Richard Manfredi, Author at Gibson Dunn

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From the Derivatives Practice Group: This week, the CFTC approved final rules amending the capital and financial reporting requirements of swap dealers and major swap participants, and amending the large trading reporting regulations for futures and options.

New Developments

CFTC Chairman Behnam Designates Ted Kaouk as the CFTC’s First Chief Artificial Intelligence Officer. On May 1, CFTC Chairman Rostin Behnam announced the designation of Dr. Ted Kaouk as the agency’s first Chief Artificial Intelligence Officer. Dr. Kaouk currently serves as the CFTC’s Chief Data Officer and Director of the Division of Data. The CFTC stated that in this newly expanded role as the CFTC’s Chief Data & Artificial Intelligence Officer, Dr. Kaouk will be responsible for leading the development of the CFTC’s enterprise data and artificial intelligence strategy to further integrate CFTC’s ongoing efforts to advance its data-driven capabilities. [NEW]
CFTC Approves Final Rule Amending the Capital and Financial Reporting Requirements of Swap Dealers and Major Swap Participants. On April 30, the CFTC announced it has approved a final rule that amends the capital and financial reporting requirements of Swap Dealers (SDs) and Major Swap Participants (MSPs). According to the CFTC, the amendments make changes consistent with CFTC Staff Letter No. 21-15 regarding the tangible net worth capital approach for calculating capital under CFTC Regulation 23.101, as well as CFTC Staff Letter No. 21-18, as further extended by CFTC Staff Letter No. 23-11, regarding the alternate financial reporting requirements for SDs subject to the capital requirements of a prudential regulator. The amendments also revise certain Part 23 regulations regarding the financial reporting requirements of SDs, including the required timing of certain notifications, the process for approval of subordinated debt for capital, and the information requested on financial reporting forms to conform to the rules. The CFTC stated that the amendments are intended to make it easier for SDs and MSPs to comply with the CFTC’s financial reporting obligations and demonstrate compliance with minimum capital requirements. To allow for sufficient time to effectuate the reporting and notification amendments, the final rule has a compliance date of September 30, 2024, and will apply to all financial reports with an “as of” reporting date of September 30, 2024, or later. [NEW]
CFTC Approves Final Rules on Large Trader Reporting for Futures and Options. On April 30, the CFTC announced approval of final rules to amend its large trading reporting regulations for futures and options. These regulations require futures commission merchants, clearing members, foreign brokers, and certain reporting markets (reporting firms) to report to the Commission position information for the largest futures and options traders. The final rules replace the data elements currently enumerated in the CFTC’s regulations with an appendix specifying applicable data elements. The final rules also provide for the publication of a separate Part 17 Guidebook specifying the form and manner for reporting. In addition, the final rules remove the outdated 80-character data submission standard in the CFTC’s regulations. According to the CFTC, that standard will be replaced by a FIXML standard, as set out in the Part 17 Guidebook. [NEW]
CFTC Approves Final Rules on Swap Confirmation Requirements for SEFs. On April 23, the CFTC approved final rules to amend its swap execution facility (SEF) regulations related to uncleared swap confirmations to address issues which have been addressed in CFTC staff no-action letters, including the most recent CFTC No Action Letter No. 17-17, as well as associated conforming and technical changes. In particular, the final rules amend CFTC Regulation 37.6(b) to enable SEFs to incorporate terms of underlying, previously negotiated agreements between the counterparties by reference in an uncleared swap confirmation without being required to obtain such underlying, previously negotiated agreements. Further, the final rules amend CFTC Regulation 37.6(b) to require such confirmation to take place “as soon as technologically practicable” after the execution of the swap transaction on the SEF for both cleared and uncleared swap transactions. The final rules also amend CFTC Regulation 37.6(b) to make clear the SEF-provided confirmation under CFTC Regulation 37.6(b) shall legally supersede any conflicting terms in a previous agreement, rather than the entire agreement. The final rules make conforming amendments to CFTC Regulation 23.501(a)(4)(i) to correspond with the amendments to CFTC Regulation 37.6(b). Finally, the final rules make certain non-substantive amendments to CFTC Regulation 37.6(a)-(b) to enhance clarity.
CFTC Extends Public Comment Period for Proposed Rule for Designated Contract Markets and Swap Execution Facilities Regarding Governance and Conflicts of Interest. On April 22, the CFTC announced it is extending the deadline for public comment period on a proposed rule that makes certain modifications to rules for Swap Execution Facilities and Designated Contract Markets in Part 37 and 38 that would establish governance requirements regarding market regulation functions, as well as related conflicts of interest standards. The deadline is being extended to May 13, 2024.

New Developments Outside the U.S.

ESMA Publishes the Annual Transparency Calculations for Non-Equity Instruments, Bond Liquidity Data and Quarterly SI Calculations. On April 30, ESMA published the results of the annual transparency calculations for non-equity instruments, new quarterly liquidity assessment of bonds and the quarterly systematic internaliser calculations under MiFID II and MiFIR. As indicated in ESMA’s public statement on March 27, the quarterly liquidity assessment of bonds as well as the data for the quarterly systematic internalizers will continue to be published by ESMA. [NEW]
ESAs Issue Spring 2024 Joint Committee Update. On April 30, the three European Supervisory Authorities (EBA, EIOPA and ESMA – the ESAs) issued their Spring 2024 Joint Committee update on risks and vulnerabilities in the EU financial system. The risk update shows that risks remain elevated in a context of slowing growth, an uncertain interest rate environment and ongoing geopolitical tensions. According to the update, in recent months, financial markets have performed strongly in anticipation of potential interest rate cuts in 2024 in both the EU and the US, despite the significant uncertainty surrounding these. The ESAs stated that this strong performance entails elevated risks of market corrections linked to unexpected events. [NEW]
Telbor Committee to Permanently Cease Publication of Telbor. On April 16, the Telbor Committee of the Bank of Israel decided that the publication of all tenor of Telbor will permanently cease following a final publication on June 30, 2025. The announcement constitutes an “Index Cessation Event” under the 2021 ISDA Interest Rate Derivatives Definitions and the November 2022 Benchmark Module of the ISDA 2021 Fallbacks Protocol. In February 2022, the Telbor Committee decided that the SHIR (Shekel overnight Interest Rate) rate would eventually replace the Telbor interest rate in shekel interest rate derivative transactions. The Bank of Israel said that the decision to switch to the SHIR rate is in accordance with the decisions reached in major economies worldwide, according to which IBOR type interest rates will be replaced by risk-free overnight interest rates. ISDA published cessation guidance for parties affected by the announcement.

New Industry-Led Developments

ISDA Launches Outreach Initiative on Proposed Notices Hub. On April 25, ISDA announced major industry outreach initiative to establish support among dealers and buy-side firms for a new online platform that would allow the instantaneous delivery and receipt of critical termination-related notices, reducing the risk exposure and potential losses from a delay. Under the ISDA Master Agreement, termination-related notices must be delivered by certain prescribed methods, using company address details listed in the agreement. However, delays can occur if a company has moved and the documentation hasn’t been updated with the new details or if delivery to a physical location is not possible due to geopolitical shocks. The proposed ISDA Notices Hub would act as a secure central platform for firms to deliver notices, with automatic alerts sent to the receiving entity. Multiple designated people at each firm would be able to access the hub from anywhere in the world, regardless of the situation at its physical location. The platform would also allow market participants to update their physical address details via a single entry, providing a golden source of those details. [NEW]
ISDA, SIFMA, and CCMA Publish T+1 Settlement Cycle Booklet. On April 30, ISDA, the Securities Industry and Financial Markets Association (SIFMA) and the Canadian Capital Markets Association (CCMA) published a T+1 settlement cycle booklet to address queries from market participants on the settlement cycle changes taking place in North America on May 27-28, 2024, and the possible impact to relevant securities and over-the-counter (OTC) derivatives transactions. This booklet may be updated from time to time. [NEW]
ISDA Publishes Sub-Annex A Maintenance Guidelines for the 2005 ISDA Commodity Definitions. On April 30, ISDA published maintenance guidelines for Sub-Annex A of the 2005 ISDA Commodity Definitions. Sub-Annex A contains definitions for various Commodity Reference Prices. [NEW]
ISDA and SIFMA Submit Addendum to Proposed FFIEC Reporting Revisions. On April 23, ISDA and the Securities Industry and Financial Markets Association (SIFMA) submitted an addendum to the joint response to the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency on the proposed reporting revisions of the call report, FFIEC 101 and FFIEC 102, which are designed to reflect the implementation of the Basel III endgame proposal. The addendum contains additional findings in the FFIEC 102 report, including end-of-week Fundamental Review of the Trading Book standardized approach average calculations and reported market risk risk-weighted assets in sub-parts D and E.
ISDA Launches Outreach Initiative on Proposed Notices Hub. On April 25 ISDA announced a major industry outreach initiative to establish support among dealers and buy-side firms for a new online platform that would allow the instantaneous delivery and receipt of critical termination-related notices, reducing the risk exposure and potential losses from a delay. Under the ISDA Master Agreement, termination-related notices must be delivered by certain prescribed methods, using company address details listed in the agreement. However, delays can occur if a company has moved and the documentation hasn’t been updated with the new details or if delivery to a physical location is not possible due to geopolitical shocks. The proposed ISDA Notices Hub would act as a secure central platform for firms to deliver notices, with automatic alerts sent to the receiving entity. Multiple designated people at each firm would be able to access the hub from anywhere in the world, regardless of the situation at its physical location. The platform would also allow market participants to update their physical address details via a single entry, providing a golden source of those details.
Four Directors Join ISDA Board. On April 18, ISDA announced that four directors have joined its Board, three directors were re-appointed, and 10 others have been re-elected at ISDA’s Annual General Meeting in Tokyo. The new directors are: Erik Tim Mueller, Chief Executive Officer, Eurex Clearing AG; Jared Noering, Managing Director, Head of Fixed Income Trading, NatWest Markets; Brad Tully, Managing Director and Global Head of Corporate Derivatives and Private Side Sales for J.P. Morgan; and Jan Mark van Mill, Managing Director of Multi Asset, APG Asset Management.
ISDA Future Leaders in Derivatives Publishes Generative Artificial Intelligence Whitepaper. On April 17, ISDA published a whitepaper from ISDA Future Leaders in Derivatives (IFLD), its professional development program for emerging leaders in the derivatives market. The whitepaper, GenAI in the Derivatives Market: a Future Perspective, was developed by the third cohort of IFLD participants, who began working together in October 2023. According to ISDA, the 38 individuals in the group represent buy- and sell-side institutions, law firms, and service providers from around the world. After being selected for the IFLD program, they were asked to engage with stakeholders, develop positions, and produce a whitepaper on the potential use of generative artificial intelligence (genAI) in the over-the-counter derivatives market. The participants were also given access to ISDA’s training materials, resources, and staff expertise to support the project and their own professional development. ISDA said that, drawing on industry expertise and academic research, the whitepaper identifies a range of potential use cases for genAI in the derivatives market, including document creation, market insight, and risk profiling. ISDA also indicated that it explores regulatory issues in key jurisdictions and addresses the challenges and risks associated with the use of genAI. The paper concludes with a set of recommendations for stakeholders, including investing in talent development, fostering collaboration and knowledge sharing with technology providers, prioritizing ethical AI principles and engaging with policymakers to promote an appropriate regulatory framework.
ISDA Publishes Research Paper on Interest Rate Derivatives, Benchmark Rates and Development Financial Markets in EMDEs. On April 17, ISDA published a research paper in which it outlines the role of interest rate derivatives (IRDs) in supporting the development of financial markets in emerging markets and developing economies (EMDEs). It also examines the significance of reliable, robust interest rate (IR) benchmarks. ISDA indicated that the paper draws valuable lessons from the transition from LIBOR to overnight risk-free rates in advanced economies and applies those insights to the context of EMDEs. Through case studies, ISDA attempts to show how various EMDE jurisdictions have successfully adopted and implemented more robust and transparent IR benchmarks.
ISDA Extends Digital Regulatory Reporting Initiative to New Jurisdictions. On April 17, ISDA announced that it is extending its Digital Regulatory Reporting (DRR) initiative to several additional jurisdictions in an effort to enable firms to implement changes to regulatory reporting requirements. The DRR is being extended to cover rule amendments being implemented under the UK European Market Infrastructure Regulation and by the Australian Securities and Investments Commission and the Monetary Authority of Singapore. Those rule changes are due to be implemented in the UK on September 30, 2024, and October 21, 2024 in Australia and Singapore. The DRR code for all three sets of rules is currently available for market participants to review and test. ISDA said that the DRR will be further extended to cover rule changes in Canada and Hong Kong, both due in 2025, and the DRR for the CFTC rules will also be updated to include further anticipated updates, currently under consultation at the commission. Firms can either use the DRR as the basis for implementation or to validate an independent interpretation of the rules.
ISDA Publishes Margin Survey. On April 16, ISDA published its latest margin survey, which shows that $1.4 trillion of initial margin (IM) and variation margin (VM) was collected by 32 leading derivatives market participants for their non-cleared derivatives exposures at the end of 2023, unchanged from the previous year. The survey also reports the amount of IM posted by all market participants to major central counterparties.
ISDA Establishes Suggested Operational Practices for EMIR Refit. On April 16, through a series of discussions held within the ISDA Data and Reporting EMEA Working Group, market participants established and agreed to Suggested Operational Practices (SOP) for over-the-counter derivative reporting in preparation for the commencement of the EMIR Refit regulatory reporting rules on April 29. ISDA said that the SOP matrix was established based on the EMIR Refit validation table, (as published by ESMA), which contains the Regulatory Technical Standards (RTS), the Implementation Technical Standards (ITS) and validation rules. Additional tabs have been added to supplement to SOPs, including product-level SOPs for several of the underlier fields, and listing names of floating rate options. There are also tabs to reflect updates made to the matrix (‘Updates’) and a tab to track questions raised by the ISDA Data and Reporting EMEA Working Group (‘WG Questions’). ISDA indicated that the document will continue to be reviewed and updated as and when required. While the intention of these SOPs is to provide an agreed and standardized market guide for firms to utilize, no firm is legally bound or compelled in any way to follow any determinations made within these EMIR SOPs.

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, jsteiner@gibsondunn.com)

Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com)

Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)

Darius Mehraban, New York (212.351.2428, dmehraban@gibsondunn.com)

Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)

Adam Lapidus – New York (+1 212.351.3869, alapidus@gibsondunn.com)

Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)

Roscoe Jones Jr., Washington, D.C. (202.887.3530, rjones@gibsondunn.com)

William R. Hallatt, Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)

David P. Burns, Washington, D.C. (202.887.3786, dburns@gibsondunn.com)

Marc Aaron Takagaki, New York (212.351.4028, mtakagaki@gibsondunn.com)

Hayden K. McGovern, Dallas (214.698.3142, hmcgovern@gibsondunn.com)

Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)

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On April 23, 2024, the Federal Trade Commission released a new rule outlawing the vast majority of non-compete agreements in the United States. This webinar provides an overview of the rule and its ramifications, discusses recommended next steps for businesses, and discusses legal challenges to the rule.

PANELISTS:

Michael Collins is a partner in Gibson Dunn’s Washington, D.C. office and Co-Chair of the Executive Compensation and Employee Benefits Practice Group. His practice focuses on all aspects of employee benefits and executive compensation. Michael’s practice runs the full gamut of tax, ERISA, accounting, corporate, and securities law aspects of stock option, SAR, restricted stock, and employee stock purchase plans; tax-qualified retirement plans, nonqualified deferred compensation; SERPs; executive employment agreements, golden parachutes and other change in control arrangements; severance, confidentiality, and noncompete contracts; performance bonus and incentive plans; director’s pay; rabbi trusts; split dollar life insurance; excess benefit and top hat plans; and the like. He represents both executives and companies in drafting and negotiating employment arrangements. Michael is a member of the District of Columbia bar.

Andrew Kilberg is a partner in Gibson Dunn’s Washington, D.C. office, where he practices in the firm’s litigation department. A member of the firm’s Labor and Employment, Administrative and Regulatory, and Appellate and Constitutional Law practice groups, Andrew has significant experience challenging onerous federal regulations, advising on regulatory proposals, and defending agency enforcement actions and investigations. He has represented clients in federal district and appellate courts and before the U.S. Supreme Court, as well as before various agencies, authoring dozens of briefs, comment letters, and other submissions. Andrew is a member of the District of Columbia and Virginia bars, and he is admitted to practice before the U.S. Supreme Court, U.S. Courts of Appeals for the Second, Third, Fourth, Fifth, Seventh, Eighth, Ninth, and D.C. Circuits, the U.S. District Court for the District of Columbia, the Supreme Court of Virginia, and the District of Columbia Court of Appeals.

Julian W. Kleinbrodt is a partner in Gibson Dunn’s San Francisco office. He practices in the firm’s Litigation Department and is a member of the firm’s Antitrust and Competition Practice Group as well as the firm’s Labor & Employment Group. Julian has experience handling a wide variety of antitrust matters through trial and appeal. He has particular experience with claims involving price-fixing, monopolization, attempted monopolization, refusals to deal, tying, bundling, exclusive dealing, disparagement, market allocation and division, and no-poach provisions. For example, Julian was part of a team that defended a major technology company in a multi-week bench trial dubbed the “Super Bowl of Antitrust.” Julian has additional experience representing clients in civil and criminal investigations by the U.S. Department of Justice and Federal Trade Commission. He also regularly counsels clients on antitrust compliance and has authored multiple articles on competition issues.

Kristen Limarzi is a partner in the highly acclaimed Antitrust and Competition Practice Group of Gibson Dunn, based in Washington, D.C. Recognized as “Dealmaker of the Year” for 2023 by Global Competition Review, Kristen leverages her experience as a top government enforcer to represent clients in merger and non-merger investigations before the DOJ, the Federal Trade Commission, and foreign antitrust enforcers, as well in as appellate and civil litigation. Prior to joining the firm, she served as a top enforcement official in the U.S. Department of Justice’s Antitrust Division. As Appellate Section Chief, she was responsible for litigating appeals in the Division’s civil and criminal enforcement actions and participating as amicus curiae in private antitrust actions. While serving in the Antitrust Division, Kristen also helped to develop Division policies on a wide range of issues, including the agency’s Antitrust Guidance for Human Resources Professionals in 2016.

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This update reviews the changes introduced by the EU Alternative Investment Fund Managers Directive II and assesses the likely impact of such changes on non-EU sponsors of private investment funds that are marketed in the EU.

On 26 March 2024, AIFMD II was published in the Official Journal of the EU.[1] AIFMD II entered into force on 15 April 2024 and, subject to certain exceptions as noted below, EU member states will have until 16 April 2026 to transpose the new rules into EU member state law.[2] This update reviews the changes introduced by AIFMD II and assesses the likely impact of such changes on non-EU sponsors of private investment funds that are marketed in the EU.

What is AIFMD II?

Following its consultation on the application and scope of the EU Alternative Investment Fund Managers Directive (“AIFMD”)[3], the European Commission concluded that there was a need to harmonise the regulatory framework applicable to alternative investment fund managers (“AIFMs”) managing alternative investment funds (“AIFs”), with a particular focus on those AIFs that originate loans, and to clarify the standards that apply to AIFMs delegating functions to third parties.

What is AIFMD II changing?

AIFMD II does not mark a complete overhaul of the AIFMD. Rather, the Directive adopts targeted amendments to address certain ambiguities identified within the existing regulatory framework. For non-EU sponsors of private investment funds that are marketed in the EU, the key changes relate to: the national private placement regime criteria; the reporting (Annex IV) and disclosure (Article 23) requirements; the delegation of portfolio management to third parties; the creation of a new loan origination regime; and the mandated use of liquidity management tools for open-ended funds.

What is the likely impact on non-EU sponsors?

AIFMD II was the subject of extensive debate among the European supervisory authorities, individual EU member states and the wider fund management industry. In particular, the proposals concerning the delegation of portfolio management and loan origination resulted in intensive negotiations. Fundamental changes to the AIFMD that would have been indicative of a more concerted move to “Fortress Europe”—for example, removing the ability of EU AIFMs to delegate portfolio management to non-EU sponsors—were not realised. That being said, AIFMD II is indicative of the trend towards tightening the avenues through which non-EU sponsors can raise EU capital, which is likely to further narrow over time. As a result of AIFMD II, there will also be a mismatch between requirements that apply to certain non-EU sponsors and those that apply to EU AIFMs, in particular, with respect to the application of the new loan origination provisions. It remains to be seen, however, whether AIFMD II will further push EU investors to prioritize investment in EU-domiciled AIFs.

The impact of AIFMD II on non-EU sponsors will primarily depend on how individual sponsors raise capital from European investors and the investment strategies that they deploy. Non-EU sponsors are currently impacted by AIFMD when they: (a) market AIFs in EU member states via the national private placement regimes (“NPPRs”); and (b) market AIFs in EU members states via the AIFMD marketing passport. With respect to the latter, in order for non-EU sponsors to avail themselves of the AIFMD marketing passport, they need to establish an EU-domiciled AIF (typically, Luxembourg or Ireland) that is managed either by an EU-affiliate of the non-EU sponsor that is licensed as an EU AIFM or by a third party “host-AIFM” located in the EU. For non-EU sponsors utilizing the AIFMD marketing passport (whether via an affiliated EU-AIFM or a “host-AIFM”), the portfolio management function with respect to the AIF is nearly always delegated back to the sponsor’s home jurisdiction (e.g., the United States).

What is the impact for non-EU sponsors accessing European capital via the NPPRs or an EU-affiliated AIFM / “host–AIFM”?

(i) Investor disclosures

Both EU AIFMs and non-EU sponsors that have registered AIFs for marketing via the NPPRs are required to make certain pre-contractual disclosures available to EU investors (i.e., the Article 23 disclosures).[4] Under AIFMD II, the Article 23 disclosures have been enhanced and will require the following information to be made available to investors: (i) the name of the AIF; (ii) a list of all fees, charges and expenses borne by the AIFM which are subsequently directly or indirectly allocated to the AIF or to any of its investments; and (iii) for open-ended funds, a description of the circumstances triggering the use of liquidity management tools. EU AIFMs and non-EU sponsors that have registered AIFs for marketing under the NPPRs will also be required to provide information periodically to investors, including: (i) all fees and charges that were directly or indirectly borne by investors; (ii) any parent undertaking, subsidiary or SPV utilised in relation to the AIF’s investments by or on behalf of the AIFM; and (iii) to the extent applicable, a report on the portfolio composition of any originated loans.

(ii) Annex IV reporting

EU AIFMs and non-EU sponsors that have registered AIFs for marketing in the EU are currently required to submit periodic “Annex IV” reports. The Annex IV reports cover quantitative disclosures in respect of the AIFM and the AIFs it manages, and are due on an annual, biannual or quarterly basis (depending on assets under management, the use of leverage and the investment strategy of the AIFs). AIFMD II introduces additional reporting fields in the Annex IV reports. ESMA has been mandated to publish updated reporting templates by 16 April 2027 and, as a result, compliance with the additional reporting fields will not be required until that date. Currently, an EU AIFM (or a non-EU sponsor marketing an AIF in the EU pursuant to the NPPRs) must report on the “principal” markets and instruments in which it trades and provide information on the “main” instruments in which it is trading and on the “principal” exposures and “most important” concentrations of each of the AIFs it manages. AIFMD II expands the Annex IV reporting obligations by removing the limitations which focus on major trades and exposures or counterparties. AIFMD II also requires the provision of information regarding the total amount of leverage employed by the AIF as well as details on the member states within which the AIF is marketed. Detailed information on portfolio management / risk management delegation (including quantitative data) will also need to be reported. Given the expanded scope of reporting, the revised Annex IV reports are likely to impose additional costs and require additional resources to prepare them.

What is the impact for non-EU sponsors marketing via national private placement regimes?

(i) Changes to accessing the NPPRs

Historically, most non-EU sponsors have accessed EU capital by registering their AIFs under the various EU member state NPPRs. AIFMD II will now prohibit the marketing of non-EU AIFs established in jurisdictions identified as “high risk” under the Fourth Anti-Money Laundering Directive (the “EU AML List”).[5] Similarly, to be eligible for registration under the NPPRs, non-EU AIFs will also need to be formed in jurisdictions that have signed agreements with the EU member state(s) in which they are to be marketed that are compliant with various international tax treaties. Finally, registration under the NPPRs will also be prohibited for any non-EU AIF that is established in a country that is included on the EU’s list of non-cooperative tax jurisdictions.[6]

From the perspective of a non-EU sponsor, these amendments are not expected to be an issue for fund vehicles established in the United States. Any change to the scope of jurisdictions that are contained on the EU’s list of “high risk” and “non-cooperative” jurisdictions is ultimately an EU political decision. That noted, the Cayman Islands was only recently removed from the EU AML List on 7 February 2024. In addition, on 23 April 2024 the European Parliament rejected the European Commission’s proposal to remove the UAE from the EU AML List.[7] Future changes in political headwinds could, therefore, result in other fund domiciles being added to such lists, which would effectively prohibit AIFs established in such jurisdictions from being marketed in the EU. To the extent that a popular fund domicile (e.g., the Cayman Islands) is added to one of the prohibited lists, this would have negative implications for non-EU sponsors seeking to access EU capital.

What is the impact for non-EU sponsors that have an EU-affiliated AIFM or use a “host-AIFM”?

(i) Delegation

The changes introduced by AIFMD II to the AIFMD delegation provisions are not as extensive as the industry originally feared. Importantly, the ability to delegate portfolio management to non-EU countries, such as the United States, remains. However, the changes outlined below indicate: (i) an increased level of scrutiny over delegation arrangements, including the “host-AIFM” model; and (ii) the costs and administrative burden of delegating an EU AIFM’s functions is likely to increase.

AIFMD II expressly provides that an EU AIFM is responsible for ensuring that the performance of functions and the provision of services by a delegate comply with the AIFMD. This requirement applies irrespective of the location or regulatory status of the delegate (i.e., even if the delegate is a non-EU sponsor). The degree to which this obligation results in a greater compliance burden for non-EU sponsors remains to be seen. That noted, EU AIFMs are likely to impose greater initial due diligence and ongoing monitoring requirements in the context of a delegation of functions, which is likely to add to the time and resources that are necessary to put such arrangements in place and to maintain them.[8]

In addition, EU AIFMs will also be required to regularly provide information to their competent authority regarding delegation arrangements that concern portfolio management or risk management functions. For example, this information includes but is not limited to: (i) details of the delegate(s); (ii) the number of full-time equivalent human resources employed by the AIFM for the purposes of performing day-to-day portfolio management or risk management tasks and to monitor the delegation arrangements; (iii) a list and description of the activities concerning risk management and portfolio management functions which are delegated; and (iv) the number and dates of the periodic due diligence reviews carried out by the AIFM to monitor the delegated activity

(ii) Loan origination

The most fundamental changes in AIFMD II concern sponsors that manage AIFs operating loan origination strategies, either through an EU-affiliated AIFM or via the engagement with a “host-AIFM”. Separate requirements are applicable to loan origination activity by “AIFs Which Originate Loans” and “Loan Originating AIFs”. Importantly, the restrictions that apply to AIFs Which Originate Loans and Loan Originating AIFs do not apply to AIFs marketed in the EU by a non-EU sponsor pursuant to the NPPRs.

“AIFs Which Originate Loans”

An “AIF Which Originates Loans” refers to an AIF that: (i) grants loans directly as the original lender; or (ii) grants loans indirectly through a third party or special purpose vehicle, which originates a loan for or on behalf of the AIF, or for or on behalf of an AIFM in respect of the AIF, where the AIF or AIFM is involved in structuring the loan, or defining or pre-agreeing its characteristics, prior to gaining exposure to the loan. With respect to “AIFs Which Originate Loans”, AIFMD II imposes commercial and operational restrictions, including:

Concentration limits – Cannot make loans to a single financial undertaking, a UCITS or other AIF which exceeds, in the aggregate, 20% of the capital of the AIF—except if the AIF is selling assets to meet redemptions or as part of the liquidation of the AIF.

Lending restrictions – Cannot make loans that could give rise to certain conflicts of interest, including to: the EU AIFM (or its staff); any entities within the same group as the EU AIFM; the EU AIFM’s delegate (or its staff); or the AIF’s depositary (or its delegate).

Risk retention – Must retain 5% of each originated loan that is subsequently transferred to a third party.[9]

Originate to distribute – EU AIFMs cannot manage AIFs Which Originate Loans with the sole purpose of selling them to third parties.[10]

Use of proceeds – The proceeds of the loans, minus any allowable fees for the administration of such loans, must be attributed in full to the concerned AIF. Any such costs and expenses must also be included in the Article 23 disclosures.

Policies / Procedures – EU AIFMs of AIFs Which Originate Loans will be required to implement and review policies and procedures relating to the granting of credit.

“Loan Originating AIFs”

A “Loan Originating AIF” refers to an AIF: (i) whose investment strategy is mainly to originate loans; or (ii) where the notional value of the AIF’s originated loans represents at least 50% of its net asset value. In addition to the restrictions applicable to AIFs Which Originate Loans noted above, a Loan Originating AIF is also subject to the following limitations:

Leverage Limit—leverage is limited to no more than: (i) 175% for open-ended Loan Originating AIFs; and (ii) 300% for closed-ended Loan Originating AIFs.[11] The foregoing leverage limits do not apply to Loan Originating AIFs whose loan activity consists solely of originating shareholder loans, provided that such loans do not exceed in aggregate 150% of the capital of the Loan Originating AIF.

Closed-Ended Structure—Must be closed-ended unless the EU AIFM can demonstrate that its liquidity risk management system is compatible with its investment strategy and redemption policy.

“Grandfathering” measures

For the 5-year period from when AIFMD II comes into force (i.e., through 15 April 2029), the leverage limits, concentration limits and the requirement to be closed-ended do not apply to pre-existing AIFs. In addition, if such AIFs do not raise further capital after 15 April 2024, they are exempt indefinitely from these requirements.

However, these grandfathering measures provide limited relief in practice. This is because: (i) if such AIFs are currently in breach of the leverage / concentration limits as at 15 April 2024, they cannot increase leverage or lending during the 5 year grandfathering period; and (ii) such AIFs that are not in breach of these requirements may only increase leverage / concentration to such level that they do not breach these limits.

Pre-existing AIFs also do not need to comply with the other loan origination rules set out above.

(iii) Liquidity management tools for open-ended AIFs

AIFMD II requires EU AIFMs operating open-ended AIFs to select at least two liquidity management tools, which must be appropriate to the investment strategy, the liquidity profile and the redemption policy of the AIF. These include: (i) suspension of redemptions and subscriptions; (ii) redemption gates; (iii) extension of notice periods; (iv) redemption fees; (v) swing pricing; (vi) dual pricing; (vii) anti-dilution levies; (viii) redemptions in kind; and (ix) side pockets. There are circumstances in which certain liquidity management tools can be activated or deactivated, or EU AIFMs may suspend the repurchase or redemption of units in the AIF. The use of liquidity management tools must be documented in policies and procedures and included in the Article 23 disclosures that are made available to investors.

What steps should non-EU sponsors be taking now?

At a high-level, certain aspects of AIFMD II (e.g., the expanded scope of Article 23 disclosures and Annex IV reporting) are consistent with the trajectory of private funds regulation in other jurisdictions, including the United States. Akin to the private fund rules that the U.S. Securities and Exchange Commission (the “SEC”) recently adopted[12] as well as other rules currently proposed by the SEC, AIFMD II is similarly focused on increased transparency with respect to private funds both for investors and for regulators. While some elements of AIFMD II may not have a meaningful impact for many non-EU sponsors, key components of the Directive are likely to impose additional costs and operational burdens. For loan originating funds, AIFMD II goes further by limiting certain commercial flexibilities that were previously negotiated matters among investors, fund sponsors and transaction counterparties.

For now, non-EU sponsors should be undertaking a gap analysis and impact assessment of AIFMD II on their EU operations and fund distribution strategy. Sponsors should also monitor the forthcoming EU Level 2 legislation and implementing legislation in key EU member states where they have a physical presence, engage a “host-AIFM” provider or market their funds. Should you have questions regarding AIFMD II and its potential implications on your business, please do not hesitate to reach out to the authors of this alert.

__________

[1] Directive (EU) 2024/927 of the European Parliament and of the Council of 13 March 2024 amending Directives 2011/61/EU and 2009/65/EC as regards delegation arrangements, liquidity risk management, supervisory reporting, the provision of depositary and custody services and loan origination by alternative investment funds.

[2] References in this client alert to the “EU” should also be deemed to include the three European Economic Area jurisdictions as the context allows (i.e., Iceland, Liechtenstein and Norway).

[3] Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers.

[4] For EU AIFs managed by EU AIFMs, the obligation to make the Article 23 disclosures available to investors lies with the EU AIFM. That noted, the non-EU sponsor will typically prepare the Article 23 disclosures for funds marketed via the marketing passport (irrespective of whether the fund is managed by an affiliated-EU AIFM or a “host-AIFM”).

[5] As at the date of this client alert, the following jurisdictions are on the EU’s AML list: Afghanistan; Barbados; Burkina Faso; Cameroon; Democratic Republic of the Congo; Gibraltar; Haiti; Jamaica; Mali; Mozambique; Myanmar; Nigeria; Panama; Philippines; Senegal; South Africa; South Sudan; Syria; Tanzania; Trinidad and Tobago; Uganda; United Arab Emirates; Vanuatu; Vietnam; and Yemen.

[6] As at the date of this client alert, the following jurisdictions are on the EU list of non-cooperative tax jurisdictions: American Samoa; Anguilla; Antigua and Barbuda; Fiji; Guam; Palau; Panama; Russia; Samoa; Trinidad and Tobago; US Virgin Islands; and Vanuatu.

[7] This decision has created a divergence in the treatment of the UAE, as the Financial Action Task Force removed the UAE from its “grey list” in February 2024.

[8] Notably, there are additional requirements for EU AIFMs managing AIFs on behalf of third parties (i.e., the “host-AIFM” model) to provide additional information to their competent authority with respect to their management of conflicts of interest.

[9] The AIF must retain that percentage of the loan: (i) until maturity for those loans whose maturity is up to eight years, or for loans granted to consumers regardless of their maturity; and (ii) for a period of at least eight years for other loans. Note that there are a number of exemptions including where the EU AIFM seeks to: (a) redeem units or shares as part of the liquidation of the AIF; (b) comply with EU sanctions or product requirements; (c) implement the investment strategy of the AIF, in the best interests of its investors; and/or (d) dispose of the loan due to a deterioration in the risk associated with the loan, detected by the AIFM as part of its due diligence and risk management process and the purchaser is informed of that deterioration when buying the loan.

[10] This is likely to apply to loans that are originated indirectly by an SPV.

[11] Leverage is expressed as the ratio between the exposure of the Loan Originating AIF and its net asset value. For the purposes of calculating this ratio, borrowing arrangements which are fully covered by contractual capital commitments from investors in the Loan Originating AIF do not constitute exposure.

[12] https://www.gibsondunn.com/guide-to-understanding-new-private-funds-rules/

The following Gibson Dunn lawyers prepared this update: Michelle Kirschner, James Hays, and Martin Coombes.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact the Gibson Dunn lawyer with whom you usually work, any member of Gibson Dunn’s Global Financial Regulatory or Investment Funds teams, or the following authors:

Michelle M. Kirschner – London (+44 20 7071 4212, mkirschner@gibsondunn.com)
James M. Hays – Houston (+1 346 718 6642, jhays@gibsondunn.com)
Martin Coombes – London (+44 20 7071 4258, mcoombes@gibsondunn.com)

From the Financial Institutions Practice Group: We are pleased to provide you with the April edition of Gibson Dunn’s monthly U.S. bank regulatory update. This update covers recent federal banking agency initiatives and legal news updates on the Community Reinvestment Act final rules and Federal Reserve Bank master accounts.

KEY NEW DEVELOPMENTS

FDIC Board Members Withdraw Proposals to Monitor Asset Managers for Compliance with Change in Bank Control Act

At the Federal Deposit Insurance Corporation’s (FDIC) board meeting on April 25, 2024, FDIC Directors Jonathan McKernan and Rohit Chopra (Director of the Consumer Financial Protection Bureau) each put forth proposals to monitor large asset managers’ compliance with the Change in Bank Control Act with respect to their investments in depository institution holding companies and, indirectly, their insured depository institution subsidiaries. Director McKernan’s proposal would have required the FDIC’s Director of the Division of Risk Management Supervision to submit within 90 days for the review and approval of the FDIC Board a plan to (i) monitor compliance with any passivity commitment or other condition of any FDIC comfort provided to a “covered fund complex” and (ii) annually determine whether any covered fund complex controls, or has controlled, directly or indirectly an FDIC-supervised institution. Director Chopra’s proposal would have removed the exemption from the Change in Bank Control Act’s prior notice requirement for acquisitions of voting securities of a depository institution holding company with an FDIC-supervised subsidiary institution for which the Board of Governors of the Federal Reserve System (Federal Reserve) reviews a notice, thus requiring duplicative notices to be filed with both the Federal Reserve and FDIC.

Insights: Director McKernan’s proposal garnered the support of Vice Chair Travis Hill and Director Chopra’s proposal garnered the support of FDIC Chairman Martin J. Gruenberg. Ultimately, though, neither had the support of Director Michael J. Hsu, Acting Comptroller of the Currency, who pushed for any proposed rulemaking to be done on an interagency basis. Although neither proposal was acted upon, given concerns raised by members of the FDIC Board, continued regulatory scrutiny on passivity commitments and the ownership of shares in financial institutions by large asset managers will undoubtedly remain.

FDIC Releases Comprehensive Report on Orderly Resolution of Global Systemically Important Banks

On April 10, 2024, the Federal Deposit Insurance Corporation (FDIC) released a comprehensive report regarding the orderly resolution of a large, complex financial company under Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The report first outlines the resolution-related provisions of the Dodd-Frank Act before describing key measures for planning and strategy in the event of a bank failure, with a particular eye towards the resolution of global systemically important banks (G-SIBs).

Insights: In issuing the report, the FDIC aims to promote transparency around the G-SIB resolution process, a topic of significant relevance in light of recent regulatory reforms aimed at aligning the regulatory framework across the largest banks, including both G-SIBs and non-G-SIBs. Most notably, the FDIC affirmed its commitment to the Single Point of Entry strategy. By providing such clarity, G-SIBs can continue to better structure their organizations to account for a potential resolution scenario, which may in turn provide opportunities for realizing operational efficiencies. Moreover, the FDIC’s report can serve as a blueprint for those firms that are not G-SIBs but which, over time, may become subject to a regulatory framework that more closely aligns with the framework currently applicable to G-SIBs.

Federal Reserve Board Publishes Financial Stability Report

On April 19, 2024, the Board of Governors of the Federal Reserve System (Federal Reserve) published the its semi-annual Financial Stability Report. According to the Federal Reserve Bank of New York’s industry survey, persistent inflation and monetary policy tightening; policy uncertainty, including trade policy, foreign policy issues related to escalating geopolitical tensions and uncertainty associated with the upcoming elections; and commercial real estate market stress were the three most commonly cited potential risks to financial stability over the next 12 to 18 months. Though commercial real estate concerns and banking sector stress did decrease as financial stability risks compared to the fall 2023 semi-annual survey.

Insights: In a nod to the Financial Stability Oversight Council’s (FSOC) focus on the potential risks to financial stability stemming from the use of leverage by certain hedge funds, the Federal Reserve’s report cites that “measures of hedge fund leverage increased in the third quarter of 2023 to the highest level observed since the beginning of data availability, with the increase driven primarily by the largest hedge funds.” This focus of course follows the FSOC’s easing of its process to designate nonbank financial companies as systemically important financial institutions, subject to any potential legal challenges. It remains to be seen whether in an election year any designations will be made by the FSOC.

Preliminary Injunction Delays Revised CRA Rules

In early February, seven industry and business associations sued the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (collectively, the Agencies) in the Northern District of Texas, seeking to block the Agencies’ final rules interpreting the Community Reinvestment Act of 1977 that were approved on October 24, 2023 and due to take effect beginning on April 1, 2024. According to the industry and business associations’ complaint, the Agencies exceeded their authority because the final rules provided that the Agencies would (1) “begin assessing banks’ activities outside of the locations where they maintain a physical presence and accept deposits, thus ignoring the critical geographic limits that Congress incorporated into the CRA,” and (2) “assess banks’ deposit products rather than the credit products that Congress targeted in the statute.” Finding that the trade associations “demonstrate[d] a substantial likelihood of success on the merits,” the District Court granted a preliminary injunction on March 29, 2024 and enjoined the Agencies from enforcing the final rules against the industry and business associations pending the resolution of the suit, and tolled the effective date and all associated implementation dates while the preliminary injunction remains in place. The Agencies are appealing the decision to the Fifth Circuit.

Insights: Although the District Court prohibited the Agencies from enforcing the new CRA regulations against the specific plaintiffs to the case, those seven trade associations collectively represent a majority of U.S. banks. The Agencies have noticed their intent to challenge the injunction before the Fifth Circuit and also moved to stay further proceedings before the District Court, indicating that both the final rules, and the compliance efforts required to comply with them, may remain on hold for at least the near future.

Federal Reserve Prevails Against Depository Institutions Seeking Master Accounts

In late March, two U.S. District Courts upheld decisions by the Federal Reserve Bank of Kansas City (FRBKC) and the Federal Reserve Bank of San Francisco (FRBSF) to deny master account applications from two depository institutions. In Custodia Bank, Inc. v. Federal Reserve Board of Governors and Federal Reserve Bank of Kansas City, Custodia Bank sued FRBKC challenging the denial of its master account application in 2023. Custodia argued that FRBKC was statutorily required to grant master accounts to all legally eligible depository institutions. The U.S. District Court for the District of Wyoming disagreed, granting summary judgment in favor of FRBKC and finding that FRBKC had discretion to grant or deny master account applications. In a similar case involving the FRBSF, the applicant lost on a similar argument regarding FRBSF’s denial of its master account application in 2023. The applicant brought three claims against FRBSF, each ultimately predicated on the existence of a nondiscretionary duty to make a master account available to the applicant. The U.S. District Court for the District of Idaho found that no such duty exists, and that FRBSF accordingly exercised its lawful discretion in denying the application.

Insights: In denying Custodia Bank’s application for a master account, FRBKC characterized Custodia’s business model as “unprecedented” in that it “proposes to focus almost exclusively on offering products and services related to novel crypto-asset activities and to accept entirely uninsured deposits.” FRBKC concluded that accepting deposits from Custodia into a master account would therefore “introduce undue risk” to the Reserve Bank and the economy at large. Likewise, FRBSF denied the pending application on the grounds that the applicant’s “novel, monoline business model” focusing largely on transactions that are either foreign in nature or involve mostly foreign participants “presents undue risk to the Reserve Bank.” FRBSF also considered the applicant’s risk management framework “insufficient” to address the heightened risks associated with its business model, and cited particular concerns with respect to money laundering, terrorism financing risks, and the potential for the applicant to allow the master account to fund or facilitate such illicit activities. While the District Courts’ decisions are not binding on other courts and are likely to be appealed, they do presently support the conclusion that the Federal Reserve maintains discretion to reject master account applications even in those cases involving eligible applicants. This may be especially true when those applicants are proposing novel business models that the Federal Reserve determines pose undue risk to financial stability or the efforts of the United States in combatting money laundering and the financing of terrorism.

FDIC’s Final Rule on Simplification of Deposit Insurance Rules for Trust and Mortgage Servicing Accounts Goes Effective April 1, 2024

On January 21, 2022, the Federal Deposit Insurance Corporation (FDIC) approved a final rule to amend the deposit insurance regulations for trust accounts and mortgage servicing accounts. The final rule became effective April 1, 2024. Under the final rule, irrevocable and revocable trusts are combined into a single category known as “Trust Accounts” for purposes of the deposit insurance coverage rules. Each Trust Account owner is insured up to $250,000 per eligible primary beneficiary, up to a maximum of five beneficiaries. The FDIC published a presentation highlighting the final here.

Insights: Although insured depository institutions have had more than two years to prepare for changes in coverage, not all Trust Account owners or their beneficiaries may be aware of the changes to the new rule, which could reduce deposit insurance coverage in those cases where Trust Account owners (1) own both revocable and irrevocable trust accounts; and/or (2) have more than five beneficiaries. Clear communication to new and existing customers will be critical in ensuring that customers have an adequate understanding of the impacts, if any, of the new rules on their deposit insurance coverage. In other cases, deposit insurance limits will increase for irrevocable trust owners, which will be calculated in the same manner as revocable trusts, up to a maximum of five beneficiaries.

Speech by Board of Governors of the Federal Reserve System Governor Michelle W. Bowman on Bank Mergers and Acquisitions

On April 2, 2024, Federal Reserve Governor Michelle W. Bowman gave a speech titled “Bank Mergers and Acquisitions, and De Novo Bank Formation: Implications for the Future of the Banking System” in which she was critical of the “broad-based and insufficiently focused reform agenda” of the federal bank regulatory agencies which creates higher barriers to entry for de novo banks, reduces efficiencies in bank M&A, and increases opportunities for “regulation by application” rather than relying on statutes, regulations, and rulemakings.

Insights: Governor Bowman’s speech highlights the obstacles to de novo bank formation and Bowman stressed that the “absence of de novo bank formation over the long run will create a void in the banking system.” She also highlighted her “more immediate concern” with the “dramatically evolving” approach” to bank M&A by prudential regulators. She concluded by reiterating her consistent message of the need to rationalize competing regulatory approaches to ensure the long-term viability of banks.

Federal Reserve Board Governor Bowman Speaks on Bank Liquidity, Regulation and the Federal Reserve’s Role as Lender of Last Resort

On April 3, 2024, Federal Reserve Board Governor Michelle W. Bowman gave a speech titled “Bank Liquidity, Regulation, and the Fed’s Role as Lender of Last Resort.” In her speech, Governor Bowman highlighted the Federal Reserve’s role as a lender of last result, including with respect to potential changes to the liquidity framework supporting the U.S. banking system. Governor Bowman acknowledged that the spring 2023 bank failures have created pressure to pass additional regulations relating to regulatory capital and/or liquidity, but Governor Bowman cautioned that, “…we should think about the response to banking stress more broadly….” In order to do so, Governor Bowman urged the Federal Reserve to analyze the challenges facing, and tools available to, the Federal Reserve’s liquidity and regulatory capital frameworks. With respect to the former, Governor Bowman highlighted the “perception of stigma” associated with utilizing the Federal Reserve discount window. With respect to the latter, Governor Bowman highlighted both available technology and the Federal Reserve’s prudential regulatory authority. Governor Bowman also discussed potential requirements relating to the pre-positioning of collateral with the Federal Reserve in order to access the discount window, reiterating the need to analyze the “important but as yet unanswered questions” associated with such requirements.

Insights: Governor Bowman is clear in her remarks that the “expectation should not be that the Federal Reserve replaces existing sources of market liquidity for banks in normal times” and reiterated the Fed’s discount window as a “source of backup liquidity.” She reiterated her consistent message of the need for the agencies to “focus on improving the targeted approach of supervision, to enhance the ‘prevention’ of banking system stress,” and described the need to consider the liquidity framework in a “broad-based manner” so that “the available tools, resources, and requirements are working in a complementary way.”

New York Fed Announces Participation in Joint International Research Effort on Tokenization and Cross-Border Payments

On April 3, 2024, the Federal Reserve Bank of New York (FRBNY) announced that it will participate in an international technical research project, Project Agorá, that will explore whether the tokenization of central bank money and commercial bank deposits operating on a shared programmable ledger can improve wholesale cross-border payments. Project Agorá, a new effort led by the Bank for International Settlements Innovation Hub in partnership with the Institute of International Finance, will bring together seven central banks and financial institutions from each of their respective jurisdictions to research ways to increase the speed and transparency of international wholesale payments and lower associated costs and risks. The project will focus on overcoming common structural inefficiencies in cross-border payments today related to differing legal, regulatory, and technical requirements, operating hours and time zones, and varying financial integrity controls. Including the FRBNY, the seven participating central banks are the Bank of England, Bank of France, Bank of Japan, Bank of Korea, Bank of Mexico, and the Swiss National Bank.

Insights: Integration of tokenized commercial bank deposits with tokenized wholesale central bank money could lead to improvements in the monetary system’s functionality and offer innovative solutions utilizing smart contracts and programmability, all while preserving its existing two-tier structure. While the FRBNY’s participation in Project Agorá is explicitly limited to research and experimentation, the participation alone marks a significant milestone for cross border Central Bank Digital Currency (CBDC) initiatives. Unlike early adoptions of a CBDC, like the Bahamas’ Sand Dollar or Uruguay’s e-Peso pilot plan, the United States has been hesitant to commit to the development or use of a CBDC. The United States’ involvement in Project Agorá does signify the United States’ further involvement in exploring the cross-border use for a CBDC but should not be read as a commitment to develop a US Dollar CBDC.

OTHER DEVELOPMENTS / RELEVANT LINKS

FDIC Board releases the first semiannual update of 2024 on the Restoration Plan for the agency’s Deposit Insurance Fund (see also Statement by FDIC Chairman Martin J. Gruenberg; Memorandum to the FDIC Board),
Federal Reserve staff publishes FEDS Notes article titled, “Tokenized Assets on Public Blockchains: How Transparent is the Blockchain?”
Federal Reserve Bank of New York publishes a Liberty Street Economics blog post titled, “Can I Speak to Your Supervisors? The Importance of Bank Supervision.”
Federal Reserve Bank of New York publishes a Liberty Street Economics blog post titled, “Internal Liquidity’s Value in a Financial Crisis.”
Federal Reserve Bank of New York publishes a Staff Report titled, “Investor Attention to Bank Risk During the Spring 2023 Bank Run.”

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, jcabral@gibsondunn.com)

Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)

M. Kendall Day, Washington, D.C. (202.955.8220, kday@gibsondunn.com)

Jeffrey L. Steiner, Washington, D.C. (202.887.3632, jsteiner@gibsondunn.com)

Sara K. Weed, Washington, D.C. (202.955.8507, sweed@gibsondunn.com)

Ella Capone, Washington, D.C. (202.887.3511, ecapone@gibsondunn.com)

Rachel Jackson, New York (212.351.6260, rjackson@gibsondunn.com)

Chris R. Jones, Los Angeles (212.351.6260, crjones@gibsondunn.com)

Zack Silvers, Washington, D.C. (202.887.3774, zsilvers@gibsondunn.com)

Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)

We are pleased to provide you with the April 2024 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

Mango Markets Exploitation Jury Finds Avraham Eisenberg Guilty of Fraud and Market Manipulation
On April 18, jurors in the Southern District of New York found Avraham Eisenberg, a cryptocurrency trader, guilty of fraud and market manipulation following a two-week jury trial. In October 2022, Eisenberg executed several purchases on Mango Markets, a decentralized exchange, in an effort to artificially raise the price of the MNGO token relative to the USD Coin, while holding MNGO perpetual futures. Eisenberg then used his perpetual futures as collateral to borrow and withdraw approximately $116 million worth of various crypto assets from Mango Markets, effectively draining all available assets from the platform. Eisenberg claimed he legally obtained the funds, and he returned $67 million in crypto to Mango Markets. He was arrested in Puerto Rico in December 2022. U.S. Attorney Damian Williams said the conviction was the first ever in a cryptocurrency market manipulation case. In addition to these criminal charges, Eisenberg faces civil charges from the SEC and CFTC for violations of the anti-fraud and market manipulation provisions of the securities laws. Reuters; Law360; Cointelegraph; Business Insider; Cointelegraph [2].
SEC Warns of Potential Enforcement Action Against Uniswap Labs
On April 9, Uniswap Labs published a blog post that it had received a Wells notice from the SEC, indicating that the SEC staff would be recommending legal action against Uniswap Labs. The Uniswap Protocol is the largest decentralized trading and automated market making protocol on Ethereum, having reportedly processed over $2 trillion worth of transactions since first launching in 2018. Uniswap Labs builds products to support the Uniswap ecosystem. Uniswap Labs vowed to fight the charges.Uniswap Labs, as with other firms that receive a Wells notice, is permitted to respond in writing concerning why litigation by the SEC would be inappropriate. The SEC has not yet commented on any actions against Uniswap Labs, and no further details on potential litigation were currently available at publishing. Uniswap Labs Blog Post; Reuters; WSJ; Cointelegraph.
DOJ Arrests and Charges Founders and CEO of Bitcoin Mixing Service Samourai Wallet With Money Laundering and Unlicensed Money Transmitting Offenses
On April 24, federal prosecutors charged the founders of Samourai Wallet, a crypto-mixing firm, with conspiracy to commit money laundering and operating an unlicensed money transmitter business. The government alleges that Samourai executed over $2 billion in unlawful transactions and laundered more than $100 million via illegal dark web markets. The government alleges that the founders encouraged and invited users to launder criminal proceeds, citing tweets and private messages; and that the platform was used to wash funds connected to Silk Road and Hydra Market. The DOJ also seized Samourai Wallet, which was hosted in Iceland, and has issued a warrant for its mobile app. The app is still available in Europe. Indictment; DOJ Press Release; Axios; CoinDesk; CoinDesk [2].
Jury Returns Verdict in SEC’s Case against Do Kwon, Terraform Labs
On April 5, a New York jury began deliberations and returned a verdict the same day in the SEC’s case against Terraform Labs and its founder, Do Kwon, finding both liable on civil fraud charges following a two-week trial. The SEC accused the defendants of misleading investors about the stability of Terra USD (USDT), an “algorithmic stablecoin” that was supposed to maintain a peg to the U.S. dollar. In May 2022, USDT unpegged, resulting in a loss of about $40 billion in market value. CoinDesk; CNBC; Reuters.
Federal Court Rejects SEC’s Claim that Coinbase Acted as Unregistered Broker, But Permits Remainder of SEC’s Case Against Coinbase to Proceed; Coinbase Requests Interlocutory Appeal
On March 27, U.S. District Court Judge Katherine Polk Failla (SDNY) granted in part and denied in part Coinbase’s motion for judgment on the pleading in the SEC’s enforcement action against the company. Judge Failla rejected the SEC’s claim that Coinbase acted as an unregistered broker by making its Wallet application available to its customers. Judge Failla also ruled that the rest of the SEC’s claims—including that Coinbase engaged in unregistered sales of securities—could proceed to discovery. On April 12, Coinbase asked the district court to certify an interlocutory appeal that would allow the Second Circuit to immediately consider whether the SEC may regulate as “investment contracts” digital asset transactions that involve no obligation running to the purchaser beyond the point of sale. CNBC; Pymnts; Bitcoin.com; CoinDesk.
Sam Bankman-Fried Files Appeal of Conviction and Sentence
On April 12, less than two weeks after receiving a 25-year prison sentence, Bankman-Fried appealed his conviction and sentence to the Second Circuit. This followed Bankman-Fried’s request to Judge Kaplan to remain at the Metropolitan Detention Center in Brooklyn, rather than transfer to a federal prison in the Bay Area, to pursue the appeal. Bankman-Fried’s lawyers have not indicated the grounds for appeal, though Bankman-Fried noted in emails to ABC News that new evidence existed that was not considered during the trial, that there were procedural flaws, and that there were improper collaborations between FTX’s bankruptcy counsel and federal prosecutors. Notice of Appeal; Forbes; ABC News; Cointelegraph; Daily Coin.
OneCoin’s Legal Boss Gets Four Years in Jail for $4 Billion Crypto Scam
On April 4, the former head of legal and compliance for OneCoin, Irina Dilkinska, was sentenced to four years in jail for her role in the infamous $4 billion crypto Ponzi scheme after admitting she helped launder millions of dollars. Judge Edgardo Ramos (SDNY) also imposed one month of supervised release and a forfeiture of $111 million as restitution. Dilkinska pled guilty to wire fraud and money laundering charges in the Southern District of New York in November 2023. This comes after OneCoin’s co-founder, Karl Sebastian Greenwood, was sentenced to 20 years in prison and ordered to pay $300 million in restitution for his involvement in the scam. The other main co-founder, Ruja Ignatova, remains at large. US Attorneys’ Office Press Release; Reuters; Bloomberg; CoinDesk.

INTERNATIONAL

Filecoin Foundation Investigating Reported Detention of Filecoin Liquid Staking (STFIL) Team Members in China
On April 8, Filecoin Foundation, a nonprofit that promotes the development of Web3 storage protocol Filecoin, reported that core technical members of its STFIL team were detained by Chinese authorities. Filecoin is a decentralized storage protocol that allows PC owners to rent out their hard disk space to users with data storage needs. Filecoin reported that withdrawals from the STFIL protocol stopped working at the same time, after a developer wallet made several unscheduled upgrades, and moved $23 million worth of Filecoin tokens to an address whose owner is unknown. Filecoin noted that it has local counsel in China looking into the incident. The Foundation has been unable to confirm whether authorities have taken possession of the funds, or to determine who is holding the STFIL team in custody. Filecoin is the latest in a set of Web3 platforms that have encountered criminal legal action in China. Cointelegraph; The Block.

REGULATION AND LEGISLATION

UNITED STATES

IRS Releases Draft Form to Report Crypto Gains in 2025
On April 19, the IRS released draft Form 1099-DA, to be used by crypto brokers to report taxable gains or losses regarding crypto trades. The form, which is similar to Form 1099-B, has an array of individual token codes that can be filled in, as well as spaces for wallet addresses and where to find transactions on the relevant blockchain. This version of the form asks the filer to check a box that describes the type of broker they are: kiosk operator, digital asset payment processor, hosted wallet provider, unhosted wallet provider or “other.” The unhosted wallet provider option appears to refer to self-custodial crypto addresses unaffiliated with any third party. Some commentators have suggested that these fields mean that the IRS aims to classify DeFi protocols as brokerage firms, revealing personal information, and potentially undermining the benefits of pseudonymity that the crypto industry offers. Some in the crypto industry have expressed interest in litigating the issue. The form, however, remains in draft, and may change before 2025. As part of the drafting process, the IRS has invited public comment. Draft Form; Reuters; Politico; CoinDesk, DeCrypt.
SEC Calls for Comments on Spot Ether ETF Applications
On April 2, the SEC solicited comments from the public regarding the proposed listing of spot Ether ETF applications on the New York Stock Exchange (“NYSE”). Under the proposed rule, the Ethereum ETF would be listed as a commodity-based trust share on the NYSE. The public had until April 23 to comment. SEC Request; Cointelegraph.
CFPB Flags Risks in Virtual Crypto Economies
On April 4, the CFPB released its report on banking in the gaming and virtual worlds. The report highlighted the growth of crypto-assets in both sectors, and stated that online video games and virtual worlds are becoming akin to traditional banking but lack federal protections. The agency received complaints regarding hacking attempts, account theft, and assets lost within games, with consumers expressing dissatisfaction over the lack of support from gaming companies. This report comes after the CFPB proposed a rule in November 2023 titled “Defining Larger Participants of a Market for General-Use Digital Consumer Payment Applications.” This rule grants the agency oversight over “larger nonbank firms” providing digital wallet and payment app services. Crypto industry insiders suggest that such reports could signal upcoming actions by the CFPB. CFPB Report; CFPB Proposed Rule; Cointelegraph.
SEC Delays Decision on Bitcoin ETF Options
On April 8, the SEC postponed its decision on the NYSE proposed rule change to amend Rule 915 to permit the listing and trading of options on any trust that holds Bitcoin. The proposed rule change was published for comment in the Federal Register on February 29, 2024. Citing the need for more time in order to adequately consider the proposed rule change, the SEC designated May 29, 2024, as the day by which the commission would make a decision on the NYSE’s proposed rule. SEC Filing; Cointelegraph.
Senators Gillibrand and Lummis Introduce Stablecoin Bill
On April 17, Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) introduced the Lummis-Gillibrand Payment Stablecoin Act, which would prohibit “unbacked, algorithmic stablecoins,” require one-to-one cash reserves for issuers, create state and federal regulatory regimes for firms and prevent illicit uses of stablecoins. Other provisions would permit state non-depository trust companies to issue up to $10 billion in payment stablecoins, with authorized institutions able to issue stablecoins “up to any amount” under a limited-purpose state charter. The bill also aims to uphold the current system of state and federal charters and established rules on custody for non-depository trust companies. Finally, the bill deals with insolvency: should a stablecoin issuer experience insolvency, the FDIC can be granted conservatorship and resolution. Senator Sherrod Brown (D-OH) and Representative Patrick McHenry (R-NC) both expressed cautious optimism regarding advancing the bill. Gillibrand Press Release; Bloomberg; Cointelegraph; The Block; CoinDesk; CoinDesk [2].
Arkansas Senate Passes Two Bills Restricting Cryptocurrency Mining
On April 18, amended legislation aiming to prohibit the establishment of crypto mining facilities and activities involving the creation, preservation, storage, and trade of cryptocurrencies passed the Arkansas Senate. The legislation aims to limit crypto mining operations in the state through a variety of regulations, including through noise limits on mining operations, prohibitions on ownership by foreign entities, grants of authority to local governments to pass ordinances regulating mines, licensing of crypto mining operations by the State Department of Energy and Environment, and special requirements on electricity rates. Arkansas Senate; Arkansas Advocate; Arkansas Democrat Gazette.

INTERNATIONAL

Hong Kong Regulator Approves Bitcoin and Ether ETFs
On April 15, Hong Kong’s Securities and Futures Commission (SFC) approved Bitcoin and Ether exchange traded funds (ETFs), permitting three firms to (conditionally) offer spot Bitcoin and Ether ETFs. The three firms are ChinaAMC, Harvest Global, and Bosera International. While no timeline has been provided for when the batch of approved ETFs can begin trading on regulated exchanges, the conditional approval signals that Hong Kong is becoming a hub for crypto market innovation. CNBC; Reuters; Elliptic.
South African Crypto Exchange VALR Has Received Regulatory Approval from the Country’s Financial Watchdog
On April 15, South African crypto exchange VALR reported that it had obtained a license from the country’s financial regulator. The company, which was valued at $240 million two years ago, is part of the first batch of crypto firms—along with exchange platform Luno and crypto social investment platform Zignaly—to obtain approvals from South Africa’s Financial Sector Conduct Authority (FSCA). VALR now has both Category I and Category II crypto asset service provider (CASP) licenses. A Category I license is the standard financial service provider required for a CASP; a Category II license enables customers to give VALR and other licensed Category II financial service providers (FSPs) a mandate to use its discretion to structure customers’ portfolio, among other things. VALR serves over 1,000 corporate and institutional clients and more than half a million crypto traders worldwide. VALR Blog; CoinDesk; Cointelegraph.
Norwegian Government Introduces Law for Data Centers, to Block Energy-Intensive Crypto Mining
On April 15, a local news outlet in Norway reported that the Norwegian government is attempting to restrict crypto mining in the country by regulating data centers, according to two ministers. Both lawmakers stated that they did not want crypto mining in the country, because of the emissions caused by mining. CoinDesk; Crypto News; VG Norway.
As Markets in Crypto-Assets (MiCA) Regulation to Take Effect, Germany’s Largest Federal Bank to Offer Crypto Custody Services
Banks in Germany are preparing for the European Union’s MiCA regulation that will take full effect in December 2024 as the first comprehensive legal framework for the crypto industry. MiCA will make crypto exchanges fully regulated entities, but the bill is still being finalized. Hand-in-hand with this forthcoming regulation, on April 15,the Landesbank Baden-Wurttemberg announced that it would start offering crypto custody services to institutional clients, in partnership with the Austria-based Bitpanda cryptocurrency exchange, beginning in the second half of 2024. The Landesbank Baden-Württemberg will tap Bitpanda’s institutional custody solution for its offering. Bitpanda Custody is a crypto custody platform with decentralized finance (DeFi) capabilities, registered with the United Kingdom’s Financial Conduct Authority (FCA). Cointelegraph; Coinedition.
Sweden Demands $90 Million in Outstanding Tax from Crypto Miners
On April 18, the Swedish Tax Agency announced that 18 crypto miners filed misleading or incomplete information to benefit from tax incentives. Some businesses provided the government with misleading business descriptions in order to obtain exemptions to paying value added tax on taxable operations. Others found ways to skirt import tax requirements and income tax on mining revenue. The crypto mining companies appealed the tax bill; two companies won on appeal, while the remaining sixteen lost. Law360; Cointelegraph.
Binance Wins Dubai Cryptocurrency Virtual Asset Service Provider License
On April 18, Dubai granted Binance a full regulatory Virtual Asset Service Provider (“VASP”) license. The license will allow Binance to target retail clients, in addition to qualified and institutional clients. This allows the platform to extend its offerings beyond spot trading and fiat services, expanding to margin trading products and staking products. This stage of approval comes almost a year after Binance secured its third-stage license. Bloomberg; Reuters; CoinDesk.This comes while Dubai’s Virtual Asset Regulatory Authority (VARA) is considering alleviating the financial burdens for smaller crypto businesses, by reducing the cost of compliance for smaller entities. Cointelegraph.

CIVIL LITIGATION

UNITED STATES

Consensys Files Suit Against SEC, Seeking Declaration that Ethereum is Not a Security
On April 25, software developer Consensys filed a lawsuit against the SEC in the Northern District of Texas, arguing that the SEC lacks authority to regulate the ether cryptocurrency (ETH) or the MetaMask wallet developed by Consensys, and that any investigation of Consensys based on the idea that ETH is a security would violate the Due Process Clause and the Administrative Procedure Act. Consensys also argued that MetaMask is not a broker and that its staking service does not violate the securities laws. The complaint seeks declaratory relief and injunction preventing the SEC from investigating or bringing an enforcement action premised on ETH transactions being securities or related to MetaMask’s swaps or staking functions. The complaint was filed after Consensys reportedly received a Wells notice from the SEC on April 10, indicating the SEC’s intention to bring an enforcement action against the company. Complaint; Reuters; Bloomberg; CoinDesk.
Blockchain Association and Crypto Freedom Alliance of Texas Challenge SEC’s Dealer Rule
On April 23, the Blockchain Association and the Crypto Freedom Alliance of Texas sued the SEC in the Northern District of Texas, challenging a rule that broadly defines a “dealer” of securities. Under the rule, entities newly deemed to be dealers would face significant new burdens and costs, including capital and registration requirements. The plaintiffs argue that the dealer rule is too broad in scope (affecting participants and traders in DeFi, rather than just dealers), does not properly explain the rule’s impact on crypto market participants, and ignores the feedback the SEC received during the rule’s public comment period. This case joins another challenge to the dealer rule filed in the same court earlier this year by three associations of private fund advisers. Complaint; WSJ; CoinDesk.
SEC Lawyers Forced to Resign After Utah Judge Censures SEC for Abuse of Power in Crypto Case
On March 18 a federal judge in Utah found that the SEC had abused its power in SEC v. Digital Licensing Inc., No. 2:23-cv-00482 (D. Utah, Mar. 18 2024), leading to the resignation of two SEC lawyers, Michael Welsh and Joseph Watkins. The SEC brought a case against Digital Licensing, which operates the blockchain company DEBT Box, accusing the company of defrauding investors of more than $50 million. But Chief District Judge Robert Shelby said that the SEC acted in “bad faith” and was “deliberately perpetuating falsehoods” in order to obtain an asset freeze and a temporary restraining order against the company. The judge also sanctioned the SEC, requiring it to pay attorneys’ fees and costs for DEBT Box. In December, SEC enforcement chief Gurbir Grewal apologized to the court for his department’s conduct. He said that he had appointed new attorneys to the case and mandated training for the agency’s enforcement staff. Opinion; Bloomberg; Reuters.
Former FTX Executives to Settle Class Action Lawsuit for $1.36 Million
On March 27, former FTX and Alameda executives came to a nearly $1.36 million settlement with a class action group of the crypto exchange’s former investors who are seeking compensation for allegedly being defrauded. Zixiao “Gary” Wang, FTX’s co-founder, Nishad Singh and Caroline Ellison each agreed to provide information in connection with the lawsuit to resolve claims against them. Notably, none of the executives admitted fault to any allegations made against them in the lawsuit, but the class group determined that their information would help strengthen its case against others it sued, including celebrities, companies, and venture capitalists. Wang, Singh and Ellison additionally agreed to provide records used in FTX’s bankruptcy case, generally make themselves available for hearings and depositions, and forfeit their assets in their criminal case. Under the settlement agreement, the executives may not oppose a request from FTX investors that their assets be distributed through the class suit rather than through FTX’s bankruptcy or other lawsuits. CoinTelegraph; Yahoo Finance.
Wyoming Federal District Court Upholds Federal Reserve’s Rejection of Custodia Bank’s Master Account Application
On March 29, the Federal District Court of Wyoming rejected Wyoming-based Custodia Bank’s argument that it is entitled to a Federal Reserve master account and membership with the Fed. Custodia Bank is a special purpose depository institution allowing a full suite of financial services both for U.S. dollars and digital assets. In the Opinion, the court held that federal laws do not require the nation’s central bank to give every eligible depository institution access to its master account system, nor did the provided evidence suggest that the Federal Reserve Board of Governors influence a regional branch of the Fed to deny its application for an account. Instead, the court found that the Kansas City Fed likely made the decision, not at the behest of the Board. In 2023, the Fed opined that it had concerns about the sustainability of a crypto-focused bank, despite Custodia’s sufficient capital and resources to launch. The Fed noted that Custodia had significant deficiencies in its ability “to manage the risks of its day-one activities,” and did not think that Custodia could handle basic safety measures or comply with banking laws regarding money laundering. Opinion; CoinDesk; CoinDesk (2023).
Google Files Lawsuit Against Alleged Crypto Scammers
On April 4, Google filed a lawsuit in the Southern District of New York against Yunfeng Sun and Hongnam Cheung for allegedly uploading fraudulent investment apps to Google Play and committing hundreds of acts of wire fraud, harming Google and approximately 100,000 Google users. Google argued that the defendants made numerous misrepresentations to be able to upload their apps to Google Play, including misrepresentations about their identity, location and the nature of the applications. Google alleges that its users were promised high returns for investing in crypto and related products, but that customers who made deposits through the defendants’ apps were unable to withdraw their funds and were required to pay various fees when they attempted to access their funds, which they were still unable to do even after paying such fees. CoinDesk; Blockworks.

SPEAKER’S CORNER

UNITED STATES

Senators Elizabeth Warren and Chuck Grassley Demand that CFTC Chair Explain His Chats with Sam Bankman-Fried
Senator Warren (D-MA) and Senator Chuck Grassley (R-IA) are demanding more information from the CFTC Chair, Rostin Benham, regarding Benham’s contact with Sam Bankman-Fried, the former FTX CEO sentenced to 25 years. Benham has disclosed meetings with Bankman-Fried, but has not provided all the records regarding these meetings. Benham and his team met with Bankman-Fried ten times at the CFTC, and Benham told lawmakers that he’d also exchanged messages with Bankman-Fried. The written communication from the senators demands all written communications, plus minutes and timelines of their interactions. The CFTC has said it will provide the information the senators are asking for. Business Insider.

INTERNATIONAL

New Zealand Minister of Commerce Andrew Bayly Says New Zealand Should Regulate Crypto Sector to Facilitate Growth of Industry
On April 10, 2024, New Zealand Minister of Commerce Andrew Bayly said that the country should support crypto industry growth and take an evidence-based approach to regulating the sector. Bayly noted that doing otherwise might risk New Zealand losing out on the industry, including the financial and technological benefits from the industry’s growth. Advisors to the ministry have proposed a variety of actions for New Zealand to catch up with the global trends towards crypto, including creating supportive policies for blockchain and digital assets, promoting government-industry collaboration, and adopting crypto-friendly measures such as educational initiatives and AML enhancements. Bayly Statement; CoinDesk.
UK Lawmakers Call for the Government to Further Develop Crypto and Blockchain Skills Pipeline
On April 17, UK Parliament’s MP Lisa Cameron called for the government to ensure that digital skills are taught from the early stages of education and in the workplace. Although the government has said it wants to make the country a hub for crypto, Cameron called for more to be done beyond recognizing crypto as a regulated activity. Cameron also noted that there should be greater partnerships with blockchain companies. CoinDesk.
Executive Director for UK’s FCA Emphasizes Crypto-User Protection Over Registration Speed
Despite these pro-crypto calls by UK lawmakers, members of the industry have said that the UK’s Financial Conduct Authority (FCA) takes too long to approve crypto application. Sarah Pritchard, the executive director for markets and international at the FCA, spoke at TheCityUK conference, noting that “[a] simple focus on numbers could undermine trust and reputation” and “[l]ower standards could leave open our market to abuse by those who seek to launder criminally made cash, damaging market integrity and confidence in financial markets,” Pritchard said. “Instead, we take a longer view. Crypto’s success – and the success of any base for crypto firms – relies on trust being built and maintained.” CoinDesk.

OTHER NOTABLE NEWS

Immunefi’s Research Report Shows Crypto Industry Saw 23% Decline in Losses Due to Hacking and Scams in 1Q 2024, Compared to 2023
Immunefi, a leading Web3 bug bounty platform, released its Quarterly Report on March 30, which showed that the amount lost to hacking and fraud incidents in Q1 of 2024 amounted to approximately $336.3 million, down from $437.5 million in Q1 of 2023. The report covers 46 hacking incidents and 15 cases of fraudulent activities. Two projects accounted for the bulk of the losses, totaling $144.5 million, or 43% of the overall amount. The largest attack, causing $81.7 million in loss, targeted the cross-chain bridge protocol Orbit Bridge on New Year’s Eve. The second largest attack was a $62 million exploit on the nonfungible token game Munchables, but the funds were recovered within 24 hours. In total, almost $73.9 million (22%) of the stolen funds from seven exploits in Q1 were recovered. Hacks accounted for 95.6% of losses, with fraud, scams, and rug pulls accounting for the rest. Report; Cointelegraph; CoinDesk.
Shomari Figures, Alabama Democratic Candidate for House, Wins Primary After Receiving $2.7 Million in Outside Support from Digital Asset Industry’s Major Campaign Finance Operation
On April 16, Shomari Figures, a Washington insider, won the Alabama House Democratic Primary runoff with 61% of the vote. The crypto-friendly candidate dominated the field, and received $2.7 million from a political action committee (PAC) backed by the cryptocurrency industry, Protect Progress. CNN; Alabama Political Reporter; CoinDesk.
Security Alliance (SEAL) Has Recovered $50 Million in Assets Since Its Inception in 2023; Launches Threat-Sharing Platform to Support Crypto Space
SEAL, a team of white-hat hackers, said it recovered $50 million in assets since its inception in 2023. On April 17, the alliance announced its threat-sharing platform, SEAL Information Sharing and Analysis Center (ISAC), to support the crypto space. The platform is purpose-built for crypto aiming to protect against cyberattacks and financial crimes, and does so by providing security intelligence and connections to experts. Nearly twenty crypto organizations have joined the initiative. SEAL ISAC Website; Cointelegraph; Business Wire.
Moody’s Says Tokenization Could Boost Liquidity for Alternative Assets
A new Moody’s report found that tokenization could offer a solution to the liquidity issues facing alternative assets, such as natural resources and private equity, by converting them into digital tokens on blockchain networks. That process could lower barriers to entry, increase transparency, and facilitate fractionalized ownership, potentially creating a more liquid secondary markets for these assets. Although tokenization has the potential to reduce costs for investors and distributors, hurdles such as regulatory uncertainty, technical challenges, and interoperability issues need to be addressed in order to achieve widespread adoption. Report; Ledger Insights.

The following Gibson Dunn attorneys contributed to this issue: Jason Cabral, M. Kendall Day, Jeffrey Steiner, Sara Weed, Ella Capone, Grace Chong, Chris Jones, Jay Minga, Nick Harper, Apratim Vidyarthi, and Alexis Levine.

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, aberinger@gibsondunn.com)

Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com

Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)

Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)

Ella Alves Capone, Washington, D.C. (202.887.3511, ecapone@gibsondunn.com)

Grace Chong, Singapore (+65 6507 3608, gchong@gibsondunn.com)

M. Kendall Day, Washington, D.C. (202.955.8220, kday@gibsondunn.com)

Michael J. Desmond, Los Angeles/Washington, D.C. (213.229.7531, mdesmond@gibsondunn.com)

Sébastien Evrard, Hong Kong (+852 2214 3798, sevrard@gibsondunn.com)

William R. Hallatt, Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)

Martin A. Hewett, Washington, D.C. (202.955.8207, mhewett@gibsondunn.com)

Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)

Stewart McDowell, San Francisco (415.393.8322, smcdowell@gibsondunn.com)

Mark K. Schonfeld, New York (212.351.2433, mschonfeld@gibsondunn.com)

Orin Snyder, New York (212.351.2400, osnyder@gibsondunn.com)

Jeffrey L. Steiner, Washington, D.C. (202.887.3632, jsteiner@gibsondunn.com)

Eric D. Vandevelde, Los Angeles (213.229.7186, evandevelde@gibsondunn.com)

Benjamin Wagner, Palo Alto (650.849.5395, bwagner@gibsondunn.com)

Sara K. Weed, Washington, D.C. (202.955.8507, sweed@gibsondunn.com)

The obligations apply with respect to a company’s own operations and those of its subsidiaries — but also to those carried out by a company’s “business partners” in the company’s “chain of activities”.

On 24 April 2024, the Corporate Sustainability Due Diligence Directive[1] (“CSDDD” or “Directive”) was finally passed by the European Parliament (“Parliament”), marking the end of the key stages of the legislative process, after four years. The CSDDD establishes far-reaching mandatory human rights and environmental obligations on both European Union (“EU”) and non-EU companies meeting certain turnover thresholds, starting from 2027. Those obligations apply with respect to a company’s own operations and those of its subsidiaries—but also to those carried out by a company’s “business partners” in the company’s “chain of activities”.[2] Generally, the CSDDD, one of the most debated pieces of European legislation of recent times, establishes an obligation on in-scope companies to:

identify and assess (due diligence) adverse human rights and environmental impacts;
prevent, mitigate and bring to an end / minimise such adverse impacts; and
adopt and put into effect a transition plan for climate change mitigation which aims to ensure—through best efforts—compatibility of the company’s business model and strategy with limiting global warming to 1.5 °C in line with the Paris Agreement.

The CSDDD also sets out minimum requirements (including the ability for claims to be made by trade unions or civil society organisations) of a liability regime to be implemented by EU Member States for violation of the obligation to prevent, mitigate and bring to an end / minimise adverse impacts.

Key Takeaways

In-scope companies under the Directive include:
- EU companies (on a standalone or consolidated basis) with more than 1,000 employees on average and a net worldwide turnover of more than EUR 450 million; and
- non-EU companies (on a standalone or consolidated basis) generating a net turnover of more than EUR 450 million within the EU.
The human rights and environmental obligations include: (a) integrating due diligence into policies and management systems; (b) identifying and assessing actual and potential adverse human rights and environmental impacts; (c) implementing measures to prevent, cease or minimise such impacts; (d) monitoring and assessing the effectiveness of measures; and (e) providing remediation to those affected by actual adverse impacts.
Obligations are not limited to the company’s own operations and those of their subsidiaries—they extend to a company’s upstream and downstream business partners throughout the company’s “chain of activities”.
Member States are required to impose penalties on companies in breach of the Directive, including pecuniary penalties with a maximum limit of not less than 5% of the in-scope company’s worldwide net turnover.
A breach of certain CSDDD obligations may result in civil liability for damages. However, a company cannot be held liable for any damage caused by its business partners in its chain of activities.
The CSDDD establishes an obligation on companies to adopt a climate change mitigation transition plan to ensure that their business model and strategy are compatible with limiting global warming to 1.5 °C in line with the Paris Agreement.
The Directive will be implemented gradually, applying to larger companies first. From 2027, the Directive will apply to: (a) EU companies with more than 5,000 employees and EUR 1,500 million net worldwide turnover; and (b) non-EU companies with more than EUR 1,500 million net turnover generated in the EU.

1. Legislative History

As reported in our earlier article,[3] in April 2020, the European Commission (“Commission”) proposed the adoption of a directive requiring companies to undertake mandatory human rights and environmental due diligence across their value chains, and a proposal followed in February 2022.[4] At that time, some Member States had already adopted national due diligence laws,[5] and the Commission considered it important to ensure a level playing field for companies operating within the internal market. The Directive was further intended to contribute to the EU’s transition towards a sustainable economy and sustainable development through the prevention and mitigation of adverse human rights and environmental impacts in companies’ supply chains.

After multiple rounds of negotiations and material amendments submitted by all EU institutions, as well as extensive negotiations between Member States, the Permanent Representative Committee of the Council of the European Union (“Council”) endorsed the draft Directive on 15 March 2024, with the Parliament voting in favour on 24 April 2024.[6]

Notably, the CSDDD crystallises into hard law at the EU level certain voluntary international standards on responsible business conduct, such as the UN Guiding Principles on Business and Human Rights (“UNGPs”), the OECD Guidelines for Multinational Enterprises, the OECD Guidance on Responsible Business Conduct, and sectoral direction. Prior to the CSDDD coming into force, these voluntary instruments will continue to offer valuable “best practice” guidance to in-scope companies.

2. Scope of Application and Timing

The Directive will apply to EU companies (i.e., companies formed in accordance with the legislation of a Member State) where a company meets the following thresholds (in each instance measured in the last financial year for which annual financial statements have been or should have been adopted):

has more than 1,000 employees on average (including in certain circumstances, temporary agency workers) and a net worldwide turnover of more than EUR 450 million;[7] or
is the ultimate parent company of a group that collectively reaches the thresholds in (a); or
has entered into or is the ultimate parent company of a group that entered into franchising or licensing agreements in the EU in return for royalties where these royalties amount to more than EUR 22.5 million and provided that the company had or is the ultimate parent company of a group that had a net worldwide turnover of more than EUR 80 million.

The Directive has extra-territorial effect since it also applies to non-EU companies (i.e., companies formed in accordance with the legislation of a non-EU country), if that company:

has generated a net turnover in the EU of more than EUR 450 million; or
is the ultimate parent company of a group that collectively reaches the thresholds under (a); or
has entered into or is the ultimate parent company of a group that entered into franchising or licensing agreements in the EU in return for royalties where these royalties amount to more than EUR 22.5 million in the EU and provided that the company had or is the ultimate parent company of a group that had a net turnover of more than EUR 80 million in the EU.

For the Directive to apply, for both EU and non-EU companies, the threshold conditions must have been satisfied for at least two consecutive financial years. Smaller companies operating in the “chain of activities” of in-scope companies will also be indirectly affected because of contractual requirements imposed on them by companies within the scope of the Directive (discussed further below).

It is notable that the scope of application of the CSDDD is more limited than that of the Corporate Sustainability Reporting Directive (“CSRD”),[8] which (save with respect to franchisors or licensors) applies both lower employee and turnover thresholds. Whilst the CSDDD is expected to apply to around 5,500 companies, the CSRD covers approximately 50,000 companies.

3. Obligations on In-scope Companies

(a) Adopt Human Rights and Environmental Due Diligence

The Directive introduces so-called human rights and environmental “due diligence obligations”. These apply to a company’s own operations, those of its subsidiaries, and those of its direct and indirect business partners throughout their “chain of activities”. The Directive defines “chain of activities” as activities of a company’s:

upstream business partners,[9] relating to the production of goods or the provision of services by the company, including the design, extraction, sourcing, manufacture, transport, storage and supply of raw materials, products or parts of the products and development of the product or the service; and
downstream business partners, relating to the distribution, transport and storage of the product, where the business partners carry out those activities for the company or on behalf of the company.[10]

Companies will be required to:

develop a due diligence policy[11] that ensures risk-based due diligence, and integrate due diligence into their relevant policies and risk management systems;
identify and assess actual or potential adverse human rights and environmental impacts (which are defined by reference to obligations or rights enshrined in international instruments),[12] including mapping operations to identify general areas where adverse impacts are most likely to occur and to be most severe; and
prevent and mitigate potential adverse impacts and bring to an end / minimise the extent of actual adverse impacts. Where it is not feasible to prevent, mitigate, bring to an end or minimise all identified adverse impacts at the same time to their full extent, companies must prioritise the steps they take based on the severity and likelihood of the adverse impacts.

In each instance, companies will be required to take “appropriate measures”; that is, measures that “effectively addres[s] adverse impacts in a manner commensurate to the degree of severity and the likelihood of the adverse impact”.[13] Such measures must take into account the circumstances of the specific case, including the nature and extent of the adverse impact and relevant risk factors.

With regards to the prevention of potential adverse impacts, companies are required (amongst other obligations) to:

develop and implement a prevention action plan, with reasonable and clearly defined timelines for the implementation of appropriate measures and qualitative and quantitative indicators for measuring improvement;
seek contractual assurances from a direct business partner that it will ensure compliance with the company’s code of conduct / prevention action plan, including by establishing corresponding contractual assurances from its partners if their activities are part of the company’s chain of activities;
make necessary financial or non-financial investments, adjustments or upgrades, such as into facilities, production or other operational processes and infrastructures; and
provide targeted and proportionate support for an SME[14] which is a business partner of the company.

Similar obligations are imposed in the context of bringing actual adverse impacts to an end.

Notably, regarding (b), companies must verify compliance. To do so, the CSDDD states that companies “may refer to” independent third-party verification, including through industry or multi-stakeholder initiatives.[15]

The financial sector has more limited obligations. “Regulated financial undertakings” are only subject to due diligence obligations for their own operations, those of their subsidiaries and the upstream part of their chain of activities. Such undertakings are expected to consider adverse impacts and use their “leverage” to influence companies, including through the exercise of shareholders’ rights.

(b) Adopt / Put into Effect a Climate Transition Plan

Companies will also be required to adopt and put into effect a climate change mitigation transition plan (“CTP”), to be updated annually, which aims to ensure that a company’s business model and strategy are compatible with limiting global warming to 1.5°C in line with the Paris Agreement and the objective of achieving climate neutrality, including intermediate and 2050 climate neutrality targets. The CTP should also address, where relevant, the exposure of the company to coal-, oil- and gas-related activities.

The CTP must contain: (a) time-bound targets in five-year steps from 2030 to 2050 including, where appropriate, absolute greenhouse gas emission reduction targets for scope 1, 2 and 3 emissions; (b) description of decarbonisation levers and key actions planned to reach the targets identified in (a); (c) details of the investments and funding supporting the implementation of the CTP; and (d) a description of the role of the administrative, management and supervisory bodies with regard to the CTP.[16]

Companies which report a CTP in accordance with the CSRD or are included in the CTP of their parent undertaking are deemed to have complied with the CSDDD’s CTP obligation. Regulated financial undertakings will also have to adopt a CTP ensuring their business model complies with the Paris Agreement.

(c) Provide Remediation

Consistent with the right to a remedy under the UNGPs, Member States must ensure that where a company has caused or jointly caused an actual adverse impact, it will provide “remediation”.[17] This is defined in the Directive as “restoration of the affected person or persons, communities or environment to a situation equivalent or as close as possible to the situation they would be in had an actual adverse impact not occurred”.[18] Such remediation should be proportionate to the company’s implication in the adverse impact, including financial or non-financial compensation to those affected and, where applicable, reimbursement of any costs incurred by public authorities for necessary remedial measures.

(d) Meaningfully[19] engage with Stakeholders

Companies are required to effectively engage with stakeholders. This includes carrying out consultations at various stages of the due diligence process, during which companies must provide comprehensive information.

(e) Establish a Notification Mechanism and Complaints Procedure

Member States must ensure that companies provide the possibility for persons or organisations with legitimate concerns regarding any adverse impacts to submit complaints.[20] There should then be a fair, publicly available, accessible, predictable and transparent procedure for dealing with complaints, of which relevant workers, trade unions and other workers’ representatives should be informed. Companies should take reasonably available measures to avoid any retaliation.

Notification mechanisms must also be established through which persons and organisations can submit information about adverse impacts.

Companies will be allowed to fulfil these obligations through collaborative complaints procedures and notification mechanisms, including those established jointly by companies, through industry associations, multi-stakeholder initiatives or global framework agreements.

(f) Monitor and Assess Effectiveness

Member States shall ensure that companies carry out periodic assessments of their own operations and measures, those of their subsidiaries and, where related to the chain of activities of the company, those of their business partners. These will assess implementation and monitor the adequacy and effectiveness of the identification, prevention, mitigation, bringing to an end and minimisation of the extent of adverse impacts.

Where appropriate, assessments are to be based on qualitative and quantitative indicators and carried out without undue delay after a significant change occurs, but at least every 12 months and whenever there are reasonable grounds to believe that new risks of the occurrence of those adverse impacts may arise.[21]

(g) Communicate Compliance

Companies will be required to report on CSDDD-matters by publishing an annual statement on their website within 12 months of the end of their financial year, unless they are subject to sustainability reporting obligations under the CSRD. The CSDDD does not introduce any new reporting obligations in addition to those under the CSRD.[22]

The contents of the annual statement will be defined by the Commission through a subsequent implementing act.

4. Enforcement and Sanctions

The Directive requires Member States to designate independent “supervisory authorities” to supervise compliance (“Supervisory Authority”).[23] A Supervisory Authority must have adequate powers and resources, including the power to require companies to provide information and carry out investigations. Investigations may be initiated by the Supervisory Authorities’ own motion or as a result of substantiated concerns raised by third parties.

Supervisory Authorities are to be empowered to “at least”: (a) order the cessation of infringements, the abstention from any repetition of the relevant conduct and the taking of remedial measures; (b) impose penalties; and (c) adopt interim measures in case of imminent risk of severe and irreparable harm.

Sanctions regimes adopted by Member States must be effective, proportionate and dissuasive. This includes pecuniary penalties with a maximum limit of not less than 5% of the in-scope company’s worldwide net turnover.[24] Additionally, the Directive stipulates that any decision of a Supervisory Authority containing penalties is: (a) published, (b) publicly available for at least five years; and (c) sent to the “European Network of Supervisory Authorities” (“naming and shaming”).[25]

Besides these sanctions, compliance with the CSDDD’s obligations can be used as part of the award criteria for public and concession contracts.

5. Civil Liability of Companies

Member States must establish a civil liability regime for companies which intentionally or negligently fail to comply with the CSDDD’s obligations and where damage has been caused to a person’s legal interest (as protected under national law) as a result of that failure.[26] However, a company cannot be held liable if the damage was caused only by its business partners in its chain of activities.

Member States must provide for “reasonable conditions” under which any alleged injured party may authorize a trade union, non-governmental human rights or environmental organization or other NGO or national human rights institution, to bring actions to enforce the rights of the alleged injured party.[27]

The Directive requires a limitation period for bringing actions for damages of at least five years and, in any case, not shorter than the limitation period laid down under general civil liability regimes of Member States.

Regarding compensation, Member States are required to lay down rules that fully compensate victims for the damage they have suffered as a direct result of the company’s failure to comply with the Directive. However, the Directive states that deterrence through damages (i.e., punitive damages) or any other form of overcompensation should be prohibited.

6. Next Steps / Implementation

The Directive must now be formally adopted by the Council and will subsequently come into force on the 20th day following that of its publication in the Official Journal of the EU, which is expected to occur in the first half of 2024. Once the Directive enters into force, Member States will need to transpose it into national law within two years, i.e., by mid-2026.

Depending on their size, companies will have between three to five years from the Directive entering into force to implement its requirements (i.e., likely until between 2027 and 2029):

three years (i.e., likely in 2027) for (a) EU companies with more than 5,000 employees and EUR 1,500 million net worldwide turnover, and (b) non-EU companies with more than EUR 1,500 million net turnover generated in the EU.
four years (i.e., likely in 2028) for: (a) companies with more than 3,000 employees and EUR 900 million net worldwide turnover and (b) non-EU companies with more than EUR 900 million net turnover generated in the EU; and
five years (i.e., likely in 2029) for companies with more than 1,000 employees and EUR 450 million turnover.

7. Relationship between the CSDDD and other EU Laws Protecting Human Rights and the Environment

The Directive is part of a series of EU regulations which aim to protect human rights and the environment through both reporting and due diligence obligations. Such regulations include the CSRD and the Sustainable Finance Disclosure Regulation, which impose mandatory reporting obligations, as well as the Regulation on Deforestation-free Products, the Conflicts Minerals Regulation, the Batteries Regulation and the Forced Labour Ban Regulation (which, coincidentally, was also approved by the European Parliament on 24 April 2024),[28] which impose due diligence requirements on companies in certain sectors / circumstances.

In this context, the CSDDD will become the “default” EU due diligence regime. The Directive expressly provides that its obligations are without prejudice to other, more specific EU regimes, meaning that if a provision of the CSDDD conflicts with another EU regime providing for more extensive or specific obligations, then the latter will prevail.

8. Practical Considerations for In-Scope Companies

Given the significance of expectations and liabilities in the CSDDD, in-scope companies would be well advised to commence preparation now, notwithstanding the implementation timeframe. Indeed, the types of measures that the CSDDD requires to be implemented will take time to operationalise. Functions and entities across multinationals will need to be engaged in that implementation, and it is prudent to involve key internal stakeholders (including legal and compliance functions) in that process from the outset.

The types of next steps in-scope companies should be considering now include:

First, mapping current and potentially future upstream and downstream business relationships to understand where any human rights and environmental risks exist. Any gaps or concerns should be addressed. Additionally, effective systems should be implemented to continually monitor risks within the chain of activities.

Second, putting in place a risk-based due diligence policy containing a description of the company’s approach, as well as supplier codes of conduct, which describe the rules and principles to be followed throughout the company and its subsidiaries. Codes of conduct should apply to all relevant corporate functions and operations, including procurement, employment and purchasing decisions.

Third, considering whether it is appropriate to involve lawyers in the development of internal due diligence systems in order to seek to apply privilege to relevant communications and documentation. This is particularly important given the: (a) matrix of legal regulation which applies in this space; and (b) envisaged regulatory and civil liability regimes.

Fourth, inserting appropriate contractual language into business partner contracts. The CSDDD requires the Commission, in consultation with Member States and stakeholders, to adopt guidance in this regard. However, the Commission has 30 months from the entry into force of the CSDDD to adopt such guidance.

Fifth, training employees—and being cognisant that training should not be limited just to those persons directly involved with sustainability compliance and reporting. Employees should understand how to spot adverse human rights and environmental impacts and understand the actions to be taken when they do.

Sixth, establishing operational level grievance mechanisms for rights holders, their representatives and civil society organisations. Such mechanisms act not only as a tool to remedy and redress but can be harnessed preventively as an early warning system for the identification and analysis of adverse impacts.

Seventh, meaningfully engaging with stakeholders will require identification of who relevant stakeholders are and require companies to design effective engagement processes.

Last, given the overlapping nature of some of the EU directives and regulations in this space (as well as laws at the Member State level), mapping all relevant obligations to ensure consistent compliance and drive efficiencies where practicable. It is notable that the Directive explicitly states that it does not prevent Member States from imposing further, more stringent obligations on companies—so companies will want to keep this under review.

__________

[1] European Parliament legislative resolution of 24 April 2024 on the proposal for a directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937.

[2] Art. 1(a) of the Directive.

[3] See our previous client alert addressing Mandatory Corporate Human Rights Due Diligence.

[4] See our previous client alert addressing the European Commission’s draft directive on “Corporate Sustainability Due Diligence”.

[5] See for example, France’s “Loi de Vigilance” enacted in 2017, which inserted provisions into the French Commercial Code imposing substantive requirements on companies in relation to human rights and environmental due diligence. Specifically, companies with more than 5,000 employees in France (or 10,000 employees in France or abroad) are required to establish, implement and publish a “vigilance plan” to address risks within their supply chains or which arise from the activities of direct or indirect subsidiaries or subcontractors. Such plans should also include action plans to mitigate those risks and prevent damage, as well as a monitoring system to ensure that the plan is effectively implemented. (See our previous client alert addressing global legislative developments and proposals in the bourgeoning field of mandatory corporate human rights due diligence). Meanwhile in Germany, the Supply Chain Due Diligence Act 2023 (the “SCCDA”) was enacted, imposing due diligence obligations on companies with a statutory seat in Germany and more than 1,000 employees, regardless of revenue. In many instances, the CSDDD and the SCDDA obligations overlap, although there are some differences. For example, whilst the CSDDD extends obligations to the company’s “chain of activities”, the SCDDA focuses primarily on direct suppliers. An in-scope company may also be required to conduct due diligence on its indirect suppliers if the company has substantiated knowledge of grievances or violations of the law. The German legislator is expected to align the obligations under the CSDDD and the SCDDA, as it did in relation to CSRD.

[6] Press Release of the European Parliament, 24 April 2024, “Due diligence: MEPs adopt rules for firms on human rights and environment”.

[7] Turnover of branches of the relevant entity are also to be taken into account when calculating whether a threshold has been reached.

[8] See our previous client alert addressing the CSRD.

[9] See Art. 3(1)(f) of the Directive, which defines “business partner” as “an entity (i) with which the company has a commercial agreement related to the operations, products or services of the company or to which the company provides services pursuant to point (g) (‘direct business partner’), or (ii) which is not a direct business partner but which performs business operations related to the operations, products or services of the company (‘indirect business partner’)”.

[10] See Art. 3(1)(g) of the Directive.

[11] See Art. 5 of the Directive. The company’s risk-based due diligence policy should be developed in consultation with its employees and their representatives and be updated after a significant change or at least every 24 months (Art. 7(3) of the Directive). It shall contain all of the following: (a) a description of the company’s approach, including in the long term, to due diligence; (b) a code of conduct describing rules and principles to be followed throughout the company and its subsidiaries, and the company’s direct or indirect business partners; and (c) a description of the processes put in place to integrate due diligence into the relevant policies and to implement due diligence, including the measures taken to verify compliance with the code of conduct and to extend its application to business partners.

[12] See Art. 3(1)(b) and (c). Adverse environmental impacts are defined as an adverse impact on the environment resulting from the breach of the prohibitions and obligations listed in Part I, Section 1, points 15 and 16 (the prohibition of causing any measurable environmental degradation and the right of individuals, groupings and communities to lands and resources and the right not to be deprived of means of subsistence), and Part II of the Annex to the Directive, which includes, for example, the obligation to avoid or minimise adverse impacts on biological diversity, interpreted in line with the 1992 Convention on Biological Diversity and applicable law in the relevant jurisdiction. Adverse human rights impacts are defined as an adverse impact on one of the human rights listed in Part I, Section 1, of the Annex to the Directive, as those human rights are enshrined in the international instruments listed in Part I, Section 2, of the Annex to the Directive, for example, The Convention on the Rights of the Child and The International Covenant on Civil and Political Rights.

[13] See Art. 3(1)(o) of the Directive.

[14] This is defined in Art. 3(1)(i) of the Directive as “a micro, small or a medium-sized undertaking, irrespective of its legal form, that is not part of a large group…”.

[15] Art. 10(5) of the Directive.

[16] Art. 22 of the Directive.

[17] Art. 12 of the Directive.

[18] Art. 3(1)(t) of the Directive.

[19] Whilst the text of Art. 13(1) of the Directive refers to “effective” engagement with stakeholders, the title of provision refers to “meaningful” engagement, which is also found in the Recitals.

[20] Art. 14 of the Directive.

[21] Ar. 15 of the Directive.

[22] Art. 16 of the Directive.

[23] Art. 24(1) of the Directive. For France and Germany, we expect the “Supervisory Authority” to be the same authority as is currently overseeing compliance with their analogous due diligence regimes.

[24] Art. 27(4) of the Directive.

[25] Art. 27(5) of the Directive.

[26] Art. 29 of the Directive.

[27] Art. 29(3)(d) of the Directive.

[28] See Press Release of the European Parliament on 23 April 2024, “Products made with forced labour to be banned from EU single market”.

The following Gibson Dunn lawyers prepared this update: Selina Sagayam, Susy Bullock, Stephanie Collins, Alexa Romanelli, and Harriet Codd in London; Robert Spano in Paris; and Ferdinand Fromholzer, Markus Rieder, Katharina Humphrey, Julian von Imhoff, Carla Baum, Melina Kronester, Julian Reichert, and Marc Kanzler in Munich.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact the Gibson Dunn lawyer with whom you usually work, any member of Gibson Dunn’s Environmental, Social and Governance (ESG) practice group, or the following authors in London, Paris and Munich:

London:
Selina S. Sagayam – London (+44 20 7071 4263, ssagayam@gibsondunn.com)
Susy Bullock – London (+44 20 7071 4283, sbullock@gibsondunn.com)
Stephanie Collins – London (+44 20 7071 4216, scollins@gibsondunn.com)
Alexa Romanelli – London (+44 20 7071 4269, aromanelli@gibsondunn.com)
Harriet Codd (+44 20 7071 4057, hcodd@gibsondunn.com)

Paris:
Robert Spano – Paris/London (+33 1 56 43 14 07, rspano@gibsondunn.com)

Munich:
Ferdinand Fromholzer (+49 89 189 33-270, ffromholzer@gibsondunn.com)
Markus Rieder (+49 89 189 33-260, mrieder@gibsondunn.com)
Katharina Humphrey (+49 89 189 33-217, khumphrey@gibsondunn.com)
Julian von Imhoff (+49 89 189 33-264, jvonimhoff@gibsondunn.com)
Carla Baum (+49 89 189 33-263, cbaum@gibsondunn.com)
Melina Kronester (+49 89 189 33-225, mkronester@gibsondunn.com)
Julian Reichert (+49 89 189 33-229, jreichert@gibsondunn.com)
Marc Kanzler (+49 89 189 33-269, mkanzler@gibsondunn.com)

The Final Regulations modify the “look-through” rule for certain domestic C corporations, and introduce a new ten-year transition rule.

On April 24, 2024, the IRS and Treasury issued final regulations for determining whether a real estate investment trust (a “REIT”)[1] qualifies as a “domestically controlled qualified investment entity” (a “DREIT,” and the final regulations, the “Final DREIT Regulations”). These regulations modify certain provisions of the regulations proposed by the IRS and Treasury in December 2022 (the “Proposed DREIT Regulations”), detailed in our previous Client Alert.

Compared with the Proposed DREIT Regulations, the Final DREIT Regulations:

(1) increase the threshold of foreign ownership required to look through a domestic C corporation that owns a REIT from 25 percent or more to more than 50 percent for purposes of determining whether the REIT qualifies as a DREIT (the “C Corporation Look-Through Rule”);

(2) provide a ten-year transition rule for application of the C Corporation Look-Through Rule to existing REITs, subject to certain restrictions; and

(3) clarify or modify certain rules relating to publicly traded entities, qualified foreign pension funds (“QFPFs”), and withholding taxes.

Background

Subject to certain exceptions discussed below, section 897[2] and related sections added to the Code by the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) require foreign persons that recognize gain from the sale or disposition of a United States real property interest (a “USRPI”) to file U.S. federal income tax returns reporting that gain and pay U.S. federal income tax on that gain at regular graduated rates, even if the gain is not otherwise effectively connected with the conduct of a U.S. trade or business.

The definition of a USRPI is broad. In addition to including a wide array of interests in U.S. real estate (which itself is a very broad term) and interests in disregarded entities and certain partnerships that own U.S. real estate, USRPIs include equity interests in domestic corporations that are United States real property holding corporations (“USRPHCs”). Generally, a USRPHC is any corporation, including a REIT, if the value of its USRPIs represents at least 50 percent of the aggregate value of its real estate (both U.S. and non-U.S.) and business assets.

Even though equity interests in domestic USRPHCs generally are treated as USRPIs, section 897(h)(2) provides that an interest in a DREIT is not a USRPI. Under section 897(h)(4), a REIT is a DREIT if less than 50 percent of the value of its stock is held “directly or indirectly” by “foreign persons” at all times during the shorter of (1) the 5-year period ending on the relevant determination date and (2) the period during which the REIT was in existence (the “Testing Period”). Importantly, gain recognized by a foreign person on the disposition of an interest in a DREIT is not subject to U.S. federal income tax under FIRPTA, even if the DREIT is a USRPHC. Foreign persons often seek to invest in U.S. real estate through DREITs because, in these structures, foreign persons can exit the investment via a sale of DREIT stock without being subject to U.S. tax on the gain or being required to file a U.S. tax return.

Proposed Regulations

Before the promulgation of the Proposed DREIT Regulations, there was relatively little guidance regarding when the stock of a REIT owned by one person was treated as held “indirectly” by another person for purposes of determining DREIT status.[3] The Proposed DREIT Regulations included a broad look-through rule for this purpose that applied to various types of passthrough and quasi-passthrough entities, including REITs, partnerships (other than publicly traded partnerships), S corporations, and RICs (the “Proposed Look-Through Rule”).[4] The Proposed Look-Through Rule would have been implemented by imputing ownership of REIT stock to the owners of such entities pro rata based on the owners’ proportionate interests in such entities.[5]

Diverging from informal IRS guidance that treated domestic C corporations as non-foreign owners of REITs for purposes of determining DREIT status, the Proposed Look-Through Rule also would have applied to “foreign-owned domestic corporations.”[6] Specifically, a “foreign-owned domestic corporation” was defined as any non-publicly traded domestic C corporation if foreign persons held directly or indirectly 25 percent or more of the value of its outstanding stock, applying certain look-through rules.[7] Thus, a “foreign-owned domestic corporation” would not have been treated as a domestic owner of a REIT; rather, ownership of the REIT’s stock would have been imputed to the owners of the “foreign-owned domestic corporation” to determine if the REIT qualified as a DREIT.

Final Regulations

The Final DREIT Regulations generally maintain the provisions of the Proposed Look-Through Rule, with certain changes described below.

Increased Ownership Threshold for Foreign-Controlled Domestic C Corporations

The IRS and Treasury narrowed the scope of the C Corporation Look-Through Rule. Specifically, the IRS and Treasury increased the threshold of foreign ownership required to qualify as a foreign-controlled domestic C Corporation from 25 percent or more to more than 50 percent.[8]

Ten-Year Transition Rule for Existing REITs

Generally, the C Corporation Look-Through Rule and other provisions of the Final DREIT Regulations apply to transactions (e.g., sales of REIT shares) occurring on or after April 25, 2024.[9] Importantly, however, the C Corporation Look-Through Rule does not apply to existing REITs until April 24, 2034, provided certain requirements are satisfied, as discussed below (the “Transition Rule”).[10]

Under the Transition Rule, the C Corporation Look-Through Rule does not apply until April 24, 2034 to a REIT in existence as of April 24, 2024, provided:

(1) the REIT qualifies at all times on and after April 24, 2024 as “domestically controlled”, taking into account all provisions of the Final DREIT Regulations other than the C Corporation Look-Through Rule;

(2) the REIT does not directly or indirectly acquire, on and after April 24, 2024, USRPIs with an aggregate fair market value exceeding 20 percent of the aggregate fair market value of the USRPIs it holds directly or indirectly as of April 24, 2024; and

(3) the percentage of the REIT’s stock held directly or indirectly by one or more “non-look-through persons” does not increase by more than 50 percentage points over the percentage of the REIT’s stock held directly or indirectly by such non-look-through persons as of April 24, 2024.[11]

For purposes of the second requirement, the fair market value of a REIT’s USRPIs as of April 24, 2024 is the value the REIT used for purposes of its REIT asset testing as of March 31, 2024.[12] The fair market value of any USRPI acquired after March 31, 2024 must be determined as of the date the USRPI is acquired “using a reasonable method,” as long as the REIT “consistently” uses the same method with respect to all of its USRPIs for purposes of the Transition Rule.[13]

If a REIT violates any of these requirements, the C Corporation Look-Through Rule will begin to apply to that REIT on the day after the REIT first violates the requirement.[14] Therefore, a REIT that becomes ineligible for the Transition Rule can still apply the Transition Rule to the portion of its Testing Period ending on the day the REIT violates the Transition Rule requirement.

Other Rules

In addition to the rules described above, the Final DREIT Regulations clarify or modify the following rules:

Consistent with the Proposed DREIT Regulations, a QFPF and a “qualified controlled entity” is a foreign person for purposes of determining whether a REIT is domestically controlled.[15]
In a departure from the Proposed DREIT Regulations, subject to the limitation described below, a publicly traded RIC generally is treated as a non-look-through person.[16] This aligns the treatment of publicly traded RICs with the treatment of publicly traded C corporations and publicly traded partnerships.
Under a newly introduced rule, a publicly traded domestic C corporation, publicly traded RIC, or publicly traded partnership will be treated as a look-through person if the REIT being tested for DREIT status has actual knowledge that the public domestic C corporation, publicly traded RIC, or publicly traded partnership is foreign controlled.[17]
A publicly traded REIT is permitted to treat as a U.S. person that is a non-look through person any person holding less than 5 percent of the REIT’s U.S. publicly traded stock (“5 Percent Person”), unless the REIT has actual knowledge that the 5 Percent Person is a non-U.S. Person or is foreign controlled (treating the 5 Percent Person as a non-public domestic C corporation for this purpose).[18]
To avoid section 1445 withholding on the transfer, a transferee of an interest in a DREIT can rely on a statement issued by the DREIT certifying that the interest is not a USRPI.

The IRS and Treasury declined to provide guidance in the Final DREIT Regulations on how a domestic C corporation certifies to a REIT whether it is foreign controlled, or any other guidance on procedures for determining whether a REIT will qualify as a DREIT, including what records a REIT must maintain in this regard.

Takeaways

Sponsors of, and investors in, existing and new REITs intended to qualify as DREITs should consider evaluating whether those REITs qualify as DREITs under the Final DREIT Regulations.

Sponsors also should review the information, representations, and covenants that they request from investors in determining whether a REIT will qualify as a DREIT and should consider what records to maintain with respect to their determination of DREIT status. Further, REIT sponsors should consider any obligations they may have to cause a REIT to qualify as a DREIT.

Sponsors of and investors in existing REITs that seek to rely on the Transition Rule to continue to be classified as DREITs should consider limiting acquisitions of new USRPIs by, and changes of ownership in, these REITs so as not to cause the Transition Rule to cease to apply before April 24, 2034. In particular, sponsors and investors should be aware that seemingly innocuous changes in the indirect ownership of a REIT (e.g., restructurings that do not change the ultimate beneficial ownership of the REIT) could inadvertently cause the Transition Rule to cease to apply to the REIT.

__________

[1] The rules also apply to certain registered investment companies (“RICs”). In our discussion, however, we focus on REITs and DREITs because foreign persons are more likely to invest in U.S. real estate through REITs than through RICs.

[2] Unless indicated otherwise, all “section” references are to the Internal Revenue Code of 1986, as amended (the “Code”), and all “Treas. Reg. §” references are to the Treasury regulations promulgated under the Code.

[3] See our previous Client Alert for a discussion of the available guidance before the promulgation of the Proposed DREIT Regulations.

[4] Prop. Treas. Reg. § 1.897-1(c)(3)(ii)(B).

[5] Id.

[6] Id. See our previous Client Alert for more details.

[7] Prop. Treas. Reg. § 1.897-1(c)(3)(v)(B).

[8] Although the Proposed DREIT Regulations refer to these entities as “foreign-owned domestic corporations,” the Final DREIT Regulations refer to these entities as “foreign-controlled domestic corporations.” 89 F.R. 31621; Treas. Reg. § 1.897-1(c)(3)(v)(B).

[9] Treas. Reg. § 1.897-1(a)(2).

[10] Treas. Reg. § 1.897-1(c)(3)(vi).

[11] Treas. Reg. § 1.897-1(c)(3)(vi)(A). There is an exception for acquisitions of USRPIs or interests in the REIT pursuant to a written agreement that was binding before April 24, 2024. Treas. Reg. § 1.897-1(c)(3)(vi)(E).

[12] Treas. Reg. § 1.897-1(c)(3)(vi)(B)(1), (C).

[13] Treas. Reg. § 1.897-1(c)(3)(vi)(D).

[14] Id.

[15] See our previous Client Alert for further discussion of QFPFs and qualified controlled entities.

[16] For purposes of the Final DREIT Regulations, the term “public RIC” (that is, a publicly traded RIC) excludes a RIC that is also a “qualified investment entity.” Treas. Reg. § 1.897-1(c)(3)(v)(I); I.R.C. § 897(h)(4)(A).

[17] To test whether a RIC is foreign controlled, the Final DREIT Regulations treat the RIC as a non-public domestic C corporation. Treas. Reg. § 1.897-1(c)(3)(v)(I).

[18] Treas. Reg. § 1.897-1(c)(3)(iii)(A). Under the Proposed DREIT Regulations, 5 Percent Persons were considered non-look-through U.S. persons unless the REIT had actual knowledge that the 5 Percent Person was not a U.S. person.

The following Gibson Dunn lawyers prepared this update: Evan M. Gusler, Kathryn A. Kelly, Brian W. Kniesly, Alex Marcellesi, Austin T. Morris, Ray Noonan, Lorna Wilson, and Daniel A. Zygielbaum.

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 of the following leaders and members of the firm’s Tax and Global Tax Controversy and Litigation practice groups:

Tax:
Dora Arash – Los Angeles (+1 213.229.7134, darash@gibsondunn.com)
Sandy Bhogal – Co-Chair, London (+44 20 7071 4266, sbhogal@gibsondunn.com)
Michael Q. Cannon – Dallas (+1 214.698.3232, mcannon@gibsondunn.com)
Jérôme Delaurière – Paris (+33 (0) 1 56 43 13 00, jdelauriere@gibsondunn.com)
Michael J. Desmond – Los Angeles/Washington, D.C. (+1 213.229.7531, mdesmond@gibsondunn.com)
Anne Devereaux* – Los Angeles (+1 213.229.7616, adevereaux@gibsondunn.com)
Matt Donnelly – Washington, D.C. (+1 202.887.3567, mjdonnelly@gibsondunn.com)
Pamela Lawrence Endreny – New York (+1 212.351.2474, pendreny@gibsondunn.com)
Benjamin Fryer – London (+44 20 7071 4232, bfryer@gibsondunn.com)
Evan M. Gusler – New York (+1 212.351.2445, egusler@gibsondunn.com)
Kathryn A. Kelly – New York (+1 212.351.3876, kkelly@gibsondunn.com)
Brian W. Kniesly – New York (+1 212.351.2379, bkniesly@gibsondunn.com)
Loren Lembo – New York (+1 212.351.3986, llembo@gibsondunn.com)
Jennifer Sabin – New York (+1 212.351.5208, jsabin@gibsondunn.com)
Eric B. Sloan – Co-Chair, New York/Washington, D.C. (+1 212.351.2340, esloan@gibsondunn.com)
Edward S. Wei – New York (+1 212.351.3925, ewei@gibsondunn.com)
Lorna Wilson – Los Angeles (+1 213.229.7547, lwilson@gibsondunn.com)
Daniel A. Zygielbaum – Washington, D.C. (+1 202.887.3768, dzygielbaum@gibsondunn.com)

Global Tax Controversy and Litigation:
Michael J. Desmond – Co-Chair, Los Angeles/Washington, D.C. (+1 213.229.7531, mdesmond@gibsondunn.com)
Saul Mezei – Washington, D.C. (+1 202.955.8693, smezei@gibsondunn.com)
Sanford W. Stark – Co-Chair, Washington, D.C. (+1 202.887.3650, sstark@gibsondunn.com)
C. Terrell Ussing – Washington, D.C. (+1 202.887.3612, tussing@gibsondunn.com)

*Anne Devereaux, of counsel in the firm’s Los Angeles office, is admitted to practice in Washington, D.C.

From the Derivatives Practice Group: This week, the CFTC approved final rules to amend its Swap Execution Facility regulations, and extended the deadline for public comment period on a proposed rule that makes certain modifications to rules for Swap Execution Facilities and Designated Contract Markets in Part 37 and 38.

New Developments

“AI Day” To Be Held at May 2 CFTC Technology Advisory Committee Meeting. On April 24, Commissioner Christy Goldsmith Romero, sponsor of the Technology Advisory Committee (TAC), announced “AI Day” is to be held at the CFTC’s Washington, D.C. headquarters on May 2, 2024, during a TAC meeting. AI Day will take place from 1:00 p.m. to 4:00 p.m. (EDT). AI Day is a continuation of the TAC’s study of AI, and the concept of Responsible AI in financial markets. The TAC Subcommittee on Emerging and Evolving Technologies will present on the work and findings of the Subcommittee in its study of AI for financial markets. [NEW]
CFTC Approves Final Rules on Swap Confirmation Requirements for SEFs. On April 23, the CFTC approved final rules to amend its swap execution facility (SEF) regulations related to uncleared swap confirmations to address issues which have been addressed in CFTC staff no-action letters, including the most recent CFTC No Action Letter No. 17-17, as well as associated conforming and technical changes. In particular, the final rules amend CFTC Regulation 37.6(b) to enable SEFs to incorporate terms of underlying, previously negotiated agreements between the counterparties by reference in an uncleared swap confirmation without being required to obtain such underlying, previously negotiated agreements. Further, the final rules amend CFTC Regulation 37.6(b) to require such confirmation to take place “as soon as technologically practicable” after the execution of the swap transaction on the SEF for both cleared and uncleared swap transactions. The final rules also amend CFTC Regulation 37.6(b) to make clear the SEF-provided confirmation under CFTC Regulation 37.6(b) shall legally supersede any conflicting terms in a previous agreement, rather than the entire agreement. The final rules make conforming amendments to CFTC Regulation 23.501(a)(4)(i) to correspond with the amendments to CFTC Regulation 37.6(b). Finally, the final rules make certain non-substantive amendments to CFTC Regulation 37.6(a)-(b) to enhance clarity. [NEW]
CFTC to Hold a Commission Open Meeting April 29. On April 22, Chairman Rostin Behnam announced the Commission will hold an open meeting on Monday, April 29 at 9:30 a.m. (EDT) at the CFTC’s Washington, D.C. headquarters. The Commission will consider Final Rule “Capital and Financial Reporting Requirements for Swap Dealers and Major Swap Participants” and Final Rule “Adopting Amendments to the Large Trader Reporting Rules for Futures and Options.” [NEW]
CFTC Extends Public Comment Period for Proposed Rule for Designated Contract Markets and Swap Execution Facilities Regarding Governance and Conflicts of Interest. On April 22, the CFTC announced it is extending the deadline for public comment period on a proposed rule that makes certain modifications to rules for Swap Execution Facilities and Designated Contract Markets in Part 37 and 38 that would establish governance requirements regarding market regulation functions, as well as related conflicts of interest standards. The deadline is being extended to May 13, 2024. [NEW]
Chairman Behnam Announces CFTC’s First DEIA Strategic Plan. On April 18, CFTC Chairman Rostin Behnam announced the agency’s first Strategic Plan to Advance Diversity, Equity, Inclusion, and Accessibility (DEIA Plan). Chairman Behnam said that the two-year DEIA Plan represents a critical step forward in aligning the CFTC with a collective DEIA vision that not only provides genuine support for team members, but also ensures the CFTC is a source of future leaders. The CFTC designed the DEIA Plan to align with its 2022-2026 Strategic Plan and to focus on the following six goals: Inclusive Workplaces, Partnerships and Recruitment, Paid Internships, Professional Development and Advancement, Data, and Equity in Procurement and Customer Education and Outreach. Each goal includes objectives and strategies/actions to achieve the goal, and identifies the agency division(s)/office(s) that will lead and contribute to the implementation of the goal. The CFTC said that an internal DEIA Executive Council will support and guide the implementation of the DEIA Plan.
CFTC Appoints Christopher Skinner as Inspector General. On April 10, the Commodity Futures Trading Commission announced that Christopher L. Skinner has been appointed CFTC’s Inspector General (IG). The CFTC stated that Mr. Skinner brings 15 years of IG experience, including leading and managing Offices of Inspector’s General (OIG), and conducting investigations, inspections, and audits. Mr. Skinner comes to the CFTC from the Federal Election Commission (FEC) where he served as IG since 2019.

New Developments Outside the U.S.

Telbor Committee to Permanently Cease Publication of Telbor. On April 16, the Telbor Committee of the Bank of Israel decided that the publication of all tenor of Telbor will permanently cease following a final publication on June 30, 2025. The announcement constitutes an “Index Cessation Event” under the 2021 ISDA Interest Rate Derivatives Definitions and the November 2022 Benchmark Module of the ISDA 2021 Fallbacks Protocol. In February 2022, the Telbor Committee decided that the SHIR (Shekel overnight Interest Rate) rate would eventually replace the Telbor interest rate in shekel interest rate derivative transactions. The Bank of Israel said that the decision to switch to the SHIR rate is in accordance with the decisions reached in major economies worldwide, according to which IBOR type interest rates will be replaced by risk-free overnight interest rates. ISDA published cessation guidance for parties affected by the announcement.
New Report Sheds Light on Quality and Use of Regulatory Data Across EU. On April 11, ESMA published the fourth edition of its Report on the Quality and Use of Data aiming to provide transparency on how the data collected under different regulations is used systematically by authorities in the EU, and clarifying the actions taken to ensure data quality. The report provides details on how National Competent Authorities, the European Central Bank, the European Systemic Risk Board and ESMA use the data that is collected through the year from different legislation requirements, including datasets from European Market Infrastructure Regulation, Securities Financing Transactions Regulation, Markets in Financial Instruments Directive, Securitization Regulation, Alternative Investment Fund Managers Directive and Money Market Funds Regulation.

New Industry-Led Developments

ISDA and SIFMA Submit Addendum to Proposed FFIEC Reporting Revisions. On April 23, ISDA and the Securities Industry and Financial Markets Association (SIFMA) submitted an addendum to the joint response to the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency on the proposed reporting revisions of the call report, FFIEC 101 and FFIEC 102, which are designed to reflect the implementation of the Basel III endgame proposal. The addendum contains additional findings in the FFIEC 102 report, including end-of-week Fundamental Review of the Trading Book standardized approach average calculations and reported market risk risk-weighted assets in sub-parts D and E. [NEW]
ISDA Launches Outreach Initiative on Proposed Notices Hub. On April 25 ISDA announced a major industry outreach initiative to establish support among dealers and buy-side firms for a new online platform that would allow the instantaneous delivery and receipt of critical termination-related notices, reducing the risk exposure and potential losses from a delay. Under the ISDA Master Agreement, termination-related notices must be delivered by certain prescribed methods, using company address details listed in the agreement. However, delays can occur if a company has moved and the documentation hasn’t been updated with the new details or if delivery to a physical location is not possible due to geopolitical shocks. The proposed ISDA Notices Hub would act as a secure central platform for firms to deliver notices, with automatic alerts sent to the receiving entity. Multiple designated people at each firm would be able to access the hub from anywhere in the world, regardless of the situation at its physical location. The platform would also allow market participants to update their physical address details via a single entry, providing a golden source of those details. [NEW]
Four Directors Join ISDA Board. On April 18, ISDA announced that four directors have joined its Board, three directors were re-appointed, and 10 others have been re-elected at ISDA’s Annual General Meeting in Tokyo. The new directors are: Erik Tim Mueller, Chief Executive Officer, Eurex Clearing AG; Jared Noering, Managing Director, Head of Fixed Income Trading, NatWest Markets; Brad Tully, Managing Director and Global Head of Corporate Derivatives and Private Side Sales for J.P. Morgan; and Jan Mark van Mill, Managing Director of Multi Asset, APG Asset Management.
ISDA Future Leaders in Derivatives Publishes Generative Artificial Intelligence Whitepaper. On April 17, ISDA published a whitepaper from ISDA Future Leaders in Derivatives (IFLD), its professional development program for emerging leaders in the derivatives market. The whitepaper, GenAI in the Derivatives Market: a Future Perspective, was developed by the third cohort of IFLD participants, who began working together in October 2023. According to ISDA, the 38 individuals in the group represent buy- and sell-side institutions, law firms, and service providers from around the world. After being selected for the IFLD program, they were asked to engage with stakeholders, develop positions, and produce a whitepaper on the potential use of generative artificial intelligence (genAI) in the over-the-counter derivatives market. The participants were also given access to ISDA’s training materials, resources, and staff expertise to support the project and their own professional development. ISDA said that, drawing on industry expertise and academic research, the whitepaper identifies a range of potential use cases for genAI in the derivatives market, including document creation, market insight, and risk profiling. ISDA also indicated that it explores regulatory issues in key jurisdictions and addresses the challenges and risks associated with the use of genAI. The paper concludes with a set of recommendations for stakeholders, including investing in talent development, fostering collaboration and knowledge sharing with technology providers, prioritizing ethical AI principles and engaging with policymakers to promote an appropriate regulatory framework.
ISDA Publishes Research Paper on Interest Rate Derivatives, Benchmark Rates and Development Financial Markets in EMDEs. On April 17, ISDA published a research paper in which it outlines the role of interest rate derivatives (IRDs) in supporting the development of financial markets in emerging markets and developing economies (EMDEs). It also examines the significance of reliable, robust interest rate (IR) benchmarks. ISDA indicated that the paper draws valuable lessons from the transition from LIBOR to overnight risk-free rates in advanced economies and applies those insights to the context of EMDEs. Through case studies, ISDA attempts to show how various EMDE jurisdictions have successfully adopted and implemented more robust and transparent IR benchmarks.
ISDA Extends Digital Regulatory Reporting Initiative to New Jurisdictions. On April 17, ISDA announced that it is extending its Digital Regulatory Reporting (DRR) initiative to several additional jurisdictions in an effort to enable firms to implement changes to regulatory reporting requirements. The DRR is being extended to cover rule amendments being implemented under the UK European Market Infrastructure Regulation and by the Australian Securities and Investments Commission and the Monetary Authority of Singapore. Those rule changes are due to be implemented in the UK on September 30, 2024, and October 21, 2024 in Australia and Singapore. The DRR code for all three sets of rules is currently available for market participants to review and test. ISDA said that the DRR will be further extended to cover rule changes in Canada and Hong Kong, both due in 2025, and the DRR for the CFTC rules will also be updated to include further anticipated updates, currently under consultation at the commission. Firms can either use the DRR as the basis for implementation or to validate an independent interpretation of the rules.
ISDA Publishes Margin Survey. On April 16, ISDA published its latest margin survey, which shows that $1.4 trillion of initial margin (IM) and variation margin (VM) was collected by 32 leading derivatives market participants for their non-cleared derivatives exposures at the end of 2023, unchanged from the previous year. The survey also reports the amount of IM posted by all market participants to major central counterparties.
ISDA Establishes Suggested Operational Practices for EMIR Refit. On April 16, through a series of discussions held within the ISDA Data and Reporting EMEA Working Group, market participants established and agreed to Suggested Operational Practices (SOP) for over-the-counter derivative reporting in preparation for the commencement of the EMIR Refit regulatory reporting rules on April 29. ISDA said that the SOP matrix was established based on the EMIR Refit validation table, (as published by ESMA), which contains the Regulatory Technical Standards (RTS), the Implementation Technical Standards (ITS) and validation rules. Additional tabs have been added to supplement to SOPs, including product-level SOPs for several of the underlier fields, and listing names of floating rate options. There are also tabs to reflect updates made to the matrix (‘Updates’) and a tab to track questions raised by the ISDA Data and Reporting EMEA Working Group (‘WG Questions’). ISDA indicated that the document will continue to be reviewed and updated as and when required. While the intention of these SOPs is to provide an agreed and standardized market guide for firms to utilize, no firm is legally bound or compelled in any way to follow any determinations made within these EMIR SOPs.
ISDA and IIF Respond to BCBS-CPMI-IOSCO Consultation on Margin Transparency. On April 12, ISDA and the Institute of International Finance (IIF) submitted a response to the Basel Committee on Banking Supervision (BCBS), Committee on Payments and Market Infrastructures (CPMI) and International Organization of Securities Commissions (IOSCO) consultation on transparency and responsiveness of initial margin in centrally cleared markets. In their response, the associations expressed support for enhancing transparency on cleared margin for all market participants, which they expect will help with liquidity preparedness and increase resilience of the system, noting it should start with central counterparties (CCPs) making fundamental disclosures about their margin models. In this regard, both associations highlight their support in the response to recommendations one through eight. Regarding recommendation nine, the associations indicated that they are supportive of clients having necessary transparency on clearing member (CM) margin requirements. Regarding recommendation 10, the associations said in the response that they are generally supportive of the principle that CCPs should have visibility into the risk profile of their clearing participants but warned that, in their opinion, the information required under recommendation 10 may raise legal, confidentiality, or competition concerns. Finally, the associations noted that they believe further work should be done on the fundamentals of CCP margin models, for example on the appropriateness of margin periods of risk and the calibration of anti-procyclicality tools, to ensure that margins do not fall too low during low volatility periods.
IOSCO Publishes Updated Workplan. On April 12, IOSCO published its updated 2024 Workplan, which directly supports its overall two-year Work Program published on April 5, 2023. The 2024 Workplan announced new workstreams, reflecting increased focus on AI, tokenization and credit default swaps, and additional work on transition plans and green finance. The 2024 Workplan set out priorities under five themes: Protecting Investors, Address New Risks in Sustainability and Fintech, Strengthening Financial Resilience, Supporting Market Effectiveness and Promoting Regulatory Cooperation and Effectiveness
ISDA, AIMA, GFXD Publish Paper on Transition to UPI. On April 9, ISDA, the Alternative Investment Management Association (AIMA) and the Global Foreign Exchange Division (GFXD) of the Global Financial Markets Association published a paper on the transition to unique product identifiers (UPI) as the basis for over-the-counter (OTC) derivatives identification across the Markets in Financial Instruments Regulation (MIFIR) regimes. The paper has been sent to the European Commission, which is working on legislation to address appropriate identification of OTC derivatives under MiFIR.
ISDA Submits Addendum to US Basel III NPR Comment Letter. On April 8, ISDA submitted an addendum to the joint US Basel III ‘endgame’ notice of proposed rulemaking response along with the Securities Industry and Financial Markets Association. The addendum contains a more developed proposal for the index bucketing approach for equity investment in funds and an update to the Fundamental Review of the Trading Book Standardized Approach Quantitative Impact Study numbers.

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

Jeffrey L. Steiner, Washington, D.C. (202.887.3632, jsteiner@gibsondunn.com)

Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com)

Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)

Darius Mehraban, New York (212.351.2428, dmehraban@gibsondunn.com)

Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)

Adam Lapidus – New York (+1 212.351.3869, alapidus@gibsondunn.com)

Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)

Roscoe Jones Jr., Washington, D.C. (202.887.3530, rjones@gibsondunn.com)

William R. Hallatt, Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)

David P. Burns, Washington, D.C. (202.887.3786, dburns@gibsondunn.com)

Marc Aaron Takagaki, New York (212.351.4028, mtakagaki@gibsondunn.com)

Hayden K. McGovern, Dallas (214.698.3142, hmcgovern@gibsondunn.com)

Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)

In a sweeping victory for speech rights against overreach by state officials, Gibson Dunn and Elias Law Group convinced a D.C. federal court to enjoin an investigation by Texas Attorney General Ken Paxton into Media Matters, a non-profit research and information center that reports on misinformation and political extremism in the U.S. media. On November 16, 2023, Media Matters published a post reporting that ads for Apple, Bravo, IBM, Oracle, and Xfinity were showing up next to antisemitic content on X (formerly Twitter). In response, X’s owner Elon Musk posted that he would bring a “thermonuclear lawsuit” against Media Matters, filing suit on November 30, 2023 in the Northern District of Texas—despite Media Matters being located in Washington, D.C.

Virtually simultaneously, Texas AG Paxton opened an investigation of Media Matters for potential fraudulent activity in violation of Texas’s Deceptive Trade Practices Act (DTPA). Invoking the DTPA’s authority, Paxton served a broad and intrusive Civil Investigative Demand (CID) upon Media Matters, seeking a broad array of records relating to Media Matters’s reporting, funding, and reporter and editorial communications—despite Media Matters’s lack of any relevant connection to Texas. Gibson Dunn and Elias Law Group sought a preliminary injunction in the D.C. federal court, arguing that Paxton lacked jurisdiction to issue and enforce the CID, that the CID was a retaliatory action for speech in violation of the First Amendment, and that the overbroad document requests violated D.C. and Maryland reporters’ shield laws. Enforcement of the CID had chilled and would further chill Media Matters’s core First Amendment-protected speech, the motion argued, and was a direct assault on its newsgathering function.

The United States District Court for D.C. ruled in favor of Media Matters, issuing a preliminary injunction enjoining Paxton and his office from enforcing the CID. The court ruled that it had personal jurisdiction over Paxton under D.C.’s long-arm statute, that Media Matters had suffered cognizable First Amendment injury, that D.C. was the right venue, and that plaintiffs have proven a likelihood of success on the merits, noting that the threat of administrative intrusion into the newsgathering process would likely deter protected speech and undermine newsgathering and reporting in violation of the First Amendment. The victory sets valuable precedent for journalistic outfits and other entities targeted by overreaching out-of-state AGs, allowing them to fight back without having to submit to the jurisdiction of the AG’s home state.

The Gibson Dunn team includes partners Ted Boutrous (Los Angeles), Amer S. Ahmed (New York), Anne Champion (New York), and Jay Srinivasan (Los Angeles), as well as New York associates Iason Togias and Apratim Vidyarthi.

In this recorded webcast, seasoned practitioners from Gibson Dunn’s Corporate and Antitrust practices discuss best practices and the latest developments in joint venture formation and operation, including:

1. Hot-button operating agreement provisions
2. Navigating transfer and exit considerations
3. Designing antitrust-compliant contractual provisions
4. Analysis and ramifications from recent antitrust enforcement actions

PANELISTS:

Robert B. Little is a partner in Gibson, Dunn & Crutcher’s Dallas office, and he is a Global Co-Chair of the Mergers and Acquisitions Practice Group. Mr. Little has consistently been named among the nation’s top M&A lawyers every year since 2013 by Chambers USA. His practice focuses on corporate transactions, including mergers and acquisitions, securities offerings, joint ventures, investments in public and private entities, and commercial transactions. Mr. Little has represented clients in a variety of industries, including energy, retail, technology, infrastructure, transportation, manufacturing and financial services.

Christopher M. Wilson is a partner in Gibson, Dunn & Crutcher’s Washington, D.C. office and a member of the firm’s Antitrust and Competition Practice Group. Mr. Wilson assists clients in navigating DOJ, FTC, and international competition authority investigations as well as private party litigation involving complex antitrust and consumer protection issues, including matters implicating the Sherman Act, the Clayton Act, the FTC Act, the Hart-Scott-Rodino (HSR) merger review process, as well as international and state competition statutes. His experience crosses multiple industries and his particular areas of focus include merger enforcement, interlocking directorates, joint ventures, compliance programs, and employee “no-poach” agreements.

Taylor Hathaway-Zepeda is a partner in the Los Angeles office of Gibson, Dunn & Crutcher. Her practice focuses on mergers, acquisitions, divestitures, joint ventures, equity investments, restructuring transactions and general corporate governance. She works with companies in a broad array of industries, and has extensive experience working with media, entertainment and technology companies and private equity sponsors. Ms. Hathaway-Zepeda currently serves on the Board of Directors of the California Chamber of Commerce and the Board of Directors of the Los Angeles Area Chamber of Commerce, where she is also Chair of the Governance Committee.

MCLE CREDIT INFORMATION:

Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact CLE@gibsondunn.com to request the MCLE form.

Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.0 hour.

California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.

On April 20, 2024, New York lawmakers approved the State’s 2024-2025 budget. As a part of the budgetary vote, lawmakers passed three notable amendments to New York Labor Law of which employers should be aware.

PAID PRENATAL LEAVE: In a first-of-its-kind law in the country, lawmakers amended the New York Labor Law’s sick leave provisions to require all employers (regardless of size) to provide employees twenty (20) hours of paid prenatal leave per year. Employees may use this leave to obtain healthcare services during or related to pregnancy – for example, for physical examinations, medical procedures, monitoring and testing, and discussions with a health care provider concerning their pregnancy.

This leave bank must be separate from other leave accruals, including the forty (40) or fifty-six (56)[1] hours of sick leave that New York employers are currently required to provide employees for their own illness or need for medical care (including mental illness), the care or treatment of certain covered family members, and for certain safety concerns (such as domestic violence).

The law prohibits employers from discriminating or retaliating against employees because they requested or utilized prenatal leave and requires employees who use prenatal leave to be restored to the same position they held prior to such leave. The amendment does not address, for example, whether and under what circumstances employers may require advance notice or documentation regarding the use of prenatal leave, though the labor commissioner has the authority to adopt regulations and issue guidance to address these and other questions. The requirements to provide prenatal leave become effective on January 1, 2025.

PAID NURSING BREAKS: The New York Labor Law was also amended to require all employers (regardless of size) to provide paid nursing breaks. This marks a notable change from the current law, which only requires reasonable unpaid breaks for expressing breast milk. Under the new law, which is effective June 19, 2024, employers must provide thirty (30) minute paid breaks each time an employee has a reasonable need to express breast milk for up to three (3) years following childbirth. The law also requires employers to permit employees to use other existing paid break and mealtime (e.g., under wage and hour laws) to express breast milk when breaks longer than thirty (30) minutes are needed.

The statute does not address how often employees may take paid nursing breaks. However, the state interpreted the prior iteration of the statute to allow employees to take unpaid breaks at least once every three hours, with accommodations made for employees that need more frequent breaks. The state might take a similar approach with the new iteration of the law requiring paid breaks.

COVID-19 SICK LEAVE: Finally, New York’s COVID-19 leave law will be deemed repealed as of July 31, 2025. The State’s COVID-19 leave law presently requires employers to provide employees up to fourteen (14) days of paid leave, separate from other leave accruals, when they are subject to a mandatory or precautionary order of quarantine or isolation due to COVID-19. Although employees with COVID-19 may still qualify for leave under the State’s sick leave law after July 31, 2025, New York employers will no longer be required to provide a separate COVID-19 leave bank after that date.

New York employers should review and revise their existing leave and break policies to ensure compliance with these new requirements by the effective dates.

__________

[1] The State’s sick leave law currently requires: (i) employers with one hundred (100) or more employees to provide fifty-six (56) hours of paid sick leave per year; (ii) employers with between five (5) and ninety-nine (99) employees to provide forty (40) hours of paid sick leave per year; and (iii) employers with less than five (5) employees to provide forty (40) hours of unpaid sick leave per year, unless the employer has a net income of greater than $1 million per year, in which case, such sick leave must be paid.

The following Gibson Dunn lawyers prepared this update: Jason C. Schwartz, Katherine V.A. Smith, Harris M. Mufson, Danielle J. Moss, Alex Downie, and Andrew Webb*.

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

Harris M. Mufson – Partner, New York (+1 212.351.3805, hmufson@gibsondunn.com)

Danielle J. Moss – Partner, New York (+1 212.351.6338, dmoss@gibsondunn.com)

Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202.955.8242, jschwartz@gibsondunn.com)

Katherine V.A. Smith – Co-Chair, Los Angeles (+1 213.229.7107, ksmith@gibsondunn.com)

*Andrew Webb, a recent law graduate in the New York office, is not admitted to practice law.

This near categorical ban on non-compete agreements marks an abrupt departure from existing law in many jurisdictions and has drawn almost immediate legal challenges.

On April 23, 2024, the FTC voted 3-2 to adopt a sweeping final rule banning the use of non-compete agreements nationwide, impacting 30 million workers by the FTC’s own estimates.[1] The final rule is presently set to become effective 120 days after its publication in the Federal Register, which is expected to occur in the next two weeks, with the possibility that the effective date may be delayed or enjoined in light of the pending litigation challenging the rule. It prohibits any new non-compete agreements and renders existing non-compete agreements with workers unenforceable, with limited exceptions. In addition to banning new non-competes, the rule requires employers to provide workers with notice that their existing non-compete agreements are no longer enforceable, but employers are not required to formally rescind the agreements.[2] Employers should be aware that the rule defines “worker” broadly, encompassing persons working as employees, independent contractors, interns, externs, volunteers, and sole proprietors.[3]

This near categorical ban on the non-compete agreements is an abrupt contrast from a regime in which these agreements had been recognized to have potential procompetitive value and therefore were reviewed for reasonableness. It also marks a sharp departure from the state law in many jurisdictions.

I. Narrow Exceptions

Notably, the final rule does not invalidate existing non-compete agreements with senior executives, one of the few changes from the proposed rule.[4] A “senior executive” is defined as a worker who: (1) earns more than $151,164 annually; and (2) is in a “policy-making position,” which is defined narrowly to mean “a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority.” The final rule also does not bar causes of action related to a non-compete that accrued prior to the effective date of the final rule. And enforcing or attempting to enforce a non-compete is not considered an unfair method of competition where an employer has a good-faith basis to believe the final rule is inapplicable.

The final rule’s general prohibition on non-competes is also not applicable to non-competes entered pursuant to the sale of a business. While the Commission had earlier proposed an exception for certain non-competes between the seller and the buyer of a business that applied only to a substantial owner, member, or partner, defined as an owner, member, or partner with at least 25% ownership interest in the business entity being sold, in response to public comments, the final rule no longer includes the proposed requirement that the restricted party be “a substantial owner of, or substantial member or substantial partner in, the business entity” to fall under the exception.

II. Functional Non-Competes

The final rule defines a “non-compete clause” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.” In assessing the impact of the final rule on other kinds of restrictive covenants, the FTC emphasizes three prongs of the “non-compete clause” definition—”prohibit,” “penalize,” and “functions to prevent.” Although the FTC declined to create a categorical prohibition on non-disclosure, non-solicitation, and similar restrictive covenants, it explained that the “functions to prevent” language applies to any term or condition of employment adopted by an employer that is so broad or onerous as to have the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends.

The FTC explained its view that a “garden-variety NDA,” in which a worker agrees not to disclose certain confidential information to a competitor, would not prevent that worker from seeking or accepting work with a competitor after leaving their job. However, the FTC would consider an NDA that spans such a wide swath of information so as to functionally prevent a worker from seeking or accepting other work to be a “non-compete clause.” Examples of problematic NDAs provided by the final rule include: (1) an agreement barring a worker from disclosing any information “usable in” or relating to the industry in which they work; and (2) an agreement barring a worker from disclosing any information obtained during their employment, including publicly available information.

Non-solicitation agreements and training repayment provisions are subject to the same fact-specific analysis. In particular, the FTC stated that agreements that impose substantial out-of-pocket costs upon workers for departing may effectively prevent them from seeking or accepting other work or starting a business and be functionally deemed a non-compete agreement.

The FTC also clarified that in its view a “garden leave” agreement—where the worker is “still employed and receiving the same total annual compensation and benefits on a pro rata basis—is not a non-compete clause,” since such an agreement does not restrict the worker post-employment. For the same reason, the FTC explained that the final rule is not meant to prohibit agreements under which a worker who does not meet a condition foregoes a particular aspect of their expected compensation, which would seemingly remove retention bonuses from the rule’s purview. Similarly, the FTC stated that agreements requiring workers to repay a bonus or forfeit accrued sick leave after leaving a job would not meet the definition of “non-compete clause” under the final rule, so long as they do not penalize or function to prevent a worker from seeking or accepting work or operating a business after the worker leaves the job.

III. Republican Dissents

Yesterday’s Special Open Commission Meeting marked the first for incoming Republican Commissioners Melissa Holyoak and Andrew Ferguson, who both dissented on constitutional and statutory grounds, among other reasons. Although their written dissents are not yet available, they stated in oral remarks[5] that the final rule exceeds the FTC’s authority and is barred by the major questions doctrine because Congress did not authorize the FTC to promulgate legislative rules (much less rules of such sweeping consequence) through either Section 6(g) or Section 5 of the FTC Act. According to Commissioner Ferguson, the FTC majority relies on “oblique or elliptical language that cannot justify the redistribution of half a trillion dollars of wealth within the general economy by regulatory fiat.” Commissioner Ferguson further stated the Rule is (1) unlawful under the non-delegation doctrine, and (2) arbitrary and capricious under the Administrative Procedure Act because the evidence on which the agency relies cannot justify the nationwide ban of non-competes irrespective of their terms, conditions, and particular effects.

IV. Immediate Legal Challenges

Within minutes of the vote, the final rule was the subject of a legal challenge filed by Gibson Dunn in the Northern District of Texas. Consistent with the dissenting views of Commissioners Holyoak and Ferguson, Gibson Dunn’s complaint argues that the FTC lacks the statutory authority to issue the rule, that any such grant of authority would be an unconstitutional delegation of legislative power, and that the FTC is unconstitutionally structured. The U.S. Chamber of Commerce also filed a lawsuit today. These cases raise the substantial questions surrounding the FTC’s authority to promulgate rules in this area and whether the agency’s rulemaking complied with the Administrative Procedure Act.

V. Employer Considerations

The final rule is presently set to become effective 120 days after its publication in the Federal Register. Given the pending litigation challenging the rule, it is possible that this effective date may be delayed or enjoined, and that the rule may ultimately be invalidated and never take effect. Accordingly, employers have, at a minimum, several months before the rule takes effect and may find it appropriate to watch how the pending legal challenges develop. Notwithstanding that uncertainty, however, businesses subject to the final rule[6] should consider using this time to: (1) review their existing non-compete agreements and be prepared to provide the required notice to non-senior executive workers, in accordance with the rule’s requirements, if and when necessary; (2) likewise, be prepared if necessary to amend existing antitrust compliance programs to provide guidance to avoid violating the rule; (3) consult with outside counsel; and (4) carefully consider the potential impact on future mergers and acquisitions, as the Hart-Scott-Rodino Act rules proposed by the FTC last year require disclosure of transaction-related agreements (including non-competes).

Gibson Dunn attorneys are closely monitoring these developments and available to discuss these issues as applied to your particular business.

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[1] The text of the FTC’s “Non-Compete Clause Rule” is available here.

[2] The rule includes model language that satisfies this notice requirement.

[3] The definition also includes persons working for a franchisee or franchisor but does not extend to a “franchisee” in the context of a franchisee-franchisor relationship.

[4] The FTC estimates that fewer than 0.75% of workers will qualify as senior executives according to the rule.

[5] A recording of the Special Open Commission Meeting is available here.

[6] The FTC stated that the “final rule applies to the full scope” of its jurisdiction, which it stated would exclude many non-profits. However, the preamble makes clear that the FTC will not treat an organization’s tax-exempt status as dispositive for purposes of evaluating its authority. Section 5 of the FTC Act also does not apply to the following entities: banks, savings and loan institutions, federal credit unions, common carriers, air carriers, and persons and businesses subject to the Packers and Stockyards Act.

The following Gibson Dunn lawyers prepared this update: Karl Nelson, Svetlana Gans, Andrew Kilberg, Chris Wilson, Claire Piepenburg, and Emma Li.

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, the authors, any leader or member of the firm’s Labor and Employment, Administrative Law and Regulatory, or Antitrust and Competition practice groups, or the following:

Labor and Employment:
Andrew G.I. Kilberg – Partner, Washington, D.C. (+1 202.887.3759, akilberg@gibsondunn.com)
Karl G. Nelson – Partner, Dallas (+1 214.698.3203, knelson@gibsondunn.com)
Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202.955.8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Co-Chair, Los Angeles (+1 213.229.7107, ksmith@gibsondunn.com)

Administrative Law and Regulatory:
Eugene Scalia – Co-Chair, Washington, D.C. (+1 202.955.8673, escalia@gibsondunn.com)
Helgi C. Walker – Co-Chair, Washington, D.C. (+1 202.887.3599, hwalker@gibsondunn.com)

Antitrust and Competition:
Rachel S. Brass – Co-Chair, San Francisco (+1 415.393.8293, rbrass@gibsondunn.com)
Svetlana S. Gans – Partner, Washington, D.C. (+1 202.955.8657, sgans@gibsondunn.com)
Cynthia Richman – Co-Chair, Washington, D.C. (+1 202.955.8234, crichman@gibsondunn.com)
Stephen Weissman – Co-Chair, Washington, D.C. (+1 202.955.8678, sweissman@gibsondunn.com)
Chris Wilson – Partner, Washington, D.C. (+1 202.955.8520, cwilson@gibsondunn.com)

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Gibson Dunn’s Workplace DEI Task Force aims to help our clients develop creative, practical, and lawful approaches to accomplish their DEI objectives following the Supreme Court’s decision in SFFA v. Harvard. Prior issues of our DEI Task Force Update can be found in our DEI Resource Center. Should you have questions about developments in this space or about your own DEI programs, please do not hesitate to reach out to any member of our DEI Task Force or the authors of this Update (listed below).

Key Developments:

On April 17, 2024, the Supreme Court held in Muldrow v. City of St. Louis, No. 22-193, that plaintiffs who challenge employers’ job transfer decisions as discriminatory under Title VII do not need to demonstrate that the harm suffered was “significant,” “material,” or “serious.” But plaintiffs must still show “some harm respecting an identifiable term or condition of employment,” such as hiring, firing, or transferring employees. A plaintiff also must show that her employer acted with discriminatory intent and that the transfer was based on a characteristic protected under Title VII. The Court emphasized that the decision does not reach retaliation or hostile work environment claims. The Court did not address how the decision might impact corporate DEI programs. For a more detailed discussion of this decision, see our April 17 Client Alert .

On April 12, 2024, Arkansas teachers and students, along with the Arkansas State Conference of the NAACP (NAACP-AR), filed a complaint against Governor Sarah Huckabee Sanders, challenging the constitutionality of Section 16 of Arkansas’s Literacy, Empowerment, Accountability, Readiness, Networking and School Safety Act (the “LEARNS Act”) and seeking to enjoin its enforcement. In Walls v. Sanders, No. 4:24-cv-002 (E.D. Ark. April 12, 2024), the plaintiffs allege that the LEARNS Act “expressly bans” the teaching of “Critical Race Theory” (which the Act refers to as “forced indoctrination”) in violation of their First Amendment and Fourteenth Amendment rights. After the Act was passed, Arkansas Secretary of Education Jacob Oliva revoked state approval for the AP African American Studies course, alleging that the course and educational materials violated Section 16. The plaintiffs allege that Section 16 chills speech, impermissibly regulates speech based on viewpoint discrimination, and violates the equal protection guarantees of the Fourteenth Amendment because it was motivated by racial animus and “created, in part, to target Black students and educators on the basis of race.” On April 17, 2024, the court denied the plaintiffs’ request for expedited briefing but scheduled a preliminary injunction hearing for April 30, 2024.

April continues to be a busy month for state legislation on both sides of the DEI debate. On April 22, 2024, Tennessee Governor Bill Lee signed H.B. 2100—a “social credit score” bill—into law. The bill limits factors that insurers and financial institutions can consider in decisions about the provision or denial of services. Specifically, the bill prohibits insurers and financial institutions from denying services or otherwise discriminating against persons for failure to satisfy ESG standards, corporate composition benchmarks, or compliance with DEI training policies. Meanwhile, on April 8, 2024, Virginia Governor Glenn Youngkin signed H.B. 1452 into law. This new law takes effect on July 1, 2024, and will require state agency heads to maintain comprehensive diversity, equity, and inclusion strategic plans. Strategic plans will need to integrate DEI goals into each agency’s mission and detail best practices for addressing equal opportunity barriers and promoting equity in operational activities including pay, hiring, and leadership. Agencies will be required to submit annual reports to enable the Governor and the General Assembly to monitor progress.

Media Coverage and Commentary:

Below is a selection of recent media coverage and commentary on these issues:

- The Wall Street Journal, “Diversity goals are disappearing from companies’ annual reports” (April 21): The Wall Street Journal’s Ben Glickman and Lauren Weber report on shifts in how companies are discussing DEI in their annual reports as a result of increased scrutiny of DEI initiatives. Glickman and Weber conclude that “[d]ozens of companies [have] altered descriptions of diversity, equity and inclusion initiatives in their annual reports to investors,” citing several examples. Glickman and Weber note that these shifts do not necessarily mean companies are abandoning their commitment to DEI, just that they are choosing to be less public about their DEI programs. Ivy Feng, an accounting professor at the University of Wisconsin, observed, “What gets disclosed gets managed. So if they don’t say anything, it’s more difficult for outsiders to find out what’s really going on.” Jason Schwartz, Gibson Dunn partner and co-head of the firm’s Labor and Employment practice group, concludes that many companies are just trying to determine what is lawful: “Forget about any ideological agenda. [Companies are] just trying to figure out, how do I follow the law? You don’t want to overcommit or undercommit or misdescribe where you’ll eventually land.”
The Washington Post, “DEI ‘lives on’ after Supreme Court ruling, but critics see an opening” (April 19): Julian Mark of The Washington Post writes on the potential impact on DEI programs following the Supreme Court’s decision in Muldrow v. City of St. Louis, Missouri. Mark notes the divergence of views on the scope of the Court’s ruling. Some practitioners interpret Muldrow narrowly. But EEOC Commissioner Andrea Lucas contends that DEI programs are now more susceptible to legal challenges than ever. Lucas asserts leadership development or training programs that are restricted to certain racial groups are now “high risk,” as are employers’ efforts to foster diverse hiring slates, opining that “the ‘some harm’ standard will [not] be the saving grace for a DEI program.”
Bloomberg Law, “The Supreme Court Just Complicated Employer DEI Programs” (April 18): Writing for Bloomberg Law, Simon Foxman examines the Supreme Court’s ruling in Muldrow v. City of St. Louis, Missouri, in which the Supreme Court unanimously held that an employee could bring suit under Title VII based on her reassignment to a position of the same pay but less favorable workdays and other benefits. The Court explained that an employee only has to suffer “‘some harm’ under the terms of their employment,” but that harm “doesn’t need to be ‘material,’ ‘substantial’ or ‘serious.’” Foxman reports that racial justice groups like the Legal Defense Fund celebrated the decision but expressed fears that “opponents of DEI programs likely will see this as an opening to launch new attacks on diversity programs.”
- The New York Times, “What Researchers Discovered When They Sent 80,000 Fake Résumés to U.S. Jobs” (April 8): Claire Cain Miller and Josh Katz of The New York Times report on a social experiment performed by a group of economists on roughly 100 of the largest companies in the country. The economists submitted thousands of fake “résumés with equivalent qualifications but different personal characteristics,” changing the name on each application to suggest whether an applicant was “white or Black, and male or female.” Miller and Katz report that the results were striking, with one company contacting “presumed white applicants 43 percent more often” than minority applicants with the same credentials. The study identifies other trends, including potential biases against older workers, women, and LGBTQ individuals. Miller and Katz note the study found various measures companies use in an effort to reduce discrimination, such has employing a chief diversity officer, offering diversity training, or having a diverse board, had no effect on the outcome of their experiment. But there was one thing all the companies who exhibited the least bias had in common: a centralized human resources function.
The New York Times, “With State Bans on D.E.I., Some Universities Find a Workaround: Rebranding” (April 12): Writing for The New York Times, Stephanie Saul reports on what she terms the “rebranding” many state universities have undertaken in the wake of legislation targeting DEI programs in higher education. Saul writes that, as an example, the University of Tennessee’s “campus D.E.I. program is now called the Division of Access and Engagement,” and at LSU, what was once the Division of Inclusion, Civil Rights and Title IX is now called the Division of Engagement, Civil Rights and Title IX. Saul states that some, like LSU VP of Marketing Todd Woodward, celebrate this “rebranding” as an effort to retain the impact of the departments and avoid job cuts. Woodward explained that the switch from “inclusion” to “engagement” better signifies the “university’s strategic plan.” But others, like Professor David Bray at Kennesaw State University, express skepticism, saying moves like this are little more than “the same lipstick on the ideological pig.”
- AP News, “Texas diversity, equity and inclusion ban has led to more than 100 job cuts at state universities” (April 13): Writing for AP News, Acacia Coronado examines the effect that SB17, Texas’ ban on DEI initiatives, has had in higher education. According to Coronado, the bill, which prohibits training and activities that reference race, color, ethnicity, gender identity, or sexual orientation, “has led to more than 100 job cuts across university campuses in Texas.” SB17 does not “apply to academic course instruction and scholarly research” positions, but Professor Aquasia Shaw, the only person of color in the Kinesiology Department at the University of Texas at Austin, suspects SB17 was responsible for the University’s decision not to renew her contract.
The Hill, “Republican states urge Congress to reject DEI legislation” (April 16): The Hill’s Cheyanne Daniels reports on Representatives Ayanna Pressley (D-MA) and Jamie Raskin’s (D-MD) introduction of the Federal Government Equity Improvement and Equity in Agency Planning Acts in the wake of “attempts to limit DEI programs . . . around the country.” These bills are designed to encourage federal agencies to enact policies focused on “providing equal opportunity for all, including people of color, women, rural communities and individuals with disabilities.” The legislation has not been welcomed by all, with Republican West Virginia Attorney General Patrick Morrisey penning a letter to Raskin and Representative James Comer (R-KY), Chairman of the Committee on Oversight and Accountability, declaring the bills “divisive.”
Law360, “Anti-DEI Complaints Filed With EEOC Carry No Legal Weight” (April 15): In an op-ed for Law360, Rutgers law professor and former EEOC counsel David Lopez asserts that the series of EEOC complaints conservative organizations like America First Legal Foundation (“AFL”) are filing against companies “carry no legal weight.” He describes these complaints as mere attempts to “weaponize the [public’s] lack of knowledge as a means of bullying employers into retreating from core values.” He encourages employers “not [to] be intimidated” by AFL’s tactics but to continue “develop[ing] workplace practices focused on rooting out entrenched and ongoing discriminatory practices against Black people, women and others in the workplace.”

Case Updates:

Below is a list of updates in new and pending cases:

1. Contracting claims under Section 1981, the U.S. Constitution, and other statutes:

Suhr v. Dietrich, No. 2:23-cv-01697-SCD (E.D. Wis. 2023): On December 19, 2023, a dues-paying member of the Wisconsin Bar filed a complaint against the Bar over its “Diversity Clerkship Program,” a summer hiring program for first-year law students. The program’s application requirements had previously stated that eligibility was based on membership in a minority group. After SFFA v. Harvard, the eligibility requirements were changed to include students with “backgrounds that have been historically excluded from the legal field.” The plaintiff claims that the Bar’s program is unconstitutional even with the new race-neutral language, because, in practice, the selection process is still based on the applicant’s race or gender. The plaintiff also alleges that the Bar’s diversity program constitutes compelled speech and compelled association in violation of the First Amendment.
- Latest update: Under a partial settlement agreement, the Bar agreed to “make clear that the Diversity Clerkship Program is open to all first-year law students.” In exchange, the plaintiff will drop his claims about the clerkship program and file an amended lawsuit challenging only the mandatory dues and how they are spent.
Do No Harm v. Pfizer, No. 1:22-cv-07908 (S.D.N.Y. 2022), aff’d, No. 23-15 (2d Cir. 2023): On September 15, 2022, conservative medical advocacy organization Do No Harm (DNH) filed suit against Pfizer, alleging that Pfizer discriminated against white and Asian students by excluding them from its Breakthrough Fellowship Program. To be eligible for the program, applicants must “[m]eet the program’s goals of increasing the pipeline for Black/African American, Latino/Hispanic and Native Americans.” DNH alleged that the criteria violate Section 1981, Title VI of the Civil Rights Act, the Affordable Care Act, and multiple New York state laws banning racially discriminatory internships, training programs, and employment. In December 2022, the Southern District of New York dismissed the case for lack of subject matter jurisdiction, finding that DNH did not have standing because it did not identify at least one member by name. On March 6, 2024, the United States Court of Appeals for the Second Circuit affirmed the district court’s dismissal, holding that an organization must name at least one affected member to establish Article III standing under the “clear language” of Supreme Court precedent. On March 20, 2024, DNH petitioned the court for a rehearing en banc.
- Latest update: On April 3, 2024, four amicus briefs were filed in support of DNH’s petition for a rehearing en banc. Briefs were filed by: (1) Speech First, an organization “committed to restoring freedom of speech on college campuses,” (2) Pacific Legal Foundation, an organization which “defend[s] individual liberty and limited government,” (3) Young America’s Foundation, which supports “individual freedom, a strong national defense, free enterprise, and traditional values,” The Manhattan Institute, “whose mission is to develop and disseminate new ideas that foster economic choice and individual responsibility,” and Southeastern Legal Foundation, which is “dedicated to defending liberty and Rebuilding the American Republic,” and (4) the American Alliance for Equal Rights, which is “dedicated to challenging distinctions and preferences made on the basis of race and ethnicity.” The four briefs argue that prohibiting anonymity in sensitive cases with “vulnerable plaintiffs” violates the First Amendment and negates the purpose of associational standing in the public interest litigation context.

2. Employment discrimination and related claims:

Bowen v. City and County of Denver, No. 1:24-cv-00917 (D. Colo. 2024): On April 5, 2024, Joseph Bowen, a sergeant in the Denver Police Department, sued the Department and the City and County of Denver alleging that the Department’s 30×30 initiative, which pledges that 30% of all police recruits will be women by 2030, caused him to lose out on a promotion to captain to three less-qualified women. Bowen alleges that the Department discriminated against him on the basis of his sex, in violation of Title VII of the Civil Rights Act of 1964.
- Latest update: A scheduling conference is scheduled for June 25, 2024.
Renault v. Adidas, No. 2024-CP-420-1549 (Court of Common Pleas, South Carolina, April 15, 2024): On April 15, 2024, pro se plaintiff Peter Renault sued Adidas in South Carolina state court for employment discrimination after he was rejected for a supply chain analyst position. Renault alleges that he was qualified but not hired due to the company’s DEI policies.
- Latest update: The docket does not reflect that Adidas has been served.

3. Challenges to agency rules, laws, and regulatory decisions:

Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir. 2021): On October 18, 2023, a unanimous Fifth Circuit panel rejected petitioners’ constitutional and statutory challenges to Nasdaq’s Board Diversity Rules and the SEC’s approval of those rules. Gibson Dunn represents Nasdaq, which intervened to defend its rules. Petitioners sought a rehearing en banc.
- Latest update: On March 21, 2024, petitioners’ briefs were filed. On March 28, 2024, Arizona, Alabama, Alaska, Arkansas, Florida, Indiana, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Montana, Nebraska, Oklahoma, South Carolina, Texas, and Utah filed an amicus brief in support of petitioners, arguing that Nasdaq’s rules violate the Equal Protection Clause and states’ rights. Nasdaq and the SEC will file their briefs on April 29, and oral argument is scheduled for May 14.

4. Actions against educational institutions:

Elliott v. Antioch University, No. 2:24-cv-502 (W.D. Wash.): On April 15, 2024, the plaintiff, a white woman, sued Antioch University for suspending her account after she criticized the school’s decision to have students sign a “civility pledge” committing to anti-racism. Elliott made a series of public videos and online posts expressing her criticisms of the policy changes at Antioch and alleges that when she refused to sign the civility pledge, she was excluded from courses necessary for her to graduate with her degree. Elliott sued Antioch under Title VI of the Civil Rights Act, breach of contract, and defamation.
- Latest update: The docket does not reflect that Antioch University has been served.

The following Gibson Dunn attorneys assisted in preparing this client update: Jason Schwartz, Mylan Denerstein, Blaine Evanson, Molly Senger, Zakiyyah Salim-Williams, Matt Gregory, Zoë Klein, Mollie Reiss, Alana Bevan, Marquan Robertson, Elizabeth Penava, Skylar Drefcinski, Mary Lindsay Krebs, David Offit, Lauren Meyer, Kameron Mitchell, Maura Carey, and Jayee Malwankar.

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 Labor and Employment practice group, or the following practice leaders and authors:

Jason C. Schwartz – Partner & Co-Chair, Labor & Employment Group
Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com)

Katherine V.A. Smith – Partner & Co-Chair, Labor & Employment Group
Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)

Mylan L. Denerstein – Partner & Co-Chair, Public Policy Group
New York (+1 212-351-3850, mdenerstein@gibsondunn.com)

Zakiyyah T. Salim-Williams – Partner & Chief Diversity Officer
Washington, D.C. (+1 202-955-8503, zswilliams@gibsondunn.com)

Molly T. Senger – Partner, Labor & Employment Group
Washington, D.C. (+1 202-955-8571, msenger@gibsondunn.com)

Blaine H. Evanson – Partner, Appellate & Constitutional Law Group
Orange County (+1 949-451-3805, bevanson@gibsondunn.com)

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From the Derivatives Practice Group: The Bank of Israel announced that it will cease publication of Telbor next year and four new directors joined ISDA’s board this week.

New Developments

Chairman Behnam Announces CFTC’s First DEIA Strategic Plan. On April 18, CFTC Chairman Rostin Behnam announced the agency’s first Strategic Plan to Advance Diversity, Equity, Inclusion, and Accessibility (DEIA Plan). Chairman Behnam said that the two-year DEIA Plan represents a critical step forward in aligning the CFTC with a collective DEIA vision that not only provides genuine support for team members, but also ensures the CFTC is a source of future leaders. The CFTC designed the DEIA Plan to align with its 2022-2026 Strategic Plan and to focus on the following six goals: Inclusive Workplaces, Partnerships and Recruitment, Paid Internships, Professional Development and Advancement, Data, and Equity in Procurement and Customer Education and Outreach. Each goal includes objectives and strategies/actions to achieve the goal, and identifies the agency division(s)/office(s) that will lead and contribute to the implementation of the goal. The CFTC said that an internal DEIA Executive Council will support and guide the implementation of the DEIA Plan. [NEW]
CFTC Appoints Christopher Skinner as Inspector General. On April 10, the Commodity Futures Trading Commission announced that Christopher L. Skinner has been appointed CFTC’s Inspector General (IG). The CFTC stated that Mr. Skinner brings 15 years of IG experience, including leading and managing Offices of Inspector’s General (OIG), and conducting investigations, inspections, and audits. Mr. Skinner comes to the CFTC from the Federal Election Commission (FEC) where he served as IG since 2019.

New Developments Outside the U.S.

Telbor Committee to Permanently Cease Publication of Telbor. On April 16, the Telbor Committee of the Bank of Israel decided that the publication of all tenor of Telbor will permanently cease following a final publication on June 30, 2025. The announcement constitutes an “Index Cessation Event” under the 2021 ISDA Interest Rate Derivatives Definitions and the November 2022 Benchmark Module of the ISDA 2021 Fallbacks Protocol. In February 2022, the Telbor Committee decided that the SHIR (Shekel overnight Interest Rate) rate would eventually replace the Telbor interest rate in shekel interest rate derivative transactions. The Bank of Israel said that the decision to switch to the SHIR rate is in accordance with the decisions reached in major economies worldwide, according to which IBOR type interest rates will be replaced by risk-free overnight interest rates. ISDA published cessation guidance for parties affected by the announcement. [NEW]
New Report Sheds Light on Quality and Use of Regulatory Data Across EU. On April 11, ESMA published the fourth edition of its Report on the Quality and Use of Data aiming to provide transparency on how the data collected under different regulations is used systematically by authorities in the EU, and clarifying the actions taken to ensure data quality. The report provides details on how National Competent Authorities, the European Central Bank, the European Systemic Risk Board and ESMA use the data that is collected through the year from different legislation requirements, including datasets from European Market Infrastructure Regulation, Securities Financing Transactions Regulation, Markets in Financial Instruments Directive, Securitization Regulation, Alternative Investment Fund Managers Directive and Money Market Funds Regulation.

New Industry-Led Developments

Four Directors Join ISDA Board. On April 18, ISDA announced that four directors have joined its Board, three directors were re-appointed, and 10 others have been re-elected at ISDA’s Annual General Meeting in Tokyo. The new directors are: Erik Tim Mueller, Chief Executive Officer, Eurex Clearing AG; Jared Noering, Managing Director, Head of Fixed Income Trading, NatWest Markets; Brad Tully, Managing Director and Global Head of Corporate Derivatives and Private Side Sales for J.P. Morgan; and Jan Mark van Mill, Managing Director of Multi Asset, APG Asset Management. [NEW]
ISDA Future Leaders in Derivatives Publishes Generative Artificial Intelligence Whitepaper. On April 17, ISDA published a whitepaper from ISDA Future Leaders in Derivatives (IFLD), its professional development program for emerging leaders in the derivatives market. The whitepaper, GenAI in the Derivatives Market: a Future Perspective, was developed by the third cohort of IFLD participants, who began working together in October 2023. According to ISDA, the 38 individuals in the group represent buy- and sell-side institutions, law firms, and service providers from around the world. After being selected for the IFLD program, they were asked to engage with stakeholders, develop positions, and produce a whitepaper on the potential use of generative artificial intelligence (genAI) in the over-the-counter derivatives market. The participants were also given access to ISDA’s training materials, resources, and staff expertise to support the project and their own professional development. ISDA said that, drawing on industry expertise and academic research, the whitepaper identifies a range of potential use cases for genAI in the derivatives market, including document creation, market insight, and risk profiling. ISDA also indicated that it explores regulatory issues in key jurisdictions and addresses the challenges and risks associated with the use of genAI. The paper concludes with a set of recommendations for stakeholders, including investing in talent development, fostering collaboration and knowledge sharing with technology providers, prioritizing ethical AI principles and engaging with policymakers to promote an appropriate regulatory framework. [NEW]
ISDA Publishes Research Paper on Interest Rate Derivatives, Benchmark Rates and Development Financial Markets in EMDEs. On April 17, ISDA published a research paper in which it outlines the role of interest rate derivatives (IRDs) in supporting the development of financial markets in emerging markets and developing economies (EMDEs). It also examines the significance of reliable, robust interest rate (IR) benchmarks. ISDA indicated that the paper draws valuable lessons from the transition from LIBOR to overnight risk-free rates in advanced economies and applies those insights to the context of EMDEs. Through case studies, ISDA attempts to show how various EMDE jurisdictions have successfully adopted and implemented more robust and transparent IR benchmarks. [NEW]
ISDA Extends Digital Regulatory Reporting Initiative to New Jurisdictions. On April 17, ISDA announced that it is extending its Digital Regulatory Reporting (DRR) initiative to several additional jurisdictions in an effort to enable firms to implement changes to regulatory reporting requirements. The DRR is being extended to cover rule amendments being implemented under the UK European Market Infrastructure Regulation and by the Australian Securities and Investments Commission and the Monetary Authority of Singapore. Those rule changes are due to be implemented in the UK on September 30, 2024, and October 21, 2024 in Australia and Singapore. The DRR code for all three sets of rules is currently available for market participants to review and test. ISDA said that the DRR will be further extended to cover rule changes in Canada and Hong Kong, both due in 2025, and the DRR for the CFTC rules will also be updated to include further anticipated updates, currently under consultation at the commission. Firms can either use the DRR as the basis for implementation or to validate an independent interpretation of the rules. [NEW]
ISDA Publishes Margin Survey. On April 16, ISDA published its latest margin survey, which shows that $1.4 trillion of initial margin (IM) and variation margin (VM) was collected by 32 leading derivatives market participants for their non-cleared derivatives exposures at the end of 2023, unchanged from the previous year. The survey also reports the amount of IM posted by all market participants to major central counterparties. [NEW]
ISDA Establishes Suggested Operational Practices for EMIR Refit. On April 16, through a series of discussions held within the ISDA Data and Reporting EMEA Working Group, market participants established and agreed to Suggested Operational Practices (SOP) for over-the-counter derivative reporting in preparation for the commencement of the EMIR Refit regulatory reporting rules on April 29. ISDA said that the SOP matrix was established based on the EMIR Refit validation table, (as published by ESMA), which contains the Regulatory Technical Standards (RTS), the Implementation Technical Standards (ITS) and validation rules. Additional tabs have been added to supplement to SOPs, including product-level SOPs for several of the underlier fields, and listing names of floating rate options. There are also tabs to reflect updates made to the matrix (‘Updates’) and a tab to track questions raised by the ISDA Data and Reporting EMEA Working Group (‘WG Questions’). ISDA indicated that the document will continue to be reviewed and updated as and when required. While the intention of these SOPs is to provide an agreed and standardized market guide for firms to utilize, no firm is legally bound or compelled in any way to follow any determinations made within these EMIR SOPs. [NEW]
ISDA and IIF Respond to BCBS-CPMI-IOSCO Consultation on Margin Transparency. On April 12, ISDA and the Institute of International Finance (IIF) submitted a response to the Basel Committee on Banking Supervision (BCBS), Committee on Payments and Market Infrastructures (CPMI) and International Organization of Securities Commissions (IOSCO) consultation on transparency and responsiveness of initial margin in centrally cleared markets. In their response, the associations expressed support for enhancing transparency on cleared margin for all market participants, which they expect will help with liquidity preparedness and increase resilience of the system, noting it should start with central counterparties (CCPs) making fundamental disclosures about their margin models. In this regard, both associations highlight their support in the response to recommendations one through eight. Regarding recommendation nine, the associations indicated that they are supportive of clients having necessary transparency on clearing member (CM) margin requirements. Regarding recommendation 10, the associations said in the response that they are generally supportive of the principle that CCPs should have visibility into the risk profile of their clearing participants but warned that, in their opinion, the information required under recommendation 10 may raise legal, confidentiality, or competition concerns. Finally, the associations noted that they believe further work should be done on the fundamentals of CCP margin models, for example on the appropriateness of margin periods of risk and the calibration of anti-procyclicality tools, to ensure that margins do not fall too low during low volatility periods. [NEW]
IOSCO Publishes Updated Workplan. On April 12, IOSCO published its updated 2024 Workplan, which directly supports its overall two-year Work Program published on April 5, 2023. The 2024 Workplan announced new workstreams, reflecting increased focus on AI, tokenization and credit default swaps, and additional work on transition plans and green finance. The 2024 Workplan set out priorities under five themes: Protecting Investors, Address New Risks in Sustainability and Fintech, Strengthening Financial Resilience, Supporting Market Effectiveness and Promoting Regulatory Cooperation and Effectiveness. [NEW]
ISDA, AIMA, GFXD Publish Paper on Transition to UPI. On April 9, ISDA, the Alternative Investment Management Association (AIMA) and the Global Foreign Exchange Division (GFXD) of the Global Financial Markets Association published a paper on the transition to unique product identifiers (UPI) as the basis for over-the-counter (OTC) derivatives identification across the Markets in Financial Instruments Regulation (MIFIR) regimes. The paper has been sent to the European Commission, which is working on legislation to address appropriate identification of OTC derivatives under MiFIR.
ISDA Submits Addendum to US Basel III NPR Comment Letter. On April 8, ISDA submitted an addendum to the joint US Basel III ‘endgame’ notice of proposed rulemaking response along with the Securities Industry and Financial Markets Association. The addendum contains a more developed proposal for the index bucketing approach for equity investment in funds and an update to the Fundamental Review of the Trading Book Standardized Approach Quantitative Impact Study numbers. [NEW]
IOSCO Seeks Feedback on the Evolution of Market Structures and Proposed Good Practices. On April 4, the International Organization of Securities Commissions (IOSCO) published a consultation report on Evolution in the Operation, Governance and Business Models of Exchanges: Regulatory Implications and Good Practices. The consultation report analyzes the structural and organizational changes within exchanges, focusing on business models and ownership structures. It highlights a shift towards more competitive, cross-border, and diversified operations as exchanges integrate into larger corporate groups. The consultation report discusses regulatory considerations, particularly in the organization of individual exchanges and exchange groups and the supervision of multinational exchange groups. It addresses potential conflicts of interest arising from matrix structures and the challenges of overseeing individual exchanges within exchange groups. Additionally, it outlines a set of six proposed good practices for regulators to consider in the supervision of exchanges, particularly when they provide multiple services and/or are part of an exchange group. The good practices are also complemented by a non-exclusive list of supervisory tools used by IOSCO jurisdictions to address the issues under discussion, in the form of “toolkits”. While the Consultation Report focuses on equities listing trading venues, the findings are also relevant to other trading venues, including non-listing trading venues and derivatives trading venues. IOSCO is seeking input from market participants on the major trends and risks observed, and the proposed good practices on or before July 3, 2024.
ISDA Submits Response to CFTC Proposed Operational Resilience Rules. On April 1, ISDA submitted comments on the CFTC’s notice of proposed rulemaking on requirements to establish an Operational Resilience Framework for Futures Commission Merchants, Swap Dealers and Major Swap Participants, which was published in the Federal Register on January 24, 2024. ISDA recommended that the CFTC adjust adjust portions of the proposed rules relating to governance, third-party relationships, incident notification and implementation period.

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

Jeffrey L. Steiner, Washington, D.C. (202.887.3632, jsteiner@gibsondunn.com)

Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com)

Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)

Darius Mehraban, New York (212.351.2428, dmehraban@gibsondunn.com)

Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)

Adam Lapidus – New York (+1 212.351.3869, alapidus@gibsondunn.com)

Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)

Roscoe Jones Jr., Washington, D.C. (202.887.3530, rjones@gibsondunn.com)

William R. Hallatt, Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)

David P. Burns, Washington, D.C. (202.887.3786, dburns@gibsondunn.com)

Marc Aaron Takagaki, New York (212.351.4028, mtakagaki@gibsondunn.com)

Hayden K. McGovern, Dallas (214.698.3142, hmcgovern@gibsondunn.com)

Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)

We are pleased to provide you with Gibson Dunn’s Accounting Firm Quarterly Update for Q1 2024. The Update is available in .pdf format at the below link, and addresses news on the following topics that we hope are of interest to you:

SEC Voluntarily Stays Climate-Disclosure Rules Pending Appellate Review
PCAOB Issues Proposed Rule on Firm Metric Reporting
SolarWinds Moves to Dismiss SEC Amended Complaint
Alabama Federal Court Declares Corporate Transparency Act Unconstitutional
SEC Adopts Final Rules Relating to SPACs
House Oversight Committee Examines PCAOB Treatment of China-Based Firms
PCAOB Proposes New Rule on False or Misleading Statements Concerning PCAOB Registration and Oversight
PCAOB Reopens Comment Period and Holds Roundtable on NOCLAR Proposal
NCLA Sues PCAOB Claiming Unconstitutional Disciplinary Proceedings
SEC Commissioner Speaks on Materiality and Engagement with the SEC
Illinois Appellate Court Issues Verein Ruling in Legal Malpractice Case
Southern District Rules That PCAOB Inspection Information Is Not “Property”
Other Recent SEC and PCAOB Enforcement and Regulatory Developments

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

Download Full Newsletter

Warmest regards,
Jim Farrell
Monica Loseman
Michael Scanlon

Chairs, Accounting Firm Advisory and Defense Practice Group, Gibson, Dunn & Crutcher LLP

In addition to the practice group chairs, this update was prepared by David Ware, Timothy Zimmerman, Benjamin Belair, Adrienne Tarver, and Monica Limeng Woolley.

Accounting Firm Advisory and Defense Group:

James J. Farrell – Co-Chair, New York (+1 212-351-5326, jfarrell@gibsondunn.com)

Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, mloseman@gibsondunn.com)

Michael Scanlon – Co-Chair, Washington, D.C.(+1 202-887-3668, mscanlon@gibsondunn.com)

On April 15, 2024, the U.S. Equal Employment Opportunity Commission (“EEOC”) issued regulations implementing the Pregnant Workers Fairness Act (“PWFA”). The final rule comes after considering extensive comments on the August 2023 draft rulemaking, and will go into effect on June 18, 2024.

The PWFA was signed into law on December 29, 2022. It was intended to fill gaps in the federal and state legal landscape regarding protections for employees affected by pregnancy, childbirth, or related medical conditions. Specifically, the PWFA requires most employers with 15 or more employees to provide reasonable accommodations for a qualified employee’s or applicant’s known limitations related to, affected by, or arising out of pregnancy, childbirth, or related medical conditions, unless the accommodation will cause an undue hardship on the operation of the employer’s business. The requirements apply even when the medical limitations giving rise to the need for an accommodation would not constitute a disability under the Americans with Disabilities Act (“ADA”). (For a detailed analysis of the PWFA’s requirements and differences between the PWFA and existing federal and state law with respect to the accommodation of pregnancy-related medical restrictions, please see our prior alert.)

The PWFA has been in effect since June 27, 2023, but the final rule and accompanying guidance clarify (and in some ways expand) the obligations that were explicit in the statute itself. Below are 10 key takeaways for employers.

10 Key Takeaways for Employers

Certain Identified Accommodations Are Assumed To Be Reasonable: The final rule specifies that the following four pregnancy accommodations are reasonable and should be granted in almost every circumstance without documentation: (1) additional restroom breaks, (2) food and drink breaks, (3) allowing water and other drinks to be kept nearby, and (4) allowing sitting or standing, as necessary. Other possible reasonable accommodations specified by the final rule, although not presumptively required, include job restructuring, modifying work schedules, use of paid leave, and reassignment to a vacant position.
Broad Scope of Covered Conditions: The EEOC’s “non-exhaustive list” of conditions that can give rise to a request for accommodation under the PWFA include: current pregnancy, past pregnancy, lactation (including breastfeeding and pumping), use of birth control, menstruation, postpartum depression, gestational diabetes, preeclampsia, infertility and fertility treatments, endometriosis, miscarriage, stillbirth, and having or choosing not to have an abortion, among other conditions. The breadth of this list has drawn criticism for exceeding the EEOC’s authority—including a public dissent from EEOC Commissioner Andrea Lucas—and the abortion-related aspect in particular has attracted strong attention (and is likely to be litigated).
Applicants/Employees May Need To Be Excused From Essential Functions For Extended Periods: Under the ADA, only a “qualified individual” is entitled to a reasonable accommodation, and a qualified individual is one who can perform the essential functions of the job with or without a reasonable accommodation. By contrast, under the PWFA, an individual is still qualified—and therefore entitled to a reasonable accommodation—even if they cannot perform an essential function of the job now, so long as the limitation is for “a temporary period” and the essential function can be performed in the “near future.”
Employers Cannot Seek Documentation For Certain Requests: The final rule generally prohibits employers from seeking documentation in many circumstances, including: (1) when the limitation and need for a reasonable accommodation is obvious; (2) when the employer already has sufficient information to support a known limitation related to pregnancy; (3) when the request is for one of the four identified reasonable accommodations listed above (i.e., additional restroom breaks; food/drink breaks; beverages near the work station; and sitting or standing as needed); (4) when the request is for a lactation accommodation; and (5) when the accommodation is available without documentation for other employees seeking the same accommodation for non-PWFA reasons.
Informal Requests Can Trigger Statutory Obligations: The guidance accompanying the final rule indicates that verbal conversations with direct supervisors can trigger accommodation obligations, and an employee’s failure to fill out paperwork or speak to the “right” supervisor or designated department is not grounds for either delaying or not providing the accommodation. In other words, the initial request (or statement of need for an accommodation) alone may be sufficient to place the employer on notice and trigger the interactive accommodation process.
Account For Accommodations In Reporting And Metrics: Where a reasonable accommodation is granted (e.g., extra bathroom or water breaks), employers should ensure that technologies are appropriately adjusted to integrate the accommodation. Given that employers are increasingly using technology in the workplace for purposes such as monitoring attendance or tracking productivity and performance, it is important that employers develop policies that contemplate how a reasonable accommodation might impact the accuracy of these tools. For example, the EEOC suggests that calculations on productivity for a given shift may need to be adjusted to account for the additional excused break periods.
Act With Expediency And Consider Interim Accommodations: Although the PWFA’s interactive process largely tracks that of the ADA, the final rule provides that employers must respond to requests under the PWFA with “expediency” and notes that granting an interim accommodation will decrease the likelihood that an unnecessary delay will be found.
Unpaid Leave As A Last Resort: As the PWFA itself makes clear, employers may only require an employee to take leave as a last resort if there are no other reasonable accommodations that can be provided absent undue hardship. The final rule and guidance continue this theme, underscoring that requiring an employee to take unpaid leave or to use their leave after they ask for an accommodation and are awaiting a response could also violate the PWFA if, for example, there is paid work that the employee could have been provided during the interactive process.
Overlap With The ADA: Overlap With The ADA: The final rule acknowledges that there may be circumstances in which a qualified individual may be entitled to an accommodation under either the PWFA or the ADA for a pregnancy-related limitation. The interpretive guidance emphasizes that employees are not required to identify the statute under which they are requesting a reasonable accommodation, so employers should train human resources and management professionals to identify and apply the applicable framework.
Don’t Forget About Applicants: The PWFA prohibits employers from refusing to hire a pregnant applicant because they assume that the applicant will soon need to leave to recover for childbirth. In addition, the interpretive guidance flags that the accommodation process is often more difficult to navigate for applicants than for existing employees. As such, employers should consider training recruiting and onboarding professionals on how to best ensure that an applicant understands the process for requesting a reasonable accommodation during the hiring process. The guidance notes that an applicant may not know enough about, for example, the equipment used by the employer or the application process itself to request an accommodation and the employer may likewise not have enough information to suggest an appropriate accommodation. Accordingly, employers might consider trying to anticipate potential hurdles to accessibility during the hiring process and either remedy the obstacles, if feasible, or provide advanced notice during the early stages of the process so that the applicant can identify any potential issues and request a reasonable accommodation.

The following Gibson Dunn lawyers prepared this update: Jason C. Schwartz, Katherine V.A. Smith, Molly Senger, David Schnitzer, and Emily M. Lamm.

Molly T. Senger – Partner, Labor & Employment
Washington, D.C. (+1 202.955.8571, msenger@gibsondunn.com)

Jason C. Schwartz – Partner & Co-Chair, Labor & Employment
Washington, D.C. (+1 202.955.8242, jschwartz@gibsondunn.com)

Katherine V.A. Smith – Partner & Co-Chair, Labor & Employment
Los Angeles (+1 213.229.7107, ksmith@gibsondunn.com)

Gibson, Dunn & Crutcher LLP has appointed Mark Leverkus as Of Counsel in its Global Finance and Transportation and Space Practice Groups in London.

Mark is recognised by The Legal 500 Rankings in Finance: Transport Finance and Leasing, and has been named a “Rising Star” by Airfinance Journal. He was previously a senior associate in the transportation and space group of Milbank, and he has also been seconded to the legal department of a major UK bank, and to a regional aircraft lessor in Dublin.

Madalyn Miller, Co-chair of the Transportation and Space Group and Partner in the Global Finance Group at Gibson Dunn, said: “Mark’s experience on some of the largest and most complex aviation and space matters make him a great addition to the team and we’re pleased to welcome him to the firm. We are continuing to expand our Global Finance and Transportation and Space Groups and the London office is particularly important as we grow.”

Mark’s hire follows a period of growth for the firm’s Global Finance Practice Group, with other recent arrivals including partners David Irvine, Trinh Chubbock, Kavita Davis and Ben Shorten in London, Jin Hee Kim and Doug Horowitz in New York, Chad Nichols in Houston/New York, Frederick Lee in Dallas, and Darko Adamovic in Paris.

About Mark Leverkus

Mark is an Of Counsel in the London office of Gibson Dunn & Crutcher, and is a member of the firm’s Transportation and Space and Global Finance practice groups. His deals have won numerous awards from transport industry publications and ratings services, and include acting for financiers, arrangers, equity investors, leasing companies, export credit agencies and operators on a range of sophisticated financing, leasing and sale and purchase transactions, involving aircraft, satellites and other moveable equipment. He also has extensive experience in the trading and repackaging of such transactions, as well as in restructurings, disputes, work-outs and repossessions.

About the Gibson Dunn Transportation and Space Practice Group

The Transportation and Space Practice Group serves some of the largest aerospace, defence and satellite companies in the world as well as cutting-edge emerging technology businesses, and the private equity and financial institutions that support and enable their growth. Our aerospace and related technologies lawyers have a wide cross-section market knowledge and offer a strong and longstanding track record serving the traditional aerospace industry and supporting clients in various new and emerging technologies and markets.

About the Gibson Dunn Global Finance Practice Group

The Global Finance Practice Group serves clients around the world, including private equity sponsors, corporate borrowers, major financial institutions, and hedge funds. It includes more than 85 lawyers in our offices worldwide, advising on a broad array of financing transactions. The group works closely with mergers and acquisitions colleagues on acquisition financings and with the firm’s capital markets team. The group also draws extensively on the knowledge and skills of other specialist practice areas, such as environmental, tax, employee benefits, and litigation.

A recent global survey of dealmakers by BCG and Gibson Dunn reveals a striking consensus: conducting environmental, social, and governance (ESG) due diligence is now indispensable for M&A transactions.

Dealmakers say that the insights gained from these assessments are crucial not only for mitigating risks but also for preserving and enhancing deal value. Although Europe has spearheaded more stringent ESG regulations, dealmakers in all surveyed countries, including those in the US, recognize the importance of performing such assessments before closing a deal.

“The Payoffs and Pitfalls of ESG Due Diligence” report was authored by Jens Kengelbach, Jana Herfurth, Dominik Degen, Dirk Oberbracht, Ferdinand Fromholzer, and Jan Schubert. Download the report here.

About the Survey

To understand the prevailing ESG due diligence practices in M&A transactions, BCG and Gibson Dunn surveyed 115 dealmakers in Europe, North and South America (including in the US), and Asia. The dealmakers are in various industries and participate in different deal sizes. (See the exhibit below.) The survey participants, who hold positions ranging from managers to roles in the C-suite, have been personally involved in deals during the past three years and are familiar with ESG due diligence practices. Approximately two-thirds of the respondents are corporate executives, while the others are from private equity or venture capital firms or financial institutions.

Muldrow v. City of St. Louis, No. 22-193 – Decided April 17, 2024

Today, the Supreme Court held that a Title VII plaintiff challenging a forced job transfer as discriminatory must show some harm from the transfer, but need not show that the harm was “significant,” “material,” or “serious.”

“Although an employee must show some harm from a forced transfer to prevail in a Title VII suit, she need not show that the injury satisfies a significance test.”

Justice Kagan, writing for the Court

Background:

The Civil Rights Act of 1964 (“Title VII”) prohibits discrimination in the “terms, conditions, or privileges of employment” because of an individual’s race, religion, sex, or national origin. 42 U.S.C. § 2000e-2(a)(1). In 2017, following a change in leadership in the St. Louis Police Department, Sergeant Jatonya Muldrow was transferred from the Intelligence Division to another unit. The transfer did not affect Muldrow’s regular pay or rank, but she was allegedly “moved from a plainclothes job in a prestigious specialized division giving her substantial responsibility over priority investigations and frequent opportunity to work with police commanders . . . to a uniformed job supervising one district’s patrol officers, in which she was less involved in high-visibility matters and primarily performed administrative work. Her schedule became less regular, often requiring her to work weekends; and she lost her take-home car.” She alleged that no male sergeants were transferred out of the Intelligence Division and that she was replaced with a male sergeant.

Muldrow brought a Title VII claim against the Department, alleging that the transfer was discriminatory because of her sex. The district court and the Eighth Circuit held that the transfer was not an adverse employment action because it did not result in a “materially significant disadvantage” to Muldrow.

Issue:

Does Title VII prohibit discrimination in transfer decisions where the transfer does not result in a “materially significant disadvantage”?

Court’s Holding:

To prevail on a Title VII claim challenging a forced job transfer, a plaintiff must show some harm from the transfer, but need not show that the harm was “significant,” “material,” or “serious.”

What It Means:

The Court’s decision is a win for Title VII plaintiffs who challenge employers’ job-transfer decisions as discriminatory based on race, sex, or some other protected characteristic. According to the six Justices who joined the Court’s decision, “this decision changes the legal standard used in any circuit that has previously required ‘significant,’ ‘material’ or ‘serious’ injury. It lowers the bar Title VII plaintiffs must meet.” Majority op. 7 n.2.
At the same time, the Court noted that there is “reason to doubt that the floodgates will open” for new Title VII claims, and that lower courts “retain multiple ways to dispose of meritless Title VII claims challenging transfer decisions.” Majority op. 9, 10. Most significantly, Title VII plaintiffs must show “some harm respecting an identifiable term or condition of employment,” such as hiring, firing, or transferring employees. Id. at 6. Justice Alito, concurring in the Court’s judgment, predicted that this requirement will mean that “careful lower court judges will mind the words they use but will continue to do pretty much just what they have done for years.” Alito op. 2.
The Court also held that a Title VII plaintiff still must show that her employer acted with discriminatory intent and the internal transfer was made on the basis of a protected characteristic such as race, color, religion, sex, or national origin. Employers should document the business reasons for an internal transfer, which will assist in defeating allegations that a transfer was based on a protected characteristic.
The Court also noted that lower courts “may consider whether a less harmful act is, in a given context, less suggestive of intentional discrimination.” Majority op. 10. Thus, lower courts appear to retain latitude to consider whether the facts alleged in a Title VII complaint are more suggestive of lawful conduct than unlawful conduct, consistent with ordinary pleading standards.
The Court emphasized that its holding did not reach Title VII retaliation claims, for which the “materially adverse” standard still applies. Majority op. 9. Nor did the Court’s decision address hostile work environment claims, or the application of ordinary pleading standards at the motion to dismiss stage.
Finally, the Court did not address how its new standard might apply to corporate Diversity, Equity, and Inclusion (“DEI”) programs. Plaintiffs challenging DEI programs under Title VII must still show that such programs caused them some harm because of a protected characteristic and with respect to a term or condition of employment.

Gibson Dunn represented the Chamber of Commerce of the United States of America, National Federation of Independent Business Small Business Legal Center, Inc., Restaurant Law Center, Inc., and National Retail Federation as Amici Supporting Respondent.

The Court’s opinion is available here.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders:

Appellate and Constitutional Law Practice

Thomas H. Dupree Jr. +1 202.955.8547 tdupree@gibsondunn.com	Allyson N. Ho +1 214.698.3233 aho@gibsondunn.com	Julian W. Poon +1 213.229.7758 jpoon@gibsondunn.com
Lucas C. Townsend +1 202.887.3731 ltownsend@gibsondunn.com	Bradley J. Hamburger +1 213.229.7658 bhamburger@gibsondunn.com	Brad G. Hubbard +1 214.698.3326 bhubbard@gibsondunn.com

Related Practice: Labor and Employment

Jason C. Schwartz
+1 202.955.8242
jschwartz@gibsondunn.com

Katherine V.A. Smith
+1 213.229.7107
ksmith@gibsondunn.com

Molly T. Senger
+1 202.955.8571
msenger@gibsondunn.com

This alert was prepared by associates Cate McCaffrey and Salah Hawkins.

Under the final rule, domestic or foreign “resource extraction issuers” are required to annually disclose information about certain payments made to foreign governments or the U.S. federal government on Form SD.

As previously reported on our Securities Regulation and Corporate Governance Monitor on December 16, 2020 (available here), the Securities and Exchange Commission (the “SEC”) adopted the final rule (available here) requiring additional disclosures by public companies that engage in the commercial development of oil, natural gas or minerals. Under the final rule, domestic or foreign “resource extraction issuers” are required to annually disclose information about certain payments made to foreign governments or the U.S. federal government on Form SD.

The final rule became effective on March 16, 2021 allowing for a two-year transition period after the effective date, with initial Form SD filings due no later than 270 calendar days after the end of an issuer’s next completed fiscal year (e.g., September 26, 2024 for issuers with a December 31, 2023 fiscal year end). While the adopting release specifically referred to September 30, 2024 as the due date for a company with a fiscal year end of December 31, 2023 (274 days after year end), we recommend filing the Form SD by September 26, 2024 to ensure timely compliance with the rule’s deadline. We note that for 2025, 2026 and 2027, the form will be due by September 27 for companies with a December 31 fiscal year end (270 days after the fiscal year end in non-leap years), unless September 27 is a Saturday, Sunday or holiday, in which case the deadline is the next business day.

What kind of information is required to be disclosed?

The final rule implements Section 13(q) of the Securities Exchange Act of 1934, as amended, which requires disclosure of company-specific, project-level information on Form SD (available here and on page 212 of the adopting release), including the:

type and total amount of payments made for each project of the resource extraction issuer relating to the commercial development of oil, natural gas or minerals;
type and total amount of such payments for all projects made to a government, as well as the country in which each such government is located;
currency used and the fiscal year in which the payments were made;
fiscal year in which the payments were made;
business segment of the issuer that made the payments;
specific projects to which such payments relate and the resources that are being developed;
method of extraction used in the project and the major subnational political jurisdiction of each project; and
payments made by a subsidiary or entity controlled by the issuer.

What kinds of activities does the rule apply to, and to whom does the rule apply?

The adopted rule applies to any resource extraction issuer. Resource extraction includes: the commercial development of oil, natural gas or minerals; the exploration, extraction, processing and export of oil, natural gas or minerals; or the acquisition of a license for any such activity.

For example, companies engaged in oil exploration and production operations and the mining industry will generally be subject to the rule.

For resource extraction joint ventures or arrangements where no one party has control, the operator of the venture or arrangement must report all of the payments. Non-operator members are only required to report payments that, as resource extraction issuers, they make directly to governments.

Who is exempt from the rule?

There are exemptions for:

issuers that are unable to comply with the final rule without violating the laws of the jurisdiction where the project is located;
issuers that are unable to comply with the final rule without violating the terms in a contract that became effective before the final rule was adopted;
smaller reporting companies, meaning issuers with a public float of less than $250 million and issuers with annual revenues of less than $100 million for previous year and public float of less than $700 million; and
emerging growth companies, meaning issuers with total annual gross revenues of less than $1,235,000,000 during their most recently completed fiscal year and that have not sold common equity securities under a registration statement.

We note that the final rule includes transitional relief for recently acquired companies that were not previously subject to the rule and for issuers that completed their initial public offering within their last full fiscal year.

What relief is afforded to acquisitions?

Form SD reporting obligations for an acquired entity will depend on whether the acquired entity was subject to Section 13(q) for the fiscal year prior to the acquisition. If the acquired entity was not subject to Section 13(q) (or an alternative reporting regime) for the issuer’s last full fiscal year prior to the acquisition, then the issuer will be required to begin reporting payment information for that acquired entity starting with the Form SD submission for the first full fiscal year immediately following the effective date of the acquisition. The issuer will therefore not be required to provide the (excluded) payment disclosure for the year in which it acquired the entity.

However, this transition period does not apply to acquisitions of entities that were already subject to Section 13(q)’s disclosure requirements. In these instances, disclosure is required for the fiscal year of the acquisition.

By way of example, if an acquisition of an entity that was not subject to Section 13(q) closes in November 2024, assuming a December 31 fiscal year end, then the acquired entity’s payments will be first reported on the Form SD covering fiscal year 2025, which must be filed by September 28, 2026, given that September 27, 2026 is a Sunday. However, if the acquired entity was already subject to Section 13(q), then the acquired entity’s payments will be reported on the Form SD covering fiscal year 2024, which must be filed by September 29, 2025, given that September 27, 2025 is a Saturday.

What about interpretive questions raised by the rule and adopting release but left unanswered?

As resource extraction issuers analyze their disclosure obligations on Form SD, various interpretative questions have arisen. We recommend coordinating discussions on these questions with your peers and industry groups. In addition, Gibson Dunn lawyers are available to assist in addressing any questions that you may have regarding compliance with this new rule and related Form SD filing requirements, as we have been working through questions with our various clients that operate in the oil and gas and mining industries.

Read More

The following Gibson Dunn lawyers assisted in preparing this update: Hillary Holmes, James Moloney, Harrison Tucker, Malakeh Hijazi, and Meghan Sherley.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. To learn more, please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Securities Regulation and Corporate Governance practice group, or the following authors:

Hillary H. Holmes – Houston (+1 346.718.6602, hholmes@gibsondunn.com)
James J. Moloney – Orange County (+1 949.451.4343, jmoloney@gibsondunn.com)
Harrison Tucker – Houston (+1 346.718.6643, htucker@gibsondunn.com)

Please also view Gibson Dunn’s Securities Regulation and Corporate Governance Monitor.