This fall, the U.S. financial agencies have taken initial, but substantial, steps towards reforming the U.S. housing finance system. In September, the U.S. Department of the Treasury (Treasury) published a detailed proposal (Housing Reform Plan), which included a call to tackle the last unfinished piece of regulatory business stemming from the Financial Crisis, the conservatorships of the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac).[1] The Housing Reform Plan set forth 49 specific legislative and administrative reform measures and is thus the most ambitious financial proposal put forth since the enactment of the Dodd-Frank Act. In addition, Treasury and the Federal Housing Finance Agency (FHFA), the regulator and conservator of Fannie Mae and Freddie Mac (GSEs), amended the Preferred Stock Purchase Agreements (PSPAs) with the GSEs to permit the GSEs to retain up to $45 billion in capital.[2] And, on October 28th, the FHFA published its 2019 Strategic Plan for the GSE conservatorships and an accompanying Scorecard.[3]

Although the prospects of legislative housing finance reform are slim given the current political environment and the upcoming 2020 election, these actions are nonetheless significant. Both GSEs have been in conservatorship for over eleven years, and government control was never intended to be permanent. Even if legislative action may be stymied until after November 2020, the Housing Reform Plan establishes an overall framework that can influence future legislative action, and other actions toward reform may be taken – as they have begun to be – as an administrative matter.

I. The Housing Finance System: Conservatorships of the GSEs

Privatized in 1970 and 1989, respectively, Fannie Mae and Freddie Mac work in conjunction with regulatory agencies like the FHFA, Federal Housing Administration (FHA) and the Department of Housing and Urban Development to provide the structural support necessary for the current housing market to function. For example, the GSEs own or guarantee approximately 44% of all outstanding single-family mortgage debt, and the FHA is responsible for more than 10% of mortgage originations.

Early in the Financial Crisis, the U.S. government put the GSEs into conservatorship as a result of their excessive risk taking in the years leading up to the Crisis. As part of this process, the FHFA, the GSEs’ regulator and conservator, entered into the PSPAs with Treasury. The PSPAs provided the Treasury with a cash-sweep right that required the GSEs to dividend to the government all net income above a miniscule capital reserve amount. Since entering into the PSPAs, the GSEs have returned to profitability, and they have paid over $300 billion to the Treasury. At the same time, however, the PSPAs have prevented them from maintaining sufficient capital to operate independently of government support. This has required the FHFA conservatorship to continue year after year.

II. Overview of the Housing Reform Plan

A principal goal of the Housing Finance Plan is to reduce the amount of U.S. government support for the U.S. housing finance system. It sets forth 18 legislative and 31 administrative measures focused on preparing the regulators and GSEs for a transition out of conservatorship and establishing a legislative framework to ensure that such a transition is orderly. Although congressional action is necessary for a permanent solution, the Housing Reform Plan notes that “reform should not and need not wait on Congress” and thus makes significant administrative recommendations as well.

The Housing Reform Plan framework is organized into 12 distinct goals, each comprising several legislative and administrative recommendations:

Clarifying Exiting Government Support: Recognizing the need for reduced taxpayer exposure, the Housing Reform Plan sets forth four legislative and five administrative recommendations directed at providing an explicit, paid-for federal guarantee of certain mortgage-backed securities (MBS) by the Government National Mortgage Association.
Support of Single-Family Mortgage Lending: In an effort to refocus GSE activities on providing stability to the lending markets, the Housing Reform Plan sets forth one legislative and two administrative recommendations directed at limiting the scope of GSE single-family mortgage activities to securitizing government-guaranteed MBS and taking a first-loss position on those MBS ahead of the government guarantee.
Support of Multifamily Mortgage Lending: Citing recent regulatory shortcomings with respect to GSE multifamily mortgage loan acquisitions, the Housing Reform plan sets forth two legislative and one administrative recommendation directed at limiting the scope of GSE multifamily mortgage activities to a specified affordability mission.
Additional Support for Affordable Housing: Concerned with the GSEs’ divergence from statutorily defined affordability goals and the associated lack of transparency with respect to underwriting criteria, the Housing Reform Plan sets forth one legislative and three administrative recommendations directed at increasing efficiencies related to affordable housing.
Ending Conservatorships: Setting the stage for legislative action, the Housing Reform Plan recommends three administrative actions aimed at ending the GSE conservatorships.
Capital and Liquidity Requirements: Recognizing the shortcomings of previous GSE capital and liquidity regulation, the Housing Reform Plan sets forth one legislative and four administrative recommendations directed at restricting regulatory discretion in establishing such requirements and increasing transparency when promulgating them.
Resolution Framework: Similar to the resolution planning requirements for large banks, the Housing Reform Plan sets forth one legislative and one administrative recommendation directed at ensuring that GSEs maintain loss-absorbing instruments (e.g., long-term debt convertible into equity) sufficient to facilitate timely resolution.
Retained Mortgage Portfolios: In an effort to scale down the size of the GSEs, the Housing Reform Plan sets forth one legislative and one administrative recommendation directed at curtailing the investment activities of GSEs in mortgage-related assets, in another effort to focus GSE activities on securitizing federally-guaranteed MBS.
Credit Underwriting Parameters: In light of past less-than-sound underwriting practices, the Housing Reform Plan sets forth one legislative and one administrative recommendation directed at restricting the underwriting criteria for MBS eligible for a government guarantee.
Leveling the Playing Field: Revisiting past attempts to encourage private market participants in the housing finance system, the Housing Reform Plan sets forth one legislative and eight administrative recommendations directed at limiting the current competitive advantages of GSEs.
Competitive Secondary Market: To ensure more competition than is the case currently, the Housing Reform Plan sets forth three legislative recommendations directed at establishing a system for chartering private market actors to compete with the GSEs.
Competitive Primary Market: To ensure a robust primary market, the Housing Reform Plan sets forth two legislative and two administrative recommendations requiring GSEs and guarantors to provide cash windows for small lenders and restrict volume-based pricing.

III. Legislative Proposals

The legislation proposed by the Housing Reform Plan would be revolutionary in the same manner as the Dodd-Frank Act. Although perhaps not as substantial as the final version of Dodd-Frank, any such legislation would do away with the GSE framework that has developed since the creation of Fannie Mae in 1938, seek to create more competition, and reduce overall government support.

An Explicit Federal Guarantee, but More Limited: Treasury supports legislation to create an explicit, paid-for guarantee backed by the full faith and credit of the U.S. government. Somewhat surprising for a conservative Republican Administration, this support reflects the reality that after decades of GSE growth, failing to continue some form of government guarantee would be hugely disruptive. The Housing Reform Plan, however, states that any such guarantee should be limited to a subset of MBS, “qualifying MBS.” It therefore calls on Congress and regulators to reexamine the products that may qualify for a guarantee.
Open Chartering Process for GSE Competitors: The Housing Reform Plan recommends legislation that would authorize the chartering of new private actors to compete with GSEs in securitizing MBS and providing first-loss protection. Treasury reasons that leveling the playing field would diversify the secondary markets and encourage greater competition among market participants.
Capital and Liquidity Requirements for Market Participants: The Housing Reform Plan recommends that the FHFA should require capital sufficient to withstand a severe economic downturn, and require shareholders and unsecured creditors, rather than taxpayers, to bear losses on insolvency. To foster a level playing field, the Housing Reform Plan recommends that similar credit risks should generally bear similar credit-risk capital charges and that the FHFA should establish a simple, transparent, leverage restriction to act as a credible supplementary measure to risk-based capital requirements. Enhanced liquidity requirements would also be mandated.
Limitation of Activities of Market Participants Benefiting from a Federal Guarantee: The Housing Reform Plan would seek to limit the scope of GSE and newly chartered competitor activities, by requiring them to be effectively monoline businesses focused on the business of securitizing guaranteed MBS. Treasury suggests that such a limitation could be “statutorily defined to include credit enhancing the mortgage collateral securing Government-guaranteed MBS and ancillary activities such as operating a cash window, loss mitigation on mortgage loans, and holding and disposing of property acquired in connection with collecting on mortgage loans.” These restrictions, however, would not necessarily extend to affiliate businesses.
Creation of a Federal Mortgage Insurance Fund: Although private companies would collect their own fees as compensation for taking the first-loss position on the mortgage collateral supporting the MBS, the Administration recommends that any legislation ensure that these actors compensate taxpayers for default risk by authorizing the FHFA to charge fees for government guarantees of qualifying MBS. Such fees would be used to create a mortgage insurance fund that would fund government-guarantee obligations. In the event that such funds are inadequate, the Housing Reform Plan suggests that legislation provide the FHFA with authority to recapitalize the fund through industry assessments.

These recommendations are laid out only as a framework, with the critical details to be left to congressional action. As such, their immediate effect will most likely be to frame one side of the debate over housing finance reform before the 2020 election.

IV. Administrative Proposals

The focus of the Housing Reform Plan’s administrative proposals is to set the stage for the transition of the GSEs out of conservatorship. In particular, nearly one-third of the contemplated administrative reforms relate to amendment of the PSPAs. These proposed amendments would largely serve to:

Reduce Non-Mission Oriented Activities: As noted above, one of the key themes to the Housing Reform Plan is to realign GSE activities by scaling back permissible activities. It therefore calls for the FHFA to amend the PSPAs to (i) reaffirm commitments to support single-family and multi-family MBS, (ii) limit federal support of each GSE’s multifamily business to its underlying affordability mission, and (iii) reduce the cap on GSE investments in mortgage-related assets, setting a different cap for each GSE, and restrict retained mortgage portfolios to solely supporting the business of securitizing MBS.
Begin the Recapitalization Process: Pending congressional action, the Housing Reform Plan recommends adding the following provisions to the PSPAs: (i) the establishment and periodic payment of commitment fees by the GSEs to the federal government to be used as part of the mortgage insurance fund contemplated under the legislative proposals, (ii) establishing a pre-capitalization plan that will allow GSEs to retain additional earnings, and (iii) requiring GSEs to maintain long-term debt convertible into equity and other loss-absorbing instruments to further reduce taxpayer risks.
Support the Primary Market: To better encourage primary market competition, the Housing Reform Plan calls for an amendment to the PSPAs to require GSEs to provide cash windows for small lenders and restrictions on volume-based pricing.

The Housing Reform Plan also calls for interim preliminary rulemaking measures in anticipation of congressional action. Treasury recommends that the FHFA begin the process of considering, among other things: (i) post-conservatorship GSE capital and liquidity requirements, (ii) operational and competitive issues relating to the private guarantor model, (iii) permissibility of new activities and products, (iv) clarification to supervisory roles between regulators, and (v) effects on secondary and primary markets.

V. FHFA Actions

The FHFA, as the GSE’s regulator and conservator, has begun to take some actions recommended by the Housing Reform Plan. First, in late September, it entered into PSPA amendments that permit the GSEs to retain additional capital – $25 billion for Fannie Mae, $20 billion for Freddie Mac. (Because, prior to the amendments, GSE leverage was approximately 1000-1, there is still a long way to go before the GSEs can become self-supporting; most large U.S. banks have at least 10-1 leverage.)

Second, on October 28, the FHFA issued its Strategic Plan and Scorecard. The Strategic Plan has three central goals for the near term – increasing competition, increasing FHFA authority, and making changes to the ways the GSEs operate. The Scorecard is the FHFA’s means of assessing the GSEs’ alignment with these overriding principles. It has three sections that are intended to ensure that the GSEs:

Focus on their core mission responsibilities to foster “Competitive, Liquid, Efficient, and Resilient” (CLEAR) national housing finance markets that support sustainable home ownership and affordable rental housing;
Operate in a safe and sound manner in conservatorship; and
Prepare for their eventual exit from government control.

The Scorecard is therefore evidence of active FHFA monitoring to advance the principles of the Housing Reform Plan in the coming year.

VI. The Future

The Strategic Plan’s statement that “restor[ing] the GSEs to their proper role as fully-private, well-capitalized, and well-regulated financial institutions . . . will take time and a great deal of effort” is likely an understatement. Although the Housing Reform Plan is ambitious in approach, the practical realities of implementing it must be seriously considered. Some considerations that we believe could hinder comprehensive reform, absent a new political impetus, are:

The Upcoming Presidential Election and Extent of Political Will

With the upcoming presidential election, legislative action is almost certain not to occur until after November 2020. Although few would disagree with the need for reform, political paralysis has only grown in Washington, and reform is not a hot button issue that is likely to get substantial airtime in the coming year. Sensing this, Senator Michael Crapo – the Senate Banking Committee Chairman who was able to craft some bipartisan financial legislation notwithstanding the current political atmosphere – stated in the Senate Banking Committee hearing on the Housing Finance Plan that “it’s time for the Administration to act and to start building the foundation in taking the necessary steps it can take in order to address this issue and actually help Congress get to a comprehensive solution.”[4]

Fractured Constituencies

As with any legislation having the potential to upend existing financial interests, a shift from government-favored enterprises to a free market, more level playing field will affect many interests that are reliant on the regulatory status quo. Because the beneficiaries of the current regulatory regime will be competing with private market actors standing to benefit from reform, there is a risk that congressional constituencies may fracture rather than coalesce behind a single, comprehensive framework.

Ideological Differences

Although members of Congress appear to agree on the need for a legislative solution, the particulars as to how to effectuate reform may suffer from the same ideological divisions that plagued GSE regulation in the years before the Financial Crisis. For example, some Democrats cite concerns over the Housing Reform Plan’s impact on affordable housing, in that financial products for lower-income individuals may fall outside the scope of a more limited federal guarantee, with the potential to increase mortgage costs for those persons.[5] Conversely, many Republicans have sought to rally support around their answer to affordable housing, the reduction of state and local regulations,[6] but this view is far from universally shared. Lack of bipartisan support for some of the more basic concepts proposed by the Housing Reform Plan may indicate challenges to producing a viable bill even after 2020.

Challenges to the FHFA

As the Housing Reform Plan notes, there are substantial actions that the FHFA itself may take in moving reform forward. In September, however, the U.S. Court of Appeals for the Fifth Circuit held that the FHFA’s structure – having a single director that may be removed only “for cause” – is unconstitutional,[7] and the U.S. Supreme Court has granted certiorari on a similar challenge to the structure of the Consumer Financial Protection Bureau, with a likely decision by June 2020. How these cases will ultimately affect the ability of the FHFA to take prompt actions that fall within its regulatory authority, such as promulgating new, heightened GSE capital and liquidity requirements, is currently unclear.

Conclusion

The Housing Reform Plan is generally a positive development in articulating a coherent vision for U.S. housing finance in the 21st century. The seventy years between the creation of Fannie Mae and the onset of the Financial Crisis demonstrate that supporting private-sector mortgage finance can be both highly profitable and potentially calamitously risky. The concept of a private-sector support system backed by a paid-for, explicit government guarantee, and subject to the same strict capital and liquidity standards as the nation’s largest banks, has many reasons to suggest it as a far better alternative to both the pre- and post-Financial Crisis housing finance system.

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[1] U.S. Department of the Treasury, Housing Finance Reform Plan (September 5, 2019), available at https://home.treasury.gov/system/files/136/Treasury-Housing-Finance-Reform-Plan.pdf.

[2] The PSPAs are available on the FHFA’s website at: https://www.fhfa.gov/Conservatorship/Pages/Senior-Preferred-Stock-Purchase-Agreements.aspx.

[3] See https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Releases-New-Strategic-Plan-and-Scorecard-for-Fannie-Mae-and-Freddie-Mac-.aspx.

[4] Remarks of Senator Michael Crapo, United States Senate Committee on Banking, Housing and Urban Affairs, Housing Finance Reform: Next Steps (Sept. 10, 2019).

[5] Senator Sherrod Brown (D-OH) argued that the Housing Reform Plan “will make mortgages more expensive and harder to get.” United States Senate Committee on Banking, Housing and Urban Affairs, Housing Finance Reform: Next Steps (Sept. 10, 2019). Similarly, a former Obama administration housing adviser argued that “[i]nvestors will be much pickier and charge more for the loans they are willing to invest in.” Andrew Ackerman and Kate Davidson, Trump Administration Aims to Privatize Fannie Mae and Freddie Mac, The Wall Street Journal (Sept. 5, 2019), available at https://www.wsj.com/articles/trump-administration-aims-to-privatize-fannie-mae-and-freddie-mac-11567717213.

[6] Senators Pat Toomey (R-PA) and Tom Cotton (R-AK) both spent their allotted times at the Senate Banking Committee Hearing discussing issues with state and local level regulations impeding affordable housing construction – as Senator Toomey stated, “[t]he primary driver is state and local regulations and it really does concern me the damage that’s being done to our economy and to affordability and access from these barriers. It’s causing a crisis in many parts of this country. We have to recognize that while the mortgage market and mortgage finance does play a role, it cannot fix this problem by itself.” Remarks of Sen. Pat Toomey, United States Senate Committee on Banking, Housing and Urban Affairs, Housing Finance Reform: Next Steps (Sept. 10, 2019).

[7] See, e.g., https://www.reuters.com/article/otc-cfpb/5th-circuit-holds-fhfa-structure-unconstitutional-boost-for-supreme-court-challenge-to-cfpb-idUSKCN1VU2D7.

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:

Matthew L. Biben – New York (+1 212-351-6300, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
James O. Springer – New York (+1 202-887-3516, [email protected])

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

On November 5, 2019, the U.S. Department of Justice announced the creation of the Procurement Collusion Strike Force to combat antitrust violations and other crimes affecting government purchasing and programs at the federal, state, and local levels.

Assistant Attorney General Makan Delrahim, head of the Antitrust Division, explained that the new Strike Force will have dedicated prosecutors from the Antitrust Division and U.S. Attorneys’ Offices, personnel from Inspector General offices (including the Department of Defense and the General Services Administration), and FBI special agents assigned to 13 districts located in the District of Columbia and eleven states. AAG Delrahim said these Strike Force teams will be tasked with investigating and prosecuting suspected procurement misconduct using a variety of federal laws, including antitrust, False Claims Act, and other statutes governing fraudulent behavior in the procurement process.

As part of this effort, the Strike Force is training U.S. Attorneys’ Offices, Inspector General offices, and state and local government procurement officials about indicia of potential collusion during the procurement process. The Strike Force also intends to train government contractors and trade associations to raise awareness of the potential penalties for criminal and civil antitrust violations—including significant fines for corporations and imprisonment for individuals. The Strike Force is also soliciting whistleblower complaints about potential procurement violations through a new web-based reporting system and plans to invest in improved data analytics to detect potential irregularities in government procurement data.

The Strike Force builds on DOJ’s successful deployment of strike forces in the past targeting specific enforcement priorities. The Health Care Fraud Strike Force, for example, has been in operation for more than a decade and resulted in charges against more than 4,200 defendants involved in nearly $19 billion in Medicare program billings. More recent initiatives have focused on elder fraud and organized crime. These strike forces have generally proven successful in concentrating federal enforcement resources on a high priority issue, thereby creating pressure for prosecutors to deliver cases. As a result, we expect to see substantially increased enforcement activity around government procurement over the next 12 to 18 months.

We expect the new Strike Force to be an enforcement priority given the Antitrust Division’s increasing activity in government procurement over the past year. At present, more than one-third of the Antitrust Division’s 100-plus open grand jury investigations involve public procurement or conduct that included the government among its potential victims. And when these cases result in criminal resolutions, DOJ has been aggressive in leveraging the False Claims Act and other federal laws to secure additional damages for alleged harm to government agencies. In two recent cases involving military fuel contracts and generic pharmaceuticals, DOJ obtained civil damages for harm to government agencies that dwarfed the criminal fines imposed for the underlying antitrust violation. We expect this approach to be replicated by the Strike Force teams and, when a criminal conviction is obtained, offenders may face debarment as well as substantial fines and damages.

Companies involved in government procurement should use this opportunity to revisit their antitrust policies and training programs to mitigate any legal risks that result from DOJ’s increased enforcement efforts.

Gibson Dunn will be hosting a webcast on Wednesday, December 4th at 12:00pm EST to discuss the Procurement Collusion Strike Force in more detail, including (i) the risk factors and red flags in competitive bids that may attract attention from the new Strike Force teams and (ii) proactive steps that in-house counsel should be taking now to prepare for DOJ’s increased enforcement efforts.

To register, please click here: https://gibsondunnevents.webex.com/mw3300/mywebex/default.do?siteurl=gibsondunnevents

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition, False Claims Act or Government Contracts practice groups, or any of the following authors:

Kristen C. Limarzi – Washington, D.C. (+1 202-887-3518, [email protected])
Scott D. Hammond – Washington, D.C. (+1 202-887-3684, [email protected])
Rachel S. Brass – San Francisco (+1 415-393-8293, [email protected])
Jeremy Robison – Washington, D.C. (+1 202-955-8518, [email protected])
Chris Wilson – Washington, D.C. (+1 202-955-8520, [email protected])
Jonathan M. Phillips – Washington, D.C. (+1 202-887-3546, [email protected])
Joseph D. West – Washington, D.C. (+1 202-955-8658, [email protected])
Lindsay M. Paulin – Washington, D.C. (+1 202-887-3701, [email protected])

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

Antitrust and Competition Group:

Washington, D.C.
D. Jarrett Arp (+1 202-955-8678, [email protected])
Adam Di Vincenzo (+1 202-887-3704, [email protected])
Scott D. Hammond (+1 202-887-3684, [email protected])
Kristen C. Limarzi (+1 202-887-3518, [email protected])
Joshua Lipton (+1 202-955-8226, [email protected])
Richard G. Parker (+1 202-955-8503, [email protected])
Cynthia Richman (+1 202-955-8234, [email protected])
Jeremy Robison (+1 202-955-8518, [email protected])
Chris Wilson (+1 202-955-8520, [email protected])

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

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

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

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

Brussels
Peter Alexiadis (+32 2 554 7200, [email protected])
Jens-Olrik Murach (+32 2 554 7240, [email protected])
Christian Riis-Madsen (+32 2 554 72 05, [email protected])
Lena Sandberg (+32 2 554 72 60, [email protected])
David Wood (+32 2 554 7210, [email protected])

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

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

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

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The German Ministry of Economics and Energy (the “Ministry”) is suggesting a significant revamp of the country’s competition rules, targeting the increased scrutiny of digital platforms.

In October, the Ministry published the Act on Digitalisation of German Competition Law (“GWB-Digitalisierungsgesetz”). The new rules shall enter into force in 2020, after the draft has passed through Parliament. Parliament might request changes to the draft bill. However, it can be expected that the main principles will become applicable law. This briefing focuses on the proposed provisions that specifically target digital platforms.[1]

Germany has always had stricter rules than EU law on the control of unilateral behaviour of companies. Under German law, not only dominant companies but also companies with ‘relative market power’ i.e. companies on which SME’s as suppliers or purchasers depend, are subject to the same strict behavioural rules as dominant companies. The draft bill seeks to widen that concept.

“Digitalisation” of the abuse of dominance rules. The draft bill suggests that a company’s access to data shall be laid down in the law as a relevant element for the assessment of market dominance. Furthermore, the importance of the services offered by an intermediary on multi-sided markets (vulgo: digital platforms) for other companies’ access to supply and sales markets shall be taken into account for the assessment of such intermediary’s market position. The refusal to grant other companies access to data shall, under certain circumstances, be considered an abuse of dominance by the intermediary.
Giving up the ‘SME’ requirement for determining ‘relative market power’. The draft bill also suggests foregoing the SME requirement for determining ‘relative market power’ so that, going forward, also larger enterprises could claim to depend on platforms. In particular, the draft bill suggests that ‘relative market power’ may arise from the fact that a company depends on access to data controlled by another company and that the refusal to grant access to that data may constitute an impediment to competition, even if the data does not yet have commercial value.
Introduction of a new type of market power. To facilitate the scrutiny of digital platforms that cannot be found either to be dominant or to possess ‘relative market power’, the draft suggests a new form of market power, namely a company with ‘paramount significance for competition across markets’ (vulgo: successful digital platforms). If a company has that significance, the competition authority shall get the power to prohibit: preferential treatment of own services; the impediment of competition on markets where the intermediary is not dominant; the creation of entry barriers by the use of data collected on a dominated market; or the restriction of the interoperability of products, services or data.
Easier interim measures. These proposed substantive changes are accompanied by the suggestion to allow Germany’s competition authority to step-in with interim measures already based on the probable cause of an infringement (if it deems the order necessary for the protection of competition or because of an imminent threat of serious harm on another undertaking).

The direction of the draft bill is clear. It is looking to codify tools that allow for greater scrutiny of digital platforms, with a particular focus on their specific business models/roles as digital intermediaries and their access to data. The draft explicitly introduces data as an essential facility, similar to the treatment that traditionally applies for example to harbours or railway infrastructure. Although, unlike such infrastructure, data is not a facility whose access is limited in nature but is rather reproducible. As the President of the Bundeskartellamt, Andreas Mundt, stated in a recent interview the goal of the bill is to “crack open data treasures.”[2]

It remains to be seen whether the introduction of new legal concepts and vague terms and of a relatively low threshold for the authority to take action will facilitate faster and more robust decisions, whilst allowing sufficient legal certainty and ensuring a reliable legal framework for the digital economy. These new rules could as well result in an increase in litigation (e.g. against the authority’s measures) and, potentially, the inconsistent application of competition rules across the EU.

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[1] The draft bill also suggests other changes to the country’s competition rules concerning e.g. the merger control thresholds, antitrust investigation procedure, leniency and cartel damage claims.

[2] Interview of 16 September 2018 with the German Frankfurter Allgemeine Zeitung newspaper.

The following Gibson Dunn lawyers assisted in preparing this client update: Jens-Olrik Murach.

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

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

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

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

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

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

On November 6, 2019, the IRS released its cost-of-living adjustments applicable to tax-qualified retirement plans for 2020. Many of the key limitations, including the elective deferral and catch-up contribution limits for employees who participate in 401(k), 403(b) and 457 tax-qualified retirement plans, have increased from current levels.

The key 2020 limits are as follows:

Limitation	2020 Limit
402(g) Limit on Employee Elective Deferrals (Note: This is relevant for 401(k), 403(b) and 457 plans, and for certain limited purposes under Code Section 409A.)	$19,500 ($19,000 for 2019)
414(v) Limit on “Catch-Up Contributions” for Employees Age 50 and Older (Note: This is relevant for 401(k), 403(b) and 457 plans.)	$6,500 ($6,000 for 2019)
401(a)(17) Limit on Includible Compensation (Note: This applies to compensation taken into account in determining contributions or benefits under qualified plans. It also impacts the “two times/two years” exclusion from Code Section 409A coverage of payments made solely in connection with involuntary terminations of employment.)	$285,000 ($280,000 for 2019)
415(c) Limit on Annual Additions Under a Defined Contribution Plan	$57,000 (or, if less, 100% of compensation) ($56,000 for 2019)
415(b) Limit on Annual Age 65 Annuity Benefits Payable Under a Defined Benefit Plan	$230,000 (or, if less, 100% of average “high 3” compensation) ($225,000 for 2019)
414(q) Dollar Amount for Determining Highly Compensated Employee Status	$130,000 ($125,000 for 2019)
416(i) Officer Compensation Amount for “Top-Heavy” Determination (Note: Because Code Section 409A defines “specified employees” of public companies by reference to this provision, this amount also affects the specified employee determination, and thus, the group subject to the six-month delay under Code Section 409A.)	$185,000 ($180,000 for 2019)
Social Security “Wage Base” for Plans Integrated with Social Security	$137,700 ($132,900 for 2019)

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

Stephen W. Fackler – Palo Alto/New York (+1 650-849-5385/+1 212-351-2392, [email protected])
Michael J. Collins – Washington, D.C. (+1 202-887-3551, [email protected])
Sean C. Feller – Los Angeles (+1 310-551-8746, [email protected])
Krista Hanvey – Dallas (+ 214-698-3425, [email protected])

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

This update provides an overview and summary of key class action developments during the third quarter of 2019 (July through September).

Part I discusses varying approaches to assessing damages at the class certification stage.
Part II addresses developments in class settlements law, including pre-certification negotiations and cy pres-only settlements.
Part III reviews further developments in the federal courts of appeals’ analysis of Article III standing under Spokeo, Inc. v. Robins, 136 S. Ct. 1540 (2016).
Part IV describes a recent California Supreme Court decision that rejected a strict interpretation of the state-law ascertainability requirement.

Part I: Federal Courts of Appeals Apply a Range of Approaches to Damages Proposals at the Class Certification Stage

Questions of how to measure a class’s damages—and what measures of damages lend themselves to classwide treatment—were addressed in several decisions during the last quarter. In each case, the courts evinced sensitivity toward the issue of individualized damages, but responded to those arguments quite differently.

In Nguyen v. Nissan North America, Inc., 932 F.3d 811 (9th Cir. 2019), a consumer brought a class action against an automobile manufacturer under state and federal law, alleging defects with the vehicle’s clutch. Id. at 813–14. The plaintiff sought class certification, arguing that his damages model—which proposed that every class member receive damages equal to the cost of a replacement clutch—was “based on the economic principle of benefit-of-the-bargain and is consistent with [his] theory of liability.” Id. at 815. The district court rejected that model because “the difference between value represented and value received only equals the cost to replace the defective [system] if consumers would have deemed the defective part valueless.” Id. at 816 (citation omitted). Because putative class members drove their vehicles for varying amounts of miles before experiencing the defect, the district court found that the plaintiff had not satisfied the predominance requirement. Id.

The Ninth Circuit reversed. The plaintiff’s theory was not that the clutch performed below his expectations—rather, the theory was that the clutch was per se defective. Accordingly, the court held that a benefit-of-the-bargain model satisfied Rule 23(b)(3)’s predominance requirement. 932 F.3d at 821–22. The Ninth Circuit explained that the “district court mischaracterized Plaintiff’s theory as being centered on performance issues, rather than the defective system itself.” Id. at 819. The court clarified that the “liability-triggering event” would be “the sale of the vehicle with the known defect,” not “when the [alleged defect] manifests.” Id. at 820. The court believed that “[t]his distinction is key”—under past precedent, individualized issues would predominate if plaintiffs sought “damages for the faulty performance of the clutch system.” Id. at 822. “Instead, Plaintiff’s theory is that the allegedly defective clutch is itself the injury, regardless of whether the faulty clutch caused performance issues.” Id.

In re Rail Freight Fuel Surcharge Antitrust Litigation, 934 F.3d 619 (D.C. Cir. 2019), wrestled with a different issue—namely, whether a class can be certified where a damages model shows not only variable damages, but also that some class members suffered no harm or damage at all. Id. at 620. The plaintiffs sought class certification under Rule 23(b)(3), and submitted an expert report that contained a regression model to establish causation, injury, and damages on a classwide basis. Id. at 621–22. The damages model indicated that approximately 2,000 putative class members (about 12.7% of the class) suffered no harm. Id. at 623–24. The district court determined that this model did not satisfy Rule 23(b)(3)’s predominance requirement, reasoning that “even assuming the model can reliably show injury and causation for 87.3 percent,” there was “no common proof of those essential elements of liability for the remaining 12.7 percent.” Id. at 623–24.

The D.C. Circuit affirmed the denial of class certification. Pursuant to Comcast Corp. v. Behrend, 569 U.S. 27 (2013), courts must take a “hard look at the soundness of statistical models that purport to show predominance.” Rail Freight, 934 F.3d at 621. Because the plaintiffs must prove through common evidence “that all class members were in fact injured” by the alleged violation, the court took a “hard look” and reasoned that the regression damages model did not satisfy the predominance requirement. Id. at 623–26. This insufficiency was confirmed by plaintiffs’ failure to propose any “winnowing mechanism” to prevent uninjured class members from recovering. Id. at 625. (Gibson Dunn represented BNSF Railway Company in this matter.)

In AA Suncoast Chiropractic Clinic, P.A. v. Progressive America Insurance Co., 938 F.3d 1170 (11th Cir. 2019), the Eleventh Circuit considered another recurring issue: whether and when a court can certify a Rule 23(b)(2) class in a case where the plaintiffs are also seeking damages. In AA Suncoast, healthcare providers brought a putative class action against an insurance company, alleging that the insurer was improperly reducing its policy limits based on the opinions of non-treating physicians. 938 F.3d at 1172. The plaintiffs sought damages for past coverage reductions, as well as an injunction that would have restored the higher coverage limit for previously affected policies. Id. at 1173. The district court certified an “injunction class” under Rule 23(b)(2), but denied certification of a “damages subclass” under Rule 23(b)(3), which would have required “each and every member of the damages subclass” to “establish an individualized entitlement to damages . . . .” Id. at 1175.

The Eleventh Circuit reversed, holding that the “injunction class” was actually a “damages subclass” seeking to evade Rule 23(b)(3)’s predominance and superiority requirements. 938 F.3d at 1175. The injunction class sought only to rectify past injuries, not enjoin future harm. Id. In fact, the injunction was “not an injunction at all” because it was “not designed to address the treatment of future claims”; it aimed to require the defendant to reimburse the plaintiffs for prior harms. Id. Certifying this class under Rule 23(b)(2) was improper because it “sidestep[ped] the Rule 23(b)(3) problems by shaving away all the issues that would require individualized determinations.” Id.

Nguyen, Rail Freight, and AA Suncoast each illustrate the general theme that courts can and should look beyond the parties’ arguments to determine the true nature of the damages alleged, and whether they might be amenable to classwide treatment.

Part II: Courts Show Flexibility in Assessing Class Action Settlements

The courts of appeals continue to actively police the process and remedies arising out of class action settlements. In the past quarter, the Ninth Circuit declined to overrule a standing order from a Northern District of California judge that bars pre-certification class settlement negotiations, and the Third Circuit declined to adopt a rule that would categorically bar cy pres remedies in Rule 23(b)(2) class actions.

Many courts have warned of the need to be “particularly vigilant of pre-certification class action settlements.” Dennis v. Kellogg Co., 697 F.3d 858, 868 (9th Cir. 2012) (citation omitted). But in the Northern District of California, Judge William Alsup has gone so far as to ban them altogether via a standing order. In a decision issued this past quarter, the Ninth Circuit denied a mandamus petition challenging this standing order on various grounds. In re Logitech, Inc., No. 19-70248, 2019 WL 4319012 (9th Cir. Sept. 12, 2019).

The panel determined that the standing order was not clearly erroneous, in part because Rule 23 “explicitly contemplates the simultaneous certification of a class and settlement, albeit with permissive and not mandatory language.” 2019 WL 4319012 at *1. The court further acknowledged that “sections of Rule 23 provide district courts with wide discretion, including the factors to be considered in the appointment of class counsel, which is required before a class can be certified and settled.” Id. (citing Fed. R. Civ. P. 23(g)(1)(A)–(B)). Given this wide discretion and Rule 23’s “lack of mandatory class settlement language,” the Ninth Circuit could not “say the [o]rder’s prohibition on class negotiations before certification is clear error.” Id.

The Ninth Circuit next determined that Judge Alsup’s standing order did not violate the principles enunciated in Gulf Oil Co. v. Bernard, 452 U.S. 89 (1981), which stated that “any restriction on communications [with putative class members] that would frustrate the policies of Rule 23 must follow ‘a specific record showing . . . the particular abuses . . . threatened’ and the district court must ‘give explicit consideration to the narrowest possible relief which would protect the respective parties.’” Logitech, 2019 WL 4319012, at *1 (quoting Gulf Oil, 452 U.S. at 102). The Ninth Circuit acknowledged that the district court had made no “specific findings of the abuses [n]or explicitly consider[ed] narrower means of protecting the parties from any abuses threatened by pre-certification class negotiations,” but nevertheless determined that the order did not “amount to clear error.” Id.

Finally, the Ninth Circuit determined that there was no violation of the defendant’s First Amendment rights, reasoning that “[e]ven if the [o]rder ‘involved serious restraints on expression,’ it is unclear whether the expression is protected by the First Amendment.” 2019 WL 4319012 at *1. (quoting Gulf Oil, 452 U.S. at 103–04). Settlement discussions “may not be protected speech because [a defendant] does not have a right to negotiate with absent, unrepresented, potential class members before there is a class or interim class counsel.” Id. (citation omitted).

In another class settlement decision, the Third Circuit confronted cy pres issues. In re: Google Inc. Cookie Placement Consumer Privacy Litigation, 934 F.3d 316 (3d Cir. 2019), involved a putative class action alleging that Google violated the California Constitution and common law by using cookies that bypassed internet browser privacy settings. The parties reached a proposed settlement under which Google would “assure it had implemented systems configured to abate or delete all third-party Google cookies” and “pay $5.5 million, to be divided among the settlement administrator, class counsel, the named class representatives, and cy pres recipients.” Id. at 321 (citation omitted). In exchange, the plaintiffs would “release all class member claims, including for damages, that did or could stem from, or relate to, the subject matter of the litigation” on behalf of a settlement class comprising “all persons in America who used Safari or Internet Explorer web browsers and who visited a website from which . . . cookies were placed by the means alleged in the Complaint.” Id. (citation omitted).

The district court preliminarily certified the settlement class under Rule 23(b)(2). 934 F.3d at 323. Following a notice period, a lone objector—Ted Frank, who was both a party and counsel in Frank v. Gaos, 139 S. Ct. 1041 (2019), covered in the First Quarter 2019 Update—challenged the settlement because it prioritized cy pres over direct compensation to class members and because there was an alleged conflict of interest among Google, class counsel, and the cy pres recipients. In re: Google, 934 F.3d at 320. The district court approved the settlement, but the Third Circuit vacated that ruling and remanded. Id. at 329, 332.

The court first determined that the plaintiffs had Article III standing under Spokeo, Inc. v. Robins, 136 S. Ct. 1540 (2016), because “[h]istory and tradition reinforce that a concrete injury for Article III standing purposes occurs when Google, or any other third party, tracks a person’s internet browser activity without authorization,” and “[p]rivacy torts have become well-ensconced in the fabric of American law.” In re: Google, 934 F.3d at 325 (citation omitted).

The court then declined to adopt the objector’s proposed rule that cy pres-only settlements of Rule 23(b)(2) class actions are per se invalid. Although the objector’s “central argument on appeal is that cy pres awards should never be preferred over direct distributions to class members because the settlement fund properly ‘belongs’ to individual class members as monetary compensation for their injuries,” the court explained there is no rule “that requires district courts to approve only settlements that provide for direct class distributions” where doing so would be “economically infeasible.” Id. at 327–28. This is especially so with respect to a Rule 23(b)(2) class, which “assumes a single, ‘indivisible’ injunctive or declaratory remedy against the defendant,” such that there is “no reason why a cy pres-only (b)(2) settlement . . . could not ‘belong’ to the class as a whole, and not to individual class members as monetary compensation.” Id. at 328 (emphasis omitted).

**Part III: Spokeo Issues Continue to Percolate Throughout the Federal Courts**

The last quarter also saw further efforts by the federal courts of appeals to interpret the “concreteness” requirement in Spokeo, Inc. v. Robins, 136 S. Ct. 1540 (2016). As we have discussed in two prior updates, the appellate courts continue to grapple with the application of Spokeo under a wide range of consumer protection statutes, with unpredictable and often irreconcilable results from circuit to circuit.

A pair of decisions from the Eighth and Eleventh Circuits addressing the Telephone Consumer Protection Act (“TCPA”) is illustrative. In Salcedo v. Hanna, 936 F.3d 1162 (11th Cir. 2019), the Eleventh Circuit concluded that “a single unsolicited text message, sent in violation of” the TCPA, was not a “concrete injury in fact” sufficient to confer standing on a named plaintiff. Id. at 1165. The court distinguished a prior Eleventh Circuit decision that held that a single unsolicited fax was sufficient, reasoning that a text message “uses no paper, ink, or toner,” does not make the phone unavailable for other uses, and that there was no allegation of a charge by the wireless service provider. Id. at 1168. It further reasoned that Congress had “less . . . concern about calls to cell phones” than about residential land lines, and rejected arguments that such messages were akin to the historic torts of intrusion upon seclusion, nuisance, conversion, or trespass to chattel. Id. at 1169–72.

This decision deepens a circuit split on text messages: As we discussed in the last update, the Second Circuit also recently considered alleged injuries from unsolicited text messages and came to the opposite conclusion in Melito v. Experian Marketing Solutions, Inc., 923 F.3d 85 (2d Cir. 2019). This past quarter, the Eighth Circuit likewise found standing for a named plaintiff in a TCPA case based on “two telemarketing messages” left on an answering machine in Golan v. FreeEats.com, Inc., 930 F.3d 950, 959 (8th Cir. 2019). The court held that such calls “b[ore] a close relationship to the types of harms traditionally remedied by tort law, particularly the law of nuisance,” and further relied on the type of harm Congress sought to remedy with the statute. Id. (citations omitted). Although the injury was “intangible” and “minimal,” under that analysis, the plaintiff had standing. Id. at 958–59.

The Ninth Circuit has been more likely to uphold standing in these scenarios. In addition to concluding that standing existed under the TCPA in Van Patten v. Vertical Fitness Group, LLC, 847 F.3d 1037 (9th Cir. 2017), in the past quarter, the court also found standing for named plaintiffs alleging a violation of Illinois’s Biometric Information Privacy Act. Patel v. Facebook, Inc., 932 F.3d 1264 (9th Cir. 2019). The suit dealt with Facebook’s “Tag Suggestions” feature, which compares the faces in newly uploaded pictures to “faces in Facebook’s database of user face templates,” and prompts the user to “tag” the photo with the names of any matches. Id. at 1268. The plaintiffs alleged that this violated the Illinois statute because it “collect[ed], us[ed], and stor[ed] biometric identifiers . . . without obtaining a written release and without establishing a compliant retention schedule.” Id. (footnote omitted). The Ninth Circuit concluded that there was a concrete injury rooted in a broad right to privacy, pointing to “common law roots” for suits protecting such rights and Supreme Court decisions recognizing privacy rights in various contexts. Id. at 1271–74. Facebook has indicated that it intends to petition for certiorari.

As shown by these decisions, litigants (and courts) will continue to confront evolving and contradictory case law applying Spokeo, deepening circuit splits, and laying the foundation for future Supreme Court review.

Part IV: The California Supreme Court Softens Ascertainability Requirement

Finally, in July 2019, the California Supreme Court held that plaintiffs need not satisfy a strict “ascertainability” requirement to obtain class certification in California state courts.

In Noel v. Thrifty Payless, Inc., 7 Cal. 5th 955 (2019), plaintiff asserted violations of California’s broad consumer protection and false advertising laws, alleging that he had been misled about the true size of an inflatable plastic pool he had purchased. He sought certification of a class of “all persons who purchased the [pool] at a Rite Aid store located in California within the four years preceding the date of the filing of this action.” Id. at 962–63.

The trial court denied the named plaintiff’s motion for class certification on the grounds that he failed to adequately demonstrate how class members would be identified. 7 Cal. 5th at 963–65.

The California Court of Appeal affirmed, emphasizing that the named plaintiff had “submitted nothing offering a glimmer of insight into who purchased the pools or how one might find out” and failed to describe what, if any, retail transaction records existed that could facilitate identification of members of the proposed class. 7 Cal. 5th at 965 (citation omitted). Although the Court of Appeal acknowledged that the named plaintiff “was not required to actually identify the 20,000-plus individuals who bought pools,” it faulted him for failing “to come up with any means of identifying them . . . .” Id. (citations omitted).

But the California Supreme Court unanimously reversed and remanded, holding that the proposed class was sufficiently ascertainable because it was “defined ‘in terms of objective characteristics and common transactional facts’ that ma[de] ‘the ultimate identification of class members possible when that identification becomes necessary.’” 7 Cal. 5th at 974 (quoting Hicks v. Kaufman & Broad Home Corp., 89 Cal. App. 4th 908, 915 (2001)). The court concluded that this standard does not “import[] an additional evidentiary burden into the ascertainability requirement.” Id. at 967.

The court explained that this ascertainability standard was constitutional because “due process does not invariably require that personal notice be directed to all members of a class [or] that an individual member of a certified class must receive notice to be bound by a judgment.” 7 Cal. 5th at 984 (citation omitted). As a result, a class is ascertainable so long as it (1) “puts members of the class on notice that their rights may be adjudicated in the proceeding” and (2) “suppl[ies] a concrete basis for determining who will and will not be bound by (or benefit from) any judgment.” Id. at 980.

In applying this standard to the facts, the California Supreme Court determined that the proposed class definition was (1) “neither vague nor subjective,” (2) provided class members with adequate notice of their membership in the class, and (3) made “the res judicata consequences of a judgment clear, creating no ambiguity as to who will and will not be bound by the outcome.” 7 Cal. 5th at 987 (citation omitted). Consequently, the court ruled that the class was sufficiently ascertainable.

Importantly, however, the court emphasized the low cost of the products at issue ($59.99 each), which led it to surmise that “the odds that any class member will bring a duplicative individual action in the future are effectively zero.” 7 Cal. 5th at 985. As such, the court held that the choice presented was “between a class action and no lawsuits being brought at all. Under the circumstances, due process may not demand personal notice to individual class members, and to build a contrary assumption into the ascertainability requirement would be a mistake.” Id. (footnote omitted). It remains to be seen whether other courts will attempt to distinguish Noel on this basis when individual claims have potentially greater value.

The following Gibson Dunn lawyers prepared this client update: Christopher Chorba, Theane Evangelis, Kahn Scolnick, Bradley Hamburger, Lauren Blas, David Schnitzer, Andrew Kasabian, Kory Hines, and Timothy Kolesk.

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

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

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

New York partner Shukie Grossman, Los Angeles partner Jennifer Bellah Maguire, and Washington, D.C. partner C. William Thomas, Jr. are the authors of Chambers Alternative Funds 2019 Guide [PDF] published November 2019.

On October 31, 2019, the United States Court of Appeals for the Federal Circuit held that the statutory scheme of appointing Patent Trial and Appeal Board (PTAB) Administrative Patent Judges (APJs) violates the Appointments Clause of the United States Constitution.

The court in Arthrex, Inc. v. Smith & Nephew, Inc., No. 18-2140, 2019 WL 5616010 (Fed. Cir. Oct. 31, 2019), ruled that APJs are “principal officers” because neither the Secretary of Commerce nor the Director of the PTO (the two executive branch officials who appoint and monitor APJs) “exercises sufficient direction and supervision over APJs to render them inferior officers.” Id. at *4. APJs are appointed by the Secretary of Commerce, whereas the Constitution requires principal officers to be appointed by the President with the advice and consent of the Senate.

To cure the identified constitutional violation, the Arthrex court held that the Director of the PTO must be permitted to remove APJs without cause. This, the court held, allows APJs to be prospectively classified as inferior officers (and hence, appropriately appointed by the Secretary of Commerce). Without reaching the merits of the appeal before it, the Arthrex panel vacated and remanded the Board’s decision that twelve of Arthrex’s patent claims were anticipated.

This decision could have substantial impact on pending proceedings before the PTAB as well as pending appeals from PTAB final written decisions and related district court actions.

I. The Federal Circuit’s Decision

Set forth below is a summary of the governing Supreme Court case law interpreting the Appointments Clause, the Federal Circuit’s decision that the APJs are principal officers under the Appointments Clause, and the court’s severance analysis and imposed remedy.

The Appointments Clause. The Appointments Clause provides in pertinent part that the President

shall nominate, and by and with the Advice and Consent of the Senate, shall appoint . . . all . . . Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law: but the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.

U.S. Const. art. II, § 2, cl. 2.

The Supreme Court applies a two-part framework to identify “Officers of the United States,” who are subject to the Appointments Clause, and to distinguish them from mere “employees,” who are not. First, “an individual must occupy a ‘continuing’ position established by law to qualify as an officer.” Lucia v. SEC, 138 S. Ct. 2044, 2051 (2018) (quoting United States v. Germaine, 99 U.S. 508, 511 (1878)). Second, the individual must “exercis[e] significant authority pursuant to the laws of the United States.” Id. (quoting Buckley v. Valeo, 424 U.S. 1, 126 (1976) (per curiam)).

In Buckley v. Valeo, the Supreme Court held that members of the Federal Election Commission qualified as officers of the United States because they exercised “extensive rulemaking and adjudicative powers,” including the authority to enforce campaign finance law through civil lawsuits and to disqualify candidates for federal office. 424 U.S. at 110–12, 126. In Freytag v. Commissioner, 501 U.S. 868 (1991), the Court held that Special Trial Judges appointed by the Chief Judge of the Tax Court were officers by virtue of their “significant authority” to “take testimony, conduct trials, rule on the admissibility of evidence, and . . . enforce compliance with discovery orders.” Id. at 881–82.

Most recently, in Lucia v. SEC, the Court held that Administrative Law Judges (ALJs) of the Securities and Exchange Commission were officers of the United States, because the ALJs were essentially indistinguishable from—“near carbon-copies of”—the Special Trial Judges addressed in Freytag. 138 S. Ct. at 2052. For that reason, the Court found it unnecessary to elaborate on the “significant authority” test applied in Buckley and Freytag, although several Justices wrote separately to suggest modifications of the standard. See id. at 2056 (Thomas, J., joined by Gorsuch, J., concurring); id. at 2057 (Breyer, J., concurring in the judgment in part and dissenting in part); id. at 2064 (Sotomayor, J., joined by Ginsburg, J., dissenting).

The Supreme Court also has addressed the Appointments Clause’s further distinction between principal officers (who must be appointed by the President and confirmed by the Senate) and inferior officers (whose appointment Congress may vest elsewhere). “Generally speaking, the term ‘inferior officer’ connotes a relationship with some higher ranking officer or officers below the President: Whether one is an ‘inferior’ officer depends on whether he has a superior,” meaning that one’s “work is directed and supervised at some level by others who were appointed by Presidential nomination with the advice and consent of the Senate.” Edmond v. United States, 520 U.S. 651, 662–63 (1997).

Thus, the Court held in Edmond v. United States that judges of the Coast Guard Court of Criminal Appeals are inferior officers “by reason of the supervision over their work exercised by the General Counsel of the Department of Transportation in his capacity as Judge Advocate General and the Court of Appeals for the Armed Forces.” 520 U.S. at 666. Although these superiors did not exercise “complete” control over the judges’ work, the Court found two factors particularly significant: the superiors had the power to “remove a Court of Criminal Appeals judge from his judicial assignment without cause,” and the judges had “no power to render a final decision on behalf of the United States unless permitted to do so by other Executive officers.” Id. at 664–65.

The Court more recently applied the same approach to members of the Public Company Accounting Oversight Board in Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477 (2010). “Given that the [Securities and Exchange] Commission is properly viewed, under the Constitution, as possessing the power to remove Board members at will, and given the Commission’s other oversight authority,” the Court in Free Enterprise Fund had “no hesitation in concluding that under Edmond the Board members are inferior officers.” Id. at 510.

In the past, the Supreme Court emphasized that it had “not set forth an exclusive criterion” or a “definitive test” to distinguish principal from inferior officers. Edmond, 520 U.S. at 661. Besides control and supervision by a superior, other factors indicating inferior status may include an individual’s “limited duties,” “narrow” jurisdiction, and “limited” tenure. Id. (citing Morrison v. Olson, 487 U.S. 654, 671–72 (1988)). In Free Enterprise Fund, however, the Court’s analysis rested exclusively on the control-and-supervision question that Edmond identified as “[g]enerally” controlling. 561 U.S. at 510. Some have read the Court’s cases since Edmond as implicitly repudiating the previous multifactor approach. See, e.g., NLRB v. SW Gen., Inc., 137 S. Ct. 929, 947 n.2 (2017) (Thomas, J., concurring); Aurelius Inv., LLC v. Puerto Rico, 915 F.3d 838, 860 n.15 (1st Cir.), cert. granted, 139 S. Ct. 2738 (2019); Intercollegiate Broad. Sys., Inc. v. Copyright Royalty Bd., 684 F.3d 1332, 1337 (D.C. Cir. 2012), cert. denied, 133 S. Ct. 2735 (2013). For now, control and supervision appear to be the predominant criteria that distinguish inferior officers under the Appointments Clause.

In particular, the precedents in this area have often focused on the ability to remove subordinates from office: “[t]he power to remove officers, we have recognized, is a powerful tool for control.” Edmond, 520 U.S. at 664. Even beyond the question of principal or inferior officer status, the availability of removal has broad implications rooted in the separation of powers. For example, the Supreme Court in Free Enterprise Fund interpreted Article II’s vesting clause to prohibit the statutory institution of “multilevel protection from removal,” which would restrict the President’s “ability to remove a principal officer, who is in turn restricted in his ability to remove an inferior officer, even though that inferior officer determines the policy and enforces the laws of the United States.” 561 U.S. at 484. Here, as in the Appointments Clause cases, removal is ultimately important as a means to ensure accountability: “The President cannot ‘take Care that the Laws be faithfully executed’ if he cannot oversee the faithfulness of the officers who execute them.” Id.

APJs as Principal Officers. The Arthrex panel had little trouble concluding that APJs are officers of the United States, like the Special Trial Judges in Freytag and the ALJs in Lucia, because they exercise significant authority to conduct inter partes review and issue final written decisions on patentability. Indeed, no party disputed that conclusion. Arthrex, 2019 WL 5616010, at *3. The more difficult question was whether APJs are “principal” or “inferior” officers.

Congress vested appointment of APJs in the Secretary of Commerce—the Head of a Department under the Appointments Clause—in consultation with the Director of the PTO. 35 U.S.C. § 6(a). As a result, the APJs’ appointment is constitutional only if APJs are inferior officers (because, if they are principal officers, presidential nomination and Senate confirmation would be required).

But the panel held that, “in light of the rights and responsibilities in Title 35, APJs are principal officers.” Arthrex, 2019 WL 5616010, at *3. Applying the Supreme Court’s precedents in Edmond and Free Enterprise Fund, the panel noted that “[t]he only two presidentially-appointed officers that provide direction to the PTO are the Secretary of Commerce and the Director,” and concluded that “[n]either of those officers individually nor combined exercises sufficient direction and supervision over APJs to render them inferior officers.” Id. at *4.

As the panel read the governing precedents, “[t]he extent of direction or control in that relationship is the central consideration, as opposed to just the relative rank of the officers, because the ultimate concern is ‘preserv[ing] political accountability.’” Arthrex, 2019 WL 5616010, at *4 (second alteration in original) (quoting Edmond, 520 U.S. at 663). In particular, the panel understood Edmond as “emphasiz[ing] three factors” that are “strong indicators of the level of control and supervision appointed officials have over the officers and their decision-making”:

(1) whether an appointed official has the power to review and reverse the officers’ decision;

(2) the level of supervision and oversight an appointed official has over the officers; and

(3) the appointed official’s power to remove the officers.

Arthrex, 2019 WL 5616010, at *4. The panel borrowed this three-part formulation from the D.C. Circuit’s decision in Intercollegiate Broadcasting System, Inc. v. Copyright Royalty Board, which applied the test to hold that Copyright Royalty Judges are principal officers under Edmond. 684 F.3d at 1338–40.

In Arthrex, the panel determined that the first and third control-and-supervision factors supported the conclusion that APJs are principal officers, while the second did not.

As to the first factor, “[n]o presidentially-appointed officer has independent statutory authority to review a final written decision by the APJs before the decision issues on behalf of the United States.” Arthrex, 2019 WL 5616010, at *4. Although the Director may influence or control various aspects of the process of inter partes review, that official conspicuously lacks “sole authority to review or vacate any decision by a panel of APJs.” Id. at *5. That distinction made Arthrex “critically different from the [situation] in Edmond,” where superior officers possessed authority to reverse and order review of decisions by the military judges at issue, who had “no power to render a final decision on behalf of the United States unless permitted to do so by other Executive officers.” Id. at *5 (internal quotation omitted). The Arthrex panel accordingly counted the first factor in support of the conclusion that APJs are principal officers.

On the other hand, the second factor weighed in favor of finding the APJs to be inferior officers, because, in the panel’s view, the PTO Director “exercises a broad policy-direction and supervisory authority over the APJs.” Arthrex, 2019 WL 5616010, at *5. That authority includes powers to issue policy directives guiding APJs’ decisionmaking, designate PTAB decisions as precedential and hence binding on future APJ panels, institute inter partes review, designate the panel of judges to decide each review, and adjust APJs’ pay. Id. at *5–6. The Arthrex panel deemed this oversight comparable to the supervisory authority exercised over the military judges in Edmond and the Copyright Royalty Judges in Intercollegiate.

However, the third factor reinforced the Arthrex panel’s conclusion that APJs are principal officers. The governing statute provided that APJs “may be removed ‘only for such cause as will promote the efficiency of the service,’” meaning that none of their superiors possessed “unfettered removal authority” over them. Arthrex, 2019 WL 5616010, at *7 (quoting 5 U.S.C. § 7513(a)). The government, which had intervened in the case, argued that the governing statute implicitly granted the Director the power to “de-designate” APJs assigned to particular panels, as a corollary to the statutory power to designate inter partes panel membership in the first instance. But the Arthrex panel expressed reluctance to read the statute as granting that power, which it feared “could create a Due Process problem.” Id. at *6 & n.3. In any event, the panel held that the existence of such authority “would not change the outcome,” because “[t]he Director’s authority to assign certain APJs to certain panels is not the same as the authority to remove an APJ from judicial service without cause”—a much more “powerful” form of control, present in Edmond and lacking here. Id.

On balance, the Arthrex panel concluded that the relative lack of effective control and supervision over APJs qualified them as principal officers. The panel acknowledged the possible relevance of other factors beyond the three-part test distilled from Edmond, but found such factors “completely absent here”: “the APJs do not have limited tenure, limited duties, or limited jurisdiction.” Arthrex, 2019 WL 5616010, at *8. In sum, like the Copyright Royalty Judges in Intercollegiate, “the control and supervision of the APJs is not sufficient to render them inferior officers.” Id. “As such, they must be appointed by the President and confirmed by the Senate; because they are not, the current structure of the Board violates the Appointments Clause.” Id.

Severance and Remedy. Having concluded that the PTAB’s statutory structure violated the Appointments Clause, the Arthrex panel turned to the question of severability. The panel concluded that the “narrowest viable approach to remedying the violation” was to rule the statutory provision of for-cause removal to be unconstitutional as applied to APJs. Arthrex, 2019 WL 5616010, at *9. Specifically, the panel held unconstitutional the application to APJs of 35 U.S.C. § 3(c), which subjects PTO officers and employees to the provisions of title 5 of the United States Code, including the for-cause removal provision in 5 U.S.C. § 7513(a). For-cause removal generally prevents the President or principal officer from removing a subordinate officer for mere differences of opinion on policy, and thus limits the President or principal officer’s ability to control the subordinate. The government had suggested several other possible ways to cure the constitutional violation, but the panel rejected them as untenable under the statutory language and the Supreme Court’s severability precedents.

The panel characterized its severability holding as “follow[ing] the Supreme Court’s approach in Free Enterprise Fund” and the D.C. Circuit’s approach in Intercollegiate, both of which cured constitutional violations by “sever[ing] the problematic ‘for-cause’ restriction from the statue rather than holding the larger structure . . . unconstitutional.” Arthrex, 2019 WL 5616010, at *9. As the D.C. Circuit had held in Intercollegiate, the Arthrex panel determined that giving the APJs’ superiors at-will removal power “was enough to render the [APJs] inferior officers,” and so legitimize, prospectively, their appointment by the Secretary (a Department Head) under the Appointments Clause on a prospective basis. Id.

“Because the Board’s decision in this case was made by a panel of APJs that were not constitutionally appointed at the time the decision was rendered,” the panel “vacate[d] and remand[ed] the Board’s decision without reaching the merits.” Arthrex, 2019 WL 5616010, at *11. The panel also held that on remand “a new panel of APJs must be designated and a new hearing granted.” Id. at *12. In so doing, the panel cited the remedial holding of Lucia, which directed a new hearing before a different ALJ in part because “Appointments Clause remedies are designed . . . to create ‘[]incentive[s]’ to raise Appointments Clause challenges.” Lucia, 138 S. Ct. at 2055 (alterations in original) (quoting Ryder v. United States, 515 U.S. 177, 183 (1995)). Under Lucia, the panel reasoned, “the remedy is not to vacate and remand for the same Board judges to rubber-stamp their earlier unconstitutionally rendered decision.” Arthrex, 2019 WL 5616010, at *12.

However, the panel clarified that the underlying decision to institute the inter partes review “is not suspect” on remand, because the identified constitutional violation did not undermine the Director’s institution authority under 35 U.S.C. § 314. Arthrex, 2019 WL 5616010, at *12. The panel also stated that it saw “no error in the new panel proceeding on the existing written record,” but left “to the Board’s sound discretion whether it should allow additional briefing or reopen the record in any individual case.” Id. In this, the panel once more followed the example of the D.C. Circuit, which permitted the remand in Intercollegiate to proceed on the existing record. See Intercollegiate Broad. Sys., Inc. v. Copyright Royalty Bd., 796 F.3d 111, 116–21 (D.C. Cir. 2015).

II. Further Potential Appellate Proceedings in Arthrex

Rehearing. Because the government is an intervenor in Arthrex, the Federal Rules of Appellate Procedure give the parties 45 days to file petitions for panel rehearing or rehearing en banc. See Fed. R. App. P. 35(c), 40(a)(1); see also Federal Circuit Rule 40(e). The government cannot file such a petition without the Solicitor General’s approval. See 28 C.F.R. § 0.20(b). But the Department of Justice has already suggested that a petition for rehearing en banc may be forthcoming. In a number of pending cases, the government’s lawyers have asked the Federal Circuit to refrain from issuing a final decision until the court resolves “any petitions for rehearing that the parties in Arthrex may choose to file.” See, e.g., Citation of Supplemental Authority for Intervenor United States, Image Processing Techs. v. Samsung Elecs. Co., No. 19-1408 (Fed. Cir. Nov. 1, 2019), ECF No. 52.

Certiorari. The parties also may seek a writ of certiorari from the Supreme Court. If there is no petition for rehearing en banc, the parties will have 90 days from the date of judgment to petition for certiorari. Sup. Ct. R. 13.1. But if a petition for rehearing is filed, the 90-day clock will run from the date of the Federal Circuit’s denial of rehearing or, if rehearing is granted, the subsequent entry of judgment. Sup. Ct. R. 13.3. Upon application by the aggrieved party, the Circuit Justice responsible for the Federal Circuit—Chief Justice Roberts—can extend the time to file a petition for up to 60 additional days. Sup. Ct. R. 13.5.

While the grant rate for certiorari petitions is below 1%, the Supreme Court in recent years has shown an increased appetite for cases presenting Appointments Clause challenges. See Aurelius Inv., LLC v. Puerto Rico, 139 S. Ct. 2736 (2019); Lucia v. SEC, 138 S. Ct. 2044 (2018); Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477 (2010).

Challenges to Panel Decision. If the government seeks rehearing or certiorari review, it is likely to focus on at least two aspects of the panel’s decision. (The private parties may also raise these or other arguments.)

First, the government seems likely to challenge the panel’s conclusion that APJs are “principal” officers, rather than “inferior” officers. The distinction is significant because, as noted, if APJs are inferior officers, then their existing appointments by the Head of a Department would have been constitutional. Second, the government may argue that even if APJs are principal officers who were not appointed consistent with the Appointments Clause, the objecting party is not entitled to a new inter partes review hearing because it did not raise the issue before the Board.

The government, through the Solicitor General, also may question the panel’s conclusion that severing the removal restrictions for APJs transformed them from principal officers to inferior officers for purposes of compliance with the Appointments Clause. The Supreme Court has not expressly held that the judicial remedy of severance can transform a principal officer into an inferior officer, and the severability remedy remains controversial. See, e.g., Murphy v. NCAA, 138 S. Ct. 1461, 1485, 1487 (2018) (Thomas, J., concurring) (expressing “my growing discomfort with our modern severability precedents” because they are “in tension with longstanding limits on the judicial power”). To be sure, the government itself recommended this severability remedy to the panel in Arthrex. However, it is unclear to what extent the Solicitor General will agree with that remedy if the case is reheard by the Federal Circuit or argued to the Supreme Court. In the Lucia case, for example, the Solicitor General expressly disagreed with positions taken by lawyers from the Securities and Exchange Commission on the constitutionality of the ALJ appointments. See 138 S. Ct. at 2050.

III. Impact on Pending Cases

As discussed in more detail below, the Arthrex decision could have substantial impacts on pending proceedings before the PTAB as well as pending appeals from PTAB final written decisions.

Preservation and Waiver. The Arthrex panel held that a party need not have presented an Appointments Clause challenge to the Board in order for the court to consider it, because “‘[a]n administrative agency may not invalidate the statute from which it derives its existence and that it is charged with implementing.’” 2019 WL 5616010, at *2, *11 (citation omitted). Nevertheless, given the large number of cases that are potentially affected by the Arthrex decision, the Federal Circuit has tried—and may further try—to limit the impact of its holding. In a precedential, per curiam order, for example, a panel of the Federal Circuit has ruled that an Appointments Clause challenge under Arthrex is forfeited if it is not raised in a party’s opening brief. See Customedia Techs., LLC v. Dish Network Corp., No. 19-1001, 2019 WL 5677704, at *1 (Fed. Cir. Nov. 1, 2019). The government has also already raised concerns about the Federal Circuit’s post-Arthrex remand of another case, in which the government was not a party and so could not contest the issue. See Uniloc 2017 LLC v. Facebook, Inc., No. 18-2251, 2019 WL 5681316 (Fed. Cir. Oct. 31, 2019) (unpublished). Additionally, it remains to be seen whether the Federal Circuit might treat inter partes review petitioners differently than patent owners, given that the former voluntarily availed themselves of the PTAB forum. Cf. CFTC v. Schor, 478 U.S. 833, 850 (1986) (holding that party had “effectively agreed” to an adjudication before an administrative agency, rather than a court, when he “chose to avail himself of the” administrative process).

However, to the extent the court tries to draw a bright-line rule, barring parties from raising Appointments Clause challenges that were not raised in their opening briefs before the court of appeals, the court may be in some tension with the Supreme Court’s decisions in Freytag v. Commissioner, 501 U.S. 868, 878–79 (1991), and Glidden Co. v. Zdanok, 370 U.S. 530, 535–36 (1962) (plurality opinion). In both cases, the Supreme Court indicated that structural constitutional challenges to officers could be considered on appeal even if the issue was not raised below. See Freytag, 501 U.S. at 878 (declining to find waiver despite petitioners’ “failing to raise a timely objection to the assignment of their cases to a special trial judge” and “consenting to the assignment”).

PTAB Proceedings. The panel did not “see [any] constitutional infirmity” in the Director’s decision to institute inter partes review. Arthrex, 2019 WL 5616010, at *12. That is because, according the panel, the institution decision is within the Director’s—not the APJs’—authority. Id. (citing 35 U.S.C. § 314). Accordingly, the Arthrex decision may have a limited impact on cases that have not yet been instituted. That said, once a case is instituted, parties may wish to raise an Appointments Clause objection before the Board. It is not yet clear whether the “remedy” adopted by the panel will, after rehearing en banc or certiorari review, ultimately be found to cure the constitutional infirmity. Moreover, the government may continue to argue that a Board-level objection is required to preserve an Appointments Clause challenge. Thus, parties to PTAB proceedings should, in appropriate cases, consider raising their challenges before the Board.

For cases that are further along, however, whether before or after a final written decision, parties may have an opportunity to seek a new panel of APJs, present issues to the new panel that they had lost before the original panel (e.g., discovery motions), and request another oral argument before the new panel. The panel in Arthrex noted that “we see no error in the new panel proceeding on the existing written record but leave to the Board’s sound discretion whether it should allow additional briefing or reopen the record in any individual case.” 2019 WL 5616010, at *12. If APJs subject to Appointments Clause challenge have participated in the proceedings, then parties may be entitled to fresh consideration from adjudicators who, from the beginning, were not operating under a constitutional infirmity.

Federal Circuit Proceedings. Generally speaking, “arguments not raised in the opening brief are waived.” SmithKline Beecham Corp. v. Apotex Corp., 439 F.3d 1312, 1319 (Fed. Cir. 2006). Thus, in cases pending before the Federal Circuit, the best practice is to raise an Appointments Clause challenge in the opening brief or in a motion filed prior to the opening brief. See Uniloc, 2019 WL 5681316, at *1 (“In light of [Arthrex and] . . . the fact that Uniloc has raised an Appointments Clause challenge in its opening brief in this case, . . . [the PTAB decision] is vacated . . . .”).

A party, however, that did not raise an Appointments Clause challenge in its opening brief may have other opportunities to attack the Board’s decision on Appointments Clause grounds. To be sure, the Federal Circuit, in Customedia Technologies, held that an Appointments Clause challenge is forfeited if it is not included in the opening brief. 2019 WL 5677704, at *1. But the parties in that case did not brief—and the court, therefore, did not address—the Supreme Court’s decisions in Freytag and Glidden, which suggest that structural errors, such as Appointments Clause issues, can be raised at any time in appropriate cases. With direct briefing on Freytag and Glidden, then, parties may be able to open an opportunity to press the Appointments Clause issue in reply briefs, notices of supplemental authority, petitions for rehearing, and the like.

District Court Proceedings. Inter partes reviews often occur in parallel with district court litigation concerning the same patent. And district courts frequently entertain requests to stay the district court proceedings pending inter partes review. See, e.g., British Telecomms. PLC v. IAC/InterActiveCorp, No. 18-cv-366, 2019 WL 4740156, at *2 (D. Del. Sept. 27, 2019); InVue Sec. Prods. Inc. v. Vanguard Prods. Grp., Inc., No. 18-cv-2548, 2019 WL 3958272, at *1 (M.D. Fla. Aug. 22, 2019). Although the test varies by jurisdiction, district courts typically consider three factors in determining whether to grant such a stay: “(1) ‘whether the stay will simplify issues in question in the litigation,’ (2) ‘whether the stay will unduly prejudice the nonmoving party or present a clear tactical disadvantage to the nonmoving party,’ and (3) ‘whether the proceedings before the court have reached an advanced stage, including whether discovery is complete and a trial date has been set.’” Peloton Interactive, Inc. v. Flywheel Sports, Inc., No. 18-cv-390, 2019 WL 3826051, at *1 (E.D. Tex. Aug. 14, 2019) (internal quotation omitted).

District courts that had been, before Arthrex, inclined to lift a stay and re-open a case after the PTAB issued its final written decision may now be hesitant to do so before all the Arthrex appeals are exhausted. Unless the party proposing to lift a stay can show a new form of prejudice arising from a delay caused by Arthrex, the district court may determine that the likelihood of vacatur and remand justifies extending the stay through appeal.

In district court proceedings following the issuance of a final written decision by the PTAB, estoppel generally applies to any invalidity issue that the petitioner “raised or reasonably could have raised during that inter partes review.” 35 U.S.C. § 315(e)(2). Parties in this situation, however, should take note of Audatex North America, Inc. v. Mitchell International, Inc., which is scheduled for argument at the Federal Circuit on December 4. In that case, the appellant argues that a decision of the PTAB in a covered business method review is not binding on a district court because APJs are principal officers under the Appointments Clause, rendering a decision by a panel of APJs unconstitutional. Because the Federal Circuit already has held in Arthrex that APJs are principal officers (prior to the remedy provided in Arthrex), the Federal Circuit in Audatex will need to address whether a decision of the PTAB that was made by unconstitutionally appointed APJs is binding on a district court. This decision could have further implications for parties involved in district court litigation following an inter partes review or covered business method review proceeding, including whether estoppel will apply in the district court under 35 U.S.C. § 315(e)(2).

Additional Litigation. Interested parties should expect and be prepared for rapid developments in this area. The Arthrex decision leaves a host of unanswered questions in its wake. And it contains a number of subsidiary holdings that can be challenged from both sides.

Litigants are already seeking to broaden the scope of the Arthrex decision. For example, in Polaris Innovations Ltd. v. Kingston Technology Company, No. 18-1768 (Fed. Cir. argued Nov. 4, 2019), Polaris argued that the Arthrex panel did not go far enough in resolving the constitutional infirmity of the APJs. According to Polaris, because the Director of the PTO cannot review the APJs’ decisions, and because the court cannot itself authorize such a review, the “only remedy” is to declare the entire system constitutionally flawed and “let Congress fix it.” These and other challenges may push the Arthrex decision even farther, and could potentially cast doubt on the Director’s authority to institute inter partes review at all (a power unquestioned by the panel).

Among other areas, parties should expect litigation regarding questions such as:

Where to draw the line between principal and inferior officers;
Limits on courts’ power to sever statutory removal protections;
Whether severance can “convert” a principal officer into an inferior officer;
Whether institution decisions are less “suspect” than final written decisions;
Effects on post grant review and covered business method proceedings in addition to inter partes review;
Whether an entirely new hearing is required as opposed to reconsideration of the paper record;
Whether other rulings by unconstitutionally appointed APJs (e.g., evidentiary rulings) must be vacated;
The role, if any of the de facto officer doctrine and ratification by constitutional actors;
Whether decisions by unconstitutional APJs are subject to collateral attacks;
Whether, and under what circumstances, decisions by unconstitutionally appointed APJs have estoppel effects in district court;
Effects on pending PTAB proceedings;
Effects on proceedings that are concluded but have not yet yielded a final written decision;
Preservation, forfeiture, and waiver;
Whether Federal Circuit panels have discretion to reach Appointments Clause issues not raised in an appellant’s opening brief;
The availability of remands to the PTAB following a determination of unconstitutionality;
The availability of inter partes review and stays in the event the Supreme Court grants review; and
Potential challenges to the appointment of ALJs in other agencies.

Finally, it is also possible that Congress or the President could take action to address these issues outside of litigation, although the other branches may wait until the Supreme Court weighs in before acting. In the aftermath of Lucia, for example, the President responded to the Supreme Court’s decision by issuing an Executive Order, E.O. 13843, exempting ALJs from competitive service selection procedures.

* * *

Arthrex is a major decision that will likely produce serious repercussions across a wide range of cases. Further review is a significant possibility, either from the en banc Federal Circuit or the Supreme Court, and it may be some time before the courts work out the full ramifications of the panel decision. It also remains to be seen whether the Federal Circuit will accede to requests, by the government or other parties, to stay other PTAB proceedings in the meantime. For example, the Federal Circuit notably declined to pause PTAB proceedings pending the Supreme Court’s decisions in SAS Institute, Inc. v. Iancu, 138 S. Ct. 1348 (2018), and Oil States Energy Services, LLC v. Greene’s Energy Group, LLC, 138 S. Ct. 1365 (2018).

Interested parties are advised to monitor the case and consult experienced patent appellate counsel to navigate this developing situation.

Gibson Dunn has significant experience in this area, including winning the landmark Supreme Court decision in Lucia. Any of the following partners would be pleased to discuss Arthrex and its implications with you:

Mark A. Perry – Washington, D.C. (+1 202-887-3667, [email protected])
Brian M. Buroker – Washington, D.C. (+1 202-955-8541, [email protected])
Blaine H. Evanson – Orange County, CA (+1 949-451-3805, [email protected])
Lucas C. Townsend – Washington, D.C. (+1 202-887-3731, [email protected])

Please also feel free to contact the following leaders of the firm’s Appellate and Constitutional Law, Intellectual Property or Life Sciences practice groups:

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

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

Life Sciences Group:
Jane M. Love – New York (+1 212-351-3922, [email protected])
Ryan A. Murr – San Francisco (+1 415-393-8373, [email protected])

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

In a move designed to encourage greater participation by banks and other lending institutions in Federal Housing Administration (“FHA”) programs, on October 28, 2019, the U.S. Department of Justice (“DOJ”) and the U.S. Department of Housing and Urban Development (“HUD”) signed a Memorandum of Understanding (“MOU”) setting forth guidance on the appropriate use of the False Claims Act (“FCA”) to enforce violations of FHA regulatory requirements.[1]

The guidance—Inter-Agency Coordination Of Civil Actions Under The False Claims Act Against Participants In FHA Single Family Mortgage Insurance Programs—is voluntary and creates no legal rights or obligations. Nevertheless, the MOU describes the interagency process for and considerations involved in determining whether certain conduct should be addressed through HUD’s administrative proceedings or similar civil action, or referred to DOJ to pursue action under the FCA. In public remarks proclaiming the MOU’s goal of encouraging banks to participate in FHA lending, HUD Secretary Ben Carson expressed that “the False Claims Act became a monster” that drove banks away in the decade following the financial crisis, “[b]ut now, the monster has been slayed.”[2] Secretary Carson added his “suspicion” that “relatively few things” will warrant referral to DOJ under the MOU, stating that “an obvious case of fraud [is] one thing,” but that “we’re not going to make a big deal of” conduct that “is not a pattern” and is a “mistake that’s correctable.”[3]

This alert briefly describes the background and key takeaways from the MOU. Gibson Dunn is available to answer any questions you may have about how this guidance applies to your organization, as well as any other topics related to the FCA.

Background

The FHA provides important access to government-backed mortgage loans, particularly for lower income and first time home buyers. Over the past decade, however, banks and other lending institutions have dramatically reduced participation in FHA programs—originating less than 14 percent of FHA-insured mortgages this year, down from nearly 45 percent in 2010. HUD officials have attributed this decline to aggressive FCA enforcement against large FHA lenders following the financial crisis.[4] DOJ has recovered approximately $7 billion in FCA actions against mortgage lenders in the last 10 years.

Against this backdrop, the MOU is specifically “intended to address [the] concerns [regarding] uncertain and unanticipated FCA liability for regulatory defects [that] led many well-capitalized lenders, including many banks and credit unions … to largely withdraw from FHA lending.”[5]

The MOU, which pledges to dial back the use of the FCA in enforcing regulatory noncompliance in FHA programs, also marks the latest development in what has become a broader trend of reining in FCA enforcement under the Trump Administration. In recent years, DOJ policy changes have included issuance of the Brand Memo,[6] which prohibits DOJ attorneys from pursuing enforcement actions predicated on violations of non-binding agency guidance; issuance of the Granston Memo,[7] which instructed prosecutors to more regularly consider moving to dismiss qui tam actions in which DOJ declines to intervene; and revisions to the Yates Memo to provide more opportunities for corporate cooperation credit and inclusion of individuals in corporate settlements, among others.[8] These policy changes have been incorporated into the Justice Manual, the main internal policy manual for DOJ.[9]

The MOU

As the MOU makes clear, going forward, HUD will handle enforcement of violations of FHA program requirements “primarily through HUD’s administrative proceedings,” including through the agency’s mortgage review board.

For more serious regulatory violations, the MOU sets forth a framework for the two agencies to follow in “deciding when to pursue False Claims Act cases to remedy material and knowing FHA violations.”[10] Specifically, the MOU identifies the standards for when HUD may refer a matter to DOJ for pursuit of FCA claims (the “FCA Evaluation Standards”), providing for referral where the following two conditions are met:

(1) the most serious violations (so-called “Tier 1” violations under HUD regulations) exist either: (i) in at least 15 loans or (ii) in loans with an unpaid principal balance of at least $2 million; AND
(2) there are aggravating factors such as evidence that the violations are systemic or widespread.[11]

Beyond this referral framework, the MOU acknowledges that DOJ will solicit HUD’s views during the investigative, litigation, and settlement phases of any FCA matters predicated in whole or in part on alleged violations of FHA requirements. This includes HUD’s view as to whether the alleged violations “are material or not material to the agency” so that DOJ “can determine whether [the materiality element and other] elements of FCA [liability] can be established.”

It has always been the case that DOJ attorneys would solicit HUD’s views of the allegations under investigation and, as a matter of policy, HUD would have to approve any DOJ action. It is therefore remarkable that the agencies not only highlight this procedure in the guidance but specifically mention materiality—an element which allows an administration to tailor its enforcement agenda by taking the position that an alleged FHA regulatory violation was not important, or at least would not have resulted in non-payment had the government known about it (i.e., was not material).

The MOU also specifically addresses qui tam litigation initiated by private relators. Although noting that ultimate dismissal authority remains with DOJ, the MOU nevertheless provides for HUD to recommend dismissal of qui tam suits where HUD determines that:

the alleged conduct would not have warranted referral to DOJ under the FCA Evaluation Standards;
the alleged conduct does not represent a material violation of FHA requirements; or
the litigation threatens to interfere with HUD’s policies or the administration of its FHA lending program and dismissal would avoid these effects.

Finally, the MOU makes clear that even in cases where HUD declines to refer to DOJ or recommends dismissal, it retains discretion to pursue civil monetary penalties for violations of FHA regulations under other applicable laws, including the Program Fraud Civil Remedies Act.

Conclusion

Citing fears of draconian FCA liability for even minor noncompliance with FHA regulations facing prospective lenders, banks and other lending institutions have shied away from participation in the program in recent years. But particularly if comments from HUD officials are any indication, the new MOU provides a sign that the government has shifted its enforcement priorities in an effort to mitigate these concerns. Organizations that follow the guidance may decrease the likelihood that they will face the prospect of FCA enforcement actions in connection with FHA programs. And particularly noteworthy is that under the MOU DOJ will seek the guidance from HUD as to whether violations alleged by qui tam whistleblowers are material or not, such that DOJ may seek to dismiss such claims outright under its recently-flexed authority to dismiss qui tam cases even over a whistleblower’s objections.

As noted above, the MOU is the latest action taken by the Trump Administration in a broader effort to temper FCA enforcement, promote more practical uses of government resources, and reduce the burden on regulated businesses of defending against cases of low or no merit. This effort has begun to generate real change—for example, since the Granston Memo, DOJ has, in fact, begun moving to dismiss qui tam actions at a greater rate than it did in the past. Whether the same can be said of the MOU as to FCA enforcement in connection with FHA lending remains to be seen, but at a minimum, it appears defendants in FCA actions based on alleged FHA program violations will have additional means to pursue declination and dismissal by the government. Gibson Dunn will monitor how this MOU actually works in practice, and will provide updates as they develop.

_____________________

[1] U.S. Dep’t of Justice and U.S. Dep’t of Housing and Urban Development, Inter-Agency Coordination Of Civil Actions Under The False Claims Act Against Participants In FHA Single Family Mortgage Insurance Programs (Oct. 28, 2019), https://www.hud.gov/sites/dfiles/SFH/documents/sfh_HUD_DOJ_MOU_10_28_19.pdf

[2] Ben Lane, HousingWire, Exclusive: HUD’s Carson on False Claims Act – “The monster has been slayed” (Oct. 28, 2019), https://www.housingwire.com/articles/exclusive-huds-carson-on-false-claims-act-the-monster-has-been-slayed/

[3] Id.

[4] Jessica Guerin, HousingWire, FHA clarifies rules to attract more participants to its mortgage lending program (May 9, 2019), https://www.housingwire.com/articles/49011-fha-clarifies-rules-to-attract-more-participants-to-its-mortgage-lending-program/; MarketWatch, Trump administration says it will penalize fewer banks who violate FHA regulations (Oct. 29, 2019), https://www.marketwatch.com/story/trump-administration-says-it-will-penalize-fewer-banks-who-violate-mortgage-regulations-2019-10-29

[5] Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Departments of Justice and Housing and Urban Development Sign Interagency Memorandum on the Application of the False Claims Act (Oct. 28, 2019), https://www.justice.gov/opa/pr/departments-justice-and-housing-and-urban-development-sign-interagency-memorandum-application

[6] U.S. Dep’t of Justice, Memorandum from Rachel Brand, Associate Attorney General (Nov. 16, 2017), https://www.justice.gov/opa/press-release/file/1012271/download

[7] U.S. Dep’t of Justice, Memorandum from Michael D. Granston, Director, Commercial Litigation Branch, Fraud Section (Jan. 10, 2018), https://drive.google.com/file/d/1PjNaQyopCs_KDWy8RL0QPAEIPTnv31ph/view

[8] See Rod J. Rosenstein, Deputy Attorney General, U.S. Dep’t of Justice, Remarks at the American Conference Institute’s 35th International Conference on the Foreign Corrupt Practices Act (Nov. 29, 2018), https://www.justice.gov/opa/speech/deputy-attorney-general-rod-j-rosenstein-delivers-remarks-american-conference-institute-0 [announcing changes]; see also U.S. Dep’t of Justice, Memorandum from Sally Yates, Deputy Attorney General (Sep. 9, 2015), https://www.justice.gov/archives/dag/file/769036/download

[9] U.S. Dep’t of Justice, Justice Manual §§ Section 4-4.111 (Granston), 4-4.112 (Yates), Title 1-20.000 et seq. (Brand)

[10] Press Release, Office of Pub. Affairs, U.S. Dep’t of Justice, Departments of Justice and Housing and Urban Development Sign Interagency Memorandum on the Application of the False Claims Act (Oct. 28, 2019), https://www.justice.gov/opa/pr/departments-justice-and-housing-and-urban-development-sign-interagency-memorandum-application

[11] U.S. Dep’t of Housing and Urban Development, Office of Lender Activities & Program Compliance, Loan Review System (LRS): Implementation and Process Changes (Jan. 26, 2017), https://www.hud.gov/sites/documents/LRS_LENDER_PROCESS.PDF, at 24 (Tier 1: Fraud/Misrepresentation; Violations of statutory requirements; Significant eligibility or insurability issues; Inability to determine/support loan approval).

The following Gibson Dunn lawyers assisted in preparing this client update: Stuart Delery, Jonathan Phillips, James Zelenay, and Sean Twomey.

Gibson Dunn’s lawyers have handled hundreds of FCA investigations and have a long track record of litigation success. Our lawyers are available to assist in addressing any questions you may have regarding the above developments. For more information, please feel free to contact the Gibson Dunn lawyer with whom you work, the authors, or any of the following members of the False Claims Act group.

Washington, D.C.
F. Joseph Warin (+1 202-887-3609, [email protected])
Stuart F. Delery (+1 202-887-3650, [email protected])
Joseph D. West (+1 202-955-8658, [email protected])
Andrew S. Tulumello (+1 202-955-8657, [email protected])
Karen L. Manos (+1 202-955-8536, [email protected])
Jonathan M. Phillips (+1 202-887-3546, [email protected])
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New York
Reed Brodsky (+1 212-351-5334, [email protected])
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Denver
Robert C. Blume (+1 303-298-5758, [email protected])
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Dallas
Robert C. Walters (+1 214-698-3114, [email protected])

Los Angeles
Timothy J. Hatch (+1 213-229-7368, [email protected])
James L. Zelenay Jr. (+1 213-229-7449, [email protected])
Deborah L. Stein (+1 213-229-7164, [email protected])

Palo Alto
Benjamin Wagner (+1 650-849-5395, [email protected])

San Francisco
Charles J. Stevens (+1 415-393-8391, [email protected])
Winston Y. Chan (+1 415-393-8362, [email protected])

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

This edition of Gibson Dunn’s Federal Circuit Update first summarizes the Federal Circuit’s far-reaching decision last week that the appointment of Administrative Patent Judges to the PTAB is unconstitutional. We then review pending petitions for certiorari to the Supreme Court in cases appealed from the Federal Circuit, as well as recent filings for en banc review and other news. Recent precedential decisions are also summarized, reflecting the Federal Circuit’s view of patent eligibility, obviousness requirements for methods of medical treatment, PTAB discretion to reverse IPR institution, PTO calculation of term extensions, and design patent protection.

Top News—Appointment of Administrative Patent Judges Held Unconstitutional

On October 31, the Federal Circuit held that appointment of PTAB Administrative Patent Judges (APJs) violates the Appointments Clause, U.S. Const., art. II, § 2, cl. 2. In Arthrex, Inc. v. Smith & Nephew, Inc., No. 18-2140 (Fed. Cir. Oct. 31, 2019), a Federal Circuit panel (Moore, J., joined by Reyna and Chen, JJ.) ruled that APJs are “principal officers” because neither the Secretary of Commerce nor the Director of the USPTO (the two executive branch officials who appoint and monitor APJs) “exercises sufficient direction and supervision over APJs to render them inferior officers.” APJs are appointed by the Secretary of Commerce, whereas the Constitution requires principal officers to be appointed by the President with the advice and consent of the Senate.

To cure the identified constitutional deficiency, the Arthrex panel severed the provisions of the Patent Act that limit the PTO’s ability to remove APJs from the Board, thus allowing them to be removed without cause. In the panel’s view, this severance allows APJs to be prospectively classified instead as inferior officers (and hence, appropriately appointed by the Secretary of Commerce).

Without reaching the merits of the appeal before it, the Arthrex panel vacated and remanded the Board’s decision that twelve of Arthrex’s patent claims were anticipated. The panel reasoned that, because the panel had not been constitutionally appointed, patentability had to be decided by a new tribunal of properly appointed APJs.

The Arthrex decision could have substantial impacts on pending proceedings before the PTAB as well as pending appeals from PTAB final written decisions. Gibson Dunn will be preparing a standalone analysis considering these issues in more detail.

Other Federal Circuit News

Supreme Court:

In October, the Supreme Court held oral argument in Peter v. NantKwest Inc., which involves the issue of whether the “expenses” that the government may charge a litigant includes time that in-house government attorneys spend on the litigation. The government argued that “expenses” is a broad term that should reach everything that the PTO spends. NantKwest argued that the word “expenses” is not specific enough to overcome the presumption against forcing a party to pay the other side’s attorney’s fees. The Justices seemed skeptical of the government’s position, for example, questioning the recent shift from the government’s longstanding view that it was not entitled to those fees, and referring to the government’s current position as a “radical departure.”

Case	Status	Issue	Amicus Briefs Filed
Peter v. NantKwest Inc., No. 18-801	Argument on October 7, 2019.	Whether the phrase “[a]ll the expenses of the proceedings” in 35 U.S.C. § 145 encompasses the personnel expenses the PTO incurs when its employees and attorneys, defend § 145 litigation.	11
Thryv, Inc., fka Dex Media, Inc. v. Click-To-Call Techs., LP, No. 18-916	Set for argument on December 9, 2019	Whether 35 U.S.C. § 314(d) permits appeal of the PTAB’s decision to institute an inter partes review upon finding that § 315(b)’s time bar did not apply.	9
Romag Fasteners Inc. v. Fossil Inc., No. 18-1233	Petition for certiorari granted on June 28, 2019.	Whether, under Section 35 of the Lanham Act, 15 U.S.C. § 1117(a), willful infringement is a prerequisite for an award of an infringer’s profits for a violation of Section 43(a), 15 U.S.C. § 1125(a).	5

Noteworthy Petitions for a Writ of Certiorari:

The Supreme Court is currently considering a number of potentially impactful cases, in particular in the area of patent eligibility under 35 U.S.C. § 101. The Court asked for the Solicitor General’s views in three cases, HP v. Berkheimer, Hikma v. Vanda, and Google v. Oracle.

HP Inc. v. Berkheimer (No. 18-415): Question presented: “whether patent eligibility is a question of law for the court based on the scope of the claims or a question of fact for the jury based on the state of the art at the time of the patent.” On January 7, 2019, the Supreme Court invited the U.S. Solicitor General to file a brief expressing the views of the United States. Mark Perry of Gibson Dunn continues to serve as co-counsel for HP in this matter.

Hikma Pharmaceuticals USA Inc. v. Vanda Pharmaceuticals Inc. (No. 18-817): Question presented: “whether patents that claim a method of medically treating a patient automatically satisfy Section 101 of the Patent Act, even if they apply a natural law using only routine and conventional steps.” On March 18, 2019, the Supreme Court invited the U.S. Solicitor General to express the views of the United States.

Atlanta Gas Light Co. v. Bennett Regulator Guards Inc. (No. 18-999): Questions presented: “(1) whether the Federal Circuit erred in concluding that it had jurisdiction to review the PTAB’s decision to institute IPR of a patent over the patent owner’s objection that it was time-barred; and (2) whether the Federal Circuit erred in rejecting the “longstanding principle that a dismissal without prejudice leaves the parties as if a suit had never been brought, splitting the circuits.”

Garmin USA, Inc., et al. v. Cellspin Soft, Inc., No. 19-400: Question presented: “Whether patent eligibility is a question of law for the court that can be resolved on a motion to dismiss, notwithstanding allegations in a complaint that the asserted claims are inventive.”

Power Analytics Corporation v. Operation Technology, Inc., No. 19-43: Question presented: “Has the Federal Circuit correctly implemented the standards for patent eligibility set forth in 35 U.S.C. § 101 and Alice v. CLS Bank?”

Google LLC v. Oracle America, Inc., No. 18-956: Questions presented: “(1) Whether copyright protection extends to a software interface; and (2) whether, as the jury found, the petitioner’s use of a software interface in the context of creating a new computer program constitutes fair use.” On September 27, 2019, the Solicitor General formally recommended that the Supreme Court deny certiorari. The office disagreed with Google’s arguments that the declaring code that organizes Java programming interfaces cannot be copyrighted, although it did state that the correctness of the Federal Circuit’s fair use decision is “not free from doubt.”

Noteworthy Denials of Petitions for a Writ of Certiorari:

On October 7, 2019, the Supreme Court denied certiorari in a number of patent cases, including a number of cases presenting Berkheimer questions (Glasswall Solutions Ltd. v. Clearswift Ltd., No. 18-1448, StrikeForce Tech., Inc. v. SecureAuth Corp., No. 19-103). Other cases of note in which certiorari was denied include:

Acorda Therapeutics, Inc. v. Roxane Labs., Inc., No. 18-1280) (whether objective indicia of non-obviousness may be discounted where the development of the invention was allegedly blocked by the existence of a prior patent).

Hyatt v. Iancu, No. 18-1285 (whether MPEP § 1207.04 violates patent applicants’ statutory right of appeal following a second rejection).

Senju Pharma. Co., Ltd. v. Akorn, Inc., No. 18-1418 (whether 35 U.S.C. § 144 precludes the Federal Circuit from resolving appeals from the PTO through a Rule 36 judgment; whether the PTAB must consider all relevant evidence, including any objective indicia, when assessing whether a patent is invalid under U.S.C. § 103).

Noteworthy Federal Circuit En Banc Petitions:

Celgene Corp. v. Peter, Nos. 18-1167 et al.: As noted in our August 2019 update, a Federal Circuit panel (Prost, C.J., joined by Bryson and Reyna, JJ.) held that retroactive application of the AIA’s IPR proceedings to patents that issued before the AIA was enacted is not an unconstitutional taking. Celgene has now petitioned for en banc review. The Court requested that the PTO respond to Celgene’s petition, and the response is due November 19, 2019.

In Oil States Energy Services, LLC v. Greene’s Energy Group, LLC, 138 S. Ct. 1365 (2018), Supreme Court held that IPR proceedings did not violate Article III or the Seventh Amendment. Id. at 1370. But the Supreme Court expressly left open the question of whether retroactive application of the AIA is constitutional, adding that its opinion should not be “misconstrued as suggesting that patents are not property for purposes of the Due Process Clause or the Takings Clause.” Id. at 1379. Thus, if en banc review is denied, Celgene may petition for certiorari.

Other Federal Circuit News:

On October 22, 2019, Judge Wallach spoke at the Federal Circuit Historical Society’s fall lecture at the Dolley Madison House. Judge Wallach is the author of The Law of War in the 21^st Century and a recognized expert in the law of war. He served on active duty as an Engineer Reconnaissance Sergeant in the U.S. Army from 1969 to 1971, and as an Attorney/Advisor to the International Affairs Division of the Judge Advocate of the Army at the Pentagon. Judge Wallach discussed various types of war and the means and methods of warfare, and in particular whether cyber warfare covers recent Russian activities directed at the American political system.

The second portion of Global Series 2019 took place in Honolulu, Hawaii, on October 14–16. The Series 2019 Session is an outreach of Global Series partners, the Federal Circuit Bar Association, EPLAW, and others. It focused on global challenges in world innovation, IP, and trade systems, and responding to emerging national and international issues in these sectors.

Key Case Summaries (August 2019–October 2019)

American Axle & Manuf., Inc. v. Neapco Holdings LLC, No. 18-1763 (Fed. Cir. Oct. 3, 2019): Mechanical engineering claims relying on broad, functional language are ineligible.

The asserted patent recited claims to methods of making drive-shaft assemblies with internal liners designed to reduce vibrations in the resulting assemblies. While the patent disclosed a few embodiments, the claims were not so limited. Instead, the claims relied on functional language to cover any means of achieving their functional result. On summary judgment, the district court held the patent ineligible under § 101, finding it to merely claim the result of laws of nature governing damping, and otherwise employing only “routine, conventional” additional steps.

The Federal Circuit panel majority (Dyk, J., joined by Taranto, J.) affirmed. The majority reasoned that problems with vibration and natural laws that governed dampening were “well known” in the art. The claims were not limited to specific liners or dampening solutions, but rather claimed “achieving that result, by whatever structures or steps happen to work.” Other elements did not convey eligibility as they offered only “conventional additions” or limited “the use of a natural law or mathematical formula to a particular process.” Judge Moore dissented, arguing that the inquiry should instead be framed in terms of an enablement failure. American Axel reaffirms the relevance of eligibility even in the context of mechanical devices or methods.

MyMail, Ltd. v. ooVoo, LLC, Nos. 18-1758, -59, (Fed. Cir. Aug. 16, 2019): Disputed claim construction must be decided before an eligibility determination is made.

The asserted patents recited methods of using server or network instructions to update “toolbars” on users’ computers without involving the users. The parties disagreed over the construction of “toolbar.” The district court then held that the claims recited the abstract idea of “using communications networks to update software stored on computers” while adding only conventional, generic components such as “Internet-connected computers and servers.” The court dismissed at the pleading stage on eligibility grounds without addressing construction.

The Federal Circuit panel majority (Reyna, J., joined by O’Malley, J.) vacated and remanded. According to the majority, “the district court’s failure to address the parties’ claim construction dispute [was] error.” The majority refused to decide “in the first instance” eligibility based on the patentee’s more technical proposed construction, as doing so “may” implicate factual questions such as whether the claimed combination was then “routine” or “conventional.” Judge Lourie dissented, arguing that the claims were “clearly abstract,” regardless of construction.

OSI Pharma, LLC v. Apotex Inc., No. 18-1925 (Fed. Cir. Oct. 4, 2019): Method of treating cancer not obvious where prior art lacks specific efficacy data.

Generic drug manufacturer Apotex petitioned to cancel OSI’s patent claims to methods of treating non-small cell lung cancer with its erlotinib drug, Tarceva. The PTAB held that OSI’s method was obvious over prior art disclosing erlotinib to treat cancer in mammals and stating that it appears to have “good anti-cancer activity … in patients with non-small cell lung cancer.”

The Federal Circuit panel (Stoll, J., joined by Newman and Taranto, JJ.) reversed. The panel reasoned that “[c]ancer treatment is highly unpredictable,” with less than 1% of non-small cell lung cancer treatments succeeding in Phase II trials. In the panel’s view, the prior art lacked substantial evidence of a reasonable expectation of success and offered “no more than hope” because it did “not disclose any data or other information about erlotinib’s efficacy.” The panel caveated, however that neither efficacy data nor “absolute predictability” are always required.

BioDelivery Scis. Int’l v. Aquestive Therapeutics, Inc., Nos. 19-1643, -44, -45 (Fed. Cir. Aug. 29, 2019): PTAB has discretion to reverse IPR institution decisions.

The PTAB instituted three of BioDelivery’s IPR petitions on some but not all grounds. After SAS Institute, Inc. v. Iancu, the Federal Circuit vacated and remanded the reviews back to the PTAB. On remand, rather than proceed to review on all petitioned grounds, the Board reversed its institution decision and decided not to proceed with review at all. BioDelivery appealed, arguing that reviews were instituted and that this decision could not be reconsidered.

The Federal Circuit majority (Reyna, J., joined by Lourie, J.) dismissed the appeal. According to the panel majority, the Board “possess[es] inherent authority to reconsider their decisions … regardless of whether they possess explicit statutory authority to do so.” Although 35 U.S.C. § 314(d) states that the decision “whether to institute … shall be final and nonappealable,” the majority did not interpret the word “final” as meaning that the Board itself could not change its mind. Rather, it meant that the institution decision could not be appealed. And since institution decisions cannot be appealed, the panel dismissed the appeal. Judge Newman dissented.

Mayo Found. for Med. Edu. & Research v. Iancu, No. 18-2031 (Fed. Cir. Sept. 16, 2019): Time in an interference during continued examination does not qualify for term extension.

During prosecution, Mayo filed a Request for Continued Examination. Time spent in continued examination is exempted from the calculation that determines term extension under 35 U.S.C. § 154. As such, in post-1995 applications, the time spent in continued examination reduces the effective term of the patent. Several months into Mayo’s continued examination, an interference was declared, which lasted for two years. Mayo argued that the interference ended the continued examination because interferences must be declared between otherwise patentable inventions. According to Mayo, the interference period should thus be credited for term extension. The PTO calculated that continued examination did not end until the post-interference notice of allowance, thus negating over two years of potential term extension. On appeal, the district court agreed.

The Federal Circuit panel majority (Lourie, J., joined by Dyk, J.) affirmed, holding that a declaration of interference is not the same as a notice of allowance because examination can continue after an interference is decided. Judge Newman dissented, arguing that delay from the interference was caused by PTO procedures and should not be attributed to the patentee.

Curver Luxembourg, SARL v. Home Expressions Inc., No. 18-2214 (Fed. Cir. Sept. 12, 2019): Design claim limited to article of manufacture specified in the design patent.

The asserted design patent claimed an “ornamental design for a pattern for a chair” as illustrated in the patent’s figures. The patentee sued a home goods manufacturer whose storage baskets featured a similar design. The district court dismissed the suit because the accused products did not apply the claimed pattern to a chair as stated in the patent.

The Federal Circuit panel (Chen, J., joined by Hughes and Stoll, JJ.) affirmed. The panel held that the claim language specifying the particular article of manufacturer for the design limited the claim. The panel noted that the Federal Circuit “has never sanctioned granting a design patent for a surface ornamentation in the abstract such that the patent’s scope encompasses every possible article of manufacture to which the surface ornamentation is applied.” Thus, the claimed design could not be disaggregated from the article of manufacture listed in the claim.

Update: Amgen Inc. v. Sandoz Inc., Nos. 18-1551 (Fed. Cir. Sept. 3, 2019). In our last update, we noted that the Amgen panel stated that the doctrine of equivalents “applies only in exceptional cases.” In granting rehearing in part, the panel has now removed that statement from its opinion.

Upcoming Oral Argument Calendar

For a list of upcoming arguments at the Federal Circuit, please click here.

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

Blaine H. Evanson – Orange County (+1 949-451-3805, [email protected])
Raymond A. LaMagna – Los Angeles (+1 213-229-7101, [email protected])

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

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

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

The third quarter of 2019 continued the public pushback on the unrestricted use of AI technologies, particularly, for the U.S., with regard to technologies used to create “deepfake” video and audio clips as well as the use of facial recognition technology in the public sector. Some of the actions this quarter were follow-on steps to matters we have discussed in prior quarterly alerts; others are new initiatives. Below we take a look at the current state of regulation efforts (both proposed and enacted) in the U.S. and EU, consider the rush to address deepfakes, and provide further updates on other movement in the U.S. and EU toward regulating the use of AI technologies during the past quarter.

_______________________

I. Key U.S. Legislative and Regulatory Developments

A. Several New AI Bills Proposed in Congress

B. Increased Focus on Countering Deepfakes

C. More Actions Against Facial Recognition Software

D. Illinois AI Video Interview Act Goes into Effect

II. Developments in the EU

A. Focus on Comprehensive AI Regulation

B. UK Focus on AI

III. Autonomous Vehicles: A New Hope for Federal Regulation

IV. Data Privacy

_______________________

I. Key U.S. Legislative and Regulatory Developments

A. SEVERAL NEW AI BILLS PROPOSED IN CONGRESS

As the adoption of AI technology in the U.S. continues across a wide range of industries and the public sector, legislators are increasingly making efforts to regulate applicable data standards at federal level. On September 24, 2019, H.R. 4476, the “Financial Transparency Act of 2019” was reintroduced into Congress by Reps. Carolyn Maloney (D-NY) and Patrick McHenry (R-NC).[1] The bipartisan bill, which calls for the Treasury secretary to create uniform, machine-readable data standards for information reported to financial regulatory agencies,[2] has been referred to the Subcommittee on Commodity Exchanges, Energy, and Credit. By seeking to make information that is reported to financial regulatory agencies electronically searchable, the bill’s supporters aim to “further enable the development of RegTech and Artificial Intelligence applications,” “put the United States on a path towards building a comprehensive Standard Business Reporting program,” and “harmonize and reduce the private sector’s regulatory compliance burden, while enhancing transparency and accountability.”[3]

Increasingly, algorithms are also being used at every stage of criminal proceedings, from gathering evidence to making sentencing and parole recommendations. H.R. 4368, the “Justice in Forensic Algorithms Act of 2019,” was introduced in the House on September 17, 2019, would prohibit the use of trade secrets privileges to prevent defense access to the source code of proprietary algorithms used as evidence in criminal proceedings, and require that the Director of the National Institute of Standards and Technology (“NIST”) establishes a program to provide for the creation and maintenance of standards for the development and use of computational forensic software (“Computational Forensic Algorithm Standards”) to protect due process rights.[4] The standards would address underlying scientific principles and methods, an assessment of disparate impact on the basis of demographic features such as race or gender, requirements for testing and validating the software and for publicly available documentation, and requirements for reports that are provided to defendants by the prosecution documenting the use and results of computational forensic software in individual cases (e.g. source code).[5]

Legislators are also taking action to recognize the potentially vast implications of AI technology on employment and employees’ rights. On September 11, 2019, Sen. Brown (D-OH) introduced S. 2468, the “Workers’ Right to Training Act,” which would require employers to provide training to employees whose jobs are in danger of being changed or replaced due to technology, and for other purposes.[6] “Technology” is defined in the bill as including “automation, artificial intelligence, robotics, personal computing, information technology, and e-commerce.”[7]

B. INCREASED FOCUS ON COUNTERING DEEPFAKES

A new AI application called “deepfakes” is raising a set of challenging policy, technology, and legal issues. Deepfake technology is used to combine and superimpose existing images and videos onto source images or videos ─ creating new “synthetic” images or videos ─ by using a machine learning technique known as a generative adversarial network (GAN), a deep neural net architecture comprised of two nets, pitting one against the other (the “adversarial”). Since GANs can learn to mimic any distribution of data (images, music, speech, or text), the applications of deepfake technology are vast. Prompted by increased public concern over the potential impact of the technology on everything from cybersecurity to electoral manipulation, tentative federal bills intended to regulate deepfakes have emerged over the past several months, while state legislatures have already reacted by banning certain deepfake applications.[8]

In September 2018, Reps. Adam Schiff (D-Calif.), Stephanie Murphy (D-Fla.) and Carlos Curbelo (R-Fla.) sent a letter to the Director of National Intelligence to warn of potential risks relating to deepfakes.[9] The lawmakers cautioned that “[d]eep fakes have the potential to disrupt every facet of our society and trigger dangerous international and domestic consequences . . . . [a]s with any threat, our Intelligence Community must be prepared to combat deep fakes, be vigilant against them, and stand ready to protect our nation and the American people.”[10] In the wake of a June 2019 hearing by the House Permanent Select Committee on Intelligence on the national security challenges of artificial intelligence, manipulated media, and deepfake technology, both the House and the Senate introduced legislation to regulate GANs. At present, however, the bills appear to do very little to restrict the use of deepfake technology, suggesting that Congress remains in “learning mode.”

1. Federal level

On July 9, 2019, Sen. Rob Portman (R-OH) introduced the “Deepfake Report Act” (S. 2065), which would require the Department of Homeland Security to submit five annual reports to Congress on the state of the “digital content forgery” technology and evaluate available methods of detecting and mitigating threats.[11] The reports will include assessments of how the technology can be used to harm national security as well as potential counter measures. The bill defines digital content forgery as “the use of emerging technologies, including artificial intelligence and machine learning techniques, to fabricate or manipulate audio, visual, or text content with the intent to mislead.” The bipartisan bill was passed in the Senate by unanimous consent on October 25 and is currently before the House Committee on Energy and Commerce, which is reviewing the same-named companion bill, H.R. 3600.[12]

In the House, H.R. 3230 (“Defending Each and Every Person from False Appearances by Keeping Exploitation Subject to Accountability Act” or the “DEEPFAKES Act”) was introduced by Rep. Clarke (D-NY-9) on June 12, 2019[13] It would require any “advanced technological false personation record” to be digitally watermarked. The watermark would be required to “clearly identifying such record as containing altered audio or visual elements.” The bill has been referred to the Subcommittee on Crime, Terrorism, and Homeland Security.

On September 17, 2019, Rep. Anthony Gonzalez (R-OH) introduced the “Identifying Outputs of Generative Adversarial Networks Act” (H.R. 4355), which would direct both the National Science Foundation and NIST to support research on deepfakes to accelerate the development of technologies that could help improve their detection, to issue a joint report on research opportunities with the private sector, and to consider the feasibility of ongoing public and private sector engagement to develop voluntary standards for the outputs of GANs or comparable technologies.[14]

2. State level

At least three states, Virginia, Texas, and California, have already created laws banning the use of deepfake technology in certain applications: nonconsensual pornography[15] and electoral malfeasance.[16] These laws may signal state regulators’ willingness to quickly regulate other controversial AI applications going forward.

C. MORE ACTIONS AGAINST FACIAL RECOGNITION SOFTWARE

1. Use in Law Enforcement

As we reported in our Artificial Intelligence and Autonomous Systems Legal Update (2Q19), biometric surveillance, or “facial recognition technology,” has emerged as a lightning rod for public debate regarding the invasive nature of the technology and the risk of disparate impact. Until very recently, there were few if any laws or guidelines governing the use of facial recognition technology. However, amid increasing public concern about the technology operating in public spaces, 2019 has seen a string of efforts by various cities in the U.S to ban the use of facial recognition technology by law enforcement.[17] Oakland City Council recently passed an ordinance to ban its use by city police and other government departments, joining San Francisco, California and Somerville, Massachusetts who had already enacted similar bans.[18] Berkeley City Council also adopted a ban at a meeting in mid-October.[19] Cambridge, Massachusetts, also moved one step closer to prohibiting local government from using facial recognition. In December 2018, Cambridge City Council passed the “Surveillance Technology Ordinance,” which requires the council’s approval prior to the acquisition or deployment of certain surveillance tech, including facial recognition software. An amendment to the ordinance, which outright prohibits any use of facial recognition software, was forwarded by the council to the Public Safety Committee on July 30, 2019.[20]

At state level, in September 2019 California lawmakers passed legislation (A.B. 1215), barring police from installing facial recognition on body-worn cameras for the next three years.[21] The bill by Assemblyman Phil Ting (D-San Francisco), which was co-sponsored by the ACLU, was signed into law by Governor Newsom on October 8. Previously, the ACLU had run demonstrations using facial-recognition technology which falsely flagged 26 California lawmakers as matching arrest photos.[22]

2. Other Uses

On July 25, 2019, Reps Yvette Clark (D-NY), Ayanna Pressley (D-Mass.) and Rashida Tlaib (D-Mich.) introduced the “No Biometric Barriers to Housing Act.” If passed, the bill would prohibit facial recognition in public housing units that receive Department of Housing and Urban Development (“HUD”) funding. It would also require HUD to submit a report on facial recognition and its impacts on public housing units and tenants.[23] New York City Council is also considering proposed legislation that would prevent landlords from mandating that tenants use facial recognition, biometric scanning, or other “smart” key technology to enter their apartment buildings or their individual unit.[24]

For businesses working on or considering the use of facial recognition technologies, the recent developments emphasize the increased scrutiny that such technologies are receiving. It is important for companies operating in these technologies to understand the legal and regulatory landscape before launching products, and to seek to minimize risks in high liability areas.[25]

D. ILLINOIS AI VIDEO INTERVIEW ACT GOES INTO EFFECT

Amid the acceleration in the spread of AI and automated decision-making in the public and private sector, many U.S. and multinational companies have begun to use AI to streamline and introduce objectivity into their hiring process,[26] using AI-powered interview platforms ─ equipped with abilities such as sentiment analysis, facial recognition, video analytics, neural language processing, machine learning and speech recognition ─ that are capable of screening candidates against various parameters to assess competencies, experience and personality on the basis of hundreds of thousands of data points, and rank them against other candidates based on an “employability” score.[27] The lack of transparency resulting from the use of proprietary algorithms to hire and reject candidates has led to some regulatory pushback. As we reported in our Artificial Intelligence and Autonomous Systems Legal Update (2Q19), in May 2019 the Illinois legislature unanimously passed H.B. 2557 (the “Artificial Intelligence Video Interview Act”), which governs the use of AI by employers when hiring candidates.[28] State Rep. Jaime Andrade Jr. (D), who co-sponsored the bill, noted that spoken accents or cultural differences could end up improperly warping the results, and that people who declined to sit for the assessment could be unfairly punished by not being considered for the job.[29] On August 9, 2019, Governor J.B. Pritzker signed the Act into law, effective January 1, 2020. Under the Act, an employer using videotaped interviews when filling a position in Illinois may use AI to analyze the interview footage only if the employer:

Gives notice to the applicant that the videotaped interview may be analyzed using AI for purposes of evaluating the applicant’s fitness for the position. (A Senate floor amendment removed from the bill a requirement for written notice.)
Provides the applicant with an explanation of how the AI works and what characteristics it uses to evaluate applicants, and
Obtains consent from the applicant to use AI for an analysis of the video interview.
Keeps video recordings confidential by sharing the videos only with persons whose expertise or technology is needed to evaluate the applicant, and destroying both the video and all copies within 30 days after an applicant requests such destruction.

Illinois employers using such software will need to carefully consider how they are addressing the risk of AI-driven bias in their current operations and whether hiring practices fall under the scope of the new law, which does not define “artificial intelligence,” what level of “explanation” is required, or whether it applies to employers seeking to fill a position in Illinois regardless of where the interview takes place. Nor is there provision in the Act for a private right of action or specific remedies. While the Illinois Act currently remains the only such law to date in the U.S., companies using automated technology in recruitment should expect that the increasing use of AI technology in recruitment is likely to lead to further regulatory proposals in due course. As previously noted,[30] a major challenge for companies subject to such laws will be explaining to regulators how their AI assessments work and how the criteria are ultimately used in any decision-making processes.

II. Developments in the EU

A. FOCUS ON COMPREHENSIVE AI REGULATION

AI remains a top priority for policymakers in the EU. The new president of the European Commission, Ursula von der Leyen, recently unveiled her policy agenda for the next five years. As part of her proposal to create “a Europe fit for the digital age” she promised to put forward legislation “for a coordinated European approach on the human and ethical implications of AI” in the first 100 days (meaning we can expect a draft by March 2020).[31] A key challenge for the new president will be to grow investment, data, and talent required to develop AI and accelerate its adoption, and creating an innovation-friendly regulatory environment across the EU, which has thus far adopted a “regulate-first” strategy.

Based on public comments by those likely to be involved in the creation of proposed AI regulation, we anticipate that the EU legislation will (1) address government funding of research, workplace training and the availability of public data, (2) not seek to significantly re-write exiting legal frameworks, but largely try to fit within the GDPR, the Directive on Copyright in the Digital Single Market, and the ePrivacy regulation, (3) require, like some U.S. states – notably California – that any chatbot or virtual assistant interacting with individuals will need to disclose that it is not a human, and create enhanced requirements for transparency as to the use of data and the bases for decisions or recommendations to avoid unintended bias or disparate impact, (4) require and potentially allocate accountability for failures or problems caused by machines, and (5) require GDPR-style impact assessments to ensure AI systems do not perpetuate discrimination or violate fundamental rights.[32]

B. UK FOCUS ON AI

A report from the UK Government’s Business, Energy and Industrial Strategy Committee published in September 2019 has investigated the state of automation in the UK.[33] The Automation and the Future of Work report highlights how the UK’s slow adoption of automation is being hampered by a lack of action from the UK Government, with entire regions of the country at risk of being left behind by G7 competitors. In 2015, the UK had 10 robots for every million hours worked, compared with 131 in the US, 133 in Germany and 167 in Japan. By 2017, the UK represented just 0.6% of industrial robotics shipments. The report argues that unless concerted efforts are made to manage the transition to the so-called Fourth Industrialization, UK businesses will miss a pivotal opportunity for economic growth.

The report urges the UK Government to establish a robot and AI strategy by 2020, which is a step towards building confidence amongst businesses, industries and universities. The report urges that the strategy be created by bringing together employers, workers, academia, and automation developers to collaboratively design the best strategic approach to “promote and manage the transition to a more automated world of work.”

Echoing many of the sentiments seen in the U.S (as noted above), in addition to issuance of the automation report, the House of Commons’ Science and Technology Committee has also called for a suspension of the use of automatic facial recognition technology until regulations have been put in place.[34]

III. Autonomous Vehicles: A New Hope For Federal Regulation

Federal regulation of autonomous vehicles (“AVs”) has so far faltered in the new Congress. However, more recently federal lawmakers have demonstrated renewed interest in a comprehensive AV bill aimed at speeding up the adoption of autonomous vehicles and deploying a regulatory framework. In July 2019, the House Energy and Commerce Committee and Senate Commerce Committee sought stakeholder input from the self-driving car industry in order to draft a bipartisan and bicameral AV bill, prompting stakeholders to provide feedback to the committees on a variety of issues involving autonomous vehicles, including cybersecurity, privacy, disability access, and testing expansion.[35]

Meanwhile, the National Highway Traffic Safety Administration (“NHTSA”) continues to take tentative steps to plug the regulatory gap. As we noted in our Artificial Intelligence and Autonomous Systems Legal Update (2Q19), the NHTSA earlier this year sought comments on petitions from industry stakeholders regarding exemptions from the Federal Motor Vehicle Safety Standards (“FMVSSs”) in connection with automated vehicles and the Federal Motor Carrier Safety Regulations (regulations governing commercial vehicles, e.g. trucks), which may be a barrier to deploying Automated Driving System-Dedicated Vehicles (“ADS-DVs”). Additionally, on September 18, 2019, the Department of Transportation (“DOT”) announced $60 million in federal grant funding to eight projects that test the safe integration of automated driving systems on roads.

On October 16, 2019, the UK Law Commission published a second public consultation[36] on a proposed regulatory framework for Highly Automated Road Passenger Services (“HARPS”) ─ vehicles that operate without a driver (or “user-in-charge”).[37] The current consultation seeks stakeholders’ views on whether HARPS operators should be subject to a national licensing scheme, and on the conditions that they should meet to obtain a license. The consultation also considers private ownership of passenger-only vehicles, accessibility for older and disabled people, how to control congestion on public roads, and how regulation can help self-driving vehicles integrate with public transport. Comments may be submitted to the law Commission before January 16, 2020, with the final report and final recommendations due in 2021. We encourage our clients to contact us if they would like further information or assistance in developing and submitting comments.

IV. Data Privacy

While not strictly focused on artificial intelligence technologies, a number of state and federal developments in the area of data privacy are noteworthy, given the central importance of access to large quantities of data (often including personal and private data) to the successful development and operation of many AI systems.

First, in California, a series of amendments to the California Consumer Privacy Act (“CCPA”) were signed into effect by the Governor in early October.[38] Some of these amendments may prove significant to certain businesses; such as A.B. 25, which provides a one-year carve-out of the personal information of employees from personal information that would otherwise fall under the requirements of the CCPA. Similarly, A.B. 1355 creates a one-year carve-out of certain personal information that is collected as part of purely business-to-business communications, which may also help alleviate concerns about how to handle personal information necessarily acquired in a business context. In addition to the amendments, the California Attorney General’s Office released a series of proposed regulations for implementing the requirements of the CCPA, and initiated a period in which they will solicit public comments before making any final changes putting the regulations into force and effect.[39] The proposed regulations generally set out guidance for how businesses should implement the notice provisions of the CCPA, procedural steps for implementing consumer rights provisions and data collection requirements, as well as provide some clarification of the CCPA’s non-discrimination provisions.

Second, in Nevada, the 2019 amendments to Nevada’s existing on-line privacy law went into effect on October 1, 2019.[40] These amendments add data privacy provisions giving consumers the ability to opt-out of the sale of their covered information, although with fewer requirements than set out in the CCPA. Similarly, the Nevada law takes a narrower view of “sale” than does the CCPA, and only applies to the collection of covered information by commercial internet website and on-line services.

Finally, in July, California Senator Dianne Feinstein introduced the Voter Privacy Act of 2019, which is currently before the Senate Committee on Rules and Administration.[41] As introduced, the Act will give voters certain rights with regard to their personal data collected in connection with voter information. In particular, the Act provides notice rights, rights of access, deletion rights, and rights to prohibit transfer or targeting through use of the data. The stated purpose of the Act is to put an end to the manipulation and misdirection of voters through the use of their personal data, and the Act would be monitored by the Federal Election Commission. Obviously, for companies collecting voter information as part of the data processed by AI systems, the Act could add a number of significant compliance requirements should it ultimately pass.

_____________________________

[1] H.R.4476, 116th Congress (U.S. House of Representatives).

[2] Id. (Including the Securities and Exchange Commission, Commodity Futures Trading Commission, Federal Deposit Insurance Corp., Federal Reserve, Office of the Comptroller of the Currency, the Consumer Financial Protection Bureau, the National Credit Union Association and the Federal Housing Finance Agency.).

[3] Id.

[4] H.R.4368, 116th Congress (U.S. House of Representatives).

[5] Press Release, Rep. Takano Introduces the Justice in Forensic Algorithms Act to Protect Defendants’ Due Process Rights in the Criminal Justice System (Sep. 17, 2019), available at https://takano.house.gov/newsroom/press-releases/rep-takano-introduces-the-justice-in-forensic-algorithms-act-to-protect-defendants-due-process-rights-in-the-criminal-justice-system.

[6] S. 2468, 116th Congress (U.S. Senate).

[7] Id.

[8] AB 730, AB 602 (California); SB 751 (Texas); HB 2678 (Virginia); HR 3230, 116th Congress (U.S. House of Representatives); S 2065, 116th Congress (U.S. Senate).

[9] Letter from Adam Schiff, U.S. Representative, Stephanie Murphy, U.S. Representative & Carlos Curbelo, U.S. Representative to Hon. Daniel R. Coats, Dir. of Nat’l Intelligence (Sept. 13, 2018).

[10] Id.

[11] S. 2065, 116th Congress (U.S. Senate).

[12] H.R. 3600, 116th Congress (U.S. House of Representatives).

[13] H.R. 3230, 116th Congress (U.S. House of Representatives).

[14] H.R. 4355, 116th Congress (U.S. House of Representatives).

[15] California (A.B. 602) and Virginia (H.B. 2678) have banned the application of pornographic deepfakes. Virginia, in enacting the first piece of legislation to directly address deepfakes, banned “dissemination or sale of certain images of another person, that “another person” includes a person whose image was used in creating, adapting, or modifying a videographic or still image with the intent to depict an actual person and who is recognizable as an actual person by the person’s face, likeness, or other distinguishing characteristic.” California created a private right of action against a person who either “(1) creates and intentionally discloses sexually explicit material if the person knows or reasonably should have known the depicted individual did not consent to its creation or disclosure or (2) who intentionally discloses sexually explicit material that the person did not create if the person knows the depicted individual did not consent to its creation.”

[16] California (A.B. 730) and Texas (S.B. 751) have banned deepfakes designed to influence elections. In Texas, it is now a crime to “with intent to injure a candidate or influence the result of an election: (1) creates a deep fake video; and (2) cause[] the deep fake video to be published or distributed within 30 days of an election.” Texas defines a “deep fake” broadly as “a video, created with the intent to deceive, that appears to depict a real person performing an action that did not occur in reality.” California has banned anyone, within 60 days of an election of a candidate, from “distributing with actual malice materially deceptive audio or visual media of the candidate with the intent to injure the candidate’s reputation or to deceive a voter into voting for or against the candidate, unless the media includes a disclosure stating that the media has been manipulated.” The California law defines the prohibited activity more narrowly, it must “falsely appear to a reasonable person to be authentic” and “cause a reasonable person to have a fundamentally different understanding or impression of the expressive content of the image or audio or video recording than that person would have if the person were hearing or seeing the unaltered, original version of the image or audio or video recording.”

[17] For further detail, see our Artificial Intelligence and Autonomous Systems Legal Update (2Q19).

[18] Sarah Ravani, Oakland bans use of facial recognition technology, citing bias concerns (Jul. 17, 2019), available at https://www.sfchronicle.com/bayarea/article/Oakland-bans-use-of-facial-recognition-14101253.php; see also, Cade Metz, Facial Recognition Tech Is Growing Stronger, Thanks to Your Face (Jul. 13, 2019), available at https://www.nytimes.com/2019/07/13/technology/databases-faces-facial-recognition-technology.html.

[19] Levi Sumagaysay, Berkeley bans facial recognition (Oct. 16, 2019), available at https://www.mercurynews.com/2019/10/16/berkeley-bans-facial-recognition/.

[20] See Jack Karp, Facial Recognition Software Sparks Transparency Battle, Law360 (Nov. 3, 2019), available at https://www.law360.com/access-to-justice/articles/1215786/facial-recognition-software-sparks-transparency-battle; Declan J. Knieriem, City Council Introduces Facial Recognition Ban Bill at Summer Meeting (Aug. 2, 2019), available at https://www.thecrimson.com/article/2019/8/2/council-may-ban-facial-recognition/.

[21] A.B. 1215 2019–2020 Reg. Sess. (Cal. 2019); see also Anita Chabria, California could soon ban facial recognition technology on police body cameras (Sep. 12, 2019), available at https://www.latimes.com/california/story/2019-09-12/facial-recognition-police-body-cameras-california-legislation.

[22] Monica Melton, Amazon Rekognition Falsely Matches 26 Lawmakers To Mugshots As California Bill To Block Moves Forward (Aug. 13, 2019), available at https://www.forbes.com/sites/monicamelton/2019/08/13/amazon-rekognition-falsely-matches-26-lawmakers-to-mugshots-as-california-bill-to-block-moves-forward/.

[23] See H.R. 4008, 116^th Congress (House of Representatives), currently pending before the House Committee on Financial Services.

[24] Brad Lander, New City Council legislation would protect tenants from facial recognition & “smart” key surveillance, NYC Council (Oct. 7, 2019), available at https://council.nyc.gov/brad-lander/2019/10/07/new-city-council-legislation-would-protect-tenants-from-facial-recognition-smart-key-surveillance/.

[25] For more on the importance of monitoring regulatory and technology developments in this space, see Fontenot, Gaedt-Sheckter, Implications of AI on Board Oversight (Oct. 2019) available at https://www.gibsondunn.com/wp-content/uploads/2019/10/Fontenot-Gaedt-Sheckter-Implications-of-AI-on-Board-Oversight-Corporate-Board-Member-10-23-2019.pdf.

[26] Robert Booth, Unilever saves on recruiters by using AI to assess job interviews, The Guardian (Oct. 25, 2019), available at https://www.theguardian.com/technology/2019/oct/25/unilever-saves-on-recruiters-by-using-ai-to-assess-job-interviews.

[27] Drew Harwell, A face-scanning algorithm increasingly decides whether you deserve the job, Washington Post (Oct. 25, 2019), available at https://www.washingtonpost.com/technology/2019/10/22/ai-hiring-face-scanning-algorithm-increasingly-decides-whether-you-deserve-job/.

[28] H.B. 2557, 2019-2020 Reg. Sess. (Ill. 2019) (101st Gen. Assembly), available at http://www.ilga.gov/legislation/101/HB/PDF/10100HB2557lv.pdf.

[29] Drew Harwell, A face-scanning algorithm increasingly decides whether you deserve the job, Washington Post (Oct. 25, 2019), available at https://www.washingtonpost.com/technology/2019/10/22/ai-hiring-face-scanning-algorithm-increasingly-decides-whether-you-deserve-job/.

[30] For further detail, see our Artificial Intelligence and Autonomous Systems Legal Update (2Q19).

[31] Ursula von der Leyen, A Union that strives for more: My agenda for Europe, available at https://www.europarl.europa.eu/resources/library/media/20190716RES57231/20190716RES57231.pdf/. Note that the von der Leyen commission was slated to begin on November 1, but due to problems with filling three of the commissioners’ seats, it is likely to be delayed at least a month (thus pushing back the 100-day deadline).

[32] See further, H. Mark Lyon, Gearing up for the EU’s next regulatory push: AI, Daily Journal (Oct. 11, 2019).

[33] U.K. House of Commons, Business, Energy and Industrial Strategy Committee, Automation and the future of work (Sep. 18, 2019), available athttps://publications.parliament.uk/pa/cm201719/cmselect/cmbeis/1093/1093.pdf.

[34] Leo Kelion, MPs call for halt to police’s use of live facial recognition (Jul 18, 2019), available at https://www.bbc.com/news/technology-49030595.

[35] Makena Kelly, Congress wants the self-driving car industry’s help to draft a new AV bill, The Verge (Jul. 31, 2019), available at https://www.theverge.com/2019/7/31/20748582/congress-self-driving-cars-bill-energy-commerce-senate-regulation.

[36] The first public consultation in this review was launched in November 2018, focusing on safety assurance and legal liability, available at https://s3-eu-west-2.amazonaws.com/lawcom-prod-storage-11jsxou24uy7q/uploads/2018/11/6.5066_LC_AV-Consultation-Paper-5-November_061118_WEB-1.pdf.

[37] U.K. Law Commission, Automated Vehicles, available at https://consult.justice.gov.uk/law-commission/automated-vehicles-harps/.

[38] For more information, see our prior client alert, California Consumer Privacy Act: 2019 Final Amendments Signed, available at https://www.gibsondunn.com/california-consumer-privacy-act-2019-final-amendments-signed/.

[39] Again, for more information on the proposed regulations for CCPA, please see our prior client alert, California Consumer Privacy Act Update: Regulatory Update, available at https://www.gibsondunn.com/california-consumer-privacy-act-update-regulatory-update/.

[40] See Nevada S.B. 220, 80^th Legislature.

[41] See S. 2398, 116^th Congress (Senate).

The following Gibson Dunn lawyers prepared this client update: H. Mark Lyon, Frances A. Waldmann, Tony Bedel, Panayiota Burquier, and Arjun Rangarajan.

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

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

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

Artificial Intelligence and Automated Systems Group:
H. Mark Lyon – Chair, Palo Alto (+1 650-849-5307, [email protected])
J. Alan Bannister – New York (+1 212-351-2310, [email protected])
Lisa A. Fontenot – Palo Alto (+1 650-849-5327, [email protected])
David H. Kennedy – Palo Alto (+1 650-849-5304, [email protected])
Ari Lanin – Los Angeles (+1 310-552-8581, [email protected])
Robson Lee – Singapore (+65 6507 3684, [email protected])
Carrie M. LeRoy – Palo Alto (+1 650-849-5337, [email protected])
Alexander H. Southwell – New York (+1 212-351-3981, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
Michael Walther – Munich (+49 89 189 33 180, [email protected])

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

On October 22, 2019, the Federal Trade Commission announced the first-of-its-kind enforcement action and settlement against the developer and marketer of three tracking applications, Retina-X Studios, LLC and James N. Johns, Jr. In this unprecedented action, the FTC alleged that Retina-X and Johns failed to take basic steps to protect sensitive personal data collected from their so-called “stalking” mobile applications, in violation of the Federal Trade Commission Act, 15 U.S.C. § 45(a) and the Children’s Online Privacy Protection Act (“COPPA”) Rule, 16 C.F.R. § 12. The FTC’s action may presage further enforcement activity against firms and individuals providing technology that can enable privacy abuses, especially when children are involved.

Background

The FTC alleged that Retina-X and Johns developed and marketed three mobile apps—MobileSpy, PhoneSheriff, and TeenShield—that allowed purchasers to monitor third parties without their knowledge or consent. In announcing the settlement, Andrew Smith, the Director of FTC’s Bureau of Consumer Protection, recognized that “although there may be legitimate reasons to track a phone, these apps were designed to run surreptitiously in the background and are uniquely suited to illegal and dangerous uses.”[1]

The complaint alleged that the three apps collected sensitive personal information and did not take adequate steps to secure the information, in violation of the FTC’s prohibition against unfair and deceptive practices and COPPA. Under Section 5 of the FTC Act, a practice is unfair if it causes or is likely to cause substantial injury to consumers, cannot be reasonably avoided by consumers, and is not outweighed by countervailing benefits to consumers. The FTC’s COPPA Rule imposes certain data collection and disclosure obligations on operators of websites or online services that collect, use, or disclose personal information from children under 13. As alleged, MobileSpy, marketed as a product to monitor children or employees, was launched in 2007 and sold more than 5,700 licenses. PhoneSheriff, marketed as a product to monitor children, was launched in 2011 and sold more than 5,000 licenses. TeenShield, marketed as a product to monitor children, was launched in 2015 and sold more than 5,000 licenses. As part of the registration process, TeenShield required the purchaser to input the date of birth of the person being monitored. Between February 2016 and October 2017, TeenShield collected about 950 dates of birth, a third of which were for children under the age of 13. Once installed, the apps collected and stored, among other data: text messages, call history, keys pressed, GPS locations, photos, contact lists, browser history, music files, notes, calendar entries, other apps installed, usage summaries, and email history. The Premium version of MobileSpy allowed consumers to access the monitored device in real time. PhoneSheriff was able to store screenshots of Snapchat activity.

To install the apps, purchasers were often required to “jailbreak” or “root” the mobile device by bypassing device manufacturer restrictions, which the FTC alleged unknowingly exposed the device to security vulnerabilities and likely invalidated manufacturer warranties. Further, the FTC alleged that the apps provided purchasers instructions about how to remove the app’s icon from appearing on the mobile device screen, so that device users would remain unware that they were being monitored. The FTC pointed to these features—the use of jailbreaking and surreptitious monitoring—in concluding that the three apps in question were more likely used by stalkers and abusers to collect victims’ physical movements and online activities, and then used to “perpetuate stalking and abusive behaviors, which cause mental and emotional abuse, financial and social harm, and physical harm including death.”[2]

Finally, the FTC alleged that on two occasions, hackers were able to access data from the Retina-X servers that had been collected from the monitoring apps. All three apps have not been available for purchase since 2018, but the websites remain accessible.

Settlement Terms

Retina-X and Johns did not admit or deny any allegations in the FTC’s complaint except for the language in the Settlement Order. The proposed settlement will be subject to public comment for 30 days after publication in the Federal Register and the FTC will then decide whether to make the proposed consent order final.

Under the proposed settlement, Retina-X and Johns agreed to refrain from selling monitoring apps that require circumvention of mobile device manufacturer’s security protections. Retina-X and Johns are required to obtain written confirmation from purchasers that their products will be used only for legitimate purposes. Any monitoring products must be used only by parents monitoring their children, employers monitoring consenting employees, or adults monitoring other consenting adults. Further, the app icon with the name of the app must be visible on the device’s screen unless the app is installed by a parent on their minor child’s device.

The proposed settlement also requires Retina-X and Johns to destroy all personal information collected from the three monitoring apps every 120 days, and to implement and maintain a comprehensive information security program to protect any personal information collected in the future. Retina-X and Johns must retain a senior corporate manager to oversee the information security program and certify compliance with the order every year. Retina-X and Johns must also obtain third-party assessments of their security program every two years for twenty years.

What To Expect

The FTC’s action against Retina-X and Johns may portend further enforcement and legislative action around technologies that can be used to enable alleged domestic violence, cyberstalking, and COPPA violations.

Following the announcement of the proposed settlement, the FTC released a warning to consumers about stalking apps[3] and cautioned other companies that sell monitoring products to ensure that their products are “used only for lawful purposes.” The FTC announced that companies cannot “require the circumvention of built-in operating system or device security protections and then claim ignorance about how [the product] is used.” When working with third-party service providers, the FTC instructed companies to “spell out [] data security expectations in [] contracts and build in monitoring mechanisms to make sure [the third parties] are following through.”[4]

Beyond the FTC, other civil and criminal authorities likely will consider further intervention to address growing concern about cyberstalking and other forms of technology-enabled domestic violence. In most states and at the federal level, cyberstalking is a crime. Under the federal statute, cyberstalking includes any course of conduct taken by the perpetrator on the Internet that places the victim in reasonable fear of death or serious bodily injury, or causes, attempts to cause, or would be reasonably expected to cause substantial emotional distress to the victim or the victim’s immediate family.[5] Other potentially applicable statutes include the Computer Fraud Abuse Act of 1986[6], which makes it a criminal offence to access a computer, tablet, or smartphone without authorization; the Electronic Communications Privacy Act of 1986[7], which prohibits interception and disclosure of wire, oral, and electronic communications; and the Violence Against Women Reauthorization Act of 2013[8], which makes cyberstalking part of the federal interstate stalking statute.

Finally, privacy advocates and legislators have proposed new legislation imposing criminal and civil penalties specifically on cyberstalking apps. Since 2011, several United States Senators have called on key federal agencies to investigate stalking apps, and since 2015, various legislators have introduced federal legislation that would prevent the development, use, and sale of tracking apps.[9]

We expect there to continue to be various legislative proposals put forward, though, given the complexity and sensitivity of the issue, no particular proposal has yet garnered broad bipartisan support. We will continue to monitor developments in this area.

_____________________

[1] Press Release, Federal Trade Commission, FTC Brings First Case Against Developers of “Stalking” Apps” (Oct. 22, 2019), https://www.ftc.gov/news-events/press-releases/2019/10/ftc-brings-first-case-against-developers-stalking-apps.

[2] In the Matter of Retina-X Studios, LLC. Complaint, https://www.ftc.gov/system/files/documents/cases/172_3118_-_retina-x_studios_complaint_updated.pdf.

[3] Lisa Weintraub Schifferle, Stalking apps: Retina-X settles charges, FTC Consumer Information (Oct. 22, 2019), https://www.consumer.ftc.gov/blog/2019/10/stalking-apps-retina-x-settles-charges.

[4] Lesley Fair, FTC takes action against stalking apps, FTC Business Blog (Oct. 22, 2019), https://www.ftc.gov/news-events/blogs/business-blog/2019/10/ftc-takes-action-against-stalking-apps.

[5] 18 U.S.C. § 2261A (2015).

[6] 18 U.S.C. § 1030.

[7] 18 U.S.C. § 2511.

[8] 34 U.S.C. § 12441.

[9] Location Privacy Protection Act of 2015, S. 2270, 114th Cong. (2015), https://www.congress.gov/bill/114th-congress/senate-bill/2270/cosponsors.

The following Gibson Dunn lawyers prepared this client update: Alexander Southwell, Matthew Benjamin and Praatika Prasad.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work or any of the following leaders and members of the firm’s Privacy, Cybersecurity and Consumer Protection practice group:

United States
Alexander H. Southwell – Co-Chair, PCCP Practice, New York (+1 212-351-3981, [email protected])
M. Sean Royall – Dallas (+1 214-698-3256, [email protected])
Debra Wong Yang – Los Angeles (+1 213-229-7472, [email protected])
Olivia Adendorff – Dallas (+1 214-698-3159, [email protected])
Matthew Benjamin – New York (+1 212-351-4079, [email protected])
Ryan T. Bergsieker – Denver (+1 303-298-5774, [email protected])
Richard H. Cunningham – Denver (+1 303-298-5752, [email protected])
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, [email protected])
Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, [email protected])
Kristin A. Linsley – San Francisco (+1 415-393-8395, [email protected])
Karl G. Nelson – Dallas (+1 214-698-3203, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, [email protected])
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, [email protected])

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

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

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

Paris associate Alexis Downe is the author of “The choice of French Law for the new ISDA Master Agreement: Part 1” [PDF] published by the Buttersworths Journal of International Banking and Financial Law in November 2019.

In October 2019, the German Conference of Federal and State Data Protection Authorities (the “DSK”) published its long-awaited guidelines for the determination of fines in privacy violation proceedings against companies (the “Fining Concept”).[1]

The Fining Concept applies to the imposition of fines by German Data Protection Authorities within the scope of the European General Data Protection Regulation (“GDPR”). According to the DSK, the Fining Concept is intended to provide for a uniform, comprehensible, transparent and case-by-case method of determining fines. The central starting point for the determination of the fine is the global annual turnover of a company in the preceding business year.

As a consequence, in the future, we will likely be seeing significantly higher GDPR fines in Germany more in the range of the higher end of the maximum fine limits laid out in Article 83 GDPR – up to 4 % of a company’s global annual group-wide turnover. The application of corporate liability principles, which were originally developed under EU antitrust law, may also heighten the stakes. Noteworthy, the Fining Concept has been tested in actual cases already,[2] leading to an increase in fines.

It is important, though, that the Fining Concept is neither binding on data protection authorities outside Germany, nor for cross-border cases, nor for the review of fines by the German national courts.

METHODOLOGY OF THE FINING CONCEPT

The methodology introduced by the DSK is complex and involves five steps:

STEPS 1 and 2: The company concerned is classified into a size category depending on its turnover (micro, small and medium-sized enterprises and large enterprises) – each with various subgroups, which are meant to provide for a more precise individual turnover range. The average annual turnover of the relevant subgroup is then determined. For corporations achieving an annual turnover of more than EUR 500 million, the actual turnover will be considered.

STEP 3: A so-called “economic base value“ is determined by dividing the annual average turnover amount of the relevant subgroup by 360 days and thus calculating an average “daily fining amount”. On average, this daily fining amount corresponds to almost 0.28 % of a company’s global annual group-wide turnover.

STEP 4: The daily fining amount will be multiplied by a factor dependent on the seriousness of the violation, which is to be assessed by the Data Protection Authority on the basis of concrete, fact-related circumstances of the individual case. The seriousness of the violation ranges from “minor”, “medium”, “severe” to “very severe”.

For “minor” infringements of the GDPR, this multiplier is determined from a range between 1 and 4 (between 1 and 2 for mere formal violations of the GDPR). For “severe” infringements, the multiplier increases to a range between 8 and 12 (between 4 and 6 for mere formal violations), and can even be higher for “very severe” infringements. Formal violations of the GDPR include, inter alia, a violation of the obligations (i) to obtain valid consent for the processing of personal data of children, (ii) to maintain records of processing activities, (iii) to carry out a data protection impact assessment if so required, (iv) to designate a qualified data protection officer, and (v) to notify the competent data protection authority in case of a personal data breach in accordance with the applicable timeline. Substantive violations of the GDPR include, inter alia, a violation of (i) the general principles relating to the processing of personal data (e.g., processing of personal data without consent or other legal basis), (ii) the data controller’s transparency and notification obligations and the data subject’s related rights, and (iii) the obligations in connection with the transfer of personal data to third countries (such as the U.S.).

STEP 5: The value determined in Step 4 may then be adjusted on the basis of individual circumstance of the case – in particular with respect to mitigating and aggravating factors. Such factors may include, inter alia, the nature, gravity and duration of the violation, the intentional or negligent character of the infringement, any action taken by the controller or processor to mitigate the effects of the violation, the degree of cooperation with the competent data protection authority and any relevant previous infringements by the data controller or processor. Additionally, the Data Protection Authority deciding on the fine takes into account any other circumstances, such as the offender’s ability to pay the fine and the duration of the proceedings.

As a matter of course, the overall fine limits in Article 83 GDPR (2 % for formal, 4 % for substantive data protection violations) cannot be exceeded.

GROUP CONCEPT AND PARENTAL LIABILITY

It is important to note that both the GDPR and the Fining Concept make reference to two key concepts from EU antitrust enforcement principles:

First, the GDPR and the Fining Concept explicitly refer to Articles 101 and 102 of the Treaty on the Functioning of the European Union (TFEU) and the “undertakings” concept established therein. For companies to be fined, this means that all entities belonging to a corporate group (based on a concept of control) will be taken into account when assessing the annual turnover. Originally, this concept was introduced for the determination of fines in cartel proceedings, but now may have far reaching consequences for GDPR violations as well.

For the purposes of the Fining Concept, the application of the “undertakings” concept means that possibly the turnover of all companies linked to the offending company and exercising positive or even negative control (i.e., ability to block strategic decisions with a veto right) might be taken into account.

Second, parent entities may be held liable for GDPR violations committed by their subsidiaries, as long as the companies concerned are considered a so-called “single economic unit” because the parent has “decisive influence” over the offending company and is exercising that influence (so-called parental liability).[3] In other words, authorities may be able to pierce the corporate veil by going up the corporate chain to hold the ultimate parent (and potentially even its management) liable. Parental liability poses a risk for non-EU parent companies as well, since the GDPR has extensive extraterritorial reach. See our earlier client update on this subject.[4]

As a consequence, parent companies may be liable for the GDPR violations committed by their subsidiaries hence the fine notice from the respective German Data Protection Authority might be addressed to them.

However, there is no case law on these issues yet, and it remains to be seen whether the courts will strictly follow the “undertakings” concept rules which were originally developed for antitrust enforcement cases.

OUTLOOK

It is hard to predict how the individual German Data Protection Authorities will apply the Fining Concept in practice, especially with regard to steps 4 and 5 which contain a rather broad margin of discretion when determining the fine. However, taking into account that the Fining Concept foresees a multiplication of the “daily fining amount” by a factor of 1 to 4 even for minor infringements, we will probably see the German Data Protection Authorities following in the footsteps of the French Data Protection Authority (“CNIL”) (see our recent client alert here[5]) and the British Information Commissioner’s Office (“ICO”) who recently indicated the intent to hand out fines in the double-digit millions area. This is already evident by the Berlin Data Protection Authority’s recent announcement of its intention to impose a double-digit millions fine against an unnamed company.[6]

Strictly applied, the Fining Concept will mean that any violation of mere formal requirements of the GDPR would result in seven digit dollar fines if the offender’s annual turnover exceeds a threshold of approximately USD 340 million (subject to a potential reduction in Step 5).

The Fining Concept has also received some criticism already. In particular, commentators allege that it violates the proportionality principle as set out in Article 83(1) GDPR. However, the concept might not be long-lived, since the European Data Protection Board (“EDPB”), which is composed of representatives of the national data protection authorities, is expected to adopt its own fining concept in the near future superseding the Fining Concept of the DSK.[7]

However, the race to the top will likely continue until the EDPB steps in and issues its own guidance – in particular to ensure a uniform GDPR enforcement throughout the EU, to prevent any attempts of forum shopping and to honor the GDPR’s principle of proportionality.

________________________

[1] See DSK, Konzept der unabhängigen Datenschutzaufsichtsbehörden des Bundes und der Länder zur Bußgeldzumessung in Verfahren gegen Unternehmen (14 October 2019), available at (German): https://www.datenschutzkonferenz-online.de/media/ah/20191016_bu%C3%9Fgeldkonzept.pdf.

[2] See DSK press release, DSK entwickelt Konzept zur Bußgeldzumessung (17 September 2019), available at (German): https://www.datenschutzkonferenz-online.de/media/pm/20190917_bu%C3%9Fgeldkonzept.pdf.

[3] This concept was first established by the „Akzo Nobel“ case decided by the European Court of Justice in 2009: C-97/08 – Akzo Nobel NV, 10 September 2009, ECLI:EU:C:2009:536, available at: http://curia.europa.eu/juris/document/document.jsf?docid=72629.

[4] See Gibson Dunn, The General Data Protection Regulation: A Primer for U.S.-Based Organizations That Handle EU Personal Data (Dec. 4, 2017), available at: https://www.gibsondunn.com/the-general-data-protection-regulation-a-primer-for-u-s-based-organizations-that-handle-eu-personal-data/.

[5] See Gibson Dunn, The French Data Protection Authority Imposes a 50 Million Euros Fine on Google LLC (24 January 2019), available at: https://www.gibsondunn.com/french-data-protection-authority-imposes-50-million-euros-fine-on-google-llc/.

[6] See Sueddeutsche Zeitung, Berlin will Datenschutz-Bußgeld in Millionenhöhe verhängen (13 August 2019), available in German at: https://www.sueddeutsche.de/politik/datenschutz-berlin-berlin-will-datenschutz-bussgeld-in-millionenhoehe-verhaengen-dpa.urn-newsml-dpa-com-20090101-190813-99-446541.

[7] For now the EDPB has endorsed the GDPR related guidelines of the former Article 29 Working Party which, however, made only very limited reference to turnover-based concepts for the determination of fines under the GDPR. See Article 29 Working Party, Guidelines on the application and setting of administrative fines for the purposes of the Regulation 2016/679 (3 October 2017), available at: https://ec.europa.eu/newsroom/article29/item-detail.cfm?item_id=611237.

The following Gibson Dunn lawyers prepared this client update: Michael Walther, Kai Gesing and Selina Grün.

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

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

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

New York partner Eduardo Gallardo is the author of “On an Expansive Definition of Shareholder Value in the Boardroom,” [PDF] published in The CLS Blue Sky Blog on October 22, 2019.

The UK’s Financial Reporting Council (“FRC”)[1] published on 24 October 2019[2], a revised version of its stewardship code – the UK Stewardship Code 2020 (the “ New Code”) which takes effect in January 2020. On the same day, the UK Financial Conduct Authority (“FCA”) published the results of the feedback from its joint initiative with the FRC, seeking views of the market on a minimum standards regulatory framework for stewardship for financial services firms that invest for clients and beneficiaries[3]. The New Code (which covers a broader asset class than just listed equity) firmly entrenches the UK as a leader in shareholder engagement and stewardship – with a strong focus on outcomes (and not just policy statements) of stewardship, and lays out new expectations on how investment and stewardship is integrated, including environmental, social and governance (“ESG”) issues. The FCA has concluded that at this stage, given other recent new regulatory requirements, it does not propose to introduce further (stewardship-related) regulatory requirements on regulated asset managers and insurers, however it has flagged a number of key areas where it considers that barriers to effective stewardship remain and should be addressed.

This alert summarises the key changes in the New Code impacting investors and asset managers, the outcomes from the FCA/FRC discussion paper and related recent and forthcoming UK and EU legal and regulatory developments.

A. The UK Stewardship Code – Background and Developments

The UK Stewardship Code was first published in 2010 following the 2009 Walker Review[4] on governance of financial institutions in the wake of the global financial crisis, with a view to enhancing the quantity and quality of engagement between investors and companies. At the time, it was the first and only Stewardship Code[5] calling for responsible and engaged investment behaviours by asset managers and owners. In 2012, following the Kay Review of UK equity markets[6], the Code was revised to expand the role of stewardship and require investors to engage with companies on strategy as well as corporate governance. Since the revision of the Code in 2012 (the “Current Code”), the UK has continued to be seen as a market which upholds high standards of corporate governance and therefore attract international investors. By 2016, there were 305 signatories to the Code however upon evaluation by the FRC of the signatories’ statements against the Current Code, the FRC noted a huge variation in quality of the signatories’ stewardship statements. In that year, the FRC introduced a two tier/ranking system – signatories to the Code in Tier 1 were recognised as having achieved the status of reporting well and those in Tier 2 were flagged as signatories whose statements required improvement.

Notwithstanding these enhancements and resulting improvements in stewardship, examples of poor governance practice, short-termism in equity markets and misalignment of incentives leading to under-performance and corporate failures persisted. The FRC has also recognised that the investment market has materially altered since the first Code was published with increased investment flows into assets other than listed equity and environmental (particularly climate change) and social factors becoming more material issues for investors, in addition to the pre-existing focus on governance. Alongside this, there have been a number of developments in the UK, EU and global level aimed at enhancing resources for stewardship, increasing transparency and engagement between asset owners and asset managers, enhancing climate change and other non-financial disclosures and incorporating ESG considerations into the mainstream. These drivers and developments collectively led to the FRC to consult on some fundamental revisions to the Current Code. It has done this in parallel with its related joint initiative with the FCA seeking views on how best to encourage the institutional investment community to engage more actively in stewardship, the outcomes of which are summarised in section C below.

The FRC issued its consultation paper in January 2019[7] and received 110 responses to its consultation which closed in March of this year. In preparing for the consultation it reached out and sought feedback from 170 members of the global investment community (including the UN PRI, ShareAction, the Investment Association and the UK Sustainable Investment and Finance Association). It also met with circa 240 stakeholders as part of and following the launch of the consultation process. The consultation responses reflected strong support for the key changes (summarised in section B below).

B. The New UK Stewardship Code 2020

Who does it apply to? Who should be interested in it? The New Code is a voluntary code which sets higher standards than minimum UK regulatory requirements for asset owners[8] and managers and for the service providers[9] who support them.

What does the New Code do/say? The New Code is structurally and substantially very different from the Current Code.

First and fundamentally, the New Code sets out a new definition of stewardship[10]. Stewardship is now defined as “the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society.” This new definition links the primary purpose of stewardship to looking after the assets of beneficiaries entrusted to other, equating long-term value creation for this cohort with sustainable benefits to a wider group of interests (i.e., the “economy, environment and society).

The New Code consists of 12 “apply or explain” Principles for asset managers and asset owners (see Annex 1). These are supported by reporting expectations which indicate the information that should be publicly reported in order to become a signatory. The Current Code has seven “comply or explain” principles that are aimed at protecting and enhancing the value that accrues to the ultimate beneficiary.

There is a strong focus on the activities and outcomes of stewardship, not just policy statements. There are new expectations about how investment and stewardship is integrated, including ESG issues – note in particular Principle 7.

The New Code[11] asks investors to explain how they have exercised stewardship across asset classes. For these purpose, the New Code extends the scope across asset classes beyond listed equity for example fixed income, private equity, infrastructure investments, and in investments outside the UK.

The New Code also sets out six separate Principles for service providers. These now include principles addressing the assurance and the role service providers play in responding to market and systemic risks. The FRC has also used the New Code as an opportunity to be clearer about its expectations on the role played by service providers in the supporting their clients to meet their stewardship and investment responsibilities “taking into account material ESG issues, and communicating what activities have been undertaken”.

When does it apply from? The New Code will take effect from 1 January 2020. Organisations will remain signatories to the UK Stewardship Code until the first list of signatories to the New Code is published. To be included in the first list of signatories, organisations must submit a final report to the FRC by 31 March 2021.

How do firms apply to become signatories and what happens upon becoming a signatory? The New Code contains various reporting requirements. Organisations who wish to become signatories should produce a single[12] Stewardship Report explaining how they have applied the New Code in the previous 12 months for approval by the FRC. The Report should be reviewed and approved by the organisation’s governing body and signed by the chair, CEO or CIO. Existing signatories[13] to the Code will also need to submit a Stewardship Report that meets the reporting expectations in the New Code, in order to be listed as signatories to the UK Stewardship Code. Throughout 2020, the FRC has said that it will work with organisations seeking to be listed as signatories (in particular asset owners) to explain their expectations in relation to reporting.

Once an organisation has been accepted as a New Code signatory and the report is approved by the FRC, the report will be a public document and must be published on the organisation’s website or in some other accessible form.

C. FCA & FRC Feedback On & Outcomes From the “Building a Regulatory Framework for Effective Stewardship” Discussion Paper

The FCA is the conduct regulator for 59,000 financial services firms and financial markets in the UK and the prudential regulator for over 18,000 of those firms. One of its primary objectives is to make markets work well – for individuals, for business, large and small, and for the economy as a whole. Specifically, the FCA aims to ensure that firms such as asset managers and life insurers deliver good outcomes for their customers. For many firms, the exercise of stewardship will be key to ensuring this outcome. The FCA has also stated that it expects “effective stewardship to have wider economic, environmental and social benefits”.

In delivering on its regulatory responsibility to ensure effective stewardship, in January 2019, the FCA issued a Discussion Paper (closely co-ordinating with the FRC), ‘Building a Regulatory Framework for Stewardship’. The objective of the Discussion Paper was to secure feedback on barriers to effective stewardship, the minimum expectations on effective stewardship that should be imposed on financial services firms investing on behalf of clients and how to achieve them.

On 24 October, the FCA published the feedback from the Discussion Paper exercise[14]. In summary, the FCA agreed with the feedback from the majority of respondents that it would be premature to impose more stewardship obligations or requirements of asset managers and life insurers at this stage and that it should let firms first adapt to the FCA’s new rules on shareholder engagement (implementing SRD II – see section D below) which took effect in June. Further, the FCA noted that many firms were already making significant investments to improve their stewardship capabilities with an enhanced focus on ESG matters.

Notwithstanding this general finding, the FCA also concluded that there were other things that it could do to address some “remaining barriers to effective stewardship”, including: (i) examining how asset owners set and communicate their stewardship objectives; (ii) helping to address regulatory, informational and structural barriers to effective stewardship practices; (iii) considering further the role of firms’ culture, governance and leadership in both the management of climate risks and the exercise of stewardship; and (iv) pursuing a number of actions to promote better disclosure of firms’ stewardship practices and outcomes.

Some of the specific actions the FCA are proposing to take and/or areas they intend to give greater attention and focus to relate to the following:-

Climate-change related & other sustainability disclosures by issuers: The FCA is intending to consult in early 2020 on proposals for new ‘comply or explain’ rules requiring climate change-related disclosures by certain listed issuers aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). Alongside this, the FCA will continue to consider whether issuer disclosures on other sustainability factors, beyond climate change, are adequate to support investors’ business, risk and investment decisions.

Climate-change related disclosures by regulated firms: The FCA will consider how best to enhance climate change disclosures by regulated firms, such as asset managers and life insurers, so that they provide transparency on how their activities align with clients’ sustainability objectives

ESG Data Service Providers: The FCA will assess the role played by specialist providers of ESG data services looking initially at the nature and quality of these services, how investors use them and how much reliance they place on them.

Tackling “Greenwashing”: The FCA intends to do more to promote consumers’ access to genuinely green products and services; will “challenge firms” where it sees potential evidence of misleading marketing or “greenwashing”; carry out further policy analysis on greenwashing and publish new guidance as appropriate.

D. Recent Related UK/ EU Developments

As noted above, one of the key drivers to the review undertaken by the FRC of the Stewardship Code and the FCA of stewardship more generally, has been the link to the growing interest in how companies and investment firms manage climate change and other ESG risks and opportunities and related legal and regulatory developments in this area. A brief overview of some of these developments are noted below:

UK Law Commission Review of Fiduciary Duties of Investment Intermediaries: In 2014, the Law Commission reviewed the legal concept of fiduciary duty with regards to investment. It stated that ‘there is no impediment to trustees taking account of ESG factors where they are, or may be, financially material’ and recommended that the government should clarify that it is part of trustees’ duties to consider long-term systemic risks such as climate change. In 2017, the Law Commission issued a further report – ‘Pension Funds and Social Investment’ which identified a critical distinction between ESG and ethical factors, and began to explore options for regulatory reform.

Pensions Regulator & UK Department of Work & Pensions (DWP) Strengthen Pension Trustees Investment Duties: In 2016 and 2017, the UK Pensions Regulator updated its guidance for defined contribution and defined benefit schemes, advising that trustees need to take all factors that are financially material to investment performance into account, including ESG factors. Then in 2018, in response to the Law Commission’s report, the DWP issued amendments to the Occupational Pension Schemes Regulations[15] requiring trustees of funds to document in their Statement of Investment Principles how they have taken ESG factors in making investment decisions and their policy towards stewardship.

Shareholders Rights Directive II (“SRD II”): The EU Shareholder Rights Directive 2007 (SRD) aimed to improve corporate governance in EU companies by setting minimum EU standards on shareholder rights in relation to general meetings (including viz notice periods, information rights, requisitions, voting) and other matter such as website disclosures and proxy appointments. SRD II substantially amends SRD broadening its scope and remit to include rules to encourage long-terms shareholder engagement and transparency between traded companies and investors. The key changes introduced by SRD II which recently came into force in the UK (June 2019) include provisions relating to identification of shareholders, transmission of information between companies and their shareholders via intermediaries, obligations on intermediaries to facilitate stewardship or the exercise of rights by shareholders, disclosure obligations on proxy advisers, obligations relating to related party transactions, rights of shareholders to vote on remuneration policies and remuneration reports and (of particular relevance to the work of the FRC and FCA outlined above) new provisions on the transparency of engagement policies of institutional investors and asset managers as well as their investment strategies.

In particular, SRD II includes three key requirements relevant to transparency of engagement policies and investment strategies. First, institutional investors and asset managers are required to develop and disclose a shareholder engagement policy, as well as disclosing annually how they implement the policy and how they have voted in general meetings of companies of which they hold shares. The matters to be covered by the engagement policy are extensive including how institutional investors and asset managers integrate shareholder engagement in their investment strategy, monitor investee companies on relevant matters, conduct dialogues with investee companies, exercise voting and other rights, co-operate with shareholders, communicate with investee company stakeholders, and manage actual and potential conflicts of interest. In the UK, these rules apply to asset managers and insurers who have the UK as their home state regulator or investment firms authorized by the FCA.

Secondly, where an asset manager invests on behalf of an institutional investor, the institutional investor must disclose certain information regarding its arrangement with the asset manager (or explain why the information is not disclosed).The disclosure should include, for example, how the arrangement incentivises the asset manager to align its investment strategy and decisions with the profile and duration of the liabilities of the institutional investor, in particular long-term liabilities. This information must be made freely available on the institutional investor’s website.

Thirdly, asset managers disclose annually to the institutional investors for whom they invest how their investment strategy and implementation of that strategy complies with the arrangement with the institutional investor; and contributes to the medium to long-term performance of the assets of the institutional investor or fund. The disclosure must include key material medium to long-term risks associated with investments. The disclosures can be made publicly (e.g. in annual reports) or otherwise provided directly to the institutional investor.

UK Government Greenhouse Gas & Plastics Commitments: The UK Government has made a legally binding commitment to achieve net zero greenhouse gas emissions by 2050. It has also signed up to the UK Plastics Pact aimed at achieving four world-leading plastic packaging elimination targets by 2025.

UK Government Green Finance Strategy: In July 2019, the UK Government published its Green Finance Strategy[16] to support, amongst other things, its economic policy for strong, sustainable and balanced growth and its domestic and international commitments on climate change, the environment and sustainable development.

European Commission Sustainable Finance Action Plan: In 2015, the European Commission committed to the UN 2030 Sustainable Development Goals agenda and to achieving the 2030 Paris Agreement targets (including a 40% cut in greenhouse gas emission). The EC recognised that substantial investment would be required to achieve these targets and fulfil on its commitments. Accordingly, in 2016, it established a High Level Expert Group on Sustainable Finance which made a series of recommendations as set out in a wide-ranging Sustainable Finance Action Plan[17] which was formally adopted in May 2018. This includes work on sustainable finance disclosures, sustainable climate benchmarks, and a taxonomy to promote a common understanding of what constitutes sustainable activity. In May 2018, the EC adopted a package of measures implementing several key actions announced in its action plan on sustainable finance (see Section E below) and in August 2018, the European Commission mandated the European Securities and Markets Association (“ESMA”) to prepare technical advice on how to require asset managers and advisers to integrate ESG risks in their investment decisions or advisory processes, as part of their duties towards investors and/or clients.

E. Upcoming UK/ EU Developments of Note

In addition to the various initiatives that the FCA has outlined in its Feedback Statement on the New Regulatory framework for Effective Stewardship (see section C above) and the actions flowing out of the EU’s Sustainable Finance Action Pan (as summarised in section D above) there are a number of other initiatives and developments underway both in the UK and at an EU level. Some developments to keep an eye out for include the following:

FCA Consultation on Extending the Remit of Independent Governance Committees (“IGCs”)[18] ESG Duties: The FCA is currently consulting[19] on imposing a new duty for IGCs to report on their firm’s policies on ESG issues, consumer concerns and stewardship, for the products that IGCs oversee. The FCA is also proposing related guidance for providers of pension products and investment-based life insurance products which sets out how these firms should consider factors such as ESG risks and opportunities that can have an impact on financial returns, and to non-financial consumer concerns, when making investment decisions on behalf of consumers.

EU Sustainable Finance Action Plan – Specific Upcoming Regulations. Under the EU’s Action Plan a number of legislative proposals have been made. These include:

ESG Taxonomy Regulation – A proposal for the establishment of a framework to facilitate sustainable investment[20]: This regulation establishes the conditions and the framework to gradually create a unified classification system or ‘taxonomy’ on what can be considered an environmentally sustainable economic activity. To be environmentally sustainable, an economic activity must: contribute substantially to one or more of six specified environmental objectives: (i) climate change mitigation; (ii) climate change adaption; (iii) sustainable use and protection of water and marine resources; (iv) transition to a circular economy, waste prevention and recycling; (v) pollution prevention and control; and (vi) protection of healthy ecosystems. Financial market participants offering financial products as environmentally-sustainable would be impacted by the proposed Taxonomy Regulation as they would have to disclose information on the criteria used to determine the environmental sustainability of the investment.
ESG Disclosure Regulation – A proposal on disclosures relating to sustainable investments and sustainability risks[21]: This regulation will introduce disclosure obligations on how institutional investors and asset managers integrate ESG factors into their risk management processes. The proposed regulation would cover all financial products offered and services (individual portfolio management and advice) provided by the entities listed below, regardless of whether they pursue sustainability investment objectives or not. The rules would impact the following entities: (i) asset managers, regulated under the directive on undertakings for collective investment in transferable securities (UCITS), the alternative investment fund managers (AIFM) directive, the European venture capital funds (EuVECA) and European social entrepreneurship funds (EuSEF) regulations; (ii) institutional investors (being insurance undertakings regulated by Solvency II and occupational pension funds regulated by the institutions for occupational retirement provision directive; (iii) insurance distributors regulated by the insurance distribution directive (“IDD”); and (iv) investment advisors and individual portfolio managers regulated by Markets in financial instruments directive (“MiFID II”).
ESG Benchmark Regulation – A proposal amending the benchmarks regulation[22]: This amendment will create a new category of benchmarks comprising two new categories: (i) a low-carbon benchmark – this is a filtered version of a standard benchmark in which the underlying assets are selected so that the resulting portfolio has lower carbon emissions than the ‘parent’ standard benchmark; and (ii) a positive carbon impact benchmark – this is a more sustainability-focused benchmark, in which the underlying assets are selected on the basis that their carbon emissions savings exceed their carbon footprint. In addition, the regulation will require benchmark administrators to methodologies for the assessment, selection and weighting of the underlying assets comprising their individual versions of these benchmarks, and explain how such benchmarks reflect ESG objectives.

MiFID II & IDD: The European Commission has also launched a consultation to assess how best to include ESG considerations into the advice that investment firms and insurance distributors offer to individual clients. The aim is to amend Delegated Acts under the Markets in Financial Instruments Directive (MiFID II)[23] and the Insurance Distribution Directive (IDD)[24]. The Commission is of the view that when assessing if an investment product meets their clients’ needs, firms should also consider the sustainability preferences of each client, according to the proposed rules. This should help a broader range of investors access sustainable investments.

By way of reminder, under the existing MiFID II “suitability framework”, firms providing investment advice and portfolio management services are required to obtain information from clients about their knowledge and experience, ability to bear losses, their investment objectives including risk tolerance, to ensure that such firms recommend and/or trade products that are suitable for the client. The proposed changes to MiFID II would incorporate ESG considerations in the suitability framework. This would mean that portfolio managers and investment advisers will have to take steps to ensure that their clients’ ESG considerations are captured and embedded in their investment decision and recommendations framework. Although clients would not be obliged to provide or specify their ESG considerations, firms would be required to proactively seek this information from clients and accordingly they will need to give consideration as to how best to ascertain and capture this information.

Timing & Conclusion: The EC hopes that the first delegated act covering the climate change adaptation and mitigation objectives could be adopted by the end of this year. The objective would be to adopt the second and third delegated acts by mid-2021 and mid-2022 respectively covering other four other environmental objectives (protection of water and marine resources, circular economy and waste management, pollution prevention and control, protection of water and marine resources, healthy ecosystems). The EU environmental taxonomy (which is the bedrock of a number of the current and proposed new measures under the EU’s Action Plan) would then be completed. In a timing set-back, late in September 2019, member states of the EU voted to delay the application of the taxonomy to end 2022 – almost two years later than the Commission originally planned. Whilst the full package of proposals will take a few years to develop and be fully implemented, asset managers and investors are advised to start reviewing the impact of the new reporting and disclosure frameworks at an early stage to consider how these can be best embedded into existing frameworks and procedures.

ANNEX 1

UK Stewardship Code 2020 – New “Apply or Explain” Principles

Principles for Asset Owners and Asset Managers

Purpose and Governance

Signatories’ purpose, investment beliefs, strategy, and culture enable stewardship that creates long term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society
Signatories’ governance, resources and incentives support stewardship.
Signatories manage conflicts of interest to put the best interests of clients and beneficiaries first.
Signatories identify and respond to market-wide and systemic risks to promote a well-functioning financial system.
Signatories review their policies, assure their processes and assess the effectiveness of their activities.

Investment approach

Signatories take account of client and beneficiary needs and communicate the activities and outcomes of their stewardship and investment to them.
Signatories systematically integrate stewardship and investment, including material environmental, social and governance issues, and climate change, to fulfil their responsibilities.
Signatories monitor and hold to account managers and/or service providers.

Engagement

Signatories engage with issuers to maintain or enhance the value of assets.
Signatories, where necessary, participate in collaborative engagement to influence issuers.
Signatories, where necessary, escalate stewardship activities to influence issuers.

Exercising rights and responsibilities

Signatories actively exercise their rights and responsibilities.

PRINCIPLES FOR SERVICE PROVIDERS

Signatories’ purpose, strategy and culture enable them to promote effective stewardship.
Signatories’ governance, workforce, resources and incentives enable them to promote effective stewardship.
Signatories identify and manage conflicts of interest and put the best interests of clients first.
Signatories identify and respond to market-wide and systemic risks to promote a well-functioning financial system.
Signatories support clients’ integration of stewardship and investment, taking into account, material environmental, social and governance issues, and communicating what activities they have undertaken.
Signatories review their policies and assure their processes.

____________________________

[1] The FRC sets the UK Corporate Governance and Stewardship Codes and UK standards for auditing, accounting and actuarial work. It monitors and takes action to promote the quality of corporate reporting; and operates independent enforcement arrangements for accountants and actuaries and enforces audit quality.

[2] Revised version of stewardship code, here.

[3] Results of feedback from joint initiative with the FRC, here.

[4] A Review of Corporate Governance in UK Banks and Financial Institutions (26 June 2009) led by Sir David Walker, here.

[5] NB: There are now over 20 stewardship codes globally many of which have been based on the original UK Code.

[6] The Kay Review UK Equity Markets and Long-Term Decision Making: Final Report June 2012, here.

[7] FRC consultation paper issued January 2019, here.

[8] These include pension funds, endowment funds and charities.

[9] These include investment consultants, proxy advisers and data and research providers.

[10] The Current Code states that the aim of stewardship is “promote the long term success of companies in such a way that the ultimate providers of capital also prosper. Effective stewardship benefits companies, investors and the economy as a whole.”

[11] Principle 12.

[12] The Code does not require disclosure of stewardship activities on a fund-by-fund basis or for each investment strategy but does require the report to indicate how stewardship differs across funds, asset class and geographies.

[13] For list of existing (i) asset manager signatories, click here; (ii) asset owner signatories, click here; and (iii) service provider signatories, click here.

[14] FCA published feedback from Discussion Paper exercise, here.

[15] Pension Protection Fund (Pensionable Service) and Occupational Pension Schemes (Investment and Disclosure) (Amendment and Modification) Regulations 2018 (the “Amending Regulations”)

[16] July 2019 UK Government Green Finance Strategy, here.

[17] Sustainable Finance Action Plan, here.

[18] IGCs provide independent oversight of the value for money of workplace personal pensions provided by firms such as life insurers and some self-invested personal pension operators. They also oversee workplace personal pensions in accumulation, i.e., before pension savings are accessed.

[19] The FCA is currently consulting on imposing a new duty for IGCs to report on their firm’s policies on ESG issues, consumer concerns and stewardship, for the products that IGCs oversee, here.

[20] ESG Taxonomy Regulation – A proposal for the establishment of a framework to facilitate sustainable investment, here.

[21] ESG Disclosure Regulation – A proposal on disclosures relating to sustainable investments and sustainability risks, here.

[22] For text of EU Low Carbon Benchmarks Regulation published on 25 October 2019, click here.

[23] Draft Amending Delegated Acts under MiFID II, here.

[24] Draft Amending Delegated Acts under the Insurance Distribution Directive, here.

To learn more about the issues covered in this alert, please contact the author of this alert, Selina Sagayam, or the Gibson Dunn lawyer with whom you usually work in the Securities Regulation and Corporate Governance practice group, or any of the following lawyers:

Selina S. Sagayam – London (+44 020 7071 4263, [email protected])
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Amy Kennedy – London ( +44 020 7071 4283, [email protected])
Jean-Philippe Robé – Paris (+33 1 56 43 13 00, [email protected])
Lori Zyskowski – New York (+1 212-351-2309, [email protected])

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

Palo Alto partner Lisa Fontenot and associate Cassandra Gaedt-Sheckter are the authors of “Implications of AI on Board Oversight,” [PDF] published in the Corporate Board Member on October 23, 2019.

On October 4, 2019, the Texas Supreme Court agreed to hear a case addressing the extent to which “anti-washout” provisions can prevent overriding royalty interests from lapsing when the lessee of an oil and gas lease enters into a new lease for the same assets.

Overriding royalty interests are “carved out” of an oil and gas lease and entitle the interest holder to some portion of a leased asset’s production without subjecting the interest holder to the expense of developing, operating, or maintaining the leased asset. These interests are tied to the lease from which they are carved out, meaning that these interests are limited in duration to the leasehold interest’s life. See Sunac Petroleum Corp. v. Parkes, 416 S.W.2d 798, 804 (Tex. 1967). Thus, absent specific language to the contrary, when the lease terminates or is renewed/extended, the overriding royalty interest does not survive. To prevent an overriding royalty interest from lapsing in such an event, interest holders often include “anti-washout” clauses in the instrument creating the overriding royalty interest. While these provisions typically prevent an overriding royalty interest from lapsing when a lease is renewed or extended, some seek to prevent the interests from lapsing even when the lessee enters into an entirely new lease with different terms for a particular mineral interest. For decades, Texas courts have confirmed that these anti-washout provisions are valid and enforceable as applied to lease extensions and renewals.

But on July 26, 2018, a Texas Court of Appeals addressed for the first time whether anti-washout provisions could extend existing overriding royalty interests to completely new leases. In Yowell v. Granite Operating Co., 557 S.W.3d 794 (Tex. App.—Amarillo 2018, pet. granted), a group of overriding royalty interest owners argued that broad anti-washout provisions allowed the group to retain ownership of their interests after new leases were entered into for a particular mineral interest. The Court rejected this argument, finding that anti-washout provisions cannot extend overriding royalty interests to a completely new lease—which in this case contained materially different terms and different lessees—when there is any uncertainty as to when the interest in the new lease would vest. The Court rested its decision on a principle of property law called the “rule against perpetuities.” Under this rule, “no interest is valid unless it must vest, if at all, within twenty-one years after the death of some life or lives in being at the time of the conveyance.” BP Am. Prod. Co. v. Laddex, Ltd., 513 S.W.3d 476, 479 (Tex. 2017). In Yowell, because (1) the underlying lease was of indeterminate duration and (2) the time between the expiration of the underlying lease and the creation of a new lease was also an indeterminate period, the Court of Appeals held that the anti-washout provision at issue violated the rule against perpetuities and was void.

The overriding royalty interest owners sought discretionary review from the Texas Supreme Court, which the Court granted. The overriding royalty interest owners argue that the appellate court’s rule against perpetuities holding is incorrect. Instead, they assert that their overriding royalty interests vested immediately when they were reserved in the original lease—the timing of the new lease is irrelevant. The new lessees disagree. They argue that any “vesting” of an interest in potential, future leases must necessarily be delayed until those leases actually exist; therefore, the overriding royalty interest provisions at issue violated the rule against perpetuities because there was no way to know if or when a new lease would be entered.

The Texas Supreme Court has scheduled oral arguments on the case for January 9, 2020. Gibson Dunn will continue to monitor this matter over the coming months, and, should the Texas Supreme Court agree with the Court of Appeals that the rule against perpetuities applies and can bar certain anti-washout provisions, we stand ready to advise our clients on whether and to what extent this decision may impact their businesses.

The following Gibson Dunn lawyers assisted in preparing this client update: Michael Raiff, Justin Stolte, Michael Darden, Christine Demana, Collin Ray, Nathan Zhang and Jordan Silverman.

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 any of the following members of the firm’s Oil and Gas practice group:

Michael P. Darden – Houston (+1 346-718-6789, [email protected])
Tull Florey – Houston (+1 346-718-6767, [email protected])
Hillary H. Holmes – Houston (+1 346-718-6602, [email protected])
Shalla Prichard – Houston (+1 346-718-6644, [email protected])
Mike Raiff – Dallas (+1 214-698-3350, [email protected])
Doug Rayburn – Dallas (+1 214-698-3442, [email protected])
Gerry Spedale – Houston (+1 346-718-6888, [email protected])
Justin T. Stolte -Houston (+1 346-718-6800, [email protected])

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

Capital in the oil and gas sector remains relatively tight, with traditional financing sources continuing to be inaccessible to many industry participants. As a result, new financing structures have been developed – and previously used structures have been revisited – to help meet the industry’s capital needs. Please join members of the Gibson Dunn Energy team in a discussion regarding the use of these non-traditional financing structures. The discussion will provide an overview of VPP, NPI, and ORRI structures; JV and non-op AFE funding structures; and preferred equity structures. We also will discuss the recent use of asset-based securities (ABS) as a financing tool in the sector.

View Slides (PDF)

PANELISTS:

Michael P. Darden is Partner-in-Charge of the Houston office of Gibson, Dunn & Crutcher, chair of the firm’s Oil & Gas practice group, and a member of the firm’s Energy and Mergers and Acquisitions practice groups. His practice focuses on international and U.S. oil and gas ventures, including LNG, deep-water, and unconventional resource development projects, international and U.S. infrastructure projects, asset acquisitions and divestitures, and energy-based financings, including project financings, reserve-based loans, and production payments.

Gerry Spedale is a partner in the Houston office of Gibson, Dunn & Crutcher. His practice focuses on capital markets, mergers and acquisitions, joint ventures and corporate governance matters for companies and private equity clients in the energy industry, including MLPs. He has extensive experience representing issuers and investment banks in both public and private debt and equity offerings, including initial public offerings, convertible note offerings and offerings of preferred securities. He also has substantial experience in public and private company acquisitions and dispositions and board committee representations.

Justin T. Stolte is a partner in the Houston office of Gibson, Dunn & Crutcher and a member of the firm’s Mergers and Acquisitions and Energy groups. His practice focuses on acquisitions, divestitures, and joint ventures across the energy sector.

On October 14, 2019, the Trump administration authorized new sanctions against the Government of Turkey in response to that country’s recent military incursion into northern Syria, an action the U.S. government condemned as “endangering innocent civilians, and destabilizing the region, including undermining the campaign to defeat ISIS.”[1]^,[2] Based on that authority, the Treasury Department immediately issued sanctions against Turkey’s Ministry of Energy and Natural Resources and Ministry of National Defense, as well as three senior officials. The Trump administration announced that these sanctions would be accompanied by an increase in steel tariffs and the halt to negotiations over a $100-billion trade deal with Turkey.[3] At the same time, the U.S. Department of Justice indicted Halk Bank, a Turkish financial institution, for evading separate sanctions regarding Iran, among other charges.[4]

Three days later on October 17, after Vice President Pence and other senior U.S. officials traveled to Ankara, the Turkish government agreed to a limited five-day ceasefire to allow the withdrawal of Kurds outside a designated “safe-zone.”[5] The resulting joint U.S.-Turkish statement on the ceasefire noted that, once Turkish military operations are paused, “the U.S. agrees not to pursue further imposition of sanctions under the Executive Order of October 14.”[6] However, the military situation in northern Syria remains fluid, as does U.S.-Turkish diplomatic engagement, leaving uncertain the status of this new sanctions regime in the near term.

The new sanctions are only the second time[7] that the U.S. Government has sanctioned governmental entities of a G20 country, and the first sanctions that the U.S. Government has issued against the government ministries of a NATO member.[8] The new sanctions are therefore likely to have significant impacts for U.S. and multinational companies doing business in Turkey, particularly those with counterparties in the defense and energy sectors. The Executive Order also authorizes the application of secondary sanctions against foreign financial institutions that continue to do business with listed entities and provides additional authority against individuals who interfere with a potential future peace process in Syria.[9] While the Treasury Department issued a general license allowing U.S. Government employees, grantees, and contractors to conduct the official business of the U.S. government with the listed Turkish entities, this license is unlikely to authorize U.S. company engagement in direct commercial sales of defense articles and services, and other goods and services, to the Ministries of National Defense and Energy and Natural Resources.[10] U.S. companies have until November 13, 2019 to wind down their operations and pre-existing contracts with those Turkish ministries.[11]

The Executive Order’s primary authorities, delineated in Section 1, enable the U.S. government to freeze property and assets of current and former Turkish officials, as well as subsets of the Turkish government, that the U.S. Treasury Secretary, in consultation with the State Department, determines are contributing to ongoing instability in the Syrian conflict or committing serious human rights abuses.[12] The scope of the order also extends to those who “materially assist” Turkish entities designated under the sanctions regime and is not limited to material assistance with any specific conduct that prompted the entities’ designation.[13] Pursuant to Section 1, the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) immediately designated Turkey’s Ministry of Energy and Natural Resources and Ministry of National Defense to the Specially Designated and Blocked Persons (“SDN”) list.[14] OFAC also designated three senior Turkish officials—Minister of National Defense, Hulusi Akar; Minister of Interior, Suleyman Soylu; and Minister of Energy, Fatih Donmez—to the SDN list.[15] As a result of these designations, U.S. persons are generally prohibited from dealing with the listed Turkish agencies and individuals, and all assets under U.S. jurisdiction owned or controlled by the sanctioned entities will be frozen.

However, the scope of this new sanctions regime extends beyond those entities immediately listed. Section 1 of the Executive Order lays the groundwork for persons and entities operating in additional sectors of the Turkish economy to be designated, and Section 2 allows the U.S. Secretary of State to authorize sanctions against anyone responsible for or complicit in disrupting or preventing a potential ceasefire or political solution to the Syrian conflict, including those brokered by the United Nations.[16] Separately, Section 3 of the order allows the U.S. Treasury Secretary to impose sanctions on any foreign financial institution that knowingly facilitates a financial transaction for or on behalf of an entity designated as an SDN pursuant to Section 1.[17] Specifically, the Executive Order authorizes the Secretary of Treasury to prohibit or restrict the opening or maintenance of correspondent or payable-through accounts in the United States.[18]

OFAC issued three general licenses providing limited exemptions to compliance with the Executive Order. The first license exempts from the scope of the sanctions regime any interaction with the listed Turkish entities as a result of official business by the U.S. government, its employees, grantees, or contractors.[19] The second license provides for a period of time—from October 14, the date of the sanction’s implementation, to 12:01 a.m. on November 13—for companies to wind down their contracts, operations, and other agreements involving the Ministries of National Defense and Energy and Natural Resources.[20] The third license exempts from compliance certain international organizations affiliated with the United Nations, such as the World Bank and World Health Organization.[21]

Given the significant ties between the defense sectors of the U.S. and Turkish governments in particular, we expect that the October 14 sanctions are likely to have significant impacts, both intended and unintended, on the companies involved in these sectors as well as the U.S. and foreign financial institutions that support those relationships. Notably, General License 1 applies only to official U.S. Government engagement with the Turkish ministries and does not cover U.S. entities with direct commercial relationships with the Ministries of National Defense and Energy and Natural Resources, or any entities owned 50% or more by these ministries that are now blocked as a result of their designation.

OFAC has not yet issued guidance on the scope of the official business concept, which will be of keen interest to many companies that have invested significantly over decades in Turkey’s defense industrial base in part to support U.S. government foreign military sales. While foreign military sales may be covered by the official business concept, direct commercial sales of defense articles and services may not be. Foreign joint ventures with a U.S. partner and foreign subsidiaries of U.S. companies are not directly subject to the new sanctions regime. However, depending on the specific joint venture arrangements and the business of the foreign subsidiaries, the U.S. joint venture partner or parent company may need to cease supporting any work by November 13, 2019, absent a specific license.

____________________

[1] Executive Order, Blocking Property and Suspending Entry of Certain Persons Contributing to the Situation in Syria (Oct. 14, 2019), available at https://www.treasury.gov/resource-center/sanctions/Programs/Documents/syria_eo_10142019.pdf.

[2] Press Release, U.S. Department of the Treasury, Treasury Designates Turkish Ministries and Senior Officials in Response to Military Action in Syria (Oct. 14, 2019), available at https://home.treasury.gov/news/press-releases/sm792.

[3] Press Release, White House, Statement from President Donald J. Trump Regarding Turkey’s Actions in Northeast Syria (Oct. 14, 2019), available at https://www.whitehouse.gov/briefings-statements/statement-president-donald-j-trump-regarding-turkeys-actions-northeast-syria/.

[4] Press Release, U.S. Department of Justice, Turkish Bank Charged in Manhattan Federal Court for its Participation in a Multibillion-Dollar Iranian Sanctions Evasion Scheme (Oct. 15, 2019) available at https://www.justice.gov/usao-sdny/pr/turkish-bank-charged-manhattan-federal-court-its-participation-multibillion-dollar.

[5] Press Release, White House, The United States and Turkey Agree to Ceasefire in Northeast Syria (Oct. 17, 2019), available at https://www.whitehouse.gov/briefings-statements/united-states-turkey-agree-ceasefire-northeast-syria/.

[6] Id.

[7] On December 29, 2016, the Obama administration designated as Specially Designated Nationals (“SDNs”) Russia’s Federal Security Services, or Federalnaya Sluzhba Bezopasnosti (FSB) and the Main Intelligence Directorate of the Russian Ministry of Defense, or Glavenoe Razvedyvatel’noe Uprvalenie (GRU), among other associated entities, for their involvement in cyber operations aimed at the 2016 U.S. presidential election, available at https://www.treasury.gov/resource-center/sanctions/ofac-enforcement/pages/20161229.aspx.

[8] Last year, the Trump administration levied separate sanctions on the Turkish Interior and Justice Ministers over the detention of an American pastor. Press Release, U.S. Department of the Treasury, Treasury Sanctions Turkish Officials with Leading Roles in Unjust Detention of U.S. Pastor Andrew Brunson (Aug. 1, 2018), available at https://home.treasury.gov/news/press-releases/sm453.

[9] Executive Order at Section 3, Section 2.

[10] General License 1 to Executive Order of October 14, 2019.

[11] General License 2 to Executive Order of October 14, 2019.

[12] Executive Order at Section 1(a).

[13] Id. at Section 1(a)(E).

[14] U.S. Department of the Treasury, Executive Order on Syria-Related Sanctions; Syria-Related Designations; Issuance of Syria-Related General Licenses (Oct. 14, 2019) available at https://www.treasury.gov/resource-center/sanctions/OFAC-Enforcement/Pages/20191014.aspx.

[15] Id.

[16] Executive Order at Section 2(a-c).

[17] Id. at Section 3(a-b).

[18] Id.

[19] General License 1 to Executive Order of October 14, 2019.

[20] General License 2 to Executive Order of October 14, 2019.

[21] General License 3 to Executive Order of October 14, 2019.

The following Gibson Dunn lawyers assisted in preparing this client update: Judith Alison Lee, Adam M. Smith, Chris Timura, Stephanie Connor and Brian Williamson.

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

United States:
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, [email protected])
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, [email protected])
Jose W. Fernandez – New York (+1 212-351-2376, [email protected])
Marcellus A. McRae – Los Angeles (+1 213-229-7675, [email protected])
Adam M. Smith – Washington, D.C. (+1 202-887-3547, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, [email protected])
Ben K. Belair – Washington, D.C. (+1 202-887-3743, [email protected])
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, [email protected])
Laura R. Cole – Washington, D.C. (+1 202-887-3787, [email protected])
Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, [email protected])
Henry C. Phillips – Washington, D.C. (+1 202-955-8535, [email protected])
R.L. Pratt – Washington, D.C. (+1 202-887-3785, [email protected])
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, [email protected])
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, [email protected])

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

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

With New York City and State agencies and government officials—from the Attorney General to the New York State Department of Financial Services to the New York City Department of Buildings—taking a more and more aggressive role in policing virtually every industry operating in New York, it has become critical for regulated industries to understand their legal options in challenging New York State and City agency regulations, executive determinations, and government policies. The primary vehicle for doing so is the Article 78 proceeding, brought in New York State Supreme Court.

In this one-hour presentation, two of our most experienced partners in the field of challenging government action in New York—Mylan Denerstein and Akiva Shapiro—provide practical and strategic guidance for the successful prosecution of these sometimes misunderstood summary proceedings. Using real-world examples from their practice, they will discuss the primary strategic issues that you should consider in deciding whether to bring an Article 78 action (versus, for example, a suit in federal court); provide a roadmap for Article 78 actions and keys to success; and discuss the procedural hurdles actors often throw up in defending against these actions, and ways of neutralizing them. The program is beneficial to anyone regulated or affected by actions taken by New York City and State agencies and officials.

View Slides (PDF)

PANELISTS:

Mylan Denerstein is a litigation partner in the New York office of Gibson, Dunn & Crutcher. Ms. Denerstein is Co-Chair of Gibson Dunn’s Public Policy Practice Group and a member of the Crisis Management, White Collar Defense and Investigations, Labor and Employment, Securities Litigation, and Appellate Practice Groups. Ms. Denerstein leads complex litigation and internal investigations, representing companies in their most critical times, typically involving state, municipal, and federal government agencies. Prior to joining Gibson Dunn, Ms. Denerstein served as Counsel to New York State Governor Andrew Cuomo; in a diverse array of legal positions in New York State and City agencies; and as a federal prosecutor and Deputy Chief of the Criminal Division in the U.S. Attorney’s Office for the Southern District of New York. Ms. Denerstein was named to the 2019 list of “Notable Women in Law” by Crain’s New York Business and the 2019 “Law Power 50” list by City & State.

Akiva Shapiro is a litigation partner in the New York office of Gibson, Dunn & Crutcher, where he is a member of the Firm’s Appellate and Constitutional Law, Media & Entertainment, Securities Litigation, and Betting & Gaming Practice Groups. Mr. Shapiro’s practice focuses on a broad range of high-stakes constitutional, commercial, and appellate litigation matters, including Article 78, First Amendment, Due Process, and statutory challenges to government actions and regulations. He is regularly engaged in front of New York’s trial courts, federal and state courts of appeal, and the U.S. Supreme Court, and has been named a Super Lawyers New York Metro “Rising Star” in Constitutional Law.

Part I: Federal Courts of Appeals Apply a Range of Approaches to Damages Proposals at the Class Certification Stage

Part II: Courts Show Flexibility in Assessing Class Action Settlements

Part III: Spokeo Issues Continue to Percolate Throughout the Federal Courts

Part IV: The California Supreme Court Softens Ascertainability Requirement

I. The Federal Circuit’s Decision

II. Further Potential Appellate Proceedings in Arthrex

III. Impact on Pending Cases

Top News—Appointment of Administrative Patent Judges Held Unconstitutional

Other Federal Circuit News

Key Case Summaries (August 2019–October 2019)

Upcoming Oral Argument Calendar

Table of Contents

I. Key U.S. Legislative and Regulatory Developments

II. Developments in the EU

III. Autonomous Vehicles: A New Hope for Federal Regulation

IV. Data Privacy

I. Key U.S. Legislative and Regulatory Developments

A. SEVERAL NEW AI BILLS PROPOSED IN CONGRESS

B. INCREASED FOCUS ON COUNTERING DEEPFAKES

1. Federal level

2. State level

C. MORE ACTIONS AGAINST FACIAL RECOGNITION SOFTWARE

1. Use in Law Enforcement

2. Other Uses

D. ILLINOIS AI VIDEO INTERVIEW ACT GOES INTO EFFECT

II. Developments in the EU

A. FOCUS ON COMPREHENSIVE AI REGULATION

B. UK FOCUS ON AI

III. Autonomous Vehicles: A New Hope For Federal Regulation

IV. Data Privacy

B. The New UK Stewardship Code 2020

C. FCA & FRC Feedback On & Outcomes From the “Building a Regulatory Framework for Effective Stewardship” Discussion Paper

D. Recent Related UK/ EU Developments

E. Upcoming UK/ EU Developments of Note

ANNEX 1

UK Stewardship Code 2020 – New “Apply or Explain” Principles

Principles for Asset Owners and Asset Managers

**Part III: Spokeo Issues Continue to Percolate Throughout the Federal Courts**