The False Claims Act (FCA) is well-known as one of the most powerful tools in the government’s arsenal to combat fraud, waste and abuse anywhere government funds are implicated. The U.S. Department of Justice has issued statements and guidance under the Trump Administration that has effectuated changes in DOJ’s approach to FCA cases. But at the same time, newly filed FCA cases remain at historical peak levels and the DOJ has enjoyed ten straight years of nearly $3 billion or more in annual FCA recoveries. The government has also made clear that it intends vigorously to pursue any fraud, waste and abuse in connection with COVID-related stimulus funds. As much as ever, any company that deals in government funds—especially in the government contracting sector—needs to stay abreast of how the government and private whistleblowers alike are wielding this tool, and how they can prepare and defend themselves.
Please join us to discuss developments in the FCA, including:
- The latest trends in FCA enforcement actions and associated litigation affecting government contractors;
- Updates on the Trump Administration’s approach to FCA enforcement, including developments with recent DOJ Civil Division personnel changes and DOJ’s use of its statutory dismissal authority;
- The coming surge of COVID-related FCA enforcement actions; and
- The latest developments in FCA case law, including developments in particular FCA legal theories affecting your industry and the continued evolution of how lower courts are interpreting the Supreme Court’s Escobar decision.
View Slides (PDF)
PANELISTS:
Jonathan M. Phillips is a partner in the Washington, D.C. office where he focuses on compliance, enforcement, and litigation in the health care and government contracting fields, as well as other white collar enforcement matters and related litigation. A former Trial Attorney in DOJ’s Civil Fraud section, he has particular experience representing clients in enforcement actions by the DOJ, Department of Health and Human Services, and Department of Defense brought under the False Claims Act and related statutes.
Erin N. Rankin is an associate in the Washington, D.C. office. She has extensive experience litigating government contract disputes and advising clients on FAR and DFARS compliance, with a particular focus on cost and pricing issues. Ms. Rankin also assists clients with all types of legal questions and disputes that arise in the creation, performance, and closing out of government contracts. She defends clients against False Claims Act allegations, negotiates and drafts subcontracts, conducts internal investigations, navigates disputes between prime and subcontractors, and represents clients in mandatory disclosures and suspension and debarment proceedings.
Andrew Tulumello is a partner in the Washington, D.C. office. He has represented several government contractors in investigations, suits, and trials (both by qui tam relators and the Department of Justice) under the False Claims Act involving federal contracts worth billions of dollars, including representing a leading defense contractor in 10(b) and derivative litigation following a $500 million deferred prosecution agreement with the Department of Justice. He was profiled by The National Law Journal in recognizing Gibson Dunn’s Washington. D.C. office as the Litigation Department of the Year, in The National Law Journal’s 2017 Appellate Hot List, and by Bloomberg BNA (“Deflategate Lawyer Heads to High Court in Securities Case”).
James Zelenay is a partner in the Los Angeles office where he practices in the firm’s Litigation Department. He is experienced in defending clients involved in white collar investigations, assisting clients in responding to government subpoenas, and in government civil fraud litigation. He also has substantial experience with the federal and state False Claims Acts and whistleblower litigation, in which he has represented a breadth of industries and clients, and has written extensively on the False Claims Act.
On September 25, 2020, California Governor Gavin Newsom signed into law the California Consumer Financial Protection Law (CCFPL), which was passed by the state legislature on August 31, 2020.[1] Under the CCFPL, California’s Department of Business Oversight (DBO) has been renamed the Department of Financial Protection and Innovation (DFPI). Modeled after the Consumer Financial Protection Bureau (CFPB) provisions in the Dodd-Frank Act, the CCFPL aims to strengthen consumer protections by expanding the regulatory authority of the DFPI and promoting access to responsible and affordable credit. The substantive provisions of the CCFPL go into effect on January 1, 2021.
The effects of the CCFPL will be felt most immediately by certain nonbank financial companies – for example, payday lenders and student loan servicers – as well as affiliated “service providers” to financial companies, because of statutory exclusions for regulated banks and many other current DBO nonbank licensees. This said, the CCFPL also gives the DFPI the authority to define other financial services whose providers would thereby become subject to its jurisdiction, and it includes new provisions relating to unfair, deceptive and abusive acts and practices enforcement authority (UDAAP) over statutorily covered persons and service providers. The DFPI will also have the authority to bring civil actions under the Dodd-Frank Act’s consumer protection provisions against all state-licensed banks and nonbank financial companies. As a result, financial institutions doing business in California are now facing a potentially powerful and reinvigorated regulatory authority.
I. Jurisdiction
The CCFPL grants authority to the DFPI to regulate the offering and provision of consumer financial products or services under California’s consumer financial laws, to exercise nonexclusive oversight and enforcement authority under California’s consumer financial laws, and, to the extent permissible under federal consumer financial laws, nonexclusive oversight and enforcement under federal consumer financial laws as well.[2]
The CCFPL’s definition of “consumer financial products and services” closely parallels the broad definition in Title X of the Dodd-Frank Act and its implementing regulations;[3] these include any financial product or service that is delivered, offered, or provided for use by consumers primarily for personal, family, or household purposes.[4] The definition also includes brokering the offer or sale of a franchise in California on behalf of another.[5] Similar to the authority granted to the CFPB under the Dodd-Frank Act, the DFPI will have authority to issue regulations defining any other financial product or service when the financial product or service (i) is entered into or conducted as a subterfuge or with a purpose to evade consumer financial law or (ii) will likely have a material impact on consumers, in each case, subject to certain exceptions.[6]
As a general matter, the CCFPL applies to “covered persons.” Subject to the important exclusions discussed immediately below, this includes (1) any person that engages in offering or providing a consumer financial product or service to a resident of California, (2) any affiliate of a covered person that acts as a service provider, and (3) any service provider to the extent that person offers or provides its own consumer financial product or service.[7] A “service provider” is any person that provides a material service to a covered person in connection with the covered person’s offering or provision of a consumer financial product or service.[8]
Reflecting a legislative compromise, the CCFPL does not apply to the following entities that were previously subject to licensing and DBO regulation: banks, bank holding companies, trust companies, savings and loan associations, savings and loan holding companies, credit unions, industrial loan corporations, insurers, certain electronic financial data transmitters, escrow agents, finance lenders and brokers, mortgage loan originators, broker-dealers, investment advisers, residential mortgage lenders, mortgage servicers, and money transmitters.[9] Payday lenders and student loan servicers, however, are not excluded. Also excluded are licensees of other state agencies and their employees where the licensee or employee is acting under the authority of the other state agency’s license (for example, real estate brokers).[10]
II. UDAAP
Like Title X of Dodd-Frank, the CCFPL contains expanded UDAAP (unfair, deceptive or abusive acts and practices) authority over “covered persons” and “service providers.” The CCFPL permits the DFPI to take action against a covered person or service provider that engages, has engaged, or proposes to engage in UDAAPs with respect to consumer financial products or services.[11] In addition to enforcement authority, the CCFPL authorizes the DFPI to prescribe rules applicable to any covered person or service provider regarding UDAAP, subject to the following limitations.[12] The DFPI must interpret “unfair” and “deceptive” in a manner consistent with California’s broad Unfair Competition Law and case law thereunder.[13] In this area, the definition of “unfair” remains unsettled.[14] Courts typically use one of two tests to determine “unfairness”: (1) an “examination of [the practice’s] impact on its alleged victim, balanced against the reasons, justifications and motives of the alleged wrongdoer”[15] or (2) the Federal Trade Commission’s definition of “unfair” conduct.[16] As for the term “abusive,” the CCFPL requires that it must be interpreted consistently with Title X of the Dodd-Frank Act, and any inconsistency must be resolved in favor of greater protections to the consumer and more expansive coverage.[17]
In addition to UDAAP authority, the DFPI is authorized to bring civil actions or other appropriate proceedings to enforce the consumer protection provisions of Title X of the Dodd-Frank Act and the CFPB’s regulations thereunder, with respect to any entity licensed, registered or subject to DFPI oversight.[18]
III. Other Enforcement Powers
In addition to its UDAAP authority, the DFPI may enforce consumer financial laws with respect to covered persons, service providers, and – broadening its authority substantially – persons who knowingly or recklessly provide substantial assistance to a covered person or service provider in violating consumer financial law.[19] This authority applies only to acts or practices engaged in on or after the January 1, 2021.[20]
The DFPI also has the power to bring administrative and civil actions, issue subpoenas, hold hearings, issue publications, and conduct investigations.[21] It may issue orders directing a person to desist and refrain from engaging in an activity, act, practice or course of business; such injunctive orders become effective and final if a respondent does not request a hearing within 30 days.[22] After notice and an opportunity for a hearing, the DFPI can suspend or revoke the license or registration of a covered person or service provider.[23] The DFPI can also apply to the appropriate superior court for an order compelling the cited licensee or person to comply with its orders.[24]
No civil action can be brought by the DFPI more than four years after the date of discovery of the violation to which an action relates.[25] What constitutes the “date of discovery” is undefined in the CCFPL and similarly undefined in Title X of the Dodd-Frank Act. The United States District Court for the Northern District of California, however, has held that the CFPB’s limitations period begins running when the CFPB “actually” discovers facts constituting a violation or when a “reasonably diligent plaintiff would have” discovered those facts.[26] If, however, an action arises solely under a California or federal consumer financial law, the limitations period under such consumer financial law will apply.[27]
With respect to UDAAP violations, the DFPI will have at its disposal the same wide-ranging remedial tools as the CFPB, including rescission or reformation of contracts, refund of moneys or return of real property, restitution, disgorgement or compensation for unjust enrichment, payment of damages, public notification regarding the violation, and limits on the activities or functions of the violator.[28] Like Title X of the Dodd-Frank Act, the CCFPL does not authorize exemplary or punitive damages,[29] but does empower the DFPI to impose considerable penalties for violations.[30]
|
CCFPL Penalties | ||||
|
May not exceed the greater of | ||||
| Violation | $5,000 for each day the violation continues | $2,500 for each act or omission in violation | ||
| Reckless Violation | $25,000 for each day the violation continues | $10,000 for each act or omission in violation | ||
|
May not exceed the lesser of | ||||
| Knowing Violation | $1,000,000 for each day the violation continues | $25,000 for each act or omission in violation | 1% of the violator’s total assets | |
IV. Consumer Complaints
The CCFPL authorizes the DFPI to promulgate regulations to round out its investigatory authority. Like the CFPB, the DFPI may promulgate rules and procedures governing informational requests from covered persons concerning consumer complaints or inquiries.[31] The DFPI is required to finalize its complaint response procedures before it may commence an enforcement action against a covered person or service provider for a violation of these provisions.[32] The DFPI may, however, make the information requests themselves beginning on January 1, 2021. Notably, these provisions do not apply to consumer complaints regarding credit reporting agencies.
V. Registration
Covered persons engaged in the business of offering or providing a consumer financial product or service may become subject to new registration requirements and attendant fees, as the latter will help support the DFPI’s operating budget.[33] The authority to promulgate rules related to the registration and reporting of covered persons will expand the reach of the DFPI to oversee entities that are not currently subject to licensure or registration. In order to deter regulation by enforcement, the CCFPL requires the DFPI to promulgate registration rules no later than three years following the initiation of its second action to enforce a violation of the CCFPL by persons providing the same or substantially similar consumer financial product or service.[34]
VI. Covered Person Reporting
Like the CFPB, the DFPI can require a covered person to generate, provide, or retain records for the purposes of facilitating oversight and assessing and detecting risks to consumers.[35] In conducting any monitoring, regulatory or assessment activity, the DFPI can also gather information regarding the organization, business conduct, markets, and activities of any covered persons or service providers.[36]
VII. DFPI Reporting
The DFPI must prepare and publish an online annual report detailing actions taken during the prior year.[37] The report must include information on actions with respect to rulemaking, enforcement, oversight, consumer complaints and resolutions, education, research, and the activities of the Financial Technology Innovation Office.[38] The report may also include recommendations, including those intended to result in improved oversight, greater transparency, or increased availability of beneficial financial products and services in the marketplace.[39]
VIII. Conclusion
Notwithstanding its exclusions for many entities previously subject to DBO oversight, the CCFPL creates a more powerful state financial services regulator with new registration authority, expanded enforcement authority, and UDAAP authority. If it makes full use of the CCFPL’s powers, the DFPI will become a significant consumer regulator. Firms that offer consumer financial products and services in California will therefore need to pay close attention to the DFPI in 2021 as it begins to implement its new statutory authority.
______________________
[1] California Assembly Bill 1864 (passed August 31, 2020), available here.
[3] See 12 C.F.R. § 1091.101 (definition of “consumer financial product or service”) and 12 U.S.C. § 5481(15) (definition of “financial product or service”).
[4] New Cal. Fin. Code § 90005(c).
[5] Id. § 90005(e). For a complete list of “financial products or services,” see id. § 90005(k).
[6] Compare New Cal. Fin. Code § 90005(k)(12) with 12 U.S.C. § 5481(15)(A)(xi).
[7] New Cal. Fin. Code § 90005(f).
[11] Id. §§ 90012(a); 90009(c); 12 U.S.C. § 5531(a), (b).
[12] New Cal. Fin. Code § 90009(c). The statute further authorizes the DFPI to define UDAAP in connection with the offering or provision of commercial financing or other financial products and services to small business recipients, nonprofits, and family farms. Id. § 90009(c)(3).
[14] See, e.g., Mui Ho v. Toyota Motor Corp., 931 F. Supp. 2d 987, 1000 n.5 (N.D. Cal. 2013) (“California courts and the legislature have not specified which of several possible ‘unfairness’ standards is the proper one.”); Ferrington v. McAfee, Inc., No. 10-CV-01455-LHK, 2010 WL 3910169, at *11 (N.D. Cal. Oct. 5, 2010) (“California law is currently unsettled with regard to the correct standard to apply to consumer suits alleging claims under the unfair prong of the UCL.”).
[15] Motors, Inc. v. Times Mirror Co., 102 Cal. App. 3d 735, 740 (1980).
[16] The Federal Trade Commission Act provides that an act or practice is unfair when (1) it causes or is likely to cause substantial injury to consumers, (2) the injury is not reasonably avoidable by consumers and (3) the injury is not outweighed by countervailing benefits to consumers or to competition. 15 U.S.C. § 45(n). The CFPB uses the same standard for unfairness. 12 U.S.C. § 5531(c).
[17] New Cal. Fin. Code § 90009(c)(3).
[26] See Consumer Financial Protection Bureau v. Nationwide Biweekly Administration, Inc., et. al., No. 15-cv-02106-RS (N.D. Cal. Sep. 8, 2017)
[27] New Cal. Fin. Code § 90014.
[29] Compare New Cal. Fin. Code § 90013(d) with 12 U.S.C. § 5565(a)(3).
[30] New Cal. Fin. Code § 90013(d).
[31] Id. § 90008. Notably, these provisions do not apply to consumer complaints regarding consumer reporting agencies. Id.
[35] Id. § 90009(b); 12 U.S.C. § 5514(b)(7)(B).
[36] New Cal. Fin. Code § 90010(f).
The following Gibson Dunn lawyers assisted in preparing this client update: Arthur S. Long, Benjamin B. Wagner, James O. Springer and Samantha J. Ostrom.
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 practice group, or the following:
Arthur S. Long – New York (+1 212-351-2426, [email protected])
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])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, [email protected])
James O. Springer – New York (+1 202-887-3516, [email protected])
Samantha J. Ostrom – Washington, D.C. (+1 202-955-8249, [email protected])
© 2020 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 of counsel Karin Portlock and associate Vinay Limbachia are the authors of “The Constitutional Risks In Pandemic-Era Criminal Jury Trials” published by Law360 on October 9, 2020.
Washington, D.C. partner Judith Alison Lee, of counsel Christopher Timura, and associates R.L. Pratt and Scott Toussaint are the authors of “U.S. Export Controls: The Future of Disruptive Technologies” [PDF] published in the NATO Legal Gazette, Issue 41 in October 2020.
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 close of trading on June 30, 2020) during the first half of 2020. As the markets weathered the dislocation caused by the novel coronavirus (COVID-19) pandemic, shareholder activist activity decreased dramatically. Relative to the first half of 2019, the number of public activist actions declined from 51 to 28, the number of activist investors taking actions declined from 33 to 10 and the number of companies targeted by such actions declined from 46 to 22.
By the Numbers – H1 2020 Public Activism Trends
Additional statistical analyses may be found in the complete Activism Update linked below.
The decline in shareholder activism activity brought concentration among those investors engaged in activist activity during the first half of 2020. For example, during the first half of 2020, NorthStar Asset Management launched six campaigns and Starboard Value LP launched four campaigns. Three activists represented half of the total public activist actions that began during the first half of 2020.
In addition, as compared to the first half of 2019, activists turned their focus away from agitating for particular transactions as the animating rationale for the campaigns they launched. While changes in board composition remained the leading rationale for campaigns initiated in the first half of 2019 and the first half of 2020, M&A (which includes advocacy for or against spin-offs, acquisitions and sales) and acquisitions of control, which served as the rationale for 24% and 8%, respectively, of activist campaigns in the first half of 2019, declined to 9% and 0%, respectively, in the first half of 2020. By contrast, advocacy for changes in governance, which emerged in 6% of campaigns in the first half of 2019, became the principal rationale for 28% of campaigns in the first half of 2020. Business strategy also remained a high-priority area of focus for shareholder activists, representing the rationale for 22% of campaigns begun in the first half of 2019 and 24% of campaigns begun in the first half of 2020. The rate at which activists engaged in proxy solicitation remained consistent at 24% in the first half of 2019 and 21% in the first half of 2020. (Note that the percentages for campaign rationales described in this paragraph sum to over 100%, as certain activist campaigns had multiple rationales.)
Publicly filed settlement agreements declined alongside the decrease in shareholder activism activity. Nine settlement agreements were filed during the first half of 2020, as compared to 17 such agreements during the first half of 2019. Nonetheless, the settlement agreements into which activists and companies entered contained many of the same features noted in prior reviews, including voting agreements and standstill periods as well as non-disparagement covenants and minimum and/or maximum share ownership covenants. Expense reimbursement provisions appeared in two thirds of the settlement agreements reviewed, which represented an increase relative to 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 Mid-Year Activism Update informative. If you have any questions, please do not hesitate to 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])
Saee Muzumdar (+1 212.351.3966, [email protected])
Daniel S. Alterbaum (+1 212.351.4084, [email protected])
Jessica L. Bondy (+1 212.351.3802, [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])
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
California’s housing shortage continues as the state grapples with the COVID-19 pandemic. In an effort to mitigate delays in housing production throughout the state, California Governor Gavin Newsom recently signed into law Assembly Bill 1561 (“AB 1561”), which extends the validity of certain categories of residential development entitlements. Devised as a remedy for impediments to housing development as a result of interruptions in planning, financing, and construction due to the pandemic, AB 1561 helps cities and counties that would otherwise need to devote significant resources to addressing individual permit extensions on a case-by-case basis.
AB 1561 adds a new section to the state’s Government Code, Section 65914.5, that extends the effectiveness of “housing entitlements” that were (a) issued and in effect prior to March 4, 2020 and (b) set to expire prior to December 31, 2021. All such qualifying housing entitlements will now remain valid for an additional period of eighteen (18) months.
Section 65914.5 broadly defines a “housing entitlement” to include any of the following:
- A legislative, adjudicative, administrative, or any other kind of approval, permit, or other entitlement necessary for, or pertaining to, a housing development project issued by a state agency;
- An approval, permit, or other entitlement issued by a local agency for a housing development project that is subject to the Permit Streamlining Act (Cal. Gov. Code § 65920 et seq);
- A ministerial approval, permit, or entitlement by a local agency required as a prerequisite to the issuance of a building permit for a housing development project;
- Any requirement to submit an application for a building permit within a specified time period after the effective date of a housing entitlement described in numbers 1 and 2 above; and
- A vested right associated with an approval, permit, or other entitlement described in numbers 1 through 4 above.
Notably, specifically excluded from the definition of a “housing entitlement” are: (a) development agreements authorized pursuant to California Government Code Section 65864; (b) approved or conditionally approved tentative maps which were previously extended for at least eighteen (18) months on or after March 4, 2020 pursuant to Government Code Section 66452.6; (c) preliminary applications under SB 330 (the Housing Crisis Act of 2019); and (d) applications for development approved under SB 35 (Cal. Gov. Code § 65913.4).
Further, housing entitlements which were previously granted an extension by any state or local agency on or after March 4, 2020, but before the effective date of AB 1561 (i.e. September 28, 2020), will not be further extended for an additional 18-month period so long as the initial extension period was for no less than eighteen (18) months.
The definition of a “housing development project” is broad and includes any of the following: (x) approved or conditionally approved tentative maps, vesting tentative maps, or tentative parcel maps for Subdivision Map Act compliance (Cal. Gov. Code § 66410 et seq); (y) residential developments; and (z) mixed-use developments in which at least two-thirds (2/3rds) of the square footage of the development is designated for residential use. For purposes of calculating the square footage devoted to residential use within a mixed-use development, the calculation must include any additional density, floor area, and units, and any other concession, incentive, or waiver of development standards obtained under California’s Density Bonus Law (Cal. Gov. Code § 65915); however, the square footage need not include any underground space such as a basement or underground parking garage.
AB 1561 makes clear that while the extension provision of Section 65914.5 applies to all cities, including charter cities, local governments are not precluded from further granting extensions to existing entitlements.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. For additional information, please contact any member of Gibson Dunn’s Real Estate or Land Use Group, or the following authors:
Doug Champion – Los Angeles (+1 213-229-7128, [email protected])
Amy Forbes – Los Angeles (+1 213-229-7151, [email protected])
Ben Saltsman – Los Angeles (+1 213-229-7480, [email protected])
Matthew Saria – Los Angeles (+1 213-229-7988, [email protected])
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
While the COVID-19 pandemic has disrupted the practice of law in 2020, courts have continued to churn out important rulings impacting the media and entertainment industries. Here, Gibson Dunn’s Media, Entertainment and Technology Practice Group highlights some of those key cases and trends: from politically charged First Amendment cases to copyright battles over rock anthems, fictional pirates, and real-life music piracy.
I. Recent Litigation Highlights
A. First Amendment Litigation
1. President Trump’s Failed Efforts to Block Publication of Critical Books.
This presidential election year saw two efforts by the federal government and President Trump to enjoin the publication of forthcoming books critical of the current president. Both efforts to obtain a prior restraint order failed and the books were released, though one of the cases is far from over.
On June 20, 2020, the District Court for the District of Columbia rejected the U.S. government’s motion for a preliminary injunction and temporary restraining order to block former National Security Advisor John Bolton from publishing his memoir, The Room Where it Happened.[1] The United States filed its lawsuit on June 16, 2020, alleging that Bolton’s book contains sensitive information that could compromise national security, that its publication breached non-disclosure agreements that bound Bolton, and that Bolton abandoned the prepublication review process.[2] In addition to an injunction, the government seeks as a remedy a constructive trust over Bolton’s proceeds from the book. PEN American Center, Inc., Association of American Publishers, Inc., Dow Jones & Company, Inc., The New York Times Company, Reporters Committee or Freedom of the Press, The Washington Post, the ACLU and others filed amicus briefs opposing the government’s effort to enjoin publication, arguing, among other things, that the First Amendment prohibits prior restraints for any duration of time.[3] Rejecting the government’s motion, the district court held that, while the government is likely to succeed on the merits of its complaint, it did not establish that it would suffer irreparable injury absent an injunction.[4] Judge Lamberth had harsh words for Bolton, stating that—while not controlling as to that present motion—Bolton “has exposed his country to harm and himself to civil (and potentially criminal) liability.”[5] On July 30, 2020, the government filed a motion for summary judgment against Bolton.[6] On September 15, 2020, it was reported that the Justice Department had opened a criminal investigation into Bolton’s alleged disclosure of classified information in connection with his book.[7] On October 1, 2020, the district court denied Bolton’s motion to dismiss the government’s civil case against him.[8] [Disclosure: Gibson Dunn represented amicus PEN American Center, Inc. in opposing the government’s effort to enjoin publication.]
On July 13, 2020, the New York Supreme Court rejected a similar attempt by President Trump’s brother, Robert S. Trump—brought shortly before his death—to enjoin publication of their niece Mary Trump’s book, Too Much and Never Enough.[9] Robert Trump filed his motion for temporary restraining order and preliminary injunction against Mary Trump and her publisher, Simon and Schuster, on June 26, 2020, alleging that publication of Ms. Trump’s book would breach a confidentiality clause in a nearly 20-year-old settlement agreement among the Trump family regarding the president’s parents’ estates.[10] Ms. Trump argued, among other things, that a prior restraint is not a constitutionally permissible method of enforcing a settlement agreement’s confidentiality provision and that the contract Robert Trump invoked was not enforceable under the circumstances.[11] The Court agreed, finding that “in the vernacular of First year law students, ‘Con. Law trumps Contracts.’”[12] Ms. Trump’s book was released and became a best-seller. [Disclosure: Gibson Dunn represents Mary Trump in this lawsuit.]
2. Defamation Litigation
a. A Barrage of Defamation Claims, Settlements, Trials, and Dismissals.
The past year has been particularly active in the defamation arena. While media defendants have won some high-profile victories over slander and libel claims, such claims remain a threat, and plaintiffs continue to file lawsuits with headline-grabbing damages requests. Sarah Palin’s libel case against The New York Times Company—over a 2017 editorial that she alleges falsely tied her to a mass shooting—will proceed to trial in February 2021 after the judge denied dueling summary judgment motions and found that the case should be decided by a jury.[13] And this year, Nicholas Sandmann settled suits brought against The Washington Post and CNN over coverage of his viral-video encounter with a Native American activist at the 2019 March for Life rally in Washington D.C.[14] Sandmann still has pending suits against NBC, ABC News, CBS News, The New York Times, Gannett, and Rolling Stone.[15]
On the other hand, in December 2019, a Los Angeles jury determined that Elon Musk did not defame Vernon Unsworth when he called him a “pedo guy” during a name-calling spat on Twitter.[16] Moreover, over the past year, Congressman Devin Nunes has seen many of his defamation suits against media companies rebuffed, with courts recently dismissing his lawsuit against Esquire and journalist Ryan Lizza, and dismissing another suit against the political research firm Fusion GPS, though Nunes continues to pursue both actions.[17] Nunes also continues to try to sue Twitter and certain of its users for defamation, including a Republican political strategist and anonymous parody accounts belonging to a fake cow (Devin Nunes’ cow @DevinCow) and to Nunes’ “mother” (Devin Nunes’ Alt-Mom @NunesAlt), even after Twitter was dismissed from the case.[18] Nunes has also filed suits against McClatchy, The Washington Post, and CNN.[19] [Disclosure: Gibson Dunn represents The McClatchy Company in the suit filed by Nunes.]
b. Rachel Maddow Wins Dismissal of One America News Network Owner’s Defamation Claim.
On May 22, 2020, Judge Cynthia A. Bashant of the Southern District of California granted Rachel Maddow, MSNBC, NBCUniversal, and Comcast’s anti-SLAPP special motion to strike in response to a complaint filed by Herring Networks, Inc., owner of the conservative news outlet One America News (“OAN”).[20] Herring Networks filed its lawsuit in September 2019 over comments Ms. Maddow made during a broadcast of The Rachel Maddow Show. During that show, she commented on a Daily Beast article that reported how OAN employed an on-air reporter who also worked for Sputnik, a pro-Kremlin news organization funded by the Russian government. While reporting on the article, Ms. Maddow exclaimed, “the most obsequiously pro-Trump right wing news outlet in America really literally is paid Russian propaganda. Their on air U.S. politics reporter is paid by the Russian government to produce propaganda for that government.”[21] Herring Networks argued Ms. Maddow’s statement that the network “really literally is paid Russian propaganda” was false and defamatory.[22]
Ms. Maddow and the other defendants challenged Herring Networks’ suit via a motion to strike under California’s anti-SLAPP law, arguing that Ms. Maddow’s statement was fully protected opinion under the First Amendment and, in any event, was substantially true.[23] The court granted the defendants’ motion, explaining Ms. Maddow clearly outlined the basis for her opinions during the segment and “inserted her own colorful commentary” regarding the facts.[24] As such, the court found the statement was protected opinion as a matter of law and disagreed with Herring Networks’ argument that Ms. Maddow’s statement raised a factual issue for a jury. The court dismissed Herring Networks’ complaint with prejudice, and ordered the defendants to file a motion to recover their fees (as required by California’s anti-SLAPP law).[25] Herring Networks has filed a notice of appeal with the Ninth Circuit. [Disclosure: Gibson Dunn represents Ms. Maddow, MSNBC, NBCUniversal, and Comcast in this action.]
c. “Wolf of Wall Street” Libel Claim Fails.
In June 2020, the Second Circuit rejected a libel lawsuit filed against Paramount Pictures over the film “The Wolf of Wall Street,” in which Wall Street brokerage-firm attorney Andrew Greene alleged he was defamed by a fictional character in the film who Greene claimed resembled him.[26] Greene, an ex-employee of the financial firm portrayed in the film, alleged that the film featured a character that is “recognizable as him” and “depicted as engaging in behavior that defames his character.”[27] The District Court for the Eastern District of New York granted the defendants’ motion for summary judgment, holding that Greene failed to raise a genuine issue of material fact as to whether Paramount Pictures acted with knowledge or reckless disregard in making defamatory statements “of and concerning” Greene.[28]
The Second Circuit affirmed, holding that Greene’s claims failed as a matter of law because a reasonable jury would not find that Paramount Pictures acted with actual malice.[29] First, the Second Circuit found that Paramount Pictures “took appropriate steps to ensure that no one would be defamed by the Film.”[30] Those steps included reading the book and news articles on which the film was based and assigning characters fictitious names with no “specific real life analogue.”[31] Second, the circuit court found that “no reasonable viewer” of “The Wolf of Wall Street” would believe that Paramount Pictures intended the character in the film as a depiction of Greene, as Paramount Pictures knew the film character was a fictitious, composite character.[32] Also, Greene worked as head of the corporate finance department at the financial firm portrayed in the film, while the character at issue worked as a broker on the trading floor.[33] Finally, the film included a disclaimer that characters in the film were fictionalized.[34]
3. Right of Publicity
a. New York Considers New Right of Publicity Law.
In July 2020, both houses of the New York Legislature unanimously passed a much-anticipated proposed right of publicity bill, which awaits signature by Governor Andrew Cuomo.[35] The bill, Senate Bill S5959D/Assembly Bill No. A05605B, would replace New York Civil Rights Law § 50 and changes the right of publicity landscape in the state.[36] Significantly, the bill makes a person’s right of publicity an independent property right that is freely transferable and creates postmortem rights for forty years after the death of an individual.[37] It further “protects a deceased performer’s digital replica in expressive works to protect against persons or corporations from misappropriating a professional performance.”[38]
Given the rise of pornographic deepfakes—“hyper-realistic manipulation of digital imagery that can alter images so effectively it’s largely impossible to tell real from fake”[39]—SAG-AFTRA called the bill’s passage “a remarkable step in the ongoing effort to protect our members, and all performers, from the exploitation of our images and voices – the very assets we use to make a living.”[40] But others, including the Motion Picture Association of America (“MPAA”) and the New York State Broadcasters Association, Inc., have voiced concerns about the bill’s implications, arguing it chills speech and presents First Amendment concerns.[41] Specifically, the MPAA argues that the bill’s language is vague and overbroad and interferes with the ability of filmmakers to tell stories inspired by real people and events.[42]
B. Profit Participation & Royalties
1. AMC Prevails in First The Walking Dead Profits Trial in California.
On July 22, 2020, following a bench trial, Judge Daniel Buckley of the Superior Court for the County of Los Angeles issued a sweeping ruling in favor of AMC in a profit participation action regarding the hit AMC series The Walking Dead.[43] This California lawsuit, governed by New York contract law, was brought by various show participants, including Robert Kirkman, David Alpert, and Gale Anne Hurd. The case also involved issues pertaining to spin-offs Fear the Walking Dead and Talking Dead. The profit participants alleged that AMC failed to properly account to them under their agreements, and Judge Buckley ordered the eight-day trial to resolve key, gateway issues of contractual interpretation.
Those issues included (1) whether AMC’s standard modified adjusted gross receipts definition (“MAGR Definition”) governed the calculation, reporting, and payment of MAGR to the plaintiffs; and (2) whether the affiliate transaction provision in certain plaintiffs’ agreements applied to AMC Network’s exhibition of The Walking Dead.[44]
Judge Buckley found that AMC’s standard MAGR Definition governed the calculation, reporting, and payment of MAGR to the plaintiffs, even where the MAGR exhibit was supplied after the plaintiffs signed their agreements. The court looked at the plain text of the parties’ agreements, which stated that “MAGR shall be defined, computed, accounted for and paid in accordance” with AMC’s MAGR Definition, and explained that “New York courts routinely uphold the right of one party to a contract to fix a material price term in the future.”[45] The court also noted that the plaintiffs bargained for and received particular MAGR protections in the agreements themselves.[46] Though the court found looking to extrinsic evidence was unnecessary, it explained how years of post-performance conduct only confirmed AMC’s position that its MAGR Definition controlled, with certain plaintiffs waiting four years to object to the MAGR Definition after they received it, all the while accepting payments from AMC under that definition.[47]
One of the plaintiffs’ key arguments was that the license fee imputed for AMC Network’s exhibition of The Walking Dead, which appeared in the MAGR Definition, was too low and not in compliance with the affiliate transaction provisions in their agreements. Those provisions required “‘AMC’s transactions with Affiliated Companies [to] be on monetary terms comparable with the terms on which AMC enters into similar transactions with unrelated third party distributors for comparable programs after arms’ length negotiation.”[48] The court held AMC Network’s exhibition of The Walking Dead was governed by the imputed license fee in the MAGR Definition, and that the affiliate transaction provisions only applied to transactions where the participant “has no seat at the table to negotiate. . . .”[49] The court found the provision did not apply to the kind of internal rights transfers the plaintiffs challenged.
Similar lawsuits over The Walking Dead were filed by CAA and Frank Darabont in New York.[50] The consolidated jury trial in these lawsuits is scheduled to begin in April 2021. [Disclosure: Gibson Dunn represents AMC in these actions.]
C. #MeToo Litigation
1. Ninth Circuit Revives Ashley Judd’s Harassment Claim against Harvey Weinstein.
On July 29, 2020, the Ninth Circuit ruled that the actor Ashley Judd could proceed with her sexual harassment claim against Harvey Weinstein. Ms. Judd filed her action alleging defamation, sexual harassment, intentional interference with prospective economic advantage, and unfair competition on April 30, 2018. Ms. Judd’s claims stemmed from events occurring in and around 1997, at which time Ms. Judd alleges Mr. Weinstein invited her, a Hollywood newcomer, to a “general” industry meeting at the Peninsula Hotel in Beverly Hills, where she was to seek advice and guidance. When Ms. Judd arrived, she was directed to Mr. Weinstein’s private hotel room, where Mr. Weinstein appeared in a bathrobe, asked to give Ms. Judd a massage, and asked her to watch him shower.
Judge Phillip Gutierrez of the Central District of California granted Mr. Weinstein’s motion to dismiss Ms. Judd’s sexual harassment claim, brought pursuant to California Civil Code section 51.9, finding Ms. Judd and Mr. Weinstein’s relationship did not fall within the definition of a “business, service, or professional relationship” under the statute. The court nonetheless explained that “an appellate decision on these important issues could provide needed guidance to lower courts applying § 51.9.” Ms. Judd appealed the dismissal of her sexual harassment claim to the Ninth Circuit.
Reversing the district court, the Ninth Circuit explained that “[Ms. Judd’s and Mr. Weinstein’s] relationship consisted of an inherent power imbalance wherein Weinstein was uniquely situated to exercise coercion or leverage over Judd by virtue of his professional position and influence as a top producer in Hollywood.”[51] The court held that section 51.9 does, in fact, cover such business or professional relationships where there is an inherent power imbalance.[52] [Disclosure: Gibson Dunn represents Ashley Judd in this action.]
D. Music Industry Litigation
1. Led Zeppelin Prevails in En Banc “Stairway” Ruling.
On March 9, 2020, the Ninth Circuit, sitting en banc, reinstated a Los Angeles jury’s 2016 verdict clearing Led Zeppelin of infringing the band Spirit’s song “Taurus.”[53] Michael Skidmore, the trustee of for the estate of Spirit’s founding member Randy Wolfe (pka Randy California), had alleged that the opening riff of “Stairway to Heaven” is substantially similar to “Taurus,” and infringed Wolfe’s copyright in the composition. In 2016, the jury found no substantial similarity between “Taurus” and the rock anthem under the extrinsic test for unlawful appropriation. But in September 2018, a Ninth Circuit three-judge panel vacated the verdict and remanded the case for a new trial.[54] The three-judge panel found that lack of an instruction explaining copyrights that cover the selection and arrangement of music, combined with an allegedly faulty instruction on the requisite element of originality prejudicially “undermined the heart of plaintiff’s argument.”[55]
The March 2020 en banc ruling overturned the panel in a detailed opinion, agreeing with U.S. District Judge R. Gary Klausner that the 1909 Copyright Act, not the 1976 Copyright Act, governed, and that only the bare-bones “deposit copy” of “Taurus” was properly introduced for comparison to “Stairway to Heaven.”[56] The en banc panel held that “[b]ecause the 1909 Copyright Act did not offer protection for sound recordings, [Spirit]’s one-page deposit copy defined the scope of the copyright at issue.”[57] Thus, it was not error for the district court to deny the plaintiff’s request to play for the jury sound recordings of “Taurus.”[58]
The en banc panel also rejected the “inverse ratio rule” previously adopted by the Ninth Circuit, under which it had “permitted a lower standard of proof of substantial similarity where there is a high degree of access.”[59] To preserve the inverse ratio rule, Judge McKeown wrote for the en banc panel, would “unfairly advantage[] those whose work is most accessible by lowering the standard of proof for similarity,” thereby benefitting “those with highly popular works.”[60] The “Stairway” case had been closely watched by the music industry and attracted numerous amicus at the court of appeals, including the U.S. Department of Justice supporting Led Zeppelin’s position on appeal. On October 5, 2020, the U.S. Supreme Court denied Skidmore’s petition for writ of certiorari.[61]
2. Labels’ and Publishers’ Billion-Dollar Verdict Against Cox Upheld.
On June 2, 2020, U.S. District Judge Liam O’Grady of the Eastern District of Virginia largely upheld a $1B verdict against Cox Communications won by over 50 records labels and music publishers, including Sony Music Entertainment, Universal Music Group, and Warner Bros. Records.[62]
Judge O’Grady rejected Cox’s contention that the evidence at trial was insufficient, concluding that there was “overwhelming” and “strong” evidence that Cox’s users illegally reproduced the sound recordings and distributed them over Cox’s network.[63] Further, there was “ample” evidence for the jury to conclude that Cox gained some direct benefit from the infringement and find Cox liable for vicarious copyright infringement.[64] Judge O’Grady emphasized evidence showing that “Cox looked at customers’ monthly payments when considering whether to terminate them for infringement.”[65]
Judge O’Grady also rejected Cox’s argument that the award was “grossly excessive.”[66] He noted that the per-work damages of $99,830.29 were more than $50,000 below the statutory maximum under the Copyright Act,[67] but ordered additional briefing on the issue of the calculation of the number of infringed works.[68]
3. Music Publishers and Peloton Reach Settlement in Copyright Suit After Dismissal of Cycling Company’s Counterclaims.
In March 2019, more than a dozen music publishers filed suit in New York federal court alleging popular fitness tech company Peloton failed to license songs for its online classes, thereby violating the publishers’ copyrights.[69] The publishers claimed over $150 million in damages for unlicensed uses of more than 1000 songs, with each use of an allegedly unlicensed song constituting a separate infringement because audiovisual “sync” licenses are issued on a per-video basis.[70] The publishers also alleged Peloton’s conduct was “deliberate and willful” because the company had obtained the necessary “sync” licenses from other music copyright owners.[71]
In response, Peloton counterclaimed against the publishers, alleging that any failure to obtain licenses was due to the National Music Publishers’ Association’s (“NMPA”) creation of a price fixing “cartel.”[72] Peloton alleged the NMPA both engaged in “horizontal collusion” to inflate prices in its own negotiations with the company and tortiously interfered with Peloton’s ability to negotiate with individual publishers.[73] On January 29, 2020, U.S. District Judge Denise Cote dismissed Peloton’s counterclaims without leave to amend, finding that Pelton failed define a “relevant market,” a necessary element to Peloton’s antitrust claim under Section 1 of the Sherman Act.[74] A month later, the case settled.
4. Second Circuit Upholds Copyright Win for Drake.
On February 3, 2020, the Second Circuit affirmed the Southern District of New York’s ruling that Drake did not violate copyright law by incorporating a 35-second clip of the song “Jimmy Smith Rap” into his song “Pound Cake” without a license.[75] The lawsuit began in April 2014, when the estate of Jimmy Smith sued Drake and Drake’s record labels and publishers for copyright infringement. The defendants moved for summary judgment, arguing that Drake’s use of the song was protected by the fair use doctrine.[76]
The District Court granted the defendants’ motion for summary judgment in May 2017.[77] In its 2020 ruling, the Second Circuit affirmed, finding Drake’s use of the song was protected by the fair use doctrine, as the use was “transformative.”[78] The Court stated that “‘Pound Cake’ criticizes the jazz-elitism that the ‘Jimmy Smith Rap’ espouses. By doing so, it uses the copyrighted work for a purpose, or imbues it with a character, different from that for which it was created.”[79] In addition, the Court found “no evidence that ‘Pound cake’ usurps demand for ‘Jimmy Smith Rap.’”[80] [Disclosure: Gibson Dunn represented one of the defendants in the action.]
E. Copyright Litigation
1. Ninth Circuit Revives Screenwriter’s Pirates of the Caribbean Copyright-Infringement Suit.
On July 22, 2020, the Ninth Circuit revived a screenwriter’s copyright-infringement suit against The Walt Disney Company alleging that the film Pirates of the Caribbean: Curse of the Black Pearl is substantially similar to plaintiff’s screenplay.[81] The district court had granted Disney’s Rule 12(b)(6) motion to dismiss on the grounds that the two works were not substantially similar as a matter of law.[82] In reversing, the Ninth Circuit acknowledged “striking differences between the two works,” but nonetheless found “the selection and arrangement of the similarities between them [to be] more than de minimis” and sufficient to warrant denial of Disney’s motion.[83]
The district court had noted the similarities between the works but concluded that many of the shared elements were “unprotected generic, pirate-movie tropes.”[84] The Ninth Circuit disagreed, explaining “it is difficult to know whether such elements are indeed unprotectible material” at the pleading stage, and further noting that additional evidence—including expert testimony—“would help inform the question of substantial similarity.”[85] According to the court, such additional evidence would be “particularly useful” given that “the blockbuster Pirates of the Caribbean film franchise may itself have shaped what are now considered pirate-movie tropes.”[86] Ultimately, because “[t]he district court erred by failing to compare the original selection and arrangement of the unprotectible elements between the two works,” the Ninth Circuit reversed the dismissal and remanded for further proceedings.[87] And on August 31, 2020, the Ninth Circuit denied Disney’s petition for panel rehearing and for rehearing en banc. Some commentators and practitioners have noted that the ruling appears to represent the latest in a shift away from the Ninth Circuit’s prior precedents that had generally leaned toward upholding dismissals of substantial similarity suits, representing a cautionary ruling for industry defendants.[88]
2. Copyright Act Preempts Lyrics Site Genius’s Claims Against Google.
On August 10, 2020, District Judge Margo Brodie dismissed Genius Media Group Inc.’s suit against Google. Genius Media had alleged in December 2019 that Google “misappropriated lyric transcriptions from its website.”[89] According to its complaint, Genius Media earns revenue by, among other things, licensing its database of high-quality lyrics to companies and generating ad revenue via traffic to its website.[90] In its complaint, Genius Media alleged that when users search for song lyrics, Google’s “Information Box”—which appears above the search results—displays complete song lyrics obtained from Genius Media’s website and thus reduces traffic to that site.[91] Genius Media sued Google for breach of contract, indemnification, unfair competition under New York and California law, and unjust enrichment.[92]
Judge Brodie determined, however, that Genius Media’s state law claims were preempted by the Copyright Act.[93] As an initial matter, Judge Brodie found that the transcribed song lyrics were among the works protected by the Copyright Act, and because the subject of Plaintiff’s claims was the transcribed lyrics, the subject-matter prong of the Copyright Act’s preemption test was met.[94] Judge Brodie additionally determined that Genius Media’s contract claims were “nothing more than claims seeking to enforce the copyright owner’s exclusive rights to protection from unauthorized reproduction of the lyrics and are therefore preempted”; however, Genius Media licensed, but did not own, the relevant copyrights.[95] The court found that Genius Media’s transcriptions are, in essence, derivative works, and held that “the case law is clear that only the original copyright owner has exclusive rights to authorize derivative works.”[96] Accordingly, the Court dismissed Genius Media’s complaint for failure to state a claim.[97]
______________________
[1] United States v. Bolton, No. 20-cv-1580, Order Denying Plaintiff’s Motion for Temporary Restraining Order and Preliminary Injunction (D. D.C. June 20, 2020).
[3] See, e.g., United States v. Bolton, No. 20-cv-1580, Brief of PEN American Center, Inc. as Amicus Curiae in Support of Defendant (D. D.C. June 19, 2020).
[4] United States v. Bolton, No. 20-cv-1580, Order Denying Plaintiff’s Motion for Temporary Restraining Order and Preliminary Injunction, *8 (D. D.C. June 20, 2020).
[6] United States v. Bolton, No. 20-cv-1580, Plaintiff’s Motion for Summary Judgment (D. D.C. July 30, 2020).
[7] Katie Benner, “Justice Dept. Opens Criminal Inquiry Into John Bolton’s Book,” N.Y. Times (Sept. 15, 2020), https://www.nytimes.com/2020/09/15/us/politics/john-bolton-book-criminal-investigation.html.
[8] Charlie Savage, “Government Lawsuit Over John Bolton’s Memoir May Proceed, Judge Rules,” N.Y. Times (Oct. 5, 2020), https://www.nytimes.com/2020/10/01/us/politics/john-bolton-book-proceeds-lawsuit.html.
[9] Trump v. Trump, No. 22020-51585, 2020 WL 4212159 (N.Y. Sup. Ct. July 13, 2020).
[10] Trump v. Trump, No. 22020-51585, Motion for Temporary Restraining Order and Preliminary Injunction (N.Y. Sup. Ct. June 26, 2020).
[11] Trump, 2020 WL 4212159, *14.
[13] Palin v. The New York Times Co., No. 17-cv-4853, Opinion and Order on Motions for Summary Judgment (S.D.N.Y Aug. 28, 2020).
[14] Ted Johnson, “Nick Sandmann, Student at Center of Viral Video, Settles Defamation Lawsuit Against Washington Post,” The Washington Post (July 24, 2020), https://deadline.com/2020/07/nick-sandmann-washington-post-defamation-1202994384/.
[15] Cameron Knight, “Sandmann files 5 more defamation lawsuits against media outlets,” Cincinnati Enquirer (Mar. 3, 2020), https://www.cincinnati.com/story/news/2020/03/03/sandmann-files-5-more-defamation-lawsuits-against-media-outlets/4938142002/.
[16] Lauren Berg, “Jury Says Elon Musk Didn’t Defame with ‘Pedo Guy’ Tweet,” Law360 (Dec. 6, 2019), https://www.law360.com/articles/1226249/jury-says-elon-musk-didn-t-defame-with-pedo-guy-tweet.
[17] Kate Irby, “Judge tells Devin Nunes for 3rd time he can’t sue Twitter over anonymous tweets,” The Fresno Bee (Aug. 14, 2020), https://www.fresnobee.com/news/california/article244958665.html.
[20] Herring Networks, Inc. v. Maddow, No. 19-cv-1713, Order Granting Defendants’ Special Motion to Strike (S.D. Cal. May 22, 2020).
[21] Id. at *3 (internal quotations omitted).
[26] Greene v. Paramount Pictures Corp., 813 F. App’x 728 (2d Cir. 2020).
[27] Id. at 730.
[28] Greene v. Paramount Pictures Corp., 340 F. Supp. 3d 161, 172 (E.D.N.Y. 2018).
[29] Greene, 813 F. App’x at 732.
[30] Id. at 731.
[31] Id.
[32] Id.
[33] Id.
[34] Id. at
[35] Senate Bill S5959D, 2019-2020 Legislative Session of The New York State Senate (last accessed Aug. 26, 2020), https://www.nysenate.gov/legislation/bills/2019/s5959.
[36] Jennifer E. Rothman, New York Reintroduces Right of Publicity Bill with Dueling Versions, Rothman’s Roadmap to the Right of Publicity (May 22, 2019), https://www.rightofpublicityroadmap.com/news-commentary/new-york-reintroduces-right-publicity-bill-dueling-versions.
[37] Senate Bill S5959D, Summary Memo, supra note 35.
[39] Eriq Gardner, Deepfakes Pose Increasing Legal and Ethical Issues for Hollywood, The Hollywood Reporter (July 12, 2019), https://www.hollywoodreporter.com/thr-esq/deepfakes-pose-increasing-legal-ethical-issues-hollywood-1222978.
[40] David Robb, SAG-AFTRA Expects NY Gov. Andrew Cuomo To Sign Law Banning “Deepfake” Porn Face-Swapping, Deadline (July 28, 2020), https://deadline.com/2020/07/deepfakes-sag-aftra-expects-andrew-cuomo-to-sign-law-banning-face-swapping-porn-1202997577/.
[41] Ben Sheffner, New York vs. biopics? The state Legislature is poised to crack down on fact-inspired works of art, New York Daily News (June 18, 2019), https://www.nydailynews.com/opinion/ny-oped-stop-this-threat-to-free-speech-20190618-evesugulizgspk4reelegxiazu-story.html.
[43] Kirkman v. AMC Film Holdings, LLC, No. BC672124, 2020 WL 4364279 (Cal. Super. Ct. July 22, 2020).
[50] Darabont v. AMC Network Entertainment LLC, No. 654328/2013 (N.Y. Sup. Ct.); Darabont v. AMC Network Entertainment LLC, No. 650251/2018 (N.Y. Sup. Ct.).
[51] Judd v. Weinstein, 967 F.3d 952, 959 (9th Cir. 2020).
[53] Skidmore v. Led Zeppelin, 952 F.3d 1051 (9th Cir. 2020) (“Skidmore II”).
[54] Skidmore v. Led Zeppelin, 905 F.3d 1116 (9th Cir. 2018) (“Skidmore I”).
[56] Skidmore II, 952 F.3d at 1079.
[61] Bill Donahue, “Supreme Court Won’t Hear Led Zeppelin Copyright Fight,” Law360 (Oct. 5, 2020), https://www.law360.com/california/articles/1308109/supreme-court-won-t-hear-led-zeppelin-copyright-fight.
[62] Sony Music Entm’t v. Cox Commc’ns, Inc., No. 1:18-CV-950-LO-JFA (E.D. Va. June 2, 2020).
[69] Complaint, Downtown Music Publishing LLC, et al v. Peloton Interactive, Inc., No. 1:19-cv-02426 (S.D.N.Y. Mar. 19, 2019).
[72] Answer to Complaint and Counterclaims Against National Music Publishers’ Association, Inc. and Plaintiff Publishers, Downtown Music Publishing LLC, et al v. Peloton Interactive, Inc., No. 1:19-cv-02426-DLC, at 35–37 (S.D.N.Y. Apr. 30, 2019).
[74] Opinion & Order, Downtown Music Publishing LLC, et al v. Peloton Interactive, Inc., No. 1:19-cv-02426 (S.D.N.Y. Jan. 29, 2020).
[75] Smith v. Graham, No. 19-28, 799 F. App’x 36 (2d Cir. Feb. 3, 2020).
[76] Smith v. Cash Money Records, Inc., 253 F. Supp. 3d 737 (S.D.N.Y. 2017).
[78] Smith v. Graham, No. 19-28, 799 F. App’x. 36, 78 (2d Cir. Feb. 3, 2020).
[81] Alfred v. Walt Disney Co., — F. App’x —, 2020 WL 4207584 (9th Cir. July 22, 2020).
[88] See Bill Donahue, “9th Circ. Making It Harder for Studios To Beat Copyright Suits,” Law360 (July 29, 2020), https://www.law360.com/articles/1296112/9th-circ-making-it-harder-for-studios-to-beat-copyright-suits.
[89] Genius Media Grp. Inc. v. Google LLC, Case No. 1:19-cv-07279-MKB-VMS, Dkt. No. 22 at 1 (E.D.N.Y. Aug. 10, 2020).
[95] Id. at 16; see also id. at 23, 29 (similarly finding the unjust enrichment and state-law unfair-competition claims preempted by the Copyright Act).
[97] Id. at 36 (also denying Genius Media’s motion to remand to state court).
The following Gibson Dunn lawyers assisted in the preparation of this client update: Theodore Boutrous, Scott Edelman, Howard Hogan, Nathaniel Bach, Jonathan Soleimani, Dillon Westfall, Marissa Moshell, Kaylie Springer, Daniel Rubin, Sarah Scharf, and Abi Averill.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or the following leaders and members of the firm’s Media, Entertainment & Technology Practice Group:
Theodore J. Boutrous, Jr. – Co-Chair, Litigation Practice, Los Angeles (+1 213-229-7000, [email protected])
Scott A. Edelman – Co-Chair, Media, Entertainment & Technology Practice, Los Angeles (+1 310-557-8061, [email protected])
Kevin Masuda – Co-Chair, Media, Entertainment & Technology Practice, Los Angeles (+1 213-229-7872, [email protected])
Orin Snyder – Co-Chair, Media, Entertainment & Technology Practice, New York (+1 212-351-2400, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Ari Lanin – Los Angeles (+1 310-552-8581, [email protected])
Benyamin S. Ross – Los Angeles (+1 213-229-7048, [email protected])
Helgi C. Walker – Washington, D.C. (+1 202-887-3599, [email protected])
Nathaniel L. Bach – Los Angeles (+1 213-229-7241,[email protected])
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Los Angeles partner Michael Farhang is the author of “New DOJ priority: targeting pandemic stimulus fraud” [PDF] published by the Daily Journal on October 5, 2020.
The Hong Kong Court of Appeal (Court of Appeal) recently reaffirmed[1], in the context of an application for an examination order of individuals (Respondents) residing in Hong Kong to obtain information which may enable partial satisfaction of a judgment debt under a judgment in proceedings in a foreign court to which neither the Respondents nor the companies of which they are officers were parties, that pre-trial discovery against non-party witness is not permitted, save within the limited scope of Norwich Pharmacal discovery.
1. Background Leading to the Application in Hong Kong
The applicants for the Hong Kong examination order (Applicants) obtained a judgment for US$100,738,980 (Judgment Debt) in the United States District Court, Western District of Washington at Seattle (Federal Court) against a number of judgment debtors.
The Applicants’ case was that based on the unaudited balance sheet of one of the judgment debtors (Judgment Debtor), there were receivables owed by some third parties to the Judgment Debtor, being US$18.9 million by an exempted limited partnership registered in Cayman Islands, and US$4 million by a company incorporated in the British Virgin Islands (respectively, the Two Sums and the Third Parties).
The Applicants were appointed by the King County Superior Court, State of Washington (State Court) as collecting agent to collect the receivables of the Judgment Debtor, including the Two Sums. Such receivables were to be applied to satisfy the Judgment Debt. The State Court subsequently clarified that it did not have jurisdiction over the Third Parties (as they had no place of business in the State of Washington) and it did not adjudicate on the issue of whether the Two Sums were owed by them to the Judgment Debtor, and held that the collection orders only placed the Applicants in the shoes of the Judgment Debtor for collection purposes and such orders could be made even though the State Court had no jurisdiction over the Third Parties.
Of importance to note is that the collection orders were not garnishee orders, and there is no evidence to suggest that the Federal Court and the State Court had the requisite personal jurisdiction over the Third Parties for garnishee proceedings. Further, the relevant transaction agreements between the Judgment Debtor and the Third Parties respectively had an exclusive jurisdiction clause, which provided that the agreements were governed by the laws in Hong Kong and subject to resolution solely in the Hong Kong Courts.
The Two Sums were disputed by the Third Parties, and their case was that it was the Judgment Debtor which owed them monies instead.
The Respondents, being the subjects of the examination order, are officers of the Third Parties, who reside in Hong Kong.
2. Procedural History in the Hong Kong Courts
The Federal Court issued two Letters of Request for an examination of the Respondents, the purpose of which was to allow the Applicants to obtain information regarding the Two Sums that may enable them to collect the monies owed to the Judgment Debtor which could be utilised to satisfy the Judgment Debt.
An ex parte application by way of an Originating Summons supported by the two Letters of Request to examine the Respondents were made by the Applicants and Master Lai of the Court of First Instance (CFI) granted an examination order (Examination Order).
The Respondents applied to set aside the Examination Order and/or to strike out the Applicants’ ex parte Originating Summons. Both applications were allowed by Recorder Yvonne Cheng SC (Judge) of the CFI.
The Applicants appealed against the decision of the Judge, which decision was upheld by the Court of Appeal.
3. Requirements under the Evidence Ordinance (Cap. 8) (Ordinance) in the Context of Evidence for Civil Proceedings in Other Jurisdictions
Whilst both sections 75(b) and 76(3) of the Ordinance are relevant in the circumstances[2], the Court of Appeal upheld the Judge’s decision based on section 76(3) alone. The analysis under paragraph 3.2 below on section 75(b) is included for completeness.
3.1 Section 76(3) – Pre-Trial Discovery Against Non-Party Witness Prohibited
Section 76 provides for the power of the Court of First Instance to give effect to an application for assistance in obtaining evidence for civil proceedings in foreign courts. Section 76(3) states that:
An order under this section shall not require any particular steps to be taken unless they are steps which can be required to be taken by way of obtaining evidence for the purposes of civil proceedings in the court making the order (whether or not proceedings of the same description as those to which the application for the order relates)…” (emphasis added)
The Judge held that the proposed examination was for pre-trial discovery against non-party witnesses, which is not permitted under Hong Kong law and prohibited by section 76(3), since the allegations of fact relied upon by the Applicants (in short, the Third Parties owed monies to the Judgment Debtor) were not live issues before and to be resolved by the Federal Court where the main action was concluded, and enforcement proceedings (i.e. garnishee proceedings) in which such allegations could be raised had not been instituted. As to the Applicants’ alternative case that after the examination of the Respondents they would “plot a course for collection depending on the evidence so obtained”, the judge held that the proposed examination was a fishing exercise.
The Court of Appeal agreed with the Judge’s decision, and made, inter alia, the following remarks:
- Hong Kong has adopted the common law position that there is no pre-trial discovery against non-party witnesses other than those falling within the limited scope of Norwich Pharmacal discovery (i.e. discovery against third parties who got innocently mixed up in the wrongdoings of others);
- whether the assistance request falls foul of section 76(3) on account of fishing must be a matter for the judge in Hong Kong by reference to Hong Kong laws rather than US laws under which the permissible scope of discovery is wider. Whilst examination which is investigatory in nature (in contrast to eliciting admissible evidence) is allowed under US laws, it is not permitted under Hong Kong laws; and
- obtaining information from a non-party witness by way of post-judgment discovery in aid of execution, whilst permissible under US laws, is not a permissible procedure in Hong Kong, noting that if a judgment creditor has sufficient ground to support the application for a garnishee order in respect of a debt due to a judgment debtor, the judgment creditor has to commence garnishee proceedings first before he can obtain directions for determination of the liability of the garnishee (including directions for discovery as necessary)[3].
3.2 Section 75(b) – Obtaining Evidence for the Purposes of Civil Proceedings
Section 75 provides for the requirements to be fulfilled in an application for assistance. Section 75(b) provides that:
“Where an application is made to the Court of First Instance for an order for evidence to be obtained in Hong Kong and the court is satisfied that the evidence to which the application relates is to be obtained for the purposes of civil proceedings which either have been instituted before the requesting court or whose institution before that court is contemplated, the Court of First Instance shall have the powers conferred on it by this part.” (emphasis added)
The central issue under this section is therefore whether evidence is to be obtained for the purposes of civil proceedings, instituted or contemplated, before the requesting court.
The Judge, without the benefit of expert evidence on US law from the Applicants which was set out in an affirmation[4], ruled that the requirement was not satisfied because the evidence was not obtained for the purposes of civil proceedings which either have been instituted before the Federal Court or whose institution was contemplated.
The Judge rejected that the very application for discovery leading to the Federal Court’s request for evidence could constitute civil proceedings within the meaning of section 75(b) as a matter of construction, since it would render the section redundant. Further, since there was no evidence that the Applicants could establish the Federal Court’s jurisdiction over the Third Parties, it could not be said that proceedings against the Third Parties in the said court for enforcement of the judgment were contemplated.
The Court of Appeal, however, left the issue open, since it disagreed with the Judge on the admissibility of the Applicants’ expert evidence on US law.[5]
Notwithstanding such disagreement and that it was prepared to assume that under US law, the obtaining of information to facilitate the “plotting of the next course of action” would be regarded as obtaining evidence for use in the Federal Court proceedings, the Court of Appeal took the view that it also had to be established that the relevant proceedings were proceedings in a civil or commercial manner in the requested jurisdiction, i.e. Hong Kong court, in addition to the requesting jurisdiction.
In this regard, the Court of Appeal considered that the mere facilitation of the Applicants to act as collection agent did not qualify as civil proceedings in Hong Kong. Whilst discovery procedure is a form of civil proceedings in Hong Kong, such discovery would not be permitted against non-party witnesses, other than the limited form of Norwich Pharmacal discovery.
4. Conclusion
It is clear from the decisions of the Judge and the Court of Appeal that to obtain an order for assistance in obtaining evidence for civil proceedings in a foreign court, such obtaining of evidence must be permissible under the laws of Hong Kong. It is not sufficient that it is only permissible under the laws of the requesting jurisdiction (which may be implied by the Letter of Request issued by the foreign court). On this note, pre-action discovery against non-party witness is not permitted in Hong Kong save for Norwich Pharmacal discovery.
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[1] Re a civil matter now pending in United States District Court for the Western District of Washington at Seattle under No 2:13-CV-1034 MJP ([2020] HKCA 766). The presiding judges were Hon Lam VP, Chu JA and G Lam J. A copy of the judgement of the Court of Appeal is available here. The judgment of the Court of First Instance ([2019] HKCFI 1738) is available here.
[2] The Respondents also argued that (1) there were material non-disclosures on the Applicants’ part when they took out the ex parte application for the Examination Order and (2) the Examination Order contravened section 6 of the Protection of Trading Interests Ordinance (Cap. 471). However, these were not the focus of the Judge or the Court of Appeal and accordingly, are not the focus of this alert.
[3] The Applicants did not commence garnishee proceedings against the Third Parties since the Federal Court did not appear to have personal jurisdiction over the Third Parties and they were also unable to say that the Two Sums were actually due from these entities to the Judgment Debtor. Further, the Applicants also faced the difficulty of the exclusive choice of forum clauses in the agreements governing the transactions between the Judgment Debtor and the Third Parties. However, these issues were not put before the Federal Court in the application for the Letters of Request and accordingly, the Federal Court had no opportunity to address it. The Court of Appeal remarked that if the Applicants wished to rely on the use of evidence of the Respondents in garnishee proceedings against the Third Parties, they should have at least alluded to such basis in their motion for application for the Letters of Request.
[4] The Judge ruled that such evidence was not admissible on the basis that there was no expert declaration in accordance with Order 38 Rule 37C of the Rules of the High Court (RHC). The expert for the Applicants, being the general counsel of the Applicants (who was heavily engaged in the present dispute), felt that he was unable to give an expert declaration.
[5] The Court of Appeal was inclined to take the view that the prohibition against admissibility for lack of expert declaration under Order 38 Rule 37C of the RHC does not apply automatically to expert evidence set out in affidavits or affirmations adduced under Order 38 Rule 2(3) (as opposed to expert reports filed for trial pursuant to directions given under Order 38 Rule 6 regarding proceedings commenced by, inter alia, Originating Summons), being an exception under Order 38 Rule 36(2) .
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, or the authors and the following lawyers in the Litigation Practice Group of the firm in Hong Kong:
Brian Gilchrist (+852 2214 3820, [email protected])
Elaine Chen (+852 2214 3821, [email protected])
Emily Chan (+852 2214 3825, [email protected])
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Washington, D.C. partners Howard Hogan and Lucas Townsend and associate Max Schulman are the authors of “Where Does Judge Barrett Fall on IP Issues?” [PDF], published by Bloomberg Law on September 30, 2020.
The False Claims Act (FCA) is well-known as one of the most powerful tools in the government’s arsenal to combat fraud, waste and abuse anywhere government funds are implicated. The U.S. Department of Justice has issued statements and guidance indicating some new thinking in the Trump Administration about its approach to FCA cases that may signal a meaningful shift in its enforcement efforts. But at the same time, newly filed FCA cases remain at historical peak levels and the DOJ has enjoyed ten straight years of nearly $3 billion or more in annual FCA recoveries. The government has also made clear that it intends vigorously to pursue any fraud, waste and abuse in connection with COVID-related stimulus funds. As much as ever, any company that deals in government funds—especially in the financial services sector—needs to stay abreast of how the government and private whistleblowers alike are wielding this tool, and how they can prepare and defend themselves.
Please join us to discuss developments in the FCA, including:
- The latest trends in FCA enforcement actions and associated litigation affecting the financial services sector;
- Updates on the Trump Administration’s approach to FCA enforcement, including developments with recent DOJ Civil Division personnel changes and DOJ’s use of its statutory dismissal authority;
- The coming surge of COVID-related FCA enforcement actions; and
- The latest developments in FCA case law, including developments in particular FCA legal theories affecting your industry and the continued evolution of how lower courts are interpreting the Supreme Court’s Escobar decision.
View Slides (PDF)
PANELISTS:
Stuart F. Delery is a partner in the Washington, D.C. office. He represents corporations and individuals in high-stakes litigation and investigations that involve the federal government across the spectrum of regulatory litigation and enforcement. Previously, as the Acting Associate Attorney General of the United States (the third-ranking position at the Department of Justice) and as Assistant Attorney General for the Civil Division, he supervised the DOJ’s enforcement efforts under the FCA, FIRREA and the Food, Drug and Cosmetic Act.
F. Joseph Warin is a partner in the Washington, D.C. office, chair of the office’s Litigation Department, and co-chair of the firm’s White Collar Defense and Investigations practice group. His practice focuses on complex civil litigation, white collar crime, and regulatory and securities enforcement – including Foreign Corrupt Practices Act investigations, False Claims Act cases, special committee representations, compliance counseling and class action civil litigation.
James Zelenay is a partner in the Los Angeles office where he practices in the firm’s Litigation Department. He is experienced in defending clients involved in white collar investigations, assisting clients in responding to government subpoenas, and in government civil fraud litigation. He also has substantial experience with the federal and state False Claims Acts and whistleblower litigation, in which he has represented a breadth of industries and clients, and has written extensively on the False Claims Act.
Munich partner Michael Walther and associate Richard Roeder are the co-authors of the “Germany” [PDF] chapter of International Comparative Legal Guides’ Sanctions 2021, 2nd Edition published in October 2020.
Gibson Dunn’s Supreme Court Round-Up provides the questions presented in cases that the Court will hear in the upcoming Term, summaries of the Court’s opinions when released, and other key developments on the Court’s docket. To date, the Court has granted certiorari in 34 cases and set 2 original-jurisdiction cases for argument for the 2020 Term, and Gibson Dunn is counsel or co-counsel for a party in 3 of those cases.
Spearheaded by former Solicitor General Theodore B. Olson, the Supreme Court Round-Up keeps clients apprised of the Court’s most recent actions. The Round-Up previews cases scheduled for argument, tracks the actions of the Office of the Solicitor General, and recaps recent opinions. The Round-Up provides a concise, substantive analysis of the Court’s actions. Its easy-to-use format allows the reader to identify what is on the Court’s docket at any given time, and to see what issues the Court will be taking up next. The Round-Up is the ideal resource for busy practitioners seeking an in-depth, timely, and objective report on the Court’s actions.
To view the Round-Up, click here.
Gibson Dunn has a longstanding, high-profile presence before the Supreme Court of the United States, appearing numerous times in the past decade in a variety of cases. During the Supreme Court’s 5 most recent Terms, 9 different Gibson Dunn partners have presented oral argument; the firm has argued a total of 16 cases in the Supreme Court during that period, including closely watched cases with far-reaching significance in separation of powers, administrative law, intellectual property, and federalism. Moreover, although the grant rate for petitions for certiorari is below 1%, Gibson Dunn’s petitions have captured the Court’s attention: Gibson Dunn has persuaded the Court to grant 31 petitions for certiorari since 2006.
* * * *
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following attorneys in the firm’s Washington, D.C. office, or any member of the Appellate and Constitutional Law Practice Group.
Theodore B. Olson (+1 202.955.8500, [email protected])
Amir C. Tayrani (+1 202.887.3692, [email protected])
Jacob T. Spencer (+1 202.887.3792, [email protected])
Joshua M. Wesneski (+1 202.887.3598, [email protected])
© 2020 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 widespread economic uncertainty caused by COVID-19 poses distinct challenges for buyers and sellers seeking to identify M&A opportunities, as companies evaluate the impact of the pandemic on their businesses to date, and seek to predict its future impact. Continued volatility in the financial markets and the lack of visibility into how the pandemic will affect the global economy in the near or longer term, as well as the pace and scope of economic recovery, introduce elements of conjecture into the valuation process. Securing financing for a transaction is also likely to be difficult, as traditional credit providers may be reluctant to lend, particularly to borrowers in sectors that have been more severely impacted by the crisis.
Buyers and sellers struggling with these challenges may find that stock-for-stock mergers offer an attractive option. Transactions based on stock consideration can enable the parties to sidestep some of the difficulties involved in agreeing on a cash price for a target, by instead focusing on the target’s and the buyer’s relative valuations. In addition, using stock as consideration allows buyers to conserve cash and increase closing certainty by eliminating the need to obtain financing to complete a transaction.
The extent and duration of COVID-19’s impact on M&A activity, and whether companies will trend toward stock-for-stock mergers in lieu of cash acquisitions, remains unclear. However, recent stock-for-stock deal announcements such as Analog Devices’s $21 billion acquisition of Maxim Integrated Products, Just Eat Takeaway’s $7.3 billion acquisition of Grubhub, Uber’s $2.65 billion acquisition of Postmates, Chevron’s $5 billion acquisition of Noble Energy, Clarivate plc’s $6.8 billion acquisition of CPA Global and Builders FirstSource’s $2.46 billion acquisition of BMC Stock Holdings suggest that companies may be more inclined to opt for stock-for-stock mergers against the backdrop of continued valuation and financing risks.
While stock-for-stock mergers may help parties address certain issues posed by the current climate, these transactions also raise concerns that do not arise in cash acquisitions. In particular, a company contemplating a stock-for-stock merger should consider the following:
Valuation issues. Setting the exchange ratio in a stock-for-stock merger requires the parties to determine their relative valuations, which, at first blush may seem easier than agreeing on a direct value for the target in a cash merger. However, stock-for-stock mergers do not eliminate difficult valuation issues, particularly if the parties are in different industries or at different stages of their development. The pandemic is likely to make valuation issues even more challenging if the parties have been impacted in dissimilar ways or levels of severity by the effects of COVID-19, or if the parties have different outlooks regarding the pace and scope of their respective recoveries.
The parties must also determine if a control premium is appropriate, and the size of any premium. A target will generally seek a premium to its current market value for a sale of control, and the demand for a premium may become more forceful if the target believes that its shares are undervalued due to general market or industry conditions. The buyer may resist this demand, arguing that the shares are not undervalued, and that in a stock-for-stock deal, unlike a cash deal, the target’s stockholders will have an ongoing equity stake in the combined company enabling them to benefit from any merger gains. In most cases, however, the buyer accepts the target’s arguments and agrees to build a premium into the exchange ratio.
Not every stock-for-stock transaction will include a premium, however. In a deal that the parties characterize as a merger of equals, the parties may agree that a premium will not be paid because neither party is acquiring control. They reason that the two companies’ respective stockholders should benefit pro rata from gains realized by the combined company, and set the exchange ratio so that it simply reflects the companies’ relative valuations.
Decisions regarding whether a premium is appropriate and the size of the premium will be carefully scrutinized by stockholders, activists and plaintiffs’ lawyers. As a result, the parties should be prepared to defend their deal based on the companies’ relative valuations, the prospects of the post-merger business and applicable factors impacting industry or stock market conditions generally.
Fixed vs floating exchange ratios. Stock-for-stock deals are structured using either a fixed exchange ratio or a floating exchange ratio. Fixed exchange ratios are based on the relative market values of the buyer and the target; floating exchange ratios are designed to ensure that target stockholders receive buyer shares with a specified dollar value. Floating exchange ratio deals do not present the same advantages as fixed exchange ratio deals in today’s environment. The parties cannot simply assess relative market values, but instead must determine a fixed value per target share, which is a difficult exercise when markets are volatile and forecasting future performance is difficult. But if the target successfully demands that its stockholders receive a specified price, the buyer may acquiesce, reasoning that a floating exchange ratio deal remains attractive because it can avoid using cash, reduce financing risk and increase closing certainty.
Collars and walk-away rights. Using stock consideration poses certain risks. When the exchange ratio floats, the buyer takes the risk that its stock price falls between signing and closing, forcing it to issue more shares at closing and diluting its existing stockholders; when the exchange ratio is fixed, the buyer takes the risk that its stock price rises between signing and closing and it overpays for the target. The target’s risks run in the opposite direction: it takes the risk that the buyer’s stock price falls between signing and closing when the exchange ratio is fixed, or that the buyer’s stock price rises between signing and closing when the exchange ratio floats, and, in each case, that its stockholders feel they have received insufficient value.
Pandemic-related market volatility and uncertainty about the pace of economic recovery may make parties more sensitive to the risks of using stock consideration. To address these risks, parties to a stock-for-stock merger may consider using mechanisms that were not commonly used before the pandemic: collars and/or walk-away rights based on stock price.
Collars provide a hedge against significant fluctuations in the buyer’s stock price between signing and closing by establishing upper and lower limits on the number of buyer shares and/or the value of the consideration that will be required to be delivered to target stockholders. A collar assures each party that the merger consideration and dilutive effect of the transaction will remain within negotiated parameters.
To further mitigate risk, the buyer and target may include a “walk-away” right for one or both of the parties if the value of the buyer’s stock drops below a designated threshold (walk-away rights are rarely triggered by increases in the buyer’s stock price). This right may be structured as either a closing condition or termination right (with or without associated termination fees). If the walk-away provisions are used together with a collar, the walk-away price may be set at, below or above the level of the collar’s “floor.” Like collars, the parties have broad flexibility to craft the walk-away provisions to achieve their desired results. For example, if the exchange ratio is fixed, the agreement may provide that if the buyer’s stock price falls below the negotiated threshold: the buyer may elect to “top-up” the consideration either through cash or shares, otherwise, the target can walk away, or that the target may choose to either walk away or require the buyer to issue more shares by flipping to a floating exchange ratio.[1]
Walk-away rights have not been used frequently in the past, in part, because a board of directors considering whether or not to exercise a walk-away right is in a difficult position. Issues a board must resolve include: should the board undertake a new analysis of the fairness of the transaction, including obtaining an updated fairness opinion? If the company’s stockholders have already approved the merger, how should this affect the answers to these questions? Board decisions regarding walk-away rights are likely to be subject to the same scrutiny, second-guessing and challenges as the board’s decision to approve the merger. If the board chooses not to exercise a walk-away right, and the merger ultimately turns out badly for the company’s stockholders, will the directors be sued? If the board does exercise a walk-away right and, in hindsight, it appears that the merger would have benefitted the company’s stockholders, will the directors be sued?
As noted above, collars and walk-away rights were not common pre-pandemic, and we have not noted a significant increase in their use in recent months. However, parties may consider using these somewhat unusual features in response to these highly unusual times.
Fiduciary duty issues for boards. The COVID-19 pandemic may place additional pressure on a board’s decision to approve a business combination (or to exercise a walk-away right). In Delaware, a stock-for-stock merger in which no single person or “group” will control the combined company is generally not subject to the value maximization imperative of a sale of control or to enhanced judicial scrutiny under Revlon Inc. v. MacAndrews & Forbes Holdings, Inc. If the target does not have a controlling stockholder, and a majority of its directors are disinterested, the decision to merge should be entitled to the protection of the business judgement rule. As a result, the directors should have broad discretion to approve a stock-for-stock merger that the board believes in good faith is in the best interests of the company and its stockholders.
Even if Revlon duties do not apply, the target board is likely to feel significant pressure to make the best deal possible under the circumstances. The board’s decision to combine is highly likely to be second-guessed under any circumstances, and even more so if the transaction is undertaken during a period of perceived overall economic risk. The board must assess whether it makes sense to combine at this time despite the current difficulty in projecting the companies’ respective future recovery, growth and prospects. Target stockholders may criticize the board for selling too low if the buyer is seen as taking advantage of the target’s falling stock price. If the company believes it has a solid plan for recovery, it must consider whether the company will be better off on a standalone basis, or if the combination will bolster its recovery. Before approving the merger, the board should be comfortable that it can defend its decision that the merger is in the company’s best interests.
Governance issues. Because target stockholders will have a stake in the combined company post-closing, the parties to a stock-for-stock merger are more likely to be sensitive to governance and social issues than they would be in a cash merger. The relevant issues include, among others, the composition of the combined company board and senior management team and the name of the combined company. Negotiations of these issues can be tricky, particularly in a deal that the parties consider a merger of equals, where there is likely to be even more intense focus on who serves in management roles at the combined company. The current economic crisis may raise the stakes riding on the outcome of the governance negotiations, particularly if the parties’ respective management teams have different strategies for dealing with the pandemic and its consequences. Enforcing post-closing agreements on these matters is also difficult. To address post-closing enforcement concerns, the parties may consider expressly including their agreement on governance matters in the combined company’s charter, to be effective as of the closing, and requiring supermajority board and/or stockholder approvals to amend the relevant charter provisions.
COVID-related deal terms. Deal negotiators should consider whether and how the merger agreement terms, such as representations, MAE definitions and post-signing covenants, should be revised as a result of the pandemic. Please refer to Gibson Dunn’s Client Alert entitled “M&A Amid the Coronavirus (COVID-19) Crisis: A Checklist”[2] for a detailed discussion of these issues. Most stock-for-stock transactions will contain certain reciprocal provisions, including representations and interim operating covenants. In considering whether to make COVID-specific revisions to these provisions, a party should either be prepared to accept the same terms for itself, or justify why reciprocity is not appropriate. Negotiations on these points may also be complicated by situations where the parties’ operating results and/or stock prices have not been similarly impacted by the crisis.
Diligence. The target’s diligence of the buyer in a cash merger is typically limited to assessing the buyer’s ability to perform its obligations under the transaction agreements. However, because the target’s stockholders will receive the buyer’s stock in a stock-for-stock merger, the target is more likely to comprehensively diligence the buyer. The mutual diligence effort in a stock-for-stock merger may lengthen the timeline, and increase the complexity and expense of the transaction.
Buyer Stockholder Approval. The buyer’s stockholders may be required to approve certain stock-for-stock mergers, e.g., if the buyer has to amend its charter to authorize the issuance of additional securities to be issued in the merger, if the buyer is one of the merging parties or if required by securities exchange listing rules because the transaction represents a change of control of the buyer or requires the issuance of securities representing twenty percent or more of the buyer’s outstanding common stock or voting power. The requirement to obtain buyer stockholder approval may reduce closing certainty, lengthen the timeline, and increase the complexity and expense of the transaction.
Mixed cash-stock deals. Some parties may consider mergers in which the consideration consists of a mix of cash and stock. While the use of stock may make it easier to finance and close the transaction, the use of stock will also introduce the valuation and other issues discussed in this Client Alert.
Scrutiny. As noted above, the parties to a business combination transaction undertaken in the current environment should expect the deal terms and business rationale to be placed under a microscope. As a result of the uneven M&A activity during the pandemic, every new deal that is announced receives significant attention. The parties should anticipate close scrutiny of the transaction, particularly by stockholder activists and plaintiffs’ firms, and develop their deal announcement and communications plans accordingly.
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[1] The March 2020 merger agreement between Provident Financial Services, Inc. and SB One Bancorp provides a current example of a walk-away right. The agreement provides for a fixed exchange ratio. However, SB One may terminate the agreement if the value of Provident Financial’s stock drops (i) by over 20% between signing and the date the last regulatory approval for the transactions is obtained and (ii) by more than the drop in the average of the NASDAQ Bank Index closing prices over the same period less 20%. If SB One exercises this termination right, Provident Financial has the option to increase the merger consideration, in cash, by the amount necessary to cause either of these conditions not to be met. As a result, SB One stockholders are assured that the dollar value of the merger consideration they receive will not fall below a minimum amount.
[2] Originally published March 18, 2020 and available at https://www.gibsondunn.com/ma-amid-the-corona-virus-covid-19-crisis-a-checklist/; updated version available at https://advance.lexis.com/api/permalink/930c7ac9-3d37-4ff9-82dd-39e19a994dce/?context=1000522.
Gibson Dunn’s lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 outbreak. For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team.
Gibson Dunn’s lawyers regularly counsel strategic and private equity buyers and sellers on the legal issues raised by this pandemic in the M&A context. Please also feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Mergers and Acquisitions or Private Equity practice groups, or the authors:
Stephen I. Glover – Washington, D.C. (+1 202-955-8593, [email protected])
Eduardo Gallardo – New York, New York (+1 212.351.3847, [email protected])
Alisa Babitz – Washington, D.C. (+1 202-887-3720, [email protected])
Marina Szteinbok – New York, New York (+1 212-351-4075, [email protected])
Ann-Marie Harrelson – Washington, D.C. (+1 202-887-3683, [email protected])
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Deferred Prosecution Agreements (DPA) and Non-Prosecution Agreements (NPA) have become a fixture in the white collar enforcement landscape, and the way that both companies and enforcement agencies think about them continues to evolve. NPAs and DPAs remain attractive alternatives to guilty pleas or trial, but what drives the analysis between these outcomes? As DOJ offers the carrot of declination in exchange for self-disclosure, how certain is the outcome and is the possibility of a declination worth the cost and risk of coming forward? And when a declination is not achievable, is the balance shifting between NPAs and DPAs? This discussion will build upon last year’s foundational webcast regarding these agreements and discuss current trends, potential pitfalls, and important considerations in bringing a government investigation to closure.
Topics:
- Varieties of resolution structures
- Trends and statistics regarding the use of NPAs and DPAs from the past two decades
- Key terms of NPAs and DPAs and where you can negotiate
- Analysis of some of the factors underlying declination, NPA, and DPA outcomes
- Cross-border considerations and post-resolution pitfalls, including an update on developments in corporate compliance monitorships
View Slides (PDF)
PANELISTS:
Stephanie L. Brooker is co-chair of Gibson Dunn’s Financial Institutions Practice Group and member of the White Collar Group. She is the former Director of the Enforcement Division at FinCEN, and previously served as the Chief of the Asset Forfeiture and Money Laundering Section in the U.S. Attorney’s Office for the District of Columbia and as a DOJ trial attorney for several years. Ms. Brooker represents multi-national companies and individuals in internal corporate investigations and DOJ, SEC, and other government agency enforcement actions involving, for example, matters involving BSA/AML; sanctions; anti-corruption; securities, tax, and wire fraud; whistleblower complaints; and “me-too” issues. Her practice also includes BSA/AML compliance counseling and due diligence and significant criminal and civil asset forfeiture matters. Ms. Brooker has been named a Global Investigations Review “Top 100 Women in Investigations” and National Law Journal White Collar Trailblazer.
Richard W. Grime is co-chair of Gibson Dunn’s Securities Enforcement Practice Group. Mr. Grime’s practice focuses on representing companies and individuals in corruption, accounting fraud, and securities enforcement matters before the SEC and the DOJ. Prior to joining the firm, Mr. Grime was Assistant Director in the Division of Enforcement at the SEC, where he supervised the filing of over 70 enforcement actions covering a wide range of the Commission’s activities, including the first FCPA case involving SEC penalties for violations of a prior Commission order, numerous financial fraud cases, and multiple insider trading and Ponzi-scheme enforcement actions.
Patrick F. Stokes is a partner in Gibson Dunn’s Washington, D.C. office, where his practice focuses on internal corporate investigations and enforcement actions regarding corruption, securities fraud, and financial institutions fraud. Prior to joining the firm, Mr. Stokes headed the DOJ’s FCPA Unit, managing the FCPA enforcement program and all criminal FCPA matters throughout the United States covering every significant business sector. Previously, he served as Co-Chief of the DOJ’s Securities and Financial Fraud Unit.
F. Joseph Warin is co-chair of Gibson Dunn’s global White Collar Defense and Investigations Practice Group, and chair of the Washington, D.C. office’s nearly 200-person Litigation Department. Mr. Warin’s group is repeatedly recognized by Global Investigations Review as the leading global investigations law firm in the world. Mr. Warin is a former Assistant United States Attorney in Washington, D.C. He is ranked annually in the top-tier by Chambers USA, Chambers Global, and Chambers Latin America for his FCPA, fraud and corporate investigations expertise. Among numerous accolades, he has been recognized by Benchmark Litigation as a U.S. White Collar Crime Litigator “Star” for ten consecutive years (2011–2020).
Courtney M. Brown is a senior associate in the Washington, D.C. office of Gibson, Dunn & Crutcher, where she practices primarily in the areas of white collar criminal defense and corporate compliance. Ms. Brown has experience representing and advising multinational corporate clients and boards of directors in internal and government investigations on a wide range of topics, including anti-corruption, anti-money laundering, sanctions, securities, tax, and “me too” matters.
On September 23, 2020, the Securities and Exchange Commission (the “Commission”) voted to adopt amendments (the “Amended Rules”) (available here)[1] to key aspects of the Commission’s shareholder proposal rule. The Amended Rules:
- modestly increase the current stock ownership threshold to submit a shareholder proposal for shareholders who have not held a company’s stock for at least three years;
- expand the procedural requirements on the submission of proposals, including changes to limit abuse of the process when non-shareholders submit a “proposal by proxy;”
- change the rules to apply the one-proposal rule to each person instead of each shareholder, thereby limiting representatives to one proposal per meeting; and
- increase the levels of shareholder support a shareholder proposal must receive in order to be eligible for resubmission at future meetings.
While the Amended Rules will be effective 60 days after publication in the Federal Register, they only apply to shareholder proposals submitted for an annual or special meeting held on or after January 1, 2022, and thus will not affect the upcoming proxy season.
The Amended Rules represent the first substantive amendments to the shareholder proposal resubmission and stock ownership thresholds since 1954 and 1998, respectively. The Amended Rules are substantially the same as the amendments proposed by the Commission in November 2019 (the “Proposed Rules”) (available here), but reflect amendments made in response to concerns raised on the Proposed Rules. Among other changes, the Amended Rules include a transition period ensuring that any shareholder who currently satisfies the ownership eligibility rules may continue to do so and do not include the “momentum requirement,” which would have permitted exclusion of a previously voted on proposal if the level of voting support had declined significantly in the most recent vote.[2]
The Amended Rules were approved by a 3-2 vote, with the majority viewing the Amended Rules as “reasonable and limited”[3] steps to “adjust these rules to reflect our current markets.”[4] As Chairman Jay Clayton explained, the Amended Rules are intended as a “restructuring and recalibrating [of] the current shareholder ownership threshold for initial submissions as well the shareholder support thresholds for resubmissions” in light of “the many changes in our markets over the past 30 plus years, as well as [the Commission’s] experience with the shareholder proposal process under Rule 14a-8.”[5] At the same time, the Amended Rules reflect that shareholder proposals impose costs on companies and their shareholders, and that some shareholder proponents have effectively outsourced their involvement to representatives. As explained by Commissioner Roisman, “The amendments … aim to strike a better balance by ensuring that a shareholder who submits a proposal to a public company has interests that are more likely to be aligned with the other shareholders who bear the expense.” In contrast, Commissioners Crenshaw and Lee expressed concern that the Amended Rules will suppress the rights of shareholders, undermine environmental, social and governance (ESG) initiatives and dial back shareholder oversight of management.
_____________________
[1] For a comparison of the Amended Rules with the current rules, see Attachment A to this client alert.
[2] The Proposed Rules included a “momentum requirement” that would have allowed companies to exclude shareholder proposals submitted three or more times in the preceding five years if they received less than 50% of the vote and support declined by 10% or more compared to the immediately preceding shareholder vote on the proposal.
[3] Commissioner Hester M. Peirce, “Statement at Open Meeting on Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8” (Sept. 23, 2020), available at https://www.sec.gov/news/public-statement/peirce-14a-8-09232020.
[4] Commissioner Elad L. Roisman, “Statement on Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8” (Sept. 23, 2020), available at https://www.sec.gov/news/public-statement/roisman-14a8-2020-09-23.
[5] Chairman Jay Clayton, “Statement of Chairman Jay Clayton on Proposals to Enhance the Accuracy, Transparency and Effectiveness of Our Proxy Voting System” (Sept. 23, 2020), available at https://www.sec.gov/news/public-statement/clayton-shareholder-proposal-2020-09-23.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. For additional information, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm’s Securities Regulation and Corporate Governance practice group, or the following authors:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Brian J. Lane – Washington, D.C. (+1 202-887-3646, [email protected])
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, [email protected])
Michael A. Titera – Orange County (+1 949-451-4365, [email protected])
Lori Zyskowski – New York (+1 212-351-2309, [email protected])
Aaron Briggs – San Francisco (415-393-8297, [email protected])
Courtney Haseley – Washington, D.C. (+1 202-955-8213, [email protected])
Geoffrey Walter – Washington, D.C. (+1 202-887-3749, [email protected])
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
OVERVIEW
On September 22, 2020, President Trump issued an Executive Order “On Combating Race and Sex Stereotyping” (“the EO”), which prohibits government contractors from including certain so-called “divisive concepts” in employee workplace training.[1] The EO aims to curb workplace training materials “teaching that men and members of certain races, as well as our most venerable institutions, are inherently sexist and racist.” The EO follows on the heels of a September 4 Office of Management and Budget (“OMB”) memorandum, which instructed federal agencies to identify contracts or agency funds being used for such trainings as a first step toward ensuring that agencies “cease and desist from using taxpayer dollars” to fund the targeted trainings.[2]
To accomplish its goal of ending the targeted trainings, the EO requires that federal contracts entered into 60 days after the EO’s September 22 effective date (i.e., contracts entered into on or after November 21, 2020) prohibit contractors from using workplace training that “inculcates . . . any form of race or sex stereotyping or any form of race or sex scapegoating.” The EO defines “race or sex stereotyping” as “ascribing character traits, values, moral and ethical codes, privileges, status, or beliefs to a race or sex, or to an individual because of his or her race or sex.” And the phrase “race or sex scapegoating” is defined to mean “assigning fault, blame, or bias to a race or sex, or to members of a race or sex because of their race or sex.”
The EO further states that federal contractor workplace trainings may not “inculcate” what are described as “divisive concepts,” which are defined to include that:
- one race or sex is inherently superior to another race or sex;
- an individual, by virtue of his or her race or sex, is inherently racist, sexist, or oppressive, whether consciously or unconsciously;
- an individual should be discriminated against or receive adverse treatment solely or partly because of his or her race or sex;
- members of one race or sex cannot and should not attempt to treat others without respect to race or sex;
- an individual’s moral character is necessarily determined by his or her race or sex;
- an individual, by virtue of his or her race or sex, bears responsibility for actions committed in the past by other members of the same race or sex;
- any individual should feel discomfort, guilt, anguish, or any other form of psychological distress on account of his or her race or sex; or
- meritocracy or traits such as a hard work ethic are racist or sexist, or were created by a particular race to oppress another race.
An OMB memorandum issued on September 28—while primarily focused on federal agency training requirements—reiterates that unless specifically exempted, “every government contract must include the provisions” required by the EO.[3]
Thus, unless exempted by rule, regulation, or order, federal contractors must include the training prohibitions in their own subcontracts or purchase orders, and they must enforce those requirements as directed by the Secretary of Labor. If a contractor is threatened with or becomes involved in litigation with a subcontractor or vendor, it may request that the federal government intervene.
Notably, while most Executive Orders include language directing the relevant agency and Federal Acquisition Regulatory Council to issue regulations implementing the Order’s requirements, the EO does not specifically require the promulgation of regulations to implement this new contract clause. It is not immediately clear whether agencies will adopt regulations to implement the requirement, notwithstanding the lack of an express directive in the EO, or how agencies will consistently implement the new contract clause requirement in the absence of such regulations. In addition, neither the EO nor the September 28 OMB memorandum provide further clarity as to whether the requirement will apply only to new contracts awarded on or after November 21, as the express language of the EO seems to suggest, or whether agencies also must insert the clause into any new contract modifications or task orders issued on or after that date.
Notice Requirements
The applicable federal agency’s contracting officer must provide a contractor with a notice of the new training requirements, which the contractor must post “in conspicuous places available to employees and applicants for employment.” The contractor is also required to provide the notice to any labor union or worker representative with which it has a collective bargaining or similar agreement.
Penalties and Enforcement
Federal contractors failing to abide by these requirements may be subject to enforcement action by the Department of Labor’s Office of Federal Contract Compliance Programs (“OFCCP”), which is tasked with enforcing the EO. The EO directs the OFCCP to establish a hotline and investigate complaints regarding the use of prohibited trainings. On September 28, the OFCCP announced that it had established such a hotline (and an email address) to receive complaints.[4] Violations of the EO may result in cancellation, termination, or suspension of the relevant contract, as well as suspension or debarment from future federal contracts.
Within 30 days of the EO, the Director of OFCCP must publish a request for information in the Federal Register, seeking information about employee training from federal contractors, subcontractors, and their employees. While the EO states that the request should seek “copies of any training, workshop, or similar programing having to do with diversity and inclusion as well as information about the duration, frequency, and expense of such activities,” it provides no detail regarding how the OFCCP should use this information.
The EO instructs the Attorney General to “continue to assess the extent to which workplace training that teaches the divisive concepts set forth” in the EO “may contribute to a hostile work environment and give rise to potential liability under Title VII.” It is not clear why this responsibility is assigned to the Attorney General instead of the Equal Employment Opportunity Commission (“EEOC”)—the agency that is otherwise principally tasked with the enforcement of Title VII. But the EO directs the Attorney General and EEOC to jointly issue guidance “to assist employers in better promoting diversity and inclusive workplaces consistent with Title VII” “if appropriate.”
Application to Grant Recipients
The EO also directs federal agencies to identify grant programs for which the agencies may require grant recipients to certify that their trainings comply with the EO’s requirements.
IMPLICATIONS FOR FEDERAL CONTRACTORS
Assuming the EO’s requirements are fully implemented in new federal contracts after 60 days, they will have a significant impact on private federal contractors’ unconscious bias training, which could in some circumstances run afoul of the new prohibitions. Such trainings—which have become an increasingly popular part of companies’ diversity and inclusion initiatives—focus on identifying employees’ possible unconscious biases about various demographic groups and providing strategies to interrupt and reduce the role of those potential biases in decision-making and interactions in the workplace. Notably, the EO expressly states that “[n]othing in this order shall be construed to prohibit discussing, as part of a larger course of academic instruction, the divisive concepts” referenced in the EO “in an objective manner and without endorsement.” Therefore, it is possible that current unconscious bias training, to the extent it might arguably be in tension with the EO, could be modified to describe unconscious bias as an academic concept in an “objective manner and without endorsement.”
Companies entering new federal contracts will be required to cease any prohibited training or run the risk of contract cancellation or sanctions up to and including debarment for future contracts. Federal contractors also will be required to include the training prohibitions in new contracts with their own subcontractors and vendors and prominently post notices describing them.
The EO is likely to be subject to legal challenge, and it is possible the EO will be delayed, enjoined, or invalidated. The EO also may be revoked by an incoming Democratic administration if President Trump is not reelected.
In the interim, private entities contracting with the federal government should inform relevant personnel of the new requirements and review any unconscious bias training or other similar training with the EO in mind.
____________________
[1] Exec. Order No. 13,950 (2020), available at https://tinyurl.com/y2emrxng (last visited Sept. 30, 2020).
[2] Memorandum for the Heads of Executive Departments and Agencies, M-20-34, U.S. Office of Mgmt and Budget, Training in the Federal Government (Sept 4, 2020), available at https://tinyurl.com/y6njnbuw (last visited Sept. 30, 2020).
[3] Memorandum for the Heads of Executive Departments and Agencies, M-20-37, U.S. Office of Mgmt and Budget, Ending Employee Trainings that Use Divisive Propaganda to Undermine the Principle of Fair and Equal Treatment for All (Sept 28, 2020), available at https://tinyurl.com/yb55hm39 (last visited Sept. 30, 2020).
[4] See News Release, U.S. Dep’t of Labor, U.S. Department of Labor Launches Hotline to Combat and Sex Stereotyping by Federal Contractors (Sept. 28, 2020), available at https://tinyurl.com/y975y2tj (last visited Sept. 30, 2020).
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the lawyer with whom you usually work in the firm’s Labor and Employment or Government Contracts practice groups, or the authors:
Jason C. Schwartz – Washington, D.C. (+1 202-955-8242, [email protected])
Katherine V.A. Smith – Los Angeles (+1 213-229-7107, [email protected])
Molly T. Senger – Washington, D.C. (+1 202-955-8571, [email protected])
Lindsay M. Paulin – Washington, D.C. (+1 202-887-3701, [email protected])
Please also feel free to contact the following practice group leaders:
Labor and Employment Group:
Catherine A. Conway – Co-Chair, Los Angeles (+1 213-229-7822, [email protected])
Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202-955-8242, [email protected])
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On Wednesday, September 23, 2020, the Securities and Exchange Commission approved—on a 3-2 vote—amendments to its whistleblower program. Democratic members Allison Herren Lee and Caroline Crenshaw voted in opposition. These amendments, in particular those pertaining to the determination of whistleblower award amounts, have attracted considerable public attention. Although the award amount provisions have been the most eye-catching, there are other critical changes contained in the amendments that warrant mention. Below, we survey and summarize the most significant new provisions and offer some key takeaways for consideration.
- Revised whistleblower definition: In accordance with the Supreme Court’s holding in Digital Realty Trust, Inc. v. Somers, the amendments provide whistleblower protections against retaliation only for individuals who make reports, in writing, to the SEC.
- Measures to address frivolous claims: The amendments include provisions designed to facilitate faster resolution of plainly non-meritorious whistleblower claims.
- Clarification on the types of resolutions that can be predicates for awards: The amendments clarify that various types of resolutions, including deferred prosecution agreements (“DPAs”) or non-prosecution agreements (“NPAs”), can serve as the basis for a whistleblower award.
- Interpretive guidance on independent analysis: The SEC is publishing interpretive guidance clarifying that “independent analysis” means “evaluation, assessment, or insight beyond what would be reasonably apparent to the Commission from publicly available information.”
- Amendments/guidance on award determinations: The amendments grant the Commission authority to adjust small awards upward and also clarify the Commission’s discretion in determining awards.
The cumulative effect of these amendments—and whether they meet their stated goals—remains to be seen. But several outcomes appear likely. On the one hand, truly frivolous whistleblower claims may decrease in light of the Commission’s new procedure for summarily disposing of meritless tips. Nevertheless, total whistleblower activity—including for lower-stakes cases—may increase. That is because the amendments (consistent with the 2018 decision in Digital Realty) reinforce the incentive to prioritize reporting directly to the SEC over reporting internally to receive whistleblower protections under the rules. This in turn could discourage internal reporting and complicate companies’ internal efforts to prevent and detect misconduct. Moreover, the Commission’s revised rules on award determinations suggest a willingness to issue a greater volume of smaller awards, which could incentivize increased reporting. Thus, companies should be vigilant and continuously evaluate and improve their internal compliance reporting and investigations protocols, as well as auditing and monitoring controls to prevent and detect potential misconduct.
Whistleblower Program Background
The SEC’s whistleblower program was established in 2010 to incentivize individuals to report high-quality tips and to help the Commission detect wrongdoing. Since the program’s inception, “[o]riginal information provided by whistleblowers has led to enforcement actions in which the Commission has obtained over $2.5 billion in financial remedies, most of which has been, or is scheduled to be, returned to harmed investors.”[1] Along the way, the SEC has awarded more than $500 million to whistleblowers.[2] Seven of the ten largest whistleblower awards were made in the last three years, with the largest individual award on record—$50 million—made in June 2020.[3]
Critical Changes Under The Final Rule
1. Revised Definition of “Whistleblower” For Anti-Retaliation Provisions
The amendments to the rule limit the SEC’s whistleblower protections to individuals who report information in writing directly to the SEC. The previous rule applied anti-retaliation protections both to internal reports and to reports to the SEC, and the SEC did not define the manner of providing information to qualify for retaliation protection.
This amendment brings Rule 21F-2 in line with the Supreme Court’s 2018 ruling in Digital Realty Trust, Inc. v. Somers, where the Court found that under the plain language of the statute, an individual is a Dodd-Frank Act “whistleblower” for purposes of the Act’s anti-retaliation provision only if she reports information directly to the SEC.[4] Therefore, under Digital Realty and the amended Rule 21F-2(d)(4), an individual who only reported alleged misconduct internally is not protected from retaliation under these regulations. (The existing rule already limits the availability of whistleblower awards to such individuals.)
Critics of the amendment argue that it will negatively impact the integrity of internal compliance programs and will further chill internal reporting. Moreover, Commissioner Crenshaw criticized the Commission’s decision to limit the “anti-retaliation protections to whistleblowers who submit information in writing,” thus failing “to protect those who cooperate with [its] exams and investigations,” for example, “through interviews or testimony.”[5]
The SEC will issue interpretive guidance defining the scope of retaliatory conduct prohibited by Section 21(h)(1)(A), which may provide much needed clarity for companies as they navigate complex employment and disciplinary determinations when addressing potential whistleblower issues. In the meantime, companies should bear in mind that internal reporting (made prior to written reporting to the SEC) may still be protected under the Sarbanes-Oxley Act and other federal and state laws with whistleblower provisions. And companies should also brace themselves for the possibility that the requirement that whistleblowers report to the SEC to avail themselves of Dodd-Frank’s anti-retaliation provision, though already announced in Digital Realty, could incentivize complainants to make written reports to the SEC sooner, more frequently, and at the same time as internal reports.
2. Measures to Increase Efficiency of Claims Review Process
Two changes were made to increase efficiency in processing whistleblower award applications. First, new rule 21F-8(e) allows the SEC to bar individuals from submitting whistleblower award applications where they have been found to have submitted false information to the SEC, and allows the SEC to bar individuals who have made three frivolous claims in SEC actions. The latter provision is particularly important because frivolous claims lead to significant expenditures of time and resources both for the Commission and corporate compliance departments.
Second, new rule 21F-18 creates a summary disposition procedure for certain types of award applications, including untimely applications, applications that involve a tip that was provided in the incorrect form, and applications where the claimant’s information was never provided to or used for the investigation. As Jane Norberg, chief of the SEC’s Office of the Whistleblower, explained, “some individuals [] submit claims that have absolutely no connection to the enforcement action. Under our current rules, we’re unable to quickly address clearly nonmeritorious claims and known serial frivolous submitters.”[6]
These changes could enable the SEC to more expeditiously dispense with nonmeritorious claims, including any uptick in such claims due to the potential increase in lower-dollar-value awards.
3. Broadening Array of Resolutions That Can Serve as Predicates for Awards
The amendments also resolve an open question as to the types of resolutions that qualify for awards. The Commission can issue awards to whistleblowers who contribute to the successful enforcement of “covered judicial or administrative actions” brought by the Commission and certain “related actions.”[7] However, prior to the amendments, the Commission’s rules were silent as to whether certain resolutions, such as DPAs or NPAs entered into by the Department of Justice (“DOJ”) or state attorneys general in criminal cases, qualified for awards. NPAs presented a particular dilemma, because—unlike DPAs—NPAs are not filed in court and thus did not squarely fit within the concept of a “judicial or administrative action[].” The rules were also silent as to whether the Commission’s own NPAs and DPAs were outside of a judicial or administrative action.[8]
In closing this gap, the Commission took the view that “Congress did not intend for meritorious whistleblowers to be denied awards simply because of the procedural vehicle that the Commission (or the other authority) has selected.”[9] As a result, the Commission’s revised definitions make clear that a broad array of resolutions can serve as predicates for whistleblower awards.
Specifically, the Commission’s amendments change the definition of “action” in Rule 21F-4(d) to include (i) DPAs/NPAs brought by DOJ or state attorneys general in a criminal case, and (ii) a settlement with the Commission, even if brought outside of a judicial or administrative proceeding. The amendments also clarify that a “required payment” made under a DPA, an NPA, or an SEC settlement outside of a judicial or administrative proceeding, is a “monetary sanction[]” under Rule 21F-4(e), on the basis of which the amount of a resulting whistleblower award can be determined. And “required payments” now include funds “designated as disgorgement, a penalty, or interest,” or funds “otherwise required as relief” in resolving a covered action.
These additions may prove significant because DOJ and some regulators rely heavily on DPAs and NPAs in reaching resolutions with corporate defendants, and because DOJ and the SEC continue to conduct parallel investigations in key areas.[10]
4. Interpretive Guidance on Independent Analysis
In addition to the proposed amendments to the rules, the SEC included proposed interpretive guidance to help clarify the meaning of “independent analysis” as defined in Exchange Act Rule 21F-4. Under the whistleblower program, (1) the whistleblower must have provided “original information” to the Commission; and (2) such information must have “led to” the successful enforcement of an action. Congress defined “original information” as information that is derived from either a whistleblower’s “independent knowledge” or the whistleblower’s “independent analysis.” The SEC’s guidance clarifies that “independent analysis” means “evaluation, assessment, or insight beyond what would be reasonably apparent to the Commission from publicly available information.”[11]
In the final rule, the Commission added that, subject to Section 21F(a)(3)(C) of the Exchange Act, the Commission may determine that a whistleblower’s examination and evaluation of publicly available information reveals information that is “not generally known or available to the public”—and therefore is “analysis” within the meaning of Rule 21F-4(b)(3)—where: (1) the whistleblower’s conclusion of possible securities violations derives from multiple sources, including sources that, although publicly available, are not readily identified and accessed by a member of the public without specialized knowledge, unusual effort, or substantial cost; and (2) these sources collectively raise a strong inference of a potential securities law violation that is not reasonably inferable by the Commission from any of the sources individually.[12]
The Commission noted that they expect to treat as “independent analysis” highly probative submissions in which the whistleblower’s insights and evaluation provide significant independent information that “bridges the gap” between the publicly available information itself and the possibility of securities violations.[13] This amendment raises the bar for whether an individual’s provision of information to the SEC will qualify them for a whistleblower award.
5. Provisions Regarding Award Amounts
a. Upward Adjustments for Smaller Awards
Under the current whistleblower program, a whistleblower who provides information that leads to a successful enforcement action against a company can be eligible for an award of between 10% and 30% of an overall monetary sanction over $1 million. Within that range, Rule 21F-6(a) and (b) identifies four criteria that may increase an award percentage, and three that may decrease it.[14]
The amendments add a new paragraph (c) to the 21F-6 framework, giving the SEC the discretion to apply upward adjustments to awards of $5 million or less. In addition to other limitations, such as the negative award factors described above, the Commission would not be permitted to use any upward adjustment to raise the award payout above $5 million, or to raise the total amount awarded to all whistleblowers in the aggregate above 30%.
In the June 2018 proposed amendments, the SEC had suggested allowing upward adjustments only to awards to a single whistleblower under $2 million. In the final rule, the SEC made a number of modifications to the proposed rule, including, but not limited to, the following:
- The SEC selected $5 million, rather than $2 million, as the ceiling for upward adjustments. From August 2012 to July 2020, 74% of awards were less than $5 million, of which 56% were less than $2 million.[15]
- In the final rule, the SEC noted that unreasonable delay under Rule 21F-6(b)(2) will not automatically disqualify individuals from receiving enhancements.
- Subject to exceptions, the new rule embodies a presumption that, where the statutory maximum is $5 million or less in the aggregate, the Commission will pay a meritorious claimant the statutory maximum amount where none of the negative award criteria specified in Rule 21F-6(b) are implicated and the award claim does not trigger Rule 21F-16. The Commission may determine that an otherwise eligible claimant will not receive the statutory maximum if it determines that the claimant’s assistance was limited or providing the statutory maximum to the claimant would be inconsistent with the public interest, investor protection or the objectives of the program.
Although the amendments to the rules have yet to officially go into effect, the implications are already being felt. On Friday, September 25, 2020, the Commission awarded over $1.8 million to a whistleblower for providing a tip about overseas conduct that formed the basis for an SEC action against the company involved.[16] The Commission wrote that after considering the administrative record and applying the award criteria in Rule 21F-6 to the facts and circumstances, it chose to increase the award amount to the whistleblower above the preliminary determination by the Claims Review Staff.
These amendments reflect the Commission’s belief that bringing meritorious whistleblowers forward is critical to the program’s success. Although the effects remain to be seen, the prospect of upward increases in smaller awards is likely to lead to an increase of whistleblower claims.
b. Clarifying SEC Discretion Regarding Awards
In the commentary to the final rule, the SEC noted that the comments in response to proposed rules Rule 21F-6(c) and (d) illuminated a disconnect between the SEC’s and the public’s understanding of the SEC’s discretion to consider the dollar amount of monetary sanctions collected, as opposed to focusing exclusively on a percentage amount (i.e., between 10% and 30%) in the statutory range, when applying the award factors and setting the award amount. To clarify the Commission’s discretionary authority, the final rules modify Rule 21F-6 to state that the Commission may consider only the factors set forth in Rule 21F-6 in relation to the facts and circumstances of each case.
The original 2018 proposal reflected a belief that the Commission would be unable to consider the application of the award criteria in dollar terms and adjust the “award amount downward if it found that amount unnecessarily large for purposes” of achieving the program’s goals.[17] Commissioner Lee objected to the final rule because she believed that instead of providing the Commission with a limited ability to adjust the award amounts downward based on their size, with which she also disagreed, with the new clarification to Rule 21F-6 the SEC now “claim[s] that we do not need a new rule at all, that we’ve had this discretion all along.”[18] Commissioner Lee added “the new rule is even more problematic than the proposal because we are no longer even restricted to the largest awards.”[19] It remains to be seen how the Commission will exercise this discretion in future awards.
Conclusion
The new rules will become effective 30 days after their publication. As described above, the amendments aim to resolve open interpretive questions, to streamline the award process, and to provide improved incentives for future whistleblowers. Whether these goals are achieved remains an open question, but both proponents and skeptics of the amendments will be eager to see whether future developments bear out their predictions.
________________________
[1] Press Release, Sec. & Exch. Comm’n, SEC Adds Clarity, Efficiency and Transparency to Its Successful Whistleblower Award Program (Sept. 23, 2020), https://www.sec.gov/news/press-release/2020-219.
[2] Sec. & Exch. Comm’n, Whistleblower Awards Over $500 Million for Tips Resulting in Enforcement Actions, https://www.sec.gov/page/whistleblower-100million (June 4, 2020).
[3] Press Release, Sec. & Exch. Comm’n, SEC Awards Record Payout of Nearly $50 Million to Whistleblower (June 4, 2020), https://www.sec.gov/news/press-release/2020-126.
[4] Digital Realty Trust Inc. v. Somers, 583 U.S. __ (2018).
[5] Public Statement, Caroline Crenshaw, Comm’r, Sec. & Exch. Comm’n, Statement of Comm’r Caroline Crenshaw on Whistleblower Program Rule Amendments (Sept. 23, 2020), https://www.sec.gov/news/public-statement/crenshaw-whistleblower-2020-09-23.
[6] Al Barbarino, SEC’s Whistleblower Chief Reflects After $500M Milestone, Law360 (July 28, 2020), https://www.law360.com/articles/1294863/sec-s-whistleblower-chief-reflects-after-500m-milestone.
[8] Press Release, Sec. & Exch. Comm’n, SEC Announces Initiative to Encourage Individuals and Companies to Cooperate and Assist in Investigations (Jan. 13, 2010), https://www.sec.gov/news/press/2010/2010-6.htm.
[9] Whistleblower Program Rules, Rel. No.34-89963, at 14.
[10] See Gibson Dunn, 2020 Mid-Year Update On Corporate Non-Prosecution Agreements And Deferred Prosecution Agreements (July 15, 2020), https://www.gibsondunn.com/wp-content/uploads/2020/07/2020-mid-year-npa-dpa-update.pdf
[11] Whistleblower Program Rules, Rel. No.34-89963, at 115.
[12] Whistleblower Program Rules, Rel. No.34-89963, at 121-122.
[13] Whistleblower Program Rules, Rel. No.34-89963, at 122.
[14] The criteria that may increase an award percentage are: (1) significance of the information provided by the whistleblower; (2) assistance provided by the whistleblower; (3) law enforcement interest in making a whistleblower award; and (4) participation by the whistleblower in internal compliance systems. Rule 21F-6(a). The criteria that may decrease the percentage are: (1) culpability of the whistleblower; (2) unreasonable reporting delay by the whistleblower; and (3) interference with internal compliance and reporting systems by the whistleblower. Rule 21F-6(b).
[15] Whistleblower Program Rules, Rel. No.34-89963, at 139.
[16] SEC Whistleblower Award Proceeding, Release No. 34-89996, https://www.sec.gov/rules/other/2020/34-89996.pdf.
[17] Whistleblower Program Rules, Rel. No. 34-83557, at 45.
[18] Public Statement, Allison Herren Lee, Comm’r, Sec. & Exch. Comm’n, June Bug vs. Hurricane: Whistleblowers Fight Tremendous Odds and Deserve Better (Sept. 23, 2020), https://www.sec.gov/news/public-statement/lee-whistleblower-2020-09-23.
The following Gibson Dunn lawyers assisted in preparing this client update: Michael Diamant, Richard Grime, Michael Scanlon, Jason Schwartz, Patrick Stokes, Oleh Vretsona, Molly Senger, Elizabeth Niles, Michael Jaskiw, Michael Dziuban, and Allison Lewis.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you usually work, or the following authors in Washington, D.C.:
Michael S. Diamant (+1 202-887-3604, [email protected])
Richard W. Grime (+1 202-955-8219, [email protected])
Michael J. Scanlon (+1 202-887-3668, [email protected])
Patrick F. Stokes (+1 202-955-8504, [email protected])
Oleh Vretsona (+1 202-887-3779, [email protected])
Please also feel free to contact any of the following practice group leaders:
Securities Enforcement Group:
Barry R. Goldsmith – New York (+1 212-351-2440, [email protected])
Richard W. Grime – Washington, D.C. (+1 202-955-8219, [email protected])
Mark K. Schonfeld – New York (+1 212-351-2433, [email protected])
White Collar Defense and Investigations Group:
Joel M. Cohen – New York (+1 212-351-2664, [email protected])
Charles J. Stevens – San Francisco (+1 415-393-8391, [email protected])
F. Joseph Warin – Washington, D.C. (+1 202-887-3609, [email protected])
Labor and Employment Group:
Catherine A. Conway – Los Angeles (+1 213-229-7822, [email protected])
Jason C. Schwartz – Washington, D.C. (+1 202-955-8242, [email protected])
Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
James J. Moloney – Orange County (+1 949-451-4343, [email protected])
Lori Zyskowski – New York (+1 212-351-2309, [email protected])
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Earlier this year, New York State enacted a comprehensive new law, N.Y. Labor Law § 196-B, requiring employers to provide sick leave to all employees. The law takes effect on September 30, 2020, and employees will begin accruing leave as of that date, but employees may not use any paid sick leave until January 1, 2021. As summarized below, the law mandates that all employers provide a minimum amount of sick leave to employees, with different requirements depending on employer size and income.
Summary of the New York State Sick Leave Law
Amount of Leave. The New York State Sick Leave law requires that all employers must provide sick leave to employees, but the amount of leave varies based on employee headcount and employer income level. The leave requirements are as follows:
- Employers with at least 100 employees in a calendar year must provide 56 hours of paid sick leave;
- Employers with between five and 100 employees in a calendar year must provide 40 hours of paid sick leave;
- Employers with fewer than five employees and a net income in excess of $1 million in the previous tax year must provide 40 hours of paid sick leave; and
- Employers with fewer than five employees and a net income of less than $1 million in the previous tax year must provide 40 hours of unpaid sick leave.
Importantly, an employer that already has a sick leave policy or time off policy in place that provides employees with an amount of leave which meets or exceeds all requirements of the New York State Sick Leave law is not required to provide employees with any additional sick leave in order to comply with the law. So, for example, if an employer already provides 2 weeks of paid vacation (80 hours), the employer does not need to provide any additional sick leave. However, even when an employer’s existing time off policy provides for a sufficient amount of leave, employers must also be sure their policy satisfies the accrual, carryover, and use requirements of the new law.
Employers who enter into collective bargaining agreements on or after September 30, 2020 must provide benefits comparable to those provided under the law.
Rate of Accrual. The law provides that leave must accrue at a rate of at least one hour per every 30 hours worked, but an employer can choose to provide the entire amount of leave at the beginning of the year. If an employer chooses to frontload leave time, it cannot later reduce the amount of leave if the employee does not work sufficient hours to accrue the amount provided.
Use of Sick Leave. While employees will start to accrue leave as of September 30, 2020, when the law takes effect, employees may not use leave until January 1, 2021. Upon the oral or written request of an employee after January 1, 2021, an employer must permit an employee to use accrued sick leave for the following reasons:
- mental or physical illness, injury, or health condition of the employee or the employee’s family member (regardless of receiving a diagnosis);
- the diagnosis, care, or treatment of a mental or physical illness, injury or health condition of, or need for medical diagnosis of, or preventive care for, the employee or the employee’s family member; or
- an absence when the employee or employee’s family member has been the victim of domestic violence, a family offense, sexual offense, stalking, or human trafficking, including absences to seek services from shelters, crisis centers, social services, attorneys, or law enforcement, or “to take any other actions necessary to ensure the health or safety of the employee or the employee’s family member or to protect those who associate or work with the employee.”
A covered family member includes an employee’s child (including biological, adopted, or foster child, a legal ward, or “a child of an employee standing in loco parentis”); spouse; domestic partner; parent (including biological, foster, step-, adoptive, legal guardian, or a “person who stood in loco parentis when the employee was a minor child”); sibling; grandchild or grandparent; and the child or parent of an employee’s spouse or domestic partner. An employer may not require the disclosure of confidential information relating to the employee’s reason for using sick leave.
An employer may choose to set a reasonable minimum increment for the use of sick leave. This minimum increment, however, may not exceed four hours. An employee who uses paid sick leave is entitled to receive compensation at his or her regular rate of pay, or the applicable minimum wage, whichever is greater.
Carry Over. The law also provides that an employee’s unused sick leave must carry over to the following calendar year, with some limitations on the use of leave. An employer with fewer than 100 employees may limit the use of sick leave to 40 hours per calendar year; an employer with 100 or more employees may limit the use of sick leave to 56 hours per calendar year. Employers are not required to pay employees for unused sick leave upon separation from employment, whether voluntary or involuntary.
Prohibition on Discrimination or Retaliation. Pursuant to Section 196-B(7), an employer must not discriminate or retaliate against any employee for exercising the right to request or use sick leave. Under Section 196-B(10), any employee who returns from sick leave must be restored to the position of employment held by such employee prior to any sick leave taken, with the same pay and other terms and conditions of employment.
Interaction with Other Laws
The New York State Sick Leave law is the first permanent sick leave law in New York State, but similar sick leave laws are already in place in certain municipalities and counties in New York, and employers must continue to comply with all applicable laws. For example, New York City’s Earned Safe and Sick Time Act requires employers with five or more employees to provide up to 40 hours of paid sick and safe time, and employers with fewer than five employees to provide up to 40 hours of unpaid safe and sick time. Similarly, Westchester County’s Earned Sick Leave Law requires employers with five or more employees to provide up to 40 hours of paid sick time and employers with fewer than five employees to provide up to 40 hours of unpaid sick time, and the Safe Time Law requires up to 40 additional hours for safe leave. Both local laws only apply if the employee has worked more than 80 hours in a calendar year, and offer expanded reasons for use. Additionally, the New York State Sick Leave law is separate and distinct from the New York State Quarantine Leave law, which went into effect March 18, 2020 and provides sick leave, family leave, and disability benefits for individuals who are subject to a mandatory or precautionary order of quarantine or isolation due to COVID-19.
Takeaways for Employers
- Employers with employees in New York State should review their employment handbooks and leave policies to ensure compliance with the new law. Critically, large employers (more than 100 employees) who are currently subject to the existing New York City or Westchester County sick leave laws will need to increase the amount of sick leave from 40 hours to 56 hours.
- Employers should prepare to accrue and track accrual of sick time for employees beginning September 30, 2020.
- Employers should put a process in place for employees to request and use sick leave, which employees can use starting January 1, 2021.
- Internal processes and procedures for tracking accrual and leave used are critical, because the new law provides that employers must provide a summary of the amount of sick leave accrued and used by an employee within three business days of an employee’s request.
- While the law does not require employers to pay out unused sick time upon termination of employment, employers should ensure their written policies are clear on this issue.
- The new law does not contain any notice requirements, but the New York Department of Labor will conduct a public outreach campaign, and employers may receive questions from employees on their sick leave policies.
- The New York Department of Labor has not yet adopted regulations or issued guidance to effectuate any provisions of the New York State Sick Leave law, but may do so in the future. Employers should continue to monitor for developments in order to ensure they are aware of, and comply with, any future regulations and guidance promulgated by the Department.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Labor and Employment practice group, or the following authors in New York:
Gabrielle Levin (+1 212-351-3901, [email protected])
Stephanie L. Silvano (+1 212-351-2680, [email protected])
Please also feel free to contact any of the following practice leaders:
Labor and Employment Group:
Catherine A. Conway – Los Angeles (+1 213-229-7822, [email protected])
Jason C. Schwartz – Washington, D.C. (+1 202-955-8242, [email protected])
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On September 21, 2020, the Office of the Comptroller of the Currency, the U.S. regulator of national banks, issued an interpretive letter that concluded that national banks may hold deposits that serve as reserves for certain stablecoin issuers (Stablecoin Letter).[1] The Stablecoin Letter’s guidance is another example of the active role the OCC has recently taken in the cryptocurrency and financial technology (fintech) space.
I. Prior Developments
Since becoming Acting Comptroller of the Currency on May 29th, Brian Brooks has made it clear that he views the OCC as taking the lead on technological developments in banking. For example, on July 22nd, the OCC issued an interpretive letter that concluded that national banks may provide “cryptocurrency custody services on behalf of customers, including by holding the unique cryptographic keys associated with cryptocurrency.”[2] The July interpretive letter reaffirms the OCC’s view that national banks may provide traditional banking services – i.e., custody – to any lawful business, including cryptocurrency businesses, “so long as they effectively manage the risks and comply with applicable law.”[3] In July as well the OCC granted the first full-service national bank charter to a fintech company, stating that it represented “the evolution of banking and a new generation of banks that are born from innovation and built on technology intended to empower consumers and businesses.”[4]
II. What Are Stablecoins?
As the OCC explains, a stablecoin is “a type of cryptocurrency designed to have a stable value as compared with other types of cryptocurrency, which frequently experience significant volatility.”[5] Cryptocurrencies often utilize cryptography and distributed ledger technology to act as a medium of exchange that is created and stored electronically. But unlike other cryptocurrencies like bitcoin and ether, a stablecoin is specifically designed to maintain a stable value by being backed by another asset with a relatively stable value, such as a fiat currency.
For example, during 2020, the value of one bitcoin in U.S. dollars has fluctuated from below $5,000 to $12,000. In contrast, one USD Coin – a stablecoin created by Centre Consortium (a collaboration between Coinbase and Circle Internet Financial) and traded on digital currency exchanges like Coinbase – can always be redeemed to the issuer for $1 (minus any fees where applicable), despite its price on third-party platforms fluctuating above $1 (having reached a high of $1.17) or below (having reached a low of $0.92).[6] This reduced volatility results from the stablecoin issuer holding in custody accounts fiat currency or other assets for each stablecoin issued (e.g., USD Coin’s issuer maintains in custody accounts at least $1 for every unit of USD Coin issued)[7] – other cryptocurrencies, such as bitcoin, typically do not maintain such a reserve.
Among other things, stablecoins (1) act as a digital store of value; (2) enable the exchange of one cryptocurrency for another without the need to either sell a cryptocurrency for fiat currency or buy it with fiat; and (3) maintain a more predictable and less volatile value compared to other cryptocurrencies, making it an attractive option as a medium of exchange for transactions such as remittances.
III. The Stablecoin Letter
The Stablecoin Letter addresses a national bank’s authority to hold reserves only for a stablecoin backed on a one-to-one basis by a single fiat currency and held in a hosted wallet.[8] The OCC issued the Stablecoin Letter because certain bank customers, particularly stablecoin issuers, “may desire to place assets in a reserve account with a national bank to provide assurance that the issuer has sufficient assets backing the stablecoin.”
In approving the activity, the OCC stated that national banks are expressly authorized to receive deposits and receiving deposits in a core banking activity. National banks are permitted to provide permissible banking services to any lawful business they choose, including cryptocurrency businesses, so long as they effectively manage the risks of those services and comply with applicable law.
The Stablecoin Letter also sets forth the compliance measures necessary for doing business with stablecoin issuer. National banks should conduct “sufficient due diligence commensurate with the risks associated with maintaining a relationship with a stablecoin issuer.” Such due diligence should include a review to ensure compliance with the customer due diligence requirements under the Bank Secrecy Act and the customer identification requirements under § 326 of the USA PATRIOT Act. In addition, national banks must identify and verify the beneficial owners of legal entity customers opening accounts, comply with applicable federal securities laws, provide accurate and appropriate disclosures regarding deposit insurance coverage, and ensure that deposit activities comply with all other applicable laws and regulations.
Finally, drawing an analogy to audit agreements with program managers for bank-issued prepaid cards, the OCC advised national banks to enter into the necessary agreements with stablecoin issuers to allow the banks to verify at least daily that the reserve account balances for the fiat currency backing the stablecoins are always equal to or greater than the number of the stablecoin issuer’s outstanding stablecoins.
IV. Conclusion
The Stablecoin Letter is another example of the OCC’s interpreting the “business of banking” provision of the National Bank Act in the light of technological advancements. It therefore shows that the agency is seeking to take a lead on fintech banking issues. As part of the business of banking under the National Bank Act, holding deposits for stablecoin issuers should also be permissible for state-chartered banks under the “wild card” provisions of state banking statutes. The Stablecoin Letter is also strong evidence that cryptocurrencies continue to become more and more mainstream, and that traditional legal regimes can no longer shy away from considering them.
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[1] OCC Interpretive Letter No. 1172, at 1 (Sept. 21, 2020), available at https://www.occ.gov/topics/charters-and-licensing/interpretations-and-actions/2020/int1172.pdf. Note that references herein to “national banks” include Federal savings associations.
[2] OCC Interpretive Letter No. 1170, at 1 (July 22, 2020), available at https://www.occ.gov/topics/charters-and-licensing/interpretations-and-actions/2020/int1170.pdf.
[4] Acting Comptroller of the Currency Presents Varo Bank, N.A. Its Charter (July 31, 2020), available at https://occ.gov/news-issuances/news-releases/2020/nr-occ-2020-99.html (last visited Sept. 28, 2020).
[6] See Circle USDC Risk Factors, available at https://support.usdc.circle.com/hc/en-us/articles/360001314526-Circle-USDC-Risk-Factors (last visited Sept. 28, 2020).
[7] USD Coin’s reserves are verified monthly by Grant Thornton LLP and published on Circle Internet Financial’s website, available at https://www.circle.com/en/usdc (last visited Sept. 28, 2020).
[8] Cryptocurrencies are held in “wallets,” which are often software programs that store the cryptographic keys associated with a unique unit of a cryptocurrency. See OCC Interpretive Letter No. 1170, at 5. The OCC defines a “hosted wallet” as a wallet in which the stored cryptographic keys are controlled by an identifiable third party, on behalf of accountholders that do not generally have access to the cryptographic keys. See Letter at note 3.
The following Gibson Dunn lawyers assisted in preparing this client update: Arthur S. Long, Jeffrey L. 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 in the firm’s Financial Institutions practice group, or the following:
Arthur S. Long – New York (+1 212-351-2426, [email protected])
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])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.