In response to a claim brought by several environmental advocacy groups (the Associations), which sought to obtain the recognition of the French State’s failure to act in response to climate change, the Administrative Court of Paris (the Court) ruled, for the first time in French law, in a judgment of February 3, 2021, that such a liability action against the State was admissible, that the ecological damage alleged by the Associations was established and that the French State was partially responsible for it. The Court ordered a further investigation in order to determine the measures that it could enjoin the French State to adopt to repair the highlighted damage and prevent its aggravation.
I. Context of the ruling rendered by the Court
The Court’s ruling comes in the wake of several rulings by the Conseil d’Etat, the French highest Administrative Court, which reveal an intensification of control and compliance with the State’s obligations in environmental matters in general, and in connection with climate change in particular.
In a ruling of July 10, 2020, the Conseil d’Etat found that the Government had not taken the measures requested to reduce air pollution in 8 areas in France, as the judge had ordered in a decision of July 12, 2017. To compel it to do so, the Conseil d’Etat imposed a penalty payment of 10 million euros for each semester of delay, the highest amount ever imposed to force the State to enforce a judgement taken by the Administrative judge (CE, Ass., 10 July 2020, Les Amis de la Terre, no. 428409).
In a Grande Synthe ruling of November 19, 2020, the Conseil d’Etat ruled for the first time on a case concerning compliance with commitments to reduce greenhouse gas emissions. Indeed, the city of Grande-Synthe referred the matter to the Conseil d’Etat after the refusal of the Government to comply with its request for additional measures to be taken to meet the goals resulting from the Paris Agreement. The Conseil d’Etat first ruled that the request of the city, a coastal city particularly exposed to the effects of climate change, was admissible. On the merits, the Conseil d’Etat noted, firstly, that although France has committed to reducing its emissions by 40% by 2030, in recent years it has regularly exceeded the emission ceilings it had set itself and, secondly, that the decree of April 21, 2020 postponed most of the reduction efforts beyond 2020. According to the High Administrative Court, it is not necessary to wait until the 2030 deadline to exercise control over the State’s actions since the control of the trajectory that the State has set itself is relevant in ecological matters. Before ruling definitively on the request, the Conseil d’Etat asked the Government to justify, within three months, that its refusal to take additional measures is compatible with compliance with the reduction trajectory chosen to achieve the objectives set for 2030. If the justifications provided by the Government are not sufficient, the Conseil d’Etat may then grant the municipality’s request and cancel the refusal to take additional measures to comply with the planned trajectory to achieve the -40% target by 2030 (EC, November 19, 2020, Commune de Grande-Synthe et al., no. 427301), or even impose obligations on the French State. According to the information provided by representatives of the Conseil d’Etat, the decision could be taken before Summer 2021.
Moreover, in a ruling of January 29, 2021, the Versailles Administrative Court of Appeal referred a question to the Court of Justice of the European Union to determine whether the rules of the European Union law should be interpreted as opening up to individuals, in the event of a sufficiently serious breach by a European Union Member State of the obligations resulting therefrom, a right to obtain from the Member State in question compensation for damage affecting their health that has a direct and certain causal link with the deterioration of air quality (CAA Versailles, January 29, 2021, no. 18VE01431).
II. Reasoning steps followed by the Court
First, the Court ruled on the admissibility of the action for compensation for ecological damage brought by the Associations against the French State. In order to recognize the Associations’ status as victims, the Court had to acknowledge the existence of a fault, damage and a causal link between the fault and the damage.
First of all, it recalled that in application of article 1246 of the French Civil Code “Any person responsible for ecological damage is required to repair it”. Implicitly, the Court considered that this provision is applicable to the State. Article 1248 of the French Civil Code provides that “The action for compensation for ecological damage is open to any person having the capacity and interest to act, [such as] associations approved or created for at least five years at the date of the institution of proceedings which have as their purpose the protection of nature and the defense of the environment”. After having examined the purpose in the Associations’ by-laws, which mention the environment protection and sometimes explicitly the fight against climate change, the Court considered that their liability action was admissible.
Second, the Court had to rule on the existence of ecological damage, bearing in mind that such damage consists of “a non-negligible damage to the elements or functions of ecosystems or to the collective benefits derived by mankind from the environment” (Article 1247 of the French Civil Code). In this respect, it should be emphasized that the Conseil Constitutionnel considered that the legislature could validly exclude from the set-up compensation mechanism, the compensation for negligible damage to the elements, functions and collective benefits derived by mankind from the environment (Decision no. 2020-881 QPC of February 5, 2021). Consequently, it is up to the courts to determine, on a case-by-case basis, according to the facts of the case, what the notion of “non-negligible damage” covers.
In order to characterize the existence of non-negligible damage, the Court first relied on the work of the Intergovernmental Panel on Climate Change (IPCC), from which it concluded “that the constant increase in the average global temperature of the Earth, which has now reached 1°C compared to the pre-industrial era, is due mainly to greenhouse gas emissions [resulting from human activity]. This increase, responsible for a modification of the atmosphere and its ecological functions, has already caused, among other things, the accelerated melting of continental ice and permafrost and the warming of the oceans, resulting in an accelerating rise in sea level”.
It also drew on the work of the National Observatory on the Effects of Global Warming, a body attached to the Ministry of Ecological Transition and responsible in particular for describing, through a certain number of indicators, the state of the climate and its impacts on the entire national territory. The Court found that “in France, the increase in average temperature, which for the 2000-2009 decade amounts to 1.14°C compared to the 1960-1990 period, is causing an acceleration in the loss of glacier mass, particularly since 2003, the aggravation of coastal erosion, which affects a quarter of French coasts, and the risk of submersion, which poses serious threats to the biodiversity of glaciers and the coastline, is leading to an increase in extreme climatic phenomena, such as heat waves, droughts, forest fires, extreme rainfalls, floods and hurricanes, which are risks to which 62% of the French population is highly exposed, and is contributing to the increase in ozone pollution and the spread of insects that are vectors of infectious agents such as dengue fever or chikungunya”.
In light of all these elements, the Court considered that the ecological damage claimed by the Associations had to be considered as established.
Third, the Court had to identify the obligations of the States in responding to climate change in order to, in a second stage, rule on possible breaches in relation to these obligations.
The Court considered that it arose in particular from the provisions of the Paris Agreement of December 12, 2015, as well as from European and national standards relating to the reduction of greenhouse gas emissions, that the French State had committed to take effective action against climate change in order to limit its causes and mitigate its harmful consequences. From this perspective, the Court recalled that the French State had chosen to exercise “its regulatory power, in particular by conducting a public policy to reduce greenhouse gas emissions emitted from the national territory, by which it undertook to achieve, at specific and successive deadlines, a certain number of objectives in this area”.
The Court then examined compliance with the greenhouse gas emission reduction trajectories that the State had set itself in order to determine whether it had failed to meet its obligations. To do so, it relied in particular on the annual reports published in June 2019 and July 2020 by the High Council for the Climate, an independent body whose mission is to issue opinions and recommendations on the implementation of public policies and measures to reduce greenhouse gas emissions of France. In its two reports, the High Council for the Climate noted that “the actions of France are not yet commensurate with the challenges and objectives it has set itself” and noted the lack of substantial reduction in all the economic sectors concerned, particularly in transportation, agriculture, construction and industry sectors.
The Court concluded that the French State should be regarded as having failed to carry out the actions that it had itself recognized as likely to reduce greenhouse gas emissions. The guilty failure to meet its commitments was thus characterized, as was the causal link between that failure and the ecological damage previously identified. The Court therefore considered that part of that damage was attributable to the failure of the French State to act.
Fourth, the Court had to rule on the modalities of reparation of the ecological damage. Under the terms of the law, this was to be carried out primarily in kind. It is only in the event of impossibility or inadequacy of the reparation measures that the judge sentences the liable person to pay damages to the plaintiff, such damage being allocated to the reparation of the environment.
The Court considered that in the state of the investigation of the case, it was not in a position to determine the measures “that must be ordered to the State” to repair the observed damage or to prevent its future aggravation. He therefore prescribed a further two-month investigation in order to identify the measures in question.
Fifth, it sentenced the State to pay each of the Associations a symbolic sum of one euro as compensation for the moral prejudice it had caused them by not respecting the goals of reducing greenhouse gas emissions.
III. Follow-up to the Court’s ruling
The Court’s ruling, which sentences the State for not having implemented the necessary measures to achieve the greenhouse gas emission reduction targets, is a landmark decision in French law.
The second ruling that will be rendered following the two-month additional investigation ordered by the Court could constitute another historic decision if the Court were to enjoin the State – as the terms of the Ruling seem to imply – to implement a number of specific measures aimed at achieving the expected reduction targets, if necessary within a set timeframe. When this judgment comes into effect, possibly before the 2021 Summer, it will then be necessary to examine the impact of the measures that would thus be ordered on the economic sectors and companies likely to be affected.
At this stage of the proceedings, it is not possible to determine whether or not the French State will decide to appeal the ruling rendered by the Court to the Administrative Court of Appeal of Paris. If the latter were to uphold the ruling, the French State could then appeal to the Conseil d’Etat. A final decision on the issue at stake in this case could thus only be made in several years’ time.
The Court’s ruling could also have the immediate effect of modifying the provisions of the “Bill to combat climate change and strengthen resilience to its effects” which will be debated in the French Parliament from the end of March 2021. During the discussion, parliamentarians in favor of strengthening the provisions of this law could rely on the Court’s ruling to motivate and justify their position.
The following Gibson Dunn attorneys assisted in preparing this client update: Nicolas Autet and Gregory Marson.
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 lawyers in Paris by phone (+33 1 56 43 13 00) or by email:
Nicolas Autet ([email protected])
Gregory Marson ([email protected])
Nicolas Baverez ([email protected])
Maïwenn Béas ([email protected])
© 2021 Gibson, Dunn & Crutcher LLP
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London partners Susy Bullock, Matthew Nunan, Michelle Kirschner and James Cox are the authors of “Big data, ethics and financial services: risks, controls and opportunities,” [PDF] published by the Butterworths Journal of International Banking and Financial Law in February 2021.
New York partner Avi Weitzman and of counsel Tina Samanta are the authors of “Congress Codifies SEC Disgorgement Remedy in Military Spending Bill,” [PDF] published by Wall Street Journal in February 2021. The material is used with permission from Thomson Reuters.
Our panelists discuss significant recent developments and forecast what to expect from the new U.S. presidential administration on topics ranging from data privacy and cybersecurity to antitrust, corporate governance, international trade, money laundering, securities fraud, white collar defense and investigations, and more. Our panelists also will provide practical tips for identifying and addressing key compliance risks and strengthening corporate compliance programs.
Topics to be discussed include:
- Global Enforcement and Regulatory Developments
- The Biden Administration’s Expected Approach to Enforcement and Regulation
- Practical Recommendations for Improving Corporate Compliance
- DOJ and SEC Priorities, Policies, and Penalties
- Update on Key Governance Issues and Regulatory Requirements
View Slides (PDF)
MODERATOR:
Joseph Warin, a partner in Washington, D.C., is Co-Chair of the firm’s White Collar Defense and Investigations practice and former Assistant U.S. Attorney in Washington, D.C. Mr. Warin is consistently recognized annually in the top-tier by Chambers USA, Chambers Global, and Chambers Latin Americafor his FCPA, fraud and corporate investigations acumen. In 2018 Mr. Warin was selected by Chambers USAas a “Star” in FCPA, and “a “Leading Lawyer” in the nation in Securities Regulation: Enforcement. Global Investigations Review reported that Mr. Warin has now advised on more FCPA resolutions than any other lawyer since 2008. Who’s Who Legal and Global Investigations Review named Mr. Warin to their 2016 list of World’s Ten-Most Highly Regarded Investigations Lawyers based on a survey of clients and peers, noting that he was one of the “most highly nominated practitioners,” and a “’favourite’ of audit and special committees of public companies.” Mr. Warin has handled cases and investigations in more than 40 states and dozens of countries. His credibility at DOJ and the SEC is unsurpassed among private practitioners — a reputation based in large part on his experience as the only person ever to serve as a compliance monitor or counsel to the compliance monitor in three separate FCPA monitorships, pursuant to settlements with the SEC and DOJ: Statoil ASA (2007-2009); Siemens AG (2009-2012); and Alliance One International (2011-2013).
PANELISTS:
Roscoe Jones, a counsel in Washington, D.C., is a member of the firm’s Public Policy, Congressional Investigations, and Crisis Management groups. Mr. Jones formerly served as Chief of Staff to U.S. Representative Abigail Spanberger, Legislative Director to U.S. Senator Dianne Feinstein, and Senior Counsel to U.S. Senator Cory Booker, among other high-level roles on Capitol Hill.
Thomas Kim, a partner in Washington, D.C., is a member of the firm’s Securities Regulation and Corporate Governance Practice Group. Mr. Kim focuses his practice on advising companies, underwriters and boards of directors on registered and exempt capital markets transactions, SEC regulatory and reporting issues, and corporate governance, as well as on general corporate and securities matters. Mr. Kim served for six years as the Chief Counsel and Associate Director of the Division of Corporation Finance at the SEC.
Kristen Limarzi, a partner in Washington, D.C., focuses on investigations, litigation, and counseling on antitrust merger and conduct matters, as well as appellate and civil litigation. Ms. Limarzi previously served as the Chief of the Appellate Section of the U.S. Department of Justice’s Antitrust Division, where she led a team of more than a dozen professionals litigating appeals in the Division’s civil and criminal enforcement actions and participating as amicus curiae in private antitrust actions.
Jason J. Mendro, a partner in Washington, D.C., represents clients in wide-ranging shareholder disputes, including securities class actions, challenges to mergers and acquisitions, and derivative lawsuits alleging breaches of fiduciary duties. Mr. Mendro also advises boards of directors and special litigation committees in conducting internal investigations and addressing shareholder litigation demands. He has earned national recognition, being named “Litigator of the Week” by The American Lawyer and a “Rising Star” by Law360 and Super Lawyers.
Adam M. Smith, a partner in Washington, D.C., was the Senior Advisor to the Director of the U.S. Treasury Department’s OFAC and the Director for Multilateral Affairs on the National Security Council. His practice focuses on international trade compliance and white collar investigations, including with respect to federal and state economic sanctions enforcement, the FCPA, embargoes, and export controls. He routinely advises multi-national corporations regarding regulatory aspects of international business.
Lori Zyskowski, a partner in New York, is Co-Chair of the firm’s Securities Regulation and Corporate Governance practice. She was previously Executive Counsel, Corporate, Securities & Finance at GE. She advises clients, including public companies and their boards of directors, on a wide variety of corporate governance and securities disclosure issues, and provides a unique perspective gained from over 12 years working in-house at S&P 500 corporations.
Lora MacDonald, an associate in Washington, D.C., practices in the firm’s Litigation Department, focusing on white collar criminal defense and internal investigations. Ms. MacDonald has experience conducting internal investigations and advising clients on compliance with the FCPA and other anti-corruption laws. She also assists clients under investigation by the World Bank Integrity Vice Presidency and companies already subject to World Bank sanction.
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On February 18, 2021, the U.S. Office of Foreign Assets Control (OFAC), an agency of the Treasury Department that administers and enforces U.S. economic and trade sanctions, issued an enforcement release of a settlement agreement with BitPay, Inc. (BitPay) for apparent violations relating to Bitpay’s payment processing solution that allows merchants to accept digital currency as payment for goods and services.[1] OFAC found that BitPay allowed users apparently located in sanctioned countries and areas to transact with merchants in the United States and elsewhere using the BitPay platform, even though BitPay had Internet Protocol (IP) address data for those users. The users in sanctioned countries were not BitPay’s direct customers, but rather its customer’s customers (in this case the merchants’ customers).
The BitPay action follows an OFAC December 30, 2020 enforcement release of a settlement agreement with BitGo, Inc. (BitGo), also for apparent violations related to digital currency transactions.[2] BitGo offers, among other services, non-custodial secure digital wallet management services, and OFAC found that BitGo failed to prevent users located in the Crimea region of Ukraine, Cuba, Iran, Sudan and Syria from using these services. OFAC determined that BitGo had reason to know the location of these users based on IP address data associated with the devices used to log into its platform.
This Alert discusses these developments.
I. OFAC’s Enforcement Against BitGo
BitGo, which was founded in 2013 and is headquartered in Palo Alto, California, is self-described as “the leader in digital asset financial services, providing institutional investors with liquidity, custody, and security solutions.”[3] As OFAC explained in its enforcement release, the company agreed to remit $98,830 to settle potential civil liability related to 183 apparent violations of multiple sanctions programs. OFAC specifically claimed that between 2015 and 2019, deficiencies in BitGo’s sanctions compliance procedures led to BitGo’s failing to prevent individuals located in the Crimea region of Ukraine, Cuba, Iran, Sudan, and Syria from using BitGo’s non-custodial secure digital wallet management service despite having reason to know that these individuals were located in sanctioned jurisdictions. Reason to know was based on BitGo’s having IP address data associated with the devices that these individuals used to log in to the BitGo platform. According to OFAC, BitGo processed 183 digital currency transactions on behalf of these individuals, totaling $9,127.79.
According to the OFAC release, prior to April 2018, BitGo had allowed individual users of its digital wallet management services to open an account by providing only a name and email address. In April 2018, BitGo supplemented this practice by requiring new users to verify the country in which they were located, with BitGo generally relying on the user’s attestation regarding his or her location rather than performing additional verification or diligence on the user’s location. In January 2020, however, BitGo discovered the apparent violations of multiple sanctions compliance programs. It thereupon implemented a new OFAC Sanctions Compliance Policy and undertook significant remedial measures. This new policy included appointing a Chief Compliance Officer, blocking IP addresses for sanctioned jurisdictions, and keeping all financial records and documentation related to sanctions compliance efforts.
II. OFAC’s Enforcement Against BitPay
BitPay, which was founded in 2011 and is headquartered in Atlanta, Georgia, provides digital asset management and payment services that enable consumers “to turn digital assets into dollars for spending at tens of thousands of businesses.”[4] As OFAC explained in its enforcement release, BitPay agreed to remit $507,375 to settle potential civil liability related to 2,102 apparent violations of multiple sanctions programs. OFAC specifically claimed that between 2013 and 2018, deficiencies in BitPay’s sanctions compliance procedures led to BitPay’s allowing individuals who appear to have been located in the Crimea region of Ukraine, Cuba, North Korea, Iran, Sudan, and Syria to transact with merchants in the United States and elsewhere using digital currency on BitPay’s platform despite BitPay having location data, including IP addresses, about those individuals prior to effecting the transactions.
BitPay allegedly “received digital currency payments on behalf of its merchant customers from those merchants’ buyers who were located in sanctioned jurisdictions, converted the digital currency to fiat currency, and then relayed that currency to its merchants.” According to OFAC, BitPay processed 2,102 such transactions totaling $128,582.61. Although BitPay had (i) screened its direct customers (i.e., its merchant customers) against OFAC’s List of Specially Designated Nationals and Blocked Persons and (ii) conducted due diligence on the merchants to ensure they were not located in sanctioned jurisdictions, BitPay failed to screen location data that it obtained about its merchants’ buyers—BitPay had begun receiving buyers’ IP address data in November 2017, and prior to that received information that included buyers’ addresses and phone numbers. BitPay had implemented sanctions compliance controls as early as 2013, including conducting due diligence and sanctions screening on its merchants, and formalized its sanctions compliance program in 2014. However, following its apparent violations, BitPay supplemented its program with the following:
- Blocking IP addresses that appear to originate in Cuba, Iran, North Korea, and Syria from connecting to the BitPay website or from viewing any instructions on how to make payment;
- Checking physical and email addresses of merchants’ buyers when provided by the merchants to prevent completion of an invoice from the merchant if BitPay identifies a sanctioned jurisdiction address or email top-level domain; and
- Launching “BitPay ID,” a new customer identification tool that is mandatory for merchants’ buyers who wish to pay a BitPay invoice equal to or above $3,000. As part of BitPay ID, the merchant’s customer must provide an email address, proof of identification/photo ID, and a selfie photo.
III. Conclusion
The major takeaway from these two enforcement cases is that OFAC expects digital asset companies to use IP address data or other location data—even for their customers’ customers—to screen that location information as part of their OFAC compliance function. OFAC will undoubtedly be considering whether a company has screened such information in assessing whether to impose a penalty. More guidance on OFAC’s perspective on the essential components of a sanctions compliance program is available in A Framework for OFAC Compliance Commitments, which OFAC published in May 2019. In addition, we anticipate ongoing scrutiny by OFAC of digital asset companies, given that key Treasury Department policymakers continue to express concerns about digital assets being used to avoid economic sanctions and anti-money laundering compliance.[5]
_____________________
[1] OFAC Enters Into $507,375 Settlement with BitPay, Inc. for Apparent Violations of Multiple Sanctions Programs Related to Digital Currency Transactions (Feb. 18, 2021), available at https://home.treasury.gov/system/files/126/20210218_bp.pdf.
[2] OFAC Enters Into $98,830 Settlement with BitGo, Inc. for Apparent Violations of Multiple Sanctions Programs Related to Digital Currency Transactions (Dec. 30, 2020), available at https://home.treasury.gov/system/files/126/20201230_bitgo.pdf.
[3] See BitGo Announces $16 Billion in Assets Under Custody (December 21, 2020), available at https://www.bitgo.com/newsroom/press-releases/bitgo-announces-16-billion-in-assets-under-custody.
[4] See For a Limited Time BitPay and Simplex Partner to Offer Zero Fees on Crypto Purchases for All of Europe (EEA) (February 15, 2021), available at https://www.businesswire.com/news/home/20210215005244/en/For-a-Limited-Time-BitPay-and-Simplex-Partner-to-Offer-Zero-Fees-on-Crypto-Purchases-for-All-of-Europe-EEA.
[5] U.S. Treasury Department Holds Financial Sector Innovation Policy Roundtable (February 10, 2021), available at https://home.treasury.gov/news/press-releases/jy0023.
The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long, Judith Alison Lee, Jeffrey Steiner and Rama Douglas.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following members of the firm’s Financial Institutions, Derivatives, or International Trade practice groups:
Financial Institutions and Derivatives Groups:
Matthew L. Biben – New York (+1 212-351-6300, [email protected])
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, [email protected])
M. Kendall Day – Washington, D.C. (+1 202-955-8220, [email protected])
Mylan L. Denerstein – New York (+1 212-351- 3850, [email protected])
Michelle M. Kirschner – London (+44 (0) 20 7071 4212, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
International Trade Group:
Judith Alison Lee – Washington, D.C. (+1 202-887-3591, [email protected])
Adam M. Smith – Washington, D.C. (+1 202-887-3547, [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.
New York partner Avi Weitzman and associate David Salant are the authors of “The Due Process Protections Act: Congress Directs Judges to More Actively Prevent and Remedy Prosecutorial Brady Violations,” [PDF] published by the Washington Legal Foundation on February 19, 2021.
This Client Alert provides an update on shareholder activism activity involving NYSE- and Nasdaq-listed companies with equity market capitalizations in excess of $1 billion and below $100 billion (as of the last date of trading in 2020) during the second half of 2020. Announced shareholder activist activity increased relative to the second half of 2019. The number of public activist actions (35 vs. 24), activist investors taking actions (31 vs. 17) and companies targeted by such actions (33 vs. 23) each increased substantially. On a full-year basis, however, owing to the market disruption caused by the COVID-19 pandemic, 2020 represented a modest slowdown in activism versus 2019, as reflected in the number of public activist actions (63 vs. 75), activist investors taking actions (41 vs. 49) and companies targeted by such actions (55 vs. 64). During the period spanning July 1, 2020 to December 31, 2020, two of the 39 companies targeted by activists—CoreLogic, Inc. and Monmouth Real Estate Investment Corporation—were the subject of multiple campaigns. CoreLogic, Inc. was the subject of an activist campaign led by Cannae Holdings and Senator Investment Group; their efforts, in turn, ultimately drew the support of Pentwater Capital Management LP. In addition, certain activists launched multiple campaigns during the second half of 2020: Elliott Management, NorthStar Asset Management and Starboard Value. These three activists represented 23% of the total public activist actions that began during the second half of 2020.
*Study covers selected activist campaigns involving NYSE- and Nasdaq-traded companies with equity market capitalizations of greater than $1 billion as of December 31, 2020 (unless company is no longer listed).
**All data is derived from the data compiled from the campaigns studied for the 2020 Year-End Activism Update.
Additional statistical analyses may be found in the complete Activism Update linked below.
The rationales for activist campaigns during the second half of 2020 changed in certain respects relative to the first half of 2020. Over both periods, board composition and business strategy represented leading rationales animating shareholder activism campaigns, representing 55% of rationales in the first half of 2020 and 49% of rationales in the second half of 2020. M&A (which includes advocacy for or against spin-offs, acquisitions and sales) took on increased importance; the frequency with which M&A animated activist campaigns rose from 9% in the first half of 2020 to 19% in the second half of 2020. At the opposite end of the spectrum, management changes, return of capital and control remained the most infrequently cited rationale for activist campaigns. (Note that the above-referenced percentages total over 100%, as certain activist campaigns had multiple rationales.) These themes are all broadly consistent with those observed in 2019. Proxy solicitation occurred in 14% of campaigns for the second half of 2020 and for 17% of campaigns in 2020 overall. These figures represent modest declines relative to 2019, in which proxy materials were filed in approximately 30% of activist campaigns for the entire year.
Eight settlement agreements pertaining to shareholder activism activity were filed during the second half of 2020 and only 17 were filed for the entire year, which continues a trend of diminution (relative to 22 agreements filed in 2019 and 30 agreements filed in 2018). Those settlement agreements that were filed had many of the same features noted in prior reviews, however, including voting agreements and standstill periods as well as non-disparagement covenants and minimum and/or maximum share ownership covenants. Expense reimbursement provisions were included in half of those agreements reviewed, which is consistent with historical trends. We delve further into the data and the details in the latter half of this Client Alert. We hope you find Gibson Dunn’s 2020 Year-End Activism Update informative. If you have any questions, please reach out to a member of your Gibson Dunn team.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this publication. For further information, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following authors in the firm’s New York office:
Barbara L. Becker (+1 212.351.4062, [email protected])
Dennis J. Friedman (+1 212.351.3900, [email protected])
Richard J. Birns (+1 212.351.4032, [email protected])
Eduardo Gallardo (+1 212.351.3847, [email protected])
Andrew Kaplan (+1 212.351.4064, [email protected])
Saee Muzumdar (+1 212.351.3966, [email protected])
Daniel S. Alterbaum (+1 212.351.4084, [email protected])
Lisa Phua (+1 212.351.2327, [email protected])
Please also feel free to contact any of the following practice group leaders and members:
Mergers and Acquisitions Group:
Jeffrey A. Chapman – Dallas (+1 214.698.3120, [email protected])
Stephen I. Glover – Washington, D.C. (+1 202.955.8593, [email protected])
Jonathan K. Layne – Los Angeles (+1 310.552.8641, [email protected])
Securities Regulation and Corporate Governance Group:
Brian J. Lane – Washington, D.C. (+1 202.887.3646, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202.955.8671, [email protected])
James J. Moloney – Orange County, CA (+1 949.451.4343, [email protected])
Elizabeth Ising – Washington, D.C. (+1 202.955.8287, [email protected])
Lori Zyskowski – New York (+1 212.351.2309, [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 Farhang is the author of “A setback for the broadening of insider trading liability,” [PDF] published by the Daily Journal on February 18, 2021.
Washington, D.C. partner Stacie Fletcher, Los Angeles partner Abbey Hudson and Washington, D.C. associate Rachel Levick Corley are the authors of “3 Key Environmental Takeaways From Biden’s First 30 Days,” [PDF] published by Law360 on February 17, 2021.
I. Introduction
At the end of the Trump Administration, the bipartisan Internet of Things (IoT) Cybersecurity Improvement Act of 2020 (“the Act”) was enacted after passing the House of Representatives on a suspension of the rules and the Senate by unanimous consent. The Act requires agencies to increase cybersecurity for IoT devices owned or controlled by the federal government. Despite its seemingly limited scope, the Act is anticipated to have a significant, wide-ranging impact on the general development and manufacturing of IoT devices.
The Internet of Things is the “extension of internet connectivity into physical devices and everyday objects.”[1] It covers devices — often labeled as “smart devices” — that have a network interface, function independently, and interact directly with the physical world.”[2] While the Act’s definition of IoT devices expressly excludes conventional information technology devices (for example, computers, laptops, tablets, and smartphones),[3] it extends to a variety of sensors, actuators, and processors used by the federal government.[4] Agencies have reported using IoT devices for controlling or monitoring equipment, tracking physical assets, providing surveillance, collecting environmental data, monitoring health and biometrics, and many other purposes.[5] This usage is likely to expand as over 85% of federal agencies either are currently employing IoT devices or plan to do so in the next five years, further elevating the significance of the Act.[6]
Although the Act is focused on federal government IoT devices, it has significant implications for the widespread and growing corporate and private consumer use of these devices. The North American market for IoT devices has been valued around $95 billion in 2018 and forecasted to be $340 billion by 2024.[7] This has been driven by about 2.3 billion IoT device connections in 2018, which are expected to reach almost 6 billion by 2025.[8] The global market for these devices is similarly expected to grow substantially, with an approximately 37% increase from 2017 to over $1.5 trillion by 2025.[9] This global number of active IoT devices is projected to rise from 9.9 billion in 2019 to 21.5 billion in 2025.[10] As federal standards are often a baseline or guide for industries, such as for product manufacturers seeking uniformity and efficiency, the measures set pursuant to the IoT Cybersecurity Improvement Act should be closely monitored by all industry stakeholders.
II. Provisions of the Act
The Act has a few primary components for strengthening IoT cybersecurity and the government’s critical technology infrastructure. First, the National Institute of Standards and Technology (NIST) is tasked with developing security standards and guidelines for the appropriate use and management of all IoT devices owned or controlled by the federal government and connected to its information systems.[11] This includes establishing minimum information security requirements for managing cybersecurity risks associated with these devices. In formulating these guidelines, NIST must consider its current efforts regarding the security of IoT devices, as well as the “relevant standards, guidelines, and best practices developed by the private sector, agencies, and public-private partnerships.”[12] Within 90 days, NIST will promulgate the standards and guidelines for the Office of Management and Budget (OMB) to implement, under consultation with the Department of Homeland Security (DHS) as necessary, by reviewing agency information security policies and principles for consistency.[13] Devices that are a part of a national security system, however, are exempt from review by OMB.[14]
A second set of the Act’s provisions govern the disclosure process among federal agencies and contractors regarding information security vulnerabilities. Again, NIST is tasked with creating guidelines, within 180 days, to advise agencies and contractors on measures for receiving, reporting, and disseminating information about security vulnerabilities and their resolution.[15] These guidelines will also be formulated by considering non-governmental sources in order to better align them with industry best practices, international standards, and “any other appropriate, relevant, and widely-used standard.”[16] Similarly, these measures will be implemented by OMB in consultation with DHS, who will also provide operational and technical assistance to agencies.[17]
While the previous components will set the baseline for federal IoT cybersecurity standards, the real bite of the Act comes from its prohibition on agencies from procuring, obtaining, or using any IoT devices that would render an agency non-compliant with NIST’s standards and guidelines.[18] These determinations will be made by an agency’s Chief Information Officer (CIO) upon reviewing its government contracts involving IoT devices.[19] Agency heads have some flexibility to waive this prohibition, however, if the agency CIO determines that the device is necessary for either national security interests or research purposes, or if it is secured using alternative and effective methods based on the function of the device.[20] IoT device manufacturers currently supplying or vying for government contracts should ensure cybersecurity compliance by the time that the prohibition takes effect in December 2022.[21] All other IoT device manufacturers, including those that focus entirely on private consumers, would also be well-advised to carefully consider the requirements established pursuant to the Act, as the U.S. government is the single largest consumer in the world and creates standards that are likely to have trickle-down effects on the industry as a whole.
Lastly, a few of the Act’s remaining provisions require the Government Accountability Office (GAO) to submit reports to Congress on the processes established by the Act and broader IoT efforts.[22]
III. Draft Guidance by NIST
Since the Act was passed, NIST has already started carrying out its mandate by releasing four new public drafts of its guidance on IoT cybersecurity. The first document — Draft NIST SP 800-213 — is a part of the Special Publication 800-series developed to address and support the security and privacy needs of U.S. government information systems.[23] This draft provides guidance for federal agencies to establish and evaluate the security capabilities required in their IoT devices.[24] It includes background information on the security challenges posed by IoT devices, as well as various considerations for managing risks and vulnerabilities.
The remaining three draft documents — NIST Interagency Reports (NISTIRs) 8259B, 8259C, and 8259D — build upon a series directed at establishing baselines for IoT device manufacturers to identify and meet the security requirements expected by customers.[25] This 8259-series currently contains a total of five documents that together discuss foundational cybersecurity activities, baselines for cybersecurity and non-technical capabilities, and a process for developing customized cybersecurity profiles to meet the needs of specific IoT device customers or applications.[26] The series contains an example of the process applied to create a profile on the federal government customer, which can also serve as a guide for manufacturers to profile other customers and markets. On January 7, 2021, NIST also published a report — NISTIR 8322 — summarizing the feedback received from its July 2020 workshop on the creation of the federal profile of IoT device cybersecurity requirements.[27]
Since releasing the drafts, NIST has opened a public comment period for soliciting community input. This comment period was recently extended to February 26, 2021. Any IoT stakeholders should consider reviewing the documents and providing feedback to NIST. The Act directs NIST to release finalized standards and guidelines by March 4, 2021, for the appropriate use and management of government IoT devices by federal agencies.[28] NIST must also establish its guidelines for receiving, reporting, and disseminating information about security vulnerabilities and their resolution by June 2, 2021.[29]
IV. Context and Effect
The IoT Cybersecurity Improvement Act of 2020 will undoubtedly help strengthen critical technology infrastructure, although how effective it will be at preventing attacks remains to be seen. The Act comes at a time when addressing information security vulnerabilities in the government’s contractor supply chain is as pressing as ever.
Some IoT devices released into consumer markets have turned out to have insufficient cybersecurity protections, as cyber criminals have found ways to exploit the trade-offs between cost, expediency, and security made by manufacturers to meet rapidly evolving consumer demands. Cyber criminals have taken advantage of IoT vulnerabilities to access systems and data, as well as to commit denial-of-service or ransomware attacks. For example, the infamous Mirai botnet used insecure IoT devices to conduct a massive distributed denial-of-service attack in 2016 that took down the websites of multiple major U.S. companies.[30] This issue has only intensified as the global coronavirus pandemic has driven further reliance on IoT devices. A recent report indicated that the share of IoT devices being infected has doubled in 2020 compared to other similarly connected devices.[31]
Very few states have enacted legislation requiring IoT device manufacturers to meet certain cybersecurity standards. These states include California and Oregon, both of which mandate manufacturers to equip devices with “reasonable security feature[s].”[32] Beyond the U.S., Europe has a baseline cybersecurity standard for consumer IoT devices, which was released by the European Telecommunications Standards Institute in June 2020,[33] as well as guidelines by the European Union Agency for Cybersecurity (ENISA) for securing supply chain processes used to develop IoT products.[34] The U.K. has also taken recent regulatory steps to directly address IoT device cybersecurity.[35] As the first federal legislation in the U.S. targeting IoT security, the IoT Cybersecurity Improvement Act is a welcome addition to the country’s historically sectored and disparate legal landscape for information security and data privacy.
The Act’s improvements for federal IoT device security are anticipated to similarly strengthen and push forward protections in the private sector. The cybersecurity standards for federal IoT devices and contractors are likely to both reflect and shift what security features are deemed “reasonable” — the legal standard adopted by California and Oregon for evaluating IoT device security.[36] The concept of reasonableness is also used to assert civil liability against product manufacturers by claiming that the lack of certain features or measures is unreasonable and a failure of the duty of care. As NIST is required to consider private sector best practices in developing its standards and guidelines, the public-private relationship can create a positive feedback loop that will propel IoT cybersecurity protections towards continuous improvement. Some manufacturers could maintain and highlight distinctions between public and private consumer security needs to attempt to avoid having the federal standards used against them in civil liability. Others manufacturers of IoT devices may simply find it easier to have uniform security mechanisms in both their government and private consumer products. Nonetheless, the developing standards and guidelines being established pursuant to the IoT Cybersecurity Improvement Act will have significant implications for the IoT device industry as a whole and should be carefully considered.
* * *
The legal issues and obligations related to the IoT Cybersecurity Improvement Act of 2020 are likely to shift as federal agencies implement its provisions. We will continue to monitor and advise on developments, and we are available to guide companies through these and related issues. Please do not hesitate to contact us with any questions.
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[1] Cong. Rsch. Serv., H.R.1668 — IoT Cybersecurity Improvement Act of 2020: Summary, Congress.Gov, https://www.congress.gov/bill/116th-congress/house-bill/1668 (last visited Dec. 29, 2020).
[2] Internet of Things Cybersecurity Improvement Act of 2020, Pub. L. No. 116-207, § 2(4), 134 Stat. 1001, 1001 (2020).
[4] U.S. Gov’t Accountability Off., GAO-20-577, Internet of Things: Information on Use by Federal Agencies 5 (2020).
[7] Shanhong Liu, Internet of Things in the U.S. — Statistics & Facts, Statista (May 29, 2020), https://www.statista.com/topics/5236/internet-of-things-iot-in-the-us.
[9] Patricia Moloney Figliola, Cong. Rsch. Serv., IF11239, The Internet of Things (IoT): An Overview 2 (2020), https://crsreports.congress.gov/product/pdf/IF/IF11239 (citing the predictions by IoT Analytics).
[11] IoT Cybersecurity Improvement Act § 4(a)(1).
[13] Id. § 4(b)(1)–(2). OMB shall conduct this review no later than 180 days after NIST completes the development of the relevant standards and guidelines. Id. § 4(b)(1).
[17] IoT Cybersecurity Improvement Act §§ 5(d)–(e), 6(a)–(c). OMB shall develop and oversee this implementation no later than two years after the Act is enacted. Id. § 6(a).
[23] NIST Special Publication 800-Series General Information, Nat’l Inst. Standards & Tech. (May 21, 2018), https://www.nist.gov/itl/publications-0/nist-special-publication-800-series-general-information.
[24] Michael Fagan et al., SP 800-213 (Draft) — IoT Device Cybersecurity Guidance for the Federal Government: Establishing IoT Device Cybersecurity Requirements, Nat’l Inst. Standards & Tech. (Dec. 2020), https://csrc.nist.gov/publications/detail/sp/800-213/draft.
[25] Defining IoT Cybersecurity Requirements: Draft Guidance for Federal Agencies and IoT Device Manufacturers (SP 800-213, NISTIRs 8259B/C/D), Nat’l Inst. Standards & Tech. (Dec. 15, 2020), https://www.nist.gov/news-events/news/2020/12/defining-iot-cybersecurity-requirements-draft-guidance-federal-agencies-and.
[26] Michael Fagan et al., NISTIR 8259 — Foundational Cybersecurity Activities for IoT Device Manufacturers, Nat’l Inst. Standards & Tech. (May 2020), https://csrc.nist.gov/publications/detail/nistir/8259/final; Michael Fagan et al., NISTIR 8259A — IoT Device Cybersecurity Capability Core Baseline, Nat’l Inst. Standards & Tech. (May 2020), https://csrc.nist.gov/publications/detail/nistir/8259a/final; Michael Fagan et al., NISTIR 8259B (Draft) — IoT Non-Technical Supporting Capability Core Baseline, Nat’l Inst. Standards & Tech. (Dec. 2020), https://csrc.nist.gov/publications/detail/nistir/8259b/draft; Michael Fagan et al., NISTIR 8259C (Draft) — Creating a Profile Using the IoT Core Baseline and Non-Technical Baseline, Nat’l Inst. Standards & Tech. (Dec. 2020), https://csrc.nist.gov/publications/detail/nistir/8259c/draft; Michael Fagan et al., NISTIR 8259D (Draft) — Profile Using the IoT Core Baseline and Non-Technical Baseline for the Federal Government, Nat’l Inst. Standards & Tech. (Dec. 2020), https://csrc.nist.gov/publications/detail/nistir/8259d/draft.
[27] Katerina Megas et al., NISTIR 8322 — Workshop Summary Report for “Building the Federal Profile For IoT Device Cybersecurity” Virtual Workshop, Nat’l Inst. Standards & Tech. (Jan. 2021), https://csrc.nist.gov/publications/detail/nistir/8322/final.
[28] See IoT Cybersecurity Improvement Act § 4(a)(1).
[30] See Nicole Perlroth, Hackers Used New Weapons to Disrupt Major Websites Across U.S., N.Y. Times (Oct. 21, 2016), https://www.nytimes.com/2016/10/22/business/internet-problems-attack.html.
[31] Nokia, Threat Intelligence Report 2020 9 (2020), https://onestore.nokia.com/asset/210088.
[32] See Cal. Civ. Code § 1798.91.04(a) (2018); Or. Rev. Stat. § 646A.813(2) (2019). Some states have proposed similar legislation. See, e.g., H.B. 3391, 101st Gen. Assemb., Reg. Sess. (Ill. 2019); A.B. 2229, Gen. Assemb., Reg. Sess. (N.Y. 2019); H.B. 888, 441st Gen. Assemb., Reg. Sess. (M.D. 2020).
[33] Sophia Antipolis, ETSI Releases World-Leading Consumer IoT Security Standard, ETSI (June 30, 2020), https://www.etsi.org/newsroom/press-releases/1789-2020-06-etsi-releases-world-leading-consumer-iot-security-standard.
[34] IoT Security: ENISA Publishes Guidelines on Securing the IoT Supply Chain, ENISA (Nov. 9, 2020), https://www.enisa.europa.eu/news/enisa-news/iot-security-enisa-publishes-guidelines-on-securing-the-iot-supply-chain.
[35] Dep’t for Digital, Culture, Media & Sport, Secure by Design, Gov.UK (July 16, 2020), https://www.gov.uk/government/collections/secure-by-design#history.
[36] See Cal. Civ. Code § 1798.91.04(a) (2018); Or. Rev. Stat. § 646A.813(2) (2019).
This article was prepared by Alexander H. Southwell and Terry Y. Wong.
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:
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Notwithstanding the ongoing spread of COVID-19 and unprecedented changes in daily life and the economy, the second half of 2020 marched on to the steady drumbeat of securities-related lawsuits we have observed in recent years, including securities class and stockholder derivative actions, insider trading lawsuits, and government enforcement actions. In this 2020 year-end edition of our semi-annual publication, we discuss developments in the securities laws that have occurred against this backdrop.
The year-end update highlights what you most need to know in securities litigation developments and trends for the second half of 2020:
- Federal securities filings decreased by approximately 22% when compared to 2019, even as the average settlement value rose and the median settlement value remained comparable.
- The Supreme Court granted certiorari in Goldman Sachs Group Inc. v. Arkansas Teacher Retirement System, No. 20-222, and is set to review the Second Circuit’s inflation-maintenance theory and consider the use of price-impact evidence to rebut the presumption of reliance at the class certification stage.
- With the Supreme Court set to provide additional guidance on “price impact” theories under Halliburton II, the Seventh Circuit followed the Second Circuit’s path by requiring trial courts to consider evidence of a lack of price impact even where that evidence overlaps with a merits issue, such as materiality, and assigning both the burden of production and the burden of persuasion to defendants.
- The Delaware Supreme Court diminished Section 220’s threshold requirement that a stockholder have a “proper purpose” to inspect a corporation’s books and records, and may soon reduce or eliminate former stockholders’ standing to continue litigating “dual-natured” merger claims post-closing. We also discuss the fraud-on-the-board theory that survived a motion to dismiss in Mindbody.
- We continue to monitor courts’ application of the disseminator theory of liability recognized by the Supreme Court’s 2019 decision in Lorenzo.
- We again survey specific securities-related lawsuits arising in connection with or related to the coronavirus pandemic, including class actions, derivative actions, and government enforcement actions filed by both the Securities and Exchange Commission (the “SEC”) and the Department of Justice.
- We review developments regarding Omnicare’s falsity of opinions standard, as rulings by the Second Circuit and several district courts shed light on the boundaries of liability for false or misleading statements of opinion as well as omissions.
- Finally, we consider notable ERISA litigation activity, including how the Supreme Court’s early 2020 decisions in Sulyma and Jander have been applied by lower courts, as well as a potential circuit split regarding an employer’s fiduciary duties while offering a single-stock fund.
I. Filing And Settlement Trends
According to data from a newly released NERA Economic Consulting (“NERA”) study, filings and settlements in 2020 reflected the volatility of a tumultuous year, though certain aspects remained consistent with existing trends. For example, a decrease in the number of merger-objection cases filed in 2020 (down to 106 from 162 in 2019) drove a decline in the number of new federal class actions filed in 2020 (down to 326 from 420 in 2019). As in 2019, the most frequently litigated industry sectors continue to be the “Health Technology and Services” and “Electronic Technology and Technology Services” sectors, each rising by 2%.
The median settlement value of federal securities cases in 2020—excluding merger-objection cases and cases settling for more than $1 billion or $0 to the class—was largely consistent with prior years (at $13 million, up from $12 million in 2019, and on par with $13 million in 2018). By contrast, average settlement values (excluding merger-objection and zero-dollar settlements) rose in 2020 (at $44 million, up from $29 million in 2019, though down from $73 million in 2018).
A. Filing Trends
Figure 1 below reflects filing rates for 2020 (all charts courtesy of NERA). 326 cases were filed last year, down considerably from the steady figures we have seen from 2017–2019. Note, however, that this figure does not include class action suits filed in state court or state court derivative suits, including those filed in the Delaware Court of Chancery.
Figure 1:
B. Mix Of Cases Filed In 2020
1. Filings By Industry Sector
As shown in Figure 2 below, the distribution of non-merger filings by industry was relatively consistent with 2019, even as the number of filings significantly decreased. The “Electronic Technology and Technology Services” and “Health Technology and Services” sectors continued to account for almost half of all filings, reaching 45% in 2020, with filings in both sectors rising by 2% over 2019. Notably, “Energy and Non-Energy Minerals” filings rose by 5% (at 6%, up from 1% in 2019), while “Commercial and Industrial Services” dropped by 4% (at 4%, down from 8% in 2019).
Figure 2:
2. Merger Cases
As shown in Figure 3 below, there were 106 merger-objection cases filed in federal court in 2020. This represents a 34.5% year-over-year decrease from 2019, and the lowest number of such filings since 2016, when the Delaware Court of Chancery put an effective end to the practice of disclosure-only settlements in In re Trulia Inc. Stockholder Litigation, 29 A.3d 884 (Del. Ch. 2016), which drove the increase in merger-objection filings between 2015 and 2017.
Figure 3:
C. Settlement Trends
As reflected in Figure 4 below, the average settlement value rebounded in 2020, reaching $44 million, after declining by more than 50% from $73 million in 2018 to $29 million in 2019, although that decrease can primarily be attributed to the inclusion of a settlement in 2018 that exceeded $1 billion, which skewed the average.
Figure 4:
Turning to the median settlement value, and excluding settlements over $1 billion, we see in Figure 5 that the steady pace of 2018 ($13 million) and 2019 ($12 million) continued in 2020 ($13 million).
Figure 5:
Finally, as shown in Figure 6, even though Median NERA-Defined Investor Losses rose steeply in 2020 to $805 million after a relatively consistent trend during the period 2014 through 2019, the Median Ratio of Settlement to Investor Losses fell for the second year in a row.
Figure 6:
II. What To Watch For In The Supreme Court
A. Supreme Court To Weigh In On Use Of Inflation Maintenance Theory
As we previewed in our 2020 Mid-Year Securities Litigation Update, the Supreme Court has granted certiorari in Goldman Sachs Group Inc. v. Arkansas Teacher Retirement System, No. 20-222, a case concerning the use of price-impact evidence to rebut the presumption of reliance at the class certification stage. ___ S. Ct. ___, 2020 WL 7296815 (Mem.) (Dec. 11, 2020). Recall that under Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014) (“Halliburton II”), the Supreme Court preserved the “fraud-on-the-market” presumption that enables courts to presume classwide reliance in Rule 10b-5 cases where plaintiffs satisfy certain prerequisites, but also opened the door to defendants rebutting that presumption at the class certification stage with evidence that the alleged misrepresentation did not impact the issuer’s stock price. Since then, lower courts have split on the viability of the “inflation maintenance” theory in this context. Arkansas Teacher Retirement System offers the Supreme Court the opportunity to resolve this split, squarely presenting the question of whether plaintiffs may use the inflation maintenance theory to demonstrate reliance by alleging that misstatements affected a stock price not by artificially inflating it, but by maintaining preexisting inflation.
By way of background, on April 7, 2020, a divided Second Circuit panel affirmed the trial court’s order certifying a class under the inflation maintenance theory premised on Goldman Sachs’s generic public statements. Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., 955 F.3d 254, 264–70 (2d Cir. 2020) (“Goldman Sachs II”). The plaintiffs did not make any showing that the challenged statements inflated the stock price, but rather premised their action on a drop in stock price following the announcement of a related regulatory action. Id. at 258–59, 262–63, 271, 273–74; see also id. at 275 (Sullivan, J., dissenting). In doing so, the Second Circuit rejected Goldman Sachs’s argument that the inflation maintenance theory may be applied only to “fraud-induced” inflation and should be narrowed to disallow its application to “general statements.” Id. at 265–70. The court also dismissed Goldman Sachs’s policy arguments that upholding inflation maintenance in these circumstances would “open the floodgates to unmeritorious litigation by allowing courts to certify classes that it believes should lose on the merits,” id. at 269, and that any time allegations of misconduct caused a stock to drop, “plaintiffs could just point to any general statement about the company’s business principles or risk controls and proclaim ‘price maintenance,’” id. (quoting Brief and Special Appendix for Defendants-Appellants at 52–53, Ark. Tchr. Ret. Sys. v. Goldman Sachs Grp., Inc., 955 F.3d 254 (2d Cir. 2020) (No. 18-3667), ECF No. 62).
Following the Second Circuit’s denial of rehearing en banc in June 2020 in Goldman Sachs II, Order, Ark. Tchr. Ret. Sys. v. Goldman Sachs Grp., Inc., No. 18-3667 (2d Cir. June 15, 2020), ECF No. 277, it was expected that the Supreme Court would consider this important issue. On December 11, 2020, after reviewing amicus briefs from the Society for Corporate Governance, former SEC officials and law professors, and financial economists, the Supreme Court granted the defendants’ petition for a writ of certiorari.
The Supreme Court will consider (1) whether the defendant in a securities class action may rebut the presumption of classwide reliance recognized in Basic Inc. v. Levinson, 485 U.S. 224 (1988), by pointing to the generic nature of the alleged misstatements in showing that the statements had no impact on the price of the security, even though that evidence is also relevant to the substantive element of materiality, and (2) whether a defendant seeking to rebut the Basic presumption has only a burden of production or also the ultimate burden of persuasion. Petition for Writ of Certiorari at I, Goldman Sachs (No. 20-222).
If the Supreme Court rejects the Second Circuit’s inflation-maintenance theory, it would protect the foundational importance of price impact to the Basic presumption of reliance, and would enable securities class action defendants to defeat the Basic presumption using any price-impact evidence—direct as well as indirect—even if that evidence overlaps with a later merits inquiry. It would stop plaintiffs from establishing price impact by pointing only to a company’s generic, aspirational statements and a subsequent stock drop in response to some enforcement activity. It would also preclude plaintiffs from showing loss causation by merely alleging that investors purchased stock at inflated prices and later suffered losses. On the other hand, if the Court were to affirm the Second Circuit’s approach, we expect a proliferation of “inflation maintenance” class actions based on a company’s general statements.
B. Questions Over Constitutional Challenges To Power Or Appointment Of Administrative Adjudicators
Readers will recall the Supreme Court’s landmark decision in Lucia v. SEC, 138 S. Ct. 2044, 2053 (2018), as discussed in our 2018 Mid-Year Securities Enforcement Update, that administrative law judges (“ALJs”) are “Officers” under the Appointments Clause and therefore must be appointed by either the President, the SEC, or a court of law. The Supreme Court’s holding in Lucia continues to generate constitutional questions over the appointment of administrative adjudicators, which could have implications for anyone considering bringing similar challenges against an ALJ of the SEC.
On March 1, 2021, the Supreme Court is set to hear argument in United States v. Arthrex, No. 19-1434 et al., which presents the question whether administrative adjudicators in the Patent and Trademark Office are “principal” or “inferior” Officers of the United States for purposes of the Appointments Clause. These consolidated cases present a question, not resolved by Lucia, as to how to categorize administrative adjudicators in light of their functions, supervision, and (possibly) removal protections. Gibson Dunn represents Smith & Nephew and ArthroCare Corp., the petitioners in No. 19-1452, in arguing (alongside the government) that administrative patent judges (“APJs”) are inferior Officers and were therefore permissibly appointed by the Secretary of Commerce. The Court’s resolution of the categorization issue in the context of APJs could have impacts for administrative adjudicators in other agencies.
On March 3, 2021, the Supreme Court is set to hear argument in Carr v. Saul and Davis v. Saul, a pair of consolidated cases involving whether parties need to present constitutional challenges to the appointment of administrative adjudicators at their administrative hearing in order to preserve the challenge for their later appeal. In both Carr and Davis, the petitioners filed for disability benefits under the Social Security Act, only for their claims to be denied by the Social Security Administration (“SSA”), the administrative tribunal, and the agency’s appeals board. Carr v. Comm’r, 961 F.3d 1267, 1268 (10th Cir. 2020); Davis v. Saul, 963 F.3d 790, 791 (8th Cir. 2020). Petitioners sought review in federal district court, and in light of Lucia, for the first time challenged the constitutionality of the appointment of the SSA ALJs. In Carr, the district court reversed the SSA decisions and remanded for new hearings before constitutionally appointed ALJs, while in Davis, the district court found that the petitioners had waived those challenges by not first bringing them during the administrative proceedings themselves. 961 F.3d at 1270; 963 F.3d at 792–93. On appeal, both the Eighth and Tenth Circuit Courts of Appeals agreed that the challenges had been waived by not being brought directly before the SSA. 961 F.3d at 1276; 963 F.3d at 795. The Court’s decision in these consolidated cases should help clarify the applicability of preservation, waiver, and forfeiture principles to these type of structural challenges.
III. Delaware Development
A. Recent Trends In Section 220 Litigation
Since the Delaware Supreme Court’s decision in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), stockholder plaintiffs have increasingly sought company books and records under Section 220 of the Delaware General Corporation Law to aid in drafting complaints that can withstand dismissal. See, e.g., Morrison v. Berry, 191 A.3d 268, 273, 275 (Del. 2018) (reversing dismissal under Corwin by relying on “crucial” documents obtained pursuant to Section 220). This uptick in Section 220 demands is not surprising, as Corwin established a formidable hurdle to plaintiffs hoping to overcome a motion to dismiss, as discussed in our 2017 Mid-Year Securities Litigation Update. Further, Delaware courts have “repeatedly admonished plaintiffs to use the ‘tools at hand’ and to request company books and records under Section 220 to attempt to substantiate their allegations before filing derivative complaints.” California State Teachers’ Ret. Sys. v. Alvarez, 179 A.3d 824, 839 (Del. 2018) (citation omitted).
1. Delaware Supreme Court Tosses “Proper Purpose” Requirement Except In “Rare” Circumstances
Section 220 permits a stockholder to inspect the company’s books and records for any “proper purpose” reasonably related to the stockholder’s “interest as a stockholder.” 8 Del. C. § 220(b). One well-recognized “proper purpose” that stockholders commonly assert is investigating alleged corporate mismanagement or wrongdoing, but a stockholder’s curiosity alone will not permit such an investigation. Seinfeld v. Verizon Commc’ns, Inc., 909 A.2d 117, 121–22 (Del. 2006). Instead, the stockholder must demonstrate “a credible basis from which the court can infer that mismanagement, waste or wrongdoing may have occurred.” Lavin v. West Corp., 2017 WL 6728702, at *7 (Del. Ch. Dec. 29, 2017) (quoting Seinfeld, 909 A.2d at 118). Although the “credible basis” standard imposes “the lowest possible burden of proof” under Delaware law, see Seinfeld, 909 A.2d at 123, Delaware case law has required stockholders to present some evidence to demonstrate that the alleged wrongdoing could be actionable, see United Techs. Corp. v. Treppel, 109 A.3d 553, 559 & n.31 (Del. 2014), and identify the course of action the stockholder plans to pursue if its demand succeeds, see Sec. First Corp. v. U.S. Die Casting & Dev. Co., 687 A.2d 563, 570 (Del. 1997).
Recently, however, the Delaware Supreme Court held in AmerisourceBergen Corp. v. Lebanon County Employees’ Retirement Fund, “that a stockholder is not required to state the objectives of his investigation” to satisfy Section 220’s “proper purpose” requirement. 2020 WL 7266362, at *6 (Del. Dec. 10, 2020). The Court reasoned that so long as the stockholder states a credible basis to support an inference of mismanagement or wrongdoing, the stockholder need not “specify the ends to which it might use the books and records” should they confirm suspicions of mismanagement or wrongdoing. Id. at *7. The Court also held that, except in “rare” circumstances, a stockholder “need not demonstrate that the alleged mismanagement or wrongdoing is actionable” to obtain company books and records under Section 220. Id. at *13–14.
In light of the developing case law in the Section 220 context, companies should continue to “honor traditional corporate formalities” in acting and maintaining corporate communications and record-keeping regarding its actions. See KT4 Partners LLC v. Palantir Techs. Inc., 203 A.3d 738, 742, 758 (Del. 2019) (ordering directors to produce emails in response to a Section 220 request, where the company “did not honor traditional corporate formalities . . . and had acted through email in connection with the same alleged wrongdoing that [the stockholder] was seeking to investigate”).
2. Delaware Corporations Not Subject To California Inspection Statute
In another recent decision concerning the inspection rights of stockholders, the Delaware Court of Chancery held that Delaware law precluded a stockholder of a Delaware corporation headquartered in California from seeking books and records under California’s inspection statute, California Corporations Code Section 1601. JUUL Labs, Inc. v. Grove, 238 A.3d 904, 913–18 (Del. Ch. 2020). The court explained that Delaware law governs the internal affairs of Delaware corporations and “[s]tockholder inspection rights are a core matter of internal corporate affairs.” Id. at 915. The court highlighted that the internal affairs doctrine serves “an important public policy . . . to ensure the uniform treatment of directors, officers, and stockholders across jurisdictions,” which the court noted “can only be attained by having the rights and liabilities of those persons with respect to the corporation governed by a single law.” Id. (citation and internal quotation marks omitted). Accordingly, the court held that the stockholder could not seek inspection under Section 1601. Id. at 918. This decision should help Delaware-incorporated companies limit the burden associated with responding to conflicting, burdensome, and invasive books and records demands under the laws of states other than Delaware.
B. Delaware Supreme Court May Eliminate Standing To Litigate “Dual-Natured” Merger Claims Post-Closing
Despite declining the opportunity to reject precedent that permits stockholders to litigate “dual-natured” merger claims post-closing, the Court of Chancery recently invited the Delaware Supreme Court to do so by certifying its decision in In re TerraForm Power, Inc. Stockholders Litigation, 2020 WL 6375859 (Del. Ch. Oct. 30, 2020), for interlocutory appeal. In TerraForm Power, Inc., plaintiff stockholders asserted breach of fiduciary duty claims against several directors, the CEO, and the majority stockholder of TerraForm Power, Inc., alleging that the controlling stockholder caused TerraForm “to issue [the controlling stockholder] stock for inadequate value, diluting both the financial and voting interest of the minority stockholders.” 2020 WL 6375859, at *1, *2. Defendants moved to dismiss for lack of standing, arguing that such dilution claims are “quintessential derivative claims that belong to the corporation” and could not be asserted by plaintiffs, who had ceased to be stockholders at the time of the motion due to a merger. Id. at *1. But Vice Chancellor Glasscock found that the facts alleged in TerraForm Power, Inc. were “indistinguishable” from those at issue in Gentile v. Rossette, 906 A.2d 91 (Del. 2006). TerraForm Power, Inc., 2020 WL 6375859, at *11. In Gentile, the Delaware Supreme Court held that, where a controlling stockholder dilutes the “economic value and voting power” of a minority stockholder’s shares by “caus[ing] the corporation” to issue itself shares for inadequate compensation, the minority stockholder is not deprived of standing to prosecute such claims after the merger closes because they are in the nature of both direct and derivative claims. Gentile, 906 A.2d at 100. Accordingly, Vice Chancellor Glasscock explained that he was bound by Delaware Supreme Court precedent and, as such, Gentile “mandate[d] that the direct claims pled survive” the motion to dismiss. TerraForm Power, Inc., 2020 WL 6375859, at *16.
In light of the criticism surrounding Gentile, however, Vice Chancellor Glasscock certified an interlocutory appeal of his decision to the Delaware Supreme Court to address whether Gentile remains good law. In re TerraForm Power, Inc. S’holders Litig., 2020 WL 6889189 (Del. Ch. Nov. 24, 2020). We will monitor the progress of this appeal and report on any developments in future editions of our Securities Litigation Update.
C. Revlon Claim Alleging “Fraud On The Board” Survives Motion To Dismiss
Recent Delaware decisions have potentially important implications for corporate directors’ disclosure obligations. In In re Mindbody, Inc., Stockholders Litigation, 2020 WL 5870084 (Del. Ch. Oct. 2, 2020), plaintiff stockholders alleged that three corporate insiders of Mindbody, Inc. manipulated the company’s sale to Vista Equity Partners for personal financial gain by withholding material information from the Board and tilting the sale process in Vista’s favor. Id. at *1, *20–25. Plaintiff alleged that the company’s founder—who acted as the company’s lead negotiator—“suffered from material conflicts in the sale process that he failed to disclose to the Board,” and that flaws related to a special committee’s mandate and effectiveness suggested that “the Board was the passive victim of a rogue fiduciary.” Id. at *24–25. The Court of Chancery rejected defendants’ attempt to dismiss this “fraud-on-the-board” theory, holding at the motion to dismiss stage where the facts are assumed to be true, that plaintiffs adequately pleaded the paradigmatic Revlon claim involving “a conflicted fiduciary who is insufficiently checked by the board and who tilts the sale process toward his own personal interests in ways inconsistent with maximizing stockholder value.” Id. at *13, *25.
Mindbody is a helpful reminder that “[a] plaintiff can state a Revlon claim by pleading that one conflicted fiduciary failed to provide material information to the board,” Mindbody, Inc., 2020 WL 5870084, at *14, and in such a case “the irrebuttable presumption of the business judgment rule” under Corwin may not apply since “it is not uncommon that a court finds the same information to be material to both directors and stockholders,” id. at *26 (internal quotations omitted).
IV. Development Of Disseminator Liability Theory Upheld In Lorenzo Continues
As we discussed in our 2019 Mid-Year Securities Litigation Update, the Supreme Court held in Lorenzo v. SEC, 139 S. Ct. 1094 (2019), that those who disseminate false or misleading information to the investing public with the intent to defraud can be liable under Section 17(a)(1) of the Securities Act and Exchange Act Rules 10b-5(a) and 10b-5(c), even if the disseminator did not “make” the statements for the purposes of enforcement under Rule 10b-5(b). Notably, Francis V. Lorenzo himself settled with the SEC on October 8, 2020, finally bringing an end to the litigation that commenced seven years ago. While the question of liability had been determined and affirmed by the Supreme Court in 2019, the SEC’s 2020 Order suspended Lorenzo from “association with any broker or dealer” and from “participating in any offering of a penny stock” for a period of twelve months but did not require Lorenzo to pay a monetary penalty. See Francis V. Lorenzo, Securities Act Release No. 10872, Exchange Act Release No. 90110, 2020 WL 5993037, at *3 (Oct. 8, 2020).
In the wake of Lorenzo’s settlement with the SEC, courts continue to grapple with whether and how to apply Lorenzo, which raised the possibility that secondary actors—such as financial advisors and lawyers—could face liability under Rules 10b-5(a) and 10b-5(c) simply for disseminating the alleged misstatement of another upon a showing that the secondary actors knew the statement contained false or misleading information.
For example, a bankruptcy court in the Northern District of Georgia emphasized the wide range of conduct captured by Rule 10b-5 in the wake of Lorenzo and denied summary judgment in an adversary proceeding on that basis. In re King, 2020 WL 6075956, at *18 (Bankr. N.D. Ga. Oct. 14, 2020). Although the bankruptcy court was interpreting Minnesota state securities law, the court analogized it to federal law to conclude that the debtor, King, could be held liable under Section 10(b) and Rule 10b-5 for the representations and omissions cited by investors. Id. Recognizing that a different individual purportedly made many of the allegedly misleading statements, the court reasoned that King nonetheless “could be liable for participating in a scheme to defraud . . . using [the other individual’s] misleading statements” as a disseminator, citing In re Cognizant Technology Solutions Corp. Securities Litigation, 2020 WL 3026564, at *16–19 (D.N.J. June 5, 2020), which we addressed in our 2020 Mid-Year Securities Litigation Update. In re King, 2020 WL 6075956, at *18. Together, the cases confirm that courts are willing to impose liability when individuals “substantially participate or are inextricably involved in the fraud.” Id.
In other instances, however, Lorenzo is merely a belt to the suspenders supplied by more traditional theories of liability. For example, in In the Matter of Laurie Bebo & John Buono, an Administrative Law Judge (“ALJ”) considered the liability of a CEO that allegedly misrepresented the state of an assisted living company’s financial affairs in order to conceal that the company was in breach of its lease agreement. Initial Decision Release No. 1401, 2020 WL 4784633, at *1 (ALJ Aug. 13, 2020). According to the SEC, the company then failed to disclose the company’s noncompliance with the lease in periodic reports filed with the SEC in violation of Section 10(b) and Rule 10b-5. Id. Although the ALJ ultimately found that the CEO “made” the relevant statements because she signed and “had responsibility for the content of the [Company’s] periodic reports,” the ALJ also reasoned that whether the CEO specifically made the statements was immaterial for scheme liability under Lorenzo. Id. at *76–77.
In future Securities Litigation Updates, we will continue to monitor closely how the Lorenzo disseminator liability theory is applied and how it is used to buttress other theories of liability.
V. Survey Of Coronavirus-Related Securities Litigation
When COVID-19 first arrived in the United States, resulting in massive economic dislocation and a stock market drop in March 2020, many predicted a wave of securities litigation would soon follow. The first wave of COVID-19-related securities lawsuits was more of a ripple, however, targeting select industries, such as travel and healthcare, that were most directly impacted by the pandemic. We surveyed these cases in our 2020 Mid-Year Securities Litigation Update.
Despite the steady recovery of the financial markets, the number of COVID-19-related securities litigations has increased. Plaintiffs have continued to sue companies in the travel and healthcare industries and have also widened their net to companies in other industries, including cybersecurity and real estate companies. This second, larger wave of cases has challenged a range of misstatements, including those concerning safety and risk disclosures.
Although it is still too soon to tell how courts will treat COVID-19 in these cases more broadly, we continue to monitor developments in these and other coronavirus-related securities litigation cases. Additional resources regarding company disclosure considerations related to the impact of COVID-19 can be found in the Gibson Dunn Coronavirus (COVID-19) Resource Center.
A. Securities Class Actions
1. False Claims Concerning Commitment To Safety
In the Second Circuit, statements concerning a company’s commitment to safety are often considered inactionable because they are “too general to cause a reasonable investor to rely upon them.” In re Vale S.A. Sec. Litig., 2017 WL 1102666, at *22 (S.D.N.Y. Mar. 23, 2017); see also Foley v. Transocean Ltd., 861 F. Supp. 2d 197, 204 n.7 (S.D.N.Y. 2012) (“[W]e note that the statements [regarding commitment to safety and training] would likely be considered expressions of ‘puffery’ that cannot form the basis of a securities fraud claim.”). Such statements may be found actionable, however, when the company operates in a dangerous industry and “it is to be expected that investors will be greatly concerned about [its] safety and training efforts.” Bricklayers & Masons Local Union No. 5 Ohio Pension Fund v. Transocean Ltd., 866 F. Supp. 2d 223, 244 (S.D.N.Y. 2012).
City of Riviera Beach Gen. Emps. Ret. Sys. v. Royal Caribbean Cruises Ltd., No. 20-cv-24111 (S.D. Fla. Oct. 7, 2020): This putative class action against a cruise line company alleges that defendants “failed to disclose material adverse facts about the company’s decrease in bookings outside China, and its inadequate policies and procedures to prevent the spread of COVID-19 on its ships.” Dkt. No. 1 at 3–4. Instead, Royal Caribbean allegedly gave false assurances to “the investing public that its safety protocols were ‘aggressive’ and would ‘ultimately contain the virus.’” Id. at 3. Within days of Royal Caribbean’s suspension of global operations on March 14, 2020, analysts downgraded the company’s stock and lowered their price targets. Id. at 5–6.
Hartel v. GEO Grp., Inc., No. 20-cv-81063 (S.D. Fla. July 7, 2020): A plaintiff stockholder filed a securities class action against GEO Group, a private corrections facilities operator, alleging that the company misled investors about the effectiveness of its COVID-19 response. Dkt. No. 1 at 1–2, 9. The complaint alleges that the company subjected its residents and employees “to significant health risks as the COVID-19 pandemic progressed,” which left the company “vulnerable to significant financial and/or reputational harm.” Dkt. No. 33 at 12. The company’s stock price declined after news of a serious outbreak in one of its facilities was released. Id. at 10.
2. Failure To Disclose Specific Risks
“Forward-looking statements are protected under the ‘bespeaks caution’ doctrine where they are accompanied by meaningful cautionary language.” In re Am. Int’l Grp., Inc. 2008 Sec. Litig., 741 F. Supp. 2d 511, 531 (S.D.N.Y. 2010). “However, generic risk disclosures are inadequate to shield defendants from liability for failing to disclose known specific risks.” Id.; see also Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d 171, 193 (S.D.N.Y. 2010) (observing generally, in adjudicating a motion to dismiss, that defendants “cannot be immunized for knowingly false statements even if they include some warnings”).
Arbitrage Fund v. Forescout Techs. Inc., No. 20-cv-03819 (N.D. Cal. June 10, 2020): Plaintiffs allege computer and network security company Forescout misled investors when, on February 6, 2020, the company announced a merger with Advent International Corp. without disclosing “the significant and disproportionate impact COVID-19 was having on [Forescout’s] business.” Dkt. No. 1 at 6, 10. Forescout previously disclosed general risks relating to COVID-19 but allegedly omitted that Advent was considering withdrawing from the merger agreement due to COVID-19. Id. at 22. On May 15, 2020, Advent announced it was terminating the merger plans. Id. at 16-17. Forescout’s stock fell nearly 24% in the following days. Id. at 24. This case was later consolidated with Sayce v. Forescout Technologies Inc., No. 20-cv-00076 (N.D. Cal. Jan. 2, 2020). Dkt. No. 55 at 7.
Berg v. Velocity Fin., Inc., No. 20-cv-06780 (C.D. Cal. July 29, 2020): A stockholder of Velocity, a real estate finance company, alleges that at the time of the company’s January 16, 2020 initial public offering, the defendants concealed “the potential impact of the novel coronavirus on Velocity’s business and operations.” Dkt. No. 1 at 2. The “Risk Factors” that Velocity reported were themselves purportedly materially misleading because they “presented as hypothetical[] risks that had already materially harmed the Company.” Dkt. No. 40 at 25. On April 8, 2020, Velocity announced it suspended all loan originations and by May 18, its share price had declined over 80% below the IPO price. Id. at 26–27, 29. As Gibson Dunn recently discussed, on January 25, 2021, the Court granted Velocity’s motion to dismiss, grounding the coronavirus-related portion of its decision on the fact that Velocity could not have anticipated the extent of the pandemic in early January 2020.
3. Alleged Insider Trading And “Pump and Dump” Schemes Connected To The Government’s Vaccination Efforts
“Under the ‘traditional’ or ‘classical theory’ of insider trading liability, § 10(b) and Rule 10b–5 are violated when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information.” United States v. O’Hagan, 521 U.S. 642, 651–52 (1997). Relatedly, in a “pump and dump” scheme, an individual promotes company stock to artificially increase the market price and then sells his shares at the inflated price. Emergent Capital Inv. Mgmt., LLC v. Stonepath Grp, Inc., 343 F.3d 189, 197 (2d Cir. 2003). In these cases, a plaintiff can adequately allege loss causation by showing that defendants had “the ability to manipulate stock prices of their ventures and that [] affiliated entities sold substantial quantities of [the stock in the relevant period].” Id. at 197 (internal quotations omitted).
Tang v. Eastman Kodak Co., No. 20-cv-10462 (D.N.J. Aug. 13, 2020): In this putative class action, a stockholder contends the company violated Sections 10(b) and 20(a) of the ’34 Act by allegedly failing to disclose that its officers were granted stock options immediately prior to the company’s public announcement that it had received a loan to produce drugs for the treatment of COVID-19. Dkt. No. 1 at 2. The price of the company’s stock increased after this announcement, and it then dropped as news of the stock options began to circulate. Id. at 4–5.
Hovhannisyan v. Vaxart, Inc., No. 20-cv-06175 (N.D. Cal. Sept. 1, 2020): A stockholder in Vaxart, a small clinical-stage biotechnology company, filed a putative class action lawsuit against the company, certain current and former senior executives and directors, and its majority stockholder. Dkt. No. 1 at 1. The complaint alleges that the defendants “engaged in a naked ‘pump and dump’ scheme” by making “a series of misleading statements to investors [suggesting the company] was a major player in the U.S. government’s effort to develop a vaccine.” Id. The stock price plummeted once The New York Times reported that the company misled investors about the nature of its vaccination efforts so that its insiders could reap massive gains. Id. at 2–3.
B. Stockholder Derivative Actions
In a derivative suit, a stockholder seeks to assert a claim belonging to the corporation. “Whenever directors communicate publicly or directly with shareholders about the corporation’s affairs, with or without a request for shareholder action, directors have a fiduciary duty to shareholders to exercise due care, good faith and loyalty.” Malone v. Brincat, 722 A.2d 5, 10 (Del. 1998). “[A] director must make a good faith effort to oversee the company’s operations. Failing to make that good faith effort breaches the duty of loyalty and can expose a director to liability.” Marchand v. Barnhill, 212 A.3d 805, 820 (Del. 2019) (citing In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 970 (Del. Ch. 1996)).
1. Disclosure Liability
Fettig v. Kim, No. 20-cv-03316 (E.D. Pa. July 7, 2020): Certain directors and officers of Inovio Pharmaceuticals allegedly breached their fiduciary duties by claiming in February and March 2020 “that Inovio had developed a COVID-19 vaccine in a matter of about three hours,” Dkt. No. 1 at 7 (internal quotations omitted), and “may be in a position to begin human clinical trials in the United States in April 2020,” id. at 10. In response to these announcements, Citron Research posted on Twitter that Inovio’s claims were false and urged the SEC to investigate. Id. at 3. Although Inovio denied Citron’s allegations, it stated that the vaccine was not actually a “vaccine,” but an “early stage prototype,” causing the company’s stock price to plummet. Id.
Wong v. Eberly, No. 20-cv-04269 (E.D.N.Y. Sept. 11, 2020): Plaintiff alleges that directors and officers of Chembio Diagnostics, Inc. made misleading statements about Chembio’s rapid COVID-19 antibody tests, including that they “were 100% accurate after 11 days following the onset of symptoms.” Dkt. No. 1 at 1, 5. On June 16, 2020, the FDA wrote Chembio a letter saying the test was far less effective than the company had represented and revoked its Emergency Use Authorization, effectively barring distribution. Id. at 6–7. After the announcement, the stock price plummeted by over 60%. Id. at 7.
2. Oversight Liability
Zarins v. Schessel, No. 654833/2020 (Sup. Ct. N.Y. Cty. Sept. 30, 2020): A stockholder in SCWorx Corp., a health care technology company, brought a derivative action against certain company directors, claiming that those directors breached their duties to the company “by making or causing the Company to make false statements that artificially inflated the price of SCWorx securities.” Dkt. No. 1 at 3. Specifically, the complaint alleges that the director defendants caused “SCWorx to announce that it had received a committed purchase order of two million COVID-19 rapid testing kits.” Id. at 11. The company’s stock dropped after an investment research firm referred to the purported deal as “completely bogus” and backed by purported fraudsters and convicted felons. Id. at 14–15.
3. Insider Trading
As discussed above, insider trading involves a corporate insider trading the company’s securities based on material, nonpublic information. O’Hagan, 521 U.S. at 651. “[A] corporate insider must abstain from trading in the shares of his corporation unless he has first disclosed all material inside information known to him.” Chiarella v. United States, 445 U.S. 222, 227 (1980). “[I]f disclosure is impracticable or prohibited by business considerations or by law, the duty is to abstain from trading.” SEC v. Obus, 693 F.3d 276, 285 (2d Cir. 2012). A similar state-law claim in Delaware is known as a Brophy claim, which permits a corporation to recover from its fiduciaries for harm caused by insider trading. Brophy v. Cities Serv. Co., 70 A.2d 5 (Del. Ch. 1949).
City of Hallandale Beach Police Officers’ and Firefighters’ Personnel Ret. Tr. v. Garcia, No. 2020-0887 (Del. Ch. Oct. 13, 2020): On October 13, 2020, plaintiffs filed suit against the controlling stockholder of a company and other individuals alleging that defendants purchased shares of the company at a price that was too low in light of a decline in the company’s stock price at the outset of the COVID-19 pandemic. Dkt. No. 1 at 2. Plaintiff brought a Brophy claim as well as derivative claims for breach of fiduciary duty, waste, and unjust enrichment. Id. at 42–45.
Jaquith v. Latour, No. 2020-0904 (Del. Ch. Oct. 20, 2020): The plaintiff in this derivative action against the directors and controlling stockholder of Vaxart, a biotechnology company, alleges that the directors breached their fiduciary duties by approving warrant amendments allowing the controlling stockholder to trade on material, nonpublic information relating to Vaxart’s participation in Operation Warp Speed (“OWS”). Dkt. No. 7 at 2–3. Three weeks after the amendments, Vaxart announced that it was selected to be part of OWS. Id. at 5. Shortly after Vaxart’s stock price skyrocketed, the controlling stockholder exercised its warrants and sold its shares for nearly $200 million in profit. Id. at 6.
C. SEC Cases
SEC v. Schena, No. 20-cv-06717 (N.D. Cal. Sept. 25, 2020): The SEC charged Mark Schena, the President of Arrayit Corporation, a healthcare technology company, for “making false and misleading statements about the status of Arrayit’s delinquent financial reports.” Dkt. No. 1 at 1. At the time, the defendant had allegedly failed to provide Arrayit’s independent auditor with the documents necessary to complete audits of the company’s financial statements. Id. at 4. Schena was also charged with making false and misleading statements that the company had a COVID-19 test and that it was pending emergency FDA approval. Id. at 8. The SEC contends that Arrayit had not applied for emergency approval when these statements were made. Id.
The Cheesecake Factory, Inc., Exchange Act Release No. 90565 (Dec. 4, 2020): As Gibson Dunn recently discussed, this enforcement action came after the company submitted a Form 8-K withdrawing prior financial guidance due to the economic impact of the pandemic. Order at 2. The company had allegedly made misstatements and omissions regarding its ability to operate sustainably in the shift to a business model centered on take-out and delivery. Id. at 3. The Cheesecake Factory settled on a neither-admit-nor-deny basis, and agreed to a $125,000 penalty. Id. at 1, 4.
D. Criminal Securities Fraud
United States v. Berman, No. 20-cr-278 (D.D.C. Dec. 15, 2020): On December 15, 2020, the CEO of Decision Diagnostics Corp. was indicted by a federal grand jury in connection with an alleged scheme to defraud investors by making false and misleading statements about the development of a new COVID-19 test, which led to millions of dollars in investor losses. Dkt. No. 1 at 4, 15. According to the indictment, the defendant falsely claimed that Decision Diagnostics had developed a 15-second, COVID-19 finger-prick rapid test that was on the verge of FDA approval. Id. at 6–7. At the time, however, the test was allegedly more of a concept than an actual product, and the company lacked the resources to conduct the clinical testing required by the FDA. Id. at 9.
* * *
Although a fair number of COVID-19 suits have been filed, the book is far from closed on these lawsuits or the continued impact COVID-19 will have on the stock market and broader economy. It is still unclear whether optimistic stock market projections regarding the success of vaccinations will bear out, and when companies in the hardest hit industries will be able to return to business as usual. Regardless of the course COVID-19 takes in 2021, we expect plaintiffs to continue filing coronavirus-related securities lawsuits.
VI. Falsity Of Opinions – Omnicare Update
As we discussed in our prior securities litigation updates, lower courts continue to analyze the boundaries of liability for false or misleading statements of opinion set forth in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 575 U.S. 175 (2015). The Omnicare Court identified two situations in which a speaker can be held liable for a statement of opinion. Id. at 184–86. First, although “a sincere statement of pure opinion is not an ‘untrue statement of material fact,’ regardless [of] whether an investor can ultimately prove the belief wrong,” liability can be found when a speaker does not “actually hold[] the stated belief,” or when the opinion statement contains demonstrably untrue “embedded statements of fact.” Id. Second, even where speakers might sincerely believe their stated opinions, they can be found liable if they omit a fact “about the issuer’s inquiry into or knowledge concerning a statement of opinion” that “conflict[s] with what a reasonable investor would take from the statement itself.” Id. at 189. We expect to see even broader application of Omnicare principles in the coming months as COVID-related securities cases begin reaching judicial decisions.
In July, the Second Circuit shed some light on what qualifies as a plausibly pled omission theory of liability in Abramson v. NewLink Genetics Corp., 965 F.3d 165 (2d Cir. 2020), reh’g en banc denied. The lower court found no liability could attach as a matter of law to the first of the defendants’ statements at issue—that “‘all the major studies’ show survival rates of at most 20 months” for certain cancer patients—because plaintiffs did not “aver that the speaker did not hold the belief.” Id. at 174–76, rev’g Nguyen v. NewLink Genetics Corp., 2019 WL 591556 (S.D.N.Y. Feb. 13, 2019). Noting that Omnicare lessened the importance of a precise distinction between statements of fact and opinion, particularly where the statement was allegedly misleading by omission, the Second Circuit panel, made up of Judges Kearse, Walker, and Livingston, rejected this analysis. Id. at 176. Instead, the panel found that the degree of fact or certainty implied in the defendant’s conclusory statement rendered it misleading because the existence of “major studies” to the contrary should have given the defendant reason to speak in more qualified terms. Id. at 176–77. Applying the same omission theory framework, the panel also reversed the trial court’s dismissal as to the second statement at issue—a mix of opinion and fact: “it is our belief that in our study today we don’t have any reason to believe that median survival for these patients will be more than low 20s,” and that the company’s study “‘is designed’ for the possibility that the control group survival rate is ‘in the low 20s.’” Id. at 178. As before, the panel concluded that the complaint plausibly alleged the statement was misleading by omission due to its categorical nature. Id. As to both statements, the court found the driving factor was whether a fact finder could conclude a reasonable investor, taking these conclusory statements at face value, could be misled to believe no credible study to the contrary existed. Thus, the decision guides issuers to use more qualified terms in their statements rather than conveying absolute certainty to investors, especially if there is reason to believe facts exist cutting the other way.
Otherwise, Omnicare remained a significant pleading barrier in the latter half of 2020, particularly where the opinions concerned general statements about financial performance. In Shreiber v. Synacor, Inc., for example, issued just a few months after Abramson, the Second Circuit affirmed dismissal of class action claims alleging that Synacor’s “upbeat statements about . . . expected future revenues” from a key contract to create a web portal were misleading because they failed to disclose certain material risks in achieving those projections—namely that the counterparty “controlled monetization” of the portal. 2020 WL 6165909, at *1–2 (2d Cir. Oct. 22, 2020). The plaintiffs in Schreiber admitted that the opinions were “honestly held” and supplied no untrue supporting facts, leaving only the question of whether the defendants “omit[ted] information whose omission makes the statement misleading to a reasonable investor.” Id. at *2. The court found no such omission, noting that the defendants disclosed the terms of the relevant contract and effectively cautioned that revenue would only be achievable after the program was fully deployed, so the omissions “fairly align[ed]” with Synacor’s stated expectations to achieve $100 million in revenue after deploying the portal and migrating customers. Id. (quoting Omnicare, 575 U.S. at 189).
Several cases in the Southern District of New York reaffirmed that appropriate cautionary language is significant in protecting issuers from Omnicare liability. For example, in In re Anheuser-Busch InBev SA/NV Securities Litigation, 2020 WL 5819558 (S.D.N.Y. Sept. 29, 2020), the plaintiff alleged that the defendants’ optimistic opinions about expected dividends had omitted material information on factors that could restrict dividend payments. Id. at *6. But because the defendants’ SEC filings had cautioned that they “may be unable to pay dividends” depending on numerous factors, the court ruled that the “alleged misstatements [were] nonactionable statements of opinion.” Id. at *5–*6; cf. In re Ferroglobe PLC Sec. Litig., 2020 WL 6585715, at *8 (S.D.N.Y. Nov. 10, 2020) (statements made during a presentation were not misleading where slides “immediately preced[ing] and follow[ing]” the statements had “acknowledged” the issues claimed to have been omitted). Likewise, in Burr v. Equity Bancshares, Inc., 2020 WL 6063558 (S.D.N.Y. Oct. 14, 2020), the court dismissed claims related to statements about loan loss allowances. Crucially, defendants’ SEC filings had described various factors that affected their allowance determinations. Id. at *6. And defendants expressly noted that their determinations were “ultimately a matter of ‘management’s judgment.’” Id. Given these warnings, as well as the “customs and practices of the relevant industry,” the court determined that a reasonable investor would not have been misled. Id. (quoting Omnicare, 575 U.S. at 189).
Recent district court opinions also illustrate that Omnicare can apply to limit claims even in the absence of classic opinion qualifiers. For example, in West Palm Beach Firefighters’ Pension Fund v. Conagra Brands, Inc., 2020 WL 6118605 (N.D. Ill. Oct. 15, 2020), the district court treated the defendants’ alleged predictions about the “success and effects” of a proposed merger as opinions—to be analyzed under Omnicare—despite the absence of “qualifiers such as ‘I think’ or ‘I believe.’” Id. at *16. The court reasoned that “future predictions” are distinguishable from statements of fact in light of the inherent uncertainty entailed in making predictions. Id. Similarly, in Costanzo v. DXC Technology Co., 2020 WL 4284838 (N.D. Cal. July 27, 2020), a California district court assumed that Omnicare applied to the claims at issue, even though “[t]he challenged statements” lacked “any clear indication” that they were opinions. Id. at *12. Thus, while it remains true that issuers are well advised to properly qualify opinion statements with phrases like “I think” or “I believe,” a failure to do so does not preclude Omnicare treatment when other factors show that the disputed statement was an opinion.
VII. Halliburton II Market Efficiency And “Price Impact” Cases
As discussed above, the most significant development related to litigating price impact during the second half of 2020 was the Supreme Court’s grant of Goldman Sachs’s petition for certiorari. The Supreme Court’s eventual decision in that case will mark the Court’s first guidance on the proper application of its 2014 holding in Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014) (“Halliburton II”). In Halliburton II, the Court affirmed that courts may presume that stockholders classwide relied on alleged misrepresentations—provided the misrepresentations were public and material, the stock traded in an efficient market, and the plaintiffs traded after the alleged misrepresentation but before any correction. See id. at 277–78; Basic Inc. v. Levinson, 485 U.S. 224, 248 & n.27 (1988). In Halliburton II, however, the Court also held a defendant can undermine the presumption—and defeat class certification—by showing that the alleged misrepresentation in fact had no impact on the stock price. See Halliburton II, 573 U.S. at 283.
As we have previously noted, lower courts have had to reconcile the Supreme Court’s explicit ruling in Halliburton II that direct and indirect evidence of price impact must be considered at the class certification stage, see id., with the Supreme Court’s previous decisions holding that plaintiffs need not prove loss causation, see Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804, 813 (2011) (“Halliburton I”), or materiality, see Amgen Inc. v. Conn. Ret. Plans & Tr. Funds, 568 U.S. 455, 470 (2013) (“Amgen”), until the merits stage. Lower courts have also struggled with the issue of what standard of proof defendants must meet to rebut the presumption and what evidence is required to successfully do so.
Before the Supreme Court’s grant of certiorari in the Goldman Sachs case, the Seventh Circuit issued In re Allstate Corp. Securities Litigation, 966 F.3d 595 (7th Cir. 2020), an opinion that both acknowledged the need for and provided guidance on reconciling the three key Supreme Court decisions regarding the presumption of reliance noted above. The Seventh Circuit followed the Second Circuit’s lead in requiring trial courts to consider evidence of a lack of price impact even where that evidence overlaps with a merits issue, such as materiality. Allstate, 966 F.3d at 600–01, 608–09. It also followed the Second Circuit on assigning both the burden of production and the burden of persuasion to defendants. Id. at 610–11 (citing Waggoner v. Barclays PLC, 875 F.3d 79, 96–104 (2d Cir. 2017)). The Seventh Circuit vacated the trial court’s ruling certifying a class and held that the district court’s refusal to engage with defendant’s evidence of a lack of price impact was error. Id. at 609. Thus, the court remanded for further consideration of defendant’s evidence, id., including evidence regarding any price increase when the challenged statements were made and whether the stock price drops when the alleged fraud is revealed, see id. at 613.
Despite the emerging consensus among circuit courts that price impact evidence must be considered at the class certification stage even where it overlaps with merits issues, several district court decisions in the second half of 2020 declined to consider arguments regarding whether alleged corrective disclosures actually corrected the challenged statements. See, e.g., Plymouth Cty. Ret. Sys. v. Patterson Cos., 2020 WL 5757695, at *13 (D. Minn. Sept. 28, 2020) (declining to consider defendants’ arguments that changes in stock price on alleged corrective disclosure dates were not attributable to the challenged statements, because loss causation is a merits issue); In re CenturyLink Sales Practices & Sec. Litig., 2020 WL 5517483, at *13 (D. Minn. Sept. 14, 2020) (same). Both Plymouth County Retirement System and In re CenturyLink cited the Second Circuit’s 2020 decision in Goldman Sachs II, now under review by the Supreme Court, for the proposition that “[d]efendants must show ‘that the entire price decline on the corrective-disclosure dates was due to something other than its alleged misstatements,’” see, e.g., Plymouth Cty., 2020 WL 5757695, at *13 (quoting Ark. Teacher Ret. Sys. v. Goldman Sachs Grp., Inc., 955 F.3d 254, 270 (2d Cir. 2020)), but refused to consider whether the corrective disclosures actually contradicted the challenged statements, see, e.g., id. (citing Amgen, 568 U.S. at 475).
We will continue to monitor developments in the Goldman Sachs matter and cases considering Halliburton II.
VIII. ERISA Litigation
Where employer stock is offered as an investment option in employee retirement plans, securities litigation is often accompanied by claims under the Employee Retirement Income Security Act of 1974 (“ERISA”). 2020 saw noteworthy ERISA litigation activity, including the Supreme Court’s Sulyma decision clarifying the statute of limitations for fiduciary breach claims. Lower courts have also been active in the wake of the Court’s January decision in Retirement Plans Committee of IBM v. Jander, 140 S. Ct. 592 (2020), in addition to analyzing the requirements for fiduciary breach claims, the requirement of administrative exhaustion as a defense to fiduciary claims, and the enforceability of arbitration agreements.
A. Sulyma And Subsequent Lower Court Developments
As we discussed in our 2020 Mid-Year Securities Litigation Update, in February the Supreme Court unanimously held in Intel Corporation Investment Policy Committee v. Sulyma, 140 S. Ct. 768 (2020), that for purposes of ERISA’s limitations period in fiduciary breach cases, a fiduciary’s disclosure of plan information alone does not create “actual knowledge” subjecting such claims to the statute’s shorter three-year period, 29 U.S.C. § 1113(2), absent proof that a beneficiary actually read such disclosures. The Court left open questions, however, concerning how to prove “actual knowledge” based on circumstantial evidence or “willful blindness.” See Sulyma, 140 S. Ct. at 779.
Only a small number of lower courts have applied this decision so far. In Guenther v. Lockheed Martin Corp., 972 F.3d 1043 (9th Cir. 2020), the Ninth Circuit affirmed dismissal of a complaint as time-barred by the three-year limitations period triggered by actual knowledge as addressed in Sulyma. The court found that the plaintiff had actual knowledge based both on his testimony that he received and read relevant plan disclosures, and on “[c]ircumstantial evidence” such as actions that reflected his understanding of their contents. Id. at 1055. By contrast, a few district courts have declined to dismiss complaints as time-barred under the standard articulated in Sulyma. In Pizarro v. Home Depot, Inc., No. 18-cv-1566, 2020 WL 6939810 (N.D. Ga. Sept. 21, 2020), the court held that a plaintiff’s admission of past “generic concerns” about the fees that ultimately gave rise to her claim was “not evidence that she had actual knowledge of the underlying fiduciary conduct at issue”: “[s]he might have thought she was paying too much for the services she received, but her personal beliefs in no way demonstrate knowledge of the details, specifically that the fees charged were allegedly above the market price . . . , and particularly that fees might have even been inflated due to the alleged kickback scheme.” Id. at *28. Another court similarly declined to dismiss on timeliness grounds in Bouvy v. Analog Devices, Inc., No. 19-cv-881, 2020 WL 3448385 (S.D. Cal. June 24, 2020). Defendants argued that the plaintiff had knowledge from receipt of plan disclosures, but “fail[ed] to provide evidence indicating Plaintiff had actual knowledge or was willfully blind.” Id. at *5. In sum, the precise contours of “actual knowledge” and “willful blindness” after Sulyma will continue to be worked out in lower court litigation.
Additionally, at least one court has read Sulyma to shed light on another question, not directly presented in that case: “whether a Plan may set its own limitations period for statutory ERISA claims” that supersedes the statutory period. Falberg v. Goldman Sachs Grp., Inc., No. 19-cv-9910, 2020 WL 7695711, at *2 (S.D.N.Y. Dec. 28, 2020). In Falberg, the district court held that the answer is “no” for a case that would otherwise be controlled by the three-year period in 29 U.S.C. § 1113(2), in part because of the Supreme Court’s statement in Sulyma that “[29 U.S.C.] § 1132(a)(2) claims ‘must be filed within one of three time periods’ pursuant to § 1113.’” Id. at *3 (quoting Sulyma, 140 S. Ct. at 774) (emphasis added by trial court). The court accordingly denied defendants’ motion to dismiss and declined to issue a certificate of appealability on this issue. See id. at *4.
B. ESOP Fiduciary Claims After Jander
Regular readers will recall the discussion in our 2019 Year-End Securities Litigation Update and 2020 Mid-Year Securities Litigation Update of the circuitous path taken by the case of Retirement Plans Committee of IBM v. Jander, 140 S. Ct. 592 (2020) (per curiam), in which the Supreme Court ultimately punted on the question whether the “more harm than good” pleading standard from Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 430 (2014), can be satisfied by generalized allegations that the harm resulting from the inevitable disclosure of an alleged fraud generally increases over time. Rather than deciding that question, the Court remanded the case in January to allow the Second Circuit to address two unresolved issues raised by the parties: (1) whether ERISA ever imposes a duty on a fiduciary for an employee stock option plan (ESOP) to act on inside information; and (2) whether ERISA requires disclosures that are not otherwise required by the securities laws. Jander, 140 S. Ct. at 595. Justice Kagan (joined by Justice Ginsburg) and Justice Gorsuch filed dueling concurrences addressing those questions and disputing whether they were properly presented.
On remand, the Second Circuit in June 2020 reinstated the judgment entered pursuant to its original opinion—an uncommon win for plaintiffs in this area. Jander v. Ret. Plans Comm. of IBM, 962 F.3d 85 (2d Cir. 2020) (per curiam). The court agreed with Justice Kagan’s suggestion that the additional arguments raised by defendants and the government in supplemental briefing “either were previously considered by this Court or were not properly raised,” and therefore were forfeited. Id. at 86.
Since then, the Second Circuit’s decision has become even more of an “outlier,” as “the overwhelming majority of circuit courts to consider an imprudence claim based on inside information post-Dudenhoeffer [have] rejected the argument that public disclosure of negative information is a plausible alternative.” Burke v. Boeing Co., No. 19-cv-2203, 2020 WL 6681338, at *5 (N.D. Ill. Nov. 12, 2020). In a pair of cases decided in July, the Eighth Circuit rejected the Second Circuit’s reasoning on this question in Allen v. Wells Fargo & Co., 967 F.3d 767, 774 (8th Cir. 2020), and instead followed the reasoning of “nearly every other circuit court to confront this type of argument” by concluding that “this chain of reasoning is uncertain and a reasonably prudent fiduciary . . . could still believe disclosure was the more dangerous of the two routes.” Dormani v. Target Corp., 970 F.3d 910, 915 (8th Cir. 2020). The plaintiffs in one of these cases, Allen v. Wells Fargo & Co., have filed a petition for certiorari asking the Supreme Court to weigh in on this deepening circuit split, which last year’s remand in Jander left unresolved.
C. Exhaustion Defenses Against Fiduciary Claims
Decisions in 2020 indicate that the circuits remain split on whether plaintiffs must exhaust administrative remedies before filing claims invoking ERISA-imposed fiduciary duties. Almost all circuits have held that plaintiffs must generally exhaust administrative remedies “before filing suit” for benefits due pursuant to a plan “under [ERISA] § 502(a)(1)(B), [29 U.S.C. § 1132(a)(1)(B)].” LaRue v. DeWolff, Boberg & Assocs., Inc., 552 U.S. 248, 258–59 (2008) (Roberts, C.J., concurring in part and concurring in the judgment). But only two courts of appeals—the Seventh and Eleventh Circuits—have extended that requirement to claims alleging a breach of fiduciary duties imposed by ERISA itself, in addition to claims for benefits due under the terms of a plan. See Lanfear v. Home Depot, Inc., 536 F.3d 1217, 1223–24 (11th Cir. 2008); Lindemann v. Mobil Oil Corp., 79 F.3d 647, 649 (7th Cir. 1996). District courts in those circuits therefore continue to dismiss cases for failure to exhaust that would proceed unhindered in other jurisdictions. See, e.g., Fleming v. Rollins, Inc., No. 19-cv-05732, 2020 WL 7693147, at *5 (N.D. Ga. Nov. 23, 2020).
This circuit split has now persisted for over thirty years. See Mason v. Cont’l Grp., Inc., 474 U.S. 1087, 1087 (1986) (White, J., dissenting from denial of certiorari) (urging that “the Court should grant certiorari in this case in order to resolve the uncertainty over the existence of an exhaustion requirement in cases of this kind”). Until the Supreme Court weighs in, this division is likely to persist for the foreseeable future.
D. Single Stock Fund Fiduciary Claims
In the past year, a circuit split has developed on the question of whether an employer can satisfy its fiduciary duties while offering a single-stock fund. ERISA requires the fiduciary of a pension plan to act prudently in managing the plan’s assets and to diversify the investments of the plan so as to minimize the risk of large losses. 29 U.S.C. § 1104(a)(1)(B), (C). Recent litigation has challenged whether single-stock funds are per se imprudent because they are not diversified, or whether single-stock funds may be offered so long as a diversified portfolio can be attained at the plan level.
In May of last year, the Fifth Circuit affirmed the dismissal of a putative fiduciary breach class action in Schweitzer v. Investment Committee of Philips 66 Savings Plan, 960 F.3d 190 (5th Cir. 2020). The court first addressed the statutory definition of a qualifying employer security, which is exempt from the otherwise applicable fiduciary duties of diversification. Id. at 105; see 29 U.S.C. § 1107(d)(1) (defining an employer security as one “issued by an employer of employees covered by the plan, or by an affiliate of such employer”). The court rejected the defendants’ argument that the single-stock funds at issue (investing in ConocoPhillips stock) were qualifying employer securities because an intervening spinoff had changed the employer into a new entity (Phillips 66) for statutory purposes. 960 F.3d at 195. Nevertheless, the court held that the defendants satisfied their fiduciary duties to diversify and act prudently because they provided plan participants with an array of other investment options that “enable[d] participants to create diversified portfolios.” Id. at 196–98. The court rejected plaintiffs’ claim that “a single-stock fund is imprudent per se.” Id. at 198.
A few months after Schweitzer, the Fourth Circuit reached the opposite conclusion and reversed the district court’s dismissal of a putative class action claiming that the defendant company breached its fiduciary duty with a single-stock fund. Stegemann v. Gannett Co., 970 F.3d 465 (4th Cir. 2020). Rejecting the argument that “diversification must be judged at the plan level rather than at the fund level,” the Fourth Circuit held that “each available fund on a menu must be prudently diversified.” Id. at 476–77 (emphasis added). The dissent argued that “the majority merge[d] the duties of diversification and prudence,” and, in effect, made it impossible for an employer to “ever prudently offer a single-stock, non-employer fund.” Id. at 484, 488 (Niemeyer, J., dissenting). No other court has adopted the Fourth Circuit’s standard. Defendants filed a petition for a writ of certiorari and, on January 4, 2021, the Supreme Court called for a response from the plaintiff, indicating that the Court might be interested in hearing the case.
E. Arbitrability Of ERISA § 502(a)(2) Claims
Whether ERISA plan participants can be required to arbitrate fiduciary duty-related disputes has continued to be litigated in the past year. Because ERISA § 502(a)(2) “claims belong to a plan—not an individual,” the “relevant question is whether the Plan agreed to arbitrate the § 502(a)(2) claims,” not the individual employee. Dorman v. Charles Schwab Corp., 780 F. App’x 510, 513 (9th Cir. 2019) (citing Munro v. Univ. of S. Cal., 896 F.3d 1088, 1092 (9th Cir. 2018)) (emphasis added). Accordingly, in Dorman, the Ninth Circuit held that because “the Plan did consent in the Plan document to arbitrate all ERISA claims,” the mandatory arbitration agreement was enforceable. Id. at 514; see also Dorman v. Charles Schwab Corp., 934 F.3d 1107 (9th Cir. 2019) (published opinion issued the same day holding that ERISA claims may be arbitrable, and overruling Amaro v. Continental Can Co., 724 F.2d 747 (9th Cir. 1984)).
If the plan does not expressly agree to arbitration in the plan document, however, then an arbitration agreement may be unlikely to be enforced for a § 502(a)(2) claim, regardless of whether the individual employee signed an arbitration agreement related to his or her own employment. For example, in Ramos v. Natures Image, Inc., No. 19-cv-7094, 2020 WL 2404902 (C.D. Cal. Feb. 19, 2020), the district court partially denied a motion to compel arbitration on an ERISA claim for breach of fiduciary duty, even though the individual employee plaintiffs had signed arbitration agreements. The key distinction for the Ramos court was whether the plan is a party to the arbitration agreement. Id. at *7. And because the employee’s arbitration agreement in Ramos concerned only the employment relationship and did not bind the plan to arbitration, the court held that the agreement did “not cover claims for breach of fiduciary duty under ERISA”. Id.; but see Woellecke v. Ford Motor Co., No. 19-CV-12430, 2020 WL 6557981, at *3–4 (E.D. Mich. Nov. 9, 2020) (holding that because “the parties agreed to arbitrate [both] the merits of any arbitrable disputes” and any arbitrability disputes, “the matter must be resolved by the arbitrator . . . to decide whether disputes are subject to their agreement”). For this reason, the court also rejected the argument that, when the plan was not bound by the arbitration agreement, there was a distinction between a plaintiff bringing a class action on behalf of the plan and a plaintiff bringing an individual action. Ramos, 2020 WL 2404902 at *7.
Finally, even if the plan expressly agrees in the plan document to arbitrate § 502(a)(2) ERISA claims, the arbitration agreement still may not be enforced, as other courts have called Dorman into question more directly. In Smith v. Greatbanc Trust Co., the District Court for the Northern District of Illinois rejected Dorman’s holding, even though the plan agreed to arbitrate. 2020 WL 4926560, at *3–4 (N.D. Ill. Aug. 21, 2020). The court reasoned that failure to notify the former employee, who remained a participant in the plan, about changes to the plan was inconsistent with ERISA’s notice requirements, and that, to the extent the arbitration agreement served as a “waiver of a party’s right to pursue statutory remedies,” the agreement was unenforceable. Id. at *4 (quoting Am. Express Co. v. Italian Colors Restaurant, 570 U.S. 228, 235–36 (2013)). The case is now pending appeal, but if the Seventh Circuit affirms the district court in Smith, it could create a split with the Ninth Circuit.
The following Gibson Dunn attorneys assisted in preparing this client update: Jeff Bell, Shireen Barday, Krista Hanvey, Monica Loseman, Brian Lutz, Karl Nelson, Mark Perry, Avi Weitzman, Lissa Percopo, Mark H. Mixon, Jr., Nick Barba, Sam Berman, Jason Bressler, Aaron Chou, Luke Dougherty, Jonathan Haderlein, Rachel Jackson, Andrew V. Kuntz, Jenny Lotova, Haley Moritz, Megan Murphy, Alex Ogren, Emily Riff, Jennifer Roges, Max E. Schulman, Alisha Siqueira, Marc Aaron Takagaki, and Luke Zaro.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following members of the Securities Litigation practice group:
Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, [email protected])
Brian M. Lutz – Co-Chair, San Francisco/New York (+1 415-393-8379/+1 212-351-3881, [email protected])
Robert F. Serio – Co-Chair, New York (+1 212-351-3917, [email protected])
Jefferson Bell – New York (+1 212-351-2395, [email protected])
Matthew L. Biben – New York (+1 212-351-6300, [email protected])
Michael D. Celio – Palo Alto (+1 650-849-5326, [email protected])
Jennifer L. Conn – New York (+1 212-351-4086, [email protected])
Thad A. Davis – San Francisco (+1 415-393-8251, [email protected])
Ethan Dettmer – San Francisco (+1 415-393-8292, [email protected])
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On February 11, 2021, in one of its inaugural foreign policy actions since taking office, the Biden Administration authorized new sanctions and export-control restrictions on Myanmar (also called Burma) in response to the Myanmar military’s recent coup against the country’s elected civilian government. These actions imposed an initial round of limited, targeted measures ten days after the Myanmar military overthrew the country’s democratically-elected government, arrested civilian leaders including State Counselor Aung San Suu Kyi and President Win Myint, and imposed an intermittent nationwide shutdown on the internet and access to social media. Some of the Myanmar military leaders targeted by the new measures were already subject to U.S. sanctions due to the serious human rights abuses against the Rohingya, an ethnic minority population in Myanmar.
The Myanmar military’s extra-judicial actions are an unfortunate echo of Burma’s recent past—Suu Kyi had been detained by the military for much of the 1990s and into the early 2000s and the international community, led by the United States, had previously responded with sanctions. Indeed, U.S. sanctions against Myanmar were only formally removed in 2016, after the Myanmar military allowed certain democratic reforms, culminating in the election of State Counsellor Suu Kyi.
In a press conference on February 9, 2021, President Biden previewed his administration’s response to the coup, calling for a series of actions including imposing sanctions against a first round of targets, promulgating strong export controls, and restricting the ability of Myanmar’s military leaders to access the substantial funds the government of Myanmar has on deposit in the United States. European and other leaders were also quick to condemn the military coup, and are contemplating their own measures.
These new sanctions are among the first hints of how the new administration will wield the United States’ tools of economic coercion after four years of record-breaking usage under President Trump. These new sanctions were imposed in the midst of a broader review by the administration regarding all sanctions programs administered and enforced by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”). We assess that the measured approach undertaken here – with a conscious effort to focus on identifying targets to limit collateral consequences, to seek multilateral buy-in, and to ensure flexibility to calibrate pressure as the situation develops on the ground – will be the model for future actions in Myanmar and other areas in which sanctions and similar tools will play a role.
The Sanctions Imposed
Designations of Ten Individuals and Three Companies Under a New Executive Order
Calling the undermining of Myanmar’s democracy and rule of law a threat to U.S. national security and foreign policy, President Biden on February 11 issued an Executive Order on Blocking Property with Respect to the Situation in Burma (the “Executive Order”) which establishes a new sanctions program focused on Myanmar. Under this authority, OFAC may designate as Specially Designated Nationals (“SDNs”) those individuals and entities directly or indirectly causing, maintaining, or exacerbating the situation in Myanmar, and/or leading Myanmar’s military or current government, or operating in its defense sector. Under the Executive Order, OFAC may also designate the adult relatives of a designee, the entities owned or controlled by a designee, or those providing material support to a designee. The breadth of the Executive Order’s designation criteria affords the administration considerable flexibility in selecting targets for designation, and is in many respects broadly parallel with the earlier Burmese Sanctions Regulations imposed, strengthened, and then relieved by former Presidents Clinton, Bush, and Obama.
Pursuant to the Executive Order, OFAC designated six officers of Myanmar’s military who played a direct role in the coup: (1) Commander-in-Chief Min Aung Hlaing; (2) Deputy Commander-in-Chief Soe Win; (3) First Vice President and retired Lieutenant General Myint Swe; (4) Lieutenant General Sein Win; (5) Lieutenant General Soe Htut; and (6) Lieutenant General Ye Aung. Notably, both Min Aung Hlaing and Soe Win had already been designated on December 10, 2019 pursuant to Executive Order 13818 (the Global Magnitsky sanctions program) for their roles in the atrocities committed against the Rohingya.
OFAC also designated four military officials who were appointed to positions in Myanmar’s State Administration Council (“SAC”) government following the coup: (1) General Mya Tun Oo, appointed Minister of Defense; (2) Admiral Tin Aung San, appointed Minister for Transport and Communications; (3) Lieutenant General Ye Win Oo, appointed Joint Secretary of the SAC; and (4) Lieutenant General Aung Lin Dwe, appointed Secretary of the SAC.
Finally, OFAC designated three entities operating in Myanmar’s gem industry that are owned or controlled by Myanmar’s military: (1) Myanmar Ruby Enterprise; (2) Myanmar Imperial Jade Co. LTD; and (3) Cancri (Gems and Jewellery) Co., LTD.
U.S. persons (as well as non-U.S. persons when engaging in a transaction with a U.S. touchpoint) are, except as authorized by OFAC, generally prohibited from engaging in transactions involving the recently-sanctioned ten individuals and three entities, and their property and interests in property (which must also be blocked to the extent they come into U.S. jurisdiction).
Targeted Ramifications for Those Operating in Myanmar
According to a 2019 United Nations Human Rights Council report, many of the designated individuals and the three designated entities are linked to Myanmar Economic Holdings Limited (“MEHL”), one of the two military-controlled conglomerates that play foundational roles throughout Myanmar’s economy. Min Aung Hlaing, Soe Win, Mya Tun Oo, and Tin Aung San are purported members of the “Patron Group,” which plays a supervisory role for MEHL. Myint Swe and Aung Lin Dwe apparently serve on MEHL’s board of directors. All three designated companies―Myanmar Ruby Enterprise, Myanmar Imperial Jade Co. LTD, and Cancri (Gems and Jewellery) Co., LTD―are alleged subsidiaries of MEHL. There do not appear to be any direct ties between the new designees and the second military-controlled conglomerate, the Myanmar Economic Corporation (“MEC”).
While some of the recently-sanctioned individuals exercise considerable influence over the public and private spheres in Myanmar, that does not mean that the new sanctions apply wholesale to the country at large. Quite the opposite: the sanctions imposed thus far are limited in their reach and scope. We assess that this outcome is purposeful. Indeed, the absence of any General Licenses issued alongside the designations (to allow companies to wind down activities, for example) may suggest that the Biden Administration does not believe that there are any systemically critical, ongoing transactions that need to be addressed before shutting off all dealings. As such, the administration may be viewing this first tranche of targets more as a warning to the Myanmar military than as means for imposing substantial economic harm.
By operation of OFAC’s “Fifty Percent Rule,” U.S. sanctions automatically apply those restrictions to entities that are majority owned by one or more sanctioned persons – even if those entities are not explicitly identified by OFAC. A wholly-owned subsidiary of Myanmar Ruby Enterprise, for example, is now restricted by operation of law to the same extent as its parent company. However, as OFAC has made clear, U.S. sanctions do not automatically extend to entities over which a sanctioned person merely has decision-making authority or otherwise exercises control, nor does it extend to the parents or corporate siblings of designated entities. As a result, in the absence of majority ownership by designated parties, the fact that a sanctioned individual is the head of a Myanmar government agency or on a Myanmar company’s board of directors does not result in the automatic imposition of OFAC restrictions on that agency or company. Moreover, that a designated entity is part of a broader conglomerate does not mean that the designation extends to its parents or corporate siblings.
While OFAC has yet to release parallel guidance, we assess that the interpretations the agency developed in connection with its recent designation of 11 senior Hong Kong and mainland Chinese government officials will likely be applicable in this case. In the Hong Kong guidance, and as reported in our 2020 Year-End Sanctions and Export Controls Update, OFAC clarified that U.S. sanctions do not extend to the non-sanctioned government agencies led by those 11 sanctioned officials, and that routine dealings with those agencies were not necessarily prohibited. At the same time, OFAC cautioned that, in interacting with such agencies, persons under U.S. jurisdiction were still prohibited from transacting or dealing with the sanctioned officials and could not, for example, enter into contracts signed by, or negotiate with, these individuals. The initial Myanmar sanctions program was the first OFAC program to make clear that contracting with designated persons (even in their official capacities as leaders of non-designated entities) was prohibited – we expect the same to be true here and hence those operating in Myanmar should take similar precautions when dealing with any government agencies, or companies, affiliated with newly designated parties.
The Export Controls Imposed
Alongside the new U.S. sanctions, the U.S. Commerce Department’s Bureau of Industry and Security (“BIS”) announced that it would apply a “presumption of denial,” effective immediately, for items requiring a license for export and reexport to Myanmar’s Ministry of Defense, the Ministry of Home Affairs, armed forces, and security services. In addition, BIS announced a suspension of certain previously-issued licenses to these Myanmar government departments and agencies, and a revocation of certain license exemptions that had been available to Myanmar as a result of its Country Group status under the Export Administration Regulations (“EAR”)―such as Shipments to Country Group B countries (GBS) and Technology and Software under restriction (TSR). In the coming days, we expect more detail from BIS as to the scope of these suspensions.
Notably, BIS also indicated in its announcement that it is assessing further specific actions, including adding Myanmar entities to the Entity List (which would impose licensing obligations on almost any export from the United States to a listed party). In this regard, we see a continuation of the Trump Administration’s use of the Entity List – unlike any administration in the past, the Trump BIS was eager to leverage the surgical impact of an Entity Listing (as compared with the more draconian impact of a sanctions listing) when dealing with certain targets where a more limited economic impact was sought. As discussed in detail in our 2020 Year-End Sanctions and Export Controls Update and 2020 Mid-Year Sanctions and Export Controls Update, the Entity List was the tool of choice in dealing with many Chinese actors.
Given the risk of harming Myanmar citizens, as well as international investors, we assess that the Biden Administration could leverage BIS in a similar fashion to respond to the situation in the country, especially if it decides to increase pressure on military companies. Restricting certain exports to the Myanmar military risks less severe collateral consequences to innocent third parties and investors than potentially blacklisting the entire military or their conglomerates (as discussed below). Other actions BIS is apparently considering include adding Myanmar to the list of countries subject to the EAR’s new military end-use and end-user (MEU) and military-intelligence end-use and end-user (MIEU) restrictions, and downgrading Myanmar’s Country Group status in the EAR (requiring more scrutiny and licenses for exports to the country).
Anticipated Restrictions on Myanmar Government Funds in the United States
In addition to the aforementioned sanctions and export controls measures, the Biden Administration has also announced that it “is taking steps to prevent the generals from improperly accessing more than $1 billion in Burmese government funds held in the United States.” Though no further details have been released, the most likely restriction will be on the ability of the military leaders to access government funds kept on deposit with the Federal Reserve Bank of New York. This limitation is in addition to various U.S. grants and foreign aid to Myanmar that are now by law restricted due to the coup.
What Is Next and What Does the Myanmar Case Suggest for Sanctions Under a Biden Administration?
As noted above, under the sanctions regime launched last week, ten individuals and three business entities associated with Myanmar’s military have been added to the SDN List. This will certainly have immediate implications for those dealing with the sanctioned parties and entities majority owned by those parties. However, it is worth noting also what the Biden Administration chose not to do at this juncture. Not only did the Administration not sanction the entirety of the Myanmar military nor place the country under an embargo, it also avoided targeting the two military-controlled conglomerates MEHL and MEC. If either had been designated, U.S. sanctions prohibitions would have flowed (pursuant to OFAC’s Fifty Percent Rule) to the conglomerates’ numerous subsidiaries operating throughout Myanmar’s economy and to the operations of numerous foreign companies that have entered the country in partnership with a MEHL and/or MEC entity since the easing of sanctions under President Obama.
Harsher sanctions measures are still possible and Treasury Secretary Yellen has promised “additional action” if Myanmar’s military does not change course. But at least for now, the Biden Administration seems intent on deploying its tools surgically and deliberately, giving an opportunity for the military to alter course and time for Washington’s multilateral partners to join in the effort, and developing ways to calibrate sanctions pressure if the situation merits. The same variables appear true for the new export-controls measures, with a narrow set of restrictions being rolled out while other restrictions are being considered. Similarly, the anticipated restrictions on Myanmar government funds in the United States has been characterized as specifically preventing withdrawals by the military (as opposed to the government writ large).
The international implications of the situation in Myanmar have likely informed the U.S. government’s approach. Since February 1, 2021, governments around the world, including Canada, France, Germany, Italy, Japan, the United Kingdom, and the European Union, have strongly condemned the military coup and related actions in Myanmar. The United Nations Human Rights Counsel has unanimously called for the release of Suu Kyi and other imprisoned civilian leaders. In his remarks, President Biden has consistently emphasized the need for a multilateral response. State Department officials have echoed that message, and have reportedly consulted with U.S. allies on the appropriate U.S. response.
However, national economic interests can sometimes check the willingness of even close allies to match U.S. measures. Countries with significant ties to the Myanmar economy, such as Japan, may have swayed the Biden Administration to employ more targeted sanctions and export controls, rather than broad-based restrictions. It is noteworthy that at this time Tokyo has yet to impose its own restrictions on trade with Myanmar. This is another echo of the prior Myanmar sanctions program – Japan has long been one of Myanmar’s principal sources of foreign capital and, for years, the scale of Japanese foreign direct investment in the country made it challenging to bring Japan into the fold and compel it to impose its own sanctions on the country. In addition to concerns about the private sector impact of broad-based sanctions, another motivation for a more restrained approach may have been, as others have hypothesized, a concern that severe sanctions on the military would only serve to enhance China’s influence in the country while reducing the likelihood of a change in approach.
Assuming that the situation in Myanmar does not improve, we anticipate that the Biden Administration will impose further sanctions and export control measures. In addition, as part of the multilateral response, we expect U.S. allies including the European Union, the United Kingdom, Australia, and Canada to promulgate sanctions and export controls restrictions of their own.
The Biden Administration’s approach at play in this case is likely to be the model of its use of economic coercive tools going forward. We assess that the Administration will pursue a whole-of-government effort – with the State Department taking the foreign policy lead and encouraging multilateral uptake, while the Treasury and Commerce Departments implement complementary restrictions – in situations like Myanmar and in other foreign policy challenges including those relating to Iran, Venezuela, Russia, Cuba, and of course China. As with most international trade policy efforts, private sector actors will remain on the front lines in dealing with these tools. But, while we will need to wait and see whether they will be spared some of the uncertainty regarding the scope and trajectory of U.S. measures that have been pervasive over the last four years, the Biden Administration’s first sanctions foreign policy move has started out with a clearer policy direction, and better coordination both within the U.S. Government and between Washington and its allies.
The following Gibson Dunn lawyers assisted in preparing this client update: Adam M. Smith, Audi K. Syarief, Judith Alison Lee, Ronald Kirk, Patrick Doris, Christopher T. Timura, Stephanie L. Connor, and Richard W. Roeder.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s International Trade practice group:
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Jose W. Fernandez – New York (+1 212-351-2376, [email protected])
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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])
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Audi K. Syarief – Washington, D.C. (+1 202-955-8266, [email protected])
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Asia:
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Patrick Doris – London (+44 (0)207 071 4276, [email protected])
Sacha Harber-Kelly – London (+44 20 7071 4205, [email protected])
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Now that the first 100 days of the Biden Administration are in full swing, its financial regulatory priorities are becoming clearer. In this Client Alert, we discuss where we expect the Administration to focus, with respect to the banking, fintech, and derivatives sectors.
We believe these to be the principal takeaways:
- The Administration’s whole-of-government emphasis on climate change issues should inform the regulatory agencies’ agendas far more than in the past.
- The Administration’s focus on racial justice will likely lead to increased enforcement activities, particularly by the Consumer Financial Protection Bureau (CFPB), as well as to a reexamination of the Office of the Comptroller of the Currency’s (OCC) recently revised Community Reinvestment Act (CRA) regulations.
- President Biden’s choices to head the OCC, Securities and Exchange Commission (SEC), and Commodity Futures Trading Commission (CFTC) will have significant input into the regulation of digital assets and fintech, with certain Trump-era regulations likely being subject to reexamination.
- The CFPB can be expected to return to Obama Administration priorities and enforcement activity, with large financial institutions the likely targets.
- The CFTC is likely to increase its aggressive enforcement in the derivatives and commodities markets, as well as maintain a keen focus on climate-related risks in those markets.
- At the federal legislative level, Representative Maxine Waters (D-CA) and Senator Sherrod Brown (D-OH), both committee chairs, will likely focus on pandemic relief, inequity in housing, consumer protection, and climate change; in addition, cannabis banking legislation may finally be advanced.
- In the immediate future, Congress is focused on the market volatility brought to light by the GameStop short squeeze, including a House Financial Services Committee hearing currently scheduled for February 18th with high-level executives of Robinhood, Citadel, Reddit, and Melvin Capital testifying. The House Financial Services Committee and Senate Banking Committee are also likely to consider legislation to ensure more market stability and possibly regulate order-flow payments.
A. Overarching Administration Priorities: Combatting Climate Change and Advancing Racial Justice
1. Climate Change
Climate change will be a new priority for the financial regulators. At her confirmation hearing, Treasury Secretary Janet Yellen called climate change an “existential threat” and stated that she plans to create a special unit, led by a senior official, to examine the risks that climate change poses to the financial system.[1] It is therefore reasonable to expect that the Financial Stability Oversight Council (FSOC), which Secretary Yellen chairs, will investigate climate-related risks. In December 2020, Senator Dianne Feinstein (D-CA) introduced the Addressing Climate Financial Risk Act, which among other things would establish a permanent FSOC committee to advise the FSOC in producing a report on how to improve the ability of the financial regulatory system to identify and mitigate climate risk.[2] Although Senator Feinstein’s bill will have to be reintroduced this year in the new Congress, Senator Feinstein has called on Secretary Yellen to implement key provisions of the bill via executive action.[3]
In a September 2020 report, titled “Managing Climate Risk in the U.S. Financial System” (the “Report”), the CFTC’s Climate-Related Market Risk Subcommittee of the Market Risk Advisory Committee recommended that the FSOC incorporate climate-related financial risks into its existing oversight function.[4] The Report makes the following policy recommendations:
- Congress should establish a price on carbon through legislation; this would be the single most important step to manage climate risk and drive an appropriate allocation of capital.
- Financial regulators should actively promote, and in some cases require, better understanding, quantification, disclosure, and management of climate-related risks by financial institutions and other market participants.
- Financial regulators should undertake and assist financial institutions to undertake their own pilot climate-risks stress testing.
- International collaboration and harmonization should be sought, and indeed, are critical for success in this area.
The Federal Reserve too has started to focus on climate issues. It created a Supervision Climate Committee, a system-wide group meant to build out the Federal Reserve’s capacity to understand the potential implications of climate change for financial institutions, infrastructure, and the markets.[5] In addition, the Federal Reserve is continuing its engagement with the Basel Committee on Banking Supervision’s Task Force on Climate-Related Financial Risks to develop recommendations for effective supervisory practices to mitigate climate-related financial risks, and has started to incorporate climate analysis into its Financial Stability Report and Supervision and Regulation Report.[6] And in December, the Federal Reserve became a full member of the Network for Greening the Financial System, a group of central banks and supervisors working to define and promote green finance best practices.[7] In addition, just this month, a paper published by the Federal Reserve Bank of San Francisco noted that the Federal Reserve has begun incorporating the impacts of global warming into its regulations, including by using climate stress tests and climate scenario analysis to measure banks’ vulnerability to climate-related losses.[8]
2. Advancing Racial Justice
The financial regulatory agency most likely to take the lead on racial justice issues is the CFPB. Acting CFPB Director Dave Uejio recently wrote that, in addition to pandemic-related relief, racial equity was his top priority, and that fair lending enforcement would be a major part of this focus.[9] On February 4th, Acting Director Uejio stated that he was asking the CFPB’s Division of Research, Markets, and Regulations to
- prepare an analysis on housing insecurity, including mortgage foreclosures, mobile home repossessions, and landlord-tenant evictions;
- prepare an analysis of the most pressing consumer finance barriers to racial equity to inform research and rulemaking priorities;
- explicitly include in policy proposals the racial equity impact of the policy intervention;
- resume data collections paused at the beginning of the pandemic, including HMDA quarterly reporting and the CARD Act data collection, as well as the previously completed 1071 data collection and the ongoing PACE data collection;
- focus the mortgage servicing rulemaking on pandemic response to avert, to the extent possible, a foreclosure crisis when the COVID-19 forbearances end in March and April; and
- explore options for preserving the status quo with respect to Qualified Mortgage and debt collection rules.[10]
Through such actions, the Biden CFPB would join in the efforts of certain states that have made strides in fair lending regulation, passing legislation to regulate more strictly student loan servicers[11] and to mandate small business truth-in-lending disclosures.[12] One should also expect the CFPB to investigate algorithmic models used in credit underwriting as to whether those models disparately impact minority borrowers.
The CRA will be another focus. In May 2020, under Acting Comptroller Brooks, the OCC finalized a substantial change to its CRA regulations, which community groups severely criticized.[13] The Federal Reserve and Federal Deposit Insurance Corporation declined to join the OCC’s action, and in October 2020, the Federal Reserve published an Advanced Notice of Proposed Rulemaking to solicit input regarding modernizing its CRA regulatory and supervisory framework, taking a different approach from the OCC’s.[14] We expect that a Biden-appointed Comptroller of the Currency is likely to revisit Acting Comptroller Brooks’ revisions.
B. Other Expected Priorities
1. Digital Assets and Cryptocurrencies
How President Biden staffs the heads of three regulatory agencies – the SEC, OCC and CFTC – may have significant effects on the regulation of digital assets and cryptocurrencies.[15] Gary Gensler, nominated to head the SEC and the former Chair of the CFTC, is now a Senior Faculty Advisor to the Digital Currency Initiative at MIT’s Sloan School of Management, where he teaches classes on blockchain technology and digital currencies.[16] Michael Barr, a Treasury official in both the Clinton and Obama Administrations, has been identified as a leading candidate to head the OCC; Mr. Barr has served as an advisor to Ripple, on Lending Club’s board, and on the fintech advisory council for the Bill and Melinda Gates Foundation.[17] And Chris Brummer, a Georgetown Law professor who was twice nominated as a CFTC Commissioner in the Obama Administration, has been mentioned as a potential CFTC Chair; when at Georgetown Law, he founded DC Fintech Week.[18]
Each of these agencies will have important digital asset and cryptocurrency issues on its agenda. Just at the end of the Trump Administration, the SEC brought an enforcement action against Ripple Labs Inc. and two of its executives on the grounds that the sale of Ripple’s digital asset, XRP, was an unregistered securities offering under the federal securities laws.[19] A Gensler-led SEC will need to decide whether to continue this action, whether to provide guidance on which digital tokens are securities, and whether digital asset exchanges have to register as national securities exchanges or alternative trading systems.[20] Although Mr. Gensler has espoused openness to helping digital assets and cryptocurrencies reach their “real potential in the world of finance,” even if doing so requires “tailor[ing] some of th[e] rules and regulations” to their ecosystem, he has also taken the view that “100 to 200” exchanges “are basically operating outside of U.S. law.”[21]
A second issue that the Gensler-led SEC will need to address is custody. During the Trump Administration, the SEC issued a statement and requested comments regarding the application of the Customer Protection Rule (Rule 15c3-3) to cryptocurrencies and other digital assets. Similar to a safe-harbor provision, the statement essentially maps a path for specialized broker-dealers to operate for five years without fear of an enforcement action in this area where they maintain physical possession or control of digital asset securities.[22] With the request for comment, however, the SEC suggests that it is looking to establish permanent rules in this area.
At the end of the Trump Administration, the OCC moved to the forefront of cryptocurrency regulation by approving the charter conversion application of Anchorage Trust Company.[23] A second charter conversion application was approved just last week, for Protego Trust Company.[24] Whether the OCC will continue to stake out this leadership position under a new Comptroller is therefore a significant question. On these issues, the fact that there has been controversy about who the new Comptroller will in fact be – progressives have been pushing President Biden to name Professor Mehrsa Baradaran, in part because of her skepticism about fintech, rather than Michael Barr – makes it more difficult to offer definitive predictions.
The CFTC, moreover, remains an important regulator in the area. It has jurisdiction over futures and other derivatives contracts on cryptocurrencies, which continue to be developed, and it also has jurisdiction over manipulation in the spot markets for cryptocurrencies that are not securities (e.g., bitcoin and ether) if such manipulation affects a CFTC-regulated futures market. Given the recent significant volatility and meteoric rise in prices in Bitcoin and other cryptocurrencies, the CFTC’s aggressiveness in exercising its legal authority in these areas could have substantial effects.
2. Fintech: The OCC and Trump Administration Rulemakings
Before leaving government service, Trump Acting Comptroller of the Currency Brian Brooks oversaw several important actions of particular relevance to fintech companies.
The first relates to the so-called “Special Purpose National Bank Charter” for financial technology companies, which was first announced by Obama Administration Comptroller of the Currency Thomas Curry in late 2016.[25] The New York State Department of Financial Services (NYDFS) reacted to this development by suing the OCC, arguing that the OCC did not have the authority under the National Bank Act to grant such charters. A district judge in the United States District Court for the Southern District of New York agreed with NYDFS,[26] and this case is on appeal to the Second Circuit Court of Appeals.[27] In November 2020, the OCC accepted a charter application by the fintech Figure Technologies, Inc. and was shortly thereafter sued again – this time by the Conference of State Bank Supervisors Inc. (CSBS) in federal district court in Washington, DC.[28] The new Comptroller will have to determine whether to press ahead with – and defend in court – the “Special Purpose National Bank” and other non-traditional charters.
The other significant actions taken by the OCC under Acting Comptroller Brooks were two rules passed in response to the 2015 Second Circuit decision, Madden v. Midland Funding LLC.[29] Madden limited the application of National Bank Act preemption of state usury laws in the case of nonbanks that purchase debt originated by a national bank.[30] For many fintechs and other nonbank lenders that partner with loan-originating banks, the Madden decision increased uncertainty as to whether nonbanks become subject to state interest rate caps upon purchasing a loan that, at the time of origination, was not subject to the same requirements. In 2020, the OCC issued the “valid-when-made” rule, which took the position that “interest permissible before [a loan] transfer continues to be permissible after the transfer,”[31] and the “true lender” rule, which stated that a national bank is the “true lender” for a loan if the national bank is either named as such on the loan documents or funds the loan.[32]
As in the case of the “Special Purpose National Bank” charter, certain states challenged the rules in federal court.[33] The states argued that the OCC exceeded its statutory authority in issuing the rules and also focused on the rules’ effects on the states’ authority to regulate interest rates and enforce consumer protection laws more broadly, claiming that the rules are “contrary to Congressional actions to rein in the OCC’s ability to preempt state consumer protection laws.”[34] Briefing is underway on cross-motions for summary judgment regarding the “valid-when-made” rule, and a hearing is calendared for mid-March.[35] With the proceedings regarding the true lender rule only a few months behind, these two cases may provide early indications about the new Comptroller’s priorities.
3. An Invigorated CFPB
Rohit Chopra, President Biden’s appointee for the CFPB Director, served in the Obama Administration as the CFPB’s expert on the student loan industry; he also served as a Democratic FTC Commissioner during the Trump Presidency. If confirmed, his appointment suggests that the CFPB will become a more active enforcement agency, as was the case in the Obama Administration. Mr. Chopra’s public statements while FTC Commissioner have encompassed the following important themes: (i) a focus of enforcement efforts on larger firms rather than small businesses; (ii) targeting firms that facilitate and profit from the largest frauds; (iii) shifting from one-off enforcement actions to systemic enforcement efforts; (iv) making greater use of rulemaking, including by codifying enforcement policy; and (v) co-operating with state attorneys general in the enforcement process.[36] The CFPB may also be expected – like the OCC as described above – to revisit certain Trump-era rulemakings, such as its rulemakings on payday lending, qualified mortgages, and debt collection.
4. Shifting Priorities and Continuing Enforcement at the CFTC
Like the SEC, the CFTC will become a majority-Democratic Commission. It is possible that a new CFTC may seek to revisit some of the rules that were finalized on party-line votes under the Trump Administration. For example, in July 2020, the CFTC approved, by a 3-2 party line vote, a final rule addressing cross-border application of the swap dealer and major swap participant registration requirements.[37] In dissent, Commissioner Rostin Behnam criticized the final rule as “refusing to appropriately retain jurisdiction . . . over transactions that are arranged, negotiated or executed in the United States by non-U.S. [swap dealers].”[38] Commissioner Dan Berkovitz critiqued the final rule for “par[ing] back . . . extraterritorial application” of the Commodity Exchange Act (CEA) and setting “a weak and vague standard” for substituted compliance under a “comparable” regulatory regime.[39] Although Professor Brummer, a contender to lead the CFTC, has written extensively about the role of supervisory cooperation and coordination among international regulators,[40] he has also emphasized that the U.S. should “lead by example” and first “commit to the highest standards” before partnering with regulators abroad “who are like-minded,” indicating that he too would support a stronger cross-border rule.[41]
A changed CFTC is likely to result in increased enforcement and collaboration between the CFTC and other agencies, like the Department of Justice. For instance, in October 2020, the DOJ and the CFTC brought related actions against BitMEX based on allegations that BitMEX illegally operated a cryptocurrency derivatives trading platform and violated the anti-money laundering provisions of the Bank Secrecy Act.[42] In December 2020, the CFTC announced a settlement with Vitol, Inc., marking the CFTC’s first public action coming out of its initiative to pursue violations of the CEA involving foreign corruption.[43] The CFTC worked with the Department of Justice and the United States Attorney’s Office for the Eastern District of New York, which announced a Deferred Prosecution Agreement with Vitol the same day.
C. Congressional Priorities
With a Democratic majority in both houses of Congress, legislative priorities will be shaped by the two relevant Committee chairs, Maxine Waters (D-CA) and Sherrod Brown (D-OH).
In December 2020, Representative Waters sent President Biden a public letter with recommendations on areas where she thinks immediate action should be taken.[44] These include:
- Promoting stable and affordable housing;
- Increasing CFPB enforcement of consumer financial protection laws;
- Restoring and enhancing regulatory safeguards on the financial system, including reversing rules that eased prudential requirements for large banks and strengthening the capital regulatory framework;
- Addressing discriminatory lending issues; and
- Focusing on climate risks, particularly in the insurance sector.
The hearings scheduled by the House Financial Services Committee also provide insight into what issues the committee believes are the most pressing, including the need for additional pandemic relief, particularly for small and minority-owned businesses, climate change, and lending discrimination. Given recent events, the Committee has also scheduled hearings on the recent market volatility involving GameStop and domestic terrorist financing.[45]
In the Senate, Sherrod Brown (D-OH), the chairman of the Senate Banking Committee, is likely to take a more aggressive stance toward the financial services industry than his predecessor, Senator Mike Crapo (R-ID). Senator Brown is known as one of Congress’s fiercest critics of Wall Street, and plans to reorient the focus of the Banking Committee on addressing the fallout of the pandemic and climate change, and strengthening regulations.[46] Senator Brown’s focus in the immediate future is extending protections from eviction, and affordable housing and housing access will continue to be a priority for the committee.[47] Senator Brown is also keen on a public-banking option and caps on interests rates for payday loans, and has said he intends to investigate the relationship among stock prices, executive compensation, and workers’ wages.[48]
A final area of potential legislative action is cannabis banking. In Congress, the SAFE Banking Act, a bill that would enable banks to offer financial services to legitimate marijuana- and hemp-related businesses, could be re-introduced. Because cannabis remains classified as a Schedule I controlled substance, most financial institutions refrain from providing services to legal cannabis businesses out of fear of adverse regulatory and supervisory action and federal forfeiture based on racketeering or trafficking charges. The SAFE Banking Act would prohibit such regulatory actions and shield banks from liability premised solely on the provision of financial services to a marijuana- or hemp-related business. The SAFE Banking Act passed the House with bipartisan support in 2019, and was originally included in the Heroes Act, passed by the House in May 2020 in response to the COVID-19 pandemic. However, the bill was dropped from the COVID relief measures ultimately enacted in December 2020, and the bill has not come up for a vote yet in the Senate despite some bipartisan support.
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[1] Zachary Warmbrodt, Yellen vows to set up Treasury team to focus on climate, in victory for advocates, Politico (Jan. 19, 2021), https://www.politico.com/news/2021/01/19/yellen-treasury-department-climate-change-460408.
[2] Senator Dianne Feinstein, Press Releases, Feinstein Introduces Bill to Minimize Climate Change Risk in Financial System (Dec. 17, 2020), https://www.feinstein.senate.gov/public/index.cfm/press-releases?ID=27A04819-E44D-435C-AB06-FBC9D6051EB2.
[3] Senator Dianne Feinstein, Press Releases, Feinstein to Secretary Yellen: Use Financial System to Mitigate Climate Change Risk (Jan. 28, 2021), https://www.feinstein.senate.gov/public/index.cfm/press-releases?id=F494CF21-B927-404B-876A-CF80D3231985.
[4] U.S. Commodity Futures Trading Commission Climate-Related Market Risk Subcommittee, Managing Climate Risk in the U.S. Financial System (2020), available at https://www.cftc.gov/sites/default/files/2020-09/
9-9-20%20Report%20of%20the%20Subcommittee%20on%20Climate-Related%20Market%20
Risk%20-%20Managing%20Climate%20Risk%20in%20
the%20U.S.%20Financial%20System%20for%20posting.pdf.
[5] Fed. Reserve Bank of N.Y., Press Release, Kevin Stiroh to Step Down as Head of New York Fed Supervision to Assume New System Leadership Role at Board of Governors on Climate (Jan. 25, 2021), https://www.newyorkfed.org/newsevents/news/aboutthefed/2021/20210125.
[6] Lael Brainerd, Strengthening the Financial System to Meet the Challenge of Climate Change (Dec. 18, 2020), available at https://www.federalreserve.gov/newsevents/speech/brainard20201218a.htm.
[7] See Central Banks and Supervisors Network for Greening the Financial System, https://www.ngfs.net/en.
[8] Glenn D. Rudebusch, FRBSF Economic Letter, Climate Change Is a Source of Financial Risk, Fed. Reserve Bank of S.F. (Feb. 8, 2021), https://www.frbsf.org/economic-research/publications/economic-letter/2021/february/climate-change-is-source-of-financial-risk/.
[9] Dave Uejio, The Bureau is taking much-needed action to protect consumers, particularly the most economically vulnerable (Jan. 28, 2021), https://www.consumerfinance.gov/about-us/blog/the-bureau-is-taking-much-needed-action-to-protect-consumers-particularly-the-most-economically-vulnerable/.
[10] Dave Uejio, The Bureau is working hard to address housing insecurity, promote racial equity, and protect small businesses’ access to credit (February 4, 2021), https://www.consumerfinance.gov/about-us/blog/the-bureau-is-working-hard-to-address-housing-insecurity-promote-racial-equity-and-protect-small-businesses-access-to-credit/.
[11] See, e.g., Jeremy Sairsingh, State Regulation of Student Loan Servicing Continues to Evolve, Am. Bar Assoc. (July 13, 2020), https://www.americanbar.org/groups/business_law/
publications/committee_newsletters/consumer/2020/202007/state-regulation/.
[12] See, e.g., Dafina Williams, Policies to Require Transparency in Small Business Lending Gain Momentum, Opportunity Fin. Network (Oct. 14, 2020), https://ofn.org/articles/policies-require-transparency-small-business-lending-gain-momentum.
[13] See, e.g., Nat’l Cmty. Reinvestment Coal., et al., Joint Statement on CRA Rule Changes from OCC (May 21, 2020), https://ncrc.org/joint-statement-on-cra-rule-changes-from-occ/.
[14] Community Reinvestment Act, 12 C.F.R. 228 (proposed Oct. 19, 2020).
[15] Ephrat Livni, What’s Next for Crypto Regulation, N.Y. Times (Jan. 30, 2021), https://www.nytimes.com/2021/01/30/business/dealbook/crypto-regulation-blockchain.html.
[16] See Gary Gensler Faculty Advisor Profile, available at https://dci.mit.edu/team.
[17] John Adams, Biden’s OCC expected to chart new course for fintechs, crypto, AML, Am. Banker (Jan. 27, 2021), https://www.americanbanker.com/news/bidens-occ-expected-to-chart-new-course-for-fintechs-crypto-aml.
[18] See About DC Fintech Week, available at https://www.dcfintechweek.org/; Chris Brummer, Faculty Profile, https://www.law.georgetown.edu/faculty/chris-brummer/.
[19] Complaint, SEC v. Ripple Labs, Inc., No. 1:20-cv-10832 (S.D.N.Y. Dec. 22, 2020).
[20] Although the SEC brought its first enforcement action for operating an unregistered exchange in 2018, and has brought at least one other such action, these matters have not been as significant as the Ripple action. See SEC, Press Release, SEC Charges EtherDelta Founder with Operating an Unregistered Exchange (Nov. 8, 2018), https://www.sec.gov/news/press-release/2018-258; SEC, Press Release, SEC Charges Dallas Company and its Founders with Defrauding Investors in Unregistered Offering and Operating Unregistered Digital Asset Exchange (Aug. 29, 2019), https://www.sec.gov/news/press-release/2019-164. For additional discussion of crypto securities registration cases, see our bi-annual Securities Enforcement updates, available here.
[21] Annalieae Milano, Everything Ex-CFTC Chair Gary Gensler Said About Cryptos Being Securities, Coindesk (Apr. 24, 2018), https://www.coindesk.com/ex-cftc-chair-gary-gensler-on-tokens-securities-and-the-sec.
[22] SEC, Press Release, SEC Issues Statement and Requests Comment Regarding the Custody of Digital Asset Securities by Special Purpose Broker-Dealers (Dec. 23, 2020), https://www.sec.gov/news/press-release/2020-340.
[23] OCC, News Release 2021-6, OCC Conditionally Approves Conversion of anchorage Digital Bank (Jan. 13, 2021), https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-6.html.
[24] OCC, News Release 2021-19, OCC Conditionally Approves Conversion of Protego Trust Bank (Feb. 5, 2021), https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-19.html.
[25] OCC, Exploring Special Purpose National Bank Charters for Fintech Companies (Dec. 2016), https://www.occ.gov/publications-and-resources/publications/banker-education/files/pub-special-purpose-nat-bank-charters-fintech.pdf.
[26] Vullo v. Office of Comptroller of Currency, 378 F. Supp. 3d 271, 292 (S.D.N.Y. 2019) (finding that “the term ‘business of banking,’ as used in the [National Bank Act], unambiguously requires receiving deposits as an aspect of the business”); Lacewell v. Office of the Comptroller of the Currency, 2019 WL 6334895, at * 1–2 (S.D.N.Y. Oct. 21, 2019) (prohibiting the OCC from issuing charter to non-depository fintech applicants).
[27] See Lacewell v. Office of the Comptroller of the Currency, No. 19-4271 (2d Cir. Dec. 16, 2020), ECF No. 108.
[28] Complaint at ¶¶ 1, 3, Conference of State Bank Supervisors v. Office of the Comptroller of the Currency, No. 20-cv-3797 (D.D.C. Dec. 22, 2020).
[29] See generally Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015).
[31] Permissible Interest on Loans That Are Sold, Assigned, or Otherwise Transferred, 85 Fed. Reg. 33,530 (June 2, 2020) (to be codified at 12 CFR Parts 7 and 160).
[32] National Banks and Federal Savings Associations as Lenders, 85 FR 68742 (Oct. 30, 2020) (to be codified at 12 CFR Part 7).
[33] See Sylvan Lane, Seven states sue regulator over ‘true lender’ rule on interest rates, The Hill (Jan. 5, 2021), https://thehill.com/policy/finance/532759-seven-states-sue-regulator-over-true-lender-rule-on-interest-rates?rl=1.
[34] Complaint at ¶¶ 11–12, People of the State of New York v. Office of the Comptroller of the Currency, No. 21-cv-00057 (S.D.N.Y Jan. 5, 2021) (challenging “true lender” rule); accord Complaint at ¶¶ 7–9, People of the State of California v. Office of the Comptroller of the Currency, No. 20-cv-05200 (N.D. Cal., July 29, 2020) (challenging valid-when-made rule).
[35] Order Granting As Modified Joint Stipulation, No. 20-cv-05200 (N.D. Cal. Oct. 5, 2020) (setting briefing schedule).
[36] See https://www.ftc.gov/about-ftc/biographies/rohit-chopra/speeches-articles-testimonies.
[37] CFTC, Press Release, CFTC Approves Final Cross-Border Swaps Rule and an Exempt SEF Amendment Order at July 23 Open Meeting (July 23, 2020), https://www.cftc.gov/PressRoom/PressReleases/8211-20.
[38] Public Statement, Dissenting Statement of Commissioner Rostin Behnam Regarding the Cross-Border Application of the Registration Thresholds and Certain Requirements Applicable to SDs and MSPs – Final Rule (July 23, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement072320
[39] Public Statement, Dissenting Statement of Commissioner Dan M. Berkovitz on the Final Rule for Cross-Border Swap Activity of Swap Dealers and Major Swap Participants (July 23, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement072320 (quoting Kadhim Shubber, US regulator investigates oil fund disclosures, Fin. Times (July 15, 2020), available at https://www.ft.com/content/1e689137-2d1f-4393-a18f-fe0da02141cc.)
[40] See, e.g., Limiting the Extraterritorial Impact of Title VII of the Dodd-Frank Act: Before the House Financial Services Committee, 112th Cong. (2012) (Written Testimony of Chris Brummer, Professor of Law, Georgetown University Law Center), https://financialservices.house.gov/uploadedfiles/hhrg-112-ba-wstate-cbrummer-20120208.pdf.
[41] Nominations of Christopher James Brummer and Brian D. Quintenz to be Commissioners of the Commodity Futures Trading Commission: Hearing before the Committee on Agriculture, Nutrition, and Forestry, 114th Cong. (2016) (testimony by Christopher James Brummer, Nominee), https://www.congress.gov/114/chrg/shrg23593/CHRG-114shrg23593.htm.
[42] CFTC, Press Release, CFTC Charges BitMEX Owners with Illegally Operating a Cryptocurrency Derivatives Trading Platform and Anti-Money Laundering Violations (Oct. 1, 2020), https://www.cftc.gov/PressRoom/PressReleases/8270-20.
[43] Gibson Dunn, What the CFTC’s Settlement with Vitol Inc. Portends about Enforcement Trends (Jan. 20, 2021) https://www.gibsondunn.com/what-the-cftcs-settlement-with-vitol-inc-portends-about-enforcement-trends/; see also CFTC, Press Release, CFTC Orders Vitol Inc. to Pay $95.7 Million for Corruption-Based Fraud and Attempted Manipulation (Dec. 3, 2020), https://www.cftc.gov/PressRoom/PressReleases/8326-20.
[44] Letter from Rep. Maxine Waters, Chairwoman, U.S. House of Representatives Committee on Financial Services, to President-elect Joseph Biden (Dec. 4, 2020), available at https://financialservices.house.gov/uploadedfiles/120420_cmw_ltr_to_biden.pdf.
[45] U.S. House Comm. On Fin. Servs., Press Releases, Waters Announces February Hearing Schedule (Feb. 1, 2021), https://financialservices.house.gov/news/documentsingle.aspx?DocumentID=407103.
[46] See, e.g., Zachary Warmbrodt, Wall Street scourge Sherrod Brown to get ‘gigantic megaphone’ as Senate Banking chair, Politico (Jan. 11, 2021), https://www.politico.com/news/2021/01/11/sherrod-brown-senate-banking-chair-457692.
[47] Sylvan Lane, Brown puts housing, eviction protections at top of Banking panel agenda, The Hill (Jan. 12, 2021), https://thehill.com/policy/finance/533911-brown-puts-housing-eviction-protections-at-top-of-banking-panel-agenda.
[48] Emily Flitter, Next Senate Banking Chairman Sets Lowe-Income and Climate Priorities, N.Y. Times (Jan. 12, 2021), https://www.nytimes.com/2021/01/12/business/banking-environment-housing-democrats-sherrod-brown.html.
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 in the firm’s Financial Institutions or Derivatives practice groups, or the following authors:
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [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])
Roscoe Jones, Jr. – Washington, D.C. (+1 202-887-3530, [email protected])
Rachel N. Jackson – New York (+1 212-351-6260, [email protected])
Amalia Reiss – Washington, D.C. (+1 202-955-8281, [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 English Supreme Court’s February 12, 2021 judgment in Okpabi and others v Royal Dutch Shell Plc and another [2021] UKSC 3 is a landmark decision in the field of human rights and environmental protection. In a unanimous ruling,[1] the Court allowed the claimants to continue with a claim that the UK-domiciled parent of a multinational group owed a duty of care to those allegedly harmed by the acts of a foreign subsidiary.
The judgment raises important issues regarding the proper approach to jurisdictional challenges and provides insight into the criteria that English courts will consider when determining questions of liability in respect of harm caused by foreign subsidiaries.
Background
In 2015, inhabitants of the Bille and Ogale communities in Nigeria brought parallel claims in negligence in England against UK company Royal Dutch Shell plc (‘RDS’) and its Nigerian subsidiary, the Shell Petroleum Development Company of Nigeria Limited (‘SPDC’). Both claims sought damages for allegedly serious pollution and environmental damage caused by oil leaks from pipelines that SPDC operated on behalf of an unincorporated joint venture. The claimants argued that RDS, the UK parent, owed them a duty of care because it exercised significant control over material aspects of SPDC’s operations and/or assumed responsibility for SPDC’s operations.
The defendants challenged the English court’s jurisdiction and sought to set aside service out of the jurisdiction on SPDC. Following a three-day hearing in November 2016, Mr Justice Fraser held that while the court had jurisdiction to try the claims against RDS, it was “not reasonably arguable that there [was] any duty of care upon RDS.” As a result, the conditions for granting permission to serve the claim on SPDC were not made out, and the Claimants’ case against RDS was struck out. The Claimants appealed.
The Court of Appeal hearing took place in November 2017. The Court considered that Fraser J had erred in his approach to the evidence, and decided that it was entitled to review the evidence for itself, including fresh evidence adduced on appeal. By that stage, some 43 witness statements and expert reports had been filed. In fact, the parties chose to “swamp” the Court of Appeal with evidence, with the witness statements running to more than 2,000 pages of material and eight files of exhibits.[2] Nevertheless, the Court of Appeal undertook a detailed review of the facts and, in February 2018, the majority upheld the judgment of Fraser J (Sales LJ dissenting).
The Claimants’ application for permission to appeal to the Supreme Court was stayed pending judgment in Vedanta Resources PLC and another v Lungowe and others [2019] UKSC 20, a case which the Supreme Court Justices acknowledged was “very relevant to both the procedural and the substantive issues raised on this appeal.”
The Supreme Court judgment in Vedanta
In the Vedanta litigation, a similar question arose as to whether a parent company, Vedanta Resources Plc, could be held liable for alleged acts of environmental damage in Zambia associated with the Nchanga copper mine and caused by its subsidiary, Konkola Copper Mines plc (“KCM”).
The Supreme Court was asked to decide whether the courts of England and Wales had jurisdiction to hear claims of common law negligence and breach of statutory duty against the parent and subsidiary. Among other things, the defendants asserted that the claimants’ pleaded case and supporting evidence disclosed no real triable issue: Vedanta could not be shown to have done anything in relation to the operation of the mine sufficient to give rise to a common law duty of care, or statutory liability under Zambian environmental protection, mining and public health legislation. Vedanta was, it was said, merely an indirect owner of KCM, and no more than that.
The Supreme Court rendered its decision in April 2019. In delivering the Supreme Court’s unanimous judgment, Lord Briggs confirmed that the appropriate test of whether there is a real issue to be tried replicates the summary judgment test; i.e. the question is whether the claim has a real prospect of success at trial.
Lord Briggs also made clear that the liability of parent companies in relation to activities of their subsidiaries is not, of itself, a distinct category of liability in negligence. Ordinary principles of the law of tort regarding the imposition of a duty of care should apply. On the facts, whether a duty of care arises “depends on the extent to which, and the way in which, the parent availed itself of the opportunity to take over, intervene in, control, supervise or advise the management of the relevant operations (including land use) of the subsidiary” (para 49). The Supreme Court held, among other things, that it was “well arguable that a sufficient level of intervention by Vedanta in the conduct of operations at the Mine may well be demonstrable at trial, after full disclosure of the relevant internal documents […].” (para 61). The question whether Vedanta owed a duty of care was, therefore, a real triable issue and for this, and other reasons, the English court had jurisdiction to hear the claim.
Okpabi: the arguments
The claimants
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The claimants in Okpabi amended their case in light of the Vedanta ruling, and argued that there were four “routes” by which RDS could be shown to owe the claimants a duty of care:
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The above routes are, therefore, guides to the sorts of issues that claimants will explore in seeking to demonstrate that a parent company has intervened in the business of the subsidiary to such a degree that it owes a duty of care to individuals harmed by the activities of that subsidiary.
With regard to the evidence, the claimants relied, among other things, on the fact that RDS had enforced mandatory group-wide health and safety policies, had centralised expertise and exercised top-down control of the health, safety, security and environmental areas of the business, and/or had joint management of the response to the oil spills. The claimants also relied on public Shell documents such as sustainability reports, and on material said to show that RDS had detailed knowledge of the environmental damage caused by SPDC. They relied on two documents in particular; the RDS Control Framework and the RDS HSSE Control Framework (the Health, Security, Safety and Environment framework). The former allegedly showed that the Shell Group was organised along “Business” and “Function” lines directly accountable to RDS and the RDS HSSE Control Framework was said to show the extent of control that the RDS Board exercised over the health, safety and environmental practices of its subsidiaries.
The defendants
The defendants argued that RDS could not be responsible for environmental pollution caused by third-party acts of theft, sabotage and pipeline interference; while RDS has mandatory policies and guidelines in place, it leaves their enforcement and implementation to subsidiaries; and although it requires subsidiaries to have health and safety audits, it leaves overall control over pipelines and related infrastructure to subsidiaries.
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The Supreme Court judgment in Okpabi The jurisdiction question
The factual questions
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Comment
The decision in Okpabi concludes an extremely important chapter on the court’s approach to claims alleging a duty of care on the part of the parent for harm said to be caused by a foreign subsidiary. On jurisdiction, and on the question whether there is a real issue to be tried, the court will not conduct a mini-trial. Defendants need to be aware that the vast reams of evidence in Okpabi were not enough to stop the claim: at this interlocutory stage the court will remain focussed on the facts alleged in the particulars of claim, and accept them unless they are demonstrably untrue or unsupportable. Alternative routes are available, however, by which cases may be resisted on the right facts, such as limitation challenges, and/or an application that the case be struck out as an abuse of process.
Further, parent companies should not take false comfort in the local implementation of global policies, and should consider carefully how management, supervision, advice and policy are handled. Ultimately, each case will turn on its own facts.
While the decision may bring clarity to the legal and factual questions at issue, like Vedanta, it also highlights the enduring difficulty for corporates trying to establish good governance, particularly in group structures where subsidiaries operate independently with local oversight and implementation of policy. As discussed in our separate client alert, European legislation may be in the pipeline, requiring parent companies to conduct human rights, environmental and good governance due diligence throughout their value chain. Importantly, the current draft of that legislation expressly includes subsidiaries in the definition of value chain. With many UK parent companies having a European commercial footprint (and therefore falling within scope of the European initiative), litigation of this nature is likely only to increase.
In the meantime, the Okpabi matter will return to the High Court to proceed on the merits, with scrutiny of liability, quantum and potential additional jurisdictional challenges yet to come.
___________________
[1] For the purposes of the Judgment, the Court was deemed constituted without Lord Kitchin, who was absent due to illness.
[2] See paragraph 105 of Lord Hamblen’s judgment in the Supreme Court and paragraphs 17 and 18 of Simon LJ’s judgment in the Court of Appeal.
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, any member of the firm’s Environmental, Social and Governance (ESG) Practice, or the following authors in London:
Susy Bullock (+44 (0) 20 7071 4283, [email protected])
Allan Neil (+44 (0) 20 7071 4296, [email protected])
Stephanie Collins (+44 (0) 20 7071 4216, [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.
New York partner Alexander Southwell is the author of “What’s to Come for Cybersecurity in the Biden Era,” [PDF] published by The National Law Journal on February 10, 2021.
With the emergence of COVID-19, 2020 was a year of significant and unprecedented change in daily life and the economy. In particular, 2020 was a busy year for Employee Retirement Income Security Act (“ERISA”) lawsuits—across industries—implicating employers’ retirement and healthcare plans. Not only were there significant decisions on a number of key issues impacting these lawsuits, but COVID-19 also triggered new and different legal exposure for plan sponsors and administrators. Recognizing the importance of this area of law to its clients, in 2020, Gibson Dunn launched an ERISA Disputes Practice Area, bringing together the Firm’s deep knowledge base and significant experience from across a variety of its award-winning practice groups, including: Executive Compensation & Employee Benefits, Class Actions, Labor & Employment, Securities Litigation, FDA & Health Care, and Appellate & Constitutional Law.
This 2020 year-end update summarizes key legal opinions and provides helpful analysis to assist plan sponsors and administrators navigating this unprecedented time.
Section I highlights four notable opinions from the United States Supreme Court addressing ERISA’s statute-of-limitations, Article III standing, and ERISA preemption. The Court also remanded a case to the Second Circuit concerning the pleading standard for alleging a breach of the duty of prudence under ERISA on the basis of a failure to act on insider information.
Section II provides a summary of hot topics in ERISA class-action litigation, including notable developments in fiduciary breach litigation and a growing trend of COBRA notice litigation.
Section III addresses evolving procedural issues, including the standard of review of benefits claim decisions, and an emerging circuit split on the arbitrability of claims brought on behalf of plans.
Section IV offers an overview of key issues in health plan litigation, including trends in behavioral health and residential treatment coverage disputes, and updates on assignments and anti-assignment clauses.
I. Significant Activity in the Supreme Court
2020 saw a significant rise in ERISA cases reaching the United States Supreme Court. In fact, the Court decided four ERISA cases in 2020, which is more than the Court has decided in any other year of the statute’s 45-year existence. These decisions provide helpful guidance to litigants on important topics in ERISA litigation. In Intel Corp. Investment Policy Committee v. Sulyma, 140 S. Ct. 768 (2020), the Court resolved a circuit conflict regarding when employers and plan fiduciaries can invoke the three-year statute of limitations period under Section 413(2) for an alleged breach of fiduciary duty. In Thole v. U.S. Bank N.A., 140 S. Ct. 1615 (2020), addressing fiduciary breach claims against a defined-benefit pension plan, the Court clarified when participants in an ERISA plan have Article III standing to sue for statutory violations. In Rutledge v. Pharmaceutical Care Management Ass’n, 141 S. Ct. 474 (2020), the Court again addressed the scope of ERISA preemption, particularly with respect to state regulations of health care and prescription drug costs, as well as state regulations of intermediaries. Finally, in Retirement Plans Committee of IBM v. Jander, 140 S. Ct. 592 (2020), the Supreme Court was expected to address whether the “more harm than good” pleading standard from Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 430 (2014), can be satisfied by generalized allegations that the harm resulting from the inevitable disclosure of an alleged fraud generally increases over time, but instead, in a per curiam decision, declined to rule on the merits and remanded the case to the Second Circuit.
A. Intel Corp. Investment Policy Committee, et al. v. Sulyma Addresses Statute of Limitations
In Intel Corp. Investment Policy Committee, et al. v. Sulyma, 140 S. Ct. 768 (2020), the Supreme Court addressed the circumstances in which employers and plan fiduciaries can invoke ERISA’s three-year statute of limitations for an alleged breach of fiduciary duty, unanimously holding that in order to trigger the three-year limitations period, an employee must have become “aware of” the plan information and that a fiduciary’s disclosure of plan information alone does not meet the “actual knowledge” requirement.
The plaintiff, a former employee of Intel, sued Intel’s investment committee, administrative committee and finance committee (collectively, “Intel”), alleging that his retirement plans improperly overinvested in alternative investments. Id. at 774. Under Section 413(1) of the Employment Retirement Income Security Act of 1974 (ERISA), breach of fiduciary duty claims may be brought within six years of the breach or violation. However, Section 413(2) of ERISA shortens the limitations period to “three years after the earliest date on which the plaintiff had actual knowledge of the breach or violation.” 29 U.S.C. § 1113(2). Plaintiff filed suit within six years of the alleged breaches but more than three years after petitioners had disclosed their investment decisions to him. Sulyma, 140 S. Ct. at 774. While Intel provided records showing that the plaintiff had received numerous disclosures explaining the extent to which his retirement plans were invested in alternative assets, the plaintiff testified in a deposition that he didn’t remember reviewing the disclosures and also stated in a declaration that he was unaware that his account was invested in alternative investments. Id. at 775.
The Court unanimously affirmed the Ninth Circuit’s decision holding that a plaintiff does not necessarily have “actual knowledge” based on receipt alone of information if he did not read it. Id. at 779. While the disclosure of information to plaintiff is “no doubt relevant in judging whether he gained knowledge of that information,” to meet § 1113(2)’s “actual knowledge” requirement, the plaintiff must have become aware of that information. Id. at 777. The Court emphasized that its decision does not foreclose any of the “usual ways” to prove actual knowledge at any stage in litigation—including through proof of willful blindness—and that the decision will not prevent defendants from using circumstantial evidence to show actual knowledge. Id. at 779.
Gibson Dunn submitted an amicus brief on behalf of the National Association of Manufacturers, the American Benefits Counsel, the ERISA Industry Committee, and the American Retirement Association in support of petitioner: Intel Corp. Investment Policy Committee.
As we discussed in our Appellate Update on the Sulyma decision, we expect the Court’s holding to lead to an uptick in lawsuits against employers and plan fiduciaries, based on allegations that the three-year limitations period is inapplicable because they did not read or cannot recall reading plan documents.
B. Thole v. U.S. Bank N.A. Addresses Article III Standing
As we reported in our Appellate Update, in June of last year, the Supreme Court held that participants in a fully funded defined-benefit pension plan lacked Article III standing to sue under ERISA for breach of fiduciary duties because they had no “concrete stake in the lawsuit.” Thole v. U.S. Bank N.A., 140 S. Ct. 1615, 1619 (2020). The plaintiffs in Thole alleged that the plan fiduciaries “violated ERISA’s duties of loyalty and prudence by poorly investing the assets of the plan,” resulting in a loss of $750 million. Id. at 1618. Defendants moved to dismiss for lack of standing, which the district court granted. Id. at 1619. The Eighth Circuit “affirmed on the ground that the plaintiffs lack[ed] statutory standing [under ERISA].” Id.
The Supreme Court, in a 5-4 decision authored by Justice Kavanaugh, affirmed on the ground that plaintiffs lacked Article III standing. Id. The Court explained that “[t]here is no ERISA exception to Article III” and that the plaintiffs lacked standing “for a simple, commonsense reason: They have received all of their vested pension benefits so far, and they are legally entitled to receive the same monthly payments for the rest of their lives.” Id. at 1622. Accordingly, the Court reasoned that the plaintiffs did not have a “concrete stake in the lawsuit” as “[w]inning or losing [the] suit would not change the plaintiffs’ monthly pension benefits.” Id.
In so ruling, the Court rejected each of the four theories plaintiffs raised to demonstrate their standing. Id. at 1619–21. First, the Court rejected plaintiffs’ argument, based on trust-law principles, that they have an equitable or property interest in the plan. Id. at 1619–20. The Court reasoned that “a defined-benefit plan is more in the nature of a contract” than a trust as “[t]he plan participants’ benefits are fixed and will not change, regardless of how well or poorly the plan is managed.” Id. at 1620. Second, the Court held that plaintiffs lacked standing to sue “as representatives of the plan itself” because they had not been “legally or contractually appointed to represent the plan.” Id. Third, the Court found that even though ERISA affords all participants “a general cause of action to sue” it does not “affect the Article III standing analysis.” Id. Fourth, and finally, the Court rejected plaintiffs’ argument that defined-benefit plans will not be “meaningfully regulate[d]” if plan participants lack standing to sue as employers have “strong incentives” to manage plans and the Department of Labor can “enforce ERISA’s fiduciary obligations.” Id. at 1621.
In a concurring opinion, Justice Thomas, joined by Justice Gorsuch, objected to the Court’s “practice of using the common law of trusts as the ‘starting point’ for interpreting ERISA” and recommended that the Court “reconsider our reliance on loose analogies in both our standing and ERISA jurisprudence.” Id. at 1623. The concurrence called for the Court to return to a “simpler framework” for standing, and one in which the party must show injury to private rights. Justice Thomas stated there was no such injury in Thole because the private rights the petitioners alleged were violated did not belong to them; they belonged to the plan, and petitioners had no legal or equitable ownership interest in the plan assets. Id.
The Supreme Court’s decision in Thole is welcome news to plan sponsors, fiduciaries, and administrators, all of whom can now rely on this decision to argue that participants of ERISA plans cannot sue for breach of fiduciary duty unless they have a “concrete stake in the lawsuit,” such as a failure by the plan to make required benefits payments. Id. at 1619. In addition, Thole—and in particular Justice Kavanaugh’s forceful statement that “[t]here is no ERISA exception to Article III”—provides strong support for application of Article III requirements and jurisprudence to cases brought under ERISA.
More litigation is ahead on these issues. For instance, a split among district courts has developed on the question of whether participants in defined-contribution plans have standing to bring claims challenging investments in which they did not personally invest. Compare Cryer v. Franklin Templeton Res., Inc., 2017 WL 4023149, at *4 (N.D. Cal. July 26, 2017) (holding plaintiff had standing to sue for funds “in which he did not invest” because “the lawsuit seeks to restore value to and is therefore brought on behalf of the [p]lan”); McDonald v. Edward D. Jones & Co., L.P., 2017 WL 372101, at *2 (E.D. Mo. Jan. 26, 2017) (finding that “a plan participant may seek recovery for the plan even where the participant did not personally invest in every one of the funds that caused an injury to the plan”), with Wilcox v. Georgetown Univ., 2019 WL 132281, at *9–10 (D.D.C. Jan. 8, 2019) (finding that plaintiffs did not have standing to challenge options in which they did not invest); Marshall v. Northrop Grumman Corp., 2017 WL 2930839, at *8 (C.D. Cal. Jan. 30, 2017) (holding that plan participants lacked standing because they failed to allege that they invested in the particular fund). Since the Supreme Court made clear that injuries to the plan do not necessarily confer standing to the plan participants, Thole may support the argument that plaintiffs lack standing to bring suit when they did not personally invest in a challenged plan investment option. It remains to be seen whether, going forward, the courts adopt this interpretation of Thole to set limits on Article III standing in defined-contribution plan suits.
C. Rutledge v. Pharmaceutical Care Management Association Narrows ERISA Preemption
On December 10, 2020, the Supreme Court issued an 8-0 decision (Justice Barrett did not participate) in Rutledge v. Pharmaceutical Care Management Association holding that ERISA did not preempt an Arkansas statute regulating the rates at which pharmacy benefit managers reimburse pharmacies for prescription drug costs. Justice Sotomayor, who authored the opinion on behalf of the unanimous Court, relied on “[t]he logic of” the Court’s previous decision in New York State Conference of Blue Cross & Blue Shield Plans v. Travelers Ins. Co., 514 U.S. 645 (1995), to conclude that the Arkansas law “is merely a form of cost regulation . . . [that] applies equally to all PBMs and pharmacies in Arkansas,” and therefore is not subject to ERISA preemption because it did not have an impermissible connection with or reference to ERISA. 141 S. Ct. 474, 481 (2020). Rutledge is likely to be viewed by regulators as supporting state authority to regulate health care costs without running afoul of ERISA preemption. (Gibson Dunn’s Appellate Update discussing this case can be found here). Gibson Dunn submitted an amicus brief on behalf of the U.S. Chamber of Commerce in support of the Pharmaceutical Care Management Association.
In Rutledge, the Court ruled that “ERISA is . . . primarily concerned with pre-empting laws that require providers to structure benefit plans in particular ways,” which include those that require “payment of specific benefits,” those that bind “plan administrators to specific rules for determining beneficiary status,” and those where “acute, albeit indirect, economic effects of the state law force an ERISA plan to adopt a certain scheme of substantive coverage.” Id. at 480. The Court found that the need for regulatory uniformity—in particular, cost uniformity—is not absolute, and that it does not alone justify application of ERISA preemption: “[N]ot every state law that affects an ERISA plan or causes some disuniformity in plan administration has an impermissible connection with an ERISA plan,” which the Court noted is “especially so if a law merely affects costs.” Id. The following sentence from the Court’s opinion encapsulates its holding: “ERISA does not pre-empt state rate regulations that merely increase costs or alter incentives for ERISA plans without forcing plans to adopt any particular scheme of substantive coverage.” Id.
The Rutledge decision will impact future litigation regarding the scope of ERISA preemption. In particular, state regulators likely will rely on this decision in seeking to insulate state laws concerning prescription drug prices and pharmacy benefit managers from preemption. The reach of Rutledge, however, likely will be tested even beyond this immediate context, because state regulators can be expected also to defend other state laws and regulations on the basis that they merely impact health care costs and lack the necessary connection with ERISA plans under Rutledge. States may also attempt to enact new statutes and issue regulations of those health care intermediaries and other service providers to covered plans.
ERISA preemption will continue to be a hot area this year with the Ninth Circuit Court of Appeals hearing argument in Howard Jarvis Taxpayers Association v. CA Secure Choice Retirement Savings Program later this month, for example. In that case, the Ninth Circuit will evaluate whether ERISA preempts California’s state-run auto-IRA program, which transfers portions of a person’s paycheck into a retirement account.
D. Retirement Plans Committee of IBM v. Jander Remands Questions About Dudenhoeffer Pleading Standard to Second Circuit
As we discussed in a recent Securities Litigation Update, in Retirement Plans Committee of IBM v. Jander, 140 S. Ct. 592, 594 (2020), the Supreme Court was slated to address whether the “more harm than good” pleading standard from Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 430 (2014), “can be satisfied by generalized allegations that the harm of an inevitable disclosure of an alleged fraud generally increases over time.” In Dudenhoeffer, the Court held that, in order to state a claim for breach of the duty of prudence under ERISA on the basis of a failure to act on insider information, a complaint must plausibly allege an alternative action that the fiduciaries could have taken that would not have violated securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it. 573 U.S. at 428.
In Jander, plaintiffs, IBM employees who participated in an employee stock ownership plan (ESOP) sponsored by IBM, sued IBM’s retirement plan fiduciary committee for breach of fiduciary duty, alleged that IBM misrepresented the value of its microelectronics division, thereby artificially inflating the value of company stock, and caused a drop in the stock price upon selling the microelectronics division. Jander v. Ret. Plans Comm. of IBM, 272 F. Supp. 3d 444, 446–47 (S.D.N.Y. 2017). Plaintiffs’ claims were dismissed by the district court on the basis that the complaint lacked context-specific allegations as to why a prudent fiduciary couldn’t have concluded that plaintiff’s hypothetical alternatives were more likely to do more harm than good, failing to satisfy the Dudenhoeffer pleading standard. Id. at 449–54.
The Second Circuit reversed, holding that plaintiffs had pled a plausible claim for violation of ERISA’s duty of prudence based on (1) the fiduciaries’ knowledge that the stock was inflated through accounting violations; (2) their power to disclose these accounting violations; and (3) their failure to promptly disclose the true value of the microelectronics division. Jander v. Ret. Plans Comm. of IBM, 910 F.3d 620, 628–31 (2d Cir. 2018). Ultimately, the Second Circuit held that if the fiduciaries knew that disclosure of the insider information was inevitable, then delaying this disclosure would cause more harm than good to the ESOP. Id. at 630.
In a per curiam decision issued on January 14, 2020, the Supreme Court declined to rule on the merits in Jander, and vacated and remanded the case for the Second Circuit to address two unresolved issues raised by the parties: (1) whether ERISA ever imposes a duty on a fiduciary for an ESOP to act on inside information, and (2) whether ERISA requires disclosures that are not otherwise required by the securities laws. 140 S. Ct. at 594–95. Justice Kagan (joined by Justice Ginsburg) and Justice Gorsuch issued concurring opinions, articulating differing views on how these questions should be resolved on remand. See id. at 595–96 (Kagan, J. concurring); id. at 596–97 (Gorsuch, J. concurring). On remand, the Second Circuit reinstated its original opinion, again reversing the district court’s decision. Jander v. Ret. Plans Comm. of IBM, 962 F.3d 85, 86 (2d Cir. 2020) (per curiam).
While not purporting to break new ground, the Court nevertheless noted two things. First, the Court explained that the Dudenhoeffer “more harm than good” standard is the correct standard to apply to ESOP fiduciaries. See 140 S. Ct. at 594. Second, the Court made clear that ERISA’s fiduciary duty of prudence does not require fiduciaries to act in a way that violates securities laws. See id. However, the opinion leaves unresolved whether there may be circumstances in which ESOP fiduciaries are required to act on the basis of inside information to benefit an ESOP, and whether the Dudenhoeffer standard requires ESOP fiduciaries to disclose information that is not required by federal securities laws. See id. at 594–95.
In recent cases following Jander, at least one district court has concluded that the Second Circuit’s decision should be classified as an outlier because “the overwhelming majority of circuit courts to consider an imprudence claim based on inside information post-Dudenhoeffer [have] rejected the argument that public disclosure of negative information is a plausible alternative.” Burke v. Boeing Co., No. 19-cv-2203, 2020 WL 6681338, at *5 (N.D. Ill. Nov. 12, 2020). Given this circuit split, plaintiffs may be more likely to target the Second Circuit for stock-drop and similar suits. However, in a recent decision from the Second Circuit, the court affirmed dismissal of an imprudence claim brought by a plaintiff who argued that two alternative actions—earlier disclosure and closure of the fund to additional investment—were “on par with those found sufficient in Jander.” Varga v. Gen Elec. Co., No. 20-1144, — F. App’x —-, 2021 WL 391602, at *2 (Feb. 4, 2021). The court found plaintiff’s allegations insufficient, conclusory, and not consistent with those in Jander, concluding that she had “failed to adequately plead alternative actions that the fiduciaries could have taken.” Id. at *2–3. Thus, while Jander remains good law in the Second Circuit, the Varga decision suggests that courts will still look closely at plaintiffs’ allegations of plausible alternative actions in the context of motions to dismiss.
II. Class Actions Continued To Be a Significant Focus of ERISA Litigation in 2020
The year 2020 was again a busy period in ERISA class-action litigation, particularly fiduciary-breach litigation. While large plans continue to be the primary targets of these lawsuits, plaintiffs are also targeting smaller plans—and some cases attempting to aggregate these claims by suing administrators or service providers to multiple plans. We discuss below two important circuit splits in the field of ERISA fiduciary-breach class actions, and also an emerging area of litigation concerning the required contents of COBRA notices.
A. Hot Topics in ERISA Fiduciary Breach Litigation
We continued to see significant activity in ERISA fiduciary-breach litigation in 2020, including on issues concerning (1) whether plaintiffs can state a fiduciary-breach claim based on offering a particular mix of investment options in a plan, and (2) whether single-stock funds are per-se imprudent under ERISA. We also may see changes regarding the rules governing whether investing in environmental, social, and corporate governance (“ESG”) funds could constitute a fiduciary breach under ERISA.
As to the first issue, the Seventh, Third, and Eighth Circuits have all recently addressed whether plaintiffs can state a fiduciary-breach claim by alleging that a plan offered certain underperforming investment options, as well as other unobjectionable options. In Divane v. Northwestern University, 953 F.3d 980 (7th Cir. 2020), the Seventh Circuit held that plaintiffs failed to allege a fiduciary breach by claiming that defendants provided investment options that were “too numerous, too expensive, or underperforming,” when the defendant also offered low-cost index funds, among other options that the plaintiffs found unobjectionable. Id. at 991–92. A few months after the Seventh Circuit’s decision in Divane, the Eighth Circuit appeared to adopt a more plaintiff-friendly interpretation by holding that plaintiffs could state a claim by alleging that “fees were too high” and that the defendants “should have negotiated a better deal.” Davis v. Wash. Univ. of St. Louis, 960 F.3d 478, 483 (8th Cir. 2020); see also Sweda v. Univ. of Pennsylvania, 923 F.3d 320, 330 (3d Cir. 2019) (stating that “a meaningful mix and range of investment options” does not necessarily “insulate[] plan fiduciaries from liability for breach of fiduciary duty”). These holdings may suggest to plaintiffs that the Third and Eighth Circuits will be more receptive to these types of claims, prompting an increase in fee-suit litigation in those jurisdictions.
Additionally, a circuit split may have recently developed concerning whether single-stock funds are per se imprudent plan offerings under ERISA. In May 2020, the Fifth Circuit affirmed the dismissal of a putative fiduciary breach class action in Schweitzer v. Investment Committee of Phillips 66 Savings Plan, 960 F.3d 190 (5th Cir. 2020). The court held that defendants satisfied their fiduciary duties to diversify and to act prudently because they provided plan participants with an array of investment options that “enable[d] participants to create diversified portfolios.” Id. at 196–98. Accordingly, the Fifth Circuit in Schweitzer rejected plaintiffs’ claim that “a single-stock fund is imprudent per se.” Id. at 197–98. But only a few months later, the Fourth Circuit held the opposite, concluding that defendants breached their fiduciary duty when offering a single-stock fund. Stegemann v. Gannett Co., 970 F.3d 465, 468 (4th Cir. 2020). The Fourth Circuit rejected the argument that “diversification must be judged at the plan level rather than the fund level,” holding that “each available fund on a menu must be prudently diversified.” Id. at 476–77 (emphasis added). In dissent, Judge Niemeyer argued that “the majority merge[d] the duties of diversification and prudence,” and, in effect, made it impossible for an employer to “ever prudently offer a single-stock, non-employer fund.” Id. at 484, 488. No other court has yet adopted the Fourth Circuit’s standard. Defendants in Stegemann filed a petition for a writ of certiorari, and on January 4, 2021, the Supreme Court called for a response from plaintiffs, indicating that the Justices may be interested in hearing the case.
Last, in the final year of the Trump administration, the Department of Labor (“DOL”) proposed and adopted a new rule that ERISA fiduciaries must make investment decisions “based solely on pecuniary factors”; and an investment intended “to promote non-pecuniary objectives” at the expense of sacrificing returns or taking on additional risk would constitute a breach of the fiduciary’s duty. Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 72,846, 72,851, 72,848 (Nov. 13, 2020). Though the final version of the rule does not explicitly reference ESG funds, the DOL’s press release announcing the rule expressly stated that the rule’s purpose was to provide further guidance “in light of recent trends involving [ESG] investing.” U.S. Dep’t of Labor, U.S. Department of Labor Announces Final Rule to Protect Americans’ Retirement Investments (Oct. 30, 2020), https://www.dol.gov/newsroom/releases/ebsa/ebsa20201030. The new rule took effect on January 12, 2021, 85 Fed. Reg. at 72,885, and there have not yet been any cases addressing when and whether investment in an ESG fund could constitute a fiduciary breach. Notably, the new rule appears to conflict with many of the Biden administration’s stated environmental goals, and the DOL rule may be a target for reversal by the new administration.[1]
B. Growing Challenges Related to COBRA Notice
The year 2020 also saw a rise in COBRA notice litigation. The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) allows employees and their dependents the opportunity to continue to participate in their employer’s group health plan when coverage would otherwise be lost due to a termination of employment or other “qualifying event[s].” 29 U.S.C. § 1163. And plan administrators are required to provide notice to employees informing them of their right to elect COBRA coverage. 29 C.F.R. § 2590.606-4. COBRA mandates that the notice include specific information and be “written in a manner calculated to be understood by the average plan participant.” Id. § 2590.606-4(b)(4). Plaintiffs have filed numerous class actions against employers alleging technical violations in the language of the notices, seeking statutory penalties up to $110 per day for each participant that received inadequate notice.
Many COBRA notice lawsuits have been filed in Florida, with others filed in venues that include New York and South Carolina. The number of such lawsuits has recently been spurred by COVID-19 layoffs. Plaintiffs’ allegations are substantially similar across cases, and generally allege that COBRA notices were deficient for one or more of the following reasons:
- Notice failed to identify the name, address, and telephone number of the plan administrator;
- Notice failed to identify the qualifying event;
- Notice failed to explain how to enroll in COBRA coverage;
- Notice failed to provide all the required explanatory language regarding the coverage;
- Notice was not written in a manner calculated to be understood by the average plan participant; and/or
- Notice failed to comply with the model notice created by the Department of Labor (“DOL”).
The influx of COBRA notice litigation highlights the importance for employers of reviewing their COBRA notices to assess whether any changes may be necessary to ensure compliance with statutory guidelines and regulations. To assist employers, the DOL has issued model notices on its website that employers can review against their own notices to ensure they are in compliance. Employers who have outsourced COBRA administration should also periodically check in with their third-party administrators to confirm compliance with all guidelines and regulations and may want to consider clearly assigning responsibility for compliance with notice requirements in their vendor agreements.
III. Key Decisions on Important ERISA Procedural Issues
The courts also issued important guidance this year to ERISA practitioners, plan sponsors, and plan administrators concerning ERISA procedural issues. In particular, the courts issued rulings concerning the standard of review for benefits claims, and provided further guidance on the ability to compel arbitration of claims brought by participants on behalf of a plan. Both of these topics are discussed below.
A. The Evolving Abuse of Discretion Standard of Review
In 2020, courts continued to wrestle with the degree of deference owed to benefit determinations made by plan administrators. The well-established rule is that a court reviews the plan administrator’s decision de novo unless the terms of the benefit plan give the administrator discretion to interpret the plan and award benefits. See Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 115 (1989). Where the plan terms grant this discretion to the administrator, courts review the administrator’s determinations under a deferential “abuse of discretion” standard (or arbitrary and capricious review, as some circuits call it). Id. Because it is common for benefit plans to give the administrator this discretion, the deferential standard often applies, and the Supreme Court has repeatedly parried attempts by plaintiffs to strip administrators of this deference. See Metro. Life Ins. Co. v. Glenn, 554 U.S. 105, 115 (2008) (abuse of discretion standard applies even when administrator has conflict of interest); Conkright v. Frommert, 559 U.S. 506, 522 (2010) (abuse of discretion standard applies even when court of appeals found previous related interpretation by administrator to be invalid).
Last year, plaintiffs persisted in their efforts to curtail the deferential abuse of discretion standard, and they found success in some instances. For example, in Lyn M. v. Premera Blue Cross, 966 F.3d 1061 (10th Cir. 2020), even though the plan gave the administrator discretion, the court nonetheless held that a de novo standard applied because plan members “lacked notice” of the discretion. Id. at 1065. The administrator failed to disclose the document granting discretion, and the plan summary it did disclose “said nothing about the existence” of that document. Id. at 1067. To preserve plan discretion under Lyn M., plan documents—including the summary plan description that plans are required to provide to their members—should disclose either the grant of discretion to the administrator or the precise document conferring that discretion.
Additionally, even when an abuse of discretion standard is found to apply, courts have developed ways to limit the degree of deference given to plan administrators. The Ninth Circuit, for example, continues to apply varying degrees of “skepticism” to the administrators’ determinations—as part of abuse of discretion review—when certain factors such as a conflict of interest are present. The precise degree of skepticism applied may provide a focal point for appellate review. In Gary v. Unum Life Insurance Co. of America, 831 F. App’x 812 (9th Cir. 2020), the circuit held that the district court “applied the incorrect level of skepticism to its abuse-of-discretion review.” Id. at 814. The district court had applied a “moderate degree” of skepticism because it found that the plan administrator had a structural conflict of interest (based on the district court’s belief that the administrator was responsible both for assessing and paying out claims) and had failed to afford the plaintiff a “full and fair review.” Id. at 813. But the Ninth Circuit held that, viewing the evidence in the light most favorable to the plaintiff, the circumstances in the case called for an even “higher degree of skepticism.” Id. This heightened skepticism was warranted, in the court’s view, because it found that the administrator’s consultants had “cherry-picked certain observations from medical records numerous times,” the administrator had not conducted an in-person examination of the plaintiff, and the administrator had reversed in part its initial decision denying benefits in full. Id. at 814. This decision suggests that, at least in the Ninth Circuit, courts may limit the degree of deference afforded to administrators—even under an abuse of discretion review—in particular circumstances.
However, not all circuits have been so receptive to plaintiffs’ efforts. The Eighth Circuit recently clarified its case law in this area, holding that, despite what an older circuit decision may have suggested and whatever other circuits may hold, a plan administrator’s delay in deciding an appeal of a benefits denial does not warrant de novo review. McIntyre v. Reliance Standard Life Ins. Co., 972 F.3d 955, 960, 964–65 (8th Cir. 2020). As with a conflict of interest, such delay is just a factor to be considered when applying abuse of discretion review. Id. at 965. The First Circuit also recently reaffirmed “the importance of giving deference” to plan administrators. Arruda v. Zurich Am. Ins. Co., 951 F.3d 12, 24 (1st Cir. 2020). The plaintiff in Arruda argued that courts can find an administrator’s decision arbitrary even when the administrator “relied on several independent experts” and a record consistent with its benefits determination. Id. at 21–22, 24. The First Circuit disagreed, finding this proposal to be “in considerable tension with” the abuse of discretion standard. Id. at 24.
Last year also saw circuit courts rebuff creative attempts by plaintiffs to avoid abuse of discretion review. For instance, in Ellis v. Liberty Life Assurance Co. of Boston, 958 F.3d 1271 (10th Cir. 2020), petition for cert. filed, (U.S. Jan. 8, 2021) (No. 20-953), all parties agreed that the plan conferred discretion on the administrator, and the plan provided that it was governed by the law of Pennsylvania, but the plaintiff sought de novo review on the ground that a Colorado statute prohibited grants of discretion in insurance policies. Id. at 1275. The court rejected the plaintiff’s argument that Colorado law should apply, holding that the law of the state selected by a plan’s choice-of-law provision normally applies, “to effectuate ERISA’s goals of uniformity and ease of administration.” Id. at 1280. Notably, the court observed that this choice-of-law question “could be avoided if ERISA preempts the Colorado statute,” but it declined to resolve this preemption issue, leaving it open for future litigation. Id. at 1279.
Finally, in Davis v. Hartford Life & Accident Insurance Co., 980 F.3d 541 (6th Cir. 2020), once again all parties agreed that the plan conferred discretion to the administrator, but the plaintiff contended that the administrator exercised no discretionary authority because a different company in the same corporate family had actually made the decision to terminate benefits. See id. at 545–46. But the Sixth Circuit found this argument “d[id] not add up as a factual matter.” Id. at 546. Even though the plan’s decisionmakers received their salaries from the other company, they were still adjudicating claims under the administrator’s policies, not the other company’s policies. Id. This precedent presents a potential obstacle for future plaintiffs who try to use the structure of a plan administrator’s corporate family as a backdoor means of securing de novo review.
B. A Possible Split on Arbitrability of ERISA § 502(a)(2) Claims
Arbitrability of ERISA section 502(a)(2) fiduciary-breach claims brought on behalf of a plan continued to be a hot topic in 2020 as courts applied key appellate decisions in this space from 2018 and 2019. In 2018, the Ninth Circuit held that section 502(a)(2) claims belong to the Plan, not the individual employee(s), and thus individual arbitration agreements that bound plan participants to arbitrate could not be used to compel the arbitration of claims brought on behalf of the plan. Munro v. Univ. of S. Cal., 896 F.3d 1088, 1092 (9th Cir. 2018). One year later, the court accordingly held that § 502(a)(2) claims are, in fact, arbitrable when the Plan has agreed to arbitration. Dorman v. Charles Schwab Corp., 780 F. App’x 510, 513–14 (9th Cir. 2019). According to the Ninth Circuit, “[t]he relevant question is whether the Plan agreed to arbitrate the § 502(a)(2) claims,” and when a “Plan [does] consent in the Plan document to arbitrate all ERISA claims,” a mandatory arbitration agreement is enforceable. Id. (emphasis added). Hence, in the Ninth Circuit, even when an individual employee has “agreed to arbitrate their claims in their employment contracts,” a § 502(a)(2) claim belongs to the plan and “that claim is not subject to arbitration unless the plan itself has consented.” Ramos v. Natures Image, Inc., 2020 WL 2404902, at *6–7 (C.D. Cal. Feb. 19, 2020) (emphasis added). Meanwhile, as noted in one of our recent class action updates, the Supreme Court has continued to enforce arbitration provisions in various contexts, and these decisions can be brought to bear in ERISA cases as well.
A circuit split may now be emerging on this issue. In Smith v. Greatbanc Trust Co., the U.S. District Court for the Northern District of Illinois rejected the Ninth Circuit’s holding in Dorman, even though in Smith (like Dorman) the plan documents indicated that the plan agreed to arbitrate. 2020 WL 4926560, at *3–4 (N.D. Ill. Aug. 21, 2020), appeal docketed, No. 20-2708 (7th Cir. Sept. 9, 2020). The court in Smith concluded that failure to notify a former employee (who remained a participant in the plan) of changes to the plan that compelled arbitration was inconsistent with ERISA’s notice requirements, and that, to the extent the arbitration agreement served as a “waiver of a party’s right to pursue statutory remedies,” the agreement was unenforceable. Id. (quoting Am. Express Co. v. Italian Colors Restaurant, 570 U.S. 228, 235–36 (2013)). The case is now pending appeal.
These decisions provide important guidance for employers considering amending their plans (or other plan-related documents, such as administrative services contracts) to include arbitration provisions. Under the Ninth Circuit’s Dorman decision, arbitration provisions in the plan documents can be used to bind the plan and to compel arbitration of claims brought on behalf of the plan. The Smith decision, however, underscores the importance of providing plan participants notice of any changes to plans, such as the addition of arbitration provisions, that would potentially impact participants’ rights to pursue statutory remedies.
IV. ERISA Health Plan Litigation
Finally, litigation concerning health plans remains a substantial part of the ERISA litigation landscape. In 2020, the federal courts of appeals addressed a significant number of disputes over behavioral-health coverage and issued a wide range of decisions addressing plan participants’ ability to assign their rights to providers.
A. Behavioral Health and Residential Treatment
ERISA disputes over behavioral-health coverage and residential treatment remained a significant source of litigation and appeals in 2020. Appellate decisions in this area mainly involved individual claims by patients challenging coverage determinations. Last year the courts of appeals decided at least 9 cases involving the denial of coverage for behavioral-health treatment, each of which involved individual claims by patients.
In disputes over individual coverage, the appellate courts in 2020 tended to afford significant deference to plan administrators’ determinations that behavioral-health treatment—and in particular residential treatment—was not medically necessary or did not qualify as emergency care. For example:
- In Doe v. Harvard Pilgrim Health Care, Inc., the First Circuit affirmed a district judge’s application of de novo review when she found that a patient’s residential treatment for psychological illness was medically unnecessary because medical experts had concluded that the patient did not require 24-hour supervision, her condition could be managed at a lower level of care, and medication had improved her condition before treatment. 974 F.3d 69, 72–74 (1st Cir. 2020).
- In Tracy O. v. Anthem Blue Cross Life & Health Insurance, the Tenth Circuit concluded that Anthem did not act arbitrarily and capriciously in denying coverage for a residential stay at a psychiatric facility because Anthem reasonably relied on four doctors’ conclusions that the patient’s condition had not significantly deteriorated and that her behavior could be managed in an outpatient setting. 807 F. App’x 845, 853–55 (10th Cir. 2020).
- In Brian H. v. Blue Shield of California, the Ninth Circuit affirmed a district judge’s determination that Blue Shield had not abused its discretion because it reasonably relied on expert opinions that a patient’s stay at a residential-treatment facility was not medically necessary because he would not have posed a danger to himself or others if treated in a less intensive setting. 830 F. App’x 536, 537 (9th Cir. 2020).
- In Meyers v. Kaiser Foundation Health Plan, Inc., the Ninth Circuit affirmed a district judge’s conclusion that Kaiser (regardless of whether de novo or abuse-of-discretion review applied) properly denied coverage for a patient’s out-of-network residential treatment because it did not meet the plan’s requirements for out-of-network coverage: It did not qualify as emergency services and, even if the treatment was unavailable in-network, the patient did not obtain Kaiser’s permission prior to treatment. 807 F. App’x 651, 653–54 (9th Cir. 2020).
- In Todd R. v. Premera Blue Cross Blue Shield of Alaska, 825 F. App’x 440, 441–42 (9th Cir. 2020), the Ninth Circuit, vacating the district court’s de novo judgment for the plaintiffs, held that a plan administrator correctly determined that a medical policy’s criteria for residential treatment were not met but remanded for the district court to consider in the first instance the plaintiff’s argument that those criteria were improper.
In each of these decisions, the court of appeals accorded deference to individual denials of coverage by administrators. By contrast, in Katherine P. v. Humana Health Plan, Inc., 959 F.3d 206, 209 (5th Cir. 2020), the Fifth Circuit determined that the district judge improperly granted summary judgment to the plan administrator. The Fifth Circuit reaffirmed prior precedent holding that when review of a coverage determination is de novo, the ordinary summary-judgment standard applies and a material dispute of fact should be decided by a bench trial. Id. The panel thus vacated the district judge’s grant of summary judgment to a plan administrator and remanded for the district judge to decide a dispute of material fact about whether treatment at a level of care less intense than partial hospitalization had been unsuccessful in controlling the plaintiff’s eating, purging, and compulsive exercise. Id. at 209–10; see also Lyn, 966 F.3d at 1064 (remanding for district court to apply de novo review to residential treatment claim rather than abuse of discretion standard).
Given the broad judicial deference ordinarily accorded to plan administrators’ medical determinations, plaintiffs have sought other grounds for challenging denials of coverage for behavioral healthcare. One common strategy is to invoke the federal Mental Health Parity and Addiction Equity Act, and related state parity acts, which require that health plans provide equal coverage for mental illnesses and physical illnesses. In Stone v. UnitedHealthcare Insurance Co., for instance, the plaintiff alleged that the health plan and its administrator violated the federal and California mental health parity acts when they refused to cover her daughter’s out-of-state residential-care treatment, but the Ninth Circuit affirmed the judgment for the defendants. 979 F.3d 770, 774–77 (9th Cir. 2020). Because the plan imposed the same limitations on out-of-state mental- and physical-health treatments, the plaintiff had not shown that the defendant treated mental health less favorably than physical health. Id. at 777.
More novel theories have met skepticism in the courts of appeals. In I.M. v. Kaiser Foundation Health Plan, Inc., for example, the plaintiff alleged that Kaiser breached its fiduciary duty to him by excluding coverage for residential treatment for eating disorders from its plans and inhibiting physicians from referring him to a residential-treatment facility. 2020 WL 7624925, at *2 (9th Cir. Dec. 22, 2020). The Ninth Circuit disagreed, finding no evidence in the record that Kaiser had erected barriers to residential treatment. Id.
B. Assignments and Anti-Assignment Clauses
The assignment of benefits remains a critical issue in ERISA health plan litigation. Under ERISA § 502(a), only “a participant or beneficiary” may sue an insurer to recover benefits owed to her or to enforce her rights under her plan. 29 U.S.C. § 1132(a)(1)(B). Ordinarily, this would mean that a patient herself would have to sue an insurer under § 502(a). However, courts have deemed it permissible for participants to “assign” their benefits to healthcare providers. See, e.g., Plastic Surgery Ctr. v. Aetna Life Ins. Co., 967 F.3d 218, 228 (3d Cir. 2020). Once a participant has validly assigned her benefits to a healthcare provider, that provider can stand in the shoes of the participant and bring suit against an insurer for non-payment under § 502(a). Id. The appellate courts in 2020 addressed a variety of issues related to the assignment of benefits
1. Scope of the Rights Conveyed
Appellate courts continue to grapple with the scope of the rights conveyed by an assignment. Decisions in 2020 reflect at least two distinct approaches. In American Colleges of Emergency Physicians v. Blue Cross & Blue Shield of Georgia, the Eleventh Circuit took a blanket approach, holding categorically that “the assignment of the right to payment includes the right to seek equitable relief.” 833 F. App’x 235, 240 (11th Cir. 2020). The Sixth and Ninth Circuits, in contrast, held that the scope of an assignment of benefits depends on the specific language used; where an assignment’s language appears to encompass only causes of actions for benefits, then additional potential causes of action under ERISA are not included. See DaVita Inc v. Amy’s Kitchen, Inc., 981 F.3d 664, 678–79 (9th Cir. 2020) (holding that assignment of “any cause of action . . . for purposes of creating an assignment of benefits” did not include the right to seek equitable relief); DaVita, Inc. v. Marietta Mem’l Hosp. Emp. Health Benefit Plan, 978 F.3d 326, 344 (6th Cir. 2020) (concluding that identical language did not include the right to bring breach-of-fiduciary-duty claims under § 1104(a)(1)(B)); see also McKennan v. Meadowvale Dairy Emp. Benefit Plan, 973 F.3d 805, 808–09 (8th Cir. 2020) (holding that an assignment of “any and all causes of action” did not include the right to challenge the rescission of the assignor’s coverage, at least where deceased assignor failed to comply with plan provisions as to third-party representatives). These decisions can be a mixed bag for plans, insurers, and administrators. The Eleventh Circuit’s approach allows providers to bundle benefits claims with equitable claims, while protecting insurers against having to litigate separate claims by patients and providers as to the same underlying treatment. The opposite is true for the Sixth and Ninth Circuit decisions: Where the assignment excludes equitable relief, providers have fewer arrows in their quiver to use against insurers, but insurers could face multiple lawsuits for the same treatment.
2. Waivability of Assignment Issues
Courts sometimes treat the existence and scope of an assignment as a jurisdictional question—going to the existence of Article III standing—that therefore cannot be waived. Cell Sci. Sys. Corp. v. La. Health Serv., 804 F. App’x 260, 264 (5th Cir. 2020) (stating that the existence “of valid and enforceable assignments of benefits” is necessary for Article III standing). In the Sixth Circuit’s DaVita decision, however, the court held that a defendant had waived the argument that one of the plaintiff’s claims fell outside of the scope of the assignment. 978 F.3d at 345. The panel explained that “[t]he question of whether [a patient] has transferred their interest to [a provider] . . . deals not with Article III standing” but with Federal Rule of Civil Procedure 17’s requirement that an action “‘must be prosecuted in the name of the real party in interest.’” Id. The court thus found Article III standing without deciding the dispute about the scope of the assignment. Id. at 341 n.8.
3. Anti-Assignment Clauses
In recent years, ERISA health plans have increasingly elected to include “anti-assignment” clauses. See Plastic Surgery Ctr., 967 F.3d at 228. These clauses bar patients from assigning their benefits to providers, or place certain limits on the scope of what claims can be assigned (or in what circumstances), putting providers back in the position of having to bill patients directly. Id. Should the patient prove unable or unwilling to pay, providers must then either rely on the patient to bring an ERISA suit or sue the patient directly. Id.
Many circuits have addressed these clauses, and they have unanimously determined that the clauses are, in general, permissible and enforceable. See Am. Orthopedic & Sports Med. v. Indep. Blue Cross Blue Shield, 890 F.3d 445, 453 (3d Cir. 2018). Still, appellate decisions in 2020 reflect multiple strategies through which providers have attempted to avoid the effect of anti-assignment clauses, with varying degrees of success:
- In Beverly Oaks Physicians Surgical Center, LLC v. Blue Cross & Blue Shield of Illinois, the Ninth Circuit held that an insurer had waived its right to invoke an anti-assignment clause by failing to raise it during the administrative claim process. 983 F.3d 435, 440–42 (9th Cir. 2020). The court also held that the plaintiff had pleaded sufficient facts to adequately allege that insurer was “equitably estopped from raising” the anti-assignment clause because the insurer had promised the provider that it was eligible to receive payment under plan. Id. at 442–43.
- In Cell Science, by contrast, the Fifth Circuit rejected an argument that an insurer was estopped from invoking anti-assignment clause. 804 F. App’x at 264–66. The court emphasized that there was “no indication from the record that [the insurer] either misrepresented or misled [the provider] with respect to its intention to enforce the anti-assignment clause in its plan.” Id. at 265.
- In King v. Community Insurance Co., the Ninth Circuit held that an assignment fell outside of the scope of the plan’s anti-assignment clause. 829 F. App’x 156, 159–60 (9th Cir. 2020). The plan expressly allowed payments to “providers” and forbade beneficiaries from assigning benefits to “anyone else.” Id. at 159. The Ninth Circuit rejected the insurer’s argument that the phrase “anyone else” meant anyone other than the beneficiary. Id. at 160. The court also held that the anti-assignment clause was unenforceable because it was not properly included in any plan document. Id. at 160–62.
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[1] Congress may also attempt to take action against the rule. The Congressional Review Act provides a procedure for Congress to pass a Joint Resolution of Disapproval within 60 legislative working days that, if signed by the President, deems recent administrative rulemaking to not have had any effect. The DOL’s new rule is still within that 60-day timeframe.
The following Gibson Dunn lawyers assisted in the preparation of this alert: Karl Nelson, Geoffrey Sigler, Katherine Smith, Heather Richardson, Lucas Townsend, Jennafer Tryck, Matthew Rozen, Jennifer Roges, Luke Zaro, Daniel Weiss, Jialin Yang, Christopher Wang, Robert Batista, Zachary Copeland, and Brian McCarty.
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On February 5, 2021, in a unanimous decision, the UK Supreme Court ruled that the SFO’s so-called “Section 2” power, found in section 2(3) of the Criminal Justice Act 1987 (“CJA”), cannot be used to compel a foreign company that has no UK registered office or fixed place of business and which has never carried on business in the UK, to produce documents it holds outside the UK. In so ruling, the Supreme Court overruled a 2018 Divisional Court decision that held that the SFO could use its power in this way, provided that there was a “sufficient connection” between the foreign company and the UK.
In this alert we provide an overview of the Supreme Court’s decision and offer our observations on the implications of the judgment for the SFO and foreign companies under investigation. We conclude with an illustrative summary of the different methods available to the SFO to obtain documents following the Supreme Court’s decision.
The decision will come as a setback for the SFO, which will now have to rely on the often cumbersome and slow Mutual Legal Assistance (“MLA”) route to obtain documents in these circumstances. The loss is compounded as the Supreme Court decision comes shortly after the UK lost access to certain investigatory powers it enjoyed by virtue of the UK’s (now prior) Membership of the European Union (“EU”), such as the European Investigation Order (“EIO”), which enabled the SFO to quickly obtain evidence, including documents, located in the EU.
Waiting to become operational is the agreement signed between the UK and U.S. in October 2019 to implement the Crime (Overseas Production Orders) Act 2019. Once in effect, the SFO, as well as other UK investigations agencies, including the Financial Conduct Authority, will be able to obtain certain “electronic data” located or controlled from the U.S. via an Overseas Production Order (“OPO”). OPOs will be issued by an English court, and the recipient must provide the data, ordinarily within seven days, to the agency named in the OPO. Although OPOs will enable authorities to obtain evidence faster, they do not apply to hard copy and certain other material, such that MLA requests will remain a necessary route in many instances. Whilst it is the intention of the UK Government to enter into agreements with other countries and blocs such as the EU, the UK/U.S. agreement is the only such agreement currently in place.
The Supreme Court decision will obviously be disappointing for the SFO. However, it will support an argument that the Government needs to consider the scope of the SFO’s powers, to ensure it has the tools necessary to investigate sophisticated, organised criminal wrongdoing in an increasingly globalised world.
Section 2 Notices
Section 2(3) of the CJA provides that “The Director [of the SFO] may by notice in writing require the person under investigation or any other person to produce … any specified documents which appear to the Director [of the SFO] to relate to any matter relevant to the investigation or any documents of a specified description which appear to him so to relate”.
It is a criminal offence to fail to comply with section 2(3) of the CJA without a “reasonable excuse”.
Section 2 notices are attractive to the SFO because the SFO alone may determine whether to compel a recipient to produce documents, and may serve the notice directly upon the recipient and enforce non-compliance. It requires no court or other third-party intervention, thereby providing a rapid, effective and largely self-regulated method of compelling the production of documents.
Background
KBR, Inc. is a U.S. incorporated engineering and construction company and the parent company of the KBR Group. In 2017, KBR, Inc.’s UK subsidiary, Kellogg Brown & Root Ltd (“KBR UK”), was under investigation by the SFO for suspected bribery. During this investigation, a representative of KBR, Inc. attended a meeting with the SFO in the UK to discuss its investigation into KBR UK. During that meeting, the SFO issued a notice to KBR, Inc. under section 2(3) of the CJA compelling the production of documents held outside of the UK (the “July Section 2 Notice”). KBR, Inc. did not have a fixed place of business in the UK and had never carried on business in the UK.
KBR, Inc. sought permission to apply for judicial review of the decision and to quash the July Section 2 Notice in the Divisional Court, on three grounds:
- The July Section 2 Notice was ultra vires the CJA as it requested material held outside of the UK from a company incorporated outside of the UK;
- The Director of the SFO made an error of law in issuing the July Section 2 Notice instead of using its power to seek MLA from the U.S. authorities under the UK’s 1994 bilateral U.S. MLA Treaty; and
- The July Section 2 Notice was not properly served on KBR, Inc. under the CJA.
In September 2018, the Divisional Court held that the SFO could require a foreign company to produce documents held overseas pursuant to section 2(3) of the CJA where there is a “sufficient connection between the company and the jurisdiction”. The Court held that there was a sufficient connection between KBR, Inc. and the UK in this case, as payments made by KBR UK required the express approval of KBR, Inc., were paid by KBR, Inc. through its U.S.-based treasury function, and for a period of time KBR, Inc.’s compliance function was required to approve the payments. In addition, an officer of KBR, Inc. was based in the KBR Group’s UK office. The fact that KBR, Inc. was the parent company of KBR UK was not sufficient by itself to establish a “sufficient connection”.
The Supreme Court Case
KBR, Inc. was granted leave to appeal and made the following arguments in the Supreme Court:
- Presumption against Extra-Territorial Effect and Principle of International Comity: there is a presumption under English law that a statute has no extra-territorial effect, as this would constitute a breach of international comity – namely, the principle of recognising, upholding and respecting other jurisdictions’ legislative and judicial acts.
- Wording of the CJA: the terms of the CJA do not suggest a Parliamentary intention to confer extraterritorial powers upon the SFO.
- Role of Parliament vs the Court and the “Sufficient Connection” test: the decision regarding the extraterritorial application of the CJA is a matter for Parliament rather than the Court. As such, the decision to introduce a “sufficient connection” test would be a question to be answered by legislation, rather than one of judicial interpretation.
Presumption against Extra-Territorial Effect and Principle of International Comity
The Supreme Court held that the “starting point” for the consideration of the scope of section 2(3) is the presumption in English law that “legislation is generally not intended to have extra-territorial effect”. This presumption, according to the Supreme Court, is rooted in both the requirements of international law and the concept of comity, which is founded on mutual respect between states.
The Supreme Court emphasised that whilst the principle of comity was not a “rule of international law” as such, the “lack of precisely defined rules in international law as to the limits of legislative jurisdiction makes resort to the principle of comity as a basis of the presumption applied by courts in this jurisdiction all the more important”.
Lord Lloyd-Jones, writing for the Supreme Court, acknowledged the “legitimate interest of States in legislating in respect of the conduct of their nationals abroad”, however, he held that this case did not concern the conduct of a UK national or UK registered company abroad. If the addressee of the July Section 2 Notice had been a UK registered company, section 2(3) would have authorised the service of a notice to produce documents held abroad by that company.
Since the addressee of the July Section 2 Notice, KBR, Inc., had never carried on business in the UK or had a registered office or any other presence in the UK, the Supreme Court held that the presumption against extra-territorial effect clearly did apply to this case. The question for the Supreme Court was, therefore, whether Parliament intended section 2(3) to displace the presumption to give the SFO the power to compel a foreign registered company with no registered office or fixed place of business in the UK and which did not conduct business in the UK to produce documents it holds outside the UK.
Wording of the CJA
With respect to the question of whether the presumption against extra-territorial effect had been rebutted by the language of the CJA, the Supreme Court held that the “answer will depend on the wording, purpose and context of the legislation considered in the light of relevant principles of interpretation and principles of international law and comity.”
The Supreme Court noted that “when legislation is intended to have extra-territorial effect Parliament frequently makes express provision to that effect” and, unlike other statutory provisions, section 2(3) “includes no such express provision”. Moreover, the Supreme Court found that the other provisions of the CJA do not provide “any clear indication, either for or against the extra-territorial effect.”
Role of Parliament vs the Court and the “Sufficient Connection” Test
KBR, Inc. submitted that:
- The extraterritorial application of an investigatory power involving criminal sanctions, where the regulatory authority purports to exercise those powers in relation to persons and documents abroad, is a matter more appropriate for the legislature to assess rather than the court – as Parliament would be able to simultaneously address the issue of international comity and the proper conditions / safeguards to be imposed with such a power; and
- The court should resist the suggestion made on behalf of the SFO that the court should imply into section 2(3) of the CJA a “sufficient connection” test, as no such test was incorporated by Parliament into this statutory scheme.
The Supreme Court held that there was no basis for the Divisional Court’s ruling that the SFO could use the power in section 2(3) of the CJA to require foreign companies to produce documents held outside the UK if there was a “sufficient connection” between the company and the UK. Implying a “sufficient connection” test into section 2(3) “would exceed the appropriate bounds of interpretation and usurp the function of Parliament” and would involve illegitimately re-writing the statute.
Implications
The SFO has been using section 2(3) notices to compel the production of documents held outside of the UK for many years. Their use suited not only the SFO but also often recipients who were provided with a seemingly lawful basis to produce often confidential and sensitive documents to the SFO. In its use of the power, the SFO has generally proceeded judiciously, avoiding potential disputes from section 2notice -recipients it perceived as likely to take jurisdictional arguments. It may now be regretting its decision to use the section 2 power against KBR, Inc.; the SFO’s apparent impatience caused it to err in its judgment and use the power against a suspect with every reason to challenge the jurisdiction of the notice.
Although this case could be characterised as something of an “own goal” for the SFO, and is doubtless a setback, the Supreme Court’s decision may provide a basis for the SFO to argue that the Government needs to reconsider the scope of its powers, in order to ensure that it has the tools it needs to operate as a leading criminal enforcement agency. Many of the laws it is expected to enforce (not least the Bribery Act 2010) have extraterritorial reach after all.
In the meantime, the setback caused by this judgment is amplified by the fact that, like other UK prosecuting agencies, it has recently lost access to certain cross-border investigatory powers it enjoyed while the UK was a Member of the EU. In the context of document gathering, the loss of the EIO, that facilitated streamlined obtaining of evidence located in the EU as an alternative to MLA, is the most significant loss.
For the SFO, all is not lost as a result of this decision, however. Since the Divisional Court decision in 2018, the UK passed the Crime (Overseas Production Orders) Act 2019, which entered into force on October 9, 2019. That Act enables officers of specified investigative agencies, including the SFO, to apply to a UK court for an OPO requiring the production within seven days of stored electronic data located or controlled outside the UK, for use in the investigation and prosecution of certain indictable offences. This power can only be exercised where a designated international co-operation arrangement exists between the UK and the country where the electronic data is located or from where it is controlled. To date, the UK has only agreed one such agreement, with the U.S. in October 2019. The agreement is yet to become operational, but when it is, it will provide an alternative to the MLA route, although the scope of the agreement provides for production of a narrow category of documentation. Further, unlike the use of section 2(3) CJA, the SFO will need to make an application to a court and require the UK Central Authority, which coordinates MLA requests, to approve and serve the OPO.
Unless the SFO can convince the Government to extend the scope of its evidence-gathering powers by passing new legislation, and until OPOs become operational, the SFO will have little choice but to rely, in most cases, on the cumbersome and slow MLA route to obtain evidence from foreign registered companies with no registered office or fixed place of business in the UK or which do not carry on business from the UK.
Practical Implications
The following diagram provides a summary of the different ways that the SFO can obtain documentary evidence, both now and when OPOs become operational:
Illustrative Practical Examples:
- The SFO can compel the production of documents held by overseas branch offices of UK registered entities.
- The SFO can compel production of documents held in the cloud by a UK registered entity.
- The SFO cannot compel documents held or controlled by an overseas parent or subsidiary of a UK registered entity.
The following Gibson Dunn lawyers assisted in the preparation of this article: Patrick Doris, Sacha Harber-Kelly, Steve Melrose, Katie Mills and Rebecca Barry.
Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you would like to discuss this alert in detail, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the firm’s UK disputes practice in London:
Patrick Doris (+44 (0) 20 7071 4276, [email protected])
Sacha Harber-Kelly (+44 (0) 20 7071 4205, [email protected])
Steve Melrose (+44 (0) 20 7071 4219, [email protected])
Allan Neil (+44 (0) 20 7071 4296, [email protected])
Matthew Nunan (+44 (0) 20 7071 4201, [email protected])
Please also feel free to contact the following leaders and members of the firm’s White Collar Defense and Investigations practice:
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Nicola T. Hanna – Los Angeles (+1 213-229-7269, [email protected])
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