 212-351-2625, [email protected])

Los Angeles
Daniel G. Swanson (+1 213-229-7430, [email protected])
Christopher D. Dusseault (+1 213-229-7855, [email protected])
Samuel G. Liversidge (+1 213-229-7420, [email protected])
Jay P. Srinivasan (+1 213-229-7296, [email protected])
Rod J. Stone (+1 213-229-7256, [email protected])

San Francisco
Rachel S. Brass (+1 415-393-8293, [email protected])
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Veronica S. Lewis (+1 214-698-3320, [email protected])
Mike Raiff (+1 214-698-3350, [email protected])
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© 2021 Gibson, Dunn & Crutcher LLP

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On March 25, 2021, the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) imposed additional sanctions in response to the ongoing crisis in Myanmar (also called Burma) by designating the country’s two largest military conglomerates:  (1) Myanmar Economic Holdings Public Company Limited (“MEHL”) and (2) Myanmar Economic Corporation Limited (“MEC”).

Because Myanmar’s military controls significant segments of the country’s economy, including trading, natural resources, and consumer goods, through these two companies, these designations are the most consequential sanctions measures that the Biden Administration has taken to-date in response to the situation.  By operation of OFAC’s “Fifty Percent Rule,” the sanctioned status of MEHL and MEC automatically flows to the dozens of their majority-owned subsidiaries that play critical roles throughout the country’s economy, implicating the Myanmar-based operations of numerous foreign companies that have touchpoints with the United States (over which the U.S. Government has enforcement jurisdiction).  Recognizing the far-reaching impact, OFAC has concurrently issued four general licenses (regulatory exemptions) that provide blanket authorization to engage in certain categories of activities that would otherwise be prohibited—including the wind down of any existing transactions involving MEHL, MEC, or their majority-owned subsidiaries.

Below we summarize the U.S. response thus far to the Myanmar situation, before discussing the significance of these new OFAC designations and general licenses.  We then survey briefly the latest developments in the sanctions regimes of the United Kingdom, Canada, and the European Union, which broadly align with the U.S. model.  In coordination with the United States, also on March 25, 2021, the United Kingdom designated MEHL, but did not designate MEC until April 1, 2021.  Canada, for its part, designated MEHL and MEC in 2007, and never lifted those designations.  Meanwhile, the European Union has yet to take direct action against either military conglomerate, although there are signs it might choose to do so in the near term.

An Incremental, Whole-of-Government Approach As Violence Escalates in Myanmar

On February 1, 2021, Myanmar’s military (the “Tatmadaw”) nullified the election of November 2020 that resulted in Aung San Suu Kyi’s National League for Democracy strengthening its standing in the Burmese government in comparison with the military-affiliated Union Solidarity and Development Party.  The Tatmadaw responded by seizing control of the government, detaining civilian leaders (including Aung San Suu Kyi), setting up the State Administration Council with military officers, and declaring a one-year state of emergency after which, supposedly, a new election will be held.

Ten days later, on February 11, 2021, President Biden issued Executive Order 14014—his first sanctions Executive Order—authorizing the designation of individuals and entities who, among others, directly or indirectly engaged in the situation in Myanmar or are leaders or officials of the Tatmadaw or the State Administration Council.  The initial set of designations by OFAC included six officers who played a direct role in the coup, four officers who were appointed to the State Administration Council, and three business entities owned or controlled by the military that are in Myanmar’s gem industry.  On the same day, the U.S. Commerce Department’s Bureau of Industry and Security (“BIS”) announced a license review policy of “presumption of denial” for exports or reexports to Myanmar’s Ministry of Defense, Ministry of Home Affairs, armed forces, and security services.  BIS also suspended certain previously issued licenses and license exceptions related to Myanmar.  Moreover, the Federal Reserve Bank of New York blocked the Tatmadaw from accessing more than $1 billion in Myanmar Government funds held in the United States.  This initial, multi-agency response by the U.S. Government was analyzed in detail in our February 16, 2021 client alert.

For two months, the military-controlled Myanmar Government has maintained tight control over the country, violently cracking down on civilian protests.  As of April 2, 2021, more than 500 protestors have been killed, and more than 2,900 have been arrested or charged—numbers that kept rising during the drafting of this update.  The Myanmar military has declared a series of martial law orders and has created a military court system for prosecuting these protestors.  To tamp down these protest movements, the military has also intermittently blocked certain social media platforms and imposed nightly Internet shutdowns.  As the situation in Myanmar continues, so have the calls for targeted sanctions on the military—both from activists outside Myanmar and from Myanmar’s own ambassador to the United Nations (“UN”).

The Biden administration has issued sanctions on an incremental basis in response to events taking place on the ground.  Over time, OFAC announced three additional sets of designations under Executive Order 14014 (on February 22, March 10, and March 22), which included:

  • Two members of the State Administration Council;
  • Two leaders of the police, military, or security forces;
  • Two family members of Commander-in-Chief Min Aung Hlaing, as well as six business entities that they own or control; and
  • Two Light Infantry Divisions of the military.

The Biden administration has also tightened the export-control restrictions regarding Myanmar.  On March 4, 2021, BIS removed Myanmar from Country Group B and placed it in Country Group D:1, which effectively created a more restrictive review process for exports or reexports of items subject to the Export Administration Regulations (“EAR”) to end-users in Myanmar.  That same day, BIS added MEHL, MEC, Myanmar’s Ministry of Defense, and Myanmar’s Ministry of Home Affairs to its “Entity List,” which is comprised of entities determined to pose a significant risk of involvement in activities contrary to U.S. security or foreign policy interests.  Notably, with these listings, BIS chose to impose its broadest restriction―export or reexport of any item subject to the EAR to any of the four aforementioned entities requires a BIS license, and requests for such licenses are subject to a presumption of denial.

Imposing Sanctions on MEHL and MEC

On March 25, 2021, in response to the most brutal crackdown yet, OFAC designated MEHL and MEC pursuant to Executive Order 14014.  Both MEHL and MEC were established during the old Myanmar military regime, respectively in 1990 and 1997.  They were created with the express purpose of fulfilling the needs of the military and its desire to play a central role in Myanmar’s economy—MEHL focused on light industry, while MEC focused on heavy industry and supplied strategically important natural resources for the military.  Although the two entities are not state-owned, they are supervised by senior leaders of the Tatmadaw, some of whom have been designated by OFAC.

As was previewed in President Biden’s speech that accompanied the initial February sanctions, the administration is interested in targeting the “business interests” of Myanmar military.  The latest designations were made based on the connection between the two entities and the Tatmadaw’s source of revenue.  OFAC Director Andrea Gacki stated that the designation of the two conglomerates is designed to “target[] the Burmese military’s control of significant segments of the Burmese economy, which is a vital financial lifeline for the military junta.”  Myanmar’s military and its members rely heavily on the profits earned by these holding companies.

The latest designations should have a more potent effect on Myanmar’s economy than the earlier measures.  The UN Human Rights Council reported in 2019 that there are 106 businesses owned by MEHL and MEC across diverse sectors of the Burmese economy “from construction and gem extraction to manufacturing, insurance, tourism and banking.”  By operation of OFAC’s Fifty Percent Rule, those businesses that are owned, directly or indirectly, 50 percent or more by MEHL or MEC are also automatically blocked by U.S. sanctions.  U.S. persons—and non-U.S. persons engaging in a transaction with a U.S. touchpoint—are generally prohibited from engaging in transactions involving the blocked entities, as well as their properties and interests in properties that come into U.S. jurisdiction.

A considerable number of foreign companies have commercial relationships with the newly designated entities.  When the United States and other countries eased sanctions on Myanmar beginning in 2012, companies—including many from Japan, Korea, and Singapore—took advantage of business opportunities in the Myanmar market.  According to the 2019 UN Human Rights Council report, there are 14 companies that have entered into formal joint ventures with MEHL, MEC, or their subsidiaries, and 44 additional companies with meaningful contractual or other commercial ties.  Dozens of other companies from around the world also have more removed relationships with MEHL, MEC, and/or their subsidiaries.  The degree to which the activities of any of these companies will be affected by the designations will depend on the extent to which they rely, directly or indirectly, on U.S. persons, companies, and/or financial institutions.

Parallel Issuance of New General Licenses and FAQs

Recognizing the potential collateral impact that the designations of MEHL and MEC could pose, OFAC concurrently issued four general licenses and related Frequently Asked Questions (“FAQs”):

General License 4, in particular, will be a critical authority for companies that intend to exit commercial relationships with MEHL, MEC, or their subsidiaries.  Where a designated company has significant economic importance, OFAC’s practice has been to promulgate a wind-down license to minimize the immediate disruption to non-targeted businesses and persons, and to allow parties the opportunity to disengage from the designated entity while hopefully limiting the negative impact on innocent parties.  Companies affected by the new prohibitions can now take time to carefully consider options for terminating engagements with the newly-designated entities, and how each might affect the security and safety of their employees on the ground.

In comparing General License 4 to others of its kind, we have two observations.  First, General License 4 covers the “wind down” of transactions, which is a flexible and broad concept.  However, unlike some wind-down licenses that OFAC has issued in other sanctions programs, this general license does not also cover the “maintenance” of “operations, contracts, and other agreements.”  Second, General License 4 does not impose any administrative conditions on parties taking advantage of the license.  This is in contrast to other wind-down licenses under different sanctions programs that require, for example, that U.S. persons file a report with OFAC detailing the transactions undertaken pursuant to the license or that require any payments made in covered transaction to be deposited into a blocked account.  The absence of such conditions—which can be onerous—could encourage more parties to take advantage of the license.

Notably, all four general licenses expressly limit their authorizations to transactions and activities that are prohibited by Executive Order 14014.  In relying on these licenses, parties should be careful not to engage in transactions and activities that are prohibited under another authority.  As such, the general licenses do not authorize transactions with persons or entities designated pursuant to other sanctions programs, such as Commander-in-Chief Min Aung Hlaing—who was sanctioned pursuant to Executive Order 13818 (Global Magnitsky Sanctions) for his role in the serious human rights abuses committed against the Rohingya in 2017.  As made clear in OFAC’s FAQ 400, without a general or specific license, U.S. persons are prohibited from transacting with sanctioned individuals like Min Aung Hlaing, such as by entering into contracts with them, even if they are acting on behalf of a non-blocked entity.

UK, Canada, and EU Sanctions Regimes Targeting Myanmar

When we last discussed Myanmar in our February 16, 2021 client alert, the United States was the only major state to have imposed sanctions on the military regime despite President Biden’s call for multilateralism.  That has changed.  Since February 16, 2021, the United Kingdom, Canada, and the European Union have all designated Myanmar-related actors and otherwise strengthened their respective sanctions targeting Myanmar—in ways that are complementary to the actions of the United States.

In Coordination with the United States, the United Kingdom Designates MEHL and then MEC

The United Kingdom’s own sanctions regulations regarding Myanmar went into effect on December 31, 2020, following Brexit, and in response to the Rohingya crisis.  Under the regulations, the Secretary of State may designate to the UK Sanctions List persons involved with the violation of various human rights in Myanmar, including right to life, right to liberty and security, right to a fair trial, and right to freedom of expression and peaceful assembly.  Designation results in the freezing of assets, including funds and economic resources, that are owned, held, or controlled, either directly or indirectly, by the designated person.

In response to the coup in Myanmar, the UK Foreign Commonwealth & Development Office (the “FCO”) designated three leaders of the police, military, and security forces on February 18, 2021, and five members of the State Administration Council on February 25, 2021.  On March 25, 2021, the United Kingdom joined the United States in adding MEHL to the UK Sanctions List, calling out the entity’s “involvement in serious human rights violations against the Rohingya” in 2017, as well as “its association with senior military figures.”

On April 1, 2021, the FCO added MEC to this list, noting that this designation was “in response to credible evidence that [MEC] has contributed funds to support . . . the Tatmadaw.” The FCO cited MEC’s association with senior military officers within the Tatmadaw, with MEC’s Board of Directors comprising mainly serving or retired personnel, as an additional reason for this designation.

In making the recent designations, the FCO noted that the United Kingdom “has been at the forefront of a strong, co-ordinated international response to situation in Myanmar.”  U.S. Secretary of State Blinken has also described the United Kingdom as “a close partner in our response to the coup.”

Canada’s Historical Designation of MEHL and MEC

Canada, for its part, has had targeted sanctions in place against MEHL and MEC for more than a decade.  Canada’s Myanmar-related sanctions regulations were first enacted on December 13, 2007.  As Myanmar progressed towards democratic reforms, Canada lifted its comprehensive sanctions on April 24, 2012.  While most Myanmar-related restrictions were effectively suspended, any trade in arms and related materials, as well as any technical and financial assistance related to military activities, remain prohibited.  Canada also continued to maintain sanctions against certain listed individuals and entities, including MEHL, MEC, and a number of their subsidiaries.

In response to recent events in Myanmar, on February 18, 2021, Canada designated nine senior officers of the military, the National Defence and Security Council, and the State Administration Council.  The designations brought the total number of Myanmar-related listed persons to fifty four.  Moreover, as further evidence of multilateralism, these new Canadian sanctions were announced on the same day as those imposed by the United Kingdom, reportedly as part of the two countries’ strategy of joint actions on international security issues.  In announcing the measures, Global Affairs Canada, the country’s foreign affairs department, noted that Canada’s sanctions “are part of a united response,” made “following recent measures by the United States and in coordination with the United Kingdom.”

European Union Contemplates Further Designation of Military Businesses

Prior to the coup in Myanmar, the European Union had in place a number of restrictions targeting Myanmar, including:

  • A ban on the export of equipment that can be used for political repression in Myanmar;
  • An export ban of dual-use goods for use by the Myanmar military and/or the border guard police;
  • Export restrictions on equipment for monitoring communications that could be used for political repression in Myanmar;
  • A prohibition on military cooperation with the Tatmadaw, including respective training; and
  • An arms embargo relating to Myanmar.

In addition, the European Union deploys financial sanctions that have been and remain in place against individuals and entities in Myanmar that are deemed responsible for atrocities committed against the Rohingya population.  Those designated parties are added to a consolidated list comparable to OFAC’s Specially-Designated Nationals List.

On March 22, 2021, the European Union imposed additional financial sanctions on 11 individuals considered responsible for the military coup in Myanmar and the crackdown on peaceful demonstrators that followed.  Currently, there are 25 individuals or entities designated by the European Union.

While the European Union has not designated MEHL or MEC, there are signs that it may be prepared to do so in the near term.  The European Union has stated that it is continuing to “review all of its policy options, including additional restrictive measures against economic entities owned or controlled by the military in Myanmar/Burma.”  Notably, the European Parliament, as early as February 8, 2021, urged the EU Council “to amend the current scheme of restrictive measures to include the possibility of listing companies and extending targeted sanctions to the vast economic holdings of Myanmar’s military and its members, which provide the military with its revenue.”  If the situation in Myanmar continues to deteriorate, we would not be surprised if the European Union follows its allied governments in the United States, the United Kingdom, and Canada in designating MEHL and/or MEC.

Possible Next Steps

The U.S. sanctions targeting MEHL and MEC represent a significant escalation in the economic pressure campaign against the Tatmadaw in Myanmar, members of whom exercise considerable influence over these conglomerates and profit from their many businesses.  The Biden Administration could have continued to gradually sanction the subsidiaries and affiliates of these two military conglomerates, as well as individuals associated with those entities.  Instead, it elected to sanction MEHL and MEC, knowing that restrictions would flow down to all of their majority-owned subsidiaries (by operation of OFAC’s Fifty Percent Rule).  These consequential measures may have been deemed necessary in light of the worsening situation in Myanmar.

To soften the immediate blow to those foreign companies engaged with MEHL, MEC, and/or their subsidiaries, OFAC has issued a wind-down license as it has done in the past with respect to other sanctions designations of this magnitude.  Such a license will be critical for those companies seeking to unwind their MEHL- or MEC-linked ventures, and will allow them to utilize the U.S. financial system and the U.S. dollar in doing so.  But companies will likely still face challenges in the execution of the wind-down transaction and activities.  The license, while inclusive in scope, cannot be invoked for operations that are not “ordinarily incident and necessary to” the wind-down of transactions.  Moreover, the license does not cover dealings with Commander-in-Chief Min Aung Hlaing and other individuals that are designated pursuant to other sanctions programs (e.g., Global Magnitsky Sanctions).  The license also expires on June 22, 2021, which may not be enough time for companies to effectively and safely extricate themselves from their respective arrangements.  As companies engage in the wind-down process, we anticipate that OFAC will continue to issue, modify, and renew general licenses and related guidance.

For those companies that plan to continue to operate in Myanmar, it will be important to understand the scope of U.S. sanctions restrictions, and in particular the risk of enforcement and/or designation.  The U.S. Department of Justice and OFAC continue to penalize non-U.S. companies under a theory of non-U.S. parties “causing” U.S. persons to engage in prohibited transactions.  U.S. authorities have also continued to use non-U.S. companies’ reliance on the U.S. dollar and U.S. correspondent banking as a hook to secure jurisdiction over these sorts of actions.  For that reason, it will be important for any non-U.S. company operating in Myanmar to understand the extent of its U.S. touchpoints.

In the little time that has passed since the MEHL and MEC designations, the Myanmar military has shown no signs of intending to relinquish their power.  In fact, civilian deaths have risen dramatically.  We would expect further action if this situation persists.  The U.S. Government may choose to continue targeting individuals and entities with ties to the Myanmar military pursuant to Executive Order 14014, or it could create new sanctions authorities that impose more comprehensive sanctions—either on the whole Myanmar government (see, e.g., Venezuela sanctions) or the entire country (see, e.g., Iran and Cuba sanctions).  Of course, the U.S. Government also has non-sanctions tools at its disposal.  Indeed, on March 29, 2021, U.S. Trade Representative Katherine Tai announced the suspension of U.S. trade pact with Myanmar under the 2013 Trade and Investment Framework Agreement.

Finally, we expect there to be continued coordinated action among the United States, Canada, the United Kingdom, and European Union.  The rhetoric used by officials in all four jurisdictions has highlighted the importance of multilateralism in responding to the situation in Myanmar.  That said, the sanctions regimes in these jurisdictions are not exact copies—as is evidenced by the fact that not all have sanctioned MEHL and MEC.  There will be differences that will be important to pinpoint and navigate, and that we are tracking closely.  As the aforementioned sanctions regimes converge for the most part, we do not expect the UN Security Council to do the same given the competing interests on that body.  While the UN Security Council has adopted multiple statements condemning the violence in Myanmar, countries such as China and Russia have reportedly steered the body away from even suggesting that it would impose sanctions.  We expect this to continue to be the case.

The following Gibson Dunn lawyers assisted in preparing this client update: Audi K. Syarief, Claire Yi, Adam M. Smith, Judith Alison Lee, Patrick Doris, Christopher T. Timura, Stephanie L. Connor, Richard W. Roeder, Matt Aleksic, and Rose Naing.

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])
Jesse Melman – New York (+1 212-351-2683, [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])

© 2021 Gibson, Dunn & Crutcher LLP

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

On 26 March 2021, the European Commission (the “Commission”) published guidance on the circumstances under which it is likely to accept requests from national competition authorities within the EU to investigate mergers that do not meet the EU or even national jurisdictional tests (the “Guidance”).[1] The Guidance concerns the application of the referral mechanism under Article 22 of the EU Merger Regulation, a hitherto relatively little-used provision.[2]  The Guidance firmly cements the Commission’s change in policy towards deals in the pharma and digital sectors, in particular with respect  to so-called “killer acquisitions”, designed to address an apparent enforcement gap in these sectors.[3] The effect of the Guidance is likely to increase significantly the jurisdictional reach of the Commission, and may go so far as to lead to a de facto notification process in the absence of sufficient turnover to meet mandatory filing requirements.

1.  A radical shift in the Commission’s approach

In a speech to the IBA in September 2020,[4] Commissioner Vestager (in charge of EU competition law enforcement) looked back on 30 years of EU merger control, including whether it is still right that the EU turnover-based thresholds for filings are the appropriate way to identify “mergers that matter for competition”. She noted that “these days, a company’s turnover doesn’t always reflect its importance in the market. In some industries, like the digital and pharmaceutical industries, competition in the future can strongly depend on new products or services that don’t yet have much in the way of sales”. In that speech, Vestager ruled out lowering the EUMR thresholds to capture such deals (as this would disproportionately capture a lot of irrelevant deals) and signalled that a change in approach to the Article 22 referral process “could be an excellent way to see the mergers that matter at a European scale”.

The Article 22 referral mechanism allows one or more Member States to ask the Commission to review a concentration that does not meet the EU thresholds but that (a) affects trade between Member States and (b) threatens to significantly affect competition within the territory of the Member State or States making the request. Until now, the Commission’s practice has been to discourage Article 22 referrals from Member States that did not have the power to review a deal under their own national merger control rules. This meant that deals that did not trigger national merger control in at least one Member State were not, in practice, referred for Commission review.

Vestager therefore stated that the Commission planned to “start accepting referrals from national competition authorities of mergers that are worth reviewing at the EU level – whether or not those authorities had the power to review the case themselves”.

The Guidance published on 26 March gives effect to this plan and sets out how the Commission foresees this new jurisdictional approach working.

2.  What deals are likely to be caught by this new approach

The Commission can accept referrals with respect to any deal, regardless of whether national filings might be required or not, provided that it meets the two formal conditions noted above. The Guidance makes is clear that these are low thresholds:

  • An effect on trade between Member States requires no more than “some discernible influence on the pattern of trade between Member States”, whether direct or indirect, actual or potential. The Guidance highlights that customers located in different Member States, cross-border sales/availability, collection of data across borders or the commercialisation of R&D efforts in more than on Member State would all meet this requirement.
  • Threatening to significantly affect competition within the territory of the Member State requires no more than a demonstration that “based on a preliminary analysis, there is a real risk” of such an effect. Here, the Guidance notes that this could include circumstances such as the “ elimination of a recent or future entrant, making entry/expansion more difficult, or the ability and incentive to leverage a strong market position from one market to another.

Further, given the Commission’s approach to date with respect to Article 22 referrals, in practice, we would not expect the Commission to take a restrictive approach to whether these conditions are met, particularly in cases where the Commission invites a national competition authority to make a referral request.

It is clear that the Commission’s focus is not on all deals involving new entrants, but primarily on the pharma and digital sectors where “services regularly launch with the aim of building up a significant user base and/or commercially valuable data inventories, before seeking to monetise the business” and where “there have been transactions involving innovative companies conducting research & development projects and with strong competitive potential, even if these companies have not yet finalised, let alone exploited commercially, the results of their innovation activities”.[5]

The Guidance also specifies that the Commission is most likely to exercise its discretion to investigate where the deal that has been referred to it is one in which the “turnover of at least one of the undertakings concerned does not reflect its actual or future competitive potential”. This may occur where the value of the consideration received by the seller is particularly high compared to the current turnover of the target. It may also occur where one party:

  • is a start-up or recent entrant with significant competitive potential that has yet to develop or implement a business model generating significant revenues (or is still in the initial phase of implementing such business model);
  • is an important innovator or is conducting potentially important research;
  • is an actual or potential important competitive force;
  • has access to competitively significant assets (such as for instance raw materials, infrastructure, data or intellectual property rights); and/or
  • provides products or services that are key inputs/components for other industries.

As the above, non-exhaustive list, shows, this new approach has the potential to catch almost any deal involving a new pharma or digital start-up, innovative company or company exploring new market areas. It would also clearly catch so-called “killer acquisitions” of small companies with high potential future value.

3.  How will the process work?

The Article 22 mechanism requires a Member State that wishes to make a referral to send a reasoned request to the Commission within 15 working days from when the concentration is made known to it.[6] The Commission then informs the other Member States and they have a further 15 working days to join the request if they so wish. After the expiry of this period, the Commission must decide within 10 working days if it accepts the referral request. Upon receipt of a referral request from a Member State, the Commission must inform the parties of the request. Once the parties are informed of this, the suspension obligation under the EU Merger Regulation applies and the transaction cannot be closed unless it has already been implemented.

Importantly, whilst the European merger control system is a pre-closing suspensory one and companies are used to assessing the need to factor in a Commission investigation prior to completion, the Guidance specifies that referrals can be made post-completion provided they are within a suitably short period. In this respect, the Guidance states that a period of six months is likely to be an appropriate period, although this may be longer if the deal is not made public on completion or if there is a sufficiently large potential for competition concerns or detrimental effect on consumers.

4.  What does this mean for deals?

The new approach has the potential to significantly reduce legal certainty for companies engaged in M&A activity in these sectors and to increase the procedural burdens on parties.

By moving the possibility of an EU-level review away from turnover-based thresholds, towards a more qualitative assessment of potential effects, and allowing for investigations to be opened post-completion, the Commission’s change in approach means that the EU system now mirrors that of the UK (with its broad “share of supply” test and post-completion review process) for deals that do not meet the EU merger review thresholds. The level of uncertainty that the UK’s system has meant for deals in these sectors in light of recent CMA decisions (see client alert on Roche/Spark) will now be felt at wider, EU-level.

Additionally, there is little likelihood that the Commission would refrain from using its new approach to referrals extensively.  The Guidance states that the Commission will engage actively with Member States to “identify concentrations that may constitute potential candidates for a referral” and encourages third-parties to contact either the Commission or the Member States to inform them of potential referral cases. Additionally, the Commission has, at the same time as it issued the Guidance, consulted on changes to the “simplified procedure” process to allow for easy/fast review of cases that do not raise competition concerns. The implication is that the Commission is “clearing the decks” to allow it to focus on these more interesting digital and pharma deals. We can therefore expect the Commission to actively seek out deals that might warrant an EU-level review and to secure their referral by one or more Member States.

For companies active in the pharma and digital sectors, their M&A planning will need to include not just an assessment of the relevant thresholds and filing requirements across EU Member States, but a more general assessment of the potential for an EU referral.

With the possibility that a Commission investigation could be initiated months after completion, with the attendant substantive risks, companies may find that it is advisable (at least in some circumstances) to proactively engage with the Commission to provide the information necessary to determine whether a deal is a good candidate for referral. Indeed, this type of de facto voluntary notification is expressly provided for in the Guidance.[7]

Companies’ M&A planning process will also need to factor in the potential impact on deal timing of this new approach. As section 3 above shows, the time period involved before the parties will even know if a deal is being investigated, not to mention the time involved for the actual Commission investigation, is significant.

___________________

[1]      Commission Guidance on the application of the referral mechanism set out in Article 22 of the Merger Regulation to certain categories of cases, C(2021) 1959 final, available at: https://ec.europa.eu/competition/consultations/2021_merger_control/guidance_article_22_referrals.pdf.

[2]      In the last 30 years, Article 22 referral requests by Member States  have been made only 41 times: See https://ec.europa.eu/competition/mergers/statistics.pdf (statistics to end February 2021).

[3]      In announcing the Guidance, together with the results of the Commission’s evaluation of the procedural and jurisdictional aspects of EU merger control, Executive Vice-President Margrethe Vestager, in charge of competition policy, said: “A number of transactions involving companies with low turnover, but high competitive potential in the internal market are not reviewed by either the Commission or the Member States. A more frequent use of the existing tool of referrals under Article 22 of the Merger Regulation can help us capture concentrations which may have a significant impact on competition in the internal market”.

[4]      Available at: https://ec.europa.eu/commission/commissioners/2019-2024/vestager/announcements/future-eu-merger-control_en.

[5]      See Guidance, paragraph 9.

[6]      This means being in receipt of sufficient information to make a preliminary assessment as to the existence of the criteria relevant for the assessment of the referral. It is unlikely that a newspaper article or press release would qualify as providing sufficient information for the national competition authorities to make an assessment. In practice, national competition authorities can be expected to request information from the parties about deals that have attracted their (or the Commission’s) attention and the 15-day period will start running upon receipt of the parties response to their information request.

[7]      Guidance, paragraph 24.

The following Gibson Dunn lawyers prepared this client alert: Deirdre Taylor, Attila Borsos, Christian Riis-Madsen, and Ali Nikpay.

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

Antitrust and Competition Group:

Brussels
Attila Borsos (+32 2 554 72 11, [email protected])
Christian Riis-Madsen (+32 2 554 72 05, [email protected])
Lena Sandberg (+32 2 554 72 60, [email protected])
David Wood (+32 2 554 7210, [email protected])
Alejandro Guerrero (+32 2 554 7218, [email protected])

London
Ali Nikpay (+44 20 7071 4273, [email protected])
Deirdre Taylor (+44 20 7071 4274, [email protected])
Philip Rocher (+44 20 7071 4202, [email protected])
Patrick Doris (+44 20 7071 4276, [email protected])
Charles Falconer (+44 20 7071 4270, [email protected])

Frankfurt
Georg Weidenbach (+49 69 247 411 550, [email protected])

Munich
Michael Walther (+49 89 189 33 180, [email protected])
Kai Gesing (+49 89 189 33 180, [email protected])

Hong Kong
Kelly Austin (+852 2214 3788, [email protected])
Sébastien Evrard (+852 2214 3798, [email protected])

Washington, D.C.
Adam Di Vincenzo (+1 202-887-3704, [email protected])
Scott D. Hammond (+1 202-887-3684, [email protected])
Joseph Kattan (+1 202-955-8239, [email protected])
Kristen C. Limarzi (+1 202-887-3518, [email protected])
Joshua Lipton (+1 202-955-8226, [email protected])
Richard G. Parker (+1 202-955-8503, [email protected])
Michael J. Perry (+1 202-887-3558, [email protected])
Cynthia Richman (+1 202-955-8234, [email protected])
Jeremy Robison (+1 202-955-8518, [email protected])
Stephen Weissman (+1 202-955-8678, [email protected])
Andrew Cline (+1 202-887-3698, [email protected])
Chris Wilson (+1 202-955-8520, [email protected])

New York
Eric J. Stock (+1 212-351-2301, [email protected])
Lawrence J. Zweifach (+1 212-351-2625, [email protected])

Los Angeles
Daniel G. Swanson (+1 213-229-7430, [email protected])
Christopher D. Dusseault (+1 213-229-7855, [email protected])
Samuel G. Liversidge (+1 213-229-7420, [email protected])
Jay P. Srinivasan (+1 213-229-7296, [email protected])
Rod J. Stone (+1 213-229-7256, [email protected])

San Francisco
Rachel S. Brass (+1 415-393-8293, [email protected])
Caeli A. Higney (+1 415-393-8248, [email protected])

Dallas
Veronica S. Lewis (+1 214-698-3320, [email protected])
Mike Raiff (+1 214-698-3350, [email protected])
Brian Robison (+1 214-698-3370, [email protected])
Robert C. Walters (+1 214-698-3114, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

Decided April 1, 2021

Facebook, Inc. v. Duguid, No. 19-511

Today, the Supreme Court unanimously held that a device counts as an automatic telephone dialing system under the Telephone Consumer Protection Act only if it stores or produces telephone numbers using a random or sequential number generator. 

Background:
Facebook users can provide a cell phone number that allows the company to send them a text message whenever someone attempts to access their account from an unknown device. Noah Duguid alleges that he has never used Facebook, yet received several of these login-notification text messages. Duguid brought a putative class action lawsuit against Facebook under the Telephone Consumer Protection Act (“TCPA”), claiming that each text message was a violation of the TCPA’s prohibitions on making calls using an automatic telephone dialing system (“autodialer”). The TCPA defines an autodialer as “equipment which has the capacity—(A) to store or produce telephone numbers to be called, using a random or sequential number generator; and (B) to dial such numbers.” 47 U.S.C. § 227(a)(1).

The Ninth Circuit held that Duguid had plausibly alleged violations of the TCPA, even if Facebook had not sent the texts using a random or sequential number generator. A device is an autodialer under the TCPA, the Ninth Circuit ruled, so long as it has the capacity to store and automatically dial numbers.

Issue:
Whether the definition of an autodialer in the TCPA encompasses any device that can store and automatically dial telephone numbers, even if the device does not use a random or sequential number generator.

Court’s Holding:
No. A device is an autodialer under the TCPA only if it can store or produce telephone numbers using a random or sequential number generator. A device that merely stores and then automatically dials telephone numbers, but does not have the capacity to use a random or sequential number generator, is not an autodialer and is therefore not subject to the TCPA’s prohibitions.

“Because Facebook’s notification system neither stores nor produces numbers ‘using a random or sequential number generator,’ it is not an autodialer.”

Justice Sotomayor, writing for the Court

What It Means:

  • Today’s ruling makes clear that a device is an autodialer only if it has the capacity to use a random or sequential number generator. Businesses with notification systems that do not have this capacity should be able to keep those systems in place without running afoul of the TCPA’s prohibitions on the use of autodialers.
  • The Court’s ruling may help reduce class-action litigation under the TCPA. However, the precise scope of the TCPA remains uncertain, as the Court left some important questions open—for example, what counts as a “random or sequential number generator,” and whether text messages are “calls” within the meaning of the TCPA. The Court’s opinion thus leaves the door open for the FCC to adopt regulations and guidance further limiting the TCPA’s scope.
  • In writing for the Court, Justice Sotomayor performed a close textual analysis of the TCPA’s autodialer definition. The Court’s opinion provides further confirmation that the Justices have embraced a method of statutory interpretation that concentrates on the text of statutes.
  • The Court’s decision is its second major ruling on the TCPA in the past year, following Barr v. American Association of Political Consultants, Inc., in which the Court left in place the TCPA’s ban on robocalls, while invalidating the federal-debt-collection exception.

The Court’s opinion is available here.

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

Appellate and Constitutional Law Practice

Allyson N. Ho
+1 214.698.3233
[email protected]		Mark A. Perry
+1 202.887.3667
[email protected]		Lucas C. Townsend
+1 202.887.3731
[email protected]
Bradley J. Hamburger
+1 213.229.7658
[email protected]		  

Related Practice: Litigation

Theodore J. Boutrous, Jr.
+1 213.229.7804
[email protected]		Randy M. Mastro
+1 212.351.3825
[email protected]		 

Related Practice: Privacy, Cybersecurity and Data Innovation

Ahmed Baladi
+33 (0)1 56 43 13 50
[email protected]		Alexander H. Southwell
+1 212.351.3981
[email protected]		S. Ashlie Beringer
+1 650.849.5327
[email protected]
Orin Snyder
+1 212.351.2400
[email protected]		Timothy W. Loose
+1 213.229.7746
[email protected]		 

Decided April 1, 2021

FCC v. Prometheus Radio Project, No. 19 1231; and

Nat’l Ass’n of Broadcasters v. Prometheus Radio Project, No. 19 1241

Today, the Supreme Court held 9-0 that the Federal Communications Commission (FCC) permissibly relaxed three decades-old rules limiting ownership of broadcast stations as part of its quadrennial regulatory review under § 202(h) of the Telecommunications Act. 

Background:
Section 202(h) of the Telecommunications Act of 1996 directs the FCC to review its media ownership rules every four years and to “repeal” or “modify” any rule that is no longer “necessary in the public interest as the result of competition.” In the FCC’s most recent review, it modified or eliminated three decades-old restrictions on the ownership of radio stations, television stations, and newspapers because it concluded that substantial competitive changes had rendered the prior rules unnecessary. No party challenged that competition analysis, but the Third Circuit nonetheless vacated the FCC’s order because it concluded that the FCC had inadequately considered the effect of its rule changes on minority and female ownership, a factor that does not appear in Section 202(h).

Issue:
Did the FCC permissibly relax its media ownership rules under Section 202(h) based on a finding that they were no longer necessary as the result of competition?

Court’s Holding:
The FCC permissibly relaxed its media ownership rules because it considered the record evidence and reasonably concluded that the rules no longer serve the public interest. The FCC further reasonably explained that its rule changes were not likely to harm minority and female ownership.

“[T]he FCC’s analysis was reasonable and reasonably explained for purposes of the APA’s deferential arbitrary-and-capricious standard.”

Justice Kavanaugh, writing for the Court

What It Means:

  • The Court’s decision clears the way for consolidation in the broadcast and newspaper industry.  It also eases the FCC’s ability to further implement the deregulatory mandate of Section 202(h).  Congress enacted that mandate in 1996 to require the FCC to keep pace with industry developments.
  • The Court applied the normal arbitrary-and-capricious standard in reviewing the FCC’s order, despite the Solicitor General’s call for special deference to the FCC under Section 202(h).
  • The Court confirmed that the Administrative Procedure Act “imposes no general obligation on agencies to conduct or commission their own empirical or statistical studies.” It further made clear that “nothing in the Telecommunications Act (or any other statute) requires the FCC to conduct its own empirical or statistical studies before exercising its discretion under Section 202(h).” If agencies lack perfect empirical data—which is “not unusual”—they generally need only make a reasonable predictive judgment based on the evidence available.
  • Because the FCC reasonably assessed effects on minority and female ownership, the Court did not reach the alternative argument that Section 202(h) does not require the FCC to consider this factor at all. Justice Thomas wrote a separate concurrence to state his view that the FCC had no obligation to consider minority and female ownership.
  • The Court reversed without remanding the case to the Third Circuit, a panel of which had retained jurisdiction over the case for the last 17 years.

The Court’s opinion is available here.

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

Appellate and Constitutional Law Practice

Allyson N. Ho
+1 214.698.3233
[email protected]		Mark A. Perry
+1 202.887.3667
[email protected]		 
Lucas C. Townsend
+1 202.887.3731
[email protected]		Bradley J. Hamburger
+1 213.229.7658
[email protected]		 

Administrative Law and Regulatory Practice

Helgi C. Walker
+1 202.887.3599
[email protected]		  

The New York State Legislature appears set to enact into law a new tax on debt financing for commercial real estate transactions involving “mezzanine debt and preferred equity investments”[1] located solely in New York City, as part of the 2021-2022 budget.

Although similar bills have failed previously, the current bills appear likely to become law.  The proposed law, reflected in both Senate Bill S2509B Pt. SS and the State Assembly Bill A03009B Pt. VV, would require mezzanine debt and preferred equity investments to be recorded and taxed in the same way that mortgages are currently.  However, the bill’s text leaves a number of important questions open to interpretation, including: whether the bill applies to debt and investments outside the real estate context; whether it would have any practical impact on preferred equity investments; and whether it will be applied retroactively.

The bill is also open to a variety of potential legal challenges, outlined below.

A 2.8% Tax on “Mezzanine Debt or Preferred Equity Investment[s]” Used to Finance Real Estate in New York City

Under the bill, a lender who finances a property subject to a mortgage in New York City[2] must also record “any mezzanine debt or preferred equity investment related to the real property upon which the mortgage instrument is filed.”[3]  And just as with recording a mortgage, the recording of the mezzanine debt or preferred equity would be associated with a tax.  The tax would be levied at the same rate and in the same manner as the tax “on the recording of a mortgage instrument financing statement.”[4]  Currently, the mortgage recordation tax in New York City on commercial properties is 2.8% of the principal debt.  Thus, borrowers from lenders whose interests are in the form of mezzanine debt or preferred equity also would have to pay an additional 2.8% tax against the amount of debt funded under these instruments.  All revenue collected from these new taxes would be remitted to the “New York City housing authority.”[5]

If a lender holding mezzanine debt or preferred equity fails to record the debt or equity under the new law, or to pay the associated tax, she would lose any “remedy otherwise available” under Article 9 of the Uniform Commercial Code.[6]  Remedies under the UCC are the usual route for owners of a debt secured by equity interests in a legal entity to foreclose on such equity collateral in the event of default.

A Lack of Clarity

Many of the details of this new mezzanine debt tax remain unclear due to ambiguities in the bill’s text.

Breadth and scope.  The bill is drafted to apply to mezzanine debt or preferred equity investment “related to … real property” and secured debt “in relation to real property.”[7]  However, the bill does not define when debt qualifies as “related to” or “in relation to” real property.  As such, the new law could be read to cover, and tax, any secured loan made to an operating company that happens to own an indirect interest in a New York City property.  Such a broad scope would have profound implications for corporate debt transactions far beyond the world of real estate debt financing. For example, a credit line to an operating company secured by an equity pledge in all of its assets, a small portion of which may include New York real estate, may be subject to taxation under this bill. Among its ambiguities, the bill does not include any allocation of debt that is secured by equity interests in New York City real estate and other assets.  Further, it has become customary for mortgage lenders on New York real estate—and in other jurisdictions where there is a lengthy time period to complete a mortgage foreclosure—to require a pledge of equity interests in the mortgage borrower as additional collateral for the loan. It is unclear whether the additional pledge of equity would require payment of a second tax on the same loan where mortgage recording taxes have already been paid.

Retroactivity.  Relatedly, the bill is unclear as to whether it seeks to require a lender to pay the recordation tax for mezzanine debt or preferred equity already financed, or whether the tax would only apply to such loan instruments that come about after the bill is enacted into law.  However, given the well-established presumption against retroactive legislation, this same lack of clarity makes it likely that a court would construe the bill not to impose a retroactive tax.[8]

Enforceability for preferred equity.  As mentioned above, a lender holding mezzanine debt or preferred equity who fails to record would lose remedies otherwise available under Article 9 of the UCC.[9]  However, lenders who hold preferred equity investments typically do not pursue UCC remedies in the first place.  Rather, because the debt is structured as equity in a joint venture, defaults are treated as breaches of partnership contracts and remedies are governed by partnership and contract law.  Thus, it is not clear if the bill would have a practical impact in these cases.

Potential Legal Challenges

As drafted, the bill may be vulnerable to legal challenge on multiple grounds.  Notably, any challenge would likely need to be brought in New York State court, not federal court.  Under the federal Tax Injunction Act, federal courts may not enjoin “the assessment, levy or collection of any tax under State law” where a remedy is available in the courts of the State.[10]

Vagueness. To the extent that the scope of the bill is materially unclear, as discussed above, it may be open to challenge as unconstitutionally vague, in violation of due process.  A statute is unconstitutionally vague when “it fails to give fair notice to the ordinary citizen that the prohibited conduct is illegal, [and] it lacks minimal legislative guidelines, thereby permitting arbitrary enforcement[.]”[11]  If expert industry actors are unable to discern which kinds of transactions and investments are subject to the new tax, and different interpretations could include or exclude entire fields of debt transaction, then the bill could likely be said to “fail to give fair notice” and create opportunities for “arbitrary enforcement.”

Retroactivity. If the bill is construed to apply retroactively, it may be subject to challenge under constitutional prohibitions against laws that “impair rights a party possessed when he acted” or which “impose[s] new duties with respect to transactions already completed.”[12]

Contracts Clause.  Relatedly, the Contracts Clause of the United States Constitution prohibits any State from “pass[ing] any . . . Law impairing the Obligations of Contracts.”[13]  To the extent one reads the bill as weakening a remedy a lender may otherwise have under a preexisting contract, the bill’s new recordation-and-tax hurdle is arguably unconstitutional.  With that said, the United States Supreme Court has severely limited the reach of the Contracts Clause.[14]

Tax on intangibles.  Under the New York Constitution, Art. 16, § 3, “[i]ntangible personal property shall not be taxed ad valorem nor shall any excise tax be levied solely because of the ownership or possession thereof[.]”  The mortgage tax, on which the new bill is based, has been held not to violate this provision because it as “a tax upon the privilege of recording a mortgage,” and not a tax on any property itself.[15]  However, the new tax is arguably distinguishable from, and not defensible under, this rationale.  First, the recording of mezzanine debt and preferred equity investments would be a requirement, not a privilege, under the new bill[16]; and second, the privileges associated with recording mezzanine debt and preferred equity would be far fewer and less significant than those associated with recording a mortgage.  On the other hand, the new bill arguably mandates recording only when a mortgage is also recorded; and it arguably would grant UCC Article 9 remedies as a new privilege associated with recording mezzanine debt and preferred equity investment.

Conclusion

Should this bill pass into law—as it seems likely to—the costs associated with financing commercial real estate transactions in New York City would increase substantially.  However, the bill’s ambiguity in certain key respects leaves open important areas for interpretation and potential legal dispute and challenge.

____________________

[1]  N.Y. State S. B. S2509B (2021), Pt. SS, § 1; N.Y. State Assemb. B. A03009B (2021), Pt. VV, § 1.

[2] See NYS Senate Bill S2509B, Pt. SS, §§ 1.1, 5.2 (2021) (“Within a city having a population of one million or more . . .”).  New York City is the only city in the State of New York with a large enough population for this to apply.

[3] Id. at § 1.1.

[4] Id. at §§ 5.1–5.3, 5.6

[5] Id. at § 7.

[6] Id. § 1.4, 5.4.

[7] Id. §§ 1.4, 5.4.

[8] See St. Clair Nation v. City of New York, 14 N.Y.3d 452, 456–57 (2010) (“It is well settled under New York law that retroactive operation of legislation is not favored by courts and statutes will not be given such construction unless the language expressly or by necessary implication requires it” (internal quotation marks omitted)).

[9] Id. at §§ 1.4, 5.4.

[10] 28 U.S.C. § 1341.

[11] People v. Bright, 71 N.Y.2d 376, 379 (N.Y. 1988).

[12] Regina Metro. Co., LLC v. New York State Div. of Hous. & Cmty. Renewal, 35 N.Y.3d 332, 365 (2020) (quoting Landgraf v. USI Film Prods., 411 U.S. 244, 278-80 (1994)).

[13] U.S. Const., Art. I, § 10, cl. 1.

[14] See, e.g., Sveen v. Melin, 138 S. Ct. 1815, 1821 (2018).

[15] S.S. Silberblatt, Inc. v. Tax Comm’n, 5 N.Y.2d 635, 640 (N.Y. 1959); see also Franklin Soc. for Home Bldg. & Sav. v. Bennett, 282 N.Y. 79, 86 (N.Y. 1939).

[16] Compare N.Y. RPP 291 (“A conveyance of real property… may be recorded”) with Section 1.1 (“any mezzanine debt or preferred equity investment … shall also be recorded”).

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 firm’s Real Estate Practice Group, or the following authors in New York:

Andrew J. Dady (+1 212-351-2411, [email protected])
Brian W. Kniesly (+1 212-351-2379, [email protected])
Andrew A. Lance (+1 212-351-3871, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

Los Angeles partner Michael Dore is the author of “Failure to Refute Should Be a Defamation Defense,” [PDF] published by Law360 on March 25, 2021.

  • Announcement represents latest effort among U.S., EU, UK, and Canadian enforcers to ratchet up scrutiny of pharma deals with an eye toward challenging more sector transactions
  • New approaches likely to focus on effects of transactions on innovation in broad therapeutic categories and the merged entity’s ability to engage in exclusionary conduct, including restricting smaller firms’ formulary placement
  • Announcement has, at a minimum, a number of potential practical implications for companies evaluating or pursuing certain pharma transactions, including longer investigations, broader discovery, and associated delays

On March 16, 2021, the U.S. Federal Trade Commission announced that it is teaming up with antitrust enforcers in the European Union, United Kingdom, Canada, and the State Attorneys General in the U.S. in an effort “to update their approach to analyzing the effects of pharmaceutical mergers.”[1]  The working group will analyze such questions as “how can current theories of harm be expanded and refreshed,” the impact posed by particular transactions on drug innovation generally, and the predictive role of an acquirer’s past anticompetitive conduct in assessing the consumer impact of a merger.  To date, it is not clear whether or how this working group might consider input from the pharmaceutical industry or other stakeholders.

The announcement follows several statements by current Acting FTC Chair Rebecca Slaughter, joined by fellow Democratic Commissioner Chopra, charging that divestitures and remedies accepted by the agency in large pharma deals did not go far enough to protect consumers from a potential decrease in innovation and higher future drug prices.[2]  Acting Chair Slaughter has criticized the established framework and methods embraced across jurisdictions for analyzing pharmaceutical deals, urging the FTC to dig deeper and take a “more expansive approach” during investigations, including through more discovery from both parties and non-parties.  And Lina Khan, who was recently nominated for appointment to the Commission, has advocated forcefully for more aggressive and expansive antitrust enforcement across sectors.

The concern about pharma deals is shared by other leading agencies.  Commenting on the launch of the working group, Margrethe Vestager, the European Commission’s Executive Vice-President in charge of competition policy, noted that “[o]ver the past years the European Commission has taken new initiatives in scrutinising global pharmaceutical mergers to ensure effective competition in the sector….  I therefore warmly welcome this initiative, which brings together some of our closest partners worldwide to take stock of the lessons learned in recent years and explore new ways to foster vibrant competition to the benefit of citizens.”

While the Democratic majority at the FTC is likely to share an interest in reining in the number and size of pharmaceutical mergers, the likely results of such efforts to develop more aggressive theories to tackle pharma deals is less certain.  Given the well-established framework adopted by U.S. courts and the agency’s own Merger Guidelines, new FTC leadership’s ambition to more aggressively challenge deals in the pharma sector faces important legal obstacles, at least in deals where merging parties have the commitment to take the FTC to court.  Specifically, settled U.S. merger case law and the agency’s Merger Guidelines, which are viewed as instructive by courts, make it difficult for enforcers to block deals without demonstrating likely anticompetitive effects within well-defined relevant markets that, according to U.S. precedent, are almost always defined quite narrowly.  Thus, a challenge to a pharmaceutical merger based principally on a theory that both companies have an important presence and strong incentives to innovate in a therapeutic area generally (such as in cardiology or neurology) is likely to be rejected by the U.S. courts as lacking the requisite proof of anticompetitive effects in a properly defined relevant market.  So, too, is a merger challenge based on a concern that a merger without significant overlaps is likely to increase the merged entity’s ability to offer bundled pricing on complementary products to attain advantageous placement on healthcare provider or insurance companies’ formularies.

The situation in other jurisdictions may however be different because of the legal frameworks under which their agencies work and the limited role for the courts.  For example, in 2019, the UK’s Competition and Markets Authority concluded – contrary to the views of most legal commentators – that it could intervene in pharma transactions on the basis of a company’s R&D efforts alone, i.e., in the absence of both parties being active in an overlapping area of supply in the UK.

Despite the legal obstacles in the U.S., the joint announcement by the FTC and other enforcers, coupled with changing leadership at the FTC, portends a number of practical considerations for any company evaluating or pursuing a pharmaceutical transaction.  These practical considerations include the following:

  • Certain types of deals likely under increased scrutiny.  In addition to the transactions that traditionally have sparked in-depth antitrust reviews (i.e., deals that seek to combine overlapping assets in an already concentrated indication or mechanism of action), we expect that the FTC and other enforcers will be giving deeper scrutiny to:
    • High-profile transactions involving large R&D-based pharma companies who participate in one or more therapeutic areas broadly, even if there is no direct overlap in certain indications;
    • Transactions that involve direct overlaps, even when both companies have pipeline projects at an early development stage (e.g., Phase 1 or early Phase 2, before pivotal clinical trials demonstrate the theoretical potential of an asset in development). These transactions are likely to attract questions when, in the past, such transactions would be viewed as virtually per se non-problematic because of the speculative nature of any theory of harm based on combining untested products still in early stages of development;
    • Transactions in which a company is acquiring an asset or technology, access to which is potentially important for innovation, such as in combination therapies; and
    • Transactions that are reportable in more than one working-group jurisdiction, especially those transactions that fit into any of the paradigms above, because those will be the most fertile ground for the working group to exchange information and fulfill its stated goals.
  • Lengthier investigations. While the FTC and Canada, unlike other jurisdictions like the EU and the UK, do not have the ability to block transactions without court intervention, which requires a significant investment of resources, they have the authority by statute to conduct in-depth probes, including by issuing burdensome and broad requests for additional information (in the U.S., so-called “Second Requests”).  Use of these investigative tools invariably delay closing pending collection and review of relevant information, and sometimes provide an important lever for enforcers in demanding remedies.  Whereas pharmaceutical companies have avoided full compliance with Second Requests in the past, increasingly such companies will need to comply in order to force a decision from the agencies.  And, if antitrust enforcers are unwilling to accept a proposed divestiture or other remedy, the only realistic path to antitrust clearance may be through litigation.  In certain cases, this possibility may warrant actions to proactively address any direct overlaps (through a “fix-it-first” strategy), effectively focusing the government’s case on a novel theory of harm.  Moreover, the threat of extensive antitrust reviews and corresponding closing delays may deter companies from pursuing certain pharma transactions in the first place.

Other practical implications flowing from the recent emphasis on more aggressive enforcement in pharma deals include increased cooperation between U.S. and foreign enforcers and more FTC use than in the past of oral depositions of company executives to secure relevant information.

We will continue to monitor closely and report on the working group’s efforts to develop new analytical approaches for pharma transactions. If you have any questions or would like additional information about these or other developments, please reach out to any of your contacts at Gibson Dunn.

_____________________

   [1]   See https://www.ftc.gov/news-events/press-releases/2021/03/ftc-announces-multilateral-working-group-build-new-approach.

   [2]   See https://www.ftc.gov/public-statements/2019/11/statement-commissioner-rebecca-kelly-slaughter-matter-bristol-myers-squibb; https://www.ftc.gov/public-statements/2020/05/dissenting-statement-commissioner-rebecca-kelly-slaughter-regarding; https://www.ftc.gov/public-statements/2020/10/dissenting-statement-commissioner-rohit-chopra-joined-commissioner-rebecca.

The following Gibson Dunn lawyers prepared this client alert: Stephen Weissman, Michael Perry, Kristen Limarzi and Ali Nikpay.

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

Antitrust and Competition Group:

Washington, D.C.
Adam Di Vincenzo (+1 202-887-3704, [email protected])
Scott D. Hammond (+1 202-887-3684, [email protected])
Joseph Kattan (+1 202-955-8239, [email protected])
Kristen C. Limarzi (+1 202-887-3518, [email protected])
Joshua Lipton (+1 202-955-8226, [email protected])
Richard G. Parker (+1 202-955-8503, [email protected])
Michael J. Perry (+1 202-887-3558, [email protected])
Cynthia Richman (+1 202-955-8234, [email protected])
Jeremy Robison (+1 202-955-8518, [email protected])
Stephen Weissman (+1 202-955-8678, [email protected])
Andrew Cline (+1 202-887-3698, [email protected])
Chris Wilson (+1 202-955-8520, [email protected])

New York
Eric J. Stock (+1 212-351-2301, [email protected])
Lawrence J. Zweifach (+1 212-351-2625, [email protected])

Los Angeles
Daniel G. Swanson (+1 213-229-7430, [email protected])
Christopher D. Dusseault (+1 213-229-7855, [email protected])
Samuel G. Liversidge (+1 213-229-7420, [email protected])
Jay P. Srinivasan (+1 213-229-7296, [email protected])
Rod J. Stone (+1 213-229-7256, [email protected])

San Francisco
Rachel S. Brass (+1 415-393-8293, [email protected])
Caeli A. Higney (+1 415-393-8248, [email protected])

Dallas
Veronica S. Lewis (+1 214-698-3320, [email protected])
Mike Raiff (+1 214-698-3350, [email protected])
Brian Robison (+1 214-698-3370, [email protected])
Robert C. Walters (+1 214-698-3114, [email protected])

London
Patrick Doris (+44 20 7071 4276, [email protected])
Charles Falconer (+44 20 7071 4270, [email protected])
Ali Nikpay (+44 20 7071 4273, [email protected])
Philip Rocher (+44 20 7071 4202, [email protected])
Deirdre Taylor (+44 20 7071 4274, [email protected])

Brussels
Peter Alexiadis (+32 2 554 7200, [email protected])
Attila Borsos (+32 2 554 72 11, [email protected])
Christian Riis-Madsen (+32 2 554 72 05, [email protected])
Lena Sandberg (+32 2 554 72 60, [email protected])
David Wood (+32 2 554 7210, [email protected])

Frankfurt
Georg Weidenbach (+49 69 247 411 550, [email protected])

Munich
Michael Walther (+49 89 189 33 180, [email protected])
Kai Gesing (+49 89 189 33 180, [email protected])

Hong Kong
Kelly Austin (+852 2214 3788, [email protected])
Sébastien Evrard (+852 2214 3798, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

Join our panelists from Gibson Dunn’s Environmental Litigation and Mass Tort practice group as they discuss significant recent developments and forecast what to expect from the Environmental Protection Agency under the new U.S. presidential administration, including anticipated agency rulemakings, enforcement targets and initiatives, action on climate change, and more. Our panelists will also provide practical tips for identifying and addressing key environmental compliance risks and strengthening corporate technical and environmental compliance and governance programs.

View Slides (PDF)

PANELISTS:

Stacie Fletcher is a litigation partner in the Washington, D.C. office and Co-Chair of the Environmental Litigation and Mass Tort Practice Group. Ms. Fletcher has handled a wide variety of cases under federal and state environmental statutes, including serving as lead counsel on numerous enforcement defense matters with the EPA and state agencies. In 2018 and 2019, Ms. Fletcher was recognized as a Euromoney LMG “Rising Star” in the area of Environmental Law, and she was named each year since 2017 by US Legal 500  as an up-and-coming “next generation” lawyer in the area of Environmental Litigation.

David Fotouhi is a partner in the Washington D.C. office and recently rejoined the firm after serving as Acting General Counsel at the EPA, where he led an office of 245 attorneys and staff. Mr. Fotouhi played a critical role in developing the litigation strategy to defend the Agency’s actions from judicial challenge. He combines his expertise in administrative and environmental law with his litigation experience and a deep understanding of EPA’s inner workings to represent clients in enforcement actions, regulatory challenges, and other environmental litigation.

Abbey Hudson is a partner in the Los Angeles office where she is a member of the Environmental Litigation and Mass Tort Practice Group. Ms. Hudson devotes a significant portion of her time to helping clients navigate environmental and emerging regulations and related governmental investigations. She has handled all aspects of environmental and mass tort litigation and regulatory compliance. She has also provided counseling and advice on environmental and regulatory compliance to clients on a wide range of issues, including supply chain transparency requirements, comments on pending regulatory developments, and enforcement counseling.

Rachel Corley is an associate in the Washington, D.C. office where she practices in the firm’s Litigation Department and is a member of the Environmental Litigation and Mass Tort Practice Group. Ms. Corley has represented clients in a wide range of federal and state litigation, including agency enforcement actions, cost recovery cases, and administrative rulemaking challenges.

MODERATOR:

Raymond Ludwiszewski is a partner in the Washington, D.C. office where he joined the firm’s Environmental Litigation and Mass Tort Practice Group after spending eight years in senior legal positions in the United States government dealing with environmental regulatory issues and litigation in the EPA and the Justice Department. He is listed in Washingtonian magazine’s Best Environmental Lawyers List, the Washington Post magazine’s Best Lawyers in America®, and Chambers USA.

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 1.5 credit hours, of which 1.5 credit hours 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.

On February 4, 2021, Senator Amy Klobuchar (D-MN) introduced S. 225, the Competition and Antitrust Law Enforcement Act (“the Klobuchar Bill”), a comprehensive legislative effort to revamp current antitrust laws and strengthen enforcement. The bill has nine cosponsors, all Democrats, including three of the four members of the Senate Judiciary Committee, Subcommittee on Competition Policy, Antitrust, and Consumer Rights (“Senate Antitrust Subcommittee”). On March 11, 2021, as the Chair of the Senate Antitrust Subcommittee, Senator Klobuchar gaveled in the first of likely many hearings on antitrust policy in the 117th session of Congress.

The Klobuchar Bill includes sweeping changes to antitrust law, such as lowering the standard that the Federal Trade Commission and Department of Justice must meet to block a merger, switching the burden of proof in certain merger cases, revising the role of market definition in merger cases, overturning existing caselaw regarding predatory pricing and other types of unilateral conduct, and imposing new civil penalties for antitrust violations.  It also provides for increased antitrust agency funding for both enforcement and studying outcomes in consummated mergers, and expanded whistleblower protections—proposals that in some instances already have cross-aisle support. The bill is currently pending before the Senate Judiciary Committee and does not yet have a House companion bill.

The Klobuchar Bill comes on the heels of more than a year of congressional hearings and investigations into the role of the antitrust laws in addressing perceived concentration across the tech sector and the broader economy.  In October of 2020, the House Judiciary Subcommittee on Antitrust, Commercial, and Administrative Law (“House Antitrust Subcommittee”) concluded a 16-month investigation into technology companies. Last Congress, the Senate also held hearings featuring testimony from top tech executives on a range of antitrust, data, and privacy issues.

If enacted into law, the Klobuchar Bill would impact antitrust enforcement across all industries.  As Senator Klobuchar recently put it, “It’s not just tech, it’s cat food to caskets.”[1]  The Klobuchar Bill takes aim at purported “higher levels of market concentration . . . driven by waves of corporate consolidation” in industries ranging from “pharmaceuticals, social media and digital technology, telecommunications, agriculture, online ticket sales, transportation, and more.”[2]

In order to become law, the Klobuchar Bill will need to pick up at least 10 Republican votes in the Senate—assuming that the Senate filibuster rules remain in place—as well as contend with tech-targeted proposals in the House that differ in substance.  As detailed in the Pathway to Passage section below, Senator Mike Lee (R-UT), the leading Republican on the Senate Antitrust Subcommittee, has signaled concerns about the Klobuchar Bill.[3]  The challenge will be moving beyond a general aversion to the power wielded by big tech companies, and finding bipartisan consensus on specific antitrust policy changes.

Key Provisions of the Klobuchar Bill

Revised Standard for Mergers.  The bill purports to change the legal standards that courts use to determine whether an acquisition is anticompetitive. The Clayton Act prohibits any acquisition or merger where the effect “may be substantially to lessen competition or to tend to create a monopoly.”  The bill revises the standard to “create an appreciable risk of materially lessening competition, or to tend to create a monopoly or a monopsony.”  The term “materially” is later defined as “more than a de minimis amount.”

The change is intended to provide more flexibility for federal agencies to challenge certain mergers.  It remains uncertain, however, how federal courts will interpret the changes.  Federal agencies already win the majority of litigated challenges.[4]  And it is unclear whether and to what extent courts will discard a well-developed body of caselaw based on a slight retooling of the legal standard.

Switch the Burden of Proof.  The bill purports to shift the burden of proof to the merging parties to demonstrate that the benefits of the transaction outweigh the potential risks in certain circumstances.  Under current law, the burden is on the government.  These enumerated circumstances include instances where:

  • The “acquisition would lead to a significant increase in market concentration”;
  • A firm with greater than 50% market share or otherwise possessing significant market power acquires a competitor or a company that has a “reasonable probability” of becoming a competitor in the relevant market;
  • The acquisition eliminates a firm that “prevents, limits, or disrupts coordinated interaction among competitors in a relevant market,” which is sometimes referred to as a “maverick” in antitrust parlance;
  • The acquisition enables the “acquiring person to unilaterally and profitably exercise market power” or “materially increase[s] the probability of coordinated interaction among competitors”;
  • The transaction is valued at more than $5 billion;
  • The acquiring party has assets, net revenue, or market capitalization above $100 billion and makes an acquisition of $50 million or more.

Some of the above modifications appear to follow agency practices and recent cases. For example, the federal agencies’ primary inquiry when reviewing a proposed transaction is whether the deal will result in higher prices, either through unilateral effects (i.e., the loss of head to head competition) or coordinated effects.[5]  Similarly, federal courts currently apply a presumption of illegality to any acquisition that increases market concentration in a well-defined relevant market in accordance with metrics used by the agencies.[6]  Furthermore, federal agencies routinely raise concerns with acquisitions that may eliminate a disruptive competitor.[7]

By expanding the presumption of illegality to cover mega-mergers and a so-called “dominant” firm’s acquisition of nascent competitors, however, the Klobuchar Bill might alter the analysis of certain types of mergers, including the following:

  • Nascent Competitor Acquisitions. The bill addresses mergers where allegedly dominant firms acquire small competitors.  The FTC and DOJ recently challenged several proposed acquisitions of nascent or potential competitors,[8] but those mergers were abandoned before the cases were litigated.
  • Start-Up Acquisitions. The bill also covers instances where large firms propose to acquire smaller companies for more than $50 million, even if those companies are not competitors and are unlikely to become competitors in the future.  Under the current legal framework, acquisitions of non-competitors rarely raise antitrust concerns.  Not only would the bill usher in a new category of potential antitrust challenges, but it would also make presumptively illegal many acquisitions that today do not require pre-merger clearance at all (for 2021, parties need only report acquisitions above $92 million).
  • Other Mergers. The presumption that any acquisition above $5 billion is anticompetitive, even if the merging parties are not competitors, might add another layer of risk, cost, and complexity to the merger review process.

Harmful Conduct By A Dominant Firm.  The Klobuchar Bill proposes to amend the Clayton Act to prohibit “dominant firms” from engaging in exclusionary conduct that presents an “appreciable risk of harming competition” within the relevant market. “Dominant firms,” according to the legislation, include those with “a market share of greater than 50 percent” or “otherwise ha[ve] significant market power,” and “exclusionary conduct” is conduct that would “materially disadvantage” competitors or “limit the ability or incentive” of competitors to compete.

The bill also provides a laundry list of “limitations”—facts that “may constitute evidence of a violation,” but that are not required to find that a specific course of conduct is exclusionary.  According to Senator Klobuchar, the list aims to overturn the “flawed court decisions” that have weakened other antitrust laws.

If enacted into law as written, the bill might lead to uncertainty about what practices constitute unlawful exclusionary conduct.  The bill’s laundry list of “limitations” enumerate circumstances that are not required to prove that a course of conduct is exclusionary; the bill provides minimal guidance about what is required to prove that conduct is exclusionary.  That uncertainty is especially problematic because many allegedly exclusionary practices have procompetitive rationales.

Pathway to Passage

The Senate.  The Klobuchar Bill appears to face an uphill battle in the Senate. Assuming that the filibuster remains intact, the bill will not pass without the support of at least 10 Republicans, assuming all Senate Democrats support the legislation.

There appears to be skepticism from across the aisle on whether a complete reworking of the antitrust laws is appropriate.  Senator Mike Lee voiced concern that this broad structural change is “misplaced,” and that, in his view, “in the rush to address our collective concerns about tech, we risk undermining the soundness and impartiality of antitrust enforcement.”[9]  During the March 11th Senate hearing he reiterated his views, stating that “what we need now is not a sweeping transformation of our antitrust laws.”  Rather, Senator Lee emphasized the need for “agency leaders who have the resources and the will to enforce the laws we have.”[10]

Not all Senate Democrats have voted in unison this Congress. At a time when the Senate is evenly divided between Democrats and Republicans, a single party defector can derail legislation, including the Klobuchar Bill.  In addition, while three of the four Democratic members of the Senate Antitrust Subcommittee have cosponsored the Klobuchar Bill, Senator Ossoff (D-GA) is the sole Democratic member of the Subcommittee who has not yet cosponsored the bill.  His support may also be helpful in moving the Klobuchar Bill through the Judiciary Committee.

House of Representatives.  Democrats in the House appear to favor many of the proposals included in the Klobuchar Bill.  Last year, in its Staff Report on competition in digital markets, the U.S. House Judiciary Committee’s Subcommittee on Antitrust, Commercial, and Administrative Law recommended Congressional actions similar to the proposals in the Klobuchar Bill.

The Staff Report recommended revamping merger policy by:

  • Shifting the burden of proof to the merging parties in cases involving concentrated markets or high market shares;[11]
  • “Prohibit[ing] acquisitions of potential rivals and nascent competitors”;
  • “Codifying a presumption against acquisitions of startups by dominant firms, particularly those that serve as direct competitors, as well as those operating in adjacent or related markets”;
  • Creating a “presumption that vertical mergers are anticompetitive when either of the merging parties is a dominant firm operating in a concentrated market”;
  • Amending the Clayton Act to prohibit acquisitions that “may lessen competition or tend to increase market power.”

And it recommended reforming monopolization law by statutorily addressing predatory pricing, essential facilities, refusals to deal, tying, and two sided platforms.[12]

Representative David Cicilline (D-RI), Chair of the House Antitrust Subcommittee, has publicly stated that he will propose legislation codifying many of the Staff Report’s recommendations.[13]  In addition to the elements that it shares in common with the Klobuchar Bill, Rep. Cicilline is expected to propose changes that might target the tech sector, such as legislation that might address firms that own and participate in online marketplaces[14]—a change that Senator Elizabeth Warren (D-MA) has proposed in the Senate as well.[15] .  On March 21, 2021, Rep. Cicilline stated that he was prepared to craft a series of narrowly tailored tech-specific bills that could be introduced as early as May.[16]

Representative Ken Buck (R-CO), the top Republican on the House Antitrust Subcommittee, has also promoted antitrust reform, including “proposals to shift the burden of proof for companies pursuing mergers and acquisitions,” “reinforcing presumptions that certain behaviors are likely to reduce competition, lowering evidentiary burdens in litigated cases, and emphasizing that anticompetitive effects are not limited to price effects and include innovation competition, quality, output, and consumer choice.”[17]

Like his Republican counterpart in the Senate, however, Rep. Buck has expressed concern that “sweeping changes could lead to overregulation and carry unintended consequences for the entire economy.  We prefer a targeted approach, the scalpel of antitrust, rather than the chainsaw of regulation.”[18]

It appears that the central debate in both the House and Senate will be whether to pass sweeping antitrust reform, or carve out targeted proposals aimed at specific industries or tech firms.

___________________

   [1]   Brent Kendall and Ryan Tracy, Congress Eyes Antitrust Changes to Counter Big Tech, Consolidation, WSJ (March 11, 2021) (available at https://www.wsj.com/articles/congress-eyes-antitrust-changes-to-counter-big-tech-consolidation-11615458603)

   [2]   https://www.klobuchar.senate.gov/public/index.cfm/2019/9/klobuchar-presses-heads-of-doj-antitrust-division-and-ftc-on-critical-issues-of-competition-in-the-u-s-economy

   [3]   https://www.lee.senate.gov/public/index.cfm/press-releases?ID=C99C6DA7-D8EE-42FB-B51E-A26B2A2F2A8A

   [4]   Since 2000, the Agencies have won more than 70% of litigated cases.

   [5]   See Horizontal Merger Guidelines §1 (“A merger can enhance market power by simply eliminating competition between the merging parties” or by “increasing the risk of coordinated, accommodating, or interdependent behavior among rivals”); id. at §§ 6 & 7 (explaining how the agencies evaluate unilateral and coordinated effects); see United States v. Aetna, 240 F. Supp. 3d 1, 43-47 (D.D.C. 2017) (evaluating evidence of unilateral and coordinated effects); United States v. H&R Block, 833 F. Supp. 2d 36, 77-89 (D.D.C. 2011) (same).

   [6]   See United States v. Baker Hughes, Inc., 908 F.2d 981, 991 (D.C. Cir. 1990) (“By showing that a transaction will lead to undue concentration in the market for a particular product in a particular geographic area, the government establishes a presumption that the transaction will substantially lessen competition.”).

   [7]   See Horizontal Merger Guidelines §2.1.5 (“If one of the merging firms has a strong incumbency position and the other merging firm threatens to disrupt market conditions with a new technology or business model, their merger can involve the loss of actual or potential competition.”).

   [8]   For example, in In re Illumina Inc. / Pacific Biosciences of California, the FTC challenged Illumina Inc.’s “$1.2 billion acquisition of Pacific Biosciences of California, alleging in an administrative complaint that Illumina is seeking to unlawfully maintain its monopoly in the U.S. market for next-generation DNA sequencing systems by extinguishing PacBio as a nascent competitive threat.” See https://www.ftc.gov/enforcement/cases-proceedings/1910035/matter-illumina-incpacific-biosciences-california-inc. The parties abandoned the transaction.  Similarly, DOJ sued Visa to block its acquisition of Plaid, asserting in its complaint that “the transaction would have enabled Visa to eliminate this competitive threat to its online debit business before Plaid had a chance to succeed, thereby enhancing or maintaining its monopoly.”  The parties terminated the deal.  See https://www.justice.gov/opa/pr/visa-and-plaid-abandon-merger-after-antitrust-division-s-suit-block

   [9]   https://www.foxnews.com/opinion/sen-mike-lee-facebook-google-others-have-big-problems-but-antitrust-law-is-not-the-answer

  [10]   Senate Hearing on Antitrust Law and Consumer Rights at 20:20, available at https://www.c-span.org/video/?509765-1/senate-hearing-antitrust-law-consumer-rights

  [11]   Staff Report at 393, available at https://judiciary.house.gov/uploadedfiles/competition_in_digital_markets.pdf

  [12]   Staff Report at 395-99.

  [13]   https://www.bloomberg.com/news/articles/2021-02-22/congress-must-seize-moment-to-reform-antitrust-cicilline-says

  [14]   https://www.politico.com/news/2020/10/06/house-democrats-antitust-overhaul-big-tech-426840

  [15]   https://www.nytimes.com/2019/03/08/us/politics/elizabeth-warren-amazon.html

  [16]   https://www.axios.com/tech-antitrust-facebook-google-amazon-apple-275f122d-b3f5-49cb-b223-f77c95a49252.html

  [17]   Rep. Buck Report at 5, available at https://www.politico.com/f/?id=00000174-fa7f-db77-abfe-fe7f5d740000

  [18]   Rep. Buck Report at 6.

The following Gibson Dunn lawyers prepared this client alert: Michael Bopp, Adam Di Vincenzo, Roscoe Jones, Jr., Kristen Limarzi, Richard Parker, Ciara Davis, and Christopher Kopp.

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, or any member of the firm’s Antitrust and Competition or Public Policy practice groups:

Public Policy Group:

Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Roscoe Jones, Jr. – Washington, D.C. (+1 202-887-3530, [email protected])

Antitrust and Competition Group:

Washington, D.C.
Adam Di Vincenzo (+1 202-887-3704, [email protected])
Scott D. Hammond (+1 202-887-3684, [email protected])
Joseph Kattan (+1 202-955-8239, [email protected])
Kristen C. Limarzi (+1 202-887-3518, [email protected])
Joshua Lipton (+1 202-955-8226, [email protected])
Richard G. Parker (+1 202-955-8503, [email protected])
Michael J. Perry (+1 202-887-3558, [email protected])
Cynthia Richman (+1 202-955-8234, [email protected])
Jeremy Robison (+1 202-955-8518, [email protected])
Stephen Weissman (+1 202-955-8678, [email protected])
Andrew Cline (+1 202-887-3698, [email protected])
Chris Wilson (+1 202-955-8520, [email protected])

New York
Eric J. Stock (+1 212-351-2301, [email protected])
Lawrence J. Zweifach (+1 212-351-2625, [email protected])

Los Angeles
Daniel G. Swanson (+1 213-229-7430, [email protected])
Christopher D. Dusseault (+1 213-229-7855, [email protected])
Samuel G. Liversidge (+1 213-229-7420, [email protected])
Jay P. Srinivasan (+1 213-229-7296, [email protected])
Rod J. Stone (+1 213-229-7256, [email protected])

San Francisco
Rachel S. Brass (+1 415-393-8293, [email protected])
Caeli A. Higney (+1 415-393-8248, [email protected])

Dallas
Veronica S. Lewis (+1 214-698-3320, [email protected])
Mike Raiff (+1 214-698-3350, [email protected])
Brian Robison (+1 214-698-3370, [email protected])
Robert C. Walters (+1 214-698-3114, [email protected])

Brussels
Peter Alexiadis (+32 2 554 7200, [email protected])
Attila Borsos (+32 2 554 72 11, [email protected])
Christian Riis-Madsen (+32 2 554 72 05, [email protected])
Lena Sandberg (+32 2 554 72 60, [email protected])
David Wood (+32 2 554 7210, [email protected])

Frankfurt
Georg Weidenbach (+49 69 247 411 550, [email protected])

Munich
Michael Walther (+49 89 189 33 180, [email protected])
Kai Gesing (+49 89 189 33 180, [email protected])

London
Patrick Doris (+44 20 7071 4276, [email protected])
Charles Falconer (+44 20 7071 4270, [email protected])
Ali Nikpay (+44 20 7071 4273, [email protected])
Philip Rocher (+44 20 7071 4202, [email protected])
Deirdre Taylor (+44 20 7071 4274, [email protected])

Hong Kong
Kelly Austin (+852 2214 3788, [email protected])
Sébastien Evrard (+852 2214 3798, [email protected])

© 2021 Gibson, Dunn & Crutcher LLP

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

With the California Privacy Rights and Enforcement Act (“CPRA”) almost two years out from its effective date of January 1, 2023, the California Consumer Privacy Act (“CCPA”) remains in effect—but remains a moving target for businesses seeking to comply. On March 15, 2021, the California Office of Administrative Law (“OAL”) approved additional regulations relating to the right to opt out of sale of personal information; these changes are effective immediately. Even as these changes to the CCPA took effect, California has begun preparing for enforcement of the CPRA: on March 17, 2021, California announced the appointment of the inaugural five-member board for the California Privacy Protection Agency (“CPPA”), which is empowered to draft regulations supporting to CPRA, and to enforce the CPRA after it becomes effective.

Highlights of the New CCPA Regulations

Among the notable provisions in the new CCPA regulations are the following:

  • New “Do Not Sell My Personal Information” Icon (§ 999.306(f)). This new regulation permits (but does not require) businesses that sell personal information (defined under the CCPA as the disclosure of personal information to a third party “for monetary or other valuable consideration”[1]) to provide consumers with the ability to opt-out of the sale of their personal information by clicking the icon below. The icon, however, cannot replace the requirement to post the notice of the right to opt-out and the “Do Not Sell My Personal Information” link at the bottom of the business’s homepage.[2] Earlier drafts of the CCPA regulations contained examples of similar icons that businesses could use, but they were omitted from the final version of the regulations issued in August 2020.

  • Offline Opt-Out Notices Explained (§ 999.306(b)(3)). The new regulations explicitly require offline businesses to inform consumers in an offline context of their right to opt-out and offer an offline method to exercise such right, but the requirements are more flexible than that those that apply to online platforms.[3] The regulations include the following examples for accomplishing this offline notice requirement.
    • Notify consumers of their right to opt-out on the paper forms that collect the personal information.[4]
    • Post signage in the area where the personal information is collected directing consumers where to find opt-out information online.[5]
    • Inform consumers from whom personal information is collected over the phone during the call of their opt-out right.[6]

  • Mechanisms to Submit Opt-Out Requests Clarified (§ 999.306(h)). This new regulation provides that methods to submit opt-out requests should be “easy to execute and shall require minimal steps.”[7] Businesses are explicitly prohibited from using a method “that is designed with the purpose or has the substantial effect of subverting or impairing a consumer’s choice to opt-out.” The regulations include the following examples:

    • The opt-out process cannot require more steps than the process to opt-in to the sale of personal information after having previously opted out or use confusing language, including double negatives (i.e., “Don’t Not Sell My Personal Information”).[8]
    • Businesses cannot require consumers to scroll through a privacy policy (or similar document) to locate the mechanism for submitting a request after clicking on the “Do Not Sell My Personal Information” link. Businesses also generally cannot require consumers to click through or listen to reasons why they should not opt-out before confirming their request.
    • Consumers cannot be required to provide personal information that is not necessary to implement the request (which is in addition to the August 2020 regulations’ prohibition against requiring consumers to provide additional personal information not previously collected by the business).
  • Verifying Authorized Agents to Exercise Consumer Requests (§ 999.326(a)). The CCPA creates a mechanism by which an authorized agent may submit personal information-related requests on behalf of a consumer, provided the agent is registered with the Secretary of State to conduct business in California. The March 2021 regulations amended Section 999.326 to provide that businesses may require the authorized agent to provide proof that the consumer gave the agent permission to submit a request to know or delete the personal information about the consumer collected by the business. However, the new regulations do not affect a business’s ability to require consumers to verify their own identity directly with the business or confirm that they provided the authorized agent permission to submit the request.[9]

California Privacy Protection Agency Members Announced

The CPRA established the CPPA, which is “vested with full administrative power, authority, and jurisdiction to implement and enforce [along with the Attorney General]” the CPRA (Section 1798.199.10(a)).[10] The Agency will consist of five members, appointed by the Governor (who appoints the Chair and one other member), the Attorney General, the Senate Rules Committee, and the Speaker of the Assembly (each of whom appoints one member).

This week, Governor Gavin Newsom, Attorney General Xavier Becerra, Senate President pro Tempore Toni Atkins, and Assembly Speaker Anthony Rendon announced their choices for the members of the California Privacy Protection Agency. Their choices span across academia, private practice, and nonprofits. Newsom appointed Jennifer M. Urban, Clinical Professor of Law and Director of Policy Initiatives for the Samuelson Law, Technology, and Public Policy Clinic at the University of California, Berkeley School of Law, as Chair of the state agency. Newsom designated John Christopher Thompson, Senior Vice President of Government Relations at LA 2028. Becerra appointed Angela Sierra, who recently served as Chief Assistant Attorney General of the Public Rights Division. Atkins appointed Lydia de la Torre, professor at Santa Clara University Law School, where she has taught privacy law and co-directed the Santa Clara Law Privacy Certificate Program. Rendon appointed Vinhcent Le, Technology Equity attorney at the Greenlining Institute, focusing on consumer privacy, closing the digital divide, and preventing algorithmic bias.

These members are tasked with—among other things—drafting CPRA regulations by July 2022, and enforcing the CPRA when it takes effect in January 2023.

We will continue to monitor the development of the CCPA, the CPRA, and other notable state privacy laws and regulations.

_______________________

   [1]   Cal Civ. Code § 1798.140(t)(1).

   [2]   Cal Civ. Code § 1798.135.

   [3]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.306(b)(3).

   [4]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.306(b)(3)(a).

   [5]   Id.

   [6]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.306(b)(3)(b).

   [7]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.306(h).

   [8]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.306(h)(a).

   [9]   Cal. Code Regs. Tit. 11, Div. 1, Chap. 20 § 999.326(a)(1)-(2).

  [10]   For more information on the CPPA, please refer to our previous alert: https://www.gibsondunn.com/potential-impact-of-the-upcoming-voter-initiative-the-california-privacy-rights-act/.

This alert was prepared by Alexander Southwell, Ashlie Beringer, Ryan Bergsieker, Cassandra Gaedt-Sheckter, Jeremy Smith, and Lisa Zivkovic

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 Privacy, Cybersecurity and Data Innovation practice group:

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])
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, [email protected])
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, [email protected])
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650-849-5203, [email protected])

Europe
Ahmed Baladi – Co-Chair, PCDI Practice, Paris (+33 (0)1 56 43 13 00, [email protected])
James A. Cox – London (+44 (0) 20 7071 4250, [email protected])
Patrick Doris – London (+44 (0) 20 7071 4276, [email protected])
Kai Gesing – Munich (+49 89 189 33-180, [email protected])
Bernard Grinspan – Paris (+33 (0)1 56 43 13 00, [email protected])
Penny Madden – London (+44 (0) 20 7071 4226, [email protected])
Michael Walther – Munich (+49 89 189 33-180, [email protected])
Alejandro Guerrero – Brussels (+32 2 554 7218, [email protected])
Vera Lukic – Paris (+33 (0)1 56 43 13 00, [email protected])
Sarah Wazen – London (+44 (0) 20 7071 4203, [email protected])

Asia
Kelly Austin – Hong Kong (+852 2214 3788, [email protected])
Connell O’Neill – Hong Kong (+852 2214 3812, [email protected])
Jai S. Pathak – Singapore (+65 6507 3683, [email protected])

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