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June 21, 2018 |
Supreme Court Rules That SEC ALJs Were Unconstitutionally Appointed

Click for PDF Lucia v. SEC, No. 17-130  Decided June 21, 2018 Today, the Supreme Court held that administrative law judges of the Securities and Exchange Commission are inferior “Officers of the United States” within the meaning of the Constitution’s Appointments Clause.  Thus, the ALJs were unconstitutionally appointed by SEC staff. Background: The SEC has relied on ALJs to resolve hundreds of enforcement actions.  Raymond Lucia challenged the lawfulness of sanctions that the SEC had imposed on him, arguing that the ALJ hearing his case was not constitutionally appointed.  He asserted that SEC ALJs are “Officers of the United States” under the Constitution’s Appointments Clause, which requires such officers to be appointed by the President, “Courts of Law,” or “Heads of Departments.” SEC ALJs, however, were appointed by agency staff.  A panel of the D.C. Circuit held that the ALJs are mere “employees”—governmental officials with lesser responsibilities than “Officers” and thus not subject to the Appointments Clause.  An evenly divided en banc court affirmed. Issue: Whether SEC ALJs are “Officers of the United States” subject to the Appointments Clause. Court’s Holding: Yes.  Because SEC ALJs exercise “significant authority pursuant to the laws of the United States,” they are inferior “Officers” under the Appointments Clause.  As such, the ALJs may not be appointed by agency staff and must instead be appointed by the President, the SEC itself, or a court of law. “[T]he Commission’s ALJs issue decisions containing factual findings, legal conclusions, and appropriate remedies. . . . And when the SEC declines review (and issues an order saying so), the ALJ’s decision itself ‘becomes final’ and is ‘deemed the action of the Commission.’” Justice Kagan, writing for the Court Gibson Dunn represented the winning party:  Raymond Lucia What It Means: The ruling largely rests on the Court’s conclusion that SEC ALJs are “near-carbon copies” of special trial judges of the Tax Court that the Court had previously found were inferior “Officers” because they exercise “significant authority.”  See Freytag v. Commissioner, 501 U.S. 868 (1991). The ruling provides new guidance on the relief available for litigants who make a timely Appointments Clause challenge:  The Court ordered the SEC to provide Mr. Lucia a new hearing before a different ALJ who has been constitutionally appointed, reasoning that the ALJ who originally presided over Mr. Lucia’s case could not be expected to consider the case “as though he had not adjudicated it before.” Before the Court issued its decision, the SEC released an order purporting to “ratify” the past ALJ appointments, but the Court did not address the validity of that order.   Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court.  Please feel free to contact the following practice leaders: Appellate and Constitutional Law Practice Caitlin J. Halligan +1 212.351.3909 challigan@gibsondunn.com Mark A. Perry +1 202.887.3667 mperry@gibsondunn.com Nicole A. Saharsky +1 202.887.3669 nsaharsky@gibsondunn.com Related Practice: Securities Litigation Brian M. Lutz +1 415.393.8379 blutz@gibsondunn.com Robert F. Serio +1 212.351.3917 rserio@gibsondunn.com Meryl L. Young +1 949.451.4229 myoung@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.

June 20, 2018 |
Acting Associate AG Panuccio Highlights DOJ’s False Claims Act Enforcement Reform Efforts

Click for PDF On June 14, 2018, Acting Associate Attorney General Jesse Panuccio gave remarks highlighting recent enforcement activity and policy initiatives by the Department of Justice (“DOJ”).  The remarks, delivered at the American Bar Association’s 12th National Institute on the Civil False Claims Act and Qui Tam Enforcement, included extensive commentary about DOJ’s ongoing efforts to introduce reforms to promote a more fair and consistent application of the False Claims Act (“FCA”).  While the impact of these policy initiatives remains to be seen, DOJ’s continued focus on these efforts, led by officials at the highest levels within DOJ, suggests that FCA enforcement reform is a priority for the Department. After giving an overview of several FCA settlements from the last eighteen months—apparently designed to demonstrate that this DOJ recognizes the importance of the FCA in a breadth of traditional enforcement areas—Mr. Panuccio discussed two particular priorities: the opioid epidemic and the nation’s elderly population.  He emphasized that DOJ would “actively employ” the FCA against any entity in the opioid distribution chain that engages in fraudulent conduct.  He then highlighted the crucial role of the FCA in protecting the nation’s elderly from fraud and abuse, citing examples of enforcement against a nursing home management company, hospices, and skilled rehabilitation facilities. The majority of Mr. Panuccio’s remarks focused, however, on policy initiatives DOJ is undertaking to ensure that enforcement “is fair and consistent with the rule of law.”  Mr. Panuccio alluded to general reform initiatives by the department, such as the ban on certain third-party payments in settlement agreements, before expanding on reforms specific to the FCA.  Mr. Panuccio highlighted that the recent FCA reform efforts have been spearheaded by Deputy Associate Attorney General Stephen Cox; Mr. Cox had delivered remarks at the Federal Bar Association Qui Tam Conference in February of this year that had provided insight into the positions articulated in the Brand and Granston memoranda.  In his speech, Mr. Panuccio described five policy initiatives being undertaken by DOJ to reform FCA enforcement: (i) qui tam dismissal criteria; (ii) the use of guidance in FCA cases; (iii) cooperation credit; (iv) compliance program credit; and (v) preventing “piling on.” Qui tam dismissals Mr. Panuccio acknowledged the tremendous increase in the number qui tam cases that are filed each year, which includes cases that are not in the public interest.  Recognizing that DOJ expends significant resources to monitor cases even when it declines to intervene, Mr. Panuccio noted that DOJ attorneys have been instructed to consider whether moving to dismiss the action would be an appropriate use of prosecutorial discretion under the FCA.  While DOJ previously exercised this authority only rarely, consistent with the Granston memo, Mr. Panuccio suggested that, going forward, DOJ may use that authority more frequently in order to free up DOJ’s resources for matters in the public interest. Although defendants generally may not yet be experiencing significant differences regarding the possibility of dismissal at the DOJ line level, the continued public discussion of the potential use of DOJ’s dismissal authority by high-level officials suggests that DOJ appreciates the problems caused by frivolous qui tams and may ultimately be more receptive to dismissal of actions lacking merit. Guidance As stated in the Brand Memorandum, DOJ will no longer use noncompliance with agency guidance that expands upon statutory or regulatory requirements as the basis for an FCA violation.  Mr. Panuccio explained that, in an FCA case, evidence that a party received a guidance document would be relevant in proving that the party had knowledge of the law explained in that guidance.  However, DOJ attorneys have been instructed “not to use [DOJ’s] enforcement authority to convert sub-regulatory guidance into rules that have the force or effect of law.” Cooperation With respect to cooperation credit, Mr. Panuccio indicated that DOJ is working on formalizing its practices and that modifications to prior practices should be expected.  That notwithstanding, Mr. Panuccio provided assurances that DOJ will continue to “expect and recognize genuine cooperation” in both civil and criminal matters.  He also noted that the extent of the discount provided when negotiating a settlement would depend on the nature of the cooperation, how helpful it was, and whether it helped identify individual wrongdoers. Though DOJ’s new policies on cooperation credit are still forthcoming, Mr. Panuccio’s remarks suggest that formal cooperation credit might be expanded to cover situations outside of those in which the defendant makes a self-disclosure. Compliance In recognition of the challenges of running large organizations, DOJ will “reward companies that invest in strong compliance measures.”  How this may differ, if at all, from current ad hoc considerations remains to be seen. Piling On Mr. Panuccio acknowledged that, when multiple regulatory bodies pursue a defendant for the same or substantially the same conduct, “unwarranted and disproportionate penalties” can result. In order to avoid this “piling on,” DOJ attorneys will promote coordination within the agency and other regulatory bodies to ensure that defendants are subject to fair punishment and receive the benefit of finality that should accompany a settlement.  Moreover, Mr. Panuccio remarked that DOJ attorneys should not “invoke the threat of criminal prosecution solely to persuade a company to pay a larger settlement in a civil case,” which really is simply a restatement of every attorney’s existing ethical duty.  Whether DOJ leadership’s interest here will result in significant practical developments is uncertain.  Such developments, though perhaps unlikely, could include eliminating the cross-designation of Assistant U.S. Attorneys as both Civil and Criminal; limiting the ability of Civil Division attorneys to invite Criminal Division lawyers to participate in meetings without the request or consent of defendants; or perhaps even somehow inhibiting the Civil Division from using the FCA, with its mandatory treble damages and per-claim penalties, following criminal fines and restitution. We will continue to monitor and report on these important developments. The following Gibson Dunn lawyers assisted in preparing this client update: Stephen Payne, Jonathan Phillips and Claudia Kraft. Gibson Dunn’s lawyers have handled hundreds of FCA investigations and have a long track record of litigation success.  Among other significant victories, Gibson Dunn successfully argued the landmark Allison Engine case in the Supreme Court, a unanimous decision that prompted Congressional action.  See Allison Engine Co. v. United States ex rel. Sanders, 128 S. Ct. 2123 (2008).  Our win rate and immersion in FCA issues gives us the ability to frame strategies to quickly dispose of FCA cases.  The firm has more than 30 attorneys with substantive FCA expertise and more than 30 former Assistant U.S. Attorneys and DOJ attorneys.  For more information, please feel free to contact the Gibson Dunn attorney with whom you work or the following attorneys. Washington, D.C. F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com) Stuart F. Delery (+1 202-887-3650, sdelery@gibsondunn.com) Joseph D. West (+1 202-955-8658, jwest@gibsondunn.com) Andrew S. Tulumello (+1 202-955-8657, atulumello@gibsondunn.com) Karen L. Manos (+1 202-955-8536, kmanos@gibsondunn.com) Stephen C. Payne (+1 202-887-3693, spayne@gibsondunn.com) Jonathan M. Phillips (+1 202-887-3546, jphillips@gibsondunn.com) New York Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com) Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com) Denver Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com) Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com) John D.W. Partridge (+1 303-298-5931, jpartridge@gibsondunn.com) Ryan T. Bergsieker (+1 303-298-5774, rbergsieker@gibsondunn.com) Dallas Robert C. Walters (+1 214-698-3114, rwalters@gibsondunn.com) Los Angeles Timothy J. Hatch (+1 213-229-7368, thatch@gibsondunn.com) James L. Zelenay Jr. (+1 213-229-7449, jzelenay@gibsondunn.com) Palo Alto Benjamin Wagner (+1 650-849-5395, bwagner@gibsondunn.com) San Francisco Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com)Winston Y. Chan (+1 415-393-8362, wchan@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.

June 14, 2018 |
Revisions to the FFIEC BSA/AML Manual to Include the New CDD Regulation

Click for PDF On May 11, 2018, the federal bank regulators and the Financial Crimes Enforcement Network (“FinCEN”) published two new chapters of the Federal Financial Institution Examination Council Bank Secrecy Act/Anti-Money Laundering Examination Manual (“BSA/AML Manual”) to reflect changes made by FinCEN to the CDD regulation.[1]  One of the chapters replaces the current chapter “Customer Due Diligence – Overview and Examination Procedures” (“CDD Chapter”), and the other chapter is entirely new and contains an overview of and examination procedures for “Beneficial Ownership for Legal Entity Customers” to reflect the beneficial ownership requirements of the CDD regulation (“Beneficial Ownership Chapter”).[2] The new CDD Chapter builds upon the previous chapter, adds the requirements of the CDD regulation, and otherwise updates the chapter, which had not been revised since 2007.  The Beneficial Ownership Chapter largely repeats what is in the CDD Rule.  Both new chapters reference the regulatory guidance and clarifications from the Frequently Asked Questions issued by FinCEN on April 3, 2018 (the “FAQs”).[3]   Other Refinements to the CDD Regulation May Impact the BSA/AML Manual Implementation of the CDD regulation is a dynamic process and may require further refinement of these chapters as FinCEN issues further guidance.  For instance, in response to concerns of the banking industry, on May 16, 2018, FinCEN issued an administrative ruling imposing a 90-day moratorium on the requirement to recertify CDD information when certificates of deposit (“CDs”) are rolled over or loans renewed (if the CDs or loans were opened before May 11, 2018).  FinCEN will have further discussions with the banking industry and will make a decision whether to make this temporary exception permanent within this 90-day period (before August 9, 2018).[4] In his May 16, 2018, testimony at a House Financial Services Committee hearing on “Implementation of FinCEN’s Customer Due Diligence Rule,” FinCEN Director Kenneth Blanco suggested that FinCEN may be receptive to refinements as compliance experience is gained with the regulation.  Director Blanco also indicated that there will be a period of adjustment for compliance with the regulation and that FinCEN and the regulators will not engage in “gotcha” enforcement, but are seeking “good faith compliance.” Highlights from the New Chapters Periodic Reviews:  The BSA/AML Manual no longer expressly requires periodic CDD reviews, but suggests that regulators may still expect periodic reviews for higher risk customers.  The language in the previous CDD Chapter requiring periodic CDD refresh reviews has been eliminated.[5]Consistent with FAQ 14, the new CDD Chapter states that updating CDD information will be event driven and provides a list of possible event triggers, such as red flags identified through suspicious activity monitoring or receipt of a criminal subpoena.  Nevertheless, the CDD Chapter does not completely eliminate the expectation of periodic reviews for higher risk clients, stating:  “Information provided by higher profile customers and their transactions should be reviewed . . . more frequently throughout the term of the relationship with the bank.”Although this appears to be a relaxation of the expectation to conduct periodic reviews, we expect many banks will not change their current practices.  For a number of years, in addition to event driven reviews, many banks have conducted periodic CDD reviews at risk based intervals because they have understood periodic reviews to be a regulatory expectation. Lower Beneficial Ownership Thresholds:  Somewhat surprisingly, there is no expression in the new chapters that consideration should be given to obtaining beneficial ownership at a lower threshold than 25% for certain high risk business lines or customer types.  The new Beneficial Ownership Chapter simply repeats the regulatory requirement stating that:  “The beneficial ownership rule requires banks to collect beneficial ownership information at the 25 percent ownership threshold regardless of the customer’s risk profile.”  The FAQs (FAQ 6 and 7) refer to the fact that a financial institution may “choose” to apply a lower threshold and “there may be circumstances where a financial institution may determine a lower threshold may be warranted.”  We understand that specifying an expectation that there should be lower beneficial thresholds for certain higher risk customers was an issue that was debated among FinCEN and the bank regulators.For a number of years, many banks have obtained beneficial ownership at lower than 25% thresholds for high risk business lines and customers (e.g., private banking for non-resident aliens).  Banks that have previously applied a lower threshold, however, should carefully evaluate any decision to raise thresholds to the 25% level in the regulation.  If a bank currently applies a lower threshold, raising the threshold may attract regulatory scrutiny about whether the move was justified from a risk standpoint.  Moreover, a risk-based program should address not only regulatory risk, but also money laundering risk.  Therefore, banks should consider reviewing beneficial ownership at lower thresholds for certain customers and business lines and when a legal entity customer has an unusually complex or opaque ownership structure for the type of customer regardless of the business line or risk rating of the customer. New Accounts:  The new chapters do not discuss one of the most controversial and challenging requirements of the CDD rule, the requirement to verify CDD information when a customer previously subject to CDD opens a new account, including when CDs are rolled over or loans renewed.  This most likely may be because application of the requirement to CD rollovers and loan renewals is still under consideration by FinCEN, as discussed above. Enhanced Due Diligence:  The requirement to maintain enhanced due diligence (“EDD”) policies, procedures, and processes for higher risk customers remains with no new suggested categories of customers that should be subject to EDD. Risk Rating:  The new CDD Chapter seems to articulate an expectation to risk rate customers:  “The bank should have an understanding of the money laundering and terrorist financing risk of its customers, referred to in the rule as the customer risk profile.  This concept is also commonly referred to as the customer risk rating.”  The CDD Chapter, therefore, could be read as expressing for banks an expectation that goes beyond FinCEN’s expectation for all covered financial institutions in FAQ 35, which states that a customer profile “may, but need not, include a system of risk ratings or categories of customers.”  It appears that banks that do not currently risk rate customers should consider doing so.  Since the CDD section was first drafted in 2006 and amended in 2007, customer risk rating based on an established method with weighted risk factors has become a best and almost universal practice for banks to facilitate the AML risk assessment, CDD/EDD, and the identification of suspicious activity. Enterprise-Wide CDD:  The new CDD Chapter recognizes the CDD approach of many complex organizations that have CDD requirements and functions that cross financial institution legal entities and the general enterprise-wide approach to BSA/AML long referenced in the BSA/AML Manual.  See BSA/AML Manual, BSA/AML Compliance Program Structures Overview, at p. 155.  The CDD Chapter states that a bank “may choose to implement CDD policies, procedures and processes on an enterprise-wide basis to the extent permitted by law sharing across business lines, legal entities, and with affiliate support units.” Conclusion Despite the CDD regulation, at its core CDD compliance is still risk based and regulatory risk remains a concern.  Every bank must carefully and continually review its CDD program against the regulatory requirements and expectations articulated in the BSA/AML Manual, as well as recent regulatory enforcement actions, the institution’s past examination and independent and compliance testing issues, and best practices of peer institutions.  This review will help anticipate whether there are aspects of its CDD/EDD program that could be subject to criticism in the examination process.  As the U.S. Court of Appeals for the Ninth Circuit recently recognized, detailed manuals issued by agencies with enforcement authority like the BSA/AML Manual “can put regulated banks on notice of expected conduct.”  California Pacific Bank v. Federal Deposit Insurance Corporation, 885 F.3d 560, 572 (9th Cir. 2018).  The BSA/AML Manual is an important and welcome roadmap although not always as up to date, clear or detailed as banks would like it to be. These were the first revisions to the BSA/AML Manual since 2014.  We understand that additional revisions to other chapters are under consideration.    [1]   May 11, 2018 also was the compliance date for the CDD regulations.  The Notice of Final Rulemaking for the CDD regulation, which was published on May 11, 2016, provided a two-year implementation period.  81 Fed. Reg. 29,398 (May 11, 2016).  https://www.gpo.gov/fdsys/pkg/FR-2016-05-11/pdf/2016-10567.pdf. For banks, the new regulation is set forth in the BSA regulations at 31 C.F.R. § 1010.230 (beneficial ownership requirements) and 31 C.F.R. § 1020.210(a)(5).    [2]   The new chapters can be found at: https://www.ffiec.gov/press/pdf/Customer%20Due%20Diligence%20-%20Overview%20and%20Exam%20Procedures-FINAL.pdfw  (CDD Chapter) and https://www.ffiec.gov/press/pdf/Beneficial%20Ownership%20Requirements%20for %20Legal%20Entity%20CustomersOverview-FINAL.pdf (Beneficial Ownership Chapter).    [3]   Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions, FIN-2018-G001.  https://www.fincen.gov/resources/statutes-regulations/guidance/frequently-asked-questions-regarding-customer-due-0.  On April 23, 2018, Gibson Dunn published a client alert on these FAQs.  FinCEN Issues FAQs on Customer Due Diligence Regulation.  https://www.gibsondunn.com/fincen-issues-faqs-on-customer-due-diligence-regulation/. FinCEN also issued FAQs on the regulation on September 29, 2017. https://www.fincen.gov/sites/default/files/2016-09/FAQs_for_CDD_Final_Rule_%287_15_16%29.pdf.    [4]   Beneficial Ownership Requirements for Legal Entity Customers of Certain Financial Products and Services with Automatic Rollovers or Renewals, FIN-2018-R002.  https://www.fincen.gov/sites/default/files/2018-05/FinCEN%20Ruling%20CD%20and%20Loan%20Rollover%20Relief_FINAL%20508-revised.pdf    [5]   The BSA/AML Manual previously stated at p. 57:  “CDD processes should include periodic risk-based monitoring of the customer relationship to determine if there are substantive changes to the original CDD information. . . .” 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 Financial Institutions practice group, or the authors: Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Linda Noonan – Washington, D.C. (+1 202-887-3595, lnoonan@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.

June 11, 2018 |
Supreme Court Rejects Tolling Of Statute Of Limitations For Successive Class Actions

Click for PDF China Agritech Inc. v. Resh, No. 17-432 Decided June 11, 2018 Today, the Supreme Court held that the filing of a class action does not toll the statute of limitations for putative class members to file their own class actions. That means that if class certification is denied, putative class members cannot file successive class actions after the statute of limitations has expired. Background: Stockholders filed two timely class actions against China Agritech, Inc. alleging that the company violated the Securities Exchange Act of 1934.  After class certification was denied in both actions, stockholders filed a third class action, well outside the two-year limitations period.  They argued that their claims were timely because the limitations period was tolled while the earlier class actions were pending. Issue: Whether previously absent class members may bring a class action outside the applicable limitations period on the theory that the pendency of a previous class action (in which the court ultimately denied class certification) tolled the statute of limitations during the pendency of earlier class actions. Court’s Holding: No. Previously absent class members may not bring successive (also called “stacked”) class actions outside the limitations period. “The ‘efficiency and economy of litigation’ that support tolling individual claims, . . . do not support maintenance of untimely successive class actions; any additional class filings should be made early on, soon after the commencement of the first action seeking class certification.” Justice Ginsburg, writing for the Court Gibson Dunn filed amicus briefs arguing against tolling for successive class actions for the Chamber of Commerce, Retail Litigation Center, and the American Tort Reform Association What It Means: The Court declined to extend the equitable tolling rule established in American Pipe & Construction Co. v. Utah, 414 U.S. 538 (1974), which permits putative class members to wait for a decision on class certification before filing an individual claim or intervening in the original lawsuit.  The Court held that the American Pipe rule does not toll the statute of limitations for putative class members to file class actions, so all class claims must be filed within the limitations period. The ruling ensures that when class certification is denied, a new plaintiff cannot revive otherwise expired claims by filing the case as a class action.  The Court explained that the decision about whether to certify a class should be made at the outset of the case for all would-be class representatives, and class members should not be able to extend the statute of limitations indefinitely by filing successive class actions each time class certification is denied. The Court made clear that its ruling applies regardless of the reason the court denied class certification in the first case. The Court stated that its ruling is not likely to lead to a dramatic increase in the number of protective class actions filed during the limitations period.  The majority of courts of appeals had already adopted the same rule, and those courts did not experience an increase in protective class action filings. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court.  Please feel free to contact the following practice leaders: Appellate and Constitutional Law Practice Caitlin J. Halligan +1 212.351.3909 challigan@gibsondunn.com Mark A. Perry +1 202.887.3667 mperry@gibsondunn.com Nicole A. Saharsky +1 202.887.3669 nsaharsky@gibsondunn.com Related Practice: Class Actions Theodore J. Boutrous, Jr. +1 213.229.7804 tboutrous@gibsondunn.com Christopher Chorba +1 213.229.7396 cchorba@gibsondunn.com Theane Evangelis +1 213.229.7726 tevangelis@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.

June 4, 2018 |
Supreme Court Holds That The Colorado Civil Rights Commission Violated Cake Baker’s Religious Freedom Rights

Click for PDF Masterpiece Cakeshop, Ltd. v. Colorado Civil Rights Commission, No. 16-111 Decided June 4, 2018 The Supreme Court held 7-2 that the Colorado Civil Rights Commission violated the Free Exercise Clause when it rejected a baker’s religious justification for refusing to create a wedding cake for a same-sex couple. Background: Jack Phillips, a Christian baker, refused to create a wedding cake for a same-sex couple.  The couple then filed a discrimination complaint with the Colorado Civil Rights Commission.  After investigating, the Commission concluded that Phillips had violated the Colorado Anti-Discrimination Act and rejected his argument that providing the cake would violate his First Amendment rights to free speech and free exercise of religion.  The Commission held formal public hearings about the case, during which some commissioners disparaged Phillips’ religious beliefs and suggested they were insincere. Issue: Whether the Commission’s decision violated the Free Speech Clause or Free Exercise Clause of the First Amendment. Court’s Holding: Yes.  The Commission violated the Free Exercise Clause because it did not give “neutral and respectful consideration” to the sincere religious beliefs that motivated Phillips’ objection. What It Means: The Court resolved the case on narrow grounds, focusing on the Commission’s animus toward Phillips’ religious beliefs and avoiding broader questions regarding the scope of religious exemptions to facially neutral laws of general applicability. The Court articulated principles that should guide the resolution of similar cases in the future, recognizing that “religious and philosophical objections to gay marriage are protected views and in some instances protected forms of expression,” yet cautioning that “such objections do not allow business owners and other actors in the economy and in society to deny protected persons equal access to goods and services.”  The Court emphasized that “gay persons and gay couples cannot be treated as social outcasts or as inferior in dignity and worth.” State agencies, courts, and other tribunals responsible for enforcing anti-discrimination statutes must consider sincere religious beliefs in a tolerant, neutral, and respectful way, consistent with “the religious neutrality that the Constitution requires.” Any future decision in favor of a business owner who refuses goods or services to a same-sex couple based on sincere religious beliefs must be “sufficiently constrained” to avoid imposing a “serious stigma on gay persons.” “[T]hese disputes must be resolved with tolerance, without undue disrespect to sincere religious beliefs, and without subjecting gay persons to indignities when they seek goods and services in an open market.” Justice Kennedy, writing for the majority Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court.  Please feel free to contact the following practice leaders: Appellate and Constitutional Law Practice Caitlin J. Halligan +1 212.351.3909 challigan@gibsondunn.com Mark A. Perry +1 202.887.3667 mperry@gibsondunn.com Nicole A. Saharsky +1 202.887.3669 nsaharsky@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.

June 4, 2018 |
Gibson Dunn Adds Appellate Partner Allyson Ho to Dallas Office

Gibson, Dunn & Crutcher LLP is pleased to announce that Allyson N. Ho has joined the firm in Dallas as a partner.  Formerly a partner with Morgan, Lewis & Bockius, she will continue her appellate practice at Gibson Dunn. “We are delighted to have Allyson as our partner,” said Ken Doran, Chairman and Managing Partner of Gibson Dunn.  “We have one of the top appellate practices in the country.  Allyson is a nationally renowned appellate advocate.  She will add depth and versatility to our exceptional appellate bench, both in Texas and nationwide.  Moreover, she is a wonderful person and will be a fabulous culture fit.” “Allyson is a splendid addition to our Dallas office,” said Rob Walters, Partner in Charge of the Dallas office.  “We have known Allyson for years, and we can attest to her superb advocacy and professionalism.  With her successful track record before the U.S. Supreme Court and other tribunals, we know she’ll quickly step in to handle the high-stakes appellate cases that our clients entrust to us.  Allyson is the perfect lawyer to lead this essential practice.” “Gibson Dunn has long been the home of the most distinguished appellate practice in the nation,” said Ho.  “I am thrilled to join the firm and to continue my appellate practice with the finest lawyers in Texas and across the country.” About Allyson Ho Ho has presented over 50 oral arguments in federal and state appellate courts nationwide – including more arguments and wins in business cases before the U.S. Supreme Court than any Texas lawyer.  She has also appeared and prevailed in every federal court of appeals in the country, as well as in various state appellate courts nationwide.  In addition, Ho advises clients in high-stakes matters before government officials and agencies, including the U.S. Senate, the Texas Attorney General’s Office and other Texas state agencies. She joins the firm from Morgan Lewis where she served as co-chair of its appellate practice group.  During her career, she served as Special Assistant to President George W. Bush from 2005 to 2006, and as Counselor to the Attorney General in the U.S. Department of Justice from 2004 to 2005.  She is among the top ranked appellate lawyers in Texas in Chambers USA from 2015 to 2018. Ho received her law degree in 2000 from Chicago Law School, with high honors and as member of the Law Review and Order of the Coif.  She served as a clerk for U.S. Supreme Court Justice Sandra Day O’Connor and Judge Jacques L. Wiener, Jr. of the U.S. Court of Appeals for the Fifth Circuit.

June 1, 2018 |
Supreme Court Round-Up (June 1, 2018)

As the Supreme Court continues its 2017 Term, Gibson Dunn’s Supreme Court Round-Up is summarizing the issues presented in the cases on the Court’s docket and the opinions in the cases the Court has already decided.  The Court has finished hearing arguments this Term, and we are awaiting decisions in 29 cases.  Gibson Dunn presented 3 oral arguments this Term, in addition to being involved in 11 cases as counsel for amici curiae.  Additionally, to date, the Court has granted certiorari in 18 cases for the 2018 Term, and Gibson Dunn is counsel for the petitioner in one of those cases. Spearheaded by former Solicitor General Theodore B. Olson, the Supreme Court Round-Up keeps clients apprised of the Court’s most recent actions.  The Round-Up previews cases scheduled for argument, tracks the actions of the Office of the Solicitor General, and recaps recent opinions.  The Round-Up provides a concise, substantive analysis of the Court’s actions.  Its easy-to-use format allows the reader to identify what is on the Court’s docket at any given time, and to see what issues the Court will be taking up next.  The Round-Up is the ideal resource for busy practitioners seeking an in-depth, timely, and objective report on the Court’s actions. To view the Round-Up, click here. Gibson Dunn has a longstanding, high-profile presence before the Supreme Court of the United States, appearing numerous times in the past decade in a variety of cases. During the Supreme Court’s 5 most recent Terms, 9 different Gibson Dunn partners have presented oral argument; the firm has argued a total of 21 cases in the Supreme Court during that period, including closely watched cases with far-reaching significance in the class action, intellectual property, separation of powers, and First Amendment fields. Moreover, while the grant rate for certiorari petitions is below 1%, Gibson Dunn’s certiorari petitions have captured the Court’s attention: Gibson Dunn has persuaded the Court to grant 23 certiorari petitions since 2006. *   *   *  * Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court.  Please feel free to contact the following attorneys in the firm’s Washington, D.C. office, or any member of the Appellate and Constitutional Law Practice Group. Theodore B. Olson (+1 202.955.8500, tolson@gibsondunn.com) Amir C. Tayrani (+1 202.887.3692, atayrani@gibsondunn.com) Brandon L. Boxler (+1 202.955.8575, bboxler@gibsondunn.com) Rajiv Mohan (+1 202.955.8507, rmohan@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.

May 31, 2018 |
California Supreme Court Spring 2018 Round-Up

Click for PDF Spearheaded by Daniel M. Kolkey, a former Associate Justice on the California Court of Appeal, Third Appellate District, and former Counsel to the Governor of California, Gibson Dunn’s California Appellate Practice Group has prepared the attached California Supreme Court Spring 2018 Round-Up, which previews upcoming cases and summarizes select opinions issued by the Court.  This edition includes opinions handed down from September 2017 through April 2018, organized by subject.  Each entry contains a description of the case, as well as a substantive analysis of the Court’s decision.  The Round-Up provides a resource for busy practitioners seeking an in-depth, timely, and objective report on the California Supreme Court’s actions. To view the Round-Up, click here. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the California Supreme Court, or in state or federal appellate courts in California.  Please feel free to contact the following lawyers in California, or any member of the Appellate and Constitutional Law Practice Group. Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com) Daniel M. Kolkey – San Francisco (+1 415-393-8420, dkolkey@gibsondunn.com) Julian W. Poon – Los Angeles (+1 213-229-7758, jpoon@gibsondunn.com) Theane Evangelis – Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com) Kirsten Galler – Los Angeles (+1 213-229-7681, kgaller@gibsondunn.com) Jennafer M. Tryck – Orange County (+1 949-451-4089, jtryck@gibsondunn.com) Michael Holecek – Los Angeles (+1 213-229-7018, mholecek@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.

May 29, 2018 |
Gibson Dunn Named Winner in Three Categories for D.C. Litigation Department of the Year

Click for PDF National Law Journal’s 2018 D.C. Litigation Department of the Year contest recognized Gibson Dunn as co-winner in the General Litigation [PDF] and Labor & Employment [PDF] categories and the winner in the Products Liability/Mass Torts [PDF] category.  Gibson Dunn was the only firm to win in three categories.  Profiles ran in the magazine’s June issue and noted the firm’s “winning streak in 2017 was marked by cases that may prove instructive for future litigation.”

May 18, 2018 |
Theodore Olson Named Litigator of the Week

The Am Law Litigation Daily named Washington, D.C. partner Theodore B. Olson as its Litigator of the Week [PDF] for convincing the U.S. Supreme Court to strike down federal limits on sports gambling. The profile was published on May 18, 2018.

May 16, 2018 |
The ‘MFW’ Framework Gains Traction Outside the Merger Context

Washington, D.C. partner Jason Mendro and associate Jeffrey Rosenberg are the authors of “The ‘MFW’ Framework Gains Traction Outside the Merger Context,” [PDF] published in the Delaware Business Court Insider on May 16, 2018.

May 14, 2018 |
Supreme Court Strikes Down Federal Limits On Sports Gambling

Click for PDF Murphy v. National Collegiate Athletic Association, No. 16-476 New Jersey Thoroughbred Horsemen’s Association, Inc. v. National Collegiate Athletic Association, No. 16-477 Decided May 14, 2018 The Supreme Court held 7-2 that a federal law prohibiting States from authorizing sports betting violates the Tenth Amendment because it impermissibly commandeers state legislatures. Background: A federal law – the Professional and Amateur Sports Protection Act of 1992 (PASPA) – prohibits States from authorizing or licensing sports gambling.  In 2014, the New Jersey legislature repealed existing prohibitions on sports gambling at casinos and racetracks.  The NCAA and the four major professional sports leagues sued the State, arguing that the decision to allow sports gambling violated PASPA. Issue: Whether PASPA’s federal prohibition on state authorization of sports gambling violates the Tenth Amendment because it commandeers state legislatures. Court’s Holding: Yes.  PASPA unconstitutionally commandeers state legislatures by dictating the content of state law regarding sports gambling (i.e., preventing States from legalizing sports gambling). “A more direct affront to state sovereignty is not easy to imagine.” Justice Alito, writing for the majority What It Means: In a significant victory for States’ rights, the Court’s decision makes clear that the Tenth Amendment’s anti-commandeering rule has teeth.  Under that rule, Congress can neither affirmatively direct the States to enact a certain law nor prohibit them from repealing an existing law.  As a result, States are now free to choose whether or not to legalize sports gambling. The Court also struck down the additional federal prohibitions on state-run lotteries, private operation of sports gambling schemes, and advertising of sports gambling. The ruling likely will lead to the legalization of sports gambling in many States.  In advance of the Court’s ruling, bills authorizing sports gambling had been introduced in approximately 15 States, and they have already been enacted in Pennsylvania, Mississippi, Connecticut, and West Virginia. Gibson Dunn represented the winning party:  Petitioners Philip D. Murphy, as Governor of the State of New Jersey, et. al. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court.  Please feel free to contact the following practice leaders: Appellate and Constitutional Law Practice Caitlin J. Halligan +1 212.351.3909 challigan@gibsondunn.com Mark A. Perry +1 202.887.3667 mperry@gibsondunn.com Nicole A. Saharsky +1 202.887.3669 nsaharsky@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.

May 4, 2018 |
First Quarter 2018 Update on Class Actions

Click for PDF This update provides an overview and summary of significant class action developments during the first quarter of 2018 (January through March), as well as a brief look ahead to some of the key class action issues anticipated later this year. Part I addresses developments at the United States Supreme Court, including the oral arguments in China Agritech, Inc. v. Resh, the decision in Jennings v. Rodriguez and its implications for Rule 23(b)(2) class actions, and three grants of certiorari in cases relating to class actions (including in two important arbitration cases, and in another that will address the use of cy pres in class action settlements). Part II covers the Ninth Circuit’s decision in In re Hyundai & Kia Fuel Economy Litigation, which may have significant consequences for plaintiffs attempting to certify nationwide class actions, as well as parties attempting to settle such actions. Part III describes several rulings addressing important issues regarding class settlements, including recent activity by the U.S. Department of Justice in scrutinizing these settlements. Part IV discusses a series of decisions from the federal courts of appeals, involving (among other things) what it takes to establish standing under Article III in data breach class actions. Part V addresses a new California Court of Appeal decision regarding the standards applicable to the use of experts at class certification. I.   The U.S. Supreme Court Hears Argument on the Tolling Effect of Putative Class Actions, Issues Guidance on Rule 23(b)(2) Class Actions, and Grants Certiorari in Three Important Cases As previewed in our fourth quarter 2017 update, the U.S. Supreme Court heard oral argument on March 26, 2018, in China Agritech, Inc. v. Resh (No. 17-432).  The case concerns the scope of the equitable tolling rule of American Pipe and Construction Co. v. Utah, 414 U.S. 538 (1974), which held that the filing of a class action tolls the statute of limitations for absent class members and permits them to bring subsequent individual suits after the original class action has been dismissed.  China Agritech asks whether the American Pipe rule should be extended to permit absent class members to bring successive class action lawsuits—a question that has divided the courts of appeals. The oral argument did not suggest a clear answer.  While some justices seemed skeptical of barring individuals who relied on their membership in a class action (as a reason not to sue within the limitations period) from then using Rule 23 in a subsequent suit, others expressed concern that applying the American Pipe rule to subsequent class actions would encourage “stacked” successive class actions that would undermine the efficiency rationales underlying the class action device.  (Gibson Dunn filed an amicus brief in this case on behalf of the Chamber of Commerce of the United States, the Retail Litigation Center, Inc., and the American Tort Reform Association in support of the petitioner.) The Court also provided guidance regarding Rule 23(b)(2) classes in Jennings v. Rodriguez, 138 S. Ct. 830 (2018), a case involving the government’s detention of aliens without bond hearings.  The Court instructed the Ninth Circuit to “consider whether a Rule 23(b)(2) class action continues to be the appropriate vehicle for respondents’ [due process] claims in light of” its holding in Wal-Mart Stores, Inc. v. Dukes, 564 U.S. 338 (2011), that “‘Rule 23(b)(2) applies only when a single injunction or declaratory judgment would provide relief to each member of the class.'”  Id. at 851–52 (quoting Dukes, 564 U.S. at 360).  Writing for the majority, Justice Alito explained that Rule 23(b)(2) may no longer permit class treatment because some class members may not be entitled to bond hearings as a matter of constitutional due process.  Id. at 852.  The Court also instructed the Ninth Circuit to consider whether the “flexible” due process inquiry, which “calls for such procedural protections as the particular situation demands,” can be adjudicated in a class action.  Id. (quotations omitted). Looking ahead, there are several significant class action issues on the Court’s docket.  As noted in our fourth quarter 2017 update, by June 2018, the Court is expected to decide whether the National Labor Relations Act precludes enforcement of class action waivers in mandatory employment arbitration agreements, which is the question presented in a consolidated trio of cases, Epic Systems Corp. v. Lewis (No. 16-285), National Labor Relations Board v. Murphy Oil USA, Inc. (No. 16-307), and Ernst & Young LLP v. Morris (No. 16-300). In the past three months, the Court granted certiorari in three more cases that will address issues relevant to class actions. First, on February 26, 2018, the Court granted certiorari in New Prime Inc. v. Oliveira (No. 17‑340) to resolve two important issues concerning the interpretation and scope of the Federal Arbitration Act (“FAA”):  (a) whether a dispute regarding the applicability of the FAA must be resolved by an arbitrator under a valid delegation clause, and (b) whether an exemption for contracts of employment for transportation workers in Section 1 of the FAA applies to independent contractors.  Both questions have divided the federal courts of appeals.  The case presents an opportunity for the Court to establish uniform, national rules concerning the interpretation of the FAA, including the ability of parties to incorporate enforceable arbitration provisions in agreements governing independent contractors.  (Gibson Dunn represents the petitioner, New Prime Inc.) Second, on April 30, 2018, the Court granted certiorari in Lamps Plus, Inc. v. Varela (No. 17‑988), which presents the question whether the FAA forecloses a state-law interpretation of an arbitration agreement that would authorize class arbitration based solely on general language commonly used in arbitration agreements.  Lamps Plus presents the Court with an opportunity to again wrestle with the propriety of class arbitration, an issue that the Court previously addressed in Stolt-Nielsen, S.A. v. AnimalFeeds International Corp., 559 U.S. 662 (2010). Finally, on April 30, 2018, the Court granted certiorari in Frank v. Gaos (No. 17-961), which we discussed in our third quarter 2017 update and our fourth quarter 2017 update.  Frank, which involved a class action settlement of claims against Google, concerns the validity of cy pres-only settlements that provide no direct compensation to class members.  Frank presents an opportunity to address the “fundamental concerns” with cy pres-only settlements that Chief Justice Roberts previously identified, “including when, if ever, such relief should be considered; how to assess its fairness as a general matter; whether new entities may be established as part of such relief; if not, how existing entities should be selected; what the respective roles of the judge and parties are in shaping a cy pres remedy,” among other issues.  Marek v. Lane, 134 S. Ct. 8, 9 (2013) (Roberts, C.J., respecting denial of certiorari). II.   Ninth Circuit Vacates Certification of Nationwide Settlement Class This past quarter, the Ninth Circuit likely increased the scrutiny that district courts must now apply to the certification of nationwide class actions asserting state-law claims.  In In re Hyundai & Kia Fuel Economy Litigation, 881 F.3d 679 (9th Cir. 2018), a divided panel vacated a nationwide class action settlement because the district court failed to properly analyze whether California law could be applied to all class members. This action arose out of alleged misstatements concerning the fuel efficiency of certain Hyundai and Kia vehicles.  In re Hyundai, 881 F.3d at 694-95.  The district court certified a nationwide Rule 23(b)(3) class for settlement purposes and granted preliminary approval of a proposed class settlement.  Id. at 700-01.  The district court ruled that it was not required to analyze whether there were significant differences between California law and the laws of the other states at issue because differences in state law could be addressed during a hearing on the fairness of the settlement.  Id. at 700.  The district court approved the settlement without conducting a choice-of-law analysis.  See id. at 701. The Ninth Circuit vacated the class certification order.  It emphasized that, under Mazza v. American Honda Motor Co., 666 F.3d 581 (9th Cir. 2012), “the district court was required to apply California’s choice of law rules to determine whether California law could apply to all plaintiffs in the nationwide class, or whether the court had to apply the law of each state, and if so, whether variations in state law defeated predominance.”  In re Hyundai, 881 F.3d at 702.  The Ninth Circuit agreed that district courts need not consider “litigation management issues” in deciding whether to certify a settlement class, but they were still obligated to ensure that the class “meets all of the prerequisites of Rule 23,” including its predominance requirement.  Id.  Punting the decision about choice-of-law issues to a “fairness hearing” was not a viable option, as a “fairness hearing under Rule 23(e) is no substitute for rigorous adherence to those provisions of the Rule designed to protect absentees[.]”  Id. at 703 (alteration in original) (quoting Ortiz v. Fibreboard Corp., 527 U.S. 815, 849 (1999)). The Ninth Circuit also took steps to limit the perception that nationwide or mass advertising campaigns can produce a “common” question of whether the class relied on certain misrepresentations by the defendants.  The court reasoned that even though there was some evidence of nationwide advertising, there was no evidence of uniform representations to used car purchasers, and no evidence of the sort of “massive advertising campaign” that could give rise to a presumption of reliance as to such purchasers.  In re Hyundai, 881 F.3d at 704.  It also rejected the argument that individualized questions regarding exposure to the advertising could simply be ignored in the settlement context. Judge Nguyen’s dissent claimed, among other things, that the majority improperly shifted the burden from the objectors to the district court or class counsel to decide whether other states’ laws apply and argued that the majority’s decision had created a circuit split and ran afoul of Erie Railroad v. Tompkins, 304 U.S. 64 (1938). The settling parties filed petitions for rehearing and rehearing en banc in March.  The objectors were ordered to file their response and did so on March 28.  The petitions are currently pending. III.   Notable Decisions Involving Objections to Class Action Settlements There were two other notable decisions regarding class action settlements this quarter. First, the United States Department of Justice signaled a renewed interest in policing class action settlements.  According to reports, the DOJ receives more than 700 notices of class action settlements each year as required by the Class Actions Fairness Act (“CAFA”), but it had only participated in two cases.  Dep’t of Justice, Associate Attorney General Brand Delivers Remarks to the Washington, D.C. Lawyers Chapter of the Federalist Society (Feb. 15, 2018), https://www.justice.gov/opa/speech/associate-attorney-general-brand-delivers-remarks-washington-dc-lawyers-chapter.  At a conference on February 15, however, Associate Attorney General Rachel L. Brand warned that “If a settlement isn’t fair or reasonable under CAFA, DOJ may file a statement of interest saying so.  Be on the lookout in the coming days for the first example.”  Id. The DOJ followed through on this promise in Cannon v. Ashburn Corp., No. 16-cv-1452, 2018 WL 1806046 (D.N.J. Apr. 17, 2018), where the district court denied a motion for final settlement approval based in part on the concerns raised by the DOJ.  The DOJ had filed a “statement of interest” objecting to the class settlement of claims involving alleged false advertising in connection with the sale of wines.  Id. at *12.  The proposed settlement offered class members coupons worth between $0.20 to $2.25 per bottle of wine purchased, with a total settlement value estimated at $10.8 million.  Id. at *3.  Class counsel were to receive $1.7 million in fees.  Id.  In its “statement of interest,” the DOJ argued that class counsel should not receive a “windfall” of $1.7 million, given the minimal benefit to class members and the apparent lack of merit of the claims.  Statement of Interest of the United States at 1, Cannon v. Ashburn Corp., No. 16‑cv‑1452 (Feb. 16, 2018), ECF No. 58.  Arguing that the settlement was “a textbook coupon settlement” that would force class members to engage in future business with the defendant if they wanted to receive any benefit, the DOJ urged the court, should it grant approval, to defer payment of fees to class counsel until the total value of redeemed coupons is known.  Id. at 9–11, 16.  The Arizona Attorney General also weighed in on behalf of 19 states’ Attorneys General, as did ten objectors.  2018 WL 1806046, at *4.  This case may be the first example of what appears to be a new trend of heightened scrutiny of class action settlements by both state and federal law enforcement officials. Second, in Low v. Trump University, LLC, 881 F.3d 1111 (9th Cir. 2018), the Ninth Circuit affirmed the district court’s order approving a class settlement between Trump University and its former students.  Id. at 1113.  A lone objector sought to opt out of the class after receiving a court-approved settlement notice and submitting her claim.  Id. at 1115-16.  The district court approved the settlement and the objector appealed.  Id. at 1116.  The objector argued that a single sentence in the long-form notice stating that class members would “be notified about how to obtain a share (or how to ask to be excluded from any settlement)” led her to believe that there would be a second opportunity to opt out.  Id. at 1117.  The Ninth Circuit found that, “reading the notice as a whole and in context,” it “promised only one opportunity to opt out,” and observed that there is “‘no authority of any kind suggesting that due process requires that members of a Rule 23(b)(3) class be given a second chance to opt out.'”  Id. at 1121 (quoting Officers for Justice v. Civil Serv. Comm’n of S.F., 688 F.2d 615, 635 (9th Cir. 1982)). IV.   In re Zappos.com and Other Notable Opinions from the Federal Courts of Appeals Addressing Article III Standing The issue of Article III standing in putative class actions, and in data privacy class actions in particular, continues to be a hotly litigated issue. The most significant decision this quarter came from the Ninth Circuit, which reversed the dismissal of a putative class action relating to the breach of Zappos.com’s data systems that had allegedly exposed the “names, account numbers, passwords, email addresses, billing and shipping addresses, telephone numbers, and credit and debit card information” of 24 million customers.  In re Zappos.com, Inc., — F.3d —, No. 16-16860, 2018 WL 1883212, at *2 (9th Cir. Apr. 20, 2018).  The district court ruled that those plaintiffs who alleged “actual fraud occurred as a direct result of the breach” had Article III standing, but that those plaintiffs who “failed to allege . . . actual identity theft or fraud” based on the breach did not.  Id. at *3. The Ninth Circuit reversed, concluding that the dismissed plaintiffs had “sufficiently alleged standing based on the risk of identity theft.”  Zappos, 2018 WL 1883212, at *2.  The Ninth Circuit relied heavily on its previous decision in Krottner v. Starbucks Corp., 628 F.3d 1139 (9th Cir. 2010), which had addressed “the Article III standing of victims of data theft.”  Zappos, 2018 WL 1883212, at *3.  The court considered whether Krottner was still good law following the Supreme Court’s decision in Clapper v. Amnesty International, USA, 568 U.S. 398 (2013), but ultimately concluded that “Krottner is not clearly irreconcilable with Clapper” and thus “control[led] the results here.”  Zappos, 2018 WL 1883212, at *5–*6. Applying Krottner, the Ninth Circuit reasoned that “the sensitivity of the personal information, combined with its theft,” meant that “the plaintiffs had adequately alleged an injury in fact” for standing purposes.  Zappos, 2018 WL 1883212, at *6.  Because the hackers had allegedly accessed full credit card numbers, the stolen information “gave hackers the means to commit fraud or identity theft,” as underscored by those “plaintiffs who alleged that the hackers had already commandeered their accounts or identities using information taken from Zappos.”  Id.  Finding the other elements of Article III standing satisfied, the Ninth Circuit remanded the case to the district court for further proceedings. While In re Zappos.com held that Article III was satisfied based on the facts alleged there, three other decisions issued this past quarter came to the opposite conclusion and thus affirmed the dismissal of putative class actions: In Owner-Operator Independent Drivers Association v. U.S. Department of Transportation, 879 F.3d 339 (D.C. Cir. 2018), the D.C. Circuit held that commercial truck drivers lacked Article III standing to sue the Department of Transportation for inaccuracies in its database of driver-safety information.  Five commercial truck drivers sued the Department because their records contained inaccuracies, but only two of the drivers ever had the inaccurate information shared with future employers.  Id. at 340.  On these facts, the court determined that “the mere existence of inaccurate database information is not sufficient to confer Article III standing” because there was no concrete or de facto harm.  Id. at 345.  Nevertheless, the court found the actual dissemination of inaccurate information was sufficient to confer standing for the two truck drivers whose information had in fact been shared.  Id. In Bassett v. ABM Parking Services, Inc., 883 F.3d 776 (9th Cir. 2018), the Ninth Circuit agreed with the Second and Seventh Circuits that alleging “a statutory violation,” without more, was “too speculative” a “theory of exposure to identity theft” to confer Article III standing on a plaintiff to litigate claims under the Fair and Accurate Credit Transactions Act and the Fair Credit Reporting Act.  Id. at 777, 783; see also Crupar–Weinmann v. Paris Baguette Am., Inc., 861 F.3d 76 (2d Cir. 2017); Meyers v. Nicolet Rest. of De Pere, LLC, 843 F.3d 724 (7th Cir. 2016).  The court determined that this bare procedural violation failed to establish a concrete harm and that plaintiff’s “theory of ‘exposure’ to identity theft”—premised on the printing of a few digits of his credit card on a parking receipt—”[was] . . . ‘too speculative for Article III purposes.'”  Bassett, 883 F.3d at 783 (quoting Missouri ex rel. Koster v. Harris, 847 F.3d 646, 654 (9th Cir. 2017)). In Hagy v. Demers & Adams, 882 F.3d 616 (6th Cir. 2018), the Sixth Circuit ruled that alleging a violation of the Fair Debt Collection Practices Act (“FDCPA”) is not enough to confer Article III standing.  The defendant’s attorney sent plaintiffs a debt-collection letter stating there would be no more “attempt[s] to collect any deficiency balance.”  Id. at 619.  This letter failed to disclose that it was a “communication . . . from a debt collector” in violation of the FDCPA.  Id. (quoting 15 U.S.C. § 1692e(11)).  The court determined that “[f]ar from causing . . . any injury, tangible or intangible, the . . . letter gave [plaintiffs] peace of mind.” Id. at 621.  It accordingly declined to elevate a “bare violation” of the statute to an injury sufficient for Article III standing, as “there must be some limits on Congress’s power to create injuries in fact suitable for judicial resolution.” Id. at 622-23. V.   California Court of Appeal Adopts Majority Position of Federal Courts of Appeals in Holding that the State’s Daubert Equivalent Applies at Class Certification In an important new decision, Apple Inc. v. Superior Court of San Diego County, 19 Cal. App. 5th 1101 (2018), the Court of Appeal held that Sargon Enterprises, Inc. v. University of Southern California, 55 Cal. 4th 747 (2012), which adopts a standard comparable to that by which federal courts evaluate the admissibility of expert testimony under Daubert v. Merrell Dow Pharmaceuticals, 509 U.S. 579 (1993), “applies to expert opinion evidence submitted in connection with a motion for class certification.”  Apple, 19 Cal. App. 5th at 1106.  The ruling aligns California law with the majority of federal courts of appeals. A proposed class of consumers sought certification of their putative class claims that a purportedly defective power button on older iPhone models decreased the phones’ value.  The plaintiffs relied on expert declarations to support their certification motion, and the trial court held that it did not need to apply the Sargon standard until evidentiary hearings later in the proceedings.  The Court of Appeal reversed, reasoning that certifying the class based on inadmissible evidence “would merely lead to its exclusion at trial, imperiling continued certification of the class and wasting the time and resources of the parties and the court.”  Apple, 19 Cal. App. 5th at 1117.  The court was careful to clarify, however, that the scope of Sargon‘s applicability at class certification was “limited . . . compared with the inquiry at trial” because the court “need not rule on the admissibility of certain expert opinion evidence” that is “irrelevant or unnecessary for [the class certification] decision.”  Id. at 1120. The ruling rested in part on the recognition that “[a]lthough some federal courts appear to have a largely semantic disagreement over whether to apply a ‘full’ or ‘focused’ Daubert analysis, the substantive result appears the same,” and these decisions show that applying the standard is both feasible and desirable.  Apple, 19 Cal. App. 5th at 1119-20.  Four circuits endorse a “full” Daubert analysis at class certification, see In re Blood Reagents Antitrust Litig., 783 F.3d 183 (3d Cir. 2015); In re Carpenter Co., No. 14-0302, 2014 WL 12809636 (6th Cir. Sept. 29, 2014); Sher v. Raytheon Co., 419 F. App’x 887 (11th Cir. 2011); American Honda Motor Co. v. Allen, 600 F.3d 813 (7th Cir. 2010), while the Eighth Circuit, and more recently, the Ninth Circuit, have adopted a more “focused” approach, see In re Zurn Pex Plumbing Prod. Liab. Litig., 644 F.3d 604 (8th Cir. 2011); Sali v. Corona Regional Medical Ctr., No. 15-56460 (9th Cir. May 3, 2018).  Although the Supreme Court has suggested that Daubert should apply to expert evidence at class certification, it has yet to squarely resolve the issue.  See Wal-Mart Stores, Inc. v. Dukes, 564 U.S. 338, 354 (2011) (“The District Court concluded that Daubert did not apply to expert testimony at the certification stage of class-action proceedings. . . . We doubt that is so. . . .”) (internal citation omitted). Apple v. Superior Court joins a growing body of case law recognizing that the “corrosive effects of improper expert opinion testimony may be felt with substantial force at class certification,” so courts must scrutinize such testimony at that stage.  19 Cal. App. 5th at 1119. The following Gibson Dunn lawyers prepared this client update: Christopher Chorba, Theane Evangelis, Kahn Scolnick, Bradley J. Hamburger, Lauren M. Blas, Gregory Bok, Jessica Culpepper, Wesley Sze, and Josh Burk. Gibson Dunn are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Class Actions or Appellate and Constitutional Law practice groups, or any of the following lawyers: Theodore J. Boutrous, Jr. – Co-Chair, Litigation Practice Group – Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com) Christopher Chorba – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com) Theane Evangelis – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com) Kahn A. Scolnick – Los Angeles (+1 213-229-7656, kscolnick@gibsondunn.com) Bradley J. Hamburger – Los Angeles (+1 213-229-7658, bhamburger@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.

May 4, 2018 |
Efforts to Strengthen U.S. Public Capital Markets Continue – New SIFMA Report Provides Recommendations to Help More Companies Go and Stay Public

Click for PDF On April 27, 2018, the Securities Industry and Financial Markets Association (“SIFMA”), the leading industry group representing broker-dealers, banks and asset managers, along with other securities industry related groups, released a report called “Expanding the On-Ramp: Recommendations to Help More Companies Go and Stay Public” (the “Report”).[1]  In response to the decline in the number of IPOs and the number of public companies generally in the United States over the last twenty years, the Report provides recommendations aimed at reducing perceived impediments to becoming and remaining a public company. As the Report notes, the United States is now home to only about half the number of public companies that existed 20 years ago.  This decline is believed to have had adverse repercussions for the American economy generally, and the jobs market specifically.  For example, the Report cites a 2010 study by IHS Global Insight suggesting that, generally speaking, 92% of a company’s job growth occurs after it completes an IPO.[2]  In addition, the growth of private capital markets at the expense of public capital markets has raised concerns that individual investors are being marginalized.  More specifically, as many of the most innovative companies in the U.S. stay private longer and raise significant amounts of capital privately, the returns generated by such companies appear to accrue disproportionally to institutional, high net worth and other similar investors.  As Securities and Exchange Commission (the “SEC”) Chairman Jay Clayton noted in a July 2017 speech, “the reduction in the number of U.S.-listed public companies is a serious issue for our markets and the country more generally.  To the extent companies are eschewing our public markets, the vast majority of main street investors will be unable to participate in their growth.  The potential lasting effects of such an outcome to the economy and society are, in two words, not good.” To remedy this decline, the Report makes recommendations in five areas: 1.      enhance several provisions of the Jumpstart Our Business Startups Act (the “JOBS Act”); 2.      encourage more research on emerging growth companies (“EGCs”)[3] and other small public companies; 3.      improve certain corporate governance, disclosure, and other regulatory requirements; 4.      address concerns relating to financial reporting; and 5.      tailor the equity market structure for small public companies. 1. Enhancing the JOBS Act Over the past six years, the JOBS Act has demonstrated that rules and regulations around capital raising can be modernized while maintaining investor protections.  Its accomodations have been widely adopted. The Report sets forth four recommendations to further enhance some of the key provisions of the JOBS Act: Extend Title I “on-ramp provisions.” The JOBS Act Title I “on-ramp” provisions  provide a number of significant benefits to EGCs, including confidential review of registration statements and streamlined financial and executive compensation disclosure requirements, among others.  The Report recommends that the benefits available to EGCs be extended from 5 years to 10 years after a company goes public.  The “on-ramp” provisions have been widely utilized by EGCs since enactment.  By increasing the length of time these benefits are available, the Report argues that even more companies may consider going public. Expand the “testing the waters” exemption to all issuers. The Report recommends that Section 5(d) of the Securities Act of 1933 (the “Securities Act”) be modified to permit all issuers, not just EGCs, to engage in “testing the waters” communications with qualified institutional buyers (“QIBs”) or institutional accredited investors to determine interest in a securities offering.  Consistent with this, in April 2018, SEC Director of Corporation Finance Bill Hinman reported to a congressional committee that the SEC is planning to expand the “testing the waters” benefit to all companies.  This change would allow companies to better understand investor interest prior to undertaking the expense of an IPO. Increase exemption for reporting on adequacy of internal controls from 5 to 10 years for EGCs. The JOBS Act gives EGCs a five-year exemption from Section 404(b) of the Sarbanes-Oxley Act, which requires external auditors to attest to the adequacy of the company’s internal control on financial reporting.  The Report recommends that this be extended from 5 years to 10 years for EGCs that have less than $50 million in revenue and less than $700 million in public float.  This change is designed to ensure that internal control reporting requirements, and associated costs, are appropriately scaled to the size of the company. Remove “phase out” rules relating to EGC status. The Report argues that the “phase out” rules related to EGC status should be removed, specifically given the overlap in certain status designations (e.g., companies who qualify as both a large accelerated filer and an EGC face uncertainty as to their status after going public. See Section 4 below).  Instead, issuers should be allowed to maintain their EGC status based on the JOBS Act definition.  The Report suggests that the SEC could still set a public float or other threshold requirement to limit the size of company that could benefit from the change in phase out triggers.[4] 2. Encourage More Research  Research coverage can increase interest from investors in a company, and a lack of research coverage can adversely impact liquidity for certain companies.  However, the Report notes that 61% of all companies listed on a major exchange with less than a $100 million market capitalization have no research coverage.  To address this disparity, the Report makes the following three recommendations: Amend the Securities Act Rule 139 research safe harbor to allow continuing research coverage for all issuers during an offering. The Report recommends that Rule 139 of the Securities Act be amended to provide that continued research analyst coverage does not constitute an offer or sale of securities, before, during, or after an offering by such issuer, regardless of whether the publishing broker-dealer is also an underwriter in the offering.  Currently, only issuers who are eligible to use Form S-3 qualify for the Rule 139 safe harbor.  As the Report notes, if an analyst has already been covering an issuer, there is no obvious logic to distinguishing companies that are S-3 eligible for the purposes of research coverage. Allow investment banking and research analysts to attend “pitch” meetings together. While the JOBS Act permits investment banks and analysts to jointly attend pitch meetings, given other restrictions on the content of what those discussions may contain, bankers and analysts typically refrain from jointly attending pitch meetings with IPO candidates.  The Report proposes that the SEC consider the removal of barriers prohibiting investment banks and analysts from jointly attending these meetings, as long as no direct or indirect promise of favorable research is given.  The Report also endorses reviewing the 2003 global research settlement between many large investment banks and the SEC, self-regulatory organizations, such as Financial Industry Regulatory Authority (“FINRA”), and other regulators regarding research analyst conflicts of interest (the “Global Research Settlement”).  The Global Research Settlement precludes settling firms from having research analysts attend EGC IPO pitch meetings, irrespective of the regulatory easing afforded by the JOBS Act.[5] Investigate why pre-IPO research remains limited. Despite the liberalization of “gun jumping” rules related to research as part of the JOBS Act, the Report states that very few investment banks have published any pre-IPO research.  The Report urges the SEC to investigate why the JOBS Act has not led to an increase in pre-IPO research.  This may be due to existing FINRA rules, the Global Research Settlement, and federal and state law liability concerns.  The Report advocates for the SEC to examine this issue in an effort to increase pre-IPO research coverage. 3. Improve Certain Corporate Governance, Disclosure and other Regulatory Requirements According to the 2011 IPO Task Force, a group convened in response to a capital access roundtable sponsored by the Department of the Treasury, 92% of U.S. public company CEOs have found the “administrative burden of public reporting” to be a significant barrier to completing an IPO.  In addition, pressure from activist investors (often supported by proxy advisory firms) can distract management from carrying out their management duties, which in turn costs shareholders.  In response to these and other pressures, the Report recommends the following eleven improvements to help deal with some of these issues: Institute reasonable and effective SEC oversight of proxy advisory firms. Proxy advisory firms have become so influential over public companies that they have in essence become the standard setters for corporate governance.  Two advisory firms effectively control the market: Institutional Shareholder Services (“ISS”) and Glass Lewis.  According to the Report, these firms operate with significant conflicts of interest and lack transparency, discouraging small and midsized companies from tapping into the public markets.  Legislation introduced in December 2017 would require proxy advisory firms to register with the SEC and to (1) disclose and manage their conflicts of interest, (2) provide issuers with reasonable time to respond to errors or flaws in advisory voting recommendations, and (3) demonstrate that they have the proper expertise to make accurate and objective recommendations.  The Report endorses the passage of this or similar legislation, and at a minimum, recommends the SEC’s withdrawal of the Egan-Jones Proxy Services (avail. May 27, 2004) and Institutional Shareholder Services, Inc. (avail. Sept. 15, 2004) no-action letters that minimize scrutiny of proxy advisory firms with respect to conflicts of interest. Reform shareholder proposal “resubmission thresholds” under Rule 14a-8 of the Securities Exchange Act of 1934 (the “Exchange Act”) to facilitate more meaningful shareholder engagement with management. Rule 14a-8 allows shareholders who own a relatively small amount of company shares to include qualifying proposals in a company’s proxy materials.  Under current law, Rule 14-8a(i)(12) (the “Resubmission Rule”) allows companies to exclude certain shareholder proposals that were voted on in recent years.  Specifically, a company may exclude a resubmitted proposal if in the last five years the proposal: was voted on once and received less than 3% of votes cast; was voted on twice and received less than 6% of votes cast the last time it was voted on; or was voted on three or more times and received less than 10% of votes cast the last time it was voted on. The Report asserts that the proxy process is currently subject to abuse by a “minority of special interests that use it to advance idiosyncratic agendas.”  The Report argues that raising these resubmission thresholds, as the SEC proposed in 1997 (6%, 15%, and 30%), is a “good starting point” to modernize the SEC’s shareholder proposal system. The Report also notes that the SEC should withdraw Staff Legal Bulletin 14H (Oct. 22, 2015), which effectively declawed Rule 14a-8(i)(9) that allowed companies to exclude certain shareholder proposals that directly conflict with a management proposal. Simplify quarterly reporting requirements. Due to the increased size and complexity of annual (Form 10-K) and quarterly (Form 10‑Q) reports, compliance has become increasingly costly and more difficult, especially for smaller companies.  The Report recommends granting EGCs the option of issuing a press release that includes quarterly earnings results in lieu of a full Form 10-Q.  This approach would simplify the quarterly reporting process for EGCs and reduce the burdens related to financial quarterly reporting, while at the same time still providing investors with necessary material information. The “materiality” standard for corporate disclosure should be maintained and certain disclosure requirements should be scaled for EGCs. The Report suggests that the SEC should maintain the longstanding “materiality” standard with respect to corporate disclosures.  The Report points to the conflict minerals and pay ratio rules under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) as examples of disclosure requirements that veer the application of securities laws away from their original mission to provide material information to investors.The Report also recommends that policymakers continue to scale down disclosure requirements for EGCs.  For example, the Report proposes exempting EGCs from conflict minerals, mine safety, and resources extraction disclosures implemented under the Dodd-Frank Act. Allow purchases of EGC shares to be qualifying investments for purposes of Registered Investment Adviser (“RIA”) exemption determinations. Under the Dodd-Frank Act, venture capital funds were meant to be exempt from the certain costs and requirements to become an RIA.  However, the definition of “venture capital fund” under the Investment Advisers Act is viewed by the Report as narrow, which limits the ability of these funds to invest in EGCs.  The Report argues that shares of EGCs should be considered qualifying investments, which would potentially expand investment in EGCs. Allow issuers of all sizes to be eligible to use Forms S-3 and F-3 for shelf registration. Many EGCs and small issuers are precluded from using the simplified registration statement Forms S-3 and F-3, which allows faster and cheaper access to public capital markets.  The Report, along with the SEC’s Annual Government-Business Forum on Small Business Capital Formation, recommends that all issuers be allowed to use Forms S-3 and F-3.[6]  In addition, the Report suggests eliminating the “baby-shelf” rules applicable to companies with a public float of less than $75 million, which limit the amount of capital a small-market cap company can raise using a shelf registration statement. Address unlawful activity related to short sales. There are currently no disclosure requirements applicable to investors who take short positions in publicly registered stock.  Although short selling can have positive effects on the overall market, the Report argues that such transactions can also lead to abusive activity that unduly harms investors or the reputation of a company.  The Report recommends that the SEC continue to take action against market manipulators who engage in unlawful activity that harms the market and ensure that there is sufficient public information with respect to potential market manipulation. Allow prospective underwriters to make offers of well-known seasoned issuer securities in advance of filing a registration statement. Since 2005, “well-known seasoned issuers” (or “WKSIs”) have been permitted to engage in oral or written communications in accordance with Securities Act Rule 163 in advance of filing a registration statement without violating “gun jumping” rules.  The SEC proposed an amendment in 2009 that would permit underwriters or dealers to engage in communications “by or on behalf of” WKSIs under similar circumstances, which would allow WKSIs to better gauge investor interest and market conditions prior to an offering.  The Report argues that this amendment should be enacted. Make eXtensible Business Reporting Language (“XBRL”) compliance optional for EGCs, smaller reporting companies (“SRCs”), and non-accelerated filers. Public companies are required to provide financial statements in XBRL, which imposes significant costs on EGCs and SRCs, and in the view of the Report, minimal benefit to investors.  Accordingly, the Report recommends exempting EGCs, SRCs, and non-accelerated filers from XBRL reporting requirements. Increase the diversified funds limit for mutual funds’ position in companies from current 10% of voting shares to 15%. Due to the increased size of mutual funds, the diversified fund thresholds have limited mutual funds’ ability to take meaningful positions in small-cap companies.  The Report argues that moving the threshold up from 10% to 15% would make investments in EGCs and other small-cap companies more attractive to mutual funds. Allow disclosure of selling stockholders to be done on a group basis. The Report recommends that disclosure of selling stockholders in registration statements should be permitted on a group or aggregate basis if each selling stockholder is (1) not a director or named executive officer of the registrant, and (2) holds less than 1% of outstanding shares. 4. Financial Reporting The SEC should consider aligning the SRC definition with the definition of a non-accelerated filer and institute a revenue-only test for pre- or low- revenue companies that may be highly valued. In 2016, the SEC proposed increasing the public float cap for SRCs from $75 million to $250 million, but did not do so with respect to non-accelerated filers that are subject to the same limit.  In the Report’s view, raising this cap for SRCs would help promote capital formation and reduce compliance costs for small companies, including scaled disclosure obligations under Regulation S-K for SRCs.  In addition, consideration should be given to whether the exemption available to non-accelerated filers from the requirement for auditor attestation over internal controls should also be extended to SRCs.  In particular, the Report points out that many companies may still choose to comply with auditor attestation requirements, noting that shareholders could also encourage issuers to maintain internal control systems similar to those called for by Sarbanes-Oxley Section 404(b).In addition, the 2016 SRC proposal introduced an alternative “revenue only” test for companies to qualify as an SRC if the company had less than $100 million in revenue, regardless of its public float.  The Report proposes that a revenue-only test should be considered as an alternative standard. Modernize the Public Company Accounting Oversight Board (“PCAOB”) inspection process related to internal control over financial reporting (“ICFR”). In 2007, the SEC issued Commission Guidance Regarding Management’s Report on Internal Controls over Financial Reporting under Section 13(a) or 15(d) of the Exchange Act (the “2007 Guidance”).  The 2007 Guidance was meant to allow companies to prioritize and focus on “what matters most” in assessing ICFR, principally those material issues that pose the greatest risk of material misstatements.  However, companies have continued to experience unintended ICFR-related burdens due to audit processes and PCAOB inspections.  The 2007 Guidance has not been effective due to changing interpretations of PCAOB standards for attestations during the inspection process.  Accordingly, the Report proposes that the 2007 Guidance should be updated to ensure that it is working as originally intended.  The Group also suggests that the PCAOB should consider an ICFR task force to address issues companies face as a result of the PCAOB inspection process and its consequences for audit firms and auditors.  Pre- and post-implementation reviews by the PCAOB would improve audit standard setting, prevent harmful impacts, and address the unintended consequences that result from implementation of new PCAOB auditing standards. 5. Tailoring Equity Market Structure for Small Public Companies While the overall U.S. equity markets have become more efficient due to venue competition and increased liquidity, some of these benefits have failed to reach small and mid-size stocks.  The Report makes two recommendations to address market structure challenges faced by these issuers: Examine tick sizes for EGCs and small capitalization stocks. The Report argues that the SEC should examine the appropriate tick size, which is the minimum price movement of a trading instrument, for EGCs and small capitalization stocks.  The Report notes that while stocks trading in penny increments may be an appropriate trading increment for large capitalization stocks, it may not be the best option for EGCs.  This is because narrower spreads resulting from penny increments may disincentivize market makers from trading in EGCs and small capitalization stocks.  Instead, individual exchanges should have the flexibility to develop tick sizes that are tailored for a limited number of stocks with distressed liquidity.[7] Allow EGCs or small issuers with distressed liquidity the choice to opt out of unlisted trading privileges. The Report recommends that a limited number of SRCs with distressed liquidity be able to opt out of unlisted trading privileges.  This would allow these less frequently traded stocks to focus their trading on fewer exchanges, thus enabling buyers and sellers to more easily find each other, providing more liquidity in these stocks.  This would also enable these companies to reduce fragmentation in trading, and simplify market making for these stocks. Conclusion Since at least 2012, the SEC and Congress have proposed various reforms[8] aimed at improving the attractiveness and competitiveness of the U.S. public capital markets.  In the last year, consistent with Chairman Clayton’s core principles,[9] the SEC has taken steps to further expand the benefits of the JOBS Act and the FAST Act to a broader range of companies, such as allowing non-EGCs to make confidential submissions of initial registration statements, permitting all companies to confidentially submit registration statements in connection with offerings within one year of an IPO and granting more waivers of financial statement requirements.  In addition, there have been a number of legislative proposals intended to further expand the benefits of the JOBS Act and the FAST Act.  The Report is consistent with these themes.  Congress and the SEC must now consider comprehensive reform in this vein and also consider how a complex system of regulations could be further simplified.  Ultimately, a company’s decision whether to go public is driven primarily by business rationales, including valuation, liquidity and investor considerations.  However, reducing the burdens of becoming and staying a public company without compromising investor protection will benefit both companies and investors, help ensure that the U.S. public capital markets remain attractive and competitive in the face of global competition, and provide more diverse investment opportunities for all investors.    [1]   SIFMA, Expanding the On-Ramp: Recommendations to Help More Companies Go and Stay Public, available at https://www.sifma.org/resources/submissions/expanding-the-on-ramp-recommendations-to-help-more-companies-go-and-stay-public (last visited April 27, 2018). Other organizations joining SIFMA in the Report included, among others, the U.S. Chamber of Commerce, the National Venture Capital Association, Biotechnology Innovation Organization (Bio), Technet and Nasdaq.    [2]   Id.    [3]   Under the JOBS Act, EGCs are defined as companies with less than $1.07 billion of annual revenue.    [4]   For a more complete discussion on the transition from EGC status, see our Alert from March 12, 2014, which is available at the following link:  https://www.gibsondunn.com/emerging-from-egc-status-transition-periods-for-former-egc-issuers-to-comply-with-reporting-and-corporate-governance-requirements/    [5]   For a more complete discussion of the interaction between the JOBS Act and the Global Research Settlement, see our alert from October 11, 2012, which is available at the following link: https://www.gibsondunn.com/jobs-act-finra-proposes-rule-changes-relating-to-research-analysts-and-underwriters/    [6]   See generally SEC Government-Business Forum on Small Capital Business Formation, which is available at the following link: https://www.sec.gov/files/gbfor36.pdf    [7]   For additional information, see the SEC’s investor alert titled “Investor Alert: Tick Size Pilot Program – What Investors Need to Know” which is available at the following link: https://www.sec.gov/oiea/investor-alerts-bulletins/ia_ticksize.html    [8]   For more information, see our post from October 13, 2017 titled “SEC Proposes Amendments to Securities Regulations to Modernize and Simplify Disclosure,” which is available at the following link: https://www.gibsondunn.com/sec-proposes-amendments-to-securities-regulations-to-modernize-and-simplify-disclosure/    [9]   See, e.g., “SEC to Tailor Disclosure Regime Under New Chair Clayton” (July 12, 2017), which is available at the following link: https://www.bna.com/sec-tailor-disclosure-n73014461648/ 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: Glenn R. Pollner – New York (+1 212-351-2333, gpollner@gibsondunn.com) Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com) Jessica Annis – San Francisco (+1 415-393-8234, jannis@gibsondunn.com) Nicolas H.R. Dumont – New York (+1 212-351-3837, ndumont@gibsondunn.com) Sean Sullivan – San Francisco (+1 415–393–8275, ssullivan@gibsondunn.com) Victor Twu – Orange County, CA (+1 949-451-3870, vtwu@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) Securities Regulation and Corporate Governance Group: 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) 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.

May 1, 2018 |
Federal District Court Enjoins Philadelphia Ordinance Prohibiting Employers from Asking Applicants About Their Wage History

Click for PDF On April 30, 2018, a federal judge in the Eastern District of Pennsylvania preliminarily enjoined enforcement of a Philadelphia Ordinance prohibiting employers from asking applicants about their wage history.[1]  Although over a dozen states and localities have recently enacted similar wage-history laws, this is the first court decision to rule on whether such laws violate employers’ First Amendment rights. Aimed at reducing the wage gap between men and women, the Ordinance imposes two prohibitions on Philadelphia employers:  It prohibits employers from inquiring about an applicant’s wage history and from relying on wage history to make a salary determination unless that history was knowingly and willingly disclosed by the applicant.[2] In a 59-page opinion, the District Court concluded that the plaintiff—the Chamber of Commerce for Greater Philadelphia, represented by Gibson Dunn—was entitled to a preliminary injunction prohibiting enforcement of the Ordinance’s inquiry provision.  The Court determined that the Chamber was likely to prevail on the merits of its First Amendment challenge for two reasons.  First, the Court held that wage-history inquiries do not concern unlawful activity under the first prong of the Central Hudson test for restrictions of commercial speech.[3]  “[W]hile using wage history to formulate salaries is made illegal” by the Ordinance, the Court reasoned, “other uses of wage history are not illegal.”[4]  The Court concluded that the City’s contrary position “would stand Central Hudson on its head.”[5] Second, the District Court held that the City had failed to show that the Ordinance “directly advances” a substantial government interest, as required under the third Central Hudson prong.[6]  Although the City had asserted a substantial interest in reducing discriminatory wage disparities, the Court ruled that the City’s evidence was “riddled with conclusory statements, amounting to ‘various tidbits’ and ‘educated guesses.'”[7]  “[M]ore is needed,” the Court emphasized.[8]  Without substantial evidence “that inquiry into salary history results in lower salaries for women and minorities,” it is “impossible to know whether the Inquiry Provision will directly advance the [City’s] substantial interests.”[9] The District Court also concluded that the other requirements for a preliminary injunction had been met.  The Court explained that the Chamber had demonstrated irreparable harm by “alleg[ing] a real and actual deprivation of its and its members’ First Amendment rights through declarations,” and that “the City cannot claim a legitimate interest in enforcing an unconstitutional law.”[10] The District Court did uphold the Ordinance’s provision prohibiting employers from relying on an applicant’s salary history in making a salary determination unless that history is knowingly and willingly disclosed.[11]  The Court reasoned that reliance on wage history is not speech for First Amendment purposes.[12]  Nonetheless, the Court’s decision preliminarily enjoining the Ordinance’s inquiry provision will enable employers to use wage-history information to ascertain prevailing market wages and to identify potentially unaffordable applicants at the outset of the hiring process.  The decision may also prompt employers to mount a First Amendment challenge to similar wage-history laws in other jurisdictions.    [1]   Chamber of Commerce for Greater Phila. v. City of Philadelphia, No. 17-1548, slip op. at 54 (E.D. Pa. Apr. 30, 2018).    [2]   Phila. Code §§ 9-1131(2)(a)(i)–(ii).    [3]   Chamber of Commerce for Greater Phila., No. 17-1548, slip op. at 12 (discussing Cent. Hudson Gas & Elec. Corp. v. Pub. Serv. Comm’n of N.Y., 447 U.S. 557, 566 (1980)).    [4]   Id. at 14.    [5]   Id. at 15.    [6]   Cent. Hudson, 447 U.S. at 566.    [7]   Chamber of Commerce for Greater Phila., No. 17-1548, slip op. at 30.    [8]   Id.    [9]   Id. at 30, 33–34. [10]   Id. at 46. [11]   See Phila. Code § 9-1131(2)(a)(ii). [12]   Chamber of Commerce for Greater Phila., No. 17-1548, slip op. at 40.   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: Miguel A. Estrada – Washington, D.C. (+1 202-955-8500, mestrada@gibsondunn.com) Amir C. Tayrani – Washington, D.C. (+1 202-887-3692, atayrani@gibsondunn.com) Kellam M. Conover – Washington, D.C. (+1 202-887-3755, kconover@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.

April 24, 2018 |
Supreme Court Clarifies That Inter Partes Review Must Decide All Challenged Claims

Click for PDF SAS Institute, Inc. v. Iancu, No. 16-969 Decided April 24, 2018 Today, the Supreme Court held 5-4 that if the Patent Trial and Appeal Board (PTAB) exercises its discretion to institute inter partes review, it must issue an opinion on all challenged claims. Background: Inter partes review is an administrative process in which the PTAB revisits the patentability of claims in existing patents. The PTAB may institute that review if the petitioner shows a “reasonable likelihood” of success on at least one claim. 35 U.S.C. § 314(a). If the PTAB institutes inter partes review, it “shall issue” a written decision as to the patentability of “any patent claim challenged by the petitioner.” 35 U.S.C. § 318(a). In this case, SAS Institute petitioned the PTAB for inter partes review of a certain patent. The PTAB reviewed only some of the claims, as U.S. Patent and Trademark Office (PTO) regulations permit. SAS Institute argues that the PTAB was required to issue a final decision on all of the claims. Issue: Whether the PTAB must issue a final written decision as to every claim challenged by the petitioner when it institutes an inter partes review. Court’s Holding: Yes, if the PTAB institutes inter partes review, it must rule on all challenged claims. “Even under Chevron, we owe an agency’s interpretation of the law no deference unless, after ‘employing traditional tools of statutory construction,’ we find ourselves unable to discern Congress’s. meaning.” Justice Gorsuch, writing for the majority What It Means: The Court determined that the statute’s plain text does not permit the PTAB to decide which claims to review when it grants inter partes review. Instead, if the PTAB decides that the petitioner is reasonably likely to succeed on at least one claim, the statute requires the PTAB to review all of the claims in the petition. The Court rejected SAS Institute’s invitation to overrule Chevron U.S.A. Inc. v. National Resources Defense Council, Inc., 467 U.S. 837 (1984), under which courts defer to reasonable agency interpretations of an ambiguous statute. Here, the Court held that the PTO is not entitled to deference because the statute is not ambiguous. The majority left open the possibility that the PTAB could deny a petition while noting that one or more claims merit reexamination and permitting the petitioners to file a new petition limited to those claims. The America Invents Act’s estoppel provisions prevent a petitioner from arguing that a claim is invalid, in a district court or before the International Trade Commission, on any ground raised or that reasonably could have been raised on inter partes review if the PTAB issues a final written decision on the claim. As a result of today’s decision, if the PTAB institutes review, every claim raised must be addressed—and so likely will trigger the estoppel provisions. The Supreme Court’s ruling may lead the PTAB to grant fewer petitions—meaning more patent litigation in the district courts. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders: Appellate and Constitutional Law Practice Caitlin J. Halligan +1 212.351.3909 challigan@gibsondunn.com Mark A. Perry +1 202.887.3667 mperry@gibsondunn.com Nicole A. Saharsky +1 202.887.3669 nsaharsky@gibsondunn.com Related Practice: Intellectual Property Wayne Barsky +1 310.552.8500 wbarsky@gibsondunn.com Josh Krevitt +1 212.351.4000 jkrevitt@gibsondunn.com Mark Reiter +1 214.698.3100 mreiter@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.

April 24, 2018 |
Supreme Court Upholds PTO Inter Partes Review of Patent Validity

Click for PDF Oil States Energy Services, LLC v. Greene’s Energy Group, LLC, No. 16-712 Decided April 24, 2018 The Supreme Court held 7-2 that the U.S. Patent and Trademark Office’s inter partes review process does not violate the Constitution. Background: In 2011, Congress passed the America Invents Act, which created a new adversarial process within the U.S. Patent and Trademark Office (PTO), known as inter partes review. This process allows anyone to challenge the validity of an existing patent on the grounds that the patent was anticipated by is or obvious in light of the prior art. Under that process, the Patent Trial and Appeal Board (PTAB) – rather than a federal court – decides whether to cancel or confirm a challenged patent, subject to deferential review by the Federal Circuit. Issue: Whether inter partes review violates Article III’s grant of judicial power to the federal courts and the Seventh Amendment’s right to a jury trial. Court’s Holding: No, patents are public rights, and not purely private rights, so Congress may allow non-Article III tribunals (like the PTAB) to adjudicate those rights. “[T]he decision to grant a patent is a matter involving public rights—specifically, the grant of a public franchise. Inter partes review is simply a reconsideration of that grant, and Congress has permissibly reserved the PTO’s authority to conduct that reconsideration.” Justice Thomas, writing for the majority Gibson Dunn filed an amicus brief defending inter partes review for Dell, Facebook, Hewlett Packard, Twitter and others. What It Means: The Court held that patents are public rights that may be granted, abridged, or withdrawn without adjudication by an Article III court or factfinding by a jury. The Court explained that a patent owner’s property rights in an issued patent are subject to PTO’s authority to reexamine or cancel the patent. Although inter partes review resembles adversarial litigation, it determines a party’s patent right against the government – not liability between private parties. The Court rejected the argument that, historically, the validity of a patent could only be challenged in court. Instead, drawing on the argument that Gibson Dunn made in its amicus brief, the Court concluded that inter partes review is consistent with historical practice under the English patent system. The Court emphasized that its holding is narrow and that it did not decide whether infringement actions or other patent matters could be heard outside of an Article III court or whether the retroactive application of inter partes review is constitutional. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders: Appellate and Constitutional Law Practice Caitlin J. Halligan +1 212.351.3909 challigan@gibsondunn.com Mark A. Perry +1 202.887.3667 mperry@gibsondunn.com Nicole A. Saharsky +1 202.887.3669 nsaharsky@gibsondunn.com   Related Practice: Intellectual Property Wayne Barsky +1 310.552.8500 wbarsky@gibsondunn.com Josh Krevitt +1 212.351.4000 jkrevitt@gibsondunn.com Mark Reiter +1 214.698.3100 mreiter@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.

April 24, 2018 |
Supreme Court Holds That Foreign Corporations Cannot Be Sued Under The Alien Tort Statute

Click for PDF Jesner v. Arab Bank, PLC, No. 16-499 Decided April 24, 2018 Today, the Supreme Court held 5-4 that a foreign corporation may not be sued under the Alien Tort Statute. Background: The Alien Tort Statute of 1789 (ATS) provides that foreign nationals may sue in federal court “for a tort only, committed in violation of the law of nations or a treaty of the United States.” 28 U.S.C. § 1350. In recent years, plaintiffs increasingly have relied on the ATS to sue multinational corporations and banks in federal courts for alleged terrorist activities and human rights violations abroad. In this case, the plaintiffs sued Arab Bank, PLC—a Jordanian financial institution with a branch in New York—alleging that the bank helped finance terrorist attacks in the Middle East. Issue: Whether foreign corporations can be sued in federal court in the United States under the ATS. Court’s Holding: No. Neither the language of the ATS nor the Court’s precedents interpreting it supports extending the statute to reach suits against foreign corporations. The political branches, rather than the courts, are responsible for weighing foreign-policy concerns and deciding whether foreign corporations should face liability for acts like those at issue in this case. The Judiciary is “not well suited to make the required policy judgments that are implicated by corporate liability in cases like this one.” “[A]bsent further action from Congress it would be inappropriate for courts to extend ATS liability to foreign corporations.” Justice Kennedy, writing for the majority What It Means: Although the decision does not resolve whether plaintiffs may sue U.S. corporations under the ATS, it does stop the recent trend of plaintiffs using the ATS to sue foreign corporations and foreign financial institutions in the United States. Jesner joins a line of recent precedents refusing to create new private rights of action and reiterating that the decision to attach liability to certain conduct is best left to Congress. By clearly prohibiting ATS liability against foreign corporations, the decision may strengthen the arguments of U.S. corporations seeking to dismiss an ATS suit when the underlying claim is based on the conduct of a foreign affiliate. The decision may place greater pressure on Congress to legislate in this area. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court.  Please feel free to contact the following practice leaders: Appellate and Constitutional Law Practice Caitlin J. Halligan +1 212.351.3909 challigan@gibsondunn.com Mark A. Perry +1 202.887.3667 mperry@gibsondunn.com Nicole A. Saharsky +1 202.887.3669 nsaharsky@gibsondunn.com Related Practice: Transnational Litigation William E. Thomson +1 213.229.7891 wthomson@gibsondunn.com Andrea E. Neuman +1 212.351.3883 aneuman@gibsondunn.com Perlette Michèle Jura +1 213.229.7121 pjura@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.

April 23, 2018 |
FinCEN Issues FAQs on Customer Due Diligence Regulation

Click for PDF On April 3, 2018, FinCEN issued its long-awaited Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions, FIN-2018-G001. https://www.fincen.gov/resources/statutes-regulations/guidance/frequently-asked-questions-regarding-customer-due-0.[1]  The timing of this guidance is very controversial, issued five weeks before the new Customer Due Diligence (“CDD”) regulation goes into effect on May 11, 2018.[2]  Most covered financial institutions (banks, broker-dealers, mutual funds, and futures commission merchants and introducing brokers in commodities) already have drafted policies, procedures, and internal controls and made IT systems changes to comply with the new regulation.  Covered financial institutions will need to review these FAQs carefully to ensure that their proposed CDD rule compliance measures are consistent with FinCEN’s guidance. The guidance is set forth in 37 questions.  As discussed below, some of the information is helpful, allaying financial institutions’ most significant concerns.  Other FAQs confirm what FinCEN has said in recent months informally to industry groups and at conferences.  A few FAQs raise additional questions, and others, particularly the FAQ on rollovers of certifications of deposit and loan renewals, are not responsive to industry concerns and may raise significant compliance burdens for covered financial institutions.  The guidance reflects FinCEN’s regulatory interpretations based on discussions within the government and with financial institutions and their trade associations.  The need for such extensive guidance on so many issues in the regulation illustrates the complexity of compliance and suggests that FinCEN should consider whether clarifications and technical corrections to the regulation should be made.  We provide below discussion of highlights from the FAQs, including areas of continued ambiguity and uncertainty in the regulation and FAQs. Highlights from the FAQs FAQ 1 and 2 discuss the threshold for obtaining and verifying beneficial ownership.  FinCEN states that financial institutions can “choose” to collect beneficial ownership information at a lower threshold than required under the regulation (25%), but does not acknowledge that financial institution regulators may expect a lower threshold for certain business lines or customer types or that there may be regulatory concerns if financial institutions adjust thresholds upward to meet the BSA regulatory threshold.  A covered financial institution may be in compliance with the regulatory threshold, but fall short of regulatory expectations. FAQ 7 states that a financial institution need not re-verify the identity of a beneficial owner of a legal entity customer if that beneficial owner is an existing customer of the financial institution on whom CIP has been conducted previously provided that the existing information is “up-to-date, accurate, and the legal entity’s customer’s representative certifies or confirms (verbally or in writing) the accuracy of the pre-existing CIP information.”  The example given suggests that no steps are expected to verify that the information is up-to-date and accurate beyond the representative’s confirmation or certification.  The beneficial ownership records must cross reference the individual’s CIP record. FAQs 9-12 address one of the most controversial aspects of the regulation, about which there has been much confusion: the requirement that, when an existing customer opens a new account, a financial institution must identify and verify beneficial ownership information.  FinCEN provides further clarity on what must be updated and how:Under FAQ 10, if a legal entity customer, for which the required beneficial ownership information has been obtained for an existing account, opens a new account, the financial institution can rely on the information obtained and verified previously “provided the customer certifies or confirms (verbally or in writing) that such information is up-to-date and accurate at the time each subsequent new account is opened,” and the financial institution has no knowledge that would “reasonably call into question” the reliability of the information.  The financial institution also would need to maintain a record of the certification or confirmation by the customer.There is no grace period.  If an account is opened on Tuesday, and a new account is opened on Thursday, the certification or confirmation is still required.  In advance planning for compliance, many financial institutions had included a grace period in their procedures. FAQ 11 provides that, when the financial institution opens a new account or subaccount for an existing legal entity customer whose beneficial ownership has been verified for the institution’s own recordkeeping and operational purposes and not at the customer’s request, there is no requirement to update the beneficial ownership information for the new account.  This is because the account would be considered opened by the financial institution and the requirement to update only applies to each new account opened by a customer.  This is consistent with what FinCEN representatives have said at recent conferences.The FAQ specifies that this would not apply to (1) accounts or subaccounts set up to accommodate a trading strategy of a different legal entity, e.g., a subsidiary of the customer, or (2) accounts of a customer of the existing legal entity customer, “i.e., accounts (or subaccounts) through which a customer of a financial institution’s existing legal entity carries out trading activity through the financial institution without intermediation from the existing legal entity customer.”  We believe the FAQ may fall far short of addressing all the concerns expressed to FinCEN on this issue by the securities industry. FAQ 12 addresses an issue which has been a major concern to the banking industry:  whether beneficial ownership information must be updated when a certificate of deposit (“CD”) is rolled over or a loan is renewed.  These actions are generally not considered opening of new accounts by banks.FinCEN continues to maintain that CD rollovers or loan renewals are openings of new accounts for purposes of the CDD regulation.  Therefore, the first time a CD or loan renewal for a legal entity customer occurs after May 11, 2018, the effective date of the CDD regulation, beneficial ownership information must be obtained and verified, and at each subsequent rollover or renewal, there must be confirmation that the information is current and accurate (consistent with FAQ 10) as for any other new account for an existing customer.  There is an exception or alternative approach authorized in FAQ 12 “because the risk of money laundering is very low”:  If, at the time of the rollover or renewal, the customer certifies its beneficial ownership information, and also agrees to notify the financial institution of any change in information in the future, no action will be required at subsequent renewals or rollovers.The response in FAQ 12 is not responsive to the concerns that have been expressed by the banking industry and will be burdensome for banks to administer.  Obtaining a certification in time, without disrupting the rollover or renewal, will be challenging, and it appears that if it the certification or promise to update is not obtained in time, the account may have to be closed. FAQs 13 through 17 address another aspect of the regulation that has generated extensive discussion: When (1) must beneficial ownership be obtained for an account opened before the effective date of the regulation, or (2) beneficial ownership information updated on existing accounts whose beneficial ownership has been obtained and verified.Following closely what was said in the preamble to the final rule, FAQ 13 states that the obligation is triggered when a financial institution “becomes aware of information about the customer during the course of normal monitoring relevant to assessing or reassessing the risk posed by the customer, and such information indicates a possible change in beneficial ownership.”FAQ 14 clarifies somewhat what is considered normal monitoring but is not perfectly clear what triggers obtaining and verifying beneficial ownership.  It is clear that there is no obligation to obtain or update beneficial ownership information in routine periodic CDD reviews (CDD refresh reviews) “absent specific risk-based concerns.” We would assume that means, following FAQ 13, concerns about the ownership of the customer.  Beyond that FAQ 14  is less clear.  It states that the obligation is triggered “when, in the course of normal monitoring a financial institution becomes aware of information about a customer or an account, including a possible change of beneficial ownership information, relevant to assessing or reassessing the customer’s overall risk profile.  Absent such a risk-related trigger or event, collecting or updating of beneficial ownership information is at the discretion of the covered financial institution.”The trigger or event may mean in the course of SAR monitoring or when conducting event-driven CDD reviews, e.g., when a subpoena is received or material negative news is identified – something that may change a risk profile.  Does the obligation then arise only if the risk profile change includes a concern about whether the financial institution has accurate ownership information?  That may be the intent, but is not clearly stated.  If the account is being considered for closure because of the change in risk profile, would the financial institution be released from the obligation to obtain beneficial ownership?   That would make sense, but is not stated.  This FAQ is in need of clarification and examples would be helpful.On another note, the language in FAQ 14 also is of interest because it may suggest, in FinCEN’s view, that periodic CDD reviews should be conducted on a risk basis, and CDD refresh reviews may not be expected for lower risk customers, as is the practice for some banks. FAQ 18 seems to address at least partially a technical issue with the regulation that arises because SEC-registered investment advisers are excluded from the definition of legal entity customer in the regulation, but U.S. pooled investment vehicles advised by them are not excluded.[3]  FAQ 18 states that, if the operator or adviser of a pooled investment vehicle is not excluded from the definition of legal entity customer, under the regulation, e.g., like a foreign bank, no beneficial ownership information is required to be obtained on the pooled investment vehicle under the ownership prong, but there must be compliance with beneficial ownership control party prong, i.e., verification of identity of a control party.  A control party could be a “portfolio manager” in these situations.FinCEN describes why no ownership information is required as follows:  “Because of the way the ownership of a pooled investment vehicle fluctuates, it would be impractical for covered financial institutions to collect and verify ownership identity for this type of entity.”  Thus, in the case where the operator or adviser of the pooled investment vehicle is excluded from the definition of legal entity, like an SEC-registered investment adviser, it would seem not to be an expectation to obtain beneficial ownership information under the ownership prong.  Nevertheless, the question of whether you need to obtain and verify the identity of a control party for a pooled investment vehicle advised by a SEC registered investment adviser is not squarely answered in the FAQ.  A technical correction to the regulation is still needed, but it is unlikely there would be regulatory or audit criticism for following the FAQ guidance at least with respect to the ownership prong. FAQ 19 clarifies that, when a beneficial owner is a trust (where the legal entity customer is owned more than 25% by a trust), the financial institution is only required to verify the identity of one trustee if there are multiple trustees. FAQ 20 deals with what to do if a trust holds more than a 25% beneficial interest in a legal entity customers and the trustee is not an individual, but a legal entity, like a bank or law firm.  Under the regulation, if a trust holds more than 25% beneficial ownership of a legal entity customer, the financial institution must verify the identity of the trustee to satisfy the ownership prong of the beneficial ownership requirement.  The ownership prong references identification of “individuals.”  Consequently, the language of the regulation does not seem to contemplate the situation where the trustee was a legal entity.FAQ 20 seems to suggest that, despite this issue with the regulation, CIP should be conducted on the legal entity trustee, but apparently, on a risk basis, not in every case:  “In circumstances where a natural person does not exist for purposes of the ownership/equity prong, a natural person would not be identified.  However, a covered financial institution should collect identification information on the legal entity trustee as part of its CIP, consistent with the covered institution’s risk assessment and customer risk profile.”  (Emphasis added.)More clarification is needed on this issue, and perhaps an amendment to the regulation to address this specific situation.  Pending additional guidance, the safest course appears to be to verify the identity of legal entity trustee consistent with CIP requirements, which may pose practical difficulties, e.g., will a law firm trustee easily provide its TIN?  Presumably, CIP would not be required on any legal entity trustee that is excepted from the definition of legal entity under 31 C.F.R. § 1010.230(e)(2). FAQ 21 addresses the question of how does a financial institution verify that a legal entity comes within one of the regulatory exceptions to the definition of legal entity customer in 31 C.F.R. § 1010.230(e)(2).  The answer is that the financial institution generally can rely on information provided by the customer if it has no knowledge of facts that would reasonably call into question the reliability of the information.  Nevertheless, that is not the end of the story.  The FAQ provides that the financial institution also must have risk-based policies and procedures that specify the type of information they will obtain and reasonably rely on to determine eligibility for exclusions. FAQ 24 may resolve another technical issue in the regulation.  The exceptions to the definition of legal entity in the regulation refer back to the BSA CIP exemption provisions, which in turn, cross reference the Currency Transaction Reporting (CTR) exemption for banks when granting so-called Tier One exemptions.  One category for the CTR exemption is “listed” entities, which includes NASDAQ listed entities, but excludes NASDAQ Capital Markets Companies, i.e., this category of NASDAQ listed entity is not subject to CIP or CTR Tier One exemptions.  31 C.F.R. § 1020.315(b)(4).  This carve out was not discussed in the preamble to the CDD final regulation or in FAQ 24.The FAQ simply states:  “[A]ny company (other than a bank) whose common stock or analogous equity interests are listed on the New York Stock Exchange, the American Stock Exchange (currently known as the NYSE American), or NASDAQ stock exchange” is excepted from the definition of legal entity.  In any event, as with the FAQ 18 issue, it would appear that a technical correction is needed on this point, but, given the FAQ, it is unlikely that a financial institution would be criticized if it treated NASDAQ Capital Markets Companies as excepted legal entities. FAQs 32 and 33 end the speculation that the CDD regulation impacts CTR compliance.  Consistent with FinCEN CTR guidance, under FAQ 32, the rule remains that, for purposes of CTR aggregation, the fact that two businesses share a common owner does not mean that a financial institution must aggregate the currency transactions of the two businesses for CTR reporting, except in the narrow situation where there is a reason to believe businesses are not being operated separately. Conclusion Financial institutions and their industry groups will likely continue to seek further guidance on the most problematic issues in the CDD regulation.  It is our understanding that FinCEN and the bank regulators also will address compliance with the CDD regulation in the upcoming update to the FFIEC Bank Secrecy Act/Anti-Money Laundering Examination Manual. Covered financial institutions already have spent, and will continue to spend, significant time and resources to meet the complex regulatory requirements and anticipated regulatory expectations.  In this flurry of activity to address regulatory risk, it is essential for financial institutions to continue to consider any money laundering risk of legal entity clients and that CDD not become simply mechanical.  It is not only a matter of documenting and updating all of the right information about beneficial ownership and control, but financial institutions should continue to assess whether the ownership structure makes sense for the business or whether it is overly complex for the business type and purposely opaque.  Also, it is important to consider whether it makes sense for a particular legal entity to be seeking a relationship with your financial institution and whether the legal entity is changing financial institutions voluntarily.  CDD measures to address regulatory risk and money laundering risk overlap but are not equivalent.    [1]   FinCEN also issued FAQs on the regulation on July 19, 2016. https://www.fincen.gov/sites/default/files/2016-09/FAQs_for_CDD_Final_Rule_%287_15_16%29.pdf.   FINRA issued guidance on the CDD regulation in FINRA Notice to Members 17-40 (Nov. 21, 2017). http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-40.pdf.    [2]   The Notice of Final Rulemaking was published on May 11, 2016 and provided a two-year implementation period.  81 Fed. Reg. 29,398 (May 11, 2016). https://www.gpo.gov/fdsys/pkg/FR-2016-05-11/pdf/2016-10567.pdf.  FinCEN made some slight amendments to the rule on September 29, 2017.  https://www.fincen.gov/sites/default/files/federal_register_notices/2017-09-29/CDD_Technical_Amendement_17-20777.pdf The new regulations are set forth in the BSA regulations at 31 C.F.R. § 1010.230 (beneficial ownership requirements); 31 C.F.R. § 1020.210(a)(5) (banks); 31 C.F.R. § 1023.210(b)(5) (broker-dealers); 31 C.F.R. § 1024.210(b)(4) (mutual funds); and 31 C.F.R. § 1026.210(b)(5) (future commission merchants and introducing brokers in commodities).    [3]   The regulation does not clearly address the beneficial ownership requirements for a U.S. pooled investment vehicle operated or controlled by a registered SEC investment adviser.  Pooled investment vehicles operated or advised by a “financial institution” regulated by a Federal functional regulator are not considered legal entities under the regulation.  31 C.F.R. § 1010.230(e)(2)(xi).  An SEC registered investment adviser, however, is not yet a financial institution under the BSA.  Under 31 C.F.R. § 1010.230(e)(3), a pooled investment vehicle that is operated or advised by a “financial institution” not excluded from the definition of legal entity is subject to the beneficial ownership control party prong. 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 Financial Institutions practice group, or the authors: Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Linda Noonan – Washington, D.C. (+1 202-887-3595, lnoonan@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.

April 18, 2018 |
Does a Nonresident Del. Officer’s Service to a Corporation Allow Courts to Compel Testimony?

New York partner James Hallowell and New York associate Lee Crain are the authors of “Does a Nonresident Del. Officer’s Service to a Corporation Allow Courts to Compel Testimony?” [PDF] published by Delaware Business Court Insider on April 18, 2018.