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October 18, 2018 |
FERC Issues Long-Awaited Order on Return on Equity for New England Electric Utilities

Click for PDF On October 16, 2018, the Federal Energy Regulatory Commission (“FERC”) issued a long-awaited order on the return on equity (“ROE”) to be used by electric utilities in New England for setting their transmission rates.  The order has major implications for all electric utilities—not just those in New England—because the order establishes a new methodology for reviewing and setting ROEs that will be applied to all FERC-regulated electric utilities going forward.  There is no indication in the order that FERC intends this methodology to apply to natural gas pipeline rates. In Tuesday’s order, FERC charted a wholly new course for setting ROEs by using neither a one-step or two-step discounted cash flow (“DCF”) methodology as it has used historically.  Implicitly responding to long standing criticism of the DCF model, FERC instead adopted a new approach in which it: (i) will first look to whether an existing ROE falls within a particular range of ROEs within a “zone of reasonableness” established through three separate financial models (one of which is the DCF) and then, if the ROE falls outside the range, (ii) it will establish a new ROE through application of four separate methodologies for estimating ROEs. The order was issued in four separate but related proceedings initiated by complaints filed against the New England utilities.  One of these proceedings was on remand from the U.S. Court of Appeals for the D.C. Circuit’s 2017 decision in Emera Maine v. FERC.  Three were pending before FERC on “exceptions” (i.e., appeal) from FERC administrative law judge (“ALJ”) decisions issued in 2016 and 2018. These four related cases began with a complaint filed against New England’s utilities on September 30, 2011 by Martha Coakley, the Attorney General of Massachusetts, and other entities and state agencies.  FERC set that matter for hearing before an ALJ but, on appeal of the ALJ’s decision, issued its then-seminal 2014 order in Coakley v. Bangor Hydro in which it changed its historic methodology for setting electric utility ROEs. Prior to Coakley, FERC established electric utility ROEs based on a “one-step” DCF methodology that estimated actual ROEs of publicly traded electric utilities to determine the appropriate ROE for the subject utility.  More specifically, the methodology calculated what investors in comparable utilities expected for ROEs (as evidenced by dividend yields and analyst earnings forecasts) and then set the ROE for the subject utility at either the midpoint or median of the range of ROEs of these comparable utilities (the so-called “zone of reasonableness”). In Coakley, FERC instead used a “two-step” DCF methodology to set the ROEs for the New England utilities.  This methodology, which had been used by FERC for natural gas pipelines for some time, looked not only at ROEs of comparable utilities but also at long-term economic growth forecasts.  All things being equal, the two-step methodology thus resulted in a lower ROE than the one-step methodology because long-term forecast economic growth generally is lower than ROEs imputed from divided yields and earnings forecasts.  However, in a major departure from precedent, FERC set the ROE for the New England utilities not at the median or midpoint of the zone of reasonableness, but at the midpoint of the upper half of the zone.  FERC explained that anomalous capital market conditions justified this departure from precedent. From 2012 to 2014, three additional complaints were filed against the New England utilities by a variety of entities seeking lower ROEs.  FERC set all three for hearing before ALJs.  All three resulted in ALJ decisions that were appealed up to FERC, where they remain pending, and partially rendered moot by yesterday’s FERC order. The Coakley decision was widely criticized as an opportunistic means to lowering overall returns at a time when lower interest rates were actually encouraging new infrastructure investment.  The decision was appealed to the U.S. Court of Appeals for the D.C. Circuit by both the utilities and their customers. The Court in 2017—in an order titled Emera Maine v. FERC—found in part for the utilities and in part for the customers.  Finding for the customers, the Court held that an existing ROE that falls within the zone of reasonableness is not per se just and reasonable and, thus, may be changed by FERC.  Finding for the utilities, the Court held that FERC had not adequately shown that the New England utilities’ existing ROE was unjust and reasonable.  The Court thus vacated the underlying Coakley decision and remanded the matter to FERC.  But by vacating the underlying decision, the Court gave FERC wide berth in adopting a new and revised approach to establishing ROE policy. Yesterday’s FERC order addresses the Coakley decision’s shortcomings identified by the Court in Emera Maine v. FERC by establishing a clear two-step approach to ROE complaint matters.  But it goes much further by looking beyond DCF analyses and espousing a methodology that uses multiple financial models. First, FERC proposes using three different financial models—the DCF, the CAPM, and the Expected Earnings models—to establish a zone of reasonableness of estimated ROEs enjoyed by utilities with comparable risk to that at issue (with risk generally indicated by credit ratings).  The DCF model, as noted, has historically been the sole model used by FERC to establish the zone of reasonableness and, if necessary, the new ROE; parties, however, have often presented evidence of results from the CAPM or Expected Earnings models as additional evidence seeking to support or refute the DCF results. Importantly, FERC held that if a utility’s existing ROE falls within a particular range (i.e., effectively a sub-zone) within the zone of reasonableness it will be presumed to be just and reasonable.  As a result, FERC will dismiss a complaint if the ROE falls within the range unless other evidence sufficiently rebuts that presumption.  Given the D.C. Circuit’s ruling in Emera Maine v. FERC, this part of FERC’s order will likely be challenged in court again. Second, if the existing ROE is found to be unjust and unreasonable, FERC will establish a new ROE based on four financial models—the three used to set the zone of reasonableness as well as the Risk Premium Model.  More specifically, FERC will set the new ROE at the average of (i) the midpoints or medians of the zones of reasonableness established by the DCF, the CAPM, and the Expected Earnings models and (ii) the single numerical result of the Risk Premium Model (which, like the CAPM and Expected Earnings models, has been used in FERC proceedings as additional evidence).  More detail on the models is provided in an appendix to the FERC order. As FERC applied this new methodology to the pending New England utility cases, it found that the range for evaluating the current ROE is 9.60 percent to 10.99 percent and that the pre-Coakley 11.14 percent ROE for the utilities is unjust and unreasonable.  FERC then applied the new composite methodology to setting ROEs and reached a “preliminary” finding that a 10.41 percent ROE is just and reasonable.  FERC however established a “paper hearing” and invited parties to submit briefs regarding the proposed new approach to ROEs and its application to the four New England complaint proceedings.  Initial briefs are due within 60 days of the date of the order and reply briefs are due 30 days thereafter. The order was issued by Chairman McIntryre, and Commissioners LaFleur and Chatterjee. Commissioner Glick did not participate in the decision, but no reason was given.  It is suspected that Commissioner Glick recused himself because he previously worked for Iberdrola, the parent of two of the New England electric utilities directly impacted by the order. On balance, FERC’s new approach, while complicated, appears to be a sounder approach to establishing ROEs than simply using the DCF method.  However, the order fails to specify many implementation details that will need to be hashed out in the upcoming briefing process.  How these details are determined will have a large impact on the end result of the new approach.  And all of this will likely be done in the context of rising interest rates and the need to invest in new transmission infrastructure in a number of parts of the country. Gibson Dunn’s Energy, Regulation and Litigation lawyers are available to assist in addressing any questions you may have regarding the developments discussed above.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, or the authors: William S. Scherman – Washington, D.C. (+1 202-887-3510, wscherman@gibsondunn.com) Jeffrey M. Jakubiak – New York (+1 212-351-2498, jjakubiak@gibsondunn.com) Jennifer C. Mansh – Washington, D.C. (+1 202-955-8590, jmansh@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 17, 2018 |
SEC Warns Public Companies on Cyber-Fraud Controls

Click for PDF On October 16, 2018, the Securities and Exchange Commission issued a report warning public companies about the importance of internal controls to prevent cyber fraud.  The report described the SEC Division of Enforcement’s investigation of multiple public companies which had collectively lost nearly $100 million in a range of cyber-scams typically involving phony emails requesting payments to vendors or corporate executives.[1] Although these types of cyber-crimes are common, the Enforcement Division notably investigated whether the failure of the companies’ internal accounting controls to prevent unauthorized payments violated the federal securities laws.  The SEC ultimately declined to pursue enforcement actions, but nonetheless issued a report cautioning public companies about the importance of devising and maintaining a system of internal accounting controls sufficient to protect company assets. While the SEC has previously addressed the need for public companies to promptly disclose cybersecurity incidents, the new report sees the agency wading into corporate controls designed to mitigate such risks.  The report encourages companies to calibrate existing internal controls, and related personnel training, to ensure they are responsive to emerging cyber threats.  The report (issued to coincide with National Cybersecurity Awareness Month) clearly intends to warn public companies that future investigations may result in enforcement action. The Report of Investigation Section 21(a) of the Securities Exchange Act of 1934 empowers the SEC to issue a public Report of Investigation where deemed appropriate.  While SEC investigations are confidential unless and until the SEC files an enforcement action alleging that an individual or entity has violated the federal securities laws, Section 21(a) reports provide a vehicle to publicize investigative findings even where no enforcement action is pursued.  Such reports are used sparingly, perhaps every few years, typically to address emerging issues where the interpretation of the federal securities laws may be uncertain.  (For instance, recent Section 21(a) reports have addressed the treatment of digital tokens as securities and the use of social media to disseminate material corporate information.) The October 16 report details the Enforcement Division’s investigations into the internal accounting controls of nine issuers, across multiple industries, that were victims of cyber-scams. The Division identified two specific types of cyber-fraud – typically referred to as business email compromises or “BECs” – that had been perpetrated.  The first involved emails from persons claiming to be unaffiliated corporate executives, typically sent to finance personnel directing them to wire large sums of money to a foreign bank account for time-sensitive deals. These were often unsophisticated operations, textbook fakes that included urgent, secret requests, unusual foreign transactions, and spelling and grammatical errors. The second type of business email compromises were harder to detect. Perpetrators hacked real vendors’ accounts and sent invoices and requests for payments that appeared to be for otherwise legitimate transactions. As a result, issuers made payments on outstanding invoices to foreign accounts controlled by impersonators rather than their real vendors, often learning of the scam only when the legitimate vendor inquired into delinquent bills. According to the SEC, both types of frauds often succeeded, at least in part, because responsible personnel failed to understand their company’s existing cybersecurity controls or to appropriately question the veracity of the emails.  The SEC explained that the frauds themselves were not sophisticated in design or in their use of technology; rather, they relied on “weaknesses in policies and procedures and human vulnerabilities that rendered the control environment ineffective.” SEC Cyber-Fraud Guidance Cybersecurity has been a high priority for the SEC dating back several years. The SEC has pursued a number of enforcement actions against registered securities firms arising out of data breaches or deficient controls.  For example, just last month the SEC brought a settled action against a broker-dealer/investment-adviser which suffered a cyber-intrusion that had allegedly compromised the personal information of thousands of customers.  The SEC alleged that the firm had failed to comply with securities regulations governing the safeguarding of customer information, including the Identity Theft Red Flags Rule.[2] The SEC has been less aggressive in pursuing cybersecurity-related actions against public companies.  However, earlier this year, the SEC brought its first enforcement action against a public company for alleged delays in its disclosure of a large-scale data breach.[3] But such enforcement actions put the SEC in the difficult position of weighing charges against companies which are themselves victims of a crime.  The SEC has thus tried to be measured in its approach to such actions, turning to speeches and public guidance rather than a large number of enforcement actions.  (Indeed, the SEC has had to make the embarrassing disclosure that its own EDGAR online filing system had been hacked and sensitive information compromised.[4]) Hence, in February 2018, the SEC issued interpretive guidance for public companies regarding the disclosure of cybersecurity risks and incidents.[5]  Among other things, the guidance counseled the timely public disclosure of material data breaches, recognizing that such disclosures need not compromise the company’s cybersecurity efforts.  The guidance further discussed the need to maintain effective disclosure controls and procedures.  However, the February guidance did not address specific controls to prevent cyber incidents in the first place. The new Report of Investigation takes the additional step of addressing not just corporate disclosures of cyber incidents, but the procedures companies are expected to maintain in order to prevent these breaches from occurring.  The SEC noted that the internal controls provisions of the federal securities laws are not new, and based its report largely on the controls set forth in Section 13(b)(2)(B) of the Exchange Act.  But the SEC emphasized that such controls must be “attuned to this kind of cyber-related fraud, as well as the critical role training plays in implementing controls that serve their purpose and protect assets in compliance with the federal securities laws.”  The report noted that the issuers under investigation had procedures in place to authorize and process payment requests, yet were still victimized, at least in part “because the responsible personnel did not sufficiently understand the company’s existing controls or did not recognize indications in the emailed instructions that those communications lacked reliability.” The SEC concluded that public companies’ “internal accounting controls may need to be reassessed in light of emerging risks, including risks arising from cyber-related frauds” and “must calibrate their internal accounting controls to the current risk environment.” Unfortunately, the vagueness of such guidance leaves the burden on companies to determine how best to address emerging risks.  Whether a company’s controls are adequate may be judged in hindsight by the Enforcement Division; not surprisingly, companies and individuals under investigation often find the staff asserting that, if the controls did not prevent the misconduct, they were by definition inadequate.  Here, the SEC took a cautious approach in issuing a Section 21(a) report highlighting the risk rather than publicly identifying and penalizing the companies which had already been victimized by these scams. However, companies and their advisors should assume that, with this warning shot across the bow, the next investigation of a similar incident may result in more serious action.  Persons responsible for designing and maintaining the company’s internal controls should consider whether improvements (such as enhanced trainings) are warranted; having now spoken on the issue, the Enforcement Division is likely to view corporate inaction as a factor in how it assesses the company’s liability for future data breaches and cyber-frauds.    [1]   SEC Press Release (Oct. 16, 2018), available at www.sec.gov/news/press-release/2018-236; the underlying report may be found at www.sec.gov/litigation/investreport/34-84429.pdf.    [2]   SEC Press Release (Sept. 16, 2018), available at www.sec.gov/news/press-release/2018-213.  This enforcement action was particularly notable as the first occasion the SEC relied upon the rules requiring financial advisory firms to maintain a robust program for preventing identify theft, thus emphasizing the significance of those rules.    [3]   SEC Press Release (Apr. 24, 2018), available at www.sec.gov/news/press-release/2018-71.    [4]   SEC Press Release (Oct. 2, 2017), available at www.sec.gov/news/press-release/2017-186.    [5]   SEC Press Release (Feb. 21, 2018), available at www.sec.gov/news/press-release/2018-22; the guidance itself can be found at www.sec.gov/rules/interp/2018/33-10459.pdf.  The SEC provided in-depth guidance in this release on disclosure processes and considerations related to cybersecurity risks and incidents, and complements some of the points highlighted in the Section 21A report. 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 in the firm’s Securities Enforcement or Privacy, Cybersecurity and Consumer Protection practice groups, or the following authors: Marc J. Fagel – San Francisco (+1 415-393-8332, mfagel@gibsondunn.com) Alexander H. Southwell – New York (+1 212-351-3981, asouthwell@gibsondunn.com) Please also feel free to contact the following practice leaders and members: Securities Enforcement Group: New York Barry R. Goldsmith – Co-Chair (+1 212-351-2440, bgoldsmith@gibsondunn.com) Mark K. Schonfeld – Co-Chair (+1 212-351-2433, mschonfeld@gibsondunn.com) Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com) Joel M. Cohen (+1 212-351-2664, jcohen@gibsondunn.com) Lee G. Dunst (+1 212-351-3824, ldunst@gibsondunn.com) Laura Kathryn O’Boyle (+1 212-351-2304, loboyle@gibsondunn.com) Alexander H. 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Mark Lyon – Palo Alto (+1 650-849-5307, mlyon@gibsondunn.com) Shaalu Mehra – Palo Alto (+1 650-849-5282, smehra@gibsondunn.com) Karl G. Nelson – Dallas (+1 214-698-3203, knelson@gibsondunn.com) Eric D. Vandevelde – Los Angeles (+1 213-229-7186, evandevelde@gibsondunn.com) Benjamin B. Wagner – Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com) Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, mwong@gibsondunn.com) Ryan T. Bergsieker – Denver (+1 303-298-5774, rbergsieker@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 15, 2018 |
Flood v. Synutra Refines “Ab Initio” Requirement for Business Judgment Review of Controller Transactions

Click for PDF On October 9, 2018, in Flood v. Synutra Intth’l, Inc.,[1] the Delaware Supreme Court further refined when in a controller transaction the procedural safeguards of Kahn v. M & F Worldwide Corp.[2] (“MFW“) must be implemented to obtain business judgment rule review of the transaction.  Under MFW, a merger with a controlling stockholder will be reviewed under the deferential business judgment rule standard, rather than the stringent entire fairness standard, if the merger is conditioned “ab initio” upon approval by both an independent, adequately-empowered Special Committee that fulfills its duty of care, and the uncoerced, informed vote of a majority of the minority stockholders.[3]  Writing for the majority in Synutra, Chief Justice Strine emphasized that the objective of MFW and its progeny is to incentivize controlling stockholders to adopt the MFW procedural safeguards early in the transaction process, because those safeguards can provide minority stockholders with the greatest likelihood of receiving terms and conditions that most closely resemble those that would be available in an arms’ length transaction with a non-affiliated third party.  Accordingly, the Court held that “ab initio” (Latin for “from the beginning”) requires that the MFW protections be in place prior to any substantive economic negotiations taking place with the target (or its board or Special Committee).  The Court declined to adopt a “bright line” rule that the MFW procedures had to be a condition of the controller’s “first offer” or other initial communication with the target about a potential transaction. Factual Background Synutra affirmed the Chancery Court’s dismissal of claims against Liang Zhang and related entities, who controlled 63.5% of Synutra’s stock.  In January 2016, Zhang wrote a letter to the Synutra board proposing to take the company private, but failed to include the MFW procedural prerequisites of Special Committee and majority of the minority approvals in the initial bid.  One week after Zhang’s first letter, the board formed a Special Committee to evaluate the proposal and, one week after that, Zhang submitted a revised bid letter that included the MFW protections.  The Special Committee declined to engage in any price negotiations until it had retained and received projections from its own investment bank, and such negotiations did not begin until seven months after Zhang’s second offer. Ab Initio Requirement The plaintiff argued that because Zhang’s initial letter did not contain the dual procedural safeguards of MFW as pre-conditions of any transaction, the “ab initio” requirement of MFW was not satisfied and therefore business judgment standard of review had been irreparably forfeited.  The Court declined to adopt this rigid position, and considered that “ab initio” for MFW purposes can be assessed more flexibly.  To arrive at this view, the Court explored the meaning of “the beginning” as used in ordinary language to denote an early period rather than a fixed point in time.  The Court also parsed potential ambiguities in the language of the Chancery Court’s MFW opinion, which provided that MFW pre-conditions must be in place “from the time of the controller’s first overture”[4] and “from inception.”[5] Ultimately, the Court looked to the purpose of the MFW protections to find that “ab initio” need not be read as referring to the single moment of a controller’s first offer.  As Synutra emphasizes, the key is that the controller not be able to trade adherence to MFW protections for a concession on price.  Hence the “ab initio” analysis focuses on whether deal economics remain untainted by controller coercion, so that the transaction can approximate an arms’ length transaction process with an unaffiliated third party.  As such, the Court’s reasoning is consistent with the standard espoused by the Chancery Court in its prior decision in Swomley v. Schlecht,[6] which the Court summarily affirmed in 2015, that MFW requires procedural protections be in place prior to the commencement of negotiations.[7] In a lengthy dissent, Justice Valihura opined that the “ab initio” requirement should be deemed satisfied only when MFW safeguards are included in the controller’s initial formal written proposal, and that the “negotiations” test undesirably introduces the potential for a fact-intensive inquiry that would complicate a pleadings-stage decision on what standard of review should be applied.  Chief Justice Strine acknowledged the potential appeal of a bright line test but ultimately rejected it because of the Court’s desire to provide strong incentive and opportunity for controllers to adopt and adhere to the MFW procedural safeguards, for the benefit of minority stockholders.  In doing so, the Court acknowledged that its approach “may give rise to close cases.”  However, the Court went on to add, “our Chancery Court is expert in the adjudication of corporate law cases.”  The Court also concluded that the facts in Synutra did not make it a close case.[8] Duty of Care The Court also upheld the Chancery Court’s dismissal of plaintiff’s claim that the Special Committee had breached its duty of care by failing to obtain a sufficient price.  Following the Chancery Court’s reasoning in Swomley, Synutra held that where the procedural safeguards of MFW have been observed, there is no duty of care breach at issue where a plaintiff alleges that a Special Committee could have negotiated differently or perhaps obtained a better price – what the Chancery Court in Swomley described as “a matter of strategy and tactics that’s debatable.”[9]  Instead, the Court confirmed that a duty of care violation would require a finding that the Special Committee had acted in a grossly negligent fashion.  Observing that the Synutra Special Committee had retained qualified and independent financial and legal advisors and engaged in a lengthy negotiation and deal process, the Court found nothing to support an inference of gross negligence and thus deferred to the Special Committee regarding deal price.[10] Procedural Posture Synutra dismissed the plaintiff’s complaint at the pleadings stage.  In its procedural posture, the Court followed Swomley, which allowed courts to resolve the MFW analysis based on the pleadings.  The dissent noted that adoption of a bright-line test would be more appropriate for pleadings-stage dismissals.  However, the Court established that it would be willing to engage some degree of fact-finding at the pleadings stage in order to allow cases to be dismissed at the earliest opportunity, even using the Court’s admittedly more flexible view of the application of MFW. Takeaways Synutra reaffirms the Court’s commitment to promoting implementation of MFW safeguards in controller transactions.  In particular: The Court will favor a pragmatic, flexible approach to “ab initio” determination, with the intent of determining whether the application of the MFW procedural safeguards have been used to affect or influence a transaction’s economics; Once a transaction has business judgment rule review, the Court will not inquire further as to sufficiency of price or terms absent egregious or reckless conduct by a Special Committee; and Since the goal is to incentivize the controller to follow MFW at a transaction’s earliest stages, complaints can be dismissed on the pleadings, thus avoiding far more costly and time consuming summary judgment motions. Although under Synutra a transaction may receive business judgment rule review despite unintentional or premature controller communications that do not reference the MFW procedural safeguards as inherent deal pre-conditions, deal professionals would be well advised not to push this flexibility too far.  Of course, there can be situations where a controller concludes that deal execution risks or burdens attendant to observance of the MFW safeguards are too great (or simply not feasible), and thus is willing to confront the close scrutiny of an entire fairness review if a deal is later challenged.  However, if a controller wants to ensure it will receive the benefit of business judgment rule review, the prudent course is to indicate, in any expression of interest, no matter how early or informal, that adherence to MFW procedural safeguards is a pre-condition to any transaction.  Synutra makes clear that the availability of business judgment review under MFW will be a facts and circumstances assessment, but we do not yet know what the outer limits of the Court’s flexibility will be, should it have to consider a more contentious set of facts in the future. [1]       Flood v. Synutra Int’l, Inc., No. 101, 2018 WL 4869248 (Del. Oct. 9, 2018). [2]      Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014). [3]      Id. at 644. [4]      In re MFW Shareholders Litigation, 67 A.3d 496, 503 (Del. Ch. 2013). [5]      Id. at 528. [6]      Swomley v. Schlecht, 2014 WL 4470947 (Del. Ch. 2014), aff’d 128 A.3d 992 (Del. 2015) (TABLE). [7]      The Court did not consider that certain matters that transpired between Zhang’s first and second offer letters, namely Synutra’s granting of a conflict waiver to allow its long-time counsel to represent Zhang (the Special Committee subsequently hired separate counsel), constituted substantive “negotiations” for this purpose since the waiver was not exchanged for any economic consideration. [8]      Synutra, 2018 WL 4869248, at *8. [9]      Id. at *11, citing Swomley, 2014 WL 4470947, at 21. [10]     In a footnote, the Court expressly overruled dicta in its MFW decision that the plaintiff cited to argue that a duty of care claim could be premised on the Special Committee’s obtaining of an allegedly insufficient price.  Id. at *10, Footnote 81. The following Gibson Dunn lawyers assisted in preparing this client update: Barbara Becker, Jeffrey Chapman, Stephen Glover, Mark Director, Eduardo Gallardo, Marina Szteinbok and Justice Flores. 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, the authors, or any of the following leaders and members of the firm’s Mergers and Acquisitions practice group: Mergers and Acquisitions Group / Corporate Transactions: Barbara L. Becker – Co-Chair, New York (+1 212-351-4062, bbecker@gibsondunn.com) Jeffrey A. Chapman – Co-Chair, Dallas (+1 214-698-3120, jchapman@gibsondunn.com) Stephen I. Glover – Co-Chair, Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Dennis J. Friedman – New York (+1 212-351-3900, dfriedman@gibsondunn.com) Jonathan K. Layne – Los Angeles (+1 310-552-8641, jlayne@gibsondunn.com) Mark D. Director – Washington, D.C./New York (+1 202-955-8508/+1 212-351-5308, mdirector@gibsondunn.com) Eduardo Gallardo – New York (+1 212-351-3847, egallardo@gibsondunn.com) Saee Muzumdar – New York (+1 212-351-3966, smuzumdar@gibsondunn.com) Mergers and Acquisitions Group / Litigation: Meryl L. Young – Orange County (+1 949-451-4229, myoung@gibsondunn.com) Brian M. Lutz – San Francisco (+1 415-393-8379, blutz@gibsondunn.com) Aric H. Wu – New York (+1 212-351-3820, awu@gibsondunn.com) Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com) Michael M. Farhang – Los Angeles (+1 213-229-7005, mfarhang@gibsondunn.com) Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, jlipshutz@gibsondunn.com) Adam H. Offenhartz – New York (+1 212-351-3808, aoffenhartz@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 10, 2018 |
Artificial Intelligence and Autonomous Systems Legal Update (3Q18)

Click for PDF We are pleased to provide the following update on recent legal developments in the areas of artificial intelligence, machine learning, and autonomous systems (or “AI” for short), and their implications for companies developing or using products based on these technologies.  As the spread of AI rapidly increases, legal scrutiny in the U.S. of the potential uses and effects of these technologies (both beneficial and harmful) has also been increasing.  While we have chosen to highlight below several governmental and legislative actions from the past quarter, the area is rapidly evolving and we will continue to monitor further actions in these and related areas to provide future updates of potential interest on a regular basis. I.       Increasing Federal Government Interest in AI Technologies The Trump Administration and Congress have recently taken a number of steps aimed at pushing AI forward on the U.S. agenda, while also treating with caution foreign involvement in U.S.-based AI technologies.  Some of these actions may mean additional hurdles for cross-border transactions involving AI technology.  On the other hand, there may also be opportunities for companies engaged in the pursuit of AI technologies to influence the direction of future legislation at an early stage. A.       White House Studies AI In May, the Trump Administration kicked off what is becoming an active year in AI for the federal government by hosting an “Artificial Intelligence for American Industry” summit as part of its designation of AI as an “Administration R&D priority.”[1] During the summit, the White House also announced the establishment of a “Select Committee on Artificial Intelligence” to advise the President on research and development priorities and explore partnerships within the government and with industry.[2]  This Select Committee is housed within the National Science and Technology Council, and is chaired by Office of Science and Technology Policy leadership. Administration officials have said that a focus of the Select Committee will be to look at opportunities for increasing federal funds into AI research in the private sector, to ensure that the U.S. has (or maintains) a technological advantage in AI over other countries.  In addition, the Committee is to look at possible uses of the government’s vast store of taxpayer-funded data to promote the development of advanced AI technologies, without compromising security or individual privacy.  While it is believed that there will be opportunities for private stakeholders to have input into the Select Committee’s deliberations, the inaugural meeting of the Committee, which occurred in late June, was not open to the public for input. B.       AI in the NDAA for 2019 More recently, on August 13th, President Trump signed into law the John S. McCain National Defense Authorization Act (NDAA) for 2019,[3] which specifically authorizes the Department of Defense to appoint a senior official to coordinate activities relating to the development of AI technologies for the military, as well as to create a strategic plan for incorporating a number of AI technologies into its defense arsenal.  In addition, the NDAA includes the Foreign Investment Risk Review Modernization Act (FIRRMA)[4] and the Export Control Reform Act (ECRA),[5] both of which require the government to scrutinize cross-border transactions involving certain new technologies, likely including AI-related technologies. FIRRMA modifies the review process currently used by the Committee on Foreign Investment in the United States (CFIUS), an interagency committee that reviews the national security implications of investments by foreign entities in the United States.  With FIRRMA’s enactment, the scope of the transactions that CFIUS can review is expanded to include those involving “emerging and foundational technologies,” defined as those that are critical for maintaining the national security technological advantage of the United States.  While the changes to the CFIUS process are still fresh and untested, increased scrutiny under FIRRMA will likely have an impact on available foreign investment in the development and use of AI, at least where the AI technology involved is deemed such a critical technology and is sought to be purchased or licensed by foreign investors. Similarly, ECRA requires the President to establish an interagency review process with various agencies including the Departments of Defense, Energy, State and the head of other agencies “as appropriate,” to identify emerging and foundational technologies essential to national security in order to impose appropriate export controls.  Export licenses are to be denied if the proposed export would have a “significant negative impact” on the U.S. defense industrial base.  The terms “emerging and foundational technologies” are not expressly defined, but it is likely that AI technologies, which are of course “emerging,” would receive a close look under ECRA and that ECRA might also curtail whether certain AI technologies can be sold or licensed to foreign entities. The NDAA also established a National Security Commission on Artificial Intelligence “to review advances in artificial intelligence, related machine learning developments, and associated technologies.”  The Commission, made up of certain senior members of Congress as well as the Secretaries of Defense and Commerce, will function independently from other such panels established by the Trump Administration and will review developments in AI along with assessing risks related to AI and related technologies to consider how those methods relate to the national security and defense needs of the United States.  The Commission will focus on technologies that provide the U.S. with a competitive AI advantage, and will look at the need for AI research and investment as well as consider the legal and ethical risks associated with the use of AI.  Members are to be appointed within 90 days of the Commission being established and an initial report to the President and Congress is to be submitted by early February 2019. C.       Additional Congressional Interest in AI/Automation While a number of existing bills with potential impacts on the development of AI technologies remain stalled in Congress,[6] two more recently-introduced pieces of legislation are also worth monitoring as they progress through the legislative process. In late June, Senator Feinstein (D-CA) sponsored the “Bot Disclosure and Accountability Act of 2018,” which is intended to address  some of the concerns over the use of automated systems for distributing content through social media.[7] As introduced, the bill seeks to prohibit certain types of bot or other automated activity directed to political advertising, at least where such automated activity appears to impersonate human activity.  The bill would also require the Federal Trade Commission to establish and enforce regulations to require public disclosure of the use of bots, defined as any “automated software program or process intended to impersonate or replicate human activity online.”  The bill provides that any such regulations are to be aimed at the “social media provider,” and would place the burden of compliance on such providers of social media websites and other outlets.  Specifically, the FTC is to promulgate regulations requiring the provider to take steps to ensure that any users of a social media website owned or operated by the provider would receive “clear and conspicuous notice” of the use of bots and similar automated systems.  FTC regulations would also require social media providers to police their systems, removing non-compliant postings and/or taking other actions (including suspension or removal) against users that violate such regulations.  While there are significant differences, the Feinstein bill is nevertheless similar in many ways to California’s recently-enacted Bot disclosure law (S.B. 1001), discussed more fully in our previous client alert located here.[8] Also of note, on September 26th, a bipartisan group of Senators introduced the “Artificial Intelligence in Government Act,” which seeks to provide the federal government with additional resources to incorporate AI technologies in the government’s operations.[9] As written, this new bill would require the General Services Administration to bring on technical experts to advise other government agencies, conduct research into future federal AI policy, and promote inter-agency cooperation with regard to AI technologies.  The bill would also create yet another federal advisory board to advise government agencies on AI policy opportunities and concerns.  In addition, the newly-introduced legislation seeks to require the Office of Management and Budget to identify ways for the federal government to invest in and utilize AI technologies and tasks the Office of Personal Management with anticipating and providing training for the skills and competencies the government requires going-forward for incorporating AI into its overall data strategy. II.       Potential Impact on AI Technology of Recent California Privacy Legislation Interestingly, in the related area of data privacy regulation, the federal government has been slower to respond, and it is the state legislatures that are leading the charge.[10] Most machine learning algorithms depend on the availability of large data sets for purpose of training, testing, and refinement.  Typically, the larger and more complete the datasets available, the better.  However, these datasets often include highly personal information about consumers, patients, or others of interest—data that can sometimes be used to predict information specific to a particular person even if attempts are made to keep the source of such data anonymous. The European Union’s General Data Protection Regulation, or GDPR, which went into force on May 25, 2018, has deservedly garnered a great deal of press as one of the first, most comprehensive collections of data privacy protections. While we’re only months into its effective period, the full impact and enforcement of the GDPR’s provisions have yet to be felt.  Still, many U.S. companies, forced to take steps to comply with the provisions of GDPR at least with regard to EU citizens, have opted to take many of those same steps here in the U.S., despite the fact that no direct U.S. federal analogue to the GDPR yet exists.[11] Rather than wait for the federal government to act, several states have opted to follow the lead of the GDPR and enact their own versions of comprehensive data privacy laws.  Perhaps the most significant of these state-legislated omnibus privacy laws is the California Consumer Privacy Act (“CCPA”), signed into law on June 28, 2108, and slated to take effect on January 1, 2020.[12]  The CCPA is not identical to the GDPR, differing in a number of key respects.  However there are many similarities, in that the CCPA also has broadly defined definitions of personal information/data, and seeks to provide a right to notice of data collection, a right of access to and correction of collected data, a right to be forgotten, and a right to data portability.  But how do the CCPA’s requirements differ from the GDPR for companies engaged in the development and use of AI technologies?  While there are many issues to consider, below we examine several of the key differences of the CCPA and their impact on machine learning and other AI-based processing of collected data. A.       Inferences Drawn from Personal Information The GDPR defines personal data as “any information relating to an identified or identifiable natural person,” such as “a name, an identification number, location data, an online identifier or to one or more factors specific to the physical, physiological, genetic, mental, economic, cultural or social identify of that nature person.”[13]  Under the GDPR, personal data has implications in the AI space beyond just the data that is actually collected from an individual.  AI technology can be and often is used to generate additional information about a person from collected data, e.g., spending habits, facial features, risk of disease, or other inferences that can be made from the collected data.  Such inferences, or derivative data, may well constitute “personal data” under a broad view of the GDPR, although there is no specific mention of derivative data in the definition. By contrast, the CCPA goes farther and specifically includes “inferences drawn from any of the information identified in this subdivision to create a profile about a consumer reflecting the consumer’s preferences, characteristics, psychological trends, preferences, predispositions, behavior, attitudes, intelligence, abilities and aptitudes.”[14]  An “inference” is defined as “the derivation of information, data, assumptions, or conclusions from evidence, or another source of information or data.”[15] Arguably the primary purpose of many AI systems is to draw inferences from a user’s information, by mining data, looking for patterns, and generating analysis.  Although the CCPA does limit inferences to those drawn “to create a profile about a consumer,” the term “profile” is not defined in the CCPA.  However, the use of consumer information that is “deidentified” or “aggregated” is permitted by the CCPA.  Thus, one possible solution may be to take steps to “anonymize” any personal data used to derive any inferences.  As a result, when looking to CCPA compliance, companies may want to carefully consider the derivative/processed data that they are storing about a user, and consider additional steps that may be required for CCPA compliance. B.       Identifying Categories of Personal Information The CCPA also requires disclosures of the categories of personal information being collected, the categories of sources from which personal information is collected, the purpose for collecting and selling personal information, and the categories of third parties with whom the business shares personal information. [16]  Although these categories are likely known and definable for static data collection, it may be more difficult to specifically disclose the purpose and categories for certain information when dynamic machine learning algorithms are used.  This is particularly true when, as discussed above, inferences about a user are included as personal information.  In order to meet these disclosure requirements, companies may need to carefully consider how they will define all of the categories of personal information collected or the purposes of use of that information, particularly when machine learning algorithms are used to generate additional inferences from, or derivatives of, personal data. C.       Personal Data Includes Households The CCPA’s definition of “personal data” also includes information pertaining to non-individuals, such as “households” – a term that the CCPA does not further define.[17]  In the absence of an explicit definition, the term “household” would seem to target information collected about a home and its inhabits through smart home devices, such as thermostats, cameras, lights, TVs, and so on.  When looking to the types of personal data being collected, the CCPA may also encompass information about each of these smart home devices, such as name, location, usage, and special instructions (e.g., temperature controls, light timers, and motion sensing).  Furthermore, any inferences or derivative information generated by AI algorithms from the information collected from these smart home devices may also be covered as personal information.  Arguably, this could include information such as conversations with voice assistants or even information about when people are likely to be home determined via cameras or motion sensors.  Companies developing smart home, or other Internet of Things, devices thus should carefully consider whether the scope and use they make of any information collected from “households” falls under the CCPA requirements for disclosure or other restrictions. III.       Continuing Efforts to Regulate Autonomous Vehicles Much like the potential for a comprehensive U.S. data privacy law, and despite a flurry of legislative activity in Congress in 2017 and early 2018 towards such a national regulatory framework, autonomous vehicles continue to operate under a complex patchwork of state and local rules with limited federal oversight.  We previously provided an update (located here)[18] discussing the Safely Ensuring Lives Future Deployment and Research In Vehicle Evolution (SELF DRIVE) Act[19], which passed the U.S. House of Representatives by voice vote in September 2017 and its companion bill (the American Vision for Safer Transportation through Advancement of Revolutionary Technologies (AV START) Act).[20]  Both bills have since stalled in the Senate, and with them the anticipated implementation of a uniform regulatory framework for the development, testing and deployment of autonomous vehicles. As the two bills languish in Congress, ‘chaperoned’ autonomous vehicles have already begun coexisting on roads alongside human drivers.  The accelerating pace of policy proposals—and debate surrounding them—looks set to continue in late 2018 as virtually every major automaker is placing more autonomous vehicles on the road for testing and some manufacturers prepare to launch commercial services such as self-driving taxi ride-shares[21] into a national regulatory vacuum. A.       “Light-touch” Regulation The delineation of federal and state regulatory authority has emerged as a key issue because autonomous vehicles do not fit neatly into the existing regulatory structure.  One of the key aspects of the proposed federal legislation is that it empowers the National Highway Traffic Safety Administration (NHTSA) with the oversight of manufacturers of self-driving cars through enactment of future rules and regulations that will set the standards for safety and govern areas of privacy and cybersecurity relating to such vehicles.  The intention is to have a single body (the NHTSA) develop a consistent set of rules and regulations for manufacturers, rather than continuing to allow the states to adopt a web of potentially widely differing rules and regulations that may ultimately inhibit development and deployment of autonomous vehicles.  This approach was echoed by safety guidelines released by the Department of Transportation (DoT) for autonomous vehicles.  Through the guidelines (“a nonregulatory approach to automated vehicle technology safety”),[22] the DoT avoids any compliance requirement or enforcement mechanism, at least for the time being, as the scope of the guidance is expressly to support the industry as it develops best practices in the design, development, testing, and deployment of automated vehicle technologies. Under the proposed federal legislation, the states can still regulate autonomous vehicles, but the guidance encourages states not to pass laws that would “place unnecessary burdens on competition and innovation by limiting [autonomous vehicle] testing or deployment to motor vehicle manufacturers only.”[23]  The third iteration of the DoT’s federal guidance, published on October 4, 2018, builds upon—but does not replace—the existing guidance, and reiterates that the federal government is placing the onus for safety on companies developing the technologies rather than on government regulation. [24]  The guidelines, which now include buses, transit and trucks in addition to cars, remain voluntary. B.       Safety Much of the delay in enacting a regulatory framework is a result of policymakers’ struggle to balance the industry’s desire to speed both the development and deployment of autonomous vehicle technologies with the safety and security concerns of consumer advocates. The AV START bill requires that NHTSA must construct comprehensive safety regulations for AVs with a mandated, accelerated timeline for rulemaking, and the bill puts in place an interim regulatory framework that requires manufacturers to submit a Safety Evaluation Report addressing a range of key areas at least 90 days before testing, selling, or commercialization of an driverless cars.  But some lawmakers and consumer advocates remain skeptical in the wake of highly publicized setbacks in autonomous vehicle testing.[25]  Although the National Safety Transportation Board (NSTB) has authority to investigate auto accidents, there is still no federal regulatory framework governing liability for individuals and states.[26]  There are also ongoing concerns over cybersecurity risks[27], the use of forced arbitration clauses by autonomous vehicle manufacturers,[28] and miscellaneous engineering problems that revolve around the way in which autonomous vehicles interact with obstacles commonly faced by human drivers, such as emergency vehicles,[29] graffiti on road signs or even raindrops and tree shadows.[30] In August 2018, the Governors Highway Safety Association (GHSA) published a report outlining the key questions that manufacturers should urgently address.[31]  The report suggested that states seek to encourage “responsible” autonomous car testing and deployment while protecting public safety and that lawmakers “review all traffic laws.”  The report also notes that public debate often blurs the boundaries between the different levels of automation the NHTSA has defined (ranging from level 0 (no automation) to level 5 (fully self-driving without the need for human occupants)), remarking that “most AVs for the foreseeable future will be Levels 2 through 4.  Perhaps they should be called ‘occasionally self-driving.'”[32] C.       State Laws Currently, 21 states and the District of Columbia have passed laws regulating the deployment and testing of self-driving cars, and governors in 10 states have issued executive orders related to them.[33]  For example, California expanded its testing rules in April 2018 to allow for remote monitoring instead of a safety driver inside the vehicle.[34]  However, state laws differ on basic terminology, such as the definition of “vehicle operator.” Tennessee SB 151[35] points to the autonomous driving system (ADS) while Texas SB 2205[36] designates a “natural person” riding in the vehicle.  Meanwhile, Georgia SB 219[37] identifies the operator as the person who causes the ADS to engage, which might happen remotely in a vehicle fleet. These distinctions will affect how states license both human drivers and autonomous vehicles going forward.  Companies operating in this space accordingly need to stay abreast of legal developments in states in which they are developing or testing autonomous vehicles, while understanding that any new federal regulations may ultimately preempt those states’ authorities to determine, for example, crash protocols or how they handle their passengers’ data. D.       ‘Rest of the World’ While the U.S. was the first country to legislate for the testing of automated vehicles on public roads, the absence of a national regulatory framework risks impeding innovation and development.  In the meantime, other countries are vying for pole position among manufacturers looking to test vehicles on roads.[38]  KPMG’s 2018 Autonomous Vehicles Readiness Index ranks 20 countries’ preparedness for an autonomous vehicle future. The Netherlands took the top spot, outperforming the U.S. (3rd) and China (16th).[39]  Japan and Australia plan to have self-driving cars on public roads by 2020.[40]  The U.K. government has announced that it expects to see fully autonomous vehicles on U.K. roads by 2021, and is introducing legislation—the Automated and Electric Vehicles Act 2018—which installs an insurance framework addressing product liability issues arising out of accidents involving autonomous cars, including those wholly caused by an autonomous vehicle “when driving itself.”[41] E.       Looking Ahead While autonomous vehicles operating on public roads are likely to remain subject to both federal and state regulation, the federal government is facing increasing pressure to adopt a federal regulatory scheme for autonomous vehicles in 2018.[42]  Almost exactly one year after the House passed the SELF DRIVE Act, House Energy and Commerce Committee leaders called on the Senate to advance automated vehicle legislation, stating that “[a]fter a year of delays, forcing automakers and innovators to develop in a state-by-state patchwork of rules, the Senate must act to support this critical safety innovation and secure America’s place as a global leader in technology.”[43]  The continued absence of federal regulation renders the DoT’s informal guidance increasingly important.  The DoT has indicated that it will enact “flexible and technology-neutral” policies—rather than prescriptive performance-based standards—to encourage regulatory harmony and consistency as well as competition and innovation.[44]  Companies searching for more tangible guidance on safety standards at federal level may find it useful to review the recent guidance issued alongside the DoT’s announcement that it is developing (and seeking public input into) a pilot program for ‘highly or fully’ autonomous vehicles on U.S. roads.[45]  The safety standards being considered include technology disabling the vehicle if a sensor fails or barring vehicles from traveling above safe speeds, as well as a requirement that NHTSA be notified of any accident within 24 hours. [1] See https://www.whitehouse.gov/wp-content/uploads/2018/05/Summary-Report-of-White-House-AI-Summit.pdf; note also that the Trump Administration’s efforts in studying AI technologies follow, but appear largely separate from, several workshops on AI held by the Obama Administration in 2016, which resulted in two reports issued in late 2016 (see Preparing for the Future of Artificial Intelligence, and Artificial Intelligence, Automation, and the Economy). [2] Id. at Appendix A. [3] See https://www.mccain.senate.gov/public/index.cfm/2018/8/senate-passes-the-john-s-mccain-national-defense-authorization-act-for-fiscal-year-2019.  The full text of the NDAA is available at https://www.congress.gov/bill/115th-congress/house-bill/5515/text.  For additional information on CFIUS reform implemented by the NDAA, please see Gibson Dunn’s previous client update at https://www.gibsondunn.com/cfius-reform-our-analysis/. [4] See id.; see also https://www.treasury.gov/resource-center/international/Documents/FIRRMA-FAQs.pdf. [5] See https://foreignaffairs.house.gov/wp-content/uploads/2018/02/HR-5040-Section-by-Section.pdf.   [6] See, e.g. infra., Section III discussion of SELF DRIVE and AV START Acts, among others. [7] S.3127, 115th Congress (2018). [8] https://www.gibsondunn.com/new-california-security-of-connected-devices-law-and-ccpa-amendments/. [9] S.3502, 115th Congress (2018). [10] See also, infra., Section III for more discussion of specific regulatory efforts for autonomous vehicles. [11] However, as 2018 has already seen a fair number of hearings before Congress relating to digital data privacy issues, including appearances by key executives from many major tech companies, it seems likely that it may not be long before we see the introduction of a “GDPR-like” comprehensive data privacy bill.  Whether any resulting federal legislation would actually pre-empt state-enacted privacy laws to establish a unified federal framework is itself a hotly-contested issue, and remains to be seen. [12] AB 375 (2018); Cal. Civ. Code §1798.100, et seq. [13] Regulation (EU) 2016/679 (General Data Protection Regulation), Article 4 (1). [14] Cal. Civ. Code §1798.140(o)(1)(K). [15] Id.. at §1798.140(m). [16] Id. at §1798.110(c). [17] Id. at §1798.140(o)(1). [18] https://www.gibsondunn.com/accelerating-progress-toward-a-long-awaited-federal-regulatory-framework-for-autonomous-vehicles-in-the-united-states/. [19]   H.R. 3388, 115th Cong. (2017). [20]   U.S. Senate Committee on Commerce, Science and Transportation, Press Release, Oct. 24, 2017, available at https://www.commerce.senate.gov/public/index.cfm/pressreleases?ID=BA5E2D29-2BF3-4FC7-A79D-58B9E186412C. [21]   Sean O’Kane, Mercedes-Benz Self-Driving Taxi Pilot Coming to Silicon Valley in 2019, The Verge, Jul. 11, 2018, available at https://www.theverge.com/2018/7/11/17555274/mercedes-benz-self-driving-taxi-pilot-silicon-valley-2019. [22]   U.S. Dept. of Transp., Automated Driving Systems 2.0: A Vision for Safety 2.0, Sept. 2017, https://www.nhtsa.gov/sites/nhtsa.dot.gov/files/documents/13069a-ads2.0_090617_v9a_tag.pdf. [23]   Id., at para 2. [24]   U.S. DEPT. OF TRANSP., Preparing for the Future of Transportation: Automated Vehicles 3.0, Oct. 4, 2018, https://www.transportation.gov/sites/dot.gov/files/docs/policy-initiatives/automated-vehicles/320711/preparing-future-transportation-automated-vehicle-30.pdf. [25]   Sasha Lekach, Waymo’s Self-Driving Taxi Service Could Have Some Major Issues, Mashable, Aug. 28, 2018, available at https://mashable.com/2018/08/28/waymo-self-driving-taxi-problems/#dWzwp.UAEsqM. [26]   Robert L. Rabin, Uber Self-Driving Cars, Liability, and Regulation, Stanford Law School Blog, Mar. 20, 2018, available at https://law.stanford.edu/2018/03/20/uber-self-driving-cars-liability-regulation/. [27]   David Shephardson, U.S. Regulators Grappling with Self-Driving Vehicle Security, Reuters. Jul. 10, 2018, available at https://www.reuters.com/article/us-autos-selfdriving/us-regulators-grappling-with-self-driving-vehicle-security-idUSKBN1K02OD. [28]   Richard Blumenthal, Press Release, Ten Senators Seek Information from Autonomous Vehicle Manufacturers on Their Use of Forced Arbitration Clauses, Mar. 23, 2018, available at https://www.blumenthal.senate.gov/newsroom/press/release/ten-senators-seek-information-from-autonomous-vehicle-manufacturers-on-their-use-of-forced-arbitration-clauses. [29]   Kevin Krewell, How Will Autonomous Cars Respond to Emergency Vehicles, Forbes, Jul. 31, 2018, available at https://www.forbes.com/sites/tiriasresearch/2018/07/31/how-will-autonomous-cars-respond-to-emergency-vehicles/#3eed571627ef. [30]   Michael J. Coren, All The Things That Still Baffle Self-Driving Cars, Starting With Seagulls, Quartz, Sept. 23, 2018, available at https://qz.com/1397504/all-the-things-that-still-baffle-self-driving-cars-starting-with-seagulls/. [31]   ghsa, Preparing For Automated Vehicles: Traffic Safety Issues For States, Aug. 2018, available at https://www.ghsa.org/sites/default/files/2018-08/Final_AVs2018.pdf. [32]   Id., at 7. [33]   Brookings, The State of Self-Driving Car Laws Across the U.S., May 1, 2018, available at https://www.brookings.edu/blog/techtank/2018/05/01/the-state-of-self-driving-car-laws-across-the-u-s/. [34]   Aarian Marshall, Fully Self-Driving Cars Are Really Truly Coming to California, Wired, Feb. 26, 2018, available at, https://www.wired.com/story/california-self-driving-car-laws/; State of California, Department of Motor Vehicles, Autonomous Vehicles in California, available at https://www.dmv.ca.gov/portal/dmv/detail/vr/autonomous/bkgd. [35]   SB 151, available at http://www.capitol.tn.gov/Bills/110/Bill/SB0151.pdf. [36]   SB 2205, available at https://legiscan.com/TX/text/SB2205/2017. [37]   SB 219, available at http://www.legis.ga.gov/Legislation/en-US/display/20172018/SB/219. [38]   Tony Peng & Michael Sarazen, Global Survey of Autonomous Vehicle Regulations, Medium, Mar. 15, 2018, available at https://medium.com/syncedreview/global-survey-of-autonomous-vehicle-regulations-6b8608f205f9. [39]   KPMG, Autonomous Vehicles Readiness Index: Assessing Countries’ Openness and Preparedness for Autonomous Vehicles, 2018, (“The US has a highly innovative but largely disparate environment with little predictability regarding the uniform adoption of national standards for AVs. Therefore the prospect of  widespread driverless vehicles is unlikely in the near future. However, federal policy and regulatory guidance could certainly accelerate early adoption . . .”), p. 17, available at https://assets.kpmg.com/content/dam/kpmg/nl/pdf/2018/sector/automotive/autonomous-vehicles-readiness-index.pdf. [40]   Stanley White, Japan Looks to Launch Autonomous Car System in Tokyo by 2020, Automotive News, Jun. 4, 2018, available at http://www.autonews.com/article/20180604/MOBILITY/180609906/japan-self-driving-car; National Transport Commission Australia, Automated vehicles in Australia, available at https://www.ntc.gov.au/roads/technology/automated-vehicles-in-australia/. [41]   The Automated and Electric Vehicles Act 2018, available at http://www.legislation.gov.uk/ukpga/2018/18/contents/enacted; Lexology, Muddy Road Ahead Part II: Liability Legislation for Autonomous Vehicles in the United Kingdom, Sept. 21, 2018,  https://www.lexology.com/library/detail.aspx?g=89029292-ad7b-4c89-8ac9-eedec3d9113a; see further Anne Perkins, Government to Review Law Before Self-Driving Cars Arrive on UK Roads, The Guardian, Mar. 6, 2018, available at https://www.theguardian.com/technology/2018/mar/06/self-driving-cars-in-uk-riding-on-legal-review. [42]   Michaela Ross, Code & Conduit Podcast: Rep. Bob Latta Eyes Self-Driving Car Compromise This Year, Bloomberg Law, Jul. 26, 2018, available at https://www.bna.com/code-conduit-podcast-b73014481132/. [43]   Freight Waves, House Committee Urges Senate to Advance Self-Driving Vehicle Legislation, Sept. 10, 2018, available at https://www.freightwaves.com/news/house-committee-urges-senate-to-advance-self-driving-vehicle-legislation; House Energy and Commerce Committee, Press Release, Sept. 5, 2018, available at https://energycommerce.house.gov/news/press-release/media-advisory-walden-ec-leaders-to-call-on-senate-to-pass-self-driving-car-legislation/. [44]   See supra n. 24, U.S. DEPT. OF TRANSP., Preparing for the Future of Transportation: Automated Vehicles 3.0, Oct. 4, 2018, iv. [45]   David Shephardson, Self-driving cars may hit U.S. roads in pilot program, NHTSA says, Automotive News, Oct. 9, 2018, available at http://www.autonews.com/article/20181009/MOBILITY/181009630/self-driving-cars-may-hit-u.s.-roads-in-pilot-program-nhtsa-says. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work, or the authors: H. Mark Lyon – Palo Alto (+1 650-849-5307, mlyon@gibsondunn.com) Claudia M. Barrett – Washington, D.C. (+1 202-887-3642, cbarrett@gibsondunn.com) Frances Annika Smithson – Los Angeles (+1 213-229-7914, fsmithson@gibsondunn.com) Ryan K. Iwahashi – Palo Alto (+1 650-849-5367, riwahashi@gibsondunn.com) Please also feel free to contact any of the following: Automotive/Transportation: Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com) Christopher Chorba – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com) Theane Evangelis – Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com) Privacy, Cybersecurity and Consumer Protection: Alexander H. Southwell – New York (+1 212-351-3981, asouthwell@gibsondunn.com) Public Policy: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Mylan L. Denerstein – New York (+1 212-351-3850, mdenerstein@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 10, 2018 |
Why We Think the UK Is Heading for a “Soft Brexit”

Click for PDF Our discussions with politicians, civil servants, journalists and other commentators lead us to believe that the most likely outcome of the Brexit negotiations is that a deal will be agreed at the “softer” end of the spectrum, that the Conservative Government will survive and that Theresa May will remain as Prime Minister at least until a Brexit deal is agreed (although perhaps not thereafter).  There is certainly a risk of a chaotic or “hard” Brexit.  On the EU side, September’s summit in Salzburg demonstrated the possibility of unexpected outcomes.  And in the UK, the splits in the ruling Conservative Party and the support it relies upon from the DUP (the Northern Irish party that supports the Government) could in theory result in the ousting of Prime Minister May, which would likely lead to an extension of the Brexit deadline of 29 March 2019.  However, for the reasons set out below we believe a hard or chaotic Brexit is now less likely than more likely. Some background to the negotiations can be found here.  It should be noted that any legally binding deal will be limited to the terms of the UK’s departure from the EU (“the Withdrawal Agreement”) and will not cover the future trading relationship.  But there will be a political statement of intent on the future trading relationship (“the Future Framework”) that will then be subject to further detailed negotiation. There is a European Council meeting on 17/18 October although it is not expected that a final agreement will be reached by then.  However, the current expectation is that a special meeting of the European Council will take place in November (probably over a weekend) to finalise both the Withdrawal Agreement and the Future Framework. Whatever deal Theresa May finally agrees with the EU needs to be approved by the UK Parliament.  A debate and vote will likely take place within two or three weeks of a deal being agreed – so late November or early December.  If Parliament rejects the deal the perceived wisdom is that the ensuing political crisis could only be resolved either by another referendum or a general election. However: the strongest Brexiteers do not want to risk a second referendum in case they lose; the ruling Conservative Party do not want to risk a general election which may result in it losing power and Jeremy Corbyn becoming Prime Minister; and Parliament is unlikely to allow the UK to leave without a deal. As a result we believe that Prime Minister May has more flexibility to compromise with the EU than the political noise would suggest and that, however much they dislike the eventual deal, ardent Brexiteers will likely support it in Parliament.  This is because it will mean the UK has formally left the EU and the Brexiteers live to fight another day. The UK’s current proposal (the so-called “Chequers Proposal”) is likely to be diluted further in favour of the EU, but as long as the final deal results in a formal departure of the UK from the EU in March 2019, we believe Parliament is more likely than not to support it, however unsatisfactory it is to the Brexiteers. The key battleground is whether the UK should remain in a Customs Union beyond a long stop date for a transitional period.  The UK Government proposes a free trade agreement in goods but not services, with restrictions on free movement and the ability for the UK to strike its own free trade deals.  This has been rejected by the EU on the grounds that it seeks to separate services from goods which is inconsistent with the single market and breaches one of the fundamental EU principles of free movement of people.  The Chequers Proposal is unlikely to survive in its current form but the EU has acknowledged that it creates the basis for the start of a negotiation. There has also been discussion of a “Canada style” free-trade agreement, which is supported by the ardent Brexiteers but rejected by the UK Government because it would require checks on goods travelling across borders.  This would create a “hard border” in Northern Ireland which breaches the Good Friday Agreement and would not be accepted by any of the major UK political parties or the EU.  The consequential friction at the borders is also unattractive to businesses that operate on a “just in time” basis – particularly the car manufacturers.  The EU has suggested there could instead be regulatory alignment between Northern Ireland and the EU, but this has been accepted as unworkable because it would create a split within the UK and is unacceptable to the DUP, the Northern Ireland party whose support of the Conservatives in Parliament is critical to their survival.  This is the area of greatest risk but it remains the case that a “no deal” scenario would guarantee a hard border in Ireland. If no deal is reached by 21 January 2019 the Prime Minister is required to make a statement to MPs.  The Government would then have 14 days to decide how to proceed, and the House of Commons would be given the opportunity to vote on these alternate plans.  Although any motion to reject the Government’s proposal would not be legally binding, it would very likely catalyse the opposition and lead to an early general election or a second referendum.  In any of those circumstances, the EU has already signalled that it would be prepared to grant an extension to the Article 50 period. This client alert was prepared by London partners Charlie Geffen and Nicholas Aleksander and of counsel Anne MacPherson. We have a working group in London (led by Nicholas Aleksander, Patrick Doris, Charlie Geffen, Ali Nikpay and Selina Sagayam) addressing Brexit related issues.  Please feel free to contact any member of the working group or any of the other lawyers mentioned below. Ali Nikpay – Antitrust ANikpay@gibsondunn.com Tel: 020 7071 4273 Charlie Geffen – Corporate CGeffen@gibsondunn.com Tel: 020 7071 4225 Nicholas Aleksander – Tax NAleksander@gibsondunn.com Tel: 020 7071 4232 Philip Rocher – Litigation PRocher@gibsondunn.com Tel: 020 7071 4202 Jeffrey M. Trinklein – Tax JTrinklein@gibsondunn.com Tel: 020 7071 4224 Patrick Doris – Litigation; Data Protection PDoris@gibsondunn.com Tel:  020 7071 4276 Alan Samson – Real Estate ASamson@gibsondunn.com Tel:  020 7071 4222 Penny Madden QC – Arbitration PMadden@gibsondunn.com Tel:  020 7071 4226 Selina Sagayam – Corporate SSagayam@gibsondunn.com Tel:  020 7071 4263 Thomas M. Budd – Finance TBudd@gibsondunn.com Tel:  020 7071 4234 James A. Cox – Employment; Data Protection JCox@gibsondunn.com Tel: 020 7071 4250 Gregory A. Campbell – Restructuring GCampbell@gibsondunn.com Tel:  020 7071 4236 © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 5, 2018 |
What Employers Need to Know About California’s New #MeToo Laws

Click for PDF On September 30, 2018, Governor Edmund G. Brown signed several new workplace laws, and vetoed others, that arose out of the #MeToo movement.  We briefly review the newly signed legislation and also highlight bills that Governor Brown rejected.  Unless otherwise indicated, these new laws will take effect on January 1, 2019. New Requirements for Employers New Training Requirements Expanded Requirements for Harassment and Discrimination Training.  Most California employers are aware that, under existing California law, employers with 50 or more employees must provide at least two hours of prescribed training regarding sexual harassment within six months of an individual’s hiring or promotion to a supervisory position and every two years while an employee remains in a supervisory position.  SB 1343 expands this requirement in two critical ways: The training requirements now cover all employers with five or more employees, which includes temporary or seasonal employees, meaning that many smaller employers are now subject to California’s training requirements. All covered employers must now provide at least one hour of sexual harassment training to non-supervisory employees by January 1, 2020, and once every two years thereafter, which may greatly expand the scope of required training for employers with large line-level workforces. SB 1343 also requires the California Department of Fair Employment and Housing (DFEH) to make available online training courses that employers may use to meet these requirements.  However, employers may wish to work with their counsel and Human Resources departments to develop training that is specific to their business and industry, which is generally regarded as more effective than “one size fits all” trainings. Education and Training for Employees in Entertainment Industry.  AB 2338 requires, prior to the issuance of a permit to employ a minor in the entertainment industry, that the minor and the minor’s parents or legal guardians receive and complete sexual harassment training.  The law also requires that talent agencies ensure that minors have a valid work permit, and that agencies provide adult artists with accessible educational material “regarding sexual harassment prevention, retaliation, and reporting resources,” as well as nutrition and eating disorders. Anti-Harassment Legislation Restrictions on Non-Disclosure and Confidentiality Agreements and More Rigorous Sexual Harassment Standards.  SB 1300 amends California’s Fair Employment and Housing Act (FEHA) to prohibit an employer from requiring an employee to agree to a non-disparagement agreement or other document limiting the disclosure of information about unlawful workplace acts in exchange for a raise or bonus, or as a condition of employment or continued employment.  Employers are also prohibited from requiring an individual to “execute a statement that he or she does not possess any claim or injury against the employer” or to release “a right to file and pursue a civil action or complaint with, or otherwise notify, a state agency, other public prosecutor, law enforcement agency, or any court or other governmental entity.”  Under the law, any such agreement is contrary to public policy and unenforceable.  (Some of these activities, such as reporting to law enforcement, are already protected, of course.)  While negotiated settlement agreements of civil claims supported by valuable consideration are exempted from these prohibitions, employers will want to review their various employee agreement templates to ensure none contain these or other types of prohibited clauses. SB 1300 also codifies several legal standards that may make it more challenging for employers to prevail on harassment claims before trial.  For example, the law provides that a single incident of harassing conduct may create a triable issue of fact in a hostile work environment case; that it is irrelevant to a sexual harassment case that a particular occupation may have been characterized by more sexualized conduct in the past; and that “hostile working environment cases involve issues ‘not determinable on paper.'”  Employers can expect to see SB 1300 cited in any plaintiff’s opposition to summary judgment in a sexual harassment case, and they will need to give serious consideration as to whether and how to seek summary judgment in light of the new law. Limitations on Confidentiality in Settlement Agreements.  SB 820 prohibits provisions in settlement agreements entered into on or after January 1, 2019 that prevent the disclosure of facts related to sexual assault, harassment, and discrimination claims that have been “filed in a civil action or a complaint filed in an administrative action.”  Note, however, that SB 820 does not prohibit provisions precluding the disclosure of the settlement payment amount, and the law carves out an exception for provisions protecting the identity of the claimant where requested by the claimant. Expanded Sexual Harassment Liability to Cover Certain Business Relationships.  Businesses in the venture capital, entertainment, and similar industries will want to be alert to SB 224, which modifies California Civil Code section 51.9 and would include within the elements in a cause of action for sexual harassment when the plaintiff proves, among other things, that the “defendant holds himself or herself as being able to help the plaintiff establish a business, service, or professional relationship with the defendant or a third party.”  The law identifies additional examples of potential defendants under the statute, such as investors, elected officials, lobbyists, directors, and producers. Limitations on Barring Testimony Related to Criminal Conduct or Sexual Harassment.  AB 3109 prohibits waivers of a party’s right to testify in an administrative, legislative, or judicial proceeding concerning alleged criminal conduct or sexual harassment by the other party to a contract, when the party has been required or requested to attend the proceeding pursuant to a court order, subpoena, or written request from an administrative agency or the legislature. Mandating Gender Diversity on Boards of Directors for Publicly Held Corporations SB 826 requires a minimum number of female directors on the boards of publicly traded corporations with principal executive offices in California.  The location of a corporation’s principal executive office will be determined by the Annual Report on Form 10-K. Under SB 826, a corporation covered by the law must have at least one female member on its board of directors by December 31, 2019, and additional female members by 2021 depending on the size of the board.  If the corporation has a board of directors with: four members or less, no additional female directors are required; five members, the board must have at least two female directors by December 31, 2021; and six or more members, at least three female directors are required to be in place by December 31, 2021. The California Secretary of State can impose fines of $100,000 for a first violation and $300,000 for subsequent violations. Potential challengers of this law argue that it suffers from numerous legal deficiencies, including that it violates the Commerce Clause and the Equal Protection Clause of the United States Constitution.  Indeed, Governor Brown himself acknowledged in his signing statement that this new law has “potential flaws that indeed may provide fatal to its ultimate implementation” and will likely be subject to challenge.  For more information on SB 826, please consult our Securities Regulation and Corporate Governance group’s analysis, available here. Bills Vetoed by Governor Brown Governor Brown also vetoed several bills relating to sexual harassment that could have significantly impacted employers in California, including: The closely watched AB 3080, which sought to forbid mandatory arbitration agreements in the workplace. AB 1867, which sought to require employers with fifty or more employees to “maintain records of employee complaints alleging sexual harassment” for a period of five years after the last day of employment of either “the complainant or any alleged harasser named in the complaint, whichever is later.” AB 1870, which sought to extend the deadline in which a complainant may file an administrative charge with the DFEH alleging employment discrimination from one year to three years. AB 3081, which sought to require a client employer and a labor contractor to share all “civil legal responsibility and civil liability for harassment” for all workers supplied by that labor contractor and prohibit an employer from shifting its duties or liabilities to a labor contractor. Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. We have been engaged by numerous clients recently to conduct investigations of #MeToo complaints; to proactively review sexual harassment policies, practices and procedures for the protection of employees and the promotion of a safe, respectful and professional workplace; to conduct training for executives, managers and employees; and to handle related counseling and litigation. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work or the following Labor and Employment or Securities Regulation and Corporate Governance practice group leaders and members: Labor and Employment Group: Catherine A. Conway – Co-Chair, Los Angeles (+1 213-229-7822, cconway@gibsondunn.com) Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com) Rachel S. Brass – San Francisco (+1 415-393-8293, rbrass@gibsondunn.com) Jesse A. Cripps – Los Angeles (+1 213-229-7792, jcripps@gibsondunn.com) Theane Evangelis – Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com) Michele L. Maryott – Orange County (+1 949-451-3945,mmaryott@gibsondunn.com) Katherine V.A. Smith – Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com) Securities Regulation and Corporate Governance Group: Elizabeth Ising – Co-Chair, Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) Lori Zyskowski – Co-Chair, New York (+1 212-351-2309, lzyskowski@gibsondunn.com) Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 3, 2018 |
2018 Mid-Year Activism Update

Click for PDF This Client Alert provides an update on shareholder activism activity involving NYSE- and NASDAQ-listed companies with equity market capitalizations above $1 billion during the first half of 2018.  After a modest decline in activist activity in the second half of 2017, activism resumed a torrid pace during the first half of 2018.  Compared to the same period in 2017, which had previously been the most active half-year period covered by any edition of this report, this mid-year edition of Gibson Dunn’s Activism Update reflects a further increase in public activist actions (62 vs. 59) and companies targeted by such actions (54 vs. 50). In this edition of the Activism Update, our survey covers 62 total public activist actions, involving 41 different activist investors targeting 54 different companies.  Eight of those companies faced activist campaigns from two different investors, and five of those situations involved at least some degree of coordination between the activists involved.  Nine activist investors were responsible for two or more campaigns between January 1, 2018 and June 30, 2018, representing 30, or nearly half, of the 62 campaigns covered by this report. By the Numbers – 2018 Full Year Public Activism Trends *All data is derived from the data compiled from the campaigns studied for the 2018 M Activism Update. Additional statistical analyses may be found in the complete Activism Update linked below.  While changes in business strategy were the top goal of activist campaigns covered by Gibson Dunn’s Activism Update for the second half of 2017, changes to board composition have returned to prominence in the first half of 2018 (75.8% of campaigns), coinciding with a dramatic uptick in publicly filed settlement agreements during the same period.  Activists pursued governance initiatives, sought to influence business strategy, and took positions on M&A-related issues (including pushing for spin-offs and advocating both for and against sales or acquisitions) at nearly equal rates, representing 35.5%, 33.9%, and 32.3% of campaigns, respectively.  Demands for management changes (21.0% of campaigns), attempts to take control of companies (9.5% of campaigns), and requests for capital returns (6.1% of campaigns) remained relatively less common goals of activist campaigns over the first half of 2018.  The frequency of activists filing proxy materials remained relatively consistent with periods covered by recent editions of this report, with investors filing proxy materials in just over one in five campaigns.  While market capitalizations of target companies ranged from this survey’s $1 billion minimum threshold to $100 billion, activists’ focus remained largely on small-cap companies with market capitalizations below $5 billion, which represented 64.8% of the 54 target companies captured by our survey. The most significant development noted in our previous report, covering the second half of 2017, was the decrease in publicly filed settlement agreements between activist investors and target companies, which we attributed partially to the concurrent decline in campaigns involving activists seeking board seats.  This trend has been reversed.  As campaigns seeking board representation have returned to prominence, the number of publicly filed settlement agreements in the first half of 2018 has seen a fivefold increase from the previous half-year period, from four such agreements in the second half of 2017 to 21 in the first half of 2018.  Trends in the key terms of settlement agreements remain relatively steady.  Voting agreements, standstills, and ownership thresholds remain nearly ubiquitous.  Non-disparagement provisions dropped off slightly in the first half of 2018, while committee appointments for new directors and other strategic initiatives (e.g., replacement of management, spin-offs, governance changes) remained near their historical averages in prior editions of this report.  The increased frequency of expense reimbursement noted in our last report has also continued into 2018, with 62% of publicly filed settlement agreements containing such a provision compared to a historical average of just 36% from 2014 through the first half of 2017.  Further details and data on publicly filed settlement agreements may be found in the latter half of this report. We hope you find Gibson Dunn’s 2018 Mid-Year Activism Update informative. If you have any questions, please do not hesitate to reach out to a member of your Gibson Dunn team. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this publication.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following authors in the firm’s New York office: Barbara L. Becker (+1 212.351.4062, bbecker@gibsondunn.com) Richard J. Birns (+1 212.351.4032, rbirns@gibsondunn.com) Dennis J. Friedman (+1 212.351.3900, dfriedman@gibsondunn.com) Eduardo Gallardo (+1 212.351.3847, egallardo@gibsondunn.com) William Koch (+1 212.351.4089, wkoch@gibsondunn.com) Please also feel free to contact any of the following practice group leaders and members: Mergers and Acquisitions Group: Jeffrey A. Chapman – Dallas (+1 214.698.3120, jchapman@gibsondunn.com) Stephen I. Glover – Washington, D.C. (+1 202.955.8593, siglover@gibsondunn.com) Jonathan K. Layne – Los Angeles (+1 310.552.8641, jlayne@gibsondunn.com) Securities Regulation and Corporate Governance Group: Brian J. Lane – Washington, D.C. (+1 202.887.3646, blane@gibsondunn.com) Ronald O. Mueller – Washington, D.C. (+1 202.955.8671, rmueller@gibsondunn.com) James J. Moloney – Orange County, CA (+1 949.451.4343, jmoloney@gibsondunn.com) Elizabeth Ising – Washington, D.C. (+1 202.955.8287, eising@gibsondunn.com) Lori Zyskowski – New York (+1 212.351.2309, lzyskowski@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 2, 2018 |
M&A Report – Fresenius Marks a Watershed Development in the Analysis of “Material Adverse Effect” Clauses

Click for PDF On October 1, 2018, in Akorn, Inc. v. Fresenius Kabi AG,[1]  the Delaware Court of Chancery determined conclusively for the first time that a buyer had validly terminated a merger agreement due to the occurrence of a “material adverse effect” (MAE). Though the decision represents a seminal development in M&A litigation generally, Vice Chancellor Laster grounded his decision in a framework that comports largely with the ordinary practice of practitioners. In addition, the Court went to extraordinary lengths to explicate the history between the parties before concluding that the buyer had validly terminated the merger agreement, and so sets the goalposts for a similar determination in the future to require a correspondingly egregious set of facts. As such, the ripple effects of Fresenius in future M&A negotiations may not be as acute as suggested in the media.[2] Factual Overview On April 24, 2017, Fresenius Kabi AG, a pharmaceutical company headquartered in Germany, agreed to acquire Akorn, Inc., a specialty generic pharmaceutical manufacturer based in Illinois. In the merger agreement, Akorn provided typical representations and warranties about its business, including its compliance with applicable regulatory requirements. In addition, Fresenius’s obligation to close was conditioned on Akorn’s representations being true and correct both at signing and at closing, except where the failure to be true and correct would not reasonably be expected to have an MAE. In concluding that an MAE had occurred, the Court focused on several factual patterns: Long-Term Business Downturn. Shortly after Akorn’s stockholders approved the merger (three months after the execution of the merger agreement), Akorn announced year-over-year declines in quarterly revenues, operating income and earnings per share of 29%, 84% and 96%, respectively. Akorn attributed the declines to the unexpected entrance of new competitors, the loss of a key customer contract and the attrition of its market share in certain products. Akorn revised its forecast downward for the following quarter, but fell short of that goal as well and announced year-over-year declines in quarterly revenues, operating income and earnings per share of 29%, 89% and 105%, respectively. Akorn ascribed the results to unanticipated supply interruptions, added competition and unanticipated price erosion; it also adjusted downward its long-term forecast to reflect dampened expectations for the commercialization of its pipeline products. The following quarter, Akorn reported year-over-year declines in quarterly revenues, operating income and earnings per share of 34%, 292% and 300%, respectively. Ultimately, over the course of the year following the signing of the merger agreement, Akorn’s EBITDA declined by 86%. Whistleblower Letters. In late 2017 and early 2018, Fresenius received anonymous letters from whistleblowers alleging flaws in Akorn’s product development and quality control processes. In response, relying upon a covenant in the merger agreement affording the buyer reasonable access to the seller’s business between signing and closing, Fresenius conducted a meticulous investigation of the Akorn business using experienced outside legal and technical advisors. The investigation revealed grievous flaws in Akorn’s quality control function, including falsification of laboratory data submitted to the FDA, that cast doubt on the accuracy of Akorn’s compliance with laws representations. Akorn, on the other hand, determined not to conduct its own similarly wide-ranging investigation (in contravention of standard practice for an FDA-regulated company) for fear of uncovering facts that could jeopardize the deal. During a subsequent meeting with the FDA, Akorn omitted numerous deficiencies identified in the company’s quality control group and presented a “one-sided, overly sunny depiction.” Operational Changes. Akorn did not operate its business in the ordinary course after signing (despite a covenant requiring that it do so) and fundamentally changed its quality control and information technology (IT) functions without the consent of Fresenius. Akorn management replaced regular internal audits with “verification” audits that only addressed prior audit findings rather than identifying new problems. Management froze investments in IT projects, which reduced oversight over data integrity issues, and halted efforts to investigate and remediate quality control issues and data integrity violations out of concern that such investigations and remediation would upend the transaction. Following signing, NSF International, an independent, accredited standards development and certification group focused on health and safety issues, also identified numerous deficiencies in Akorn’s manufacturing facilities. Conclusions and Key Takeaways The Court determined, among others, that the sudden and sustained drop in Akorn’s business performance constituted a “general MAE” (that is, the company itself had suffered an MAE), Akorn’s representations with respect to regulatory compliance were not true and correct, and the deviation between the as-represented condition and its actual condition would reasonably be expected to result in an MAE. In addition, the Court found that the operational changes implemented by Akorn breached its covenant to operate in the ordinary course of business. Several aspects of the Court’s analysis have implications for deal professionals: Highly Egregious Facts. Although the conclusion that an MAE occurred is judicially unprecedented in Delaware, it is not surprising given the facts. The Court determined that Akorn had undergone sustained and substantial declines in financial performance, credited testimony suggesting widespread regulatory noncompliance and malfeasance in the Akorn organization and suggested that decisions made by Akorn regarding health and safety were re-prioritized in light of the transaction (and in breach of a highly negotiated interim operating covenant). In In re: IBP, Inc. Shareholders Litigation, then-Vice Chancellor Strine described himself as “confessedly torn” over a case that involved a 64% year-over-year drop-off in quarterly earnings amid allegations of improper accounting practices, but determined that no MAE had occurred because the decline in earnings was temporary. In Hexion Specialty Chemicals, Inc. v. Huntsman Corp., Vice Chancellor Lamb emphasized that it was “not a coincidence” that “Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement” and concluded the same, given that the anticipated decline in the target’s EBITDA would only be 7%. No such hesitation can be found in the Fresenius opinion.[3] MAE as Risk Allocation Tool. The Court framed MAE clauses as a form of risk allocation that places “industry risk” on the buyer and “company-specific” risk on the seller. Explained in a more nuanced manner, the Court categorized “business risk,” which arises from the “ordinary operations of the party’s business” and which includes those risks over which “the party itself usually has significant control”, as being retained by the seller. By contrast, the Court observed that the buyer ordinarily assumes three others types of risk—namely, (i) systematic risks, which are “beyond the control of all parties,” (ii) indicator risks, which are markers of a potential MAE, such as a drop in stock price or a credit rating downgrade, but are not underlying causes of any MAE themselves, and (iii) agreement risks, which include endogenous risks relating to the cost of closing a deal, such as employee flight. This framework comports with the foundation upon which MAE clauses are ordinarily negotiated and underscores the importance that sellers negotiate for industry-specific carve-outs from MAE clauses, such as addressing adverse decisions by governmental agencies in heavily regulated industries. High Bar to Establishing an MAE. The Court emphasized the heavy burden faced by a buyer in establishing an MAE. Relying upon the opinions that emerged from the economic downturns in 2001 and 2008,[4]  the Court reaffirmed that “short-term hiccups in earnings” do not suffice; rather, the adverse change must be “consequential to the company’s long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months.” The Court underscored several relevant facts in this case, including (i) the magnitude and length of the downturn, (ii) the suddenness with which the EBITDA decline manifested (following five consecutive years of growth) and (iii) the presence of factors suggesting “durational significance,” including the entrance of new and unforeseen competitors and the permanent loss of key customers.[5] Evaluation of Targets on a Standalone Basis. Akorn advanced the novel argument that an MAE could not have occurred because the purchaser would have generated synergies through the combination and would have generated profits from the merger. The Court rejected this argument categorically, finding that the MAE clause was focused solely on the results of operations and financial condition of the target and its subsidiaries, taken as a whole (rather than the surviving corporation or the combined company), and carved out any effects arising from the “negotiation, execution, announcement or performance” of the merger agreement or the merger itself, including “the generation of synergies.” Given the Court’s general aversion to considering synergies as relevant to determining an MAE, buyers should consider negotiating to include express references to synergies in defining the concept of an MAE in their merger agreements. Disproportionate Effect. Fresenius offers a useful gloss on the importance to buyers of including “disproportionate effects” qualifications in MAE carve-outs regarding industry-wide events. Akorn argued that it faced “industry headwinds” that caused its decline in performance, such as heightened competition and pricing pressure as well as regulatory actions that increased costs. However, the Court rejected this view because many of the causes of Akorn’s poor performance were actually specific to Akorn, such as new market entrants in Akorn’s top three products and Akorn’s loss of a specific key contract. As such, these “industry effects” disproportionately affected and were allocated from a risk-shifting perspective to Akorn. To substantiate this conclusion, the Court relied upon evidence that Akorn’s EBITDA decline vastly exceeded its peers. The Bring-Down Standard. A buyer claiming that a representation given by the target at closing fails to satisfy the MAE standard must demonstrate such failure qualitatively and quantitatively. The Court focused on a number of qualitative harms wrought by the events giving rise to Akorn’s failure to bring down its compliance with laws representation at closing, including reputational harm, loss of trust with principal regulators and public questioning of the safety and efficacy of Akorn’s products. With respect to quantitative measures of harm, Fresenius and Akorn presented widely ranging estimates of the cost of remedying the underlying quality control challenges at Akorn. Using the midpoint of those estimates, the Court estimated the financial impact to be approximately 21% of Akorn’s market capitalization. However, despite citing several proxies for financial performance suggesting that this magnitude constituted an MAE, the Court clearly weighted its analysis towards qualitative factors, noting that “no one should fixate on a particular percentage as establishing a bright-line test” and that “no one should think that a General MAE is always evaluated using profitability metrics and an MAE tied to a representation is always tied to the entity’s valuation.” Indeed, the Court observed that these proxies “do not foreclose the possibility that a buyer could show that percentage changes of a lesser magnitude constituted an MAE. Nor does it exclude the possibility that a buyer might fail to prove that percentage changes of a greater magnitude constituted an MAE.” Fresenius offers a useful framework for understanding how courts analyze MAE clauses. While this understanding largely comports with the approach taken by deal professionals, the case nevertheless offers a reminder that an MAE, while still quite unlikely, can occur. Deal professionals would be well-advised to be thoughtful about how the concept should be defined and used in an agreement.    [1]   Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018).    [2]   See, e.g., Jef Feeley, Chris Dolmetsch & Joshua Fineman, Akorn Plunges After Judge Backs Fresenius Exit from Deal, Bloomberg (Oct 1, 2018) (“‘The ruling is a watershed moment in Delaware law, and will be a seminal case for those seeking to get out of M&A agreements,’ Holly Froum, an analyst with Bloomberg Intelligence, said in an emailed statement.”); Tom Hals, Delaware Judge Says Fresenius Can Walk Away from $4.8 Billion Akorn Deal, Reuters (Oct. 1, 2018) (“‘This is a landmark case,’ said Larry Hamermesh, a professor at Delaware Law School in Wilmington, Delaware.”).    [3]   The egregiousness of the facts in this case is further underscored by the fact that the Court determined that the buyer had breached its own covenant to use its reasonable best efforts to secure antitrust clearance, but that this breach was “temporary” and “not material.”    [4]   See, e.g., Hexion Specialty Chems. Inc. v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008); In re: IBP, Inc. S’holders Litig., 789 A.2d 14 (Del. Ch. 2001).    [5]   This view appears to comport with the analysis highlighted by the Court from In re: IBP, Inc. Shareholders Litigation, in which the court determined that an MAE had not transpired in part because the target’s “problems were due in large measure to a severe winter, which adversely affected livestock supplies and vitality.” In re: IBP, 789 A.2d at 22. In this case, the decline of Akorn was not the product of systemic risks or cyclical declines, but rather a company-specific effect. The following Gibson Dunn lawyers assisted in preparing this client update:  Barbara Becker, Jeffrey Chapman, Stephen Glover, Mark Director, Andrew Herman, Saee Muzumdar, Adam Offenhartz, and Daniel Alterbaum. 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, the authors, or any of the following leaders and members of the firm’s Mergers and Acquisitions practice group: Mergers and Acquisitions Group / Corporate Transactions: Barbara L. Becker – Co-Chair, New York (+1 212-351-4062, bbecker@gibsondunn.com) Jeffrey A. Chapman – Co-Chair, Dallas (+1 214-698-3120, jchapman@gibsondunn.com) Stephen I. Glover – Co-Chair, Washington, D.C. (+1 202-955-8593, siglover@gibsondunn.com) Dennis J. Friedman – New York (+1 212-351-3900, dfriedman@gibsondunn.com) Jonathan K. Layne – Los Angeles (+1 310-552-8641, jlayne@gibsondunn.com) Mark D. Director – Washington, D.C./New York (+1 202-955-8508/+1 212-351-5308, mdirector@gibsondunn.com) Andrew M. Herman – Washington, D.C./New York (+1 202-955-8227/+1 212-351-5389, aherman@gibsondunn.com) Eduardo Gallardo – New York (+1 212-351-3847, egallardo@gibsondunn.com) Saee Muzumdar – New York (+1 212-351-3966, smuzumdar@gibsondunn.com) Mergers and Acquisitions Group / Litigation: Meryl L. Young – Orange County (+1 949-451-4229, myoung@gibsondunn.com) Brian M. Lutz – San Francisco (+1 415-393-8379, blutz@gibsondunn.com) Aric H. Wu – New York (+1 212-351-3820, awu@gibsondunn.com) Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com) Michael M. Farhang – Los Angeles (+1 213-229-7005, mfarhang@gibsondunn.com) Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, jlipshutz@gibsondunn.com) Adam H. Offenhartz – New York (+1 212-351-3808, aoffenhartz@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 1, 2018 |
Congress Clarifies Statutory Thresholds for FERC Merger Approvals

Click for PDF On September 28, 2018, President Trump signed into law amendments to Section 203 of the Federal Power Act that, among other things, narrow the scope of transactions that require prior approval from the Federal Energy Regulatory Commission (“FERC”).  The changes become effective on March 27, 2019. Presently, FERC prior approval is required anytime a public utility or an affiliate of a public utility acquires facilities subject to FERC’s jurisdiction (i.e., it engages in a “utility merger”)—regardless of value.  The new law establishes a $10 million threshold for such transactions and also requires after-the-fact reporting of such transactions involving assets valued between $1 million and $10 million. This amendment fixes inconsistencies in the Federal Power Act and eases significantly the regulatory burden associated with the purchase of smaller and/or lower value, FERC-jurisdictional assets.  Under the Energy Policy Act of 2005, Congress eliminated entirely any clear monetary threshold for utility merger approvals while at the same time increasing the threshold from $50,000 to $10 million for all other types of sales and purchases requiring FERC approval.  Since the statute was silent regarding any sort of de minimis threshold utility merger approvals, FERC interpreted its authority to extend to all such mergers regardless of the value of the facilities.  This has led to numerous applications to FERC for approval of transactions involving minimally valued assets (some as low as $1), frustration on the part of some utilities, and some entities incurring fines from the FERC Office of Enforcement due to erroneous reading of a $10 million threshold into the statute. The amended Section 203(a)(1) will also significantly ease the regulatory burden associated with the sales of lower value, FERC-jurisdictional assets.  Applications to FERC under Section 203 are burdensome to compile and it can often take months before the Commission issues an order on the request.  This amendment will help to encourage sales of less valuable FERC-jurisdictional assets while also freeing up the Commission to focus on other matters. Starting on March 27, 2019, entities wishing to engage in transactions involving FERC-jurisdictional assets of more than $10 million must continue to request FERC approval for consummating the transaction.  Entities wishing to engage in transactions involving FERC-jurisdictional assets between $1 million and $10 million do not need to seek FERC pre-approval, and instead must only notify FERC of the transaction within one month of the closing.  Transactions involving FERC-jurisdictional assets below the $1 million threshold do not need to be reported. Gibson Dunn’s Energy, Regulation and Litigation lawyers are available to assist in addressing any questions you may have regarding the developments discussed above.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, or the authors: William S. Scherman – Washington, D.C. (+1 202-887-3510, wscherman@gibsondunn.com) Jeffrey M. Jakubiak – New York (+1 212-351-2498, jjakubiak@gibsondunn.com) Jennifer C. Mansh – Washington, D.C. (+1 202-955-8590, jmansh@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 26, 2018 |
Chancery Reaffirms Safe Harbor for Directors’ Reasonable Reliance on Expert Advice

San Francisco partner Brian M. Lutz and New York associate Mark H. Mixon Jr. are the authors of “Chancery Reaffirms Safe Harbor for Directors’ Reasonable Reliance on Expert Advice” [PDF] published in the Delaware Business Court Insider on September 26, 2018.  

September 24, 2018 |
U.S. Court of Appeals Allows Specific Personal Jurisdiction Over German Web-Services Firm With No Physical U.S. Presence

Click for PDF On September 13, 2018, the U.S. Court of Appeals for the First Circuit handed down an important personal-jurisdiction ruling in the age of e-commerce.  In Plixer International, Inc. v. Scrutinizer GmbH, the First Circuit interpreted Federal Rule of Civil Procedure 4(k)(2) to affirm a district court’s exercise of personal jurisdiction over a German company whose only ties to the United States were the provision of web-based services to businesses all over the world, including in the United States.[1]  This is still a developing area of personal jurisdiction law without clear guidance from the U.S. Supreme Court, and non-U.S. companies should carefully consider whether and how their online commerce might subject them to U.S. litigation. The decision arose out of a trademark dispute between two companies—U.S.-based Plixer International, Inc. and the German firm Scrutinizer GMBH—over whether Scrutinizer’s use of its corporate name in the U.S. caused confusion with Plixer’s registered “Scrutinizer” mark.[2]  Scrutinizer offers web-based services to software companies, principally in helping customers build better software.  These offerings are all cloud-based, and Scrutinizer’s activities occur exclusively outside the United States.  In particular, Scrutinizer does not have any office, phone number, or agent for service of process in the United States; its employees do not travel to the United States for business; and it does not advertise in the United States.  Scrutinizer accepts payment only in euros, and its contracts provide that only German law governs disputes, which would be adjudicated only in German courts.  Notwithstanding these non-U.S. ties, Scrutinizer does have business dealings in the United States: its website is published in English, and although its business is “global,” 156 of its customers were based in the United States over a three year period, with revenues amounting to just under $200,000.00 (€165,212.07).  The only U.S.-based conduct highlighted in the opinion was an unexplained trademark application for the term “Scrutinizer ” in January 2017, three years after the case was filed.[3] Plixer sued Scrutinizer in the U.S. District Court for the District of Maine and Scrutinizer contested personal jurisdiction.[4]  (The dispute was not based on Scrutinizer’s contracts and thus did not trigger the forum selection clause.)  The district court rejected Plixer’s initial effort to base personal jurisdiction solely on Scrutinizer’s Maine-based contacts, which consisted only of two sales worth approximately €3,100.[5]  But, after allowing for jurisdictional discovery, the district court ultimately found jurisdiction based on Scrutinizer’s contacts with the United States as a whole, finding that Scrutinizer “operated a highly interactive website that sold its cloud-based services directly through the website, that it was open to business throughout the world, that it accepted recurrent business from the United States in a substantial amount, and that it did so knowingly.”[6]  According to the district court, this sufficed to exercise personal jurisdiction over Scrutinizer under Federal Rule of Civil Procedure 4(k)(2), which provides: (2) Federal Claim Outside State-Court Jurisdiction. For a claim that arises under federal law, serving a summons or filing a waiver of service establishes personal jurisdiction over a defendant if: (A) the defendant is not subject to jurisdiction in any state’s courts of general jurisdiction; and (B) exercising jurisdiction is consistent with the United States Constitution and laws. The district court denied Scrutinizer’s motion to dismiss on these grounds, but granted Scrutinizer’s motion to file an interlocutory appeal under 28 U.S.C. § 1292(b). On appeal, the First Circuit affirmed.  The court explained at the outset that the only contested aspect of the case was Rule 4(k)(2)(B), which invokes the requirement that personal jurisdiction comport with due process, a test requiring Plixer to show that (1) its claim directly arises out of or relates to the defendant’s forum activities; (2) the defendant’s forum contacts represent a purposeful availment of the privilege of conducting activities in that forum, thus invoking the benefits and protections of the forum’s laws and rendering the defendant’s involuntary presence in the forum’s courts foreseeable; and (3) the exercise of jurisdiction is reasonable.[7] As Plixer’s trademark claim necessarily related to Scrutinizer’s U.S. sales, the First Circuit analyzed only elements (2) and (3), and held that Plixer had satisfied both. The court first found that Scrutinizer had purposely availed itself of the United States—such that Scrutinizer had the necessary “minimum contacts” with the United States for personal jurisdiction—despite the fact that it had no physical contacts with the United States.  The court recognized that a prior personal-jurisdiction decision from the Supreme Court, Walden Fiore, expressly “le[ft] questions about virtual contacts for another day,” and the First Circuit therefore based its ruling solely on Scrutinizer’s “sizeable and continuing commerce with United States customers,” but was otherwise “extremely reluctant to fashion any general guidelines beyond those that exist in law [and] emphasize[d] that [its] ruling [was] specific to the facts of this case.”[8] The court also rejected each of Scrutinizer’s arguments against the finding of minimum contacts.  According to the court, Scrutinizer had not simply “enter[ed] its products into the stream of commerce” and thus had no control where those products ended; “Scrutinizer’s service [went] only to the customers that Scrutinizer has accepted.”[9]  Scrutinizer did not attempt to limit access to its website to block U.S. users, nor did it “take the low-tech step of posting a disclaimer that its service is not intended for U.S. users.”[10]  The court similarly rejected Scrutinizer’s argument that its U.S. contacts were solely “the product of its customers’ unilateral actions,” because Scrutinizer “knew that it was serving U.S. customers” through its “globally accessible website.”[11] But the key minimum-contacts analysis arose in the Court’s rejection of Scrutinizer’s final argument that it did not “specifically target” the United States.[12]  That test came from a four-justice plurality opinion in the 2011 Supreme court Decision, J. McIntyre Machinery, Ltd. v. Nicastro, where the plurality would have allowed jurisdiction only “where the defendant can be said to have targeted the forum.”[13]  The First Circuit instead relied on Justice Breyer’s more narrow concurrence in Nicastro, which relied on findings that the defendant in Nicastro had not made any regular course of sales in the jurisdiction to support a finding of purposeful availment or minimum contacts.[14]  According to the First Circuit, Nicastro thus did not concern itself with companies that, like Scrutinizer, “‘target[] the world’ by making its website globally available.”[15]  Ultimately, the Court held that “the German company could have ‘reasonably anticipated’ the exercise of specific personal jurisdiction based on its U.S. contacts,” including Scrutinizers regular sales to the U.S. and its use of a website “to obtain U.S. customer contracts.”[16]  The First Circuit defended this conclusion as consistent prior decisions from the Supreme Court and other courts emphasizing the importance of forum sales in minimum-contacts analysis.[17] Having found that Scrutinizer had sufficient minimum contacts, the First Circuit concluded that exercising personal jurisdiction was reasonable.[18]  The First Circuit recognized that litigating in the United States would burden Scrutinizer given its location in Germany, but discounted that burden in light of Scrutinizer’s U.S. business and the fact that “modern travel ‘creates no especially ponderous burden for business travelers.'”[19] But no other factor weighed against exercising jurisdiction.  The court concluded that “‘[w]hen minimum contacts have been established, often the interests of the plaintiff and the forum in the exercise of jurisdiction will justify even the serious burdens placed on the alien defendant.'”[20] The First Circuit’s decision is drafted in narrow terms, but non-U.S. companies should take note of Plixer’s potentially sweeping conclusion:  A company with no physical ties to the U.S. whatsoever could be hauled into a U.S. court based solely on rather modest web-based sales.  The Internet and e-commerce have revolutionized the ways in which companies can do business all over the world, opening up markets in ways that were unthinkable in the analog past.  But the flip-side of this openness is the risk of litigation in foreign fora.  In light of decisions such as Plixer, non-U.S. companies should carefully assess the costs and benefits of selling their products to identifiable U.S. individuals and companies. [1]   — F.3d —-, 2018 WL 4357137 (1st Cir. Sept. 13, 2018). [2]   Id. at *2. [3]   Id. at *1-2. [4]   Id. at *2. [5]   Id. at *2 n.4. [6]   Id. at *2. [7]   Id.at *3. [8]   Id. at *4 (citing Walden v. Fiore, 571 U.S. 227, 290 n.9 (2014)). [9]   Id.  at *5. [10]   Id. at *5. [11]   Id. at *5. [12]   See id. at *6-7. [13]   564 U.S. 873, 882 (2011) (plurality). [14]   Id. at 889 (Breyer, J., concurring). [15]   Plixer, 2018 WL 4357137, at *6 (quoting Nicastro, 564 U.S. at 890 (Breyer, J. concurring)). [16]   Id. at *6. [17]   Id. at *7 (citing Keeton v. Hustler Magazine, 465 U.S. 770 (1984); Oticon, Inc. v. Sebotek Hearing Sys., LLC, 865 F. Supp. 2d 501 (D.N.J. 2011); Willemsen v. Invacare Corp., 282 P.3d 867 (Or. 2012); Mavrix Photo, Inc. v. Brand Techs., Inc., 647 F.3d 1218 (9th Cir. 2011); Bird v. Parsons, 289 F.3d 865 (6th Cir. 2002); Advanced Tactical Ordnance Sys., LLC v. Real Action Paintball, Inc., 751 F.3d 796 (7th Cir. 2014); Carefirst of Md., Inc. v. Carefirst Pregnancy Ctrs., Inc., 334 F.3d 390 (4th Cir. 2003)). [18]   Id. at *8. [19]   Id. at *8. [20]   Id. at *9 (quoting Asahi Metal Indus. Co. v. Super. Ct. of Cal., Solano, Cnty., 480 U.S. 102, 114 (1987)). The following Gibson Dunn lawyers assisted in the preparation of this client update: Perlette Jura, Andrea Neuman, William Thomson and Christopher Leach. 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 Transnational Litigation Group: United States: Randy M. Mastro – New York (+1 212-351-3825, rmastro@gibsondunn.com) Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com) Scott A. Edelman – Los Angeles (+1 310-557-8061, sedelman@gibsondunn.com) Andrea E. Neuman – New York (+1 212-351-3883, aneuman@gibsondunn.com) William E. Thomson – Los Angeles (+1 213-229-7891, wthomson@gibsondunn.com) Perlette Michèle Jura – Los Angeles (+1 213-229-7121, pjura@gibsondunn.com) Kahn A. Scolnick – Los Angeles (+1 213-229-7656, kscolnick@gibsondunn.com) Anne M. Champion – New York (+1 212-351-5361, achampion@gibsondunn.com) Europe: Philip Rocher – London (+44 20 7071 4202, procher@gibsondunn.com) Charlie Falconer – London (+44 20 7071 4270, cfalconer@gibsondunn.com) Patrick Doris – London (+44 20 7071 4276, pdoris@gibsondunn.com) Michael Walther – Munich (+49 89 189 33 180, mwalther@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 11, 2018 |
SFO Successfully Defends Challenge over the Territorial Scope of Compulsory Document Requests

Click for PDF Last week the High Court in London handed down its decision following a challenge by KBR, Inc. against the issuing of compulsory document requests that required the production of documents held by the company outside of the UK. KBR, Inc. is a U.S. engineering and construction company and ultimate parent company of the KBR Group. It does not have a physical presence in the UK, but has a subsidiary, KBR Ltd, that does. KBR Ltd is under investigation by the SFO for suspected bribery. At the heart of the proceedings was a notice issued to KBR, Inc. by the Serious Fraud Office (“SFO“) under section 2(3) of the Criminal Justice Act 1987 (“CJA“) (the “July Section 2 Notice“) compelling the production of documents held outside the UK.  The SFO issued the July Section 2 Notice to a representative of KBR, Inc. who had attended a meeting with the SFO in the UK to discuss its investigation into KBR Ltd. The Challenge KBR, Inc. challenged the July Section 2 Notice on three grounds: Jurisdiction:  the July Section 2 Notice was ultra vires the CJA, as it requested material held outside of the UK from a company incorporated outside of the UK. Discretion:  the Director of the SFO made an error of law in issuing the July Section 2 Notice instead of using its power to seek Mutual Legal Assistance (“MLA“) from the US authorities under the UK’s 1994 bilateral MLA Treaty with the US. Service:  the July Section 2 Notice was not properly served on KBR, Inc. under the CJA. Jurisdiction The Court held that in relation to UK companies with documents outside of the UK, that section 2(3) of the CJA must have “an element of extraterritorial application” otherwise “a UK company could resist an otherwise lawful s.2(3) notice on the ground that the documents in question were held on a server out of the jurisdiction“. The extraterritorial reach would minimize the risk of the SFO’s investigations being frustrated by companies moving their documents out of the jurisdiction. As regards documents held by foreign companies outside of the UK, the court held that section 2(3) will extend to some foreign companies in respect of documents held abroad, when there is a “sufficient connection” between the foreign company and the jurisdiction (the UK). This test is fact specific in order to allow for “practical justice in the individual case“. In KBR, Inc.’s case, the Court found that certain following factors were not sufficient on their own to satisfy the “sufficient connection” test, including: the fact that KBR, Inc. was the parent company of KBR Ltd, as it would ensnare parent companies of multinational groups without justification. the fact that KBR, Inc. cooperated to a degree with the SFO’s request for documents and remained willing to do so voluntarily, on terms that it would apply SFO search terms across data held in the US.  Cooperation is to be encouraged but it should not give rise to a risk of being held to imply acceptance of jurisdiction. the fact that a KBR, Inc. representative agreed to, and did, attend a meeting with the SFO.  This is for similar reasons as those set out above. However, the Court went on to find that there was a sufficient connection between KBR, Inc. and the UK in this case, based on the fact that some suspected corrupt payments made by KBR to Unaoil required the express approval of KBR, Inc. and were processed by KBR, Inc.’s treasury function, and for a period approval was also required from KBR, Inc.’s compliance function before payment could be released.  The Court also observed that a corporate officer of KBR, Inc. was based in the Group’s UK office. Discretion KBR, Inc. argued that even if the CJA did confer jurisdiction on the SFO to compel the production of materials abroad, the Director of the SFO should not have exercised his power under section 2(3) of the CJA, which is discretionary, and should have first considered using the MLA route.  KBR, Inc.’s position was that in failing to do this amounted to an error of law. This argument was rejected. The High Court held that the MLA option was an additional power available to the SFO: “The availability of MLA gives the Director additional options; it does not curtail his discretion to use the separate power of issuing s.2(3) notices… It follows that KBR [Inc] has failed to demonstrate any error of law on the part of the Director in the exercise of his discretion to issue the July Notice.” The High Court noted additionally in the SFO’s favour that there are “good practical reasons” for the Director to use a section 2 notice instead of MLA. Such reasons included delays, the risk that a request is ignored, and the burden on the requested state of having to deal with a request when it would be simpler to obtain the materially directly. KBR, Inc. had neither shown nor suggested that compliance with the July Section 2 Notice would have raised any complexities or issues of local U.S. law, or conflict with duties owed by KBR, Inc. to third parties. Service KBR, Inc. argued that simply giving the July Notice to KBR, Inc.’s representative during an SFO meeting was not enough to “serve” KBR, Inc. with the July Section 2 Notice, and that the fact that KBR, Inc. ‘s representative was in the UK did not signify that KBR, Inc. was present in the UK. The court rejected this challenge, noting in particular that section 2(3) required no additional formality beyond the giving of the notice. The Court held that KBR, Inc. was “plainly present” in the jurisdiction when the SFO gave the July Section 2 Notice to its representative. The SFO made the meeting in question conditional on the attendance of “the clients” (i.e., KBR, Inc.). As such, it was clear that KRB Inc’s representatives were in the jurisdiction in their capacity as representatives and not “coincidentally or on some personal frolic“. The High Court, however, noted that the SFO’s plan to give the July Notice to KBR, Inc.’s representative during the course of the meeting had “unappealing features“. However, those features did not invalidate the July Notice; rather they serve as a warning to others who may attend similar meetings with the SFO in the future. Implications The decision has helped to clarify the scope of the SFO’s section 2 notice power, which to-date has not been considered comprehensively by the courts. The SFO will no doubt be satisfied with the result. Foreign companies that hold documents outside of the UK will not be immune from the SFO’s section 2 power, provided that the SFO can illustrate a “sufficient connection” between the company in question and the UK.  A parent / subsidiary relationship alone will not suffice, but where there are links between a UK subsidiary and its foreign parent, for example if they share accounting or compliance functions, this will likely suffice.  In this case, another connection was the presence of a KBR, Inc. employee in KBR Ltd’s office. This seems a rather tenuous connection. Whether that factor alone would have been enough is difficult to assess. The High Court, however, obviously thought it was sufficiently material to identify and take into account. This decision is likely to embolden the SFO in serving section 2 notices on foreign companies involved in their investigations. The Crime (Overseas Production Orders) Bill, which is currently before Parliament, may soon render the decision less relevant, at least as far as documents are stored electronically and in states where reciprocal arrangements are made for recognition of production orders.  The Bill has received little press attention to date but it may have significant implications.  If enacted, the SFO (amongst other authorities) will be able to make an application to the Crown Court for an order requiring an overseas person to produce electronic data in connection with an investigation, where there is an international cooperation agreement in place with the jurisdiction in question.  We note that the U.S. has passed the CLOUD Act (Clarifying Lawful Use of Overseas Data Act), which the UK Government has stated was passed “in anticipation and preparation” for a bilateral UK-US data access agreement.  If the Bill becomes law and agreements are put in place, it may become much easier for the SFO to obtain electronic data from overseas to aid its investigations. This client alert was prepared by Patrick Doris, Sacha Harber-Kelly, Steve Melrose and Rose Naing. Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments.  If you would like to discuss this alert in greater detail, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following members of the firm’s disputes practice: Philip Rocher (+44 (0)20 7071 4202, procher@gibsondunn.com) Patrick Doris (+44 (0)20 7071 4276, pdoris@gibsondunn.com) Sacha Harber-Kelly (+44 20 7071 4205, sharber-kelly@gibsondunn.com) Charles Falconer (+44 (0)20 7071 4270, cfalconer@gibsondunn.com) Allan Neil (+44 (0)20 7071 4296, aneil@gibsondunn.com) Steve Melrose (+44 (0)20 7071 4219, smelrose@gibsondunn.com) Sunita Patel (+44 (0)20 7071 4289, spatel2@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

August 27, 2018 |
SEC Streamlines Disclosure Requirements As Part of Its Overall Disclosure Effectiveness Review

Click for PDF This client alert provides an overview of changes to existing disclosure requirements recently adopted by the Securities and Exchange Commission (the “Commission”).  On August 17, 2018, the Commission adopted several dozen amendments (available here) to existing disclosure requirements to “simplify compliance without significantly altering the total mix of information” (the “Final Rules”).  In Release No. 33-10532, the Commission characterized the amended requirements as redundant, duplicative, overlapping, outdated or superseded, in light of subsequent changes to Commission disclosure requirements, U.S. Generally Accepted Accounting Principles (“GAAP”), International Financial Reporting Standards (“IFRS”) and technology developments.  The Final Rules are largely consistent with the changes outlined in the Commission’s July 13, 2016 proposing release, available here (the “Proposed Rules”).  They form part of the Commission’s ongoing efforts in connection with the Disclosure Effectiveness Initiative relating to Regulations S-K and S-X and the Commission’s mandate under the Fixing America’s Surface Transportation (“FAST”) Act to eliminate provisions of Regulation S-K that are duplicative, overlapping, outdated, or unnecessary. The Commission adopted the amendments addressed in the Proposed Rules with few exceptions. The Final Rules will become effective 30 days from publication in the Federal Register.  In the short term, issuers and registrants will need to revise their disclosure practices and compliance checklists in light of the amendments before filing a registration statement or periodic report following effectiveness of the Final Rules. I.   Summary of Adopted Changes For certain disclosure requirements that are related to, but not the same as, U.S. GAAP, IFRS, or other Commission disclosure requirements, the Commission: (i) deleted those disclosure requirements that convey reasonably similar information to or are encompassed by the disclosures that result from compliance with overlapping U.S. GAAP, IFRS, or Commission disclosure requirements; and (ii) integrated those disclosure requirements that overlapped, but required information that was incremental to, other Commission disclosure requirements. A.   Deletions of Requirements Covered Otherwise The Commission eliminated the following disclosure requirements, as proposed:[1] Amount Spent on R&D.  The Commission deleted the requirement to disclose amounts spent on research and development activities for all years presented (Item 101(c)(1)(xi) of Regulation S-K) because it is already covered by U.S. GAAP. Financial Information by Segment.  The Commission deleted the requirement to disclose financial information (specifically, revenues from external customers, a measure of profit or loss and total assets) about segments for the last three years (Item 101(b) of Regulation S-K),[2] because it is already covered by U.S. GAAP. Financial Information by Geographic Area.  The Commission deleted the requirement to disclose financial information by geographic area (Item 101(d)(2) of Regulation S-K) and risks associated with an issuer’s foreign operations and any segment’s dependence on foreign operations (Item 101(d)(3) of Regulation S-K), because it is already covered by U.S. GAAP. Dividend History.  The Commission deleted the requirement to disclose the frequency and amount of cash dividends declared (Item 201(c)(1) of Regulation S-K), because this information is already covered by amended Rule 3-04 of Regulation S-X. Ratio of Earnings to Fixed Charges.  The Commission deleted the requirement to provide a ratio of earnings to fixed charges (Items 503(d) and 601(b)(12) of Regulation S-K; Instruction 7 to Exhibits of Form 20-F), because U.S. GAAP already provides the disclosure of the components commonly used to calculate these ratios.  Issuers no longer need to include this information in an exhibit to their 10-K or in their registration statements. B.   Integrations of Duplicative Requirements The Commission integrated the following duplicative disclosure requirements, as proposed: Restrictions on Dividends.  The Commission consolidated several disclosure requirements related to the restriction of dividends and related items.  Where formerly the disclosure requirements were located in parts of both Regulation S-K and Regulation S-X, the Commission consolidated such disclosure requirements for domestic issuers under a single requirement in revised Rule 4-08(e)(3) of Regulation S-X. The disclosure will now only appear in the notes to the financial statements. Discussion of Geographic Areas.  The Commission integrated the requirement to discuss facts indicating why performance in certain geographic areas may not be indicative of current or future operations by eliminating the requirement from Item 101(d)(4) of Regulation S-K and revising Item 303 of Regulation S-K (which currently requires a discussion regarding elements of income that are not indicative of the issuer’s ongoing business), to add an explicit reference to “geographic areas.”  In addition, the Commission adopted the following clarification as suggested by the commenters: the discussion of income from certain geographic areas under revised Item 303 of Regulation S-K is not required in all circumstances, but only when management believes such discussion would be appropriate to an understanding of the business. C.   Deletions of Outdated Disclosure Requirements[3] The Commission also eliminated provisions that have become outdated as a result of the passage of time or changes in the regulatory, business, or technological environment (such as stale transition dates and moot income tax instructions), including the following: Available Information. The Commission deleted the requirement (contained in Item 101(e)(2) and Item 101(h)(5)(iii) of Regulation S-K, Forms S-1, S-3, S-4, S-11, F-1, F-3, and F-4,  Item 1118(b) of Regulation AB, and Forms SF-1, SF-3, N-1A, N-2, N-3, N-5, N6, and N-8B-2) to identify the Public Reference Room and disclose its physical address and phone number. The Commission retained the requirement (contained in Item 101(e)(2) of Regulation S-K, and Forms S-1, S-3, S-4, S-11, F-3, F-4, SF-1, SF-3, and N-4) to disclose the Commission’s Internet address and a statement that electronic SEC filings are available there and expanded this requirement to Forms 20-F and F-1. The Commission added a requirement to Items 101(e) and 101(h)(5) of Regulation S-K, and Forms S-3, S-4, F-1, F-3, F-4, 20-F, SF-1, and SF-3 that all issuers disclose their Internet addresses (or, in the case of asset-backed issuers, the address of the specified transaction party). Exchange Rate Data. The Commission deleted the requirement in Item 3.A.3 of Form 20-F  that foreign private issuers provide exchange rate data when financial statements are prepared in a currency other than the U.S. dollar insofar as this data is widely available on the internet. Age of Financial Statements. The Commission added language clarifying the facts and circumstances when foreign private issuers may comply with the aging requirement to include audited financial statements in an initial public offering that are not older than 15 months compared to the 12 months aging requirement. They also deleted the reference to a waiver in Instruction 2 to Item 8.A.4 of Form 20-F. Market Price. The Commission eliminated the detailed disclosure requirement under Item 201(a)(1) of Regulation S-K related to historical high and low sale prices in light of the fact that the daily market price of most publicly traded securities are easily accessible free of charge on numerous websites that provide more information than is required under Regulation S-K.  Such requirements remain in place for issuers with no class of common equity traded in an established trading market; however, for issuers with established trading markets, the Final Rules require the disclosure of the trading symbols used for each class of common equity and the principal foreign public trading market in the case of foreign issuers.  In addition, issuers with common equity that is not traded on an exchange are required to indicate, as applicable, that any over-the-counter quotations reflect inter-dealer prices and may not necessarily represent actual transactions. The Final Rules also amended Item 9.A.4 of Form 20-F to be consistent with the adopted amendments to Item 201(a). D.   Amendments to Superseded Disclosure Requirements[4] The Commission amended disclosure requirements that were inconsistent with recent legislation and more recently updated U.S. GAAP and Commission disclosure requirements.  In addition to updating references to auditing standards in numerous rules and Commission forms and eliminating non-existent or incorrect references and typographical errors, the Final Rules include several substantive changes with both generally applicable and industry-specific effects in light of changes to U.S. GAAP requirements, including the following: Sale of REIT Property.  The Commission eliminated the requirement that REITs present separately all gains and losses on the sale of properties outside of continuing operations (Rule 3-15(a)(1) of Regulation S-X), insofar as U.S. GAAP rules require only the presentation of gains and losses on the disposal of “discontinued operations.” Insurance Companies.  The Final Rules include changes applicable to Insurance Company issuers. The Commission removed elements of disclosure requirements regarding reinsurance recoverable on paid losses and the reporting of separate account assets (Rules 7-03(a)(6) and 7-03(a)(11) of Regulation S-X) that conflict with U.S. GAAP. Consolidated and Combined Financial Statements.  The Final Rules include several changes to Regulation S-X related to the presentation of consolidated and combined financial statements in order to reflect changes to U.S. GAAP. Specifically, the Commission corrected for numerous inconsistencies with respect to Differences in Fiscal Periods (Rule 3A-02 of Regulation S-X), the Bank Holding Act of 1956 (Rule 3A-02 of Regulation S-X), Intercompany Transactions (Rules 3A-04 and 4-08 of Regulation S-X) and Dividends Per Share in Interim Financial Statements (Rules 3-04, 8-03, and 10-01 of Regulation S-X). E.   Deletion of Redundant or Duplicative Requirements[5] The Commission deleted all duplicative requirements identified in the Proposed Rules, primarily under Regulation S-X, that require substantially similar disclosure as required under U.S. GAAP, IFRS, or other Commission requirements (with the exception of the requirements in Rule 3-20 of Regulation S-X related to the foreign currency disclosure in the financial statements of foreign private issuers).  These minor amendments deleted duplicative language covering a wide variety of disclosure topics, including the following: Consolidation. The Commission deleted Rule 4-08(a) of Regulation S-X requiring compliance with Article 3A (duplicative of Article 3A), Rule 3A-01 of Regulation S-X stating the subject matter of Article 3A (duplicative of Article 3A), language in Rule 3A-02(b)(1) of Regulation S-X permitting consolidation of an entity’s financial statements for its fiscal period if the period does not differ from that of the issuer by more than 93 days (duplicative of ASC 810-10-45-12), language in Rule 3A-02(d) of Regulation S-X requiring consideration of the propriety of consolidation under certain restrictions (duplicative of ASC 810-10-15-10), language in Rule 3A-02 and 3A-03(a) of Regulation S-X requiring disclosure of the accounting policies followed in consolidation or combination (duplicative of ASC 235-10-50-1 and ASC 810-10-50), and language in  Rule 3A-04 of Regulation S-X requiring the elimination of intercompany transactions (duplicative of ASC 323-10-35-5a and ASC 810-10-45). Income Tax Disclosure. The Commission deleted language in Rule 4-08(f) of Regulation S-X requiring income tax rate reconciliation (duplicative of ASC 740-10-50-12) and language in Rule 4-08(h)(2) of Regulation S-X permitting income tax rate reconciliation to be presented in either percentages or dollars (duplicative of ASC 740-10-50-12). Earnings Per Share. The Commission deleted language in Rule 10-01(b)(2) of Regulation S-X requiring presentation of earnings per share on interim income statement (duplicative of ASC 270-10-50-1b) and Item 601(b)(11) of Regulation S-K and Instruction 6 to “Instructions as to Exhibits” of Form 20-F requiring disclosure of the computation of earnings per share in annual filings (duplicative of ASC 260-10-50-1a, Rule 10-01(b)(2) of Regulation S-X, and IAS 33, paragraph 70). Interim Financial Statements. The Commission deleted Rule 10-01(b)(5) of Regulation S-X requiring  disclosure of the effect of discontinued operations on interim revenues, net income, and earnings per share for all periods presented (duplicative of ASC 205-20-50-5B, ASC 205-20-50-5C, ASC 260-10- 45-3, and ASC 270-10-50-7) and language in Rule 10-01(b)(3) of Regulation SX requiring that common control transactions be reflected in current and prior comparative periods’ interim financial statements (duplicative of ASC 805-50-45-1 to 5). Bank Holding Companies. The Commission deleted Rule 9-03.6(a) of Regulation S-X requiring disclosure of the carrying and market values of securities of the U.S. Treasury and other U.S. Government agencies and corporations, securities of states of the U.S. and political subdivisions, and other securities (duplicative of ASC 320-10-50-1B, ASC 320-10-50-2, ASC 320-10-50-5, and ASC 942-320-50-2), Rule 9-03.7(d) of Regulation S-X requiring  disclosure of changes in the allowance for loan losses (duplicative of ASC 310-10-50-11B(c)), and language in Rule 9-04.13(h) of Regulation S-X requiring disclosure of the method followed in determining the cost of investment securities sold (duplicative of ASC 235-10-50-1 and ASC 320-10-50-9b). II.   Summary of Proposed Rules Not Adopted A.   Retained Requirements The Commission originally proposed to delete the following overlapping disclosure requirements, but instead chose to retain the requirements without amendment: Pro-Forma Dispositions.  The Commission retained the requirement under Rule 8-03(b)(4) of Regulation S-X to present pro forma financial information regarding business dispositions. This decision was in response to commenter concerns that the disclosure would not be sufficiently substituted by Regulation S-K, because Item 9.01 of Form 8-K only references significant acquisitions rather than dispositions.  The Commission determined that the issue warranted additional analysis and consideration and opted not to amend the requirement. Seasonality.  The requirement to discuss seasonality under Item 101(c)(1)(v) of Regulation S-K was retained without amendment. This decision was in response to concerns about the potential loss of information in the fourth quarter about the extent to which an issuer’s business is seasonal because U.S. GAAP may not elicit this disclosure. Legal Proceedings.  The Commission declined to adopt amendments to the legal proceedings disclosure required under Item 103 of Regulation S-K or to refer the disclosure requirements under Item 103 to the FASB for potential incorporation into U.S. GAAP.  The Commission cited several differences between the Regulation S-K requirement and its parallel requirement under U.S. GAAP, and emphasized that integration could have broad implications such as expanding costly audit reviews and increasing the disclosure of immaterial items. Mutual Life Insurance Companies. The Commission did not adopt the proposed change to Rule 7-02(b) of Regulation S-X, which would have eliminated the ability of mutual life insurance companies to prepare financial statements in accordance with statutory accounting requirements. B.   Potential Changes Referred to FASB For Prompt Review The Commission originally proposed to delete the following overlapping disclosure requirements, but instead opted to retain these requirements and refer them to the Financial Accounting Standards Board (“FASB”), with a request that FASB complete its review within 18 months of the publication of the Final Rules in the Federal Register: Repurchase and Reverse Repurchase Agreements.  The Commission retained  the Regulation S-X disclosure requirements related to repurchase and reverse repurchase agreements (such as the separate presentation of repurchase liabilities on the balance sheet).  The Commission emphasized that several commenters had expressed concern that deletion of this requirement would eliminate disclosures that are material and not otherwise available to investors in the repo market. Equity Compensation Plans.  The Commission also retained the requirement under Item 201(d) of Regulation S-K to discuss securities authorized under equity compensation plans in an information table, noting commenter concerns that U.S. GAAP does not require certain information, such as the number of securities available for issuance under an equity compensation plan, which may be material to investors. C.   Retained Requirements Referred to FASB for Potential Review For disclosure requirements that overlapped with, but required information incremental to, U.S. GAAP, the Commission elected to solicit further comment before determining whether to retain, modify, eliminate, or refer them to FASB for potential incorporation into U.S. GAAP.[6]  In the Final Rules, the Commission generally retained and referred such requirements to FASB to be considered in its normal standard-setting process.  For example: Major Customers.  The Commission retained the requirement to discuss major customers under Item 101(c)(1)(vii) of Regulation S-K despite it being substantially similar to U.S. GAAP requirements, because Regulation S-K (unlike U.S. GAAP) contains an incremental requirement to disclose the name of a major customer in certain instances.  The Commission referred this particular requirement to FASB because it continues to believe the identity of major customers represents material information to investors and allows investors to better assess the risks associated with a particular customer. Revenue from Products and Services.  While Regulation S-K and U.S. GAAP both require the disclosure of the amount of revenue from products and services, Item 101(c)(1)(i) of Regulation S-K only requires this information if a certain threshold is met, while U.S. GAAP includes a “practicability” exception.  Accordingly, the Commission retained and referred the Regulation S-K requirement to FASB for potential incorporation into U.S. GAAP. Conclusion The amendments contained in the Final Rules are highly technical and are explicitly intended to avoid any substantive changes to the “total mix of information provided to investors.” Nonetheless, these changes should reduce the cost and time of issuer compliance both by eliminating specific outdated and superfluous disclosure requirements and by reducing the overall number of rules to consider. In the short term, issuers and registrants will need to revise their disclosure practices and compliance checklists in light of the amendments before filing a registration statement or periodic report following effectiveness of the Final Rules. Furthermore, issuers should expect additional changes in the future as part of the Commission’s ongoing efforts to clean up and modernize disclosure requirements in connection with its Disclosure Effectiveness Initiative.    [1]   For a complete discussion on final adoptions for overlapping disclosure requirements proposed to be deleted, see page 37 of the Final Rules.    [2]   Additionally, the Commission eliminated Rule 3-03(e) of Regulation S-X as suggested by a commenter (which was not in the Proposed Rules), because it is likewise redundant with U.S. GAAP (see page 71 of the Final Rules).    [3]   A complete discussion of adopted amendments for outdated disclosure requirements begins on page 100 of the Final Rules.    [4]   A complete discussion of adopted amendments for superseded disclosure requirements begins on page 108 of the Final Rules.    [5]   A complete discussion of adopted amendments for redundant or duplicative disclosure requirements begins on page 28 of the Final Rules.    [6]   For a complete discussion on overlapping disclosure requirements where the Commission solicited comments see page 83 of the Final Rules. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Capital Markets or Securities Regulation and Corporate Governance practice groups, or the authors: Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com) Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) James J. Moloney – Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com) Michael Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com) Michael A. Mencher – New York (+1 212-351-5309, mmencher@gibsondunn.com) Maya J. Hoard – Orange County, CA (+1 949-451-4046, mhoard@gibsondunn.com) Please also feel free to contact any of the following practice leaders: Capital Markets Group: Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com) Peter W. Wardle – Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com) Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com) Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com) J. Alan Bannister – New York (+1 212-351-2310, abannister@gibsondunn.com) Securities Regulation and Corporate Governance Group: Elizabeth Ising – Co-Chair, Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com) James J. Moloney – Co-Chair, Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com) Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com) © 2018 Gibson, Dunn &amp Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

August 17, 2018 |
Miguel Estrada and Robert Weigel Named Litigators of the Week

The Am Law Litigation Daily named Washington, D.C. partner Miguel Estrada and New York partner Robert Weigel as “Litigators of the Week” [PDF] for obtaining a significant victory for client Crystallex International Corporation that holds a $1.4 billion judgment against Venezuela.  The profile was published on August 17, 2018.

August 13, 2018 |
Wayne Barsky and James Zelenay Named Top Litigators in Los Angeles

Century City partner Wayne Barsky and Los Angeles partner James Zelenay were named to Los Angeles Business Journal’s list of Top Litigators in Los Angeles. The list highlights “50 of the very best litigators in the business” who “go to the proverbial mat to fight for their clients.”  The list was published on August 13, 2018.

August 6, 2018 |
SEC Proposes Streamlined Financial Disclosures for Certain Guaranteed Debt Securities and Affiliates Whose Securities Are Pledged to Secure a Series of Debt Securities

Click for PDF On July 24, 2018, the Securities and Exchange Commission (the “Commission”) proposed amendments to Rules 3-10 and 3-16 of Regulation S-X (available here) (the “Proposal”) in an effort to “simplify and streamline” the financial disclosures required in offerings of certain guaranteed debt and debt-like securities (collectively referred to as “debt securities”), as well as offerings of securities collateralized by securities of an affiliate of the registrant, registered under the Securities Act of 1933, as amended (the “Securities Act”). These proposed changes would, if implemented, facilitate greater speed to market for such public offerings, significantly reducing the Securities Act disclosure burdens for such registrants, as well as reducing the registrant’s disclosure obligations in its subsequent annual and interim reports required under Securities Exchange Act of 1934, as amended (the “Exchange Act”). Background Current Alternative Disclosure Regime for Certain Guaranteed Debt Securities.  For purposes of the Securities Act and the Exchange Act, guarantees of securities are deemed separate securities from the underlying security that is guaranteed.  As a result, absent a regulatory exception or exemption, a prospectus prepared for a public offering of guaranteed debt securities registered under the Securities Act is required to include the full separate financial statements of (and disclosure regarding) each guarantor (in addition to those of the issuer of the guaranteed debt security) in the form and for the periods required for registrants under Regulation S-X, and each such guarantor (like the issuer of the guaranteed debt security) is also required to be registered under the Exchange Act and thereafter file annual and interim reports under that Act just as any other registrant.  Recognizing the substantial burdens of such disclosures that would otherwise be imposed in connection with registered public offerings of certain guaranteed debt securities involving parent companies and their wholly-owned subsidiaries, much of which would be duplicative, the SEC has embraced exceptions (as currently set out in Regulation S-X Rule 3-10 (“S-X 3-10”)) to instead permit the parent company in a qualifying offering of such guaranteed debt securities to file only its consolidated financial statements, together with certain condensed consolidating financial information (“Consolidating Financial Information”) intended to allow investors to distinguish between the obligor and non-obligor components of the consolidated group of companies represented in the parent’s consolidated financial statements.  S-X 3-10 also requires the registrant to include specified textual disclosure, where applicable,  about the limited nature of the assets and operations of the issuer, guarantor(s) or non-guaranteeing subsidiaries, as the case may be, and describing any material limitations on the ability of the parent or any guarantor to obtain funds (whether by dividend, loan or otherwise) from its subsidiaries and any other relevant limitations on any subsidiary’s use of its fund (together with the Consolidating Financial Information, the “Alternative Disclosure”).  The Alternative Disclosure is required to be included in a note to the parent’s consolidated audited financial statements and must cover the same periods for which the parent is required to include its consolidated financial statements.  The parent company is required to include the Alternative Disclosure in its annual and quarterly Exchange Act reports filed after the guaranteed debt securities are issued and to continue to do so as long as the securities remain outstanding, even for periods in which the issuer(s) and guarantors have no Exchange Act reporting obligation with respect to such securities.  In addition, for certain significant recently-acquired subsidiary guarantors, S-X 3-10 currently requires that the registration statement for the offering include the separate audited financial statements for such subsidiaries’ most recent fiscal year and unaudited financial statements for any interim period for which the parent is required to include its interim financial statements. Pursuant to Rule 12h-5, each guarantor or issuer subsidiary in any such qualifying transaction is exempt from the separate ongoing Exchange Act reporting obligations otherwise applicable to a registrant. Notwithstanding the advantages offered by the exception provided by S-X 3-10, the conditions to the current regulation, including that the subsidiaries be 100% owned by the parent and that all guarantees be full and unconditional, the often time-consuming process of producing and auditing the Consolidating Financial Information, as well as the requirement that the parent continue to include the Alternative Disclosure for as long as any of the guaranteed debt securities remain outstanding, have limited the range of subsidiaries that are used as guarantors, delayed offerings and/or led to reliance on Rule 144A for life offer structures for some guaranteed debt offerings to avoid registration. Current Disclosure Requirements for Securities Collateralized by Affiliate Securities.  Current Regulation S-X Rule 3-16 (“S-X 3-16”) requires a registrant to provide separate audited annual financial statements, as well as unaudited interim financial statements, for each affiliate whose securities constitute a “substantial portion”[1] of the collateral pledged for such registrant’s registered securities as though such affiliate were itself a registrant, and thereafter file annual and interim reports under the Exchange Act for such affiliate.  The production of the financial statements required by S-X 3-16 is often time consuming and costly to the issuer and the requirement is triggered entirely by the outcome of the substantial portion test, without regard to the comparative importance of the relevant affiliate to the registrant’s business and operations as a whole or the materiality of such financial statements to an investment decision.  To avoid the burden of preparing separate full financial statements for each affiliate whose securities are pledged as collateral, issuers often reduce collateral packages or structure collateralized securities as unregistered offerings.  Additionally, debt agreements are sometimes structured to specifically release collateral if and when such collateral may trigger the S-X 3-16 financial statement requirements. Proposed Amendments In the SEC’s effort to streamline the disclosure requirements in connection with certain guaranteed debt securities offered and sold in public offerings registered under the Securities Act, as well as simplify the current number of myriad offer structures entitled to disclosure relief, the amendments proposed to S-X 3-10 would: replace the current detailed list of offer structures permitted relief under S-X 3-10 with a more simple requirement that the debt securities be either: issued by the parent or co-issued by the parent, jointly and severally, with one or more of its consolidated subsidiaries; or issued by a consolidated subsidiary of the parent (or co-issued with one or more other consolidated subsidiaries of the parent) and fully and unconditionally guaranteed by the parent; replace the condition currently included in S-X 3-10 that a subsidiary issuer or guarantor be 100% owned by the parent company, requiring instead that the subsidiary merely be consolidated in the parent company’s consolidated financial statements in accordance with U.S. GAAP or, in the case of foreign private issuer, IFRS (as promulgated by the IASB).  As a result, in addition to 100% owned subsidiaries, controlled subsidiaries and joint ventures which are consolidated in the parent’s financial consolidated financial statements could be added as issuers or guarantors in such offerings and take advantage of the reduced disclosure permitted under the Proposal, provided the other conditions of the revised regulation are met; modify the requirement that all guarantees be full and unconditional, requiring only that the parent guarantee (in the case of a subsidiary issuer) be full and unconditional.  The proposal would thereby allow greater flexibility with the extent and nature of guarantees to be given by subsidiary guarantors, provided the terms and limitations of such guarantees are adequately disclosed; eliminate the Consolidating Financial Information currently required to be included in the registration statement and the parent’s Exchange Act annual and (where applicable) quarterly reports under S-X 3-10, and, in lieu thereof, add a new Rule 13-01 of Regulation S-X requiring such parent companies to include (i) certain summary financial information (the “Summary Financial Information”) for the parent and guarantors (the “Obligor Group”) on a combined basis (after eliminating intercompany transactions among members of this Obligor Group), and (ii) certain non-financial disclosures, including expanded qualitative disclosures about the guarantees and factors which could limit recovery thereunder, and any other quantitative or qualitative information that would be material to making an investment decision about the guaranteed debt securities (the Summary Financial Information and such non-financial disclosures, the “Proposed Alternative Disclosure”); require that the Summary Financial Information conform to the current provisions of Regulation S-X Rule 1-02(bb) and include summarized information as to the assets, liabilities and results of operations of the Obligor Group only; reduce the periods for which the Summary Financial Information must be provided, requiring such information for only the most recent fiscal year and any interim period for which consolidated financial statements of the parent are otherwise required to be included; permit the parent flexibility as to the location of the Summary Financial Information and other Proposed Alternative Disclosures, including in the notes to it consolidated financial statements, in the “management’s discussion and analysis of financial condition and results of operations” or immediately following “risk factors” (if any”) or the pricing information in the Securities Act registration statement and related prospectus and in Exchange Act reports on Forms 10-K, 20-F and 10-Q required to be filed during the fiscal year in which the first bona fide sale of the guaranteed debt securities is completed.  By permitting such flexibility, the parent issuers may realize greater speed to market for such offering as the Summary Financial Information would not be required to be audited if located outside the notes to its consolidated financial statements; by allowing a parent company the option to exclude the Summary Financial Information from the notes to its audited financial statements, such parent may realize greater speed to market for such offerings as the Summary Financial Information would not be required to be audited as part of the offer process; such Summary Financial Information would, however, be required to be included in a footnote to the parent’s annual and (where applicable) quarterly reports (and thus audited), beginning with its annual report filed on Form 10-K or 20-F for the fiscal year during which the first bona fide sale of the guaranteed debt securities is completed.  Thus, for example, for guaranteed debt securities issued in the second quarter of fiscal 2018, the Summary Financial Information would first be required to be included in the notes to the parent’s financial statements filed in its annual report filed on Form 10-K for its fiscal year 2019; eliminate the current requirement that, for so long as the guaranteed debt securities remain outstanding, a parent company continue to include the Consolidating Financial Information within its annual and interim reports (including for periods in which the Obligor Group is not then  subject to the reporting requirements of the Exchange Act).  Under the Proposal, the Summary Financial Information and other Proposed Alternative Disclosures would not be required to be included in the parent’s annual and quarterly reports for such periods in which the Obligor Group is not then subject to the reporting requirements of the Exchange Act.  Nonetheless, some parent companies with an Obligor Group that issues guaranteed debt securities on a regular basis may elect to continue to prepare and include the Revised Alternative Disclosure in its Exchange Act reports to ensure a more rapid access to the market for future transactions; and eliminate, with respect to recently-acquired subsidiary guarantors or issuers, the current requirement under S-X 3-10 that the parent include in the registration statement for the offering separate audited financial statements for the most recent fiscal year of the recently-acquired subsidiary (as well as separate unaudited interim financial statements for any relevant interim periods).  Note, however, that other provisions of Regulation S-X regarding the impact of recent material acquisitions and the potential requirement thereunder to include separate financial statements of the acquired entity (and, in some cases, pro forma consolidated financial information regarding the acquisition) remain unchanged by the Proposal. The proposed amendments to S-X 3-16 would: replace the existing requirement to provide separate financial statements for each affiliate whose securities are pledged as collateral with a requirement to include the Summary Financial Information and any additional non-financial information material to investment decisions about the affiliate(s) (if more than one affiliate, such information could be provided on a combined basis) and the collateral arrangement(s).  The elimination of the requirement to include the affiliate’s separate audited financial statements would significantly decrease the cost and burden of an offering secured by the securities of an affiliate of the registrant; permit the proposed financial and non-financial affiliate disclosures to be located in filings in the same manner (and for reports for the same corresponding periods) as described above for the disclosures related to guarantors and guaranteed securities, which would bring the level and type of disclosure for collateralized securities in line with other forms of credit enhancement; and replace the requirement to provide disclosure only when the pledged securities meet or exceed a numerical threshold relative to the securities registered or being registered with a requirement to provide the applicable disclosures in all cases, unless they are immaterial to holders of the collateralized security, which would replace the arbitrary numerical cutoff with a consideration of materiality to investors. Set forth below, we summarizing the current requirements, and proposed changes to such requirements, for the use of abbreviated disclosure for subsidiary issuer/guarantors of certain guaranteed debt securities and for issuers of securities collateralized by securities of affiliates. Guaranteed Debt Securities:  Summary of Current Requirements for Abbreviated Disclosure and Proposed Revisions Current Provisions of S-X 3-10: Proposed Provisions: Offer Structures Permitted Disclosure Relief Finance subsidiary issuer of debt securities guaranteed by  parent; Operating subsidiary issuer of debt securities guaranteed by parent; Subsidiary issuer of debt securities guaranteed by  parent and one or more other subsidiaries; Single subsidiary guarantor of debt securities issued by parent; or Multiple subsidiary guarantors of debt securities issued by parent Debt securities: Issued by parent or co-issued by parent, jointly and severally, with one or more of its consolidated subsidiaries; or Issued by a consolidated subsidiary of parent (or co-issued with one or more other consolidated subsidiaries) and fully and unconditionally guaranteed by parent Conditions to Relief Each subsidiary issuer or guarantor must be 100% owned by parent; and All guarantees must be full and unconditional Subsidiary issuer/guarantors must be consolidated in the parent’s consolidated financial statements Only the parent guarantee, if any, must be full and unconditional Alternative Disclosure Condensed Consolidating Financial  Information, and certain textual disclosure Summary Financial Information for Obligor Group on a combined basis (after eliminating transactions between Obligors) and certain textual disclosure Periods for which Disclosure Required in Registration Statement For each year and any interim periods for which parent is required to include financial statements The most recent fiscal year and any interim period for which the parent is required to include financial statements Locations of Disclosure The Alternative Disclosure must be included in the notes to the parent’s audited consolidated financial statements (and in its unaudited interim financial statements where such financial statements are required to be included) In the Registration Statement and in Exchange Act reports filed during the fiscal year in which the debt securities are first bona fide offered to the public, the parent has the choice of including them in the notes to its consolidated financial statements or elsewhere, including within “management’s discussion and analysis of financial condition and results of operations” or immediately following “risk factors” For the parent’s annual report for the fiscal year in which the debt securities were first offered to the public, and all Exchange Act reports required to be filed thereafter, the Proposed Alternative Disclosures must be included in the notes to the parent’s consolidated financial statements How Long is Exchange Act Disclosure Required For so long as any of the debt securities remain outstanding Only for periods in which the Obligors are required to file Exchange Act reports in respect of the debt securities Additional Requirements For Recently Acquired Subsidiary Guarantor/Issuers Parent must include separate audited financial statements of the recently acquired subsidiary issuer/guarantor for the most recent fiscal and any interim period for which the parent is required to include financial statements No separate financial statements of a recently acquired subsidiary issuer/guarantor is required for relief under the Proposal Summary of Current Disclosure Requirements for Securities Collateralized by Securities of Affiliates and the Proposed Revisions Current Provisions of S-X 3-16: Proposed Provisions: Offer Structure Triggering Disclosure Requirement Securities issued by a registrant and collateralized with the securities of its affiliates where such collateral constitutes a “substantial portion” of the collateral for any class of securities Securities issued by a registrant and collateralized with the securities of its affiliates, unless such collateral is immaterial to making an investment decision about the registrant’s securities Additional Disclosure Required If the pledged securities of an affiliate constitute a “substantial portion” of the collateral for the secured class of securities, separate audited annual financial statements, as well as unaudited interim financial statements, for such affiliate as though such affiliate were itself a registrant Summary Financial Information with respect to any affiliate whose securities are pledged to secure a class of securities, and any additional non-financial information material to investment decisions about the affiliate(s) and the collateral arrangement Basis of Presentation Separate financial statements for each affiliate whose securities constitute a “substantial portion” of the collateral Summary Financial Information of affiliates consolidated in the registrant’s financial statements can be presented on combined basis If information is applicable to a subset of affiliates (but not all) separate Summary Financial Information required for such affiliates Periods for which Disclosure Required in Registration Statement For each year and any interim period as if affiliate were a registrant The most recent fiscal year and any interim period for which the registrant is required to include consolidated financial statements Locations of Disclosure Separate financial statements required to be included in the registration statement in the registrant’s annual report on Form 10-K or 20-F Disclosure not required in quarterly reports of the registrant In the Registration Statement and in Exchange Act reports filed during the fiscal year in which the first bona fide sale is completed, the registrant has the choice of including them in the notes to its consolidated financial statements or elsewhere, including within “management’s discussion and analysis of financial condition and results of operations” or immediately following “risk factors” For the registrant’s annual report for the fiscal year in which the first sale was completed, and all Exchange Act reports required to be filed thereafter, the required information must be included in the notes to the registrant’s consolidated financial statements   The SEC is seeking public comments on its proposal for a period of 60 days from July 24, 2018. Comments can be submitted on the internet at http://www.sec.gov/rules/other.shtml; via email to  rule-comments@sec.gov (File Number S7-19-18 should be included on the subject line); or via mail to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090.    [1]   E.g., if the aggregate principal amount, par value or book value of the pledged securities as carried by the issuer of the collateralized securities, or market value, equals 20% or more of the aggregate principal amount of the secured class of securities offered. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Capital Markets or Securities Regulation and Corporate Governance practice groups, or the authors: J. Alan Bannister – New York (+1 212-351-2310, abannister@gibsondunn.com) Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com) Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com) Alina E. Iarve – New York (+1 212-351-2406, aiarve@gibsondunn.com) Michael J. Scanlon – Washington, D.C. (+1 202-887-3668, mscanlon@gibsondunn.com) Peter W. Wardle – Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

August 2, 2018 |
EPA & NHTSA Issue SAFE Vehicles Rule, Proposing Changes to Vehicle GHG Limits and Revocation of California Waiver

Click for PDF On August 2, 2018, the U.S. Environmental Protection Agency (EPA) and the National Highway Traffic Safety Administration (NHTSA) issued a notice of proposed rulemaking (NPRM), the Safer Affordable Fuel-Efficient (SAFE) Vehicles Rule for Model Years 2021–2026 Passenger Cars and Light Trucks (SAFE Vehicles Rule), relating to the national automobile fuel economy and greenhouse gas (GHG) emissions standards set by EPA for cars and light-duty trucks.[1] The proposed SAFE Vehicles Rule is the expected next step in the Trump Administration’s efforts to reevaluate fuel economy and emissions standards set by the Obama Administration.  In 2012, the Obama Administration set GHG and fuel economy standards for passenger cars and light-duty trucks for model years 2017 to 2025, but EPA and NHTSA committed in that rulemaking to “a comprehensive midterm evaluation and agency decision-making process for the MYs 2022–2025 standards.”[2]  This “midterm evaluation” was to be completed by April 1, 2018.[3] On December 6, 2016, the Obama EPA published a “proposed determination,” finding that the standards set in the October 2012 rule should remain in place,[4] and on January 12, 2017, the agency issued a final determination to that effect.[5]  In March 2017, the Trump EPA announced its intention to reconsider that final determination.[6]  And in April 2018, the agency formally withdrew the Obama Administration’s January 2017 final determination and announced that it would initiate a notice and comment rulemaking to evaluate the appropriate standards for MYs 2022–2025.[7] The SAFE Vehicles Rule is the first step in the rulemaking process to evaluate the appropriate future GHG emissions and fuel economy standards for light-duty vehicles.  The proposed rulemaking includes several important developments of interest for the automotive industry: The proposed rulemaking includes several alternative regulatory proposals for fuel economy and tailpipe carbon dioxide (CO2) standards that would be applicable to vehicles sold in MYs 2021 to 2026. The alternative preferred by EPA and NHTSA would freeze fuel economy and CO2 standards at MY 2020 levels for MYs 2021 through 2026. The agencies are inviting comments on seven other options presented in the NPRM.  These options include maintaining the regulatory plan promulgated under the Obama Administration, or implementing increasingly stringent fuel economy and CO2 requirements at varying rates between MYs 2020 and 2026. EPA and NHTSA are also seeking comment on the compliance flexibilities associated with the fuel economy and CO2 programs, including whether to require some level of public disclosure for credit trading, or whether to eliminate credit trading in the CAFE program altogether. EPA is proposing to change CO2 targets after MY 2021 to remove the adjustments related to refrigerant and the offsets for nitrous oxide and methane emissions.  In practice, this would increase the applicable threshold for CO2 requirements for MYs 2020 and 2021. The NPRM also proposes to create a single 50-state standard for GHG emissions.  This would be accomplished by withdrawing California’s waiver of preemption under the Clean Air Act for the GHG and Zero Emissions Vehicle (ZEV) requirements of California’s Advanced Clean Cars program. California does not have authority to regulate fuel economy directly, as the Energy Policy and Conservation Act of 1975 (EPCA), as amended by the Energy Independence and Security Act of 2007 (EISA), preempts state standards relating to fuel economy.[8] The SAFE Vehicles Rule will be published in the Federal Register in the coming weeks, and will be open for public comment for a period of 60 days after publication.  In addition, EPA and NHTSA will hold three public hearings on the rule in Washington, DC, Detroit, MI, and Los Angeles, CA.  The dates for these hearings will be announced in a forthcoming notice in the Federal Register. If the agencies’ preferred proposals are adopted and the rule becomes final, it is virtually certain that the revised standards and the withdrawal of California’s waiver authority will be challenged in court by California and other states, and by the environmental community.    [1]   The official version of the SAFE Vehicles Rule will be published in the Federal Register in the coming weeks.  Until it is published, the proposed rule is available at https://www.epa.gov/sites/production/files/2018-08/documents/safe-my-2021-2026-cafe-ld-ghg-nhtsa-epa-nprm-2018-08-02.pdf.    [2]   2017 and Later Model Year Light-Duty Vehicle Greenhouse Gas Emissions and Corporate Average Fuel Economy Standards, 77 Fed. Reg. 62,624, 62,628 (Oct. 15, 2012).    [3]   Id. at 62,784.    [4]   Proposed Determination on the Appropriateness of the Model Year 2022–2025 Light-Duty Vehicle Greenhouse Gas Emissions Standards Under the Midterm Evaluation, 81 Fed. Reg. 87,927 (Dec. 6, 2016).    [5]   Final Determination on the Appropriateness of the Model Year 2022-2025 Light-Duty Vehicle Greenhouse Gas Emissions Standards Under the Midterm Evaluation (Jan. 12, 2017), available at https://nepis.epa.gov/Exe/ZyPDF.cgi?Dockey=P100QQ91.pdf.    [6]   Notice of Intention to Reconsider the Final Determination of the Mid-Term Evaluation of Greenhouse Gas Emissions Standards for Model Year 2022–2025 Light Duty Vehicles, 82 Fed. Reg. 14,671 (Mar. 22, 2017).    [7]   Mid-Term Evaluation of Greenhouse Gas Emissions Standards for Model Year 2022–2025 Light-Duty Vehicles, 83 Fed. Reg. 16,077 (Apr. 13, 2018).  Gibson Dunn is currently representing the Association of Global Automakers as movant-intervenors before the Court of Appeals for the District of Columbia Circuit in California v. EPA, No. 18-1114, California’s challenge to the withdrawal of the January 2017 final determination.    [8]   From 2006 to 2008, Gibson Dunn represented the Association of Global Automakers in litigation regarding the EPCA preemption of GHG motor vehicle emissions standards adopted by several states. The following Gibson Dunn lawyers assisted in the preparation of this client alert: Ray Ludwiszewski, Stacie Fletcher, Rachel Levick Corley and Veronica Till Goodson. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues.  For additional information about this regulatory change and other regulations, or related litigation, please contact the Gibson Dunn lawyer with whom you usually work or the following leaders and members of the firm’s Environmental Litigation and Mass Tort practice group in Washington, D.C.: Avi S. Garbow – Co-Chair (+1 202-955-8558, agarbow@gibsondunn.com) Daniel W. Nelson – Co-Chair (+1 202-887-3687, dnelson@gibsondunn.com) Peter E. Seley – Co-Chair (+1 202-887-3689, pseley@gibsondunn.com) Raymond B. Ludwiszewski (+1 202-955-8665, rludwiszewski@gibsondunn.com) Stacie B. Fletcher (+1 202-887-3627, sfletcher@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP, 333 South Grand Avenue, Los Angeles, CA 90071 Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

August 1, 2018 |
Who’s Who Legal Recognizes Nine Gibson Dunn Partners

Nine Gibson Dunn partners were recognized by Who’s Who Legal in their respective fields. In Who’s Who Legal Corporate Tax 2018, three partners were recognized: Sandy Bhogal (London), Hatef Behnia (Los Angeles) and Eric Sloan (New York). In the 2018 Who’s Who Legal Project Finance guide, two partners were recognized: Michael Darden (Houston) and Tomer Pinkusiewicz (New York). In the Who’s Who Legal Labour, Employment & Benefits 2018 guide, two partners were recognized: William Kilberg (Washington, D.C.) and Eugene Scalia (Washington, D.C.). Two partners were recognized by Who’s Who Legal Patents 2018: Josh Krevitt (New York) and William Rooklidge (Orange County). These guides were published in July and August of 2018.

July 31, 2018 |
EPA Amendments to the Coal Ash Rule

Click on PDF On July 30, 2018, the Environmental Protection Agency (“EPA”) published a final rule amending the national minimum criteria for existing and new landfills and surface impoundments that contain coal combustion residuals (“CCR”), also known as coal ash.[1]  This rule, which directly affects over four hundred coal-fired electricity generating plants nationwide, is the first in a series of anticipated amendments altering regulations promulgated under the Obama Administration to address the disposal of coal ash in landfills and surface impoundments.  This first phase of regulatory changes has three key elements: It adopts two alternative performance standards that either participating state directors or the EPA may apply to owners and operators of CCR units; It revises groundwater protection standards (“GWPS”) for four regulated constituents which do not have an established maximum contaminant level under the Safe Drinking Water Act; and It extends certain deadlines by which facilities must cease the placement of waste in CCR units that are closing. I.   Background and Context Coal ash is produced from the burning of coal in coal-fired power plants.  According to the American Coal Ash Association, approximately 110 million tons of coal ash are generated every year, making it one of the most-generated forms of industrial waste in the United States.  While over one-third of all coal ash produced in the United States is recycled into construction materials, such as concrete or wallboard, a significant amount must be disposed of each year.  Coal ash contains contaminants like mercury, cadmium, and arsenic, which can pose environmental and health risks if not properly managed or disposed of. On April 17, 2015, the Obama Administration promulgated regulations setting federal standards for the disposal of coal ash pursuant to its authority under the Resource Conservation and Recovery Act, notably regulating such waste as a solid waste pursuant to Subtitle D, rather than as a hazardous waste pursuant to Subtitle C.[2]  The regulations addressed the risks associated with disposal, including leaking of contaminants into ground water, blowing into the air as dust, and catastrophic failure of coal ash surface impoundments.  EPA set certain minimum criteria consisting of location restrictions, design and operating criteria, groundwater monitoring and corrective action requirements, closure and post-closure care requirements, and record keeping, notification, and internet posting requirements. It also required unlined CCR surface impoundments contaminating groundwater above certain protection standards to stop receiving wastes and either retrofit or close, except in certain circumstances. Congress subsequently passed the Water Infrastructure for Improvements to the Nation (“WIIN”) Act, signed into law on December 16, 2016, which authorized EPA-approved state permitting programs to regulate coal ash disposal.[3]  Under the WIIN Act’s Section 2301, states may develop and operate their own permitting programs that adhere to, or are at least as protective as, the EPA’s standards.  On June 18, 2018, Oklahoma became the first (and so far only) state to have its permit program approved for the management of coal ash.  The EPA regulates coal ash disposal in states that choose not to implement permitting programs or that have inadequate programs that fail to meet federal standards. II.   Amendments to the 2015 Regulations On September 13, 2017, the EPA granted petitions from certain industry groups requesting reconsideration of certain provisions of the 2015 regulations in light of the WIIN Act and other factors.  EPA announced that it anticipates completing reconsideration of all provisions in two phases:  a first phase, which includes these amendments, to be finalized no later than June 2019, and a second phase to be proposed by September 30, 2018 and finalized by December 2019. The recently signed Amendments constituting phase one, part one, make three major changes to the prior regulations governing coal ash management and disposal.  First, EPA adopted two alternative performance standards that either participating state directors in states with approved CCR permit programs, or EPA where it is the permitting authority, may apply to owners and operators of CCR units:  (1) the suspension of groundwater monitoring requirements if there is evidence that there is no potential for migration of hazardous constituents to the uppermost aquifer during the active life of the unit and post-closure care; and (2) the issuance of technical certifications in lieu of the current requirement to have professional engineers issue certifications. Second, the Amendments revise the GWPSs for the four constituents[4] which do not have established maximum contaminant levels under the Safe Drinking Water Act, in place of the background levels under 40 CFR § 257.95(h)(2).  This revision adopts national criteria as health-based standards available to facilities to use to compare against monitored groundwater concentrations and to develop cleanup goals. Finally, the Amendments extend the deadline for when CCR units closing for cause must initiate closure under two circumstances:  (1) where the facility has detected a statistically significant increase from an unlined surface impoundment above a GWPS; and (2) where the unit is unable to comply with the aquifer location restriction.  With respect to unlined surface impoundments, the Amendments extend the 90-day period in which the owner or operator is to perform the required analysis and demonstrations by 18 months, until October 31, 2020.  With respect to aquifer location restrictions, the revision extends the timeframes during which facilities may continue to use the units by the same period, until October 31, 2020.  The EPA states that this extension allows facilities time to adjust their operations and better coordinate engineering, financial, and permitting activities. Generally speaking, these changes reduce the compliance obligations for facilities managing coal ash surface impoundments and provide increased flexibility in the management of coal ash.  They also grant the industry more time for compliance with the 2015 regulations, addressing concerns about feasibility of compliance within the original deadlines. These regulations are subject to challenge, even as EPA considers additional rulemakings to address other aspects of the 2015 coal ash rule.  In addition, EPA is currently scheduled to propose revisions to the Clean Water Act’s Effluent Limitation Guidelines applicable to steam electric power generators in December 2018, potentially posing added challenges relating to overlapping compliance schedules relevant to the management and disposal of coal ash.  In light of the ongoing complexities of the regulatory landscape, owners or operators of coal ash disposal facilities should evaluate how these proposed changes will impact their operations, costs, and investments.    [1]   See Hazardous and Solid Waste Management System:  Disposal of Coal Combustion Residuals from Electric Utilities; Amendments to the National Minimum Criteria (Phase One, Part One); Final Rule (83 Fed. Reg. 36435, July 30, 2018) (hereinafter, the “Amendments”).    [2]   40 C.F.R. § 257 pt. D.    [3]   Water Infrastructure for Improvements to the Nation Act, Pub. L. No. 114-322, 130 Stat. 1628 (2016).    [4]   These four constituents are cobalt, lithium, molybdenum, and lead. The following Gibson Dunn lawyers assisted in the preparation of this client alert: Avi Garbow and Courtney Aasen. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues.  For additional information about this regulatory change and other regulations affecting the management and disposal of coal ash, or related litigation, please contact the Gibson Dunn lawyer with whom you usually work or the following leaders of the firm’s Environmental Litigation and Mass Tort practice group: Avi S. Garbow (+1 202-955-8558, agarbow@gibsondunn.com) Daniel W. Nelson (+1 202-887-3687, dnelson@gibsondunn.com) Peter E. Seley (+1 202-887-3689, pseley@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 31, 2018 |
Webcast: Strategies Regarding Corporate Veil Piercing and Alter Ego Doctrine

Please join a panel of seasoned Gibson Dunn attorneys for a presentation on how a company can best protect itself against “veil-piercing” claims and “alter ego” liability.  We provide an overview of what it means to “pierce the corporate veil” and the circumstances that have prompted courts to ignore the corporate separateness of entities and impose “alter ego” liability. We also focus on strategies to minimize the risk of facing claims for veil piercing and alter ego liability and maximize your chances for success in connection with any such claims. View Slides [PDF] PANELISTS: Robert A. Klyman is a partner in Gibson Dunn’s Los Angeles office. He is Co-Chair of the Firm’s Business Restructuring and Reorganization practice group. Mr. Klyman represents debtors, acquirers, lenders, ad hoc groups of bondholders and boards of directors in all phases of restructurings and workouts. His experience includes advising debtors in connection with traditional, prepackaged and “pre-negotiated” bankruptcies; representing lenders and bondholders in complex workouts; counseling strategic and financial players who acquire debt or provide financing as a path to take control of companies in bankruptcy; structuring and implementing numerous asset sales through Section 363 of the Bankruptcy Code; and litigating complex bankruptcy and commercial matters arising in chapter 11 cases, both at trial and on appeal. John M. Pollack is a partner in Gibson Dunn’s New York office. He is a member of the Firm’s Mergers and Acquisitions, Private Equity, Aerospace and Related Technologies and National Security practice groups. Mr. Pollack focuses his practice on public and private mergers, acquisitions, divestitures and tender offers, and his clients include private investment funds, publicly-traded companies and privately-held companies. Mr. Pollack has extensive experience working on complex M&A transactions in a wide range of industries, with a particular focus on the aerospace, defense and government contracts industries. Lori Zyskowski is a partner in Gibson Dunn’s New York office. She is Co-Chair of the Firm’s Securities Regulation and Corporate Governance practice group. Ms. Zyskowski advises public companies and their boards of directors on corporate governance matters, securities disclosure and compliance issues, executive compensation practices, and shareholder engagement and activism matters. Ms. Zyskowski advises clients, including public companies and their boards of directors, on corporate governance and securities disclosure matters, with a focus on Securities and Exchange Commission reporting requirements, proxy statements, annual shareholders meetings, director independence issues, and executive compensation disclosure best practices. Ms. Zyskowski also advises on board succession planning and board evaluations and has considerable experience advising nonprofit organizations on governance matters. Sabina Jacobs Margot is an associate in Gibson Dunn’s Los Angeles office. She is a member of the Firm’s Business Restructuring and Reorganization and Global Finance practice groups. Ms. Jacobs Margot practices in all aspects of corporate reorganization and handles a wide range of bankruptcy and restructuring matters, representing debtors, lenders, equity holders, and strategic buyers in chapter 11 cases, sales and acquisitions, bankruptcy litigation, and financing transactions. Ms. Jacobs Margot also represents borrowers, sponsors, and lending institutions in connection with acquisition financings, secured and unsecured credit facilities, asset-based loans, and debt restructurings. MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. This program has been approved for credit in accordance with the requirements of the Texas State Bar for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the area of accredited general requirement. Attorneys seeking Texas credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.0 hour. California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.