Jeff Shapiro, Author at Gibson Dunn

By Jim Moloney, Partner, Gibson Dunn

Lock-ups are quite common in business combination and similar transactions, but when can such arrangements lead to questions about whether the transaction is subject to Rule 13e-3? This is an issue that most deal practitioners do not consider until they receive comments from the SEC Staff (the “Staff”) asking for their Rule 13e-3 analysis.

As many practitioners know, a “going private” transaction is, simply put, one in which a publicly-held company, or an affiliate of such company, seeks to acquire a registered class of the company’s outstanding securities, thereby taking the company private and excluding public shareholders from continued equity ownership in the company. Rule 13e-3 defines a going private transaction as any one or a series of transactions (involving a securities purchase, tender offer, or specified proxy solicitation) by an issuer or an affiliate of the issuer, which has a reasonable likelihood or purpose of directly or indirectly (i) causing any registered class of equity securities to be eligible for termination of registration, or eligible for termination or suspension of reporting obligations; or (ii) causing any listed class of equity securities to cease to be listed on a national securities exchange.¹ Due to the potential for abuse and overreaching by the issuer and/or its affiliates, who may be viewed as having roles on both sides of the transaction, and the significant impact that such transactions can have on minority shareholders,² Rule 13e-3 imposes certain filing, dissemination, heightened disclosure, and antifraud requirements on issuers and their affiliates engaged in these types of transactions.

A person engaging in a transaction will be viewed as an “affiliate” if such person directly or indirectly “controls, is controlled by, or is under common control with” the issuer.³ The element of “control” is fundamental to the concept of “affiliate,” and the Staff has stated that “[t]he determination of whether a person is in control of an issuer, of course, depends on all of the facts and circumstances.”⁴

As noted above, it is not unusual for acquirors to purchase securities and/or enter into lock-ups (e.g., voting, tender or support agreements) in order to increase the likelihood the transaction will be successful. Such agreements are often negotiated and entered into with significant shareholders at or near the time that the merger or other acquisition agreement is signed with the target company. Of course, the timing of these events and disclosures related to the parties’ ultimate intentions with respect to the target company will vary from transaction to transaction.

Still, it should come as no surprise that the Staff closely scrutinizes business combination transactions, often probing into whether the facts of a particular transaction involve one or more affiliates, thereby triggering the application of Rule 13e-3.⁵ Therefore, careful planning and structuring is important to limit the potential application of those heightened disclosure requirements that are better suited to a truly “affiliated” transaction. For example, where an acquiror has sought to lock-up a deal, the Staff may question whether the acquiror has in fact become an affiliate prior to or during the course of the transaction, such that Rule 13e-3 should apply to the deal.⁶

Depending on the facts, including whether shares are purchased in advance, optioned, or subject to a voting, tender, or support agreement, the specific terms of the arrangement can influence whether Rule 13e-3 is implicated. Of course, where the acquiror purchases a significant amount of target securities well before the business combination transaction, the likelihood of Staff inquiry regarding affiliate status, and risk of Rule 13e-3 applying, is at its greatest. Whereas a plain vanilla lock-up entered into at the same time as the merger or other acquisition agreement is signed, without other indicia of affiliation or control, presents less of a risk. But there are many scenarios that fall in between these two ends of the spectrum that can raise red flags for a Staff member seeking to uncover a hidden going private transaction.⁷ Accordingly, acquirors will want to take steps to ensure that the terms, timing and disclosures surrounding their lock-ups and business combinations do not implicate Rule 13e-3, especially when the transaction started out as an otherwise unaffiliated arm’s-length negotiated deal.

When entering into lock-ups and signing up deals, few stop to consider the legal basis for why such arrangements generally do not implicate the Rule. The key provision here is paragraph (g)(1) of Rule 13e‑3 which generally excludes transactions by a person “that occur within one year of the termination of a tender offer in which such person was the bidder and became an affiliate of the issuer as a result of such tender offer,” from application of the Rule so long as certain so-called “unitary transaction” requirements are met.⁸ More specifically, paragraph (g)(1) provides that an unaffiliated acquiror that negotiates at arm’s-length an acquisition transaction and locks-up a controlling block of target company shares may avoid being deemed an “affiliate” for purposes of Rule 13e-3 so long as the transaction satisfies all of the following criteria:

The acquiror is not an affiliate of the issuer prior to the initial acquisition of the securities by the acquiror. The acquiror and issuer must not have an affiliate relationship prior to the initial acquisition of the securities.⁹
The initial and “second-step” transactions are made pursuant to an agreement for the acquisition of all of the securities at the same price. The acquiror who locks-up a significant amount of the issuer’s shares must acquire all of the issuer’s securities at the same price.
The intention of the acquiror to engage in the second-step transaction is publicly announced at the time of the initial acquisition, including the form and effect of such transaction and the proposed terms of the transaction, if known. The acquiror’s plans for the entire transaction must be unequivocally and publicly disclosed at the commencement of the first-step transaction to ensure that the second-step transaction is indeed based upon arm’s-length negotiations and not upon the use of any control position resulting from the completion of the first step.¹⁰
The second-step transaction is effected within one year from the expiration of the tender offer.
The acquiror does not change the management or the board of directors, or otherwise seek to exercise control, of the issuer prior to the completion of the second-step transaction. The acquiror must not subsequently exercise control over the issuer by virtue of its newfound “affiliate” status as a result of the first step, and instead must ensure the transaction proceeds on an arm’s-length basis.

Unfortunately, the conditions of (g)(1) are not always squarely met, or the facts of a transaction may play out in a way that precludes reliance on the exception to the Rule. For example, there are circumstances where the acquiror purchases securities from a controlling shareholder prior to commencement of the tender offer (or signing of the merger agreement), and in those situations, the Staff has generally concluded that it would not be eligible to rely on the (g)(1) exception.

Similarly, where the acquiror enters into a lock-up agreement and the issuer or controlling shareholder has granted the bidder an option (which is immediately exercisable) to purchase a significant amount of securities, the Staff will generally view such acquiror as an affiliate for Rule 13e-3 purposes. The one exception to this position is where the lock-up agreement is subject to substantial conditions beyond the control of the parties (e.g., a top-up option with the issuer to reach the short-form merger threshold or an option with a controlling shareholder that a majority of unaffiliated shareholders vote in favor of the transaction or tender their shares in the offer). In those situations, the agreement is unlikely to render the acquiror an affiliate. All important considerations to take into account before rushing to lock-up that next big deal.

Conclusion
It is important to keep in mind the conditions in (g)(1) and the various Staff no-action letters¹¹ when structuring business combination transactions (e.g., how and when lock-ups are entered into and securities acquired) as well as the related disclosures regarding any intentions of the acquiror to take the target company private or engage in subsequent securities acquisitions. Through careful structuring of lock-ups and drafting of disclosures related to future intentions,¹² otherwise unaffiliated acquirors can avoid, or at least minimize, Staff inquiries into the potential application of the “going private” provisions of Rule 13e-3. Certainly, one clear path is to ensure the transaction satisfies the conditions of Rule 13e-3(g)(1), so that the acquisition will be viewed as a single, unitary transaction by a non-affiliate, and thus fall safely beyond the reach of Rule 13e-3.

***

This article was originally published in the September-October 2013 edition of Deal Lawyers, with the assistance of former associate Nicole Behesnilian.

¹ Exchange Act Rule 13e-3.

² See Exchange Act Release No. 17719 (April 13, 1981) (“Because a going private transaction is undertaken either solely by the issuer or by the issuer and one or more of its affiliates, standing on both sides of the transaction, the terms of the transaction, including the consideration received and other effects upon unaffiliated security holders, may be designed to accommodate the interests of the affiliated parties rather than determined as a result of arm’s length negotiations.”) (hereinafter “Release No. 17719”).

³ Rule 13e-3(a)(1).

⁴ See Exchange Act Release No. 16075 (Aug. 2, 1979). While share ownership is a factor in the “control” determination, the Staff has also stated that the ownership of any specific percentage of securities is not dispositive of whether a shareholder controls, and is therefore an affiliate of, an issuer.

⁵ See Shane de Búrca, The Definition of Affiliates under the SEC’s Going Private Rule, Insights, Vol. 18 No. 8, August 2004 (detailing the extent to which the Staff will sometimes go to find an affiliation with the issuer when seeking to apply Rule 13e-3).

⁶ See, e.g., Turbosonic Technologies Inc. Response to SEC Comment Letter (Dec. 6, 2012), available at http://www.sec.gov/Archives/edgar/data/900393/000089109212007277/filename1.htm (voting agreements with company founder and executive officers with approximately 21% addressed in Rule 13e-3 analysis); Icahn Enterprises Holdings L.P. Response to SEC Comment Letter (Jan. 6, 2011), available at http://www.sec.gov/Archives/edgar/data/1034563/000119312511002613/filename1.htm (bidder’s ownership of approximately 15% prompting comments on application of Rule 13e-3); American Community Properties Trust Response to SEC Comment Letter (Nov. 27, 2009), available at http://www.sec.gov/Archives/edgar/data/1065645/000114036109027623/filename1.htm (voting agreements with shareholders holding approximately 47% triggering Staff comments regarding application of Rule 13e-3 to transaction); First Montauk Financial Corp. Response to SEC Comment Letter (Jul. 14, 2006), available at http://www.sec.gov/Archives/edgar/data/83125/000008312506000028/filename1.txt (buyer’s acquisition of shares and lock-ups covering approximately 49% triggering Staff comments regarding affiliation and application of Rule 13e-3 to transaction). See also Release No. 17719, Question and Answer No. 8.

⁷ Even the mere reservation of the right to purchase target company shares has given rise to Staff inquiry regarding the availability of Rule 13e-3(g)(1). SEC Comment Letter Issued to Immucor, Inc. (Jul. 26, 2011), available at http://www.sec.gov/Archives/edgar/data/736822/000000000011045311/filename1.pdf (bidder reserving right to purchase target company shares on the open market in a twostep transaction triggering Staff comment regarding availability of Rule 13e-3(g)(1)); SEC Comment Letter Issued to Pyramid Breweries Inc. (Jul. 14, 2008), available at http://www.sec.gov/Archives/edgar/data/1001917/000000000008034738/filename1.pdf (same); SEC Comment Letter Issued to Digimarc Corporation (Jul. 14, 2008), available at http://www.sec.gov/Archives/edgar/data/1089443/000000000008034743/filename1.pdf (same); SEC Comment Letter Issued to Onyx Software Corporation (Jul. 18, 2006), available at http://www.sec.gov/Archives/edgar/data/1014383/000000000006033386/filename1.txt (buyer indicating uncertainty as to whether second-step merger would be consummated giving rise to Staff comment regarding applicability of Rule 13e-3(g)(1)).

⁸ Rule 13e-3(g)(1). See Release No. 17719, Question and Answer No. 8. The Staff has also taken a no-action position that the transactions set forth in paragraph (g)(1) do not trigger Rule 13e-3’s heightened disclosure obligations when the unitary transaction conditions are present. See no-action letters re. Federal-Mogul Corp. (avail. Sep. 29, 1980) and HM Acquisition Corp. (avail. Mar. 2, 1981), where the Staff took a no-action position with respect to the applicability of Rule 13e-3 to merger transactions in which the acquiror had concurrently purchased target shares via a stock purchase agreement for the acquisition of all target shares at the same price, the merger was expected to be consummated within a relatively short time, and the acquiror would not change the management or otherwise exercise control over the target company in the interim period.

9 See SEC Division of Corporation Finance Manual of Publicly Available Telephone Interpretations, Question No. 9, available at http://www.sec.gov/interps/telephone/cftelinterps_goingprivate.pdf. SEC Division of Corporation Finance, Compliance and Disclosure Interpretations of Going Private Transactions (Jan. 26, 2009), Question 211.02 available at http://www.sec.gov/divisions/corpfin/guidance/13e-3-interps.htm.

¹⁰ SEC Division of Corporation Finance, Compliance and Disclosure Interpretations of Going Private Transactions (Jan. 26, 2009), Question 111.01 available at http://www.sec.gov/divisions/corpfin/guidance/13e-3-interps.htm.

¹¹ See supra note 8.

¹² See supra note 7.

The amended guidance sets out a new practice that has been adopted by the Panel Executive in respect of private sale processes initiated by potential target companies which are in scope of the UK public takeovers rules, and the practice note reminds practitioners on the approach to compliance that the Panel Executive takes on disclosures relating to intentions of a bidder with respect to target company’s employees and business.

The Executive organ of the UK regulatory body which oversees public M&A and related transactions, The Panel on Takeovers and Mergers (the “Panel Executive”), recently published an updated version of the Panel Executive’s informal guidance on “Formal sale processes, private sale processes, strategic reviews and public searches for potential offerors” which is set out in Practice Statement 31 [1]. The amended guidance, which we explain in further detail in section A, sets out a new practice that has been adopted by the Panel Executive in respect of private sale processes initiated by potential target companies which are in scope of the UK public takeovers rules as set out in the City Code on Takeovers and Mergers (the “Takeover Code”).The Panel Executive considers that the requirement to “out”, i.e. name a potential bidder with which a target company is in talks or from which an approach has been received in the context of a private sale process, may operate in an appropriate manner, and the updated guidance note sets out the circumstances in which the Panel Executive may grant dispensations from the Takeover Code requirements [2] to identify a potential bidder. This is a welcome development by potential bidders of UK target companies.

In another recent development [3], the Panel Executive has issued new Panel Bulletin 7 on “Offeror intention statements” which sets out a reminder to market participants as to how the Takeover Code provisions[4], which require disclosure of a bidder’s intentions with regard to the business, employees and pensions schemes of a target company, operate in practice. Disclosure of these matters for bidders can be particularly challenging in circumstances where a bidder has not been fully able to crystallize its analysis and plans for the target business (pre acquiring full control), and whilst the Panel Executive is cognizant of these challenges, it has provided examples of certain approaches by bidders to addressing these Takeover Code requirements which it considers falls short of compliance with the requirements of the rule, and these are set out in further detail in section B.

Finally, the Panel on Takeovers and Mergers also has updated the document fees and charges that it charges as follows: (i) to reinstate the level of documentary fees for offer documents to the pre-August 2021 levels [5]; (ii) rebalance the fees charged on so-called “Rule 9” waiver circulars to lower the charges for smaller value transactions, increase the charges for larger value transactions and introduce a new top band; and (iii) increase by 25% the fees charged for granting exempt principal trader, exempt fund manager and recognised intermediary status [6].

A. LET’S KEEP THINGS QUIET

On April 30, 2024, the Panel Executive published an updated version of Practice Statement 31 which sets out new guidance on the Panel’s interpretation and application of its rules relating to the (i) requirement to publicly identify (i.e. name) possible bidders; (ii) requirement to set a “put up or shut up” deadline on possible bidders; (iii) general prohibition on inducement fees in favour of bidders; and (iv) ability of a target company to impose special conditions or restrictions on a bidder wishing to gain access to Target company information, in the context of different types of sales processes or situations involving UK target companies.
By way of summary explanation of these rules:
1. Public identification of bidders

Under the Code:

When a company (or major shareholder) is seeking a purchaser for 30%+ of the voting rights of the company OR when the company is seeking more than one bidder, a public announcement will be required either: (1) if rumour or speculation arises or there is an untoward movement in the share price of the company [7]; or (2) the number of bidders being approached is more than a “very restricted number” (generally considered to be six)[8].
A company will enter into an “offer period” (and consequently be publicly listed on the Panel’s website [9] as being in play) when the company announces it is seeking potential bidders or a purchaser is being sought for 30%+ of its voting rights [10].
Generally, the announcement by the company which commences the offer period must identify the potential bidder that the company is in talks with or from which an approach has been received (and not rejected)[11].
If the company subsequently chooses to announce the existence of a new potential bidder (and before it is in receipt of a firm intention offer), it must identify (i.e. name) that potential bidder [12].

“Put up or shut up” deadline imposition on possible bidders

An identified potential bidder must either announce a firm intention to make an offer (i.e. ‘put up’) or announce that it does not intend to make an offer (i.e. ‘shut up’) by 5.00 pm on the 28th day following the date of the announcement in which it is first identified [13].
This rule does not apply if another bidder has announced a firm intention to make an offer for the company.

Prohibition on inducement or ‘break up’ fees

Since 2011, the Code has included a general prohibition on target companies granting inducement fees and other so-called “offer related” arrangements in favour of a bidder or persons acting in concert with a bidder when the company is in an offer period or when an offer is reasonably contemplated [14].

Equality of information to all bona fide potential bidders and permissible terms of access

Target companies are required, if requested, to provide a bidder or bona fide potential bidder with information that it has provided to another bidder or potential bidder [15] – the so called equality of information rule.
This requirement normally only applies when there is a public announcement of a (potential) bidder to which information has been provided or the requesting bidder has been informed authoritatively of the existence of another potential bidder [16].
The Target company is only permitted to impose certain limited conditions (generally relating to confidentiality and non-solicit provisions) on the person requesting information access and the conditions cannot be more onerous than those imposed on another (potential) bidder [17].

The Code and the updated guidance in Practice 31 specifically address the application of the rules summarized in section 2 above, in the context of the following type of sales processes or situations:
- A formal sale process (“FSP”) – being a process by which a UK Code company puts itself up for sale through a process commencing with a public announcement that it is commencing a “formal sale process” and thus effectively initiate a public auction of itself.
- A strategic review process – a situation in which a company has publicly announced that it is undertaking a strategic review of its business, which refers to an offer or bid for the company as a possible outcome.
- A public search for potential buyers or bidders – where a company announces for example that it is seeking “potential offerors” or “seeking purchasers”.
- A private sale process – where a company wishes to initiate discussions on a private basis with more than one potential buyer (but not more than a “very restricted number” of buyers) and chooses not to announce those discussions.
The Panel introduced the concept of a FSP procedure in 2011 to aid companies desirous of achieving an exit for shareholders (expected in many cases to be used in distress or similar situations) to implement a process to garner bidder interest by offering dispensations from certain onerous Code rules applicable to bidders (the “FSP dispensations”). Specifically, the FSP dispensations allow for relief from: (i) the requirement to identify potential bidders (see 2a above); (ii) the requirement to set a “put up and shut up” deadline on a potential bidder (see 2b above); (iii) the general prohibition on offering an inducement fee to a potential bidder (see 2c above). The Code requires parties to consult with the Executive if a company wishes to seek any of the FSP Dispensations. Practice Statement 31 provides guidance that the Panel Executive will normally grant these FSP Dispensations where it is satisfied that a board is genuinely putting the company up for sale through a formal and public process.
Practice Statement 31 clarifies that the Panel Executive also would normally grant the dispensation from identifying a potential bidder in the context of strategic reviews (and provided of course that any (potential) bidder that the company is in talks with or from which an approach has been received, has not been specifically identified in any rumour or speculation).
The key change in updated Practice Statement 31 is confirmation that it is the Panel Executive’s normal practice to grant a dispensation (if requested by a target company) to publicly identify a potential bidder also in the situation where it is satisfied that the company is genuinely initiating a private sale process. Even if the company subsequently chooses to announce that it had commenced a private sale process [18], it will not be required to identify any (potential) bidders it is in talks with or from which an approach has been received. The discretion remains with the company as to whether to rely on the dispensation and/or to identify a potential bidder that it is in talks with.
This new clarificatory guidance from the Panel Executive is, as noted, a welcome and helpful approach as it gives potential bidders greater comfort about the risk of being prematurely outed or named by a target company which is a key concern for bidders particularly in early stages of considering a potential bid and/or prior to the time when it is fully ready to launch a firm offer announcement. This may in turn encourage greater participation by bidders in these types of processes.
Of final note, it is important to clarify the status of a Panel Executive Practice Statement [19] such as the Practice Statement 31 discussed above. Whilst Practice Statements are stated to be informal guidance issued by the Executive body of the Takeover Panel (which is distinct from the legislative and adjudicative arm of the Panel), in practice, UK public M&A practitioners will be well aware of the need to pay due and careful attention to the content of these Practice Statements as these provide critical guidance which will be applied and accepted in the majority of live public M&A transactions regulated by the Panel.

WHAT DOES GOOD LOOK LIKE?

On May 15, 2024, the Panel Executive published Panel Bulletin 7 on “Offeror Intention Statements” which serves as reminder to practitioners and market participants of the operation of specific provisions of the Takeover Code following observations of the Panel Executive. These bulletins do not entail any changes to the interpretation of the Code [20].
The Code requires bidders to disclose in their offer document[21], amongst other things, its intentions with regard to the business, employees and pension schemes operated by the target company. In particular, the Code requires that the bidder explains:
1. its intentions with regard to the future business of the target company and intentions for any R&D functions of the Target
2. its intentions with regard to the continued employment of employees and management of the target group including any material change to the Ts&Cs of employment and roles/ functions
3. its strategic plans for the target company and the likely repercussions on employment, locations of places of business including the headquarters
4. its intentions with regard to contributions to the target company pension schemes, including arrangements to fund any scheme deficit
5. its intentions with regard to redeployment of the fixed assets of the target company
6. its intentions with regard to the maintenance of any existing trading facilities for the relevant securities of the target, i.e. any plans to delist.

Whilst some aspects of the above mandated disclosure requirements are readily capable of compliance by a bidder (e.g. intentions with respect to (de)listing or general intentions regarding to the business of the target and its strategic plans for the target – the latter likely being foundational items to developing the financial model and pricing on the bid), the ability and feasibility of developing firm intentions with respect to some of the other disclosure items noted above can be a challenge particularly when a bidder may have had limited access to target due diligence information and/or is in a competitive situation or otherwise where timing is tight (e.g. due to imposition of a ‘put up shut up’ deadline).
The Panel, however, has in recent years tightened up its approach on these disclosures – denouncing the practice of “boilerplate” disclosures by bidders, requiring further detail on bidder’s intentions with respect to the target’s business, setting out the standards it expects to be applied by bidders when making these disclosures [22], and introducing (in 2014) a new framework to monitor any “post-offer intention statements” made by a bidder [23]. The Panel has emphasised the importance of these statements – not only for target companies when formulating their views on the merit of a potential bid but also for other stakeholder (such as employees and pension scheme beneficiaries, both of whom have locus under the Code to have their views and opinions on a bid disclosed and published by the bidder).
In Panel Bulletin 7, the Panel Executive has gone on to elaborate on how it approaches compliance with these disclosure requirements. In particular, the Panel Executive has noted that over time, bidders have tried to navigate around the disclosure requirements mandated by Rule 24.2(a) as set out in paragraph 2 above by making arguments such as (i) it has not formulated intentions on employees or locations of business as it is uncertain about expected synergies arising from the acquisition/ combination; (ii) if there is to be any reduction in headcount it expects this not to be material and thus does not consider this merits disclosure; (iii) the bidder has not as yet completed its strategic review and its only post-offer intention in the 12-month period is to conduct such a review; or (iv) the proposed post-offer intention disclosures are aligned with other “boilerplate” or standard disclosures and thus suffices. In this new bulletin, the Panel Executive has stated that “none of these arguments … provides an acceptable basis for formulating statements of intention”. This is a clear warning shot across the bow from the Panel Executive of which the market should take note.

IT’S TIME TO UP THE ANTE

On April 18, 2024, the Panel published a statement setting out new fees and charges that it will be applying from June/July 2024 in relation to takeover transactions, whitewash transactions and approval of certain exempt status potentially available for certain financial institutions [24].

The updated fees and charges bring about the following changes: (i) to reinstate the level of documentary fees for offer documents to the pre-August 2021 levels [25]; (ii) rebalance the fees charged on so-called “Rule 9” waiver circulars[26] to lower the charges for smaller value transactions, increase the charges for larger value transactions, and introduce a new top band of a £50,000 charge for offers with a value of over £250 million; (iii) increase by 25% the fees charged to lower the charges for smaller value transactions and increase a new top band; and (iv) increase by 25% the fees charge for granting exempt principal trader, exempt fund manager and recognised intermediary status [27] to £7,000 per entity.

These revised charges will apply from 1 June 2024 (in the case of (i) and (ii)) or from 1 July 2024 in the case of (iii). In reinstating its fees to pre August 2021 levels, the Panel noted the reduction in its revenues due to lower levels of market activity since that time, and, as noted in our last alert on changes to the scope of the Takeover Code, we may see some further reduction in revenues over time due to the narrowing of the types of companies which will fall within the remit of the Code.

__________

[1] The updated version of Practice Statement 31 (previously entitled “Strategic reviews, formal sale processes and other circumstances in which a company is seeking potential offerors”) was published on 30 April 2024.

[2] These are set out in Rules 2.4(a) and (b) of the Takeover Code and are discussed in further detail in this alert.

[3] Practice Bulletin 7 was published on 15 May 2024.

[4] These are set out in Rules 2.7(c)(viii), Note 1 on Rule 2.7 and Rule 24.2 of the Takeover Code and are discussed in further detail in this alert.

[5] In August 2021, the Panel has reduced charges payable on offer documents by approximately 25%.

[6] These fees were last revised in 2015.

[7] Rule 2.2.(f)(i).

[8] Rule 2.2(f)(ii).

[9] Companies in an offer period are listed on the Panel’s Disclosure Table.

[10] Definition of “offer period”.

[11] Rule 2.4(a).

[12] Rule 2.4(b).

[13] Rule 2.6(a).

[14] Rule 21.2(a).

[15] Rule 21.3(a).

[16] Rule 21.3(b).

[17] Note 1 on Rule 21.3(a).

[18] From that point onwards, the company would be treated as having commenced a public search for possible bidders.

[19] There are currently 17 live Practice Statements being applied by the Panel Executive.

[20] The Panel commenced the practice of issuing Panel Bulletins in 2021 and since then have issued 7 such bulletins including the one under discussion in this alert.

[21] Rule 24.2(a).

[22] Rule 19.8(a) requires statements of intention relating to the post-offer period to be: (i) accurate statements of that party’s intentions at the time it is made; and (ii) made on reasonable grounds.

[23] Rule 19.8(b) requires a bidder to consult with the Panel if it intends to depart from its statement of intention in the 12 months post bid and Rule 19.8(c) requires a bidder to confirm in writing to the Panel at the end of the 12-month period post bid that it has fulfilled its post-offer statement(s) of intention.

[24] In summary, these exemptions afford dispensations from certain disclosure requirements and dealing restrictions.

[25] In August 2021, the Panel has reduced charges payable on offer documents by approximately 25%.

[26] These are circulars convening shareholder meetings to consider and approve the requirement on a party to make a mandatory or “Rule 9” offer where such a requirement has been triggered under the Code.

[27] These fees were last revised in 2015.

The following Gibson Dunn lawyer prepared this update: Selina Sagayam.

If you have any questions on the impact of the proposed changes, including application of the transitional arrangements, or are seeking advice on assessing and implementing alternative arrangements for companies which will come out of scope of the Code, we are happy to assist.

For questions about this alert or other UK public M&A or capital market queries, contact the Gibson Dunn lawyer with whom you usually work, the author of this alert or these public listed company and capital markets contacts in London:

Selina S. Sagayam (+44 20 7071 4263, [email protected])

Chris Haynes (+44 20 7071 4238, [email protected])

Steve Thierbach (+44 20 7071 4235, [email protected])

For US securities regulatory queries, including the impact of the proposal on US transition companies, please contact:

James J. Moloney – Orange County, CA (+1 949.451.4343, [email protected])

Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.

=We are pleased to provide you with the next edition of Gibson Dunn’s digital assets regular update. This update covers recent legal news regarding all types of digital assets, including cryptocurrencies, stablecoins, CBDCs, and NFTs, as well as other blockchain and Web3 technologies. Thank you for your interest.

ENFORCEMENT ACTIONS

UNITED STATES

FTX Founder Sam Bankman-Fried Sentenced to 25 Years in Prison
On March 28, Sam Bankman-Fried was sentenced to 25 years in prison after being found guilty of fraud and money laundering in connection with the collapse of his FTX cryptocurrency exchange. Bankman-Fried’s presentencing report recommended he be sentenced to 100 years in prison. Bankman-Fried’s legal team urged the court to impose a lenient sentence, relied on 29 character references in his sentencing memo, and argued that he did not intend to cause the harms alleged. Bankman-Fried has been held at the Metropolitan Detention Center in New York since his bail was revoked on August 23, 2023, and will be transferred to a low or medium-security prison near his parents in San Francisco to serve his sentence. At sentencing Bankman-Fried said, “I’m sorry about what happened at every stage . . . It haunts me every day.“ He has stated that he plans to appeal his conviction. NYT; Financial Times; CNBC; Reuters; Law360.
DOJ Makes First Public Indictment of Individual for Underreporting Cryptocurrency Capital Gains
On February 6, Frank Ahlgren III was indicted for unreported capital gains from a $4 million sale of bitcoin. According to the DOJ, Ahlgren willfully failed to report capital gains from bitcoin sales between 2017-2019, and knowingly evaded reporting requirements by making cash deposits “in individual amounts of $10,000 or less to avoid the filing of a [Currency Transaction Report].” This marks the first public indictment of an individual for unreported capital gains from legal transactions involving cryptocurrency. This development showcases the federal government’s continued scrutiny of digital asset transactions. DOJ; Law360.
SEC Sanctioned in Debt Box Case
On March 18, the SEC was sanctioned for misstatements made by its counsel in proceedings against the crypto project Debt Box. The court found that the SEC acted in bad faith by making misleading statements about evidence it used to obtain a temporary restraining order and other emergency measures. The SEC initiated the suit against Debt Box in July 2023, and obtained a temporary asset freeze, restraining order, and receivership. Utah Federal District Judge Robert Shelby said in his sanctions order that the SEC acted in “bad faith” and “deliberately perpetuat[ed] falsehoods.” The SEC was ordered to pay attorneys’ fees and all expenses arising from the emergency measures. Judge Shelby rejected the SEC’s argument that it was protected from monetary sanctions by sovereign immunity, instead finding that the common law permits assessment of attorneys’ fees when a party has acted in bad faith. The court also denied the SEC’s motion to dismiss the case without prejudice. Law360; Yahoo Finance; The Block.
SEC Accepts Settlement with ShapeShift AG
On March 5, the SEC entered into a settlement with ShapeShift AG, which, according to the SEC, facilitated the buying and selling of digital assets from 2014 until early 2021 through its ShapeShift.io platform. The SEC’s order alleges ShapeShift violated Section 15(a) of the Securities Exchange Act of 1934. Without admitting liability, ShapeShift agreed to pay a $275,000 penalty and consented to a cease-and-desist order. Commissioners Uyeda and Peirce criticized the enforcement action, calling it “the latest installment in the serial drama of the Commission’s poorly conceived crypto policy.” SEC Press Release; Peirce and Uyeda Statement; The Block.
SEC Demands Information Related to Ethereum Foundation
As of March 20, as part of an investigation into Ethereum, the SEC demanded information from companies regarding dealings with the Ethereum Foundation. Gary Gensler, chair of the SEC, has not commented on Ethereum’s status, but according to companies that have received subpoenas, the SEC seeks to classify Ethereum as a security. Gensler has said that some digital assets are unregistered securities and therefore subject to SEC rules. If Ether is designated as a security, it could create pressure to delist the token. In addition, it could decrease the likelihood of SEC approval of ETFs investing directly in Ether, which is currently being sought by multiple issuers. In the past, the threat of action by the SEC has negatively impacted token prices. Ether, however, gained rather than lost value as news of the investigation spread. Fortune; Bloomberg; Bloomberg.
DOJ Charges Digitex CEO for Failing to Implement Anti-Money Laundering Safeguards
On February 12, Adam Todd, the CEO of Digitex Futures Exchange (Digitex), was charged with allegedly violating the Bank Secrecy Act by failing to implement proper anti-money laundering and know-your-customer protocols. Todd faces up to five years in prison, if convicted. DOJ; Law360; Cointelegraph.
Trial Commences for Accused Operator of Cryptocurrency Mixer Bitcoin Fog
On February 13, the trial for Roman Sterlingov, accused operator of cryptocurrency mixer Bitcoin Fog, commenced in D.C. federal court. Sterlingov was charged with money laundering and operating an unlicensed money transmitting business, among other things. Prosecutors allege that Sterlingov knew Bitcoin Fog facilitated illegal transactions and made a concerted effort to conceal his involvement, including the use of the pseudonym “Akemashite Omedotou.” Law360; Bloomberg.
Crypto Exchange Kraken Seeks Dismissal of Claims in Dispute with SEC
On February 22, Kraken filed a motion to dismiss the SEC lawsuit filed against it in November 2023. The SEC alleges that Kraken failed to register as a securities exchange, broker, and clearinghouse. Kraken’s motion to dismiss argues that the SEC has failed to establish that the tokens on its platform are investment-contract securities. Kraken’s motion also cites the major questions doctrine, arguing that the SEC has expanded its authority beyond what has been delegated to it by Congress. Kraken’s argument echoes those made by other exchanges in their respective SEC enforcement actions. Law360; Bloomberg; CoinDesk; Kraken.
Digital Currency Group Files Motion to Dismiss NY AG’s Suit
On March 6, Digital Currency Group (DCG) filed a motion to dismiss a lawsuit brought by New York Attorney General Letitia James, denying allegations of concealing losses and defrauding investors. DCG founder Barry Silbert also filed a motion to dismiss the claims. In an accompanying press release, the firm described the New York Attorney General’s allegations as based upon “blatant mischaracterizations and unsupported conclusory statements,” and asserted that DCG proceeded based on the advice of its accountants, investment bankers, and advisors. The motion further alleges that rather than creating a “liquidity crunch” as alleged by the AG, DCG invested hundreds of millions of dollars into its subsidiary leading up to its bankruptcy, despite no obligation to do so. CoinDesk; The Block; DCG Motion; Silbert Motion; Press Release.
U.S. District Court Dismisses SEC Claim Against Coinbase Wallet, Allows Lawsuit to Continue
On March 27, a U.S. District Court judge partially ruled in favor of Coinbase’s motion to dismiss by dismissing the SEC’s claim that Coinbase’s Wallet application acts as an unregistered broker under U.S. law. The judge concluded however that the lawsuit could proceed for now with the claim that Coinbase had failed to register its staking program with the SEC, finding that the SEC had plausibly alleged that staking customers had a reasonable expectation of profit due to “Coinbase’s managerial efforts.” CoinDesk; Cointelegraph; Bloomberg.

INTERNATIONAL

Do Kwon Wins Extradition Appeal – Will be Extradited to South Korea Instead of United States
The Appellate Court of Montenegro has overturned a previous decision by the High Court of Podgorica to extradite Terraform Labs co-founder, Do Kwon, to the United States. Now, Kwon likely will be extradited to South Korea after March 23. Kwon, arrested in Montenegro in March 2023, faced extradition requests from both the U.S. and South Korea, with ongoing speculation as to his whereabouts amidst allegations of fraud related to Terraform Labs and its Terra blockchain. AP News; Reuters.
Worldcoin Must Stop Data Collection in Spain for Three Months
On March 6, the Spanish Agency for the Protection of Data (AEPD) directed Worldcoin to cease collecting and processing data in Spain for three months as it investigates complaints related to data collection. Worldcoin, a project that seeks to create a private and secure technology that allows individuals to prove their humanness online, filed suit against AEPD’s order. On March 11, the Spanish High Court upheld the three month pause. Worldcoin has over 4 million users, states that it operates lawfully in all locations in which it is available, and is “grateful to now have the opportunity to help the AEPD better understand the important facts regarding” the technology. Worldcoin Statement; Reuters; Cointelegraph.

REGULATION AND LEGISLATION

UNITED STATES

Republican Senators Introduce “The CBDC Anti-Surveillance State Act”
On February 26, Republican senators introduced legislation aimed at blocking a central bank digital currency (CBDC) in the United States. U.S. Senator Ted Cruz (R-Texas), joined by Senators Bill Hagerty (R-Tenn.), Rick Scott (R-Fla.), Tedd Budd (R-N.C.), and Mike Braun (R-Ind.), filed legislation titled “The CBDC Anti-Surveillance State Act” due to concerns that a digital dollar would impinge on personal privacy. In a post on Cruz’s website, Cruz expressed his view that the “Biden administration salivates at the thought of infringing on our freedom and intruding on the privacy of citizens to surveil their personal spending habits, which is why Congress must clarify that the Federal Reserve has no authority to implement a CBDC.” Former President Donald Trump, the presumptive Republican presidential nominee, has promised to ban the creation of a CBDC. CoinDesk; Press Release.
House Finance Committee Votes to Move Forward with Measure to Overturn SEC’s Staff Accounting Bulletin 121
On February 29, the U.S. House Financial Services Committee voted to advance a resolution aimed at overturning the SEC’s Staff Accounting Bulletin 121 (SAB 121), which mandates regulated financial institutions to record their customers’ crypto holdings as liabilities on their own balance sheets. The resolution garnered bipartisan support, with 31 lawmakers voting in favor of the resolution and 20 lawmakers voting against. SAB 121 has drawn controversy over the past few years due to concerns that it would disincentivize banks from providing custodial services for digital assets and create unnecessary risks in the crypto ecosystem. Rep. Mike Flood (R-Neb.), who introduced the resolution, argues that the result of SAB 121 “is that banks must choose to either custody digital assets[,] thus inflating their balance sheet and severely affecting every other line of business[,] or stay entirely out of the market.” SAB 121 qualifies as a rule under the Congressional Review Act and therefore can be reviewed and disapproved by Congress. Disapproval requires each chamber to pass a resolution of disapproval, which must then be signed by the President. The Block; CoinDesk; Blockworks; Law360; Cointelegraph.
House Financial Services Committee Votes on Bill to Clarify Secret Service’s Authority Over Crypto Cybercrimes
On February 29, every member of the House Financial Services Committee voted in favor of the Combating Money Laundering in Cyber Crime Act, which would clarify the U.S. Secret Service’s power to investigate crypto cybercrimes. Rep. Zach Nunn (R-Iowa), one of the cosponsors of the bill, states that cybercrimes have led to hundreds of billions of dollars lost. According to Nunn, this “is a bipartisan bill and it closes the gap to empower our Secret Service professionals to continue to investigate cybercriminals[,] including cases involving digital assets[,]” around the globe. Rep. Gregory Meeks (D-NY) says this bill will “allow us to better address threats from nations like and including Russia and North Korea,” and by expanding the scope of U.S. Secret Service investigations, this bill “brings another element of protection and defense in line with the 21st century.” The Block; CoinDesk.
SEC Postpones Decision on Ether ETFs, Decision Expected in May
On March 4, the SEC postponed its decision regarding the approval or rejection of BlackRock’s and Fidelity’s spot Ether exchange-traded funds (ETFs). This delay marks the second postponement since January, when the SEC initially delayed its decision after approving several spot Bitcoin ETFs. The SEC is expected to approve or deny the ETFs in May once the first final deadline for a decision is due. Reuters; Cointelegraph.
Virginia Creates Working Group to Foster Blockchain and Digital Asset Expansion Within State
The Virginia Senate passed Senate Bill No. 339, creating a dedicated workgroup within the state to study and recommend measures for fostering the expansion of blockchain technology, digital asset mining, and cryptocurrency. Proposed by Senator Saddam Azlan Salim (D-Virginia), the bill aims to exempt miners from money transmitter licenses and prohibit targeted ordinances. The workgroup, comprising 13 members from legislative and non-legislative backgrounds, is tasked with concluding studies and presenting recommendations on the cryptocurrency ecosystem by November 1, 2024, for consideration in the 2025 Regular Session of the General Assembly. Cointelegraph.
Wyoming Gives DAOs a Nonprofit Legal Framework
On March 7, Governor Mark Gordon signed a bill into state law that would allow in-state decentralized autonomous organizations (DAOs) to establish themselves as decentralized unincorporated nonprofit associations (DUNA). This new legal framework gives DAOs more options, as DAOs have already been cleared to establish themselves as limited-liability corporations within the state of Wyoming. Establishing a DAO as a DUNA gives the DAO legal existence, enables the DAO to pay taxes, and provides the DAO with limited liability from the actions of other members. Miles Jennings, general counsel at a16z Crypto, called this development a “major breakthrough,” as this will give DAOs “much-needed protections and empower them to keep blockchain networks open.” CoinDesk; Blockworks.
President Biden Proposes Crypto Mining Tax and Wash-Sale Rules for Digital Assets
On March 11, United States President Joe Biden announced his fiscal year 2025 budget proposal, which included a crypto mining tax and changes in wash-sale rules. Last year, similar taxes were proposed, but they were not taken up by Congress in drafting budget bills. The new wash trading rules aim to inhibit people from selling an investment for a loss, and then quickly rebuying the investment. CoinDesk; CCN.

INTERNATIONAL

UK Financial Regulator Issued 450 Alerts on Illegal Cryptoasset Advertisements in Q4 2023
On February 14, the Financial Conduct Authority (FCA), an independent financial regulatory body in the UK, reported that it issued 450 consumer alerts against firms for the illegal promotion of cryptocurrency during the last three months of 2023. The FCA previously introduced financial promotion rules for cryptoassets in October 2023, heightening regulatory scrutiny. The regulator has worked with tech companies to address illegal promotions, including the removal of 35 mobile applications from app stores at the end of December 2023, and pledged it will be “continuing [its] robust action against firms issuing illegal financial promotions in 2024.” Financial Conduct Authority; CoinDesk; The Block.
English Draft Legislation Labels Crypto as Property
On February 22, England’s Law Commission published draft legislation confirming the existence of an additional category of common law personal property that includes digital assets. This legislation builds on a report on digital assets produced by the Commission in June 2023, which showed that crypto tokens and NFTs are property rights. The report also concluded that the common law was flexible enough to accommodate digital assets. The legislation seeks to confirm that digital assets are covered by the common law and to remove any legal uncertainty. The Commission accepted responses to the draft legislation until March 22. CoinDesk; Yahoo.
Taiwan Considering Implementation of Further Digital Asset Law
In response to an October 2023 bill introduced in Taiwan’s parliament and a speech by the Chairman of the Financial Supervisory Commission (FSC), Taiwan is considering the implementation of a special act to regulate the cryptocurrency industry, with results expected to be released in September 2024. The bill will aim to protect investors and to create more effective regulations for digital asset markets. The Block; Cointelegraph.
UK Considering How to Implement OECD Crypto Reporting Framework
The UK government launched a consultation to implement the Organization for Economic Co-operation and Development’s (OECD) crypto reporting framework, aiming to address tax non-compliance and enhance tax transparency in the crypto market. The framework, expected to generate £35 million ($45 million) between 2026 and 2027, and £95 million between 2027 and 2028, aims to exchange information on relevant crypto transactions across jurisdictions. The consultation, initiated after the spring budget speech, will close on May 29. The government plans to publish a response and seek further feedback on draft regulations thereafter. CoinDesk.
UAE Grants Initial Approval to Crypto Exchange Nexo
Nexo, a digital asset services provider, has received initial approval as a licensed entity in Dubai from the Virtual Assets Regulatory Authority (VARA). This marks the first step in obtaining full licensing for various activities including lending and borrowing, management and investment, and broker-dealer services. CoinDesk.
UK Law Enforcement Authority to Seize Crypto Assets Expanded
UK law enforcement agencies’ increased ability to seize cryptocurrency assets in criminal cases, including terrorism, will take effect on April 26, following approval of the legislation in March. The provisions include a civil recovery regime for crypto and crypto asset confiscation orders, which enables authorities to seize items associated with crypto assets. CoinDesk.
United Kingdom to Allow Institutional Investors to Build Crypto-Backed ETN Market
On March 11, the United Kingdom’s Financial Conduct Authority (FCA) announced it will not object to requests from Recognized Investment Exchanges (REIs) to build a listed market segment for crypto asset-backed exchange-traded notes (ETNs). ETNs are a form of exchange-traded product, which are often issued by a bank or an investment manager, that tracks an underlying asset or index. While these products would be available to professional investors, retail consumers remain banned. The FCA explained that crypto-backed products are ill-suited for retail investors. The FCA stated that exchanges will be responsible for making sure sufficient controls are in place so that ETN trading is safe and orderly. The London Stock Exchange stated that it will accept applications for bitcoin and ether ETNs in the second quarter of 2024. CoinDesk.
OKX Secures the Monetary Authority of Singapore’s In-Principle Approval for Major Payment Institution License
On March 12, the President of OKX announced that OKX secured in-principle approval for a Major Payment Institution (MPI) license from the Monetary Authority of Singapore (MAS). The license will allow OKX to facilitate multiple payment services. OKX’s President states that “the in-principle approval from MAS is a validation of [OKX’s] business strategy, and also an exciting opportunity for [OKX] to continue as a responsible stakeholder in [Singapore].” After receiving the full license from MAS, OKX will be able to facilitate cross-border transactions in the country, as well as provide digital payment token services to consumers. OKX; Cointelegraph.
EU Approves Anti-Money Laundering Legislation Targeting Anonymous Crypto Transactions Using Hosted Wallets
On March 19, the European Parliament approved a ban on anonymous crypto payments involving hosted wallets, which are wallets operated by third-party providers. The ban has no threshold and applies to any such transaction. Opponents argue that anonymity is a crucial feature of crypto that promotes financial privacy, while the new legislation would have a minimal effect on crime. The new legislation will take effect within three years from its promulgation. Cointelegraph.

CIVIL LITIGATION

UNITED STATES

Coinbase Challenges SEC’s Refusal to Engage in Rulemaking Regarding Digital Assets
On March 11, U.S. crypto exchange Coinbase filed an action against the SEC in the Third Circuit arguing that the SEC violated the Administrative Procedure Act by denying a rulemaking petition that Coinbase filed in July 2022. Coinbase’s rulemaking petition asked the SEC to propose new rules explaining the basis for the broad authority the agency has asserted over the digital-asset industry. Coinbase’s petition also identified the many ways in which existing SEC rules are unworkable for digital asset firms. The SEC denied the rulemaking petition in December 2023, only after Coinbase filed a mandamus action seeking to compel a response from the agency. Coinbase is asking the Third Circuit to require the SEC to engage in rulemaking or, at a minimum, to provide a rational explanation for its refusal to engage in rulemaking. CoinDesk; CCN.
Texas Crypto Firm Sues the SEC
On February 21, LEJILEX, a Texas based crypto firm, sued the SEC in Texas federal court challenging the SEC’s jurisdiction over digital assets. Working with the Crypto Freedom Alliance of Texas (CFAT), LEJILEX hopes to preemptively avoid an SEC enforcement action against them for failing to register securities or securities exchanges on their platforms. The suit asks the court to enjoin the SEC from bringing actions against LEJILEX or other CFAT members, pointing to cases brought against other crypto exchanges. Law360; Yahoo; Bloomberg.
Survey of Crypto Miners’ Energy Use is Suspended
On February 23, the U.S. Department of Energy (DOE) agreed to suspend its mandatory survey soliciting information about electricity consumption from cryptocurrency miners. The suspension occurred in response to a suit filed by the Texas Blockchain Council and a crypto-mining company, Riot Platforms, Inc., seeking to block the survey. Later the same day, a federal district judge in Texas granted a temporary restraining order against federal agencies and the survey. The U.S. Energy Information Administration (EIA), the DOE’s statistical arm, sought the information to evaluate concerns that increased electricity use by cryptocurrency miners could threaten energy grid reliability. The Office of Management and Budget granted an emergency request from the EIA allowing them to move forward with the survey without following regular statutory processes such as notice and comment. The plaintiffs argue that the EIA failed to make the necessary showing that such emergency approval would prevent public harm, therefore unlawfully circumventing statutory procedure. Law360; Reuters.
SEC Seeks to Leverage Default Judgment in Enforcement Actions Against Crypto Exchanges
Judge Tana Lin of the Western District of Washington granted partial satisfaction of the SEC’s motion for default judgment against Sameer Ramani, a defendant in the case involving former Coinbase product manager Ishan Wahi and co-defendants. Ramani, who reportedly fled the United States and failed to respond to court summonses, faces permanent injunctions, civil penalties, and disgorgement of funds. In its default judgment order, the court assumed that the allegations in the SEC’s complaint were true and concluded that the digital assets at issue in that case were securities. The SEC subsequently filed the default judgment order as supplemental authority in its pending enforcement actions against various crypto exchanges. The exchanges responded that the default judgment order should be disregarded because it was “procured against an empty chair.” Cointelegraph; Response Letter.
Voyager Users Sue Public Relations Firm Ketchum Inc. Over Involvement in Crypto Promotion
On February 9, a class of users of Voyager, a bankrupt digital assets lender, sued public relations firm Ketchum Inc. in federal court for aiding and abetting Voyager’s sale of unregistered securities. Ketchum provided Voyager marketing and communications support for a high-profile press conference with the Dallas Mavericks, which promoted the Voyager platform and products. The complaint argues that Ketchum “knew or should have known that the objective of their partnership, and the promotional activity they undertook together, constituted promoting unregistered securities.” Law360.
Genesis Approved to Sell $1.6 Billion in Shares of Investment Trust to Fund Chapter 11 Bankruptcy Payouts
On February 14, the New York bankruptcy court granted crypto lender Genesis Global’s (Genesis) request to sell $1.6 billion in Grayscale Investments shares to fund payouts to creditors. Digital Currency Group, the parent company of Genesis, objected to the request due to the timing and a demand for Digital Currency Group to be consulted before such sales. Genesis continues its liquidation plan after filing for bankruptcy in January 2023. Bloomberg; Law360; Reuters; WSJ.
Celsius Distributes $2 Billion of Cryptocurrency Pursuant to Bankruptcy Plan
On February 15, Celsius Network filed an update with the court that “[n]early 75% of the BTC/ETH set to be distributed by PayPal/Venmo and through Coinbase has already been collected,” equating to $2 billion for nearly 172,000 creditors. This comes on the heels of the company exiting bankruptcy in late January 2024. The Block; Cointelegraph.
FTX Investors File Class Action Against the Company’s Bankruptcy Counsel
On February 16, FTX investors filed a class action racketeering lawsuit in Florida federal court against FTX’s bankruptcy counsel, alleging that the law firm aided in FTX’s fraudulent behavior. Ryne Miller, a former partner at the law firm, left to become FTX’s general counsel in 2021. The plaintiffs argue that the firm knew of FTX’s impending financial turmoil, but “realized it stood to gain hundreds of millions more from their work in bankruptcy.” According to the complaint, the firm served as counsel for FTX for 16 months prior to the company’s collapse, receiving over $8.5 million in legal fees, and has continued to serve as FTX’s bankruptcy counsel, generating $180 million in fees. Bloomberg; The Block; Reuters; Law360.
FTX Files Proposed Settlement in FTX Europe Clawback Case
On February 22, FTX filed for approval of a settlement resolving a lawsuit seeking to claw back $323 million from the co-founders of an entity they acquired. If approved by the court, the settlement would have FTX sell the subsidiary back to the co-founders for $32.7M. The proposed settlement comes after FTX tried and failed to sell the entity. In 2021, FTX bought Digital Assets DA AG and rebranded it as FTX Europe. The current lawsuit claims that the purchase price was a “massive overpayment” for a company that had just a little more than a business plan. This is one of numerous lawsuits FTX has filed to recover funds for creditors and customers since filing for bankruptcy in November 2022. FTX stated in its court filing that litigation would be costly and complicated, and that the proposed settlement is the best option for creditors. Reuters; WSJ; Law 360.

SPEAKER’S CORNER

UNITED STATES

CFTC Chair Emphasizes Need for Congress to Pass Legislation
Commodity Futures Trading Commission (CFTC) Chair Rostin Behnam reiterated the need for Congress to pass legislation addressing regulatory gaps in the crypto industry during his annual appearance before the House Agriculture Committee. Behnam emphasized the importance of regulating cryptocurrencies like Bitcoin (BTC) and Ether (ETH), which make up a significant portion of the market. He highlighted the Financial Innovation and Technology Act for the 21st Century (FIT Act), which aims to address regulatory uncertainties but has yet to pass a floor vote. Behnam expressed confidence in the CFTC’s ability to establish a regulatory framework within 12 months if the FIT Act is enacted. CoinDesk.
House Financial Services Committee Discusses Cryptocurrency and Illicit Finance
On February 15, the House Financial Services Committee hosted a congressional panel on how to address the use of cryptocurrency for illicit finance. In his opening statement, Chairman French Hill (R-Ark.) highlighted that the “borderless nature of blockchain technology necessitates international cooperation” and that “members of both sides of the aisle are interested in working on solutions.” House Financial Services Committee; Law360; The Block; Politico.
Leading U.S. Investment Bank Argues U.S. Authorities Can Exert Some Control Over Tether via OFAC
On February 15, a leading U.S. investment bank released a research report stating that “U.S. regulators can exert some control on Tether’s offshore usage via [the Office of Foreign Assets Control],” which is a unit of the U.S. Treasury Department. The report cited Tether’s association with Tornado Cash as an example of such regulation. In 2022, OFAC sanctioned Tornado Cash for allegedly assisting in money laundering. Although Tether initially did not take action against Tornado Cash addresses, in December 2023, Tether decided to freeze stablecoin held in OFAC-sanctioned wallets as a proactive measure. The Block; CoinDesk.
OCC Acting Chief Advocates for Trip Wires Around Payments and Private Equity Activity
On February 21, the acting chief of the Office of the Comptroller of the Currency (OCC), Michael Hsu, advocated for regulators to set numerical “trip wires” around activity in the digital payments and private equity industries. In a speech given at Vanderbilt University, Hsu said that payments and private equity pose the largest risk for the next “great blurring” of banking and commerce, with activity in these areas resembling a phase of surging nonbank growth that preceded 2008 and other historic market failures. Hsu called on the Financial Stability Oversight Council (FSOC) to develop quantitative thresholds to identify when a payments or private equity firm becomes a systemic risk. When the threshold is crossed, the FSOC would then formally assess the individual firm. This assessment would inform any additional regulatory activity, which could include use of the FSOC’s designation power to apply heightened bank-like regulations. This proposal follows the FSOC’s policies enacted last year, which lay out an analytical framework for its work as a watchdog and remove procedural hurdles to the use of its designation power, which were put in place during the Trump administration. Law360; Politico; Bloomberg.
Senator and Eight Attorneys General File Amicus Briefs Opposing SEC’s Authority to Regulate Crypto Assets as Securities
On February 27, Senator Cynthia Lummis (R-Wyo.), crypto industry groups, and a veteran appellate attorney filed an amicus brief asserting that the SEC’s suit against crypto exchange Kraken expands the definition of investment contract beyond what Congress intended. Lummis argues that the SEC is overreaching its authority by encroaching on Congress’s lawmaking power. In the suit, the SEC claims that Kraken operated as an unregistered broker, dealer, exchange, and clearing agency. The amicus brief argues that the “SEC is not suited to the task of crafting a holistic regulatory framework for crypto assets, particularly through a judicial enforcement action (where neither the SEC nor this court is positioned to grapple with the unintended consequences of the SEC’s current enforcement stance and the policy implications of its novel legal opinion).” The amicus brief concludes that “such policymaking is precisely the role the Constitution assigns to Congress.” Law360.On February 29, a coalition of attorneys general from eight U.S. states submitted a joint amicus brief, also arguing that the SEC’s attempt to regulate crypto assets as securities exceeds the SEC’s authority. The brief asserts that Congress has not delegated such authority to the SEC and emphasizes the states’ interest in preventing the potential preemption of consumer protection laws. The Block.
DOJ Changes Prosecution Strategy from Whack-a-Mole to Systemic
According to veteran crypto-focused prosecutors, the Department of Justice is no longer playing “whack-a-mole” in its crypto cases, but rather focusing on large, important actors to further the goal of bringing the broader industry into compliance. On February 23, Tara La Morte and Noah Solowiejczyk, leaders of the U.S. Attorney’s Office for the Southern District of New York’s Illicit Finance and Money Laundering Unit, spoke at a New York City Bar Association event about this change in strategy. La Morte stated that law enforcement is focusing on “systemic-type prosecution that’s going to make an industry impact” and lead “the industry to take notice.” Law360.

OTHER NOTABLE NEWS

The Philippines Central Bank, Bangko Sentral ng Pilipinas, Plans to Launch Wholesale Central Bank Digital Currency Within Two Years
On February 12, the Philippines’ central bank, the Bangko Sentral ng Pilipinas (BSP), revealed the bank’s intention of introducing a wholesale central bank digital currency (CBDC) within the next two years. In discussing its decision to limit the CBDC to wholesale, the BSP acknowledged that retail CBDC could intensify bank runs in times of financial stress. Additionally, the BSP confirmed that it will not use blockchain or distributed ledger technology, stating that “[o]ther central banks have tried blockchain, but it didn’t go well.” Cointelegraph; CoinDesk; The Inquirer.
OKX Opens Crypto Exchange in Turkey as Part of International Expansion
On February 27, crypto exchange OKX entered Turkey as part of its global expansion plan. In an interview with CoinDesk, OKX President Hong Fang said that “Turkey is a very important and special market for us. It ranks high in terms of crypto adoption and crypto transaction volume.” Fang detailed that “there is a natural tendency to look for value in bitcoin in Turkey, particularly for wealth preservation.” Due to Turkey’s double-digit inflation rate, crypto has become a lifeline for many. CoinDesk; The Block.
Crypto Campaign Contributions Impacted Super Tuesday
Crypto political action committees spent more than $78 million on Super Tuesday races, helping propel Adam Schiff (D-CA), Young Kim (R-CA), Shomari Figures (D-AL), Julie Johnson (R-TX), and Tim Moore (R-NC) to win their races and advance to run offs. Fast Company; CoinDesk.

The following Gibson Dunn attorneys contributed to this issue: The following Gibson Dunn attorneys contributed to this issue: Jason Cabral, Jeff Steiner, Kendall Day, Sara Weed, Ella Alves Capone, Grace Chong, Chris Jones, Jay Minga, Nick Harper, Simon Moskovitz, Anne Lonowski, Amanda Goetz, and Cody Wong.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s FinTech and Digital Assets practice group, or the following:

FinTech and Digital Assets Group:

Ashlie Beringer, Palo Alto (650.849.5327, [email protected])

Michael D. Bopp, Washington, D.C. (202.955.8256, [email protected]

Stephanie L. Brooker, Washington, D.C. (202.887.3502, [email protected])

Jason J. Cabral, New York (212.351.6267, [email protected])

Ella Alves Capone, Washington, D.C. (202.887.3511, [email protected])

Grace Chong, Singapore (+65 6507 3608, [email protected])

M. Kendall Day, Washington, D.C. (202.955.8220, [email protected])

Michael J. Desmond, Los Angeles/Washington, D.C. (213.229.7531, [email protected])

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

William R. Hallatt, Hong Kong (+852 2214 3836, [email protected])

Martin A. Hewett, Washington, D.C. (202.955.8207, [email protected])

Michelle M. Kirschner, London (+44 (0)20 7071.4212, [email protected])

Stewart McDowell, San Francisco (415.393.8322, [email protected])

Mark K. Schonfeld, New York (212.351.2433, [email protected])

Orin Snyder, New York (212.351.2400, [email protected])

Jeffrey L. Steiner, Washington, D.C. (202.887.3632, [email protected])

Eric D. Vandevelde, Los Angeles (213.229.7186, [email protected])

Benjamin Wagner, Palo Alto (650.849.5395, [email protected])

Sara K. Weed, Washington, D.C. (202.955.8507, [email protected])

From the Derivatives Practice Group: Several CFTC advisory committees are scheduled to meet in the upcoming weeks, and ESMA was busy issuing reports and consultations on MiCA.

New Developments

CFTC’s Energy and Environmental Markets Advisory Committee to Meet. The CFTC’s Energy and Environmental Markets Advisory (EEMAC) will hold a public meeting from 9:00 a.m. to 12:00 p.m. (CDT) on Wednesday, April 10 at the University of Missouri – Kansas City in Kansas City, Missouri. At this meeting, the EEMAC will continue its discussion on the federal prudential financial regulators’ proposed rules implementing Basel III and the implications for and impact on the derivatives market. There will also be presentations and discussions on the state of crude oil markets and the future of power markets. Finally, the two EEMAC subcommittees will offer updates on their continued work related to traditional energy infrastructure and metals markets. [NEW]
CFTC’s Agricultural Advisory Committee to Meet. The CFTC’s Agricultural Advisory Committee (AAC) will hold a public meeting on April 11 from 9:30 a.m. to 11:00 a.m. (CDT) at the Sheraton Overland Park Hotel in Overland Park, Kansas. At this meeting, the AAC will discuss topics related to the agricultural economy and recent developments in the agricultural derivatives markets. [NEW]
SEC Adopts Reforms Relating to Investment Advisers Operating Exclusively Through the Internet. On March 27, the SEC adopted amendments to the rule permitting certain internet investment advisers to register with the Commission (the “internet adviser exemption”). The amendments will require an investment adviser relying on the internet adviser exemption to have at all times an operational interactive website through which the adviser provides digital investment advisory services on an ongoing basis to more than one client. The amendments will also eliminate the current rule’s de minimis exception by requiring an internet investment adviser to provide advice to all of its clients exclusively through an operational interactive website and to make certain corresponding changes to Form ADV. [NEW]
CFTC’s Market Risk Advisory Committee to Meet. The CFTC’s Market Risk Advisory Committee (MRAC) will meet on April 9 at 9:30 am ET. The MRAC will consider current topics and developments in the areas of central counterparty risk and governance, market structure, climate-related risk, and emerging technologies affecting derivatives and related financial markets.

New Developments Outside the U.S.

ESMA Clarifies Application of Certain MIFIR Provisions, Including Volume Cap. On March 27, the European Securities and Markets Authority (ESMA) published a statement, including practical guidance supporting the transition and the consistent application of the revised Markets in Financial Instruments Regulation (MiFIR).The statement covers guidance on equity transparency and non-equity transparency; the systematic internaliser (SIs) regime; designated publishing entities (DPEs); and reporting. Regarding the volume cap, following the publication by the European Commission, ESMA confirmsed that DVC data will continue to be published, with the next publication scheduled for early April. [NEW]
ESMA Provides Market Participants with Guidance on the Clearing Obligation for Trading with 3rd Country Pension Schemes. On March 27, ESMA issued a public statement on deprioritizing supervisory actions linked to the clearing obligation for third-country pension scheme arrangements (TC PSA), pending the finalization of the review of EMIR. ESMA expects National Competent Authorities (NCAs) not to prioritize supervisory actions in relation to the clearing obligation for derivative transactions conducted with TC PSAs exempted from the clearing obligation under their third-country’s national law. Additionally, ESMA recommends that NCAs apply their risk-based supervisory powers in their day-to-day enforcement of applicable legislation in this area in a proportionate manner. The Council and the European Parliament reached a provisional agreement on February 7. The political agreement on the EMIR 3 text provides for an exemption regime from the EMIR clearing obligation when the TC PSA is exempted from the clearing obligation under that third country’s national law. [NEW]
ESMA Finalizes First Rules on Crypto-Asset Service Providers. On March 25, ESMA published the first Final Report under the Markets in Crypto-Assets Regulation (MiCA). ESMA stated that Tthe report, which aims to foster clarity and predictability, promote fair competition between crypto-asset service providers (CASPs) and a safer environment for investors across the Union, includes proposals on: (1) information required for the authorization of CASPs; (2) the information required where financial entities notify their intent to provide crypto-asset services; (3) information required for the assessment of intended acquisition of a qualifying holding in a CASP, and (4) how CASPs should address complaints. [NEW]
ESMA Launches the Third Consultation Under MiCA. On March 25, ESMA published its third consultation package under the MiCA. In the consultation package, ESMA is seeking input on four sets of proposed rules and guidelines, covering: (1) detection and reporting of suspected market abuse in crypto-assets; (2) policies and procedures, including the rights of clients, for crypto-asset transfer services; (3) suitability requirements for certain crypto-asset services and format of the periodic statement for portfolio management; and (4) ICT operational resilience for certain entities under MiCA. [NEW]
SFC and HKMA Further Consult on Enhancements to Hong Kong’s OTC Derivatives Reporting Regime. On March 22, 2024, the Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) launched a joint-further consultation on enhancements to the over-the-counter (OTC) derivatives reporting regime in Hong Kong. This further consultation follows an earlier joint-consultation in April 2019, in which the SFC and HKMA proposed a requirement to identify transactions submitted to the Hong Kong Trade Repository (HKTR) for the reporting obligation by a Unique Transaction Identifier. The current joint-further consultation consults on the implementation of the Unique Transaction Identifier, together with the mandatory use of Unique Product Identifier and Critical Data Elements for submission of transactions to the HKTR. The Interested parties are encouraged to submit responses to the SFC or HKMA on the consultation by May 17, 2024. [NEW]
ESMA Publishes Feedback on Shortening Settlement Cycle. On March 21, the ESMA published feedback received to its Call for Evidence on shortening the settlement cycle in the EU. According to ESMA’s report on the feedback, respondents focused on four areas: (1) many operational impacts, beyond adaptations of post-trade processes, were identified as the result of a reduction of the securities settlement cycle in the EU; (2) respondents identified a wide range of both potential costs and benefits of a shortened cycle, with some responses supporting a thorough impact assessment; (3) respondents provided suggestions around how and when a shorter settlement cycle could be achieved, with a strong demand for a clear signal from the regulatory front at the start of the work and clear coordination between regulators and the industry; and (4) stakeholders made clear the need for a proactive approach to adapt their own processes to the transition to T+1 in other jurisdictions. Additionally, according to ESMA, some responses warned about potential infringements due to the misalignment of the EU and North America settlement cycles.
HKMA Issues New SPM Modules on Market Risk and CVA Risk Capital Charges. On March 15, the HKMA released a circular informing the industry that it has issued new Supervisory Policy Manual (SPM) modules MR-1: Market Risk Capital Charge and MR-2: CVA Risk Capital Charge as statutory guidance, which will come into effect on a day to be appointed by the HKMA (intended to be January 1, 2025). The HKMA said that the revised market risk and credit valuation adjustment (CVA) risk capital frameworks will be set out in Part 8 and Part 8A of the Banking (Capital) Rules, respectively. The SPM MR-1: Market Risk Capital Charge covers the standardized approach for market risk, the internal models approach, the simplified standardized approach and requirements related to the boundary between the trading book and banking book, while the SPM MR-2: CVA Risk Capital Charge covers the reduced basic CVA approach, the full basic CVA approach and the standardized CVA approach. According to the HKMA, both new SPM modules are designed not just to provide additional technical details in addition to the rules but to integrally cover all of the related requirements. They set out the minimum standards that all locally incorporated authorized institutions are expected to adopt for the calculation of their market risk and CVA risk capital charges.
ASIC Finalizes Minor and Technical Changes to OTC Derivatives Reporting Rules. On March 13, the Australian Securities and Investments Commission (ASIC) finalized the minor and technical changes to the ASIC Derivative Transaction Rules (Reporting) 2024 under ASIC Derivative Transaction Rules (Reporting) 2024 Amendment Instrument 2024/1 to implement the proposed changes to the 2024 rules set out in Consultation Paper 361a ASIC Derivative Transaction Rules (Reporting) 2024: Follow-on consultation on changes to data elements and other minor amendments (CP 361a). The changes include (1) seven additional data elements; (2) provide clarifications and administrative updates to the data elements; (3) make consequential changes to Chapter 2: Reporting Requirements; and (4) make other administrative updates including re-referencing the location of definitions in the Corporations Act 2001 that have been moved by the Treasury Laws Amendment (2023 Law Improvement Package No. 1) Act 2023. According to ISDA, feedback to CP 361a was broadly supportive. In response to industry requests, the final changes also (1) provide for an additional circumstance where the name of Counterparty 2 is not reported and (2) change how the amount of one kind of collateral is reported.

New Industry-Led Developments

ISDA Submits Joint Response to BCBS Crypto Standard Amendments Consultation. On March 28, ISDA, with the Global Financial Markets Association, the Futures Industry Association, the Institute of International Finance and the Financial Services Forum, submitted a joint response to the Basel Committee on Banking Supervision (BCBS) consultation on proposed crypto asset standard amendments. ISDA and the other trade associations stated that they welcome the BCBS’s continued focus on designing and improving the prudential framework for crypto assets. The key topics in the consultation response include public permissionless blockchains, classification condition 2 and settlement finality and Group 1b eligibility. [NEW]
ISDA Responds to CFTC on Clearing Member Funds Protection. On March 18, ISDA responded to the CFTC’s consultation on proposed rules for the protection of clearing member funds held by derivatives clearing organizations (DCOs), including the assets of futures commission merchants (FCMs). According to ISDA, it proposed that the CFTC should finalize the enhanced protection for clearing member assets in connection with an intermediated DCO only, which includes multiple FCMs, unaffiliated with the DCO, as its members. Regarding a DCO providing direct clearing without multiple FCMs unaffiliated with the DCO, ISDA suggested the CFTC should wait to propose enhanced protection for clearing members’ assets, once a full assessment of the risks and complications associated with a DCO providing direct clearing has been completed. At which point, in ISDA’s opinion, it would be appropriate for the CFTC to propose a comprehensive framework to address these risks holistically. Otherwise, ISDA said, the current notice of proposed rulemaking would create a sense of safety for the disintermediated model, which is superficial due to the rule not creating a comprehensive safety regime for disintermediated central counterparties (CCPs), with many risks arising from such models being left unaddressed.
ISDA Responds to FASB on Induced Conversion of Convertible Debt. On March 18, ISDA submitted a response to the Financial Accounting Standards Board’s (FASB) exposure draft on File Reference No. 2023-ED600, Debt—Debt with Conversion and Other Options (Subtopic 470-20): Induced Conversions of Convertible Debt Instruments. ISDA indicated that it supports FASB’s proposals in the exposure draft and believes it achieves the objective of improving the application and relevance of the induced conversion guidance to cash convertible debt instruments.

The following Gibson Dunn attorneys assisted in preparing this update: Jeffrey Steiner, Adam Lapidus, Marc Aaron Takagaki, Hayden McGovern, and Karin Thrasher.

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

Jeffrey L. Steiner, Washington, D.C. (202.887.3632, [email protected])

Michael D. Bopp, Washington, D.C. (202.955.8256, [email protected])

Michelle M. Kirschner, London (+44 (0)20 7071.4212, [email protected])

Darius Mehraban, New York (212.351.2428, [email protected])

Jason J. Cabral, New York (212.351.6267, [email protected])

Adam Lapidus – New York (+1 212.351.3869, [email protected])

Stephanie L. Brooker, Washington, D.C. (202.887.3502, [email protected])

Roscoe Jones Jr., Washington, D.C. (202.887.3530, [email protected])

William R. Hallatt, Hong Kong (+852 2214 3836, [email protected])

David P. Burns, Washington, D.C. (202.887.3786, [email protected])

Marc Aaron Takagaki, New York (212.351.4028, [email protected])

Hayden K. McGovern, Dallas (214.698.3142, [email protected])

Karin Thrasher, Washington, D.C. (202.887.3712, [email protected])

From the Financial Institutions Practice Group: We are pleased to provide you with the first edition of Gibson Dunn’s monthly U.S. bank regulatory update. This monthly update will analyze legal, regulatory and policy developments in the banking industry in the United States and provide insights into how those developments impact and shape the industry.

FDIC Proposes Revised Statement of Policy on Review of Bank Merger Transactions

On March 21, 2024, the Federal Deposit Insurance Corporation (FDIC) approved a Federal Register notice seeking comment on proposed updates to the FDIC’s Statement of bank merger applications subject to FDIC approval under the Bank Merger Act. The proposed Statement of Policy is more principles based than the current Statement of Policy, last updated in 2008, affirms the FDIC’s view concerning the broad applicability of the Bank Merger Act to merger transactions, including mergers in substance, involving an insured depository institution and any non-insured entity, and would revise how the FDIC evaluates various statutory factors under the Bank Merger Act, including competition, convenience and needs, financial stability, and financial and managerial resources. Comments on the proposal will be due 60 days from the date of publication in the Federal Register.

Insights: The FDIC’s proposed policy statement follows closely in time the Office of the Comptroller of the Currency’s (OCC) proposal to adopt a new policy statement summarizing the OCC’s approach to reviewing proposed bank merger transactions under the Bank Merger Act. Like the OCC’s proposed policy statement, the FDIC’s proposal provides no clarity as to the FDIC’s timing expectations for its review and approval of Bank Merger Act applications. Although Acting Comptroller Michael J. Hsu says in his statement in support of the FDIC’s proposal that it “is broadly consistent with the proposed policy statement issued by the OCC in January,” the two proposals differ in several ways. Notably, contrary to current practice, the proposed policy statement contemplates that the FDIC Board of Directors may release a statement regarding its concerns with any transaction for which a Bank Merger Act application has been withdrawn “if such a statement is considered to be in the public interest for purposes of creating transparency for the public and future applicants.” In addition, the proposed policy statement provides that the FDIC may require divestitures to mitigate competitive concerns before allowing a merger to be consummated, a departure from historical precedent. A divestiture could itself require a separate Bank Merger Act approval, thus delaying significantly the merger transaction. Although the FDIC would not use conditions “as a means for favorably resolving any statutory factors that otherwise present material concerns” (as the OCC would), the FDIC would approve applications subject to standard and non-standard conditions pertaining to capital requirements and other factors.The proposed statement of policy would revise how the FDIC evaluates the statutory factors for a Bank Merger Act application, in certain instances seemingly beyond the statutory factor on its face—as raised by FDIC Director Jonathan McKernan in his statement in opposition of the proposal.
- On competition, the proposal would deemphasize the longstanding 1,800/200 HHI thresholds (although the FDIC does intend to coordinate with other relevant agencies regarding any potential changes to the calculation of, or thresholds for, HHI usage). Although deposits will serve “as an initial proxy for commercial banking products and services,” the FDIC “may consider concentrations in any specific products or customer segments” (e.g., small business or residential loan originations volume, activities requiring specialized expertise). The proposal also provides that the FDIC generally will require that the selling institution not enter into non-compete agreements with any employee of the divested entity.
- On convenience and needs, the proposed policy statement would require the resulting institution “to better meet the convenience and the needs of the community to be served” than would occur without the merger. To establish this, applicants will be required “to provide forward-looking information to the FDIC” for purposes of evaluating the statutory factor, and the FDIC would expect to require “commitments regarding future retail banking services in the community to be served for at least three years following consummation of the merger.” Job losses or lost job opportunities from branching changes “will be closely evaluated.”
- On the financial and managerial resources factors, the FDIC would “not find favorably … if the merger would result in a weaker IDI from an overall financial perspective” and would assess “existing or pending enforcement actions,” and “issues or concerns with regard to specialty areas, including information technology and trust examinations,” and integration planning.
Like the OCC’s proposed policy statement, the FDIC’s proposed policy statement focuses in part on large bank mergers, highlighting that the agency would generally expect “to hold a hearing for any application resulting in an IDI with greater than $50 billion in assets or for which a significant number of CRA protests are received.” It also states that transactions that result in a large institution (e.g., in excess of $100 billion) “will be subject to added scrutiny.” (Currently, only four nonmember banks or industrial banks have total assets of $100 billion or more.)

Comments Due April 15, 2024 on OCC’s Proposed Bank Merger Act Approval Requirements

On January 29, 2024, the Office of the Comptroller of the Currency (OCC) issued a notice of proposed rulemaking that would adopt a new policy statement summarizing the OCC’s approach to reviewing proposed bank merger transactions under the Bank Merger Act and make two substantive changes to its business combination regulation (12 C.F.R. § 5.33). In his speech previewing the proposed rule, Acting Comptroller Michael J. Hsu described the policy statement as laying down “chalk lines” demarcating among three groups of merger applications along a spectrum: those that are “straightforward”; those that have “significant deficiencies”; and the majority which “lie somewhere in between.” The proposed policy statement would set forth thirteen (13) indicators that bank merger applications that “are consistent with approval” would generally include and six (6) indicators, any one of which would raise “supervisory or regulatory concerns” favoring denial or a request to withdraw unless “adequately addressed or remediated.” The proposed rule would remove the expedited review procedures and the streamlined Bank Merger Act application form. Comments on the proposal are due by April 15, 2024.

Insights: The proposed policy statement provides no clarity as to the OCC’s timing expectations for its review and approval of Bank Merger Act applications. In his remarks previewing the proposal, Acting Comptroller Hsu noted only that applications including the thirteen (13) indicators in favor of approval—and presumably none of the indicators in favor of denial or withdrawal—would be “consistent with timely approval.” It also does not speak to mergers that include most, but not all, of the factors in favor of approval and none of the factors in favor of denial or withdrawal, which presumably will be subject to enhanced scrutiny.The policy statement includes a bias against size and mergers of equals. The list of thirteen (13) indicators favoring approval includes (i) the “resulting institution will have total assets less than $50 billion” and (ii) the “target’s combined total assets are less than or equal to 50% of acquirer’s total assets” and the list of six (6) indicators favoring denial or withdrawal includes that the “acquirer is a global systemically important banking organization, or subsidiary thereof.” The policy statement also notes that a resulting institution with $50 billion or more in total assets would “inform[] the OCC’s decision on whether to hold public meetings.” The 50% of assets factor presumably would result in bank mergers of equals being subject to enhanced scrutiny, including even small community bank mergers of equals. In addition, “multiple acquisitions with overlapping integration periods” is viewed unfavorably, which could negatively impact community bank roll-up strategies.In his remarks, Acting Comptroller Hsu also noted the “need to develop modes of analysis for banking competition that go beyond retail deposits as a proxy for market power,” though the policy statement does not propose any new antitrust guidance or modify the OCC’s review of competitive factors, which Hsu said is “ongoing” with the Department of Justice. Finally, it is unclear whether the Federal Reserve or FDIC would propose similar guidance for those agencies’ review of applications pursuant to the Bank Merger Act or the Federal Reserve’s review of holding company merger applications pursuant to Section 3 of the Bank Holding Company Act.

Powell Testimony – “broad and material changes” coming to Basel III proposal and “nowhere near” development of CBDC

On March 7, 2024, Chair of the Federal Reserve Board (Federal Reserve) Jerome Powell testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs as part of his mandated semiannual discussion of the Monetary Policy Report. In response to questions regarding the proposed Basel III endgame reforms, Powell addressed the opposition to the proposed rule, noting that the Federal Reserve “hear[s] the concerns” and that Powell “expect[s]” there will be broad material changes to the proposed rule, going so far as to not rule out “re-propos[ing] parts or all of the thing.” Separately, in response to questions regarding the Federal Reserve’s exploration of a central bank digital currency (CBDC), Powell responded by stating that the Federal Reserve is “nowhere near recommending, let alone adopting” a CBDC in any form.

Insights: With respect to the adoption of the Basel III endgame reforms, Chair Powell appears to be signaling a willingness to reconsider such proposals (or certain aspects thereof) in a meaningful way in the wake of the significant opposition. Consistent with the Federal Reserve’s general skepticism of digital- and tokenized-assets, the Federal Reserve appears unwilling to consider the issuance of an on-chain CBDC at this time, creating market opportunities for other issuers (particularly stablecoin issuers) to capitalize on the market’s desire for fiat-backed stablecoins that enable faster payments through immediate settlement.

FDIC Vice Chairman Travis Hill Speech on Tokenization

On March 11, 2024, Vice Chair Travis Hill gave a speech titled, “Banking’s Next Chapter? Remarks on Tokenization and Other Issues” at the Mercatus Center. The prepared remarks focused specifically on tokenization, or the “representation of ‘real-world assets’ on a distributed ledger, including, but not limited to, commercial bank deposits, government and corporate bonds, money market fund shares, gold and other commodities, and real estate.” Vice Chair Hill lauded the potential benefits that tokenization offers, including 24/7/365 operations, programmability, “atomic settlement, or the simultaneous exchange and settlement of payment and delivery…” and immutability, while also highlighting associated risks that could develop and challenges to development, including increased speed and intensity of bank runs, interoperability and legal uncertainty. The Vice Chair then addressed regulatory challenges, namely the need for effective guidance that provides banks with clear answers on questions like when tokenized deposits differ from traditional deposits and “crypto.”

Insights: Vice Chair Hill’s remarks tend to counteract the “general public perception that the FDIC is closed for business” when it comes to blockchain or distributed ledger technology by offering clear thoughts and proposals on future regulation and guidance. Vice Chair Hill recognizes that experimentation and testing, particularly in areas with no material risk, is neither harmful nor requires a lengthy approval process, and cautions that an overly restrictive approach historically could have stifled development of credit cards in the U.S., which was initially “disastrous” but soon after, “revolutionize[d] how millions of Americans pay for things.” These remarks illustrate Vice Chair Hill’s desire to foster greater innovation in banking.Vice Chair Hill also advocated for a more formal regulatory approach to certain bank-friendly approaches, and signaled disapproval of other approaches, indicating disagreement on both process and substance between the FDIC and other regulators. Specifically, Vice Chair Hill embraced a more formalized rulemaking approach over the “bank-by-bank approval process” if the FDIC decides that tokenized deposits differ from traditional deposits, and urged agencies to “distinguish between ‘crypto’ and the use by banks of blockchain and distributed ledger technologies” that are merely “a new way of recording ownership and transferring value.” He contrasted these positions with those taken by the Securities and Exchange Commission (SEC) in issuing Accounting Bulletin 121 (SAB 121), which Vice Chair Hill criticized for making it “prohibitively challenging for banks to engage in [crypto-asset] activity at any scale” and failing to distinguish between “blockchain-native assets” and “tokenized versions of real-world assets.” He also cited the SEC’s approach in SAB 121 as “a clear example of why it is generally constructive for agencies to seek public comment before publishing major policy issuances,” further indicating his preference for industry collaboration and input.

CFPB Issues Final Rule on Credit Card Late Fees

On March 5, 2024, the Consumer Financial Protection Bureau (CFPB) issued a final rule governing late fees charged by “Larger Card Issuers” (those with one million or more open credit card accounts). The final rule effectively caps the amount such Larger Card Issuers can charge in late fees at $8 per incident, subject to an exemption for fees to cover a portion of actual collection costs. The rule also eliminates the automatic annual inflation adjustments to allowable fees, providing instead that the CFPB will “monitor the market” and adjust the $8 threshold as necessary. Notably, the final rule actually increases the amount smaller card issuers can charge in late fees, from $30 to $32 for initial violations, and from $41 to $43 for subsequent violations. The final rule has an effective date of May 14, 2024.

Insights: The final rule will create challenges for issuers, including operationalizing changes resulting from the final rule, amending cardholder agreements, customer disclosures, and more broadly, marketing materials, and issuing any required change in terms notices or adverse action notices to customers resulting from changes to customer terms arising from the final rule. The final rule also will not permit issuers to recover full collection costs or take into account deterrence or consumer conduct, factors Congress expressly directed the CFPB to consider. On March 7, 2024, just two days after the final rule was announced, a coalition of industry trade groups filed suit, challenging the rule on multiple grounds. The trade groups argue, among other things, that the rule violates the CARD Act, the Dodd-Frank Act, the Administrative Procedure Act, and the Truth in Lending Act. As noted, the final rule has an effective date of May 14, 2024, subject to the current litigation which may impact the final rule’s effective date.

Federal Reserve Governor Bowman Speaks on Tailoring

On March 5, 2024, Federal Reserve Governor Michelle W. Bowman gave a speech titled “Tailoring, Fidelity to the Rule of Law, and Unintended Consequences.” In her speech, Governor Bowman states that tailoring, being the setting of regulatory priorities and allocation of supervisory resources in a risk-based manner, ensures a focus on the most critical risks over time, avoiding the over-allocation of resources or imposition of unnecessary costs on the banking system. Governor Bowman further claimed that “the current regulatory agenda includes many … regulatory reform proposals [that] lack sufficient attention to regulatory tailoring and thereby fail to further statutory directives to tailor certain requirements and, more importantly, to address the condition of the banking system.” Governor Bowman cites both the pending Basel III endgame reforms and the final climate guidance as regulatory actions that deviate from the principle of tailoring.

Insights: Governor Bowman’s speech on tailoring is not net-new for her, following on her January 2024 speech to the South Carolina Bankers Association, in which she called for a “renewed commitment to [the Federal Reserve’s] Congressionally mandated obligation to tailoring.” In making this call for a renewed commitment to tailoring, Governor Bowman notes “all banks are affected when policymakers shift away from or deemphasize tailoring. When we fail to recognize fundamental differences among firms, there is a strong temptation to continually push down requirements designed and calibrated for larger and more complex banks, to smaller and less complex banks that cannot reasonably be expected to comply with these standards.”In expanding on her prior critique of Basel III, in her March 5th speech, Governor Bowman stated that “the federal banking agencies have proposed several reforms to the capital framework, among them the Basel III ‘endgame’ and new long-term debt requirements that would apply to all banks with over $100 billion in assets. I have expressed concern with both of these proposals on the merits, in terms of striking the right balance between safety and soundness and efficiency and fairness, and out of concern for potential unintended consequences. Another concern is whether these proposals show fidelity to the law, which requires regulatory tailoring above the $100 billion asset threshold.”

Federal Reserve Governor Bowman Speaks on Bank Regulation

On March 7, 2024, Federal Reserve Governor Michelle W. Bowman gave a speech titled “Reflections on the Economy and Bank Regulation,” in which she shared her thoughts on monetary policy, the economy, and the path of regulatory reform. In the speech, Governor Bowman made several key observations: (1) regulatory reforms within bank mergers and acquisitions should prioritize speed and timeliness; (2) when considering new liquidity requirements, the Federal Reserve must consider not only calibration and scope, but also the unintended consequences of such requirements; and (3) the Federal Reserve must manage its supervisory programs and teams to ensure effective and consistent supervision.

Insights: Governor Bowman states that to accomplish these goals, the Federal Reserve should aim to conduct supervision “in a manner that respects due process and provides transparency around supervisory expectations.” Due process, transparency, calibration of supervision, and the communication of supervisory expectations are consistent themes of Governor Bowman as it relates to proper oversight and supervision by regulators. As it relates to current bank M&A procedures and policies, a footnote in Governor Bowman’s speech directs readers to provide feedback through the recently launched mandatory review of regulatory burdens under the Economic Growth and Regulatory Paperwork Reduction Act of 1996.

The following Gibson Dunn attorneys contributed to this issue: Jason Cabral, Rachel Jackson, Zach Silvers, Karin Thrasher, Andrew Watson, and Nathan Marak.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Financial Institutions or Global Financial Regulatory practice groups, or the following:

Jason J. Cabral, New York (212.351.6267, [email protected])

Stephanie L. Brooker, Washington, D.C. (202.887.3502, [email protected])

M. Kendall Day, Washington, D.C. (202.955.8220, [email protected])

Jeffrey L. Steiner, Washington, D.C. (202.887.3632, [email protected])

Sara K. Weed, Washington, D.C. (202.955.8507, [email protected])

Ella Capone, Washington, D.C. (202.887.3511, [email protected])

Rachel Jackson, New York (212.351.6260, [email protected])

Chris R. Jones, Los Angeles (212.351.6260, [email protected])

Zack Silvers, Washington, D.C. (202.887.3774, [email protected])

Karin Thrasher, Washington, D.C. (202.887.3712, [email protected])

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We are pleased to provide you with Gibson Dunn’s ESG monthly updates for March 2023. This month our update covers the following key developments. Please click on the blue links below for further details.

International
1. PRI releases new report on stewardship practices across investment managers
  The United Nations Principles for Responsible Investment (“PRI”) released a report on stewardship practices amongst their investment manager signatories on March 17, 2023, resulting from the PRI’s analysis of responses from 1,858 investment managers. As part of the report, the PRI has identified a number of key areas for development which include: (i) the development of detailed, public responsible investment policies, (ii) broader coverage across assets under management, asset classes and ESG issues, (iii) clear accountability and governance for implementing responsible investment, (iv) expansion of client reporting, including quantitative analysis relating to ESG performance, and (v) robust implementation of the recommendations of the Task Force on Climate-Related Financial Disclosures.
2. IASB initiates project to consider climate-related risks in financial statements and proposes amendments to classification requirements for financial assets with ESG features
  The International Accounting Standards Board (“IASB”) launched a project on March 20, 2023 aimed at exploring whether and how companies can provide better information about climate-related risks in their financial statements. In undertaking the project, the IASB will research the cause of stakeholders’ concerns in respect of: (i) the inconsistent application of the International Financial Reporting Standards’ Accounting Standards in relation to climate-related risks, and (ii) the disclosure of insufficient information in financial statements about climate-related risks. The project will include a consideration of the work of the International Sustainability Standards Board in respect of financial statements to ensure that any proposals are complementary to that work.
  
  Separately, on March 21, 2023, the IASB also published an Exposure Draft proposing amendments to IFRS 9 (Financial Instruments) and related requirements in IFRS 7 (Financial Instruments: Disclosures) to include clarifications in respect of the assessment of contractual cash flow characteristics in financial assets containing ESG features. Comments on the Exposure Draft are to be received by July 19, 2023.
3. TNFD releases fourth and final beta framework
  On March 28, 2023, the Taskforce on Nature-related Financial Disclosures (“TNFD”) released its fourth and final beta framework for nature-related risk management and disclosure for market participants to identify, assess, respond to, and disclose their nature-related issues. In this final beta draft, the TNFD has outlined its approach to disclosure metrics proposing a three-tiered approach as to disclosure metrics for nature-related issues: (i) core global disclosure metrics (that cover all sectors), (ii) core sector-specific disclosure metrics, and (iii) additional disclosure metrics (that can be used more flexibly). The TNFD is expected to release its final recommendations in September 2023.
4. APLMA, LMA and LSTA publish two guidance documents on green, social and sustainability-linked loans
  On March 3, 2023, the Asia Pacific Loan Market Association (“APLMA”), the Loan Market Association (“LMA”) and the Loan Syndications and Trading Association (“LSTA”) announced the joint publication of two new ESG guidance documents to support the development of green, social and sustainability-linked loans. The first of these documents entitled “Guidance for Green, Social, and Sustainability-Linked Loans External Reviews“ is intended to provide best practice guidance on the professional and ethical standards for the external review process, which is recommended in certain circumstances by the Green Loan Principles, the Social Loan Principles or the Sustainability-Linked Loan Principles, in connection with entering into green, social, or sustainability-linked loans respectively. The second guidance document entitled “Guidance on Social Loan Principles“ is designed to sit alongside the Social Loan Principles and is intended to provide greater clarity for market participants with regards to the requirements of the Social Loan Principles.
United Kingdom
1. UK government publishes an updated green finance strategy and a strategic framework for international climate and nature action
  On March 30, 2023, the UK government published: (i) its revised green finance strategy (the “Strategy”), which is an update to its earlier 2019 predecessor, and (ii) its 2030 Strategic Framework For International Climate And Nature Action (the “Framework”), which sets out the direction for the UK’s integrated approach to international action on nature and climate up to 2030. Both the Strategy and the Framework are important cogs in a series of mechanisms aimed at furthering the UK’s goal to become the world’s first “net-zero financial centre”.
  
  The Strategy showcases the UK government’s focus on five key objectives: (i) the growth of the UK’s financial services sector, (ii) investment in the green economy, (iii) financial stability to manage risks from climate change and nature loss, (iv) incorporation and adaptation of nature and climate into the government’s green finance policy framework, and (v) alignment of global financial flows with climate and nature objectives.
  
  On the other hand, the Framework sets out three key global goals to ensure that the UK delivers internationally on its climate and nature goals: (i) keeping the 1.5^°C target within reach by halving global emissions, (ii) building resilience to current and future climate impacts, and (iii) halting and reversing global nature loss. It proposes to do so by focussing on six local objectives: (i) a transition to clean technologies and sustainable practices, (ii) building resilience and adapting to climate impacts, (iii) increasing protection, conservation and restoration of nature, (iv) the strengthening of international agreements and cooperation to accelerate the delivery of climate and nature commitments, (v) alignment of global financial flows with a net zero future, and (vi) shifting trade and investment rules and patters to support the transition to a climate and nature positive future.
2. UK Treasury publishes a consultation paper on a potential regime for ESG ratings providers
  On March 30, 2023, the UK Treasury published a consultation paper on a potential regulatory regime for ESG ratings providers. In the consultation paper, the Treasury outlines that the proposed regime would broadly seek to establish a framework whereby any assessment (excluding raw ESG data collection) regarding one or more ESG factors, whether or not it is labelled as such, provided to a UK user in relation to a number of specified investments, would be deemed to be a restricted activity in the UK. Consequently, such restricted activity could only be carried out if the relevant person (individual or corporate) is either authorised by the appropriate regulator or exempt from the authorisation requirement. The consultation paper itself seeks market participants’ views on a range of issues, such as whether there should be fewer requirements for smaller providers and the scope of the regulatory regime. The consultation will close on 30 June 2023.
3. FCA outlines areas for improvement for ESG benchmarks
  On March 20, 2023, the UK’s Financial Conduct Authority (“FCA”) announced that it had completed a preliminary review on ESG benchmarks and reported that the overall quality of ESG-related disclosures made by benchmark administrators was poor. At the same time, the FCA announced that it had sent a further letter to benchmark administrators outlining the key issues it had identified, which included: (i) lack of sufficient detail on the relevant ESG factors considered in benchmark methodologies, (ii) lack of accessibility and clarity of the underlying methodologies for ESG data and rating products, and (iii) ESG benchmark administrators not fully implementing all ESG disclosure requirements.
4. UK Treasury Committee raises concerns on consumer cost of the FCA’s proposed ESG designation criteria and the FCA publishes update on its proposals
  Following the UK’s Financial Conduct Authority’s (“FCA”) a consultation paper in October 2022 proposing new criteria that a UK investment fund would need to meet to describe itself as “sustainable” (or similar), on March 9, 2023 the Treasury Committee raised concerns with the FCA that consumers who have invested in investment funds guilty of greenwashing may have to pay to move their investments into other ‘sustainable’ funds. As a result, the Treasury Committee has called for the FCA to conduct a more detailed cost-benefit analysis of its proposals and provide an assessment of the risks to both consumers and the funds industry. The FCA subsequently published an update on its proposals on March 29, 2023, confirming that the regime would be aimed primarily at protecting consumers, that there will be flexibility as to the labelling restrictions, and that it will seek international coherence with other regimes. The FCA’s full Policy Statement on the topic is expected to be published in Q3 of 2023.
Europe
1. EU Commission proposes reforms of the EU electricity market design to boost renewables
  On March 14, 2023, the European Commission announced a proposal for a European Union (“EU”) Regulation to reform the EU’s electricity market which envisages revisions to several pieces of key EU electricity legislation, notably the Electricity Regulation, the Electricity Directive, and the REMIT Regulation. The key proposals include the introduction of: (i) measures to incentivise more stable longer term contracts with non-fossil power production, (ii) more clean flexible solutions to compete with gas, such as demand response and storage, and (iii) a wider choice of consumer contracts and clearer information about them to allow consumers to lock in secure, long-term prices to avoid excessive risks and volatility (while retaining the flexibility for consumers to enter into dynamic pricing contracts to take advantage of price variability to use electricity when it is cheaper).
2. EU Commission proposes the Net Zero Industry Act
  On March 16, 2023, the European Commission proposed the Net Zero Industry Act, which aims to simplify the regulatory framework for the manufacturing of technologies (or key components of technologies) which are key to achieve climate neutrality. The Act supports in particular eight strategic net zero technologies: (i) solar photovoltaic and solar thermal technologies, (ii) onshore wind and offshore renewable energy, (iii) batteries and storage, (iv) heat pumps and geothermal energy, (v) electrolysers and fuel cells, (vi) biogas/biomethane, (vii) carbon capture and storage, and (viii) grid technologies (which also include electric vehicles’ smart and fast charging). Other net zero technologies are also supported by the measures in the proposed Act, to a different degree, including sustainable alternative fuels technologies, advanced technologies to produce energy from nuclear processes with minimal waste from the fuel cycle, small modular reactors and related best-in-class fuels. The proposed Act now needs to be discussed and agreed by the European Parliament and the Council of the European Union before its adoption and entry into force.
3. EU Commission proposes a directive on “green claims”
  The European Commission proposed the Green Claims Directive on March 22, 2023, which would have a significant impact on businesses making “green claims” for their products in the European Union. A “green claim” under the directive may include any message or representation in any form that states or implies a positive or no environmental impact for a product, service, or organisation. The directive, among others, provides for strict rules for evidence supporting any such green claims made by companies, mandates third-party verification for green claims, and requires businesses to provide consumers with information on such claims, either in a physical form or via weblink or QR code.
4. European Parliament and European Council reach a deal on cleaner maritime fuels
  On March 23, 2023, the European Parliament and the European Council reached a provisional agreement to establish a fuel standard for ships to steer the European Union (“EU”) maritime sector towards the uptake of renewable and low-carbon fuels and decarbonisation. This agreement is part of the EU’s “Fit for 55” target of reducing net greenhouse gas emissions by at least 55% by 2030. The proposed legislation requires that the greenhouse gas intensity of fuels is lowered over time (below the 2020 levels of 91.16 grams of CO2 per MJ), initially by 2% as of 2025, increasing incrementally and reaching up to 80% reduction as of 2050.
United States
1. Biden vetoes anti-ESG investment legislation
  The president of the United States Joe Biden issued the first veto of his presidency on March 20, 2023, rejecting legislation that sought to void the Department of Labor’s rule allowing fiduciaries to consider ESG factors when choosing retirement investments. This ESG legislation, which took effect on January 30, 2023, was finalised in November of last year, following an executive order signed by President Biden in May 2021 that directed federal agencies to consider policies to protect against the threats of climate-related financial risk. The rule has been subject to significant debate, with opponents arguing that it will hurt retirement savings but the Department of Labor has emphasised that the rule permits, but does not mandate, fiduciaries to consider these factors.
2. West Virginia House of Delegates passes bill targeting ESG shareholder votes
  On March 28, 2023, the governor of West Virginia, Jim Justice, signed legislation that targets shareholder votes (on behalf of the state’s investment boards) that factor in ESG principles. The West Virginia House Bill 2862 seeks to designate “environmental, social, corporate governance, or other similarly oriented considerations” as factors that should not be considered in shareholder votes cast by the state’s Investment Management Board or the fund managers it entrusts with casting such votes, unless such ESG factors directly and materially affect the financial risk or financial returns of the relevant investments. This is expected to impact decisions on investments of over USD $4 billion as the West Virginia Investment Management Board is tasked with investing assets for the retirement systems of deputy sheriffs, emergency management services, judges, municipal police officers, firefighters, public employees, state police officers and teachers within the state.
3. Proxy Preview publishes 2023 report on ESG shareholder proposals
  On March 7, 2023, As You Sow, the Sustainable Investments Institute, and Proxy Impact, published the Proxy Preview 2023 report, containing information on hundreds of shareholder proposals, including environmental, corporate political spending, human rights, diversity, sustainable governance issues and others. Key takeaways from the report regarding 2023 developments are: (i) a continued increase in climate change shareholder proposals, and (ii) a significant expansion of shareholder proposals on reproductive health, in response to the United States Supreme Court’s decision from June 2022 that is prompting a wave of restrictions across the United States. Proxy Preview also reports a surge in proposals pressing companies to commit (or re-commit) to international standards that protect the right to organise unions, notes that corporate political influence proposals are evenly split among lobbying, election spending and values congruency, and predicts (based on early indications) that anti-ESG resolutions, which increased in numbers last year, will expand further.
4. COSO releases new supplemental guidance on internal control over sustainability reporting
  On March 30, 2023, the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) released supplemental guidance for organisations on improving internal control over sustainability reporting (“ICSR”). The supplemental guidance uses the globally recognised COSO Internal Control Integrated Framework as its basis and includes the following notable aspects: (i) references to the role of the internal audit function in sustainability reporting in the scope of the guidance, reflecting their integral part of ICSR, (ii) key themes to consider as organisations continue their journeys toward establishing and maintaining an effective system of internal control over financial and sustainable business information, and (iii) insights from companies with a particular ICSR focus to help more firmly establish ICSR practice within the internal audit profession.
APAC
1. Japan announces timeline for introducing sustainability disclosure standards
  Japan announced on March 2, 2023 that it plans to introduce its own sustainability disclosure standards based on the International Sustainability Standards Board (“ISSB”) framework ahead of the 2025-2026 financial year. The timeline for this was announced following a meeting between the ISSB and the Sustainability Standards Board of Japan and includes a proposed initial draft of the standards to be tabled by March 31, 2024 and final form standards to be issued by March 31, 2025. It is expected that the standards will be voluntary initially, with mandatory requirements to follow at a later date (which is yet to be decided).
2. Malaysia’s stock exchange plans to introduce a sustainability reporting platform in April
  Bursa Malaysia announced on March 22, 2023 that it is set to launch a sustainability reporting platform in April, in conjunction with the London Stock Exchange. The platform is expected to serve as a repository where both listed entities and small-to-medium enterprises can calculate their supply chain carbon emission impact and disclose common ESG data in accordance with established global standards, such as those of the Task Force on Climate-Related Financial Disclosures. The announcement follows last year’s memorandum of understanding between Bursa Malaysia and the London Stock Exchange, which seeks to improve collaboration between the two exchanges, in particular in relation to ESG educational initiatives, implementation of supply chain finance and corporate ESG reporting solutions.
3. South Korea reduces 2030 emission reduction targets for industrial sector
  On March 21, 2023, the South Korean Presidential Commission on Carbon Neutrality and Green Growth announced via a press release from the Korean Ministry of Environment that it has decided to cut South Korea’s 2030 targets for reducing gas emissions (compared to its 2018 levels) in the industrial sector by 3.1% from the 14.5% set in late 2021 to 11.4%. The announcement also notes that South Korea is committed to maintaining its national goal of cutting emissions by 40% of 2018 levels and the gap created by this reduction is expected to be filled by switching more energy sources to renewables and making more reductions overseas. The Commission has backed its proposal noting that it has been necessitated “in light of realistic domestic conditions including raw material supply and technology prospects.”

Please let us know if there are topics that you would be interested in seeing covered in future editions of the monthly update.

Warmest regards,

Susy Bullock
Elizabeth Ising
Perlette M. Jura
Ronald Kirk
Michael K. Murphy
Selina S. Sagayam

Chairs, Environmental, Social and Governance Practice Group, Gibson Dunn & Crutcher LLP

The following Gibson Dunn lawyers prepared this client update: Selina Sagayam, Elizabeth Ising, David Woodcock, Patricia Tan Openshaw, Sarah Leiper-Jennings, and Grace Chong.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any leader or member of the firm’s Environmental, Social and Governance practice group:

Environmental, Social and Governance (ESG) Group:
Susy Bullock – London (+44 (0) 20 7071 4283, [email protected])
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, [email protected])
Perlette M. Jura – Los Angeles (+1 213-229-7121, [email protected])
Ronald Kirk – Dallas (+1 214-698-3295, [email protected])
Michael K. Murphy – Washington, D.C. (+1 202-955-8238, [email protected])
Patricia Tan Openshaw – Hong Kong (+852 2214-3868, [email protected])
Selina S. Sagayam – London (+44 (0) 20 7071 4263, [email protected])
David Woodcock – Dallas (+1 214-698-3211, [email protected])

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice. Please note, prior results do not guarantee a similar outcome.

The second quarter of 2022 saw U.S. federal lawmakers and agencies focus on draft legislation and guidance aimed at closing the gap to the EU with respect to addressing risks in the development and use of AI systems, in particular risks related to algorithmic bias and discrimination. The American Data Privacy and Protection Act (“ADPPA”), the bipartisan federal privacy bill introduced to the U.S. House in June 2022, marks a major step towards a comprehensive national privacy framework, and companies should take particular note of its inclusion of mandated algorithmic impact assessments. Meanwhile, the E.U.’s regulatory scheme for AI continues to wind its way through the EU legislative process. Though it is unlikely to become binding law until late 2023 at the earliest, the EU policy landscape remains dynamic.

Our 2Q22 Artificial Intelligence and Automated Systems Legal Update focuses on these key efforts, and also examines other policy developments within the U.S. and EU that may be of interest to domestic and international companies alike.

I. U.S. ENFORCEMENT, REGULATORY & POLICY DEVELOPMENTS

A. U.S. National AI Strategy

1. U.S. Department of Commerce: U.S. Department of Commerce Appoints 27

Members to National AI Advisory Committee

On April 14, 2022, the U.S. Department of Commerce announced the appointment of 27 experts to the National Artificial Intelligence Advisory Committee (“NAIAC”), which will advise the President and the National AI Initiative Office on a range of issues related to AI.[1] The appointments are the first for the recently established committee, created in response to the National AI Initiative Act of 2020. The initiative directs the NAIAC to provide recommendations on topics like the current state of U.S. AI competitiveness, the state of science around AI, and AI workforce issues. The committee also is responsible for advice regarding the management and coordination of the initiative itself, including its balance of activities and funding.

2. NIST AI Risk Management Framework

As noted in our 1Q22 Legal Update,[2] in March 2022, the National Institute of Standards and Technology (“NIST”) released for public comment an initial draft of its AI Risk Management Framework (“AI RMF”), which provides guidance for managing risks in the design, development, use, and evaluation of AI systems. NIST separately released a document titled, “Towards a Standard for Identifying and Managing Bias within Artificial Intelligence,” which aims to provide guidance for mitigating harmful bias in AI systems.

Subsequently, on March 29-31, 2022, NIST held its second broad stakeholder workshop on its draft AI RMF titled, “Building the NIST AI Risk Management Framework: Workshop #2.”[3] The workshop extensively discussed the AI RMF as well as international trends and standards and mitigating harmful AI bias. NIST is seeking stakeholder feedback on the draft framework as part of a process over the next year to release a full version 1.0 of the AI RMF, which NIST intends to be a critical tool for organizations to identify and manage risks related to AI, including in areas like potential bias. We stand ready to assist clients who wish to participate in this process.

B. Algorithmic Accountability and Consumer Protection

1. FTC

The Federal Trade Commission (“FTC”) continues to position itself as a key regulator of AI technology. In December 2020, as part of the 2021 Appropriations Act, Congress tasked the FTC with conducting a study and reporting on whether and how AI could be used to identify, remove, or take other appropriate action to address a variety of online harms (scams, deepfakes, child sexual abuse, terrorism, hate crimes and harassment, election-related disinformation, and the traffic in illegal drugs and counterfeit goods). Congress also required the FTC to recommend reasonable policies and procedures for using AI to combat these online harms, and any legislation to “advance the adoption and use of [AI]” for these purposes.

In its June 16, 2022 report,[4] the FTC advised that, while AI can be used as a tool to detect and remove harmful material online, there are significant risks associated with its use. In particular, the FTC cautioned that because AI systems rely on algorithms and inputs created by humans, and often have built-in motivations geared more towards consumer engagement rather than content moderation, even supposedly neutral systems can disproportionately harm minorities while threatening privacy and free speech. Additionally, the FTC stated that while many companies currently use AI tools to moderate content, they “share little information about how these systems work, or how useful they are in actually combating harmful content.”[5] The FTC therefore advised that there needs to be more transparency before the government can understand how AI tools work in the real world. Although the Commission acknowledged that major tech platforms and others are already using AI tools to address online harms, the report’s final recommendation is that Congress should avoid laws that would mandate or overly rely on the use of AI to combat online harms and instead conduct additional investigation into other tools that might also be helpful in moderating online content. In his dissenting statement, Commissioner Phillips noted that the report “has no information gleaned directly from individuals and companies actually using AI to try to identify and remove harmful online content, precisely what Congress asked us to evaluate.”[6]

Further, on June 22, 2022, Senators Ed Markey (D-MA), Elizabeth Warren (D-MA), Brian Schatz (D-HI), Cory Booker (D-NJ), Ron Wyden (D-OR), Tina Smith (D-MN), and Bernie Sanders (VT) sent a letter to FTC chair Lina Khan urging the FTC to “build on its guidance regarding biased algorithms and use its full enforcement and rulemaking authority to stop damaging practices involving online data and artificial intelligence.”[7] The letter cites the National Institute of Standards and Technology’s study that Black and Asian individuals “were up to 100 times more likely to be misidentified” by biometric surveillance tools than white individuals, and asks the FTC to use its authority to combat “invasive and discriminatory biometric surveillance tools,” including facial recognition tools.

a) Digital Platform Commission Act of 2022 (S. 4201)

On May 12, 2022, Senator Michael Bennet (D-CO) introduced the Digital Platform Commission Act of 2022 (S. 4201), which would empower a new federal agency, the Federal Digital Platform Commission, to promulgate rules, impose civil penalties, hold hearings, conduct investigations, and support research with respect to online platforms that facilitate interactions between consumers, as well as between consumers and entities offering goods and services.[8] The Commission would have a broad mandate to promote the public interest, with specific directives to protect consumers, promote competition, and assure the fairness and safety of algorithms on digital platforms, among other areas. Regulations contemplated by the bill include requirements that algorithms used by online platforms “[be] fair, transparent, and without harmful, abusive, anticompetitive, or deceptive bias.” The bill has been referred to the Committee on Commerce, Science, and Transportation.

b) Health Equity and Accountability Act of 2022 (H.R. 7585)

Introduced in the House on April 26, 2022, the Health Equity and Accountability Act of 2022 (H.R. 7585) aims to address algorithmic bias in the context of healthcare.[9] The Bill would require the Secretary of Health and Human Services to establish a “Task Force on Preventing AI and Algorithmic Bias in Healthcare” to develop guidance “on how to ensure that the development and [use] of artificial intelligence and algorithmic technologies” in delivering care “does not exacerbate health disparities” and help ensure broader access to care. Additionally, the Task Force would be charged with identifying the risks posed by a healthcare system’s use of such technologies to individuals’ “civil rights, civil liberties, and discriminatory bias in health care access, quality, and outcomes.” The bill has been referred to the Committee on Energy and Commerce.

c) California Department of Insurance Issues Bulletin Addressing Racial Bias and Unfair Discrimination

On June 30, 2022, the California Department of Insurance issued a bulletin addressing racial bias and unfair discrimination in the context of consumer data.[10] The bulletin notes that insurance companies and other licensees “must avoid both conscious and unconscious bias or discrimination that can and often does result from the use of artificial intelligence, as well as other forms of ‘Big Data’ … when marketing, rating, underwriting, processing claims, or investigating suspected fraud.”[11] To that end, the Department now requires that insurers and licensees conduct their own due diligence to ensure full compliance with all applicable law “before utilizing any data collection method, fraud algorithm, rating/underwriting or marketing tool, insurers and licensees must conduct their own due diligence to ensure full compliance with all applicable laws.” In addition, insurers and licensees “must provide transparency to Californians by informing consumers of the specific reasons for any adverse underwriting decisions.”[12]

d) EEOC and DOJ Guidance on the Americans with Disabilities Act and the Use of AI to Assess Job Applicants and Employees

On May 12, 2022, more than six months after the Equal Employment Opportunity Commission (“EEOC”) announced its Initiative on Artificial Intelligence and Algorithmic Fairness,[13] the agency issued its first guidance regarding employers’ use of AI.[14] The EEOC’s non-binding, technical guidance provides suggested guardrails for employers for the use of AI technologies in their hiring and workforce management systems.

The EEOC’s guidance outlines best practices and key considerations that, in the EEOC’s view, help ensure that employment tools do not disadvantage applicants or employees with disabilities in violation of the Americans with Disabilities Act (“ADA”). The guidance provides three ways in which an employer’s tools could be found to violate the ADA: (1) by relying on the tool, the employer fails to provide a reasonable accommodation; (2) the tool screens out an individual with a disability that is able to perform the essential functions of the job with or without an accommodation; and (3) the tool makes a disability-related inquiry or otherwise constitutes a medical examination.

e) EEOC Brings Age Discrimination Action Against Tutoring Software Company

On May 5, 2022, the EEOC filed a complaint in the Eastern District of New York alleging that a software company providing online English-language tutoring to adults and children violated the Age Discrimination in Employment Act (“ADEA”) by denying employment as tutors to a class of plaintiffs because of their age.”[15] Specifically, the EEOC alleges that the company’s application software automatically denied older, qualified applicants by soliciting applicant birthdates and automatically rejecting female applicants age 55 or older and male applicants age 60 or older. The EEOC seeks a range of damages, including back wages, liquidated damages, a permanent injunction enjoining the challenged hiring practice, and the implementation of policies, practices, and programs providing equal employment opportunities for individuals 40 years of age and older.

C. Data Privacy

1. Legislation and Regulation

a) American Data Privacy and Protection Act (H.R. 8152)

On June 21, 2022, members of Congress introduced a bipartisan federal privacy bill, H.R. 8152, the American Data Privacy and Protection Act (“ADPPA”).^{^[16]} The ADPPA aims to create a national framework that would preempt many, but not all, state privacy laws. The bill passed the U.S. House Energy and Commerce Committee on July 20, but is now increasingly unlikely to be passed during this Congressional session.^{^[17]} While ADPPA shares similarities with current state privacy laws, companies should pay attention to several proposed requirements that are particularly relevant to AI technologies.

i. Overview of ADPPA

The ADPPA proposes broad limitations on the kind of data processing that covered entities are allowed to engage in, [18] and also requires companies to provide certain rights to consumers, including a right to notice, a right to ownership or control (a right to access data, correct data, or have data deleted), and a right to opt out or object.[19]

The bill defines “covered entities” as entities subject to the FTC Act, common carriers under federal law, or nonprofits, that “alone or jointly with others” determine the purposes and means of collecting, processing, and transferring covered data.[20] The ADPPA covers a wide variety of personal data, including any data “linked” or “linkable” to an individual or a device, which is similar to the EU’s General Data Protection Regulation (“GDPR”) as well as state privacy laws such as the California Consumer Privacy Act (“CCPA”) or the Virginia Consumer Data Protection Act (“VCDPA”). “Covered data” under the ADPPA includes data that is linkable to a device, not just an individual. Additionally, the definition of “biometric information” does not include photographs or recordings, but does include fingerprints, voice prints, iris or retina scans, “facial mapping or hand mapping,” and gait. De-identified data, employee data, and publicly available information are among the enumerated exemptions.[21]

ii. Algorithmic Assessments

The bill contains new AI assessment obligations that would directly impact companies developing AI technologies. ADPPA would require covered entities and service providers that knowingly develop an algorithm to collect, process, or transfer covered data to produce an algorithm design evaluation (including training data), which must specifically consider any data used to develop the algorithm to reduce the risk of potential harms.[22]

Large data holders must conduct an additional annual impact assessment of any algorithm that is used to collect, process, or transfer covered data, and may cause potential harm to an individual. The assessments must describe the algorithm’s design process, purpose, foreseeable uses, data inputs and the outputs the algorithms generate, as well as steps taken to mitigate potential harms.[23] In particular, harms related to the following areas must be addressed: (1) individuals under the age of 17; (2) advertising for housing, education, employment, healthcare, insurance, or credit opportunities; (3) access to, or restrictions on the use of, a place of public accommodation; or (4) a disparate impact on the basis of protected characteristics.[24] Entities must use an external, independent researcher or auditor to the extent possible and both design evaluations and impact assessments must be submitted to the FTC within 30 days of completion.

Mirroring the risk-based approach adopted by the EU’s draft AI Act, the ADPPA contemplates that the FTC will promulgate regulations that would allow entities to exclude from their design evaluations and impact assessments any algorithms that present low or minimal risk for the enumerated harms.[25]

b) CPRA Draft Regulations

The California Privacy Protection Agency (“CPPA”) released its CPRA draft regulations on May 27, 2022.^{^[26]} The regulations were intended to be finalized by July 1, 2022, but public participation in the rulemaking process is still ongoing, with additional public hearings now scheduled for August 24 and 25, 2022.

In August 2020, the California Attorney General released the final regulations for the CCPA, the comprehensive state privacy law that will be replaced by the CPRA in January 2023. The May 2022 draft CPRA regulations redline the August 2020 CCPA regulations and mostly focus on the CPRA’s changes to the preexisting CCPA concepts. Key regulations addressed by this initial draft include those relating to dark patterns, expanded rules for service providers, third-party contracts, third-party notifications, requests to correct, opt-out preference signals, data minimization, privacy policy rules, revised definitions, and enforcement considerations.

One of the most conspicuous omissions concerns the lack of parameters for automated decision-making. The CPRA defines “profiling” as “any form of automated processing of personal information, as further defined by regulations pursuant to paragraph (16) of subdivision (a) of Section 1798.185 [of the CCPA], to evaluate certain personal aspects relating to a natural person and in particular to analyze or predict aspects concerning that natural person’s performance at work, economic situation, health, personal preferences, interests, reliability, behavior, location, or movements,” leaving the contours relatively amorphous in scope.^{^[27]} Contrary to the scope defined by other comprehensive state privacy laws and GDPR, commenters have pointed out that the CPRA’s language casts an incredibly wide net that could be argued to cover everything from invasive facial recognition in public places to routine automated processes like calculators and spellcheckers that may process personal information. As expressed in many CPPA public record comments, numerous stakeholders hoped the initial set of regulations would at least clarify this definition, for example, by limiting it to automated technologies that could create a material impact on a person, similar to the GDPR.^{^[28]}

2. Cases

On April 18, 2022, the Ninth Circuit reaffirmed that scraping data in bulk from public websites, like LinkedIn profiles, likely does not breach the federal Computer Fraud and Abuse Act (“CFAA”).^{^[29]} In coming to its conclusion, the Ninth Circuit relied on 2021 U.S. Supreme Court precedent, Van Buren v. United States,^{^[30]} which narrowed what constitutes a CFAA violation to include only situations in which there is unauthorized access to a computer system—in other words where authorization is required and has not been given. The Ninth Circuit found that because there are no rules or access permissions to prevent access on a publicly available website, accessing that publicly available data cannot violate the CFAA.

a) Illinois’ Biometric Information Privacy Act (“BIPA”)

In the second quarter of 2022, we again observed a stream of lawsuits alleging claims under state biometrics laws, in particular, claims relating to the use of facial recognition technology under BIPA. Some notable developments:

The Northern District of Illinois determined that BIPA does not exclude photograph-derived facial information from its scope.^{^[31]} In Sosa et al. v. Onfido Inc., plaintiffs alleged that a biometric software company violated BIPA through software that scans uploaded photographs, extracts biometric identifiers, and determines if those photographs match uploaded identification cards. While the scans were of photographs, the court found that scanning face geography on photographs was effectively obtaining biometric identifiers because nothing in BIPA specifies that the scan must be “in person.”

Several technology companies settled BIPA lawsuits relating to the use of facial recognition software. On May 11, 2022, Clearview AI, Inc. settled a BIPA lawsuit filed in 2020 by the ACLU.^{^[32]} Under the settlement agreement, Clearview agreed to not sell its software to most private companies or individuals in the U.S.—a decision that will largely restrict its use in the U.S. to law-enforcement agencies. On May 25, 2022, seven plaintiffs in the consolidated class action filed against the insurance technology company, Lemonade Inc., were granted preliminary approval of a $4 million settlement. The lawsuit alleged that the company collected users’ facial data between June 2019 and May 2021 without first obtaining written consent or making mandatory disclosures required by BIPA.^{^[33]} As part of the settlement, Lemonade agreed to delete previously collected biometric data.

II. EU ENFORCEMENT, REGULATORY & POLICY DEVELOPMENTS

1. Digital Services Act

In July 2022, the new Digital Services Act (“DSA”), which would require major marketplace and social media platforms to provide insight into their algorithms to the government and to provide users with avenues to remove abusive content and disinformation, was adopted in the first reading by the European Parliament. The DSA must now go through the final stages of adoption before being finalized with an effective date of January 2024 at the earliest.[34] The DSA will impose different obligations on four categories of online intermediaries. The most stringent requirements apply to platforms and search engines with at least 45 million monthly active users in the EU – whether they are established inside or outside the EU – and require them to conduct risk assessments and independent audits, adopt certain crisis response mechanisms and heightened transparency requirements, provide access, upon request, to data for monitoring and assessing compliance, and establish a dedicated DSA compliance function. Accordingly, the DSA – which will be directly applicable in all 27 EU member states – will bring with it significant compliance obligations for large online businesses as well as increased accountability to relevant authorities.

2. The EU Parliament Adopts Special Report on AI

The European Parliament adopted a special report on AI, which sets out a list of demands to secure the EU’s position in AI, and points to research as one of the key means to achieving that goal.[35] The report was developed by the Parliament’s special committee on AI and will underpin work on the upcoming AI Act. The European Parliament’s aim is to support AI research in the EU by increasing public and private investment to €20 billion by 2030. Policymakers believe that “with clear regulations and an investment push,” the EU can catch up with the U.S. and China in terms of AI investment, technology development, research, and attracting talent.

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[1] U.S. Dep’t of Commerce, Press Release, U.S. Department of Commerce Appoints 27 Members to National AI Advisory Committee (Apr. 14, 2022), available at https://www.commerce.gov/news/press-releases/2022/04/us-department-commerce-appoints-27-members-national-ai-advisory.

[2] Artificial Intelligence and Automated Systems Legal Update (1Q22), available at https://www.gibsondunn.com/artificial-intelligence-and-automated-systems-legal-update-1q22/.

[3] NIST, Building the NIST AI Risk Management Framework: Workshop #2 (Apr. 19, 2022), available at https://www.nist.gov/news-events/events/2022/03/building-nist-ai-risk-management-framework-workshop-2.

[4] Fed. Trade Comm’n, FTC Report Warns About Using Artificial Intelligence to Combat Online Problems (June 16, 2022), available at https://www.ftc.gov/news-events/news/press-releases/2022/06/ftc-report-warns-about-using-artificial-intelligence-combat-online-problems.

[5] Id.

[6] Fed. Trade Comm’n, Dissenting Statement of Commissioner Noah Joshua Phillips Regarding the Combatting Online Harms Through Innovation Report to Congress (June 16, 2022), available at https://www.ftc.gov/system/files/ftc_gov/pdf/Commissioner%20Phillips%20Dissent%20to%20AI%20Report%20%28FINAL%206.16.22%20noon%29_0.pdf.

[7] Letter to Hon. Lina Khan, Chair FTC (June 22, 2022), available at https://www.politico.com/f/?id=00000181-8b25-d86b-afc1-8b2d11e00000.

[8] S. 4201, 117^th Cong. (2021-2022); see also Press Release, Bennet Introduces Landmark Legislation to Establish Federal Commission to Oversee Digital Platforms (May 12, 2022), available at https://www.bennet.senate.gov/public/index.cfm/2022/5/bennet-introduces-landmark-legislation-to-establish-federal-commission-to-oversee-digital-platforms.

[9] H.R. 7585, 117^th Cong. (2021-2022).

[10] Cal. Ins. Comm’r, Bulletin 2022-5 (June 30, 2022), available at https://www.insurance.ca.gov/0250-insurers/0300-insurers/0200-bulletins/bulletin-notices-commiss-opinion/upload/BULLETIN-2022-5-Allegations-of-Racial-Bias-and-Unfair-Discrimination-in-Marketing-Rating-Underwriting-and-Claims-Practices-by-the-Insurance-Industry.pdf.

[11] Id.

[12] Id.

[13] EEOC, EEOC Launches Initiative on Artificial Intelligence and Algorithmic Fairness (Oct. 28, 2021), available at https://www.eeoc.gov/newsroom/eeoc-launches-initiative-artificial-intelligence-and-algorithmic-fairness.

[14] EEOC, The Americans with Disabilities Act and the Use of Software, Algorithms, and Artificial Intelligence to Assess Job Applicants and Employees (May 12, 2022), available at https://www.eeoc.gov/laws/guidance/americans-disabilities-act-and-use-software-algorithms-and-artificial-intelligence?utm_content=&utm_medium=email&utm_name=&utm_source=govdelivery&utm_term.

[15] EEOC v. iTutorGroup, Inc., No. 1:22-cv-02565 (E.D.N.Y. May 5, 2022).

[16] American Data Privacy and Protection Act, H.R. 8152, 117th Cong. (2022).

[17] The full text of the proposed statute is available here.

[18] Specifically, the legislation limits covered entities to collecting, processing, or transferring data based on what is “reasonably necessary and proportionate” to (1) provide or maintain a specific product or service requested by the individual to whom the data pertains, (2) deliver a communication that is reasonably anticipated by the individual recipient in the context of the individual recipient’s interactions with the covered entity, or (3) for one of the “permissible purposes” enumerated in the bill’s text. The bill would further prohibit the collection and processing of sensitive data “except where such collection or processing is strictly necessary to provide or maintain a specific product or service requested by an individual to whom the covered data pertains” or to effectuate one of the permitted purposes.

[19] The ADPPA would also impose requirements on relationships between covered entities and services providers and third parties, including requirements for contractual terms, and requires covered entities to implement certain accountability measures, like the appointment of data privacy and security officers.

[20] ADPPA § 2(9).

[21] ADPPA § 2(8).

[22] ADPPA § 207(c)(2).

[23] ADPPA § 207(c)(1).

[24] ADPPA § 207(c)(1)(B)(vi)(I)–(IV).

[25] ADPPA § 207(c)(5)(B).

[26] The full text of the proposed regulations is available here.

[27] Cal. Civ. Code § 1798.140(z) (emphasis added).

[28] The GDPR uses an impact to risk–based approach—only governing processing “which produces legal effects concerning him or her or similarly significantly affects him or her.” GDPR at Art. 22(1) (emphasis added). For example, this may include loan or employment applications.

[29] hiQ Labs Inc. v. LinkedIn Corp., No. 17-16783 (9th Cir. 2022).

[30] 141 S. Ct. 1648 (2021).

[31] Sosa et al. v. Onfido Inc., No. 20-cv-4247 (N.D. Ill. 2022).

[32] ACLU v. Clearview AI, Inc., 2020 CH 04353 (Cir. Ct. Cook Cty., Ill. 2022).

[33] Prudent v. Lemonade Inc. et al., 1:21-cv-07070 (S.D.N.Y. 2022).

[34] European Commission, The Digital Services Act package, available at https://digital-strategy.ec.europa.eu/en/policies/digital-services-act-package.

[35] European Parliament, Report – A9-0088/2022, REPORT on artificial intelligence in a digital age (Apr. 5, 2022), available at https://www.europarl.europa.eu/doceo/document/A-9-2022-0088_EN.html; see further Goda Naujokaityte, Parliament gives EU a push to move faster on artificial intelligence, Science Business (May 5, 2022), available at https://sciencebusiness.net/news/parliament-gives-eu-push-move-faster-artificial-intelligence.

The following Gibson Dunn lawyers prepared this client update: H. Mark Lyon, Frances Waldmann, Emily Lamm, and Samantha Abrams-Widdicombe.

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

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

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

Artificial Intelligence and Automated Systems Group:

J. Alan Bannister – New York (+1 212-351-2310, [email protected])
Patrick Doris – London (+44 (0)20 7071 4276, [email protected])
Cassandra L. Gaedt-Sheckter – Co-Chair, Palo Alto (+1 650-849-5203, [email protected])
Kai Gesing – Munich (+49 89 189 33 180, [email protected])
Ari Lanin – Los Angeles (+1 310-552-8581, [email protected])
Carrie M. LeRoy – Palo Alto (+1 650-849-5337, [email protected])
H. Mark Lyon – Co-Chair, Palo Alto (+1 650-849-5307, [email protected])
Vivek Mohan – Co-Chair, Palo Alto (+1 650-849-5345, [email protected])
Alexander H. Southwell – New York (+1 212-351-3981, [email protected])
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, [email protected])
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, [email protected])
Michael Walther – Munich (+49 89 189 33 180, [email protected])

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