On 12 October 2022, the Hong Kong Securities and Futures Commission (“SFC”) reprimanded and imposed a HK$1.75 million fine on Asia Research & Capital Management Limited (“ARCM”), a Hong Kong licensed corporation (“LC”), for its failure to:
- comply with Regulation (EU) No 236/2012 of the European Parliament and of the Council of 14 March 2012 on short selling and certain aspects of credit default swaps (“EU Regulation”); and
- promptly notify the SFC of its regulatory breaches.[1]
The SFC also banned ARCM’s Manager-In-Charge (“MIC”) for Compliance, Mr. Billy Wong Yim Chi (“Wong”), for 2 months in relation to the above failures.
This disciplinary action is particularly noteworthy given that the SFC has imposed disciplinary action in relation to a licensed firm’s failure to comply with foreign regulatory requirements. [2] [3] Further, this matter is also the second time that the SFC has announced disciplinary actions against an MIC since the introduction of the MIC regime in 2017. The SFC’s first disciplinary action against an MIC was in November 2021 against Fulbright Securities Limited and its MIC.[4]
I. Disciplinary action against ARCM
The disciplinary action against ARCM by the SFC followed a similar action against the firm by the Financial Conduct Authority (“FCA”) in the United Kingdom in relation to its failures to comply with the EU Regulation in relation to disclosures of its net short position in Premier Oil Plc, a company listed on the London Stock Exchange.[5]
The SFC was unsympathetic towards ARCM’s explanations that its breach of the EU Regulation was due to ARCM’s unfamiliarity with the EU Regulation, its reliance on reference materials provided by its prime brokers rather than on legal advice regarding the EU reporting regime and the absence of alerts from ARCM’s investment bank counterparts.
Instead, the SFC attributed ARCM’s failures to:
- a lack of any formal process in its compliance framework requiring its staff members to analyse and understand reporting requirements which might apply when the firm invests in a new jurisdiction and implement appropriate controls;
- its failure to incorporate controls to ensure continuous compliance with the EU Regulation; and
- its decision to rely on reference materials provided by its prime brokers without conducting any further analysis. The SFC noted that if ARCM had sought legal advice on its reporting obligations or taken steps to independently check on reporting obligations under the EU Regulation, it would have identified its obligations to report short positions held through swap transactions.
The SFC considered that the above failures amounted to a breach of:
- General Principle 2 (Diligence) of the Code of Conduct for Persons Licensed or Registered with the Securities and Futures Commission (“Code of Conduct”)[6], which requires licensed corporations to act with due skill, care and diligence in the best interests of its clients and the integrity of the market; and
- General Principle 7 (Compliance) and paragraph 12.1 of the Code of Conduct, which require licenced corporations to comply with all regulatory requirements applicable to the conduct of its business activities and to implement and maintain measures appropriate to ensuring compliance with the law, rules, regulations and codes administered or issued by the Commission, the rules of any exchange or clearing house of which it is a member or participant, and the requirements of any regulatory authority which apply to the licensed or registered person.
The SFC also found that ARCM’s notification of its breaches of the EU Regulation two months after notification of such breaches to the FCA constituted a breach of the requirement under paragraph 12.5 (Notifications to the Commission) of the Code of Conduct to notify the SFC immediately of any material breach of any regulatory requirements applicable to the licensed corporation.
II. Disciplinary action against Wong
Wong was ARCM’s Head of Compliance and Operations, and the MIC for Compliance during the relevant time periods. As MIC for Compliance, his responsibilities included handling regulatory filings in relation to ARCM’s portfolio positions, and consulting external legal advisors where necessary. The SFC took the view that ARCM’s failures were attributable to Wong’s neglect in discharging his responsibilities as MIC for Compliance and as a member of senior management. In particular, the SFC noted that Wong failed to:
- implement adequate controls to ensure ARCM’s compliance with the EU Regulation; and
- seek legal advice on the short position reporting obligations under the EU Regulation despite Wong and his team’s unfamiliarity with the EU regulatory regime.
Based on the above findings, the SFC held that Wong had breached General Principle 9 (Responsibility of senior management), and paragraph 14.1 of the Code of Conduct. The provisions required Wong, as senior manager, to bear primary responsibility for maintaining appropriate standards of conduct and procedures, and to properly manage risks associated with the business of the LC.
III. Conclusion
This disciplinary action serves as a reminder to LCs and their senior management of the broad scope of the Code of Conduct in relation to foreign regulatory requirements, both from a compliance perspective as well as a self-reporting perspective. In particular, it serves as an important caution to firms considering whether foreign regulatory breaches may have triggered foreign self-reporting obligations that they must also carefully consider whether a self-report under paragraph 12.5 is required. Given the stringency of the self-reporting standard under paragraph 12.5 in comparison to foreign reporting requirements, this may put some firms in the uncomfortable position that foreign regulatory breaches may not require reports to be made to foreign regulators, but will require reporting in Hong Kong to the SFC. Similarly, given the ‘immediate’ nature of the Hong Kong self-reporting requirement and the SFC’s expectation that firms report prior to completion of investigations into the relevant conduct, firms may also need to report to the SFC before reporting to foreign regulators.
Further, this case is also particularly significant given the SFC’s clear expectation that senior management will seek legal advice in relation to regulatory requirements where they and their teams are unfamiliar with these requirements, rather than relying on (for example) summaries provided by counterparts. This should serve as an important reminder to senior Compliance staff of the need to carefully assess the necessity of seeking legal advice when entering new jurisdictions and/or rolling out new product types or lines of business. We would recommend that firms review their processes in relation to new types of business activity more broadly to ensure that these processes require active consideration by senior management as to whether legal advice is required, with a particular emphasis on new types of business activity which might lead to the firm being subject to foreign regulatory requirements.
_____________________
[1] “SFC reprimands and fines Asia Research & Capital Management Limited $1.75 million and bans former senior executive Billy Wong Yim Chi for two months” (12 October 2022), published by the Securities and Futures Commission, available at: https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=22PR79
[2] Previously, the SFC had disciplined Capital Global Management Limited (“CGML”) over breaches of foreign regulatory laws. In February 2020, the SFC reprimanded and fined CGML HK$1.5 million for failing to ensure compliance with Taiwan’s Securities Investment Trust and Consulting Act when distributing investment funds and offering investment advice in Taiwan, and for failing to adequately supervise the business activities of its representatives to ensure such compliance. The SFC enforcement action followed the judgment of the Prosecution Office of the Taipei District Court which fined the owners of CGML. See “SFC reprimands and fines Capital Global Management Limited $1.5 million” (14 February 2020). Published by the SFC, available at https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=20PR16.
[3] We further note that the SFC recently suspended a Responsible Officer and CEO of a licensed firm for two years following the SFAT upholding the SFC’s disciplinary action against this individual for breaches of the SFC Code of Conduct which occurred as a result of breaches of Korean legislation. See “SFAT affirms SFC decision to suspend hedge fund manager Christopher James Aarons” (29 September 2022), published by the Securities and Futures Commission, available at https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=22PR75.
[4] “SFC reprimands and fines Fulbright Securities Limited $3.3 million and suspends its responsible officer for internal control failures” (1 November 2021), published by the Securities and Futures Commission, available at https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=21PR107
[5] “Final Note to Asia Research and Capital Management Ltd” (14 October 2020), published by the Financial Conduct Authority, available at https://www.fca.org.uk/publication/final-notices/asia-research-and-capital-management-ltd-2020.pdf. The FCA’s disciplinary action against ARCM resulted in ARCM being fined £873,118.
[6] “Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission” (August 2022), published by the Securities and Futures Commission, available at https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-and-futures-commission/Code_of_conduct_05082022_Eng.pdf
The following Gibson Dunn lawyers prepared this client alert: William Hallatt, Emily Rumble, and Jane Lu.
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 any member of Gibson Dunn’s Global Financial Regulatory team, including the following members in Hong Kong:
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On 27 September 2022, following a ministerial review, the Office of Financial Sanctions Implementation (OFSI) imposed a monetary penalty of £30,000 in accordance with s. 146 of the Policing and Crime Act 2017 (PACA) against Hong Kong International Wine and Spirits Competition Limited (HKIWSC) for breaching UK[1] and EU[2] sanctions regulations. According to the relevant legislative provisions, it is prohibited to make funds or economic resources available, directly or indirectly, to a sanctioned party.
Between September 2017 and August 2020 HKIWSC received three payments and seventy-eight wine bottles from the sanctioned State Unitary Enterprise of the ‘Republic of Crimea’ Production-Agrarian Union (Massandra) for entry into HKIWSC’s 2017, 2018, 2019 and 2020 competitions.
OFSI identified two types of breaches: four relating to the provision of funds and tangible economic resources (i.e. the wine bottles) and one relating to the provision of intangible economic resources in the form of the publicity that was made available to Massandra by entering its wine into competitions. OFSI imposed the monetary penalty because it was satisfied that, on the balance of probabilities, HKIWSC knew or had reasonable cause to suspect that it was in breach of the relevant prohibitions. No voluntary disclosures were made in this case, therefore a penalty discount was not applied.
Intangible Economic Resources: A Novel Interpretation
This decision represents a material development as OFSI’s determination that publicity constitutes an intangible economic resource, i.e. an asset that may be exchanged for funds, is not intuitive, nor currently envisaged by the available guidance.
OFSI based its determination on the “reasonable inference” that publicity would increase Massandra’s wine sales, and PACA expressly allows the imposition of monetary penalties when the exact financial value of the resources being made available cannot be determined[3]. However, publicity may more conventionally be construed as a service, and it does not squarely fit within the definition of ‘economic resources’, i.e. “assets of every kind, whether tangible or intangible, movable or immovable, which are not funds but can be used to obtain funds, goods or services”[4].
Publicity is not conventionally treated as an asset on a company’s balance sheet and there is no way of directly exchanging ‘publicity’ for ‘funds, goods or services’. Publicity may lead to increased sales which in turn may lead to increased profits, yet the path from publicity to funds is not linear. It would have been different – and perhaps more coherent – if OFSI were to have held that the publicity increased Massandra’s goodwill in the form of brand recognition, and that such goodwill constituted an intangible economic resource. This construction would preserve the linearity of the exchange between ‘economic resources’ and ‘funds’ envisaged by the definition in the legislation, as goodwill is conventionally recognised as an asset which can directly be used to obtain funds.
Key Takeaways
This case serves as a useful reminder of the following:
- The breadth of the legislative provisions may not always be foreseeable based on a close textual reading. OFSI’s creative construction of what constitutes intangible economic resources is an example. OFSI may favour generous, over-inclusive interpretations of key terms if it is motivated to enforce.
- Many categories of assets can fall under the umbrella of intangible economic resources. OFSI’s report makes an explicit reference to intellectual property rights. This inclusion is to be expected given that intellectual property rights are conventionally treated as intangible assets and can be readily exchanged for money. Other inclusions may be less conventional, as this enforcement case shows.
- OFSI has the power to impose hefty penalties even in the face of relatively minor violations. The total cumulative value of tangible economic resources and funds received by HKIWSC was estimated at £3,919.62. Nevertheless, the penalty amounted to £30,000. In cases where the breach relates to funds or economic resources, OFSI is authorised to impose a monetary penalty the greater of £1 million and 50% of the estimated value of the funds or resources. In any other case, the maximum penalty is capped at £1 million[5]. Notably, penalties may be reduced if a voluntary disclosure is made. This highlights the value of proactive reporting supported by strong internal compliance systems which may detect breaches before the regulator does.
- OFSI continues to investigate and impose penalties for breaches of EU regulations and UK regulations that occurred prior to 31 December 2020. The breaches in this case occurred between 2017 and 2020 and were therefore breaches of the EU regulations and the now-repealed UK regulations implementing the EU regulations. If pre-2021 breaches are identified internally, it is worth considering a voluntary disclosure as the regulator can impose penalties if it becomes aware of historic noncompliance.
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[1] Regulations 3(1) and 6(1) of the Ukraine (European Union Financial Sanctions) (No. 2) Regulations 2014
[2] Articles 2(1) and 2(2) of Council Regulation (EU) No. 269/2014
[3] Policing and Crime Act 2017, s. 146(4)
[4] Sanctions and Anti-Money Laundering Act 2018, s. 60
[5] Policing and Crime Act 2017, s. 146
The following Gibson Dunn lawyers prepared this client alert: Irene Polieri, Michelle Kirschner, and Patrick Doris.
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, the authors, or the following members and leaders of the firm’s International Trade practice group:
Europe
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Asia
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We are pleased to provide you with Gibson Dunn’s Accounting Firm Quarterly Update for Q3 2022. 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:
- PCAOB Signs Cooperative Agreement with China
- Sens. Warren and Lujan Push for Increased Suspension/Debarment
- Ohio Supreme Court Leaves Verein Ruling in Place
- SEC Adopts Whistleblower Program Enhancements
- PCAOB, SEC, and DOJ Signal Continued Aggressive Enforcement
- Supreme Court Grants Certiorari in Attorney-Client Privilege Case
- New York Dept. of Financial Services Strengthens Corporate Cyber Requirements
- Other Recent SEC and PCAOB Regulatory Developments
Accounting Firm Advisory and Defense Group:
James J. Farrell – Co-Chair, New York (+1 212-351-5326, jfarrell@gibsondunn.com)
Ron Hauben – Co-Chair, New York (+1 212-351-6293, rhauben@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)
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Personal Data | Cybersecurity | Data Innovation
Europe
10/07/2022 – United States Government | Executive Order | EU-US Data Transfers
President Biden signed an Executive Order to implement the EU-US Data Privacy Framework, aiming to safeguard cross-border data flows.
As a reminder, the Privacy Shield framework (which used to enable transfers of personal data from the EU to the US) was declared invalid by the Court of Justice of the European Union in 2020 (Schrems II ruling). In March 2022, leaders of the EU and the US announced that they agreed “in principle” to a new trans-Atlantic data flow agreement (the EU-US Data Privacy Framework). For that purpose, the Executive Order on Enhancing Safeguards for United States Signals Intelligence Activities directs the steps that the US will take to implement the US commitments under the EU-US Data Privacy Framework.
The Framework notably aims to provide binding safeguards to limit US intelligence authorities access to data to what is necessary and proportionate to protect national security. A Data Protection Review Court will also be created to investigate and resolve complaints of Europeans on access of data by US intelligence authorities.
The White House asserts that this will provide the European Commission with a basis to adopt a new adequacy determination, but also greater legal certainty for companies using Standard Contractual Clauses to transfer personal data to the US.
For further information: White House Website
09/20/2022 – Court of Justice of the European Union | Decision | Data Retention
The Court of Justice of the European Union ruled that the general and indiscriminate retention of traffic data by operators providing electronic communications services for a year in order to combat market abuse offences including insider dealing is not compliant with European law.
However, in case of a serious threat to national security, some personal data (such as traffic and location data or IP addresses) may be retained under certain circumstances.
For further information: CJEU Website
09/15/2022 – European Commission | Regulation | Cybersecurity
The European Commission has presented its proposal for a new Cyber Resilience Act. The aim of the proposal is to protect both consumers and businesses from products with inadequate security features and thereby ensure a better level of cybersecurity.
In particular, the Cyber Resilience Act draft introduces mandatory cybersecurity requirements and obligations for manufacturers, as well as importers and distributors, of products with digital elements (i.e., software or hardware product and its remote data processing solutions, defined as any data processing at a distance for which the software is designed and developed by the manufacturer or under its responsibility and the absence of which would prevent the product from performing one of its functions) within the European Union. Any vulnerability contained in the product or any incident impacting its security will have to be reported by the manufacturer to the European Union Agency for Cybersecurity (ENISA). The “critical products” (e.g., operating systems, firewalls or network interfaces) would be subject to a specific compliance procedure.
This proposal of Regulation, if adopted, will be directly applicable in all Member States. Sanctions for violation will depend on the concerned breach (up to €15 million or 2.5% of the company’s total worldwide annual turnover of the preceding financial year, whichever is the higher).
In terms of timeline, it still has to be examined by the European Parliament and the Council and, once adopted, companies will have two years to adapt to the new requirements (one year for reporting obligations of manufacturers of incidents/vulnerabilities — if not modified in the final version of the Regulation).
For further information: European Commission Website
08/01/2022 – Court of Justice of the European Union | Decision | Special Categories of Data
The Court of Justice of the European Union ruled that indirectly revealing the sexual orientation of a natural person constitutes processing of special categories of personal data, protected under Article 9 of the GDPR.
In this case, Lithuanian legislation provided for the online publication of the declaration of private interests, required from individuals working in the public service in order to prevent corruption. This declaration contained name-specific data relating to the individual’s spouse, cohabitee or partner, thus disclosing indirectly his/her sexual orientation.
For further information: CJEU Website
07/28/2022 – European Data Protection Board and European Data Protection Supervisor | Joint Opinion | Child Sexual Abuse
The European Data Protection Board and the European Data Protection Supervisor adopted a Joint Opinion 04/2022 on the Proposal for a regulation to prevent and combat child sexual abuse.
In particular, the Opinion stresses the concerns regarding the proportionality of the interferences and limitations to the protection of the fundamental rights to privacy and the protection of personal data.
For further information: EDPB Website
07/18/2022 – European Union | Regulation | Digital Markets Act
The Council of the European Union gave its final approval to the Digital Markets Act.
Following the signature of the Digital Markets Act by the President of the European Parliament and the President of the Council, it will apply six months after publication in the Official Journal of the European Union.
For further information: Council of the European Union
07/14/2022 – European Data Protection Board | Document | Cooperation
In order to enhance cooperation between European supervisory authorities, the Board has published a set of criteria for identifying cross-border cases of strategic importance in different Member States, as well as the process followed by the Board to select these cases.
The Commission recalls that cases of strategic importance are primarily one-stop-shop cases which are likely to involve a high risk to the rights and freedoms of individuals in several Member States. In particular, several criteria have been defined by the Council (e.g., cases related to the intersection of data protection and other legal fields, where a high risk can be assumed, where a data protection impact assessment is required or where there is a large number of complaints in several Member States).
The supervisory authorities may refer to other supervisory authorities in any case that meets at least one of the criteria. The Board members will then decide which cases will be identified as cases of strategic importance at the European level. The Board already agreed on three (undisclosed) cases to start the project.
For further information: EDPB Website
07/12/2022 – European Data Protection Board and European Data Protection Supervisor | Joint Opinion | European Health Data Space
The European Data Protection Board and the European Data Protection Supervisor adopted a Joint Opinion 03/2022 on the European Commission’s Proposal for a Regulation on the European Health Data Space.
The Opinion aims to draw attention to a number of overarching concerns such as the clarification of the interplay between the Proposal and the GDPR or Member State laws.
For further information: Joint Opinion
07/12/2022 – European Data Protection Board | Statement | Data Transfers
The Board adopted a Statement on data transfers to Russia.
The Board recalls that data exporters who transfer personal data to Russia should assess and identify appropriate safeguards and the necessity for supplementary measures to ensure that data subjects are afforded a level of protection that is essentially equivalent to that guaranteed within the EU.
For further information: EDPB Website
Belgium
09/07/2022 – Belgian Supervisory Authority | Preliminary Questions | Advertising
The Belgian Supervisory Authority announced it has referred preliminary questions to the Court of Justice of the European Union (CJEU) regarding the appeal filed by IAB Europe in the case against the compliance of the so-called Transparency & Consent Framework (TCF) with the GDPR.
As a reminder, the TCF aims to contribute to the GDPR compliance of the OpenRTB protocol, which is one of the most widely used Real-Time Bidding protocols. In February 2022, the Belgian Supervisory Authority fined IAB €250.000 on the basis that the TCF infringes the GDPR.
In particular, the CJEU will have to determine whether a transparency and consent string which reflects users’ consent, objections and preferences can be considered as personal data.
For further information: CJUE Questions
08/19/2022 – Belgian Supervisory Authority | Sanction | Medical Data
The Belgian Supervisory Authority imposed a €20.000 fine on a medical analysis laboratory regarding various GDPR violations.
The Authority found that the principles of integrity and confidentiality were violated insofar as health data was processed through a website without using encryption. In addition, the argument that a privacy policy was not required on the website used as a “mere commercial showcase” was rejected as it was considered as an important operational tool for the laboratory’s activities. Finally, the Authority sanctioned the company for not having carried out a data protection impact assessment despite the fact that a large amount of health data was processed.
For further information: APD Website [NL]
08/17/2022 – Belgian Supervisory Authority | Decision | Complaint
The Belgian Supervisory Authority considered that a company may file a complaint against another one.
According to the Authority, the GDPR does not prohibit national regulations from allowing persons other than data subjects to file a complaint before a supervisory authority, for example where a personal data breach occurs in the context of a business relationship.
For further information: APD Website [NL]
Croatia
07/21/2022 – Croatian Supervisory Authority | Sanction | Security Breach
Following a personal data breach, the Croatian Supervisory Authority fined a company HRK 2.15 million (approx. €285.000) for failure to take adequate technical and organizational security measures.
In particular, the Authority highlighted that no access restrictions had been implemented and considered it an aggravating factor that the company is one of the main telecommunications services providers in Croatia.
For further information: AZOP Website [HR]
Denmark
09/21/2022 – Danish Supervisory Authority | Press Release | Data Transfers
The Danish Supervisory Authority issued a decision against a company using the analytics tool of an American company, reaffirming that said tool cannot be used in accordance with Chapter V of the GDPR without supplementary measures.
As a reminder, the Austrian, French and Italian Authorities expressed similar concerns.
For further information: Datatilsynet Website [DK]
08/18/2022 – Danish Supervisory Authority | Decision | Data Transfers
The Danish Supervisory Authority upheld the ban on a municipality’s use of a cloud-based workspace, imposed on July 14, 2022.
The Authority specified that the ban will apply until the municipality brings its processing activities in line with the GDPR and carries out a data protection impact assessment that meets the GDPR requirements.
For further information: Datatilsynet Website [DK]
07/14/2022 – Danish Supervisory Authority | Sanction | Security Breach
The Danish Supervisory Authority proposed to fine a Danish law firm DKK 500.000 (approx. €67.000) for failing to implement appropriate data security measures.
The Authority found that basic security measures (such as multifactor authentication to login to IT systems) were not implemented by the Danish law firm while a large amount of personal data was being processed.
For further information: Datatilsynet Website [DK]
Estonia, Latvia and Lithuania
07/27/2022 – Baltics States Data Supervisory Authorities | Coordination | Short-Term Vehicle Rental
Supervisory Authorities of the Baltic States initiated a coordinated inspection of privacy practices in the field of short-term vehicle rental.
The Estonian, Latvian and Lithuanian Supervisory Authorities launched a coordinated preventive supervision of companies specialized in short-term vehicle rental. The aim is to monitor compliance with the GDPR and to proactively address potential threats to privacy in this sector, in light of its increasing importance in the daily lives of many citizens over the last three years.
For further information: EDPB Website
Finland
07/05/2022 – Finnish Supervisory Authority | Sanction | Data Subject Rights
The Finnish Supervisory Authority published a decision issued on May 9, 2022, imposing a €85.000 fine on a Finnish magazine publisher for deficiencies in the implementation of data subject rights.
In particular, the decision outlines that some of the data subjects’ requests were not handled due to a technical issue in the e-mail redirect. In addition, the company gathered an excessive amount of information for identification by requiring data subjects to complete and sign a printable form to identify the customer exercising his/her right, and collecting signatures, without a justified reason (such as comparing the customer’s signature with one already in its possession, which was not the case here).
For further information: Ombudsman Website
France
09/08/2022 – French Supervisory Authority | Sanction | Data Security
The French Supervisory Authority fined the French Trade and Companies Register €250.000, for breaches relating to data security and retention periods.
In particular, strong passwords were not required to create a user account and personal data such as passwords were stored and transmitted in clear text. Besides, the data of a quarter of the service’s users was kept beyond the retention period.
For further information: CNIL Website [FR]
09/07/2022 – French Government | Regulation | Cybersecurity
A bill proposed various revisions to French legislation, with the aim to act against cybercrime.
In particular, the bill proposes a framework for insurance reimbursement clauses, making such reimbursement conditional on the filing of a complaint by the victim. Besides, in the context of a criminal procedure, and under the authorization given by the official authorities, enforcement authorities may seize digital assets.
For further information: French Senate Website [FR]
08/03/2022 – French Supervisory Authority | Sanction | Marketing Communication
The French Supervisory Authority fined a French group of hotels €600.000 for various breaches in the context of marketing activities.
The group sent marketing messages to customers without their consent, and did not comply with the exercise of data subject’s rights. For example, the box to subscribe to a marketing newsletter was pre-ticked, and technical issues prevented individuals from exercising their right to object.
For further information: CNIL Website [FR]
07/26/2022 – French Supervisory Authority | Recommendations | Age Verification Systems
The French Supervisory Authority issued its recommendations for online age verification systems.
In particular, the Authority reminded that pornographic websites shall not directly collect identity documents, estimate a visitor’s age based his/her browsing history, nor process biometric data to uniquely identify or authenticate an individual. The Authority further suggested using an independent trusted third party to prevent the direct transmission of identifying data about the user to the website or application publishing pornographic content, in accordance with the data minimization principles.
For further information: CNIL Website [FR]
07/22/2022 – French Administrative Court | Decision | Personal Data Breach Notification
The French Administrative Court (Conseil d’Etat) ruled that data controllers are not required to notify a personal data breach to the French Supervisory Authority (CNIL) if the CNIL was already aware of the breach.
On that basis, the Conseil d’Etat reduced the fine imposed by the CNIL from €3.000 to €2.500.
For further information: French Administrative Court Website [FR]
07/21/2022 – French Supervisory Authority | Sanction | Geolocation Data
The French Supervisory Authority fined a short-term vehicle rental company €175.000, in particular for having disproportionately infringed the privacy of its customers by geolocating them almost permanently.
The company also failed to identify and implement a proportionate data retention period, and to inform individuals.
For further information: CNIL Website
07/08/2022 – French Supervisory Authority | Formal Notices | Website Security
The French Supervisory Authority issued formal notices against fifteen organizations for insufficiently secured websites, amongst the twenty-one websites inspected in 2021.
The Authority highlights the lack of sufficient data encryption, including obsolete versions of the transport layer security (TSL) protocol and unsecured access (HTTP) to the website, and the lack of sufficient measures to protect users’ accounts, such as weak password policies.
For further information: CNIL Website [FR]
Germany
09/21/2022 – Baden Württemberg Supervisory Authority | Sanction | Use of Personal Data from Public Land Register
The Baden Württemberg Supervisory Authority imposed fines of €50.000 against a company and €5.000 against an individual for using personal data from a public land register for business development purposes.
The Authority highlights that there is no legitimate interest to process personal data as the register is created pursuant to a legal obligation, to ensure legal certainty and protect property interests, but not to facilitate marketing.
For further information: BfDI-BW Website [DE]
09/20/2022 – Berlin Commissioner for Data Protection and Freedom of Information | Sanction | Data Protection Officer
The Berlin Supervisory Authority imposed a €525.000 fine on the subsidiary of an e-commerce group because its data protection officer had a conflict of interest.
The Authority highlighted that the appointed data protection officer was the managing director of two service companies that processed personal data on behalf of the company for which he was the data protection officer. The Authority held that the subsidiary failed to comply with the GDPR insofar as a conflict of interest had arisen with no action being taken by the company, despite a previous warning issued in 2021.
For further information: BfDI Website [DE]
09/08/2022 – Lower Saxony Supervisory Authority | Warning | Profiling
The Lower Saxony Supervisory Authority issued a press release warning banks against profiling for advertising purposes.
In particular, payment transaction data and third-party data was used by the bank to assess whether a customer might be interested in a particular product. According to the Supervisory Authority, such processing would be unlawful insofar as legitimate interests of the controller cannot constitute the legal basis for the processing, and the consent forms used did not meet the GDPR requirements.
For further information: LfD Niedersachsen [DE]
09/07/2022 – Karlsruhe Higher Regional Court | Decision | Data Transfers
The Karlsruhe Higher Regional Court overturned the judgment of the Baden-Württemberg Procurement Chamber, which argued that a company had to be excluded from a public procurement procedure as its offer violated Chapter V of the GDPR governing data transfers.
As a reminder, the Baden-Württemberg Procurement Chamber excluded a company from a procurement procedure insofar as the company intended to employ the services of a Luxembourg subsidiary of an American cloud provider. According to the Baden-Württemberg Procurement Chamber, the mere risk of access to personal data stored in the European Union by American authorities would be considered as a data transfer.
The Regional Court overturned the judgment, considering that the sole group affiliation does not imply that illegal instructions might be received from the American cloud provider. However, the Regional Court did not address the Chamber of Public Procurement’s argument that the mere ability to access personal data from outside the European Union by a US cloud provider would be considered a transfer under Chapter V of the GDPR.
For further information: Oberlandesgericht Karlsruhe [DE]
08/18/2022 – Thuringia Data Protection Authority | Recommendation | Data Transfers
The Thuringia Data Protection Authority published a recommendation regarding the dynamic embedding of an American provider’s fonts on a website without obtaining visitors’ prior consent.
The Authority refers to recent case law regarding the dynamic embedding of fonts, which was found to constitute a data transfer to the US (of at least the IP address of a website visitor) because of the dynamic linking. Instead, the Authority recommends considering hosting these fonts locally to avoid any link to US servers.
For further information: TLfDI Thüringen Website [DE]
08/09/2022 – Federal Institute for Drugs and Medical Devices | Regulation | Data Protection Certification
The Federal Institute for Drugs and Medical Devices has published standard data protection criteria for digital health and care applications, making it one of the first authorities to establish a data protection certification under Article 42 of the GDPR.
For further information: BfArM Website [DE]
07/28/2022 – Lower Saxony Supervisory Authority | Sanction | Profiling
The Lower Saxony Supervisory Authority fined a bank €900.000 for profiling its active and former customers for advertising purposes without their consent.
For further information: LfD Niedersachsen Website [DE]
07/26/2022 – Lower Saxony Supervisory Authority | Sanction | Driver Assistance System
The Lower Saxony Supervisory Authority fined a car company €1.1 million for using a test vehicle with a driver assistance system using a surveillance camera without informing data subjects, conducting a data protection impact assessment, nor entering into an agreement with its processor.
In particular, the Authority highlights that a vehicle equipped with a driver assistance system using surveillance cameras must be equipped with magnetic signs displaying a camera symbol and other required information for the data subjects, in this case other road users.
For further information: LfD Niedersachsen Website [DE]
07/19/2022 – German Supervisory Authorities | Recommendation | Data Processing Agreements
Several German data protection authorities undertook a joint exercise to review model data processing agreements used by website hosting providers for the processing of their customers’ personal data.
The German data protection authorities have published a detailed checklist for data processing agreements in this respect.
For further information: BlnBDI Website [DE]
Greece
07/13/2022 – Hellenic Supervisory Authority | Sanction | Facial Recognition
The Hellenic Supervisory Authority fined an American AI company specialized in facial recognition €20 million for multiple breaches of the GDPR.
As a reminder, the company used data scraped from the internet for facial recognition and has already been subject to enforcement actions, including in France, Italy, Australia, the UK and Canada.
The Authority notably highlights that the Company failed to name a representative since the company is not established in the European Union, to lawfully process personal data, to inform the data subject and to ensure the right of access of data subjects.
For further information: HDPA Website [GR]
Ireland
09/15/2022 – Irish Supervisory Authority | Sanction | Protection of Minors
The Irish Supervisory Authority fined a social media company €405 million for breaches relating to the public disclosure of children’s personal data using the social media’s business features and a public-by-default setting for personal accounts of children.
As the Authority was unable to reach consensus with the concerned supervisory authorities, the European Data Protection Board issued a binding decision in accordance with the GDPR dispute resolution process. In addition to the fine, the Authority imposed a range of corrective measures, including an order to bring the processing into compliance by taking a range of specified remedial actions.
For further information: DPC website; EDPB Binding Decision
07/06/2022 – Irish Supervisory Authority | Reprimand | Erasure Request
The Irish Supervisory Authority published a reprimand issued on April 27, 2022 against a social media company, for requiring data subjects to provide copies of their IDs when submitting erasure requests.
In particular, the Authority found that the company failed to comply with the data minimization principle and to provide a valid legal basis for such processing. It also ordered the company to revise its internal policies and procedures for handling erasure requests.
For further information: DPC Decision
Italy
06/30/2022 – Italian Supervisory Authority | Sanction | Financial Data
The Italian Supervisory Authority published a decision issued on May 26, 2022, imposing a €100.000 fine on an Italian bank for the unlawful disclosure of customer data to an unauthorized third party.
The bank disclosed a data subject’s banking activity to its parent company without a valid legal basis. The Authority rejected the bank’s argument according to which the disclosure was made by an employee in good faith.
For further information: Garante Website [IT]
Netherlands
07/27/2022 – Dutch Council of State | Decision | Legitimate Interest
The Dutch Council of State upheld a decision overturning the €575.000 fine imposed by the Dutch Supervisory Authority against a video and social platform in 2020. Besides, the European Commission issued a letter, asking the Authority to change its position according to which pure commercial interest does not qualify as legitimate interest.
As a reminder, the case concerned a video and social media platform that installed streaming cameras around amateur soccer fields. The Authority held that the platform could not use legitimate interest as a legal basis since its interest is exclusively commercial. On the contrary, the district court and the Council of State ruled that the platform has other interests such as the interests of players or the public watching the game.
In its letter, the European Commission considers that the Authority’s strict interpretation of legitimate interests is not in line with the GDPR and severely limits businesses’ possibilities of processing personal data for commercial interests, as they would have to collect consent from the data subject in every case where an economic interest is pursued. Against this background, the Commission invited the Authority to readjust its position and reflect that commercial interests can be regarded as legitimate interests when they are not overridden by the fundamental rights and freedoms of the data subject.
For further information: Raad van State Website [NL]; European Commission Letter
Norway
09/09/2022 – Norwegian Supervisory Authority | Sanction | Credit Assessment
The Norwegian Supervisory Authority published a decision issued on August 25, 2022, imposing a NOK 200.000 (approx. €20.000) fine on a company for performing a credit assessment on a data subject without any legal basis to do so.
The Authority notes that the data subject did not have any kind of customer relationship or other connection with the company. In particular, the Authority found that legitimate interest cannot be used a lawful basis insofar as the data subject did not expect the company to process his credit information.
For further information: Datatilsynet Website [NO]
Poland
07/06/2022 – Polish Supervisory Authority | Sanction | Personal Data Breach Notification
The Polish Supervisory Authority fined a company PLN 15.994 (approx. €3.500) for failing to notify a personal data breach.
The Authority considered that a company who loses an employment certificate must notify such breach, even if the employee does not file a complaint, since the certificate of employment contains personal data (e.g., period of employment, parental and child care leave taken).
For further information: EDPB Website
Portugal
08/16/2022 – Portuguese Supervisory Authority | Sanction | Data Security
The Portuguese Supervisory Authority announced the publication of Law No. 16/2022 of August 16, 2022 which approves the Electronic Communications Law.
The law aims to implement several EU Directives, including the Directive 2018/1972 establishing the European Electronic Communications Code. The law notably requires operators to notify the Authority of any security incident and imposes obligations to ensure an adequate level of security for public electronic communication networks and publicly available electronic communications services. This new law will come into force within 90 days as of its publication.
For further information: ANACOM Website [PT]
Romania
09/08/2022 – Romanian Supervisory Authority | Sanction | Security
The Romanian Supervisory Authority fined a digital and media company RON 39.272 (approx. €8.000) for failure to implement adequate technical and organizational measures.
The Authority found that a security incident impacting the platform managed by the company led to an unauthorized disclosure or access to personal data, including names, telephone numbers and bank data.
For further information: ANSPDCP Website [RO]
08/22/2022 – Romanian Supervisory Authority | Sanction | Security of Processing
The Romanian Supervisory Authority fined an energy company RON 49.337 (approx. €10.000) for failure to implement remedial measures to reduce risk following a personal data breach.
The Authority considered that the company, which sent an email containing personal data to the wrong person, breached Article 32 of the GDPR by not providing the Authority with sufficient information on the remedial measures taken following the incident. In addition, the Authority issued a warning against the company for failing to notify the breach.
For further information: ANSPDCP Website [RO]
08/09/2022 – Romanian Supervisory Authority | Sanction | Transparency
The Romanian Supervisory Authority fined a passenger transportation company RON 34.630,40 (approx. €7.000) for failure to provide clear, complete and accurate information to data subjects.
In particular, the company’s website did not provide information regarding the purpose and the legal basis of the processing, the identity and contact data of the data controller, the data retention periods and the conditions for the exercise of data subject’s rights.
For further information: ANSPDCP Website [RO]
Slovenia
08/05/2022 – Slovenian Supervisory Authority | Guidance | Data Protection Impact Assessments
The Slovenian Supervisory Authority published a guide for conducting data protection impact assessments (DPIA).
In particular, the guidance highlights common DPIA shortcomings, gives recommendations to data controllers, and provides a checklist to help determine if a DPIA is comprehensive.
For further information: Slovenian Supervisory Authority Website [SL]
Spain
08/04/2022 – Spanish Supervisory Authority | Sanction | Data Accuracy
The Spanish Supervisory Authority fined an electricity company €50.000 for violation of the accuracy principle.
The Authority found that the company breached the principle of accuracy by linking wrong information, and consequently causing the cancellation of the complainant’s electricity supply contract with his provider.
For further information: AEPD Website [ES]
08/02/2022 – Spanish Supervisory Authority | Sanction | Lawfulness of Processing – Spanish Supervisory Authority | Sanction | Lawfulness of Processing
The Spanish Supervisory Authority fined a bank €42.000 for violations of the lawfulness of processing principle.
The Authority found that after the claimant asked the bank several times not to send any stock market investment report by post to his home address, the bank continued to do so.
For further information: AEPD Website [ES]
07/26/2022 – Spanish Supervisory Authority | Guidance | Biometric Data
The Spanish Supervisory Authority issued guidance regarding the use of biometric data.
The guidance focuses on data protection impact assessments in relation to biometric data and the criteria used to classify biometric systems in the framework of a processing operation when assessing the risk to the rights and freedoms of individuals that the processing of such data may entail.
For further information: AEPD Website
07/22/2022 – Spanish Supervisory Authority | Sanction | Marketing Calls
The Spanish Supervisory Authority fined a telecommunications company €40.000 for unlawful marketing calls, despite a data subject’s registration in the national opt-out list and notification of his direct opt-out to the company.
For further information: AEPD Website [ES]
07/18/2022 – Spanish Supervisory Authority | Sanction | Data Processing Principles
The Spanish Supervisory Authority fined a bank €56.000 for failing to comply with various data processing principles.
In particular, the Authority ruled that the bank violated the principle of integrity and confidentiality of processing by sending a report on a data subject’s investment to the wrong recipient, due to a computer error.
For further information: AEPD Website [ES]
07/13/2022 – Spanish Supervisory Authority | Sanction | Personal Data Breach
The Spanish Supervisory Authority published a decision issued on May 3, 2022, imposing a €132.000 fine on an insurance company for repeatedly sending medical data to an unauthorized third party and failing to notify a personal data breach despite being alerted.
For further information: AEPD Website [ES]
Sweden
09/13/2022 – Swedish Supervisory Authority | Decision | Sensitive Personal Data
The Swedish Supervisory Authority sanctioned a company for offering a browsing service that allows users to access court decisions containing sensitive personal data.
In particular, the Authority highlighted that the company’s database gave users access to court decisions with information on individuals who had undergone mandatory care due to mental illness or addiction. Therefore, the Authority issued a reprimand and ordered the company to take measures to prevent such access.
For further information: IMY Website [SE]
09/06/2022 – Swedish Supervisory Authority | Investigation | Employee Monitoring
The Swedish Supervisory Authority announced that it has opened an investigation regarding a transport company for monitoring the driving behavior of some of its employees.
The Swedish Supervisory Authority asked the transport company to clarify whether it had a legal basis for processing and whether it had provided required information to its employees.
For further information: IMY Website [SE]
Switzerland
08/31/2022 – Swiss Supervisory Authority | Press Release | New Data Protection Legislation
The Swiss Supervisory Authority announced that a new data legislation will come into force on September 1, 2023.
This regulation aims to improve data protection in Switzerland and shares similarities with the GDPR, such as data processing principles, the obligation to report personal data breaches and to conduct data protection impact assessments. It differs from the GDPR in some respects as, for example, there is no obligation for companies to appoint a data protection officer.
For further information: Swiss Supervisory Authority Website [FR]
08/09/2022 – Swiss Supervisory Authority | Document | Access Request
The Swiss Supervisory Authority issued recommendations on the exercise of access requests.
The Authority published recommendations in a dispute settlement procedure between a the Federal Intelligence Service (FIS) and a claimant requesting access to documents concerning the legal basis and processing of the FIS’ facial recognition systems. The FIS refused on the basis of national law, which provides that access to official documents shall be restricted if it jeopardizes the internal or external security of Switzerland. However, the Supervisory Authority deemed the FIS’ arguments too general and unspecific to prove a threat to the internal or external security of Switzerland and recommended the FIS to grant the claimant full access to the required documents.
For further information: Swiss Supervisory Authority recommendations [DE]
United Kingdom
09/07/2022 – UK Supervisory Authority | Guidance | Privacy-Enhancing Technologies
The UK Supervisory Authority has published draft guidance on privacy-enhancing technologies (PETs).
The publication forms part of the Authority’s draft guidance on anonymization and pseudonymization. The draft guidance explains some of the different types of PETs and their benefits, as well as how they can help organizations comply with data protection law.
For further information: ICO Website
09/06/2022 – UK Supervisory Authority | Sanction | Direct Marketing
The UK Supervisory Authority fined a UK-based motoring and cycling retailer £30.000 (approx. €34.000) for sending unsolicited marketing emails to data subjects without their consent.
The Authority held that the company improperly relied on legitimate interest as a lawful basis and could not count on the soft opt-in exemption insofar as the customers who received the email had opted out of marketing.
For further information: ICO Website
08/19/2022 – UK Supervisory Authority | Guidance | Complaint
The UK Supervisory Authority published guidance for small businesses that receive data protection complaints.
The Authority issued a six-step guide to acknowledge receipt of the complaint, find out the specific issue related to the complaint, provide updates to the data subject, record actions taken in response to the complaint, formally respond to the individual regarding the outcome of the investigation, and review the lessons learned.
For further information: ICO Website
07/21/2022 – UK and US Government | Joint Statement | Data Access Agreement
UK and US Governments issued a joint statement announcing that the UK-US Data Access Agreement will come into force on October 3, 2022.
As a reminder, the Data Access Agreement allows the US and the UK law enforcement agencies to directly request data held by communications providers in the other party’s jurisdiction in order to prevent, detect, investigate and prosecute serious crimes such as terrorism and child sexual abuse and exploitation.
In October 2019, the UK and US Governments signed an agreement on cross-border law enforcement demands for data from communication service providers. Recently, the two countries have completed the procedural steps required to bring this agreement into force.
For further information: US Department of Justice Website
07/18/2022 – UK Parliament | Regulation | Data Protection and Digital Information Bill
The UK Government published a draft of the Data Protection and Digital Information Bill.
The draft Bill provides for various changes to the UK’s legal framework, including replacement of the role of data protection officer with a designated senior responsible individual, changes to record-keeping requirements, replacement of the regime for carrying out data protection impact assessments and removal of the requirement for non-UK organizations to appoint a UK representative, as well as exempting additional types of website cookies from the existing consent requirements.
Please note that the Bill may be subject to substantial change following the announcement in October by the Secretary of State that the UK will be replacing GDPR with a new data protection regime.
For further information: UK Parliament Website
07/05/2022 – UK Government | Data Transfers | Data Adequacy Agreement
The UK and the Republic of Korea reached an adequacy agreement in principle to secure the transfer of data outside of the UK.
For further information: UK Government Website
This newsletter has been prepared by the EU Privacy team of Gibson Dunn. For further information, you may contact us by email:
- Ahmed Baladi – Partner, Co-Chair, PCCP Practice, Paris (abaladi@gibsondunn.com)
- Vera Lukic – Partner, Paris (vlukic@gibsondunn.com)
- Kai Gesing – Partner, Munich (kgesing@gibsondunn.com)
- Joel Harrison – Partner, London (jharrison@gibsondunn.com)
- Alison Beal – Partner, London (abeal@gibsondunn.com)
- Clémence Pugnet – Associate, Paris (cpugnet@gibsondunn.com)
- Léna Bionducci – Associate, Paris (lbionducci@gibsondunn.com)
- Yannick Oberacker – Associate, Munich (yoberacker@gibsondunn.com)
© 2022 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On October 7, 2022, the Department of Commerce Bureau of Industry and Security (“BIS”) released broad changes in the Export Administration Regulations (“EAR”) that together will create an effective embargo against providing to China the technology, software, manufacturing equipment, and commodities that are used to make certain advanced computing integrated circuits (“ICs”) and supercomputers. These changes include new restrictions on the participation by U.S. companies on enabling any semiconductor development or production at a facility in China[1] that manufactures or even potentially manufactures certain advanced ICs. BIS explained that it developed this sweeping set of new regulations to curtail China’s use of these items in the development of weapons of mass destruction, artificial intelligence and supercomputing-enhanced war fighting, and in technologies that enable violations of human rights. BIS further noted that these broad-based controls are necessary to address China’s mobilization of vast resources to support its defense modernization and the implementation of its “military-civil fusion” development strategy in ways that are contrary to U.S. national security and foreign policy interests.
BIS framed this new set of regulations as an interim final rule, which allows it to impose immediate controls with specified effective dates. Generally speaking, the new restrictions on exports of items associated with semiconductor manufacturing activities went into effect immediately on October 7, 2022, and the new restrictions on the exports of supercomputers, as well as associated parts, software, and technology, will come into effect on October 21, 2022. In addition, a new licensing requirement for support of foreign items destined for use in Chinese company development and production of ICs will become effective between these two dates, on October 12. In the table below we summarize almost 20 separate changes that BIS’s interim final rule is implementing in the coming weeks.
| Effective Fri., Oct. 7, 2022 (U.S. Time) |
Effective Wed., Oct. 12, 2022 (U.S. Time) |
Effective Fri., Oct. 21, 2022 (U.S. Time) |
| 15 C.F.R. § 740.2 (NEW restriction on license exceptions for certain ECCNs) | 15 C.F.R. § 744.6 (NEW and Expanded controls on U.S. person’s ability to support China development of integrated circuits) | 15 C.F.R. § 734.9(e) (Revised Entity List FDP Rule to add additional restrictions to 28 Chinese entities on the Entity List) |
| 15 C.F.R. § 740.10 (Revised recordkeeping requirement for License Exception RPL) | 15 C.F.R. § 734.9(h) (NEW Advanced Computing FDP Rule) | |
| 15 C.F.R. § 742.6 (NEW Regional Stability (“RS”) Controls for semiconductor manufacturing items sent to China) | 15 C.F.R. § 734.9(i) (NEW Supercomputer FDP Rule) | |
| >15 C.F.R. § 744.11(b) (NEW criteria for adding entities to the Entity List) | 15 C.F.R. Part 734, Supplement No. 1 (NEW model certification for Advanced Computing FDP Rule) | |
| 15 C.F.R. § 744.23 (NEW semiconductor manufacturing end-use prohibitions) | 15 C.F.R. Part 736, Supplement No. 1 (NEW Temporary General License for certain newly controlled activities) | |
| 15 C.F.R. Part 774, Supplement No. 1 (NEW ECCN 3B090 and Revised ECCNs 3B991, 3D001, and 3E001) | 15 C.F.R. § 740.2 (NEW Restriction on License Exceptions for certain ECCNs) This is an expansion of the new controls implemented on Oct. 7, 2022. |
|
| 15 C.F.R. § 742.6 (NEW RS Controls for semiconductor manufacturing and advanced computing items to China) This is an expansion of the new controls implemented on Oct. 7, 2022. |
||
| 15 C.F.R. § 744.1 (NEW restrictions on supercomputer and semiconductor manufacturing end-use prohibitions) | ||
| 15 C.F.R. § 744.11 (NEW licensing requirements concerning expansion of Entity List FDP Rule and “Footnote 4” Entity List entities) | ||
| 15 C.F.R. § 744.23 (New supercomputer and semiconductor manufacturing end-use prohibitions) This is an expansion of the new controls implemented on Oct. 7, 2022. |
||
| 15 C.F.R. Part 744, Supplement No. 4 (NEW Footnote 4 added to 28 Chinese entities on Entity List to account for expansion of Entity List FDP Rules) | ||
| 15 C.F.R. § 762.2 (NEW recordkeeping requirement to retain Advanced Computing FDP Rule supply chain certificate) | ||
| 15 C.F.R. § 772.1 (NEW definition for “supercomputer” under the Commerce Control List (“CCL”)) | ||
| 15 C.F.R. Part 774, Supplement No. 1 (Revised Note 3 to Category 3, Product Group A; Revised ECCNs 3A991, 3D001, 3E001, 4A994, 4D994, 4E001, 5A992, and 5D992; NEW ECCNs 3A090, 4A090, and 4D090) |
On October 7, 2022, BIS also released a final rule adding 31 Chinese technology companies to the Commerce Department’s Unverified List. It also revised the criteria for inclusion on the Entity List to include an entity’s refusal or a host country’s continued interference in the ability of the entity to provide its bona fides or information to verify end-use checks. A concurrent rule issued by Commerce’s Export Enforcement division states that it will be applying a new, staged approach to adding companies to the Entity List where a foreign government interferes in end-use checks, essentially using the Unverified List as a first step.
We explain and outline the impacts of each of the new provisions below.
New Controls for Exports to China of Advanced IC, Advanced IC Manufacturing Equipment, and Associated Commodities, Software and Technology (15 C.F.R. §§ 740.2, 740.10, 742.6, and Part 774, Supplement No. 1)
One of the most consequential changes contained in the new regulations is the imposition of unilateral “Regional Stability” or RS controls on exports to China of advanced computing ICs, computer commodities that contain such ICs, and certain semiconductor manufacturing equipment, as well as associated software and technology. These new unilateral controls impose a license requirement for exports, reexports, and in-country transfers of identified items to or within China.
The new RS-based licensing requirement will be imposed in stages on a set of new and revised items defined by Export Control Classification Numbers (“ECCNs”). The new RS controls on certain semiconductor manufacturing items, as well as associated software and technology, became effective on October 7, 2022. Similar controls on certain advanced computing items will come into effect on October 21, 2022.
- Effective October 7, 2022:
- New ECCN 3B090 to control certain semiconductor manufacturing equipment and specially designed parts, component, and accessories.
- Revised ECCNs 3B991, 3D001, and 3E001 to account for new RS controls and corresponding changes in light of new ECCN 3B090.
- Effective October 21, 2022:
- New ECCNs 3A090, 4A090, and 4D090 to control specified high-performance ICs; certain computers, electronic assemblies, and components containing ICs; and associated software, respectively.
- Revised ECCNs 3D001, 3E001, and 4E001 for the software and technology associated with ECCNs 3A090, 4A090, and 4D090, as well as 5A992 and 5D992 for commodities and software that meet or exceed the performance parameters of ECCNs 3A090 or 4A090.
BIS further restricted access in China to the items described by these ECCNs by limiting the availability of most license exceptions for these items, including the widely used license exception for encryption items (referred to as “ENC”). Prior to this rule change, some advanced ICs did not require licensing when exported to China solely because they incorporated an information security functionality that could qualify for license exception ENC after certain classification, filing, and/or reporting requirements were met. Under the new rules, license exception ENC will not be available to overcome the new RS license requirements for items that also meet the classification criteria for ECCNs 3A090, 4A090, and the associated software and technology in 3D001, 3E001, 4D090, and 4E001.
Importantly, the new RS controls do not apply to deemed exports or deemed reexports.
BIS will review license applications to export, reexport, and transfer in-country RS-controlled items to PRC-IC fabricators under a presumption of denial. However, BIS will review applications for semiconductor manufacturing items destined to end users in China that are headquartered in the United States or in certain closely allied nations listed in Country Groups A:5 and A:6 on a case-by-case basis.
New Controls on Specified High-Performance Computing ICs and Commodities That Contain Them (15 C.F.R. Part 774, Supplement No. 1)
BIS is also adding new unilateral “anti-terrorism” or AT controls on the export of certain high-performance ICs, and their associated software and technology. These ICs can be found in a wide range of applications, including central processing units (“CPU”), graphics processing units (“GPU”), tensor processing units (“TPU”), neural processors, in-memory processors, vision processors, text processors, co-processors/accelerators, adaptive processors, and field-programmable logic devices (“FPLDs”). These new IC controls are described under ECCNs 3A991p and 4A994.l, and their corresponding software and technology controls under ECCNs 3D991, 3E991, 4D994, and 4E992, and exports, reexports, and transfers of these items to Iran, North Korea, and Syria will now require licensing.
Impact of New AT Controls on Certain Foreign National Employees in the United States – Deemed Exports
Whenever BIS identifies new technologies for control, companies and other organizations that employ foreign nationals in the United States need to consider whether the new controls will impose a requirement for them to obtain “deemed export” licenses. With respect to these new controls on these high-performance ICs and the commodities that contain them, BIS clarified that foreign national employees who did not previously require a license, but now do, will not require licensing unless they are provided access to new technology or software that exceeds the scope of the technology or software they received previously. For example, an Iranian national technologist who lawfully accessed technology or software specified in new ECCN paragraphs 3A991.p or 4A994.l prior to the effective date would not need a new license to continue receiving the same technology or software, but would require a license for the release of controlled technology or software different from that previously released, even if the technology or software is classified under the same ECCNs.
Although this clarification creates something of a safe harbor for existing national employees who support U.S. domestic companies with the development of high-performance ICs, the harbor is not particularly deep or wide, and we expect these new export controls to pose significant deemed export compliance challenges for many. Among other challenges, few companies would have already created detailed inventories of the specific software and technology its employees have access to that Commerce now controls with the new ECCNs prior to their creation last week. Moreover, even if and when such inventories are developed, the question of what would constitute the release of a new or different software or technology to the foreign national employee will immediately present itself. For example, would foreign national’s writing of new source code for the same piece of software be considered new? What if the employee is asked to work on design changes for a similar, but different IC than a company currently sells? Not only will many companies have significant difficulties identifying access to the newly controlled technologies, and then construing what releases of technology and software are new, but once they determine a license is needed, the companies and the foreign national employees will then be faced with a protracted period of uncertainty as BIS adjudicates the deemed export license application, a process that often takes between six and twelve months.
New and Expanded Foreign Direct Product (“FDP”) Rules
BIS is also significantly expanding the application of its existing Entity List FDP rules and creating two new FDP rules on advanced computing ICs and supercomputers. These rules come into effect October 21, 2022.
- Entity List FDP Rule (15 C.F.R. §§ 734.9(e), 744.11, and Part 744, Supplement No. 4)
After early attempts to cut off the flow of U.S.-origin items to Huawei, BIS modified the national security-related control known as the Foreign Direct Product Rule to enable it to target a broader range of exports to specific companies that it has designated to the EAR Entity List (“Entity List FDP rule”). The Foreign Direct Product Rule concept is at the farthest end of U.S. efforts to extend its export controls jurisdiction extraterritorially because it applies to non-U.S.-origin items that are the direct products of specified U.S.-origin software and technology, or of “major components” or whole plants that are the direct product of this software and technology. BIS also has used new FDP rule modifications to limit the access by Russian and Belarusian military end users and military intelligence end users to commodities produced with controlled U.S. software and technology.
BIS has now expanded its Entity List FDP rule to cover 28 China-based entities that it had already designated to the Entity List over the last several years for their alleged participation in nuclear and other weapons of mass destruction proliferation, as well as surveillance and other human rights violations. Thus, in addition to requiring licenses for exports of U.S. origin items, any non-U.S. based exporters also will require U.S. export licenses to export, reexport or transfer items that are direct products of technology or software classified by the following ECCNs: 3D001, 3D991, 3E001, 3E002, 3E003, 3E991, 4D001, 4D993, 4D994, 4E001, 4E992, 4E993, 5D001, 5D002, 5D991, 5E001, 5E002, or 5E991, as well as the direct product of any plant or “major component” of a plant that is the “direct product” of U.S.-origin “technology” or “software” that is specified in the ECCNs listed above. These ECCNs apply to most ICs, computers, telecommunications, and information security items controlled by Commerce.
BIS also has created two new, similarly structured FDP rules to target the export, reexport and transfer of foreign direct products used to develop or produce ICs and supercomputers for China-based manufacturers.
- Advanced Computing FDP Rule (15 C.F.R. §§ 734.9(h), 762.2, and Part 734, Supplement No. 1)
The Advanced Computing FDP rule expands the scope of the EAR to certain items destined for China, as well as certain items produced in China. The rule is applicable whenever an exporter has “knowledge” (as defined under the EAR to cover actual knowledge and an awareness of a high probability, which can be inferred from acts constituting willful blindness) that the item is (1) destined for China or will be incorporated into any “part,” “component,” “computer,” or “equipment” (not designated EAR99) destined for China, or (2) the technology is developed by an entity headquartered in China for the “production” of a mask or an IC wafer or die. The foreign-produced items that are affected by this new rule include those items that are either:
- (i) the “direct product” of “technology” or “software” subject to the EAR and specified in ECCNs 3D001, 3D991, 3E001, 3E002, 3E003, 3E991, 4D001, 4D090, 4D993, 4D994, 4E001, 4E992, 4E993, 5D001, 5D002, 5D991, 5E001, 5E991, or 5E002; and
-
- (a) are described by ECCNs 3A090, 3E001 (for 3A090), 4A090, or 4E001 (for 4A090); or
- (b) are ICs, computers, “electronic assemblies,” or “components” specified elsewhere on the CCL that meet the performance parameters of ECCNs 3A090 or 4A090;
- (ii) or are produced by any complete plant or “major component” of a plant that is located outside the United States, when the plant or “major component” of a plant, whether made in the United States or a foreign country, itself is a “direct product” of U.S.-origin “technology” or “software” that meets the requirements discussed immediately above.
As a suggested compliance aid, BIS has provided a suggested (voluntary) sample certification that suppliers can complete to comply with this Advanced Computing FDP. See Supplement 1 to Part 734. In this certification, the supplier would assert that an item being provided will be subject to the EAR if a future transaction meets the destination scope outlined above. If a certificate is not provided by a supplier, BIS explains that the supplier’s customers will need to complete additional due diligence to determine if the item purchased is subject to the Advanced Computing FDP’s licensing requirement for onward exports to China. BIS further notes, however, that the certification alone should not be the only due diligence conducted before an export occurs. Moreover, BIS advises that entities outside of China that receive 3E001 for 3A090 technology from China should consider confirming that a license was obtained to export such technology from China, as the provisions of the Advanced Computing FDP also extend to certain items produced in China by China-based manufacturers. If no such license has been obtained, the item would have been exported from China in violation of the EAR. In addition, parties involved in supporting the transaction would be subject to the EAR’s General Prohibition 10, which prohibits any person from taking further action on a transaction with knowledge (see definition above) that a violation has occurred or is about to occur.
- Supercomputer FDP Rule (15 C.F.R. §§ 734.9(i) and 772.1)
Similarly, BIS has now issued the Supercomputer FDP rule to expand the scope of the EAR to certain items destined for China whenever the exporter has “knowledge” that the foreign-produced item will be (1) used in the design, “development,” “production,” operation, installation (including on-site installation), maintenance (checking), repair, overhaul, or refurbishing of a “supercomputer” (as defined in the EAR) located in or destined to China; or (2) incorporated into, or used in the “development,” or “production,” of any “part,” “component,” or “equipment” that will be used in a “supercomputer” located in or destined to the China.
The foreign-produced items affected by this new rule are as follows:
- foreign-produced items that are the “direct product” of “technology” or “software” subject to the EAR and specified in ECCNs 3D001, 3D991, 3E001, 3E002, 3E003, 3E991, 4D001, 4D993, 4D994, 4E001, 4E992, 4E993, 5D001, 5D991, 5E001, 5E991, 5D002, or 5E002; or
- are produced by any plant or “major component” of a plant that is located outside the United States, when the plant or “major component” of a plant, whether made in the United States or a foreign country, itself is a “direct product” of U.S.-origin “technology” or “software” that is specified in the ECCNs 3D001, 3D991, 3E001, 3E002, 3E003, 3E991, 4D001, 4D994, 4E001, 4E992, 4E993, 5D001, 5D991, 5E001, 5E991, 5D002, or 5E002.
As of October 21, 2021, “supercomputer” will be specifically defined under the EAR as “a computing “system” having a collective maximum theoretical compute capacity of 100 or more double-precision (64-bit) petaflops or 200 or more single-precision (32-bit) petaflops within a 41,600 ft3 or smaller envelope.” Commerce’s definition for “supercomputer” is interesting in at least two ways. First, it appears that a large variety of advanced ICs can be used to create the level of computing power density outlined by the definition. Thus, this definition creates a kind of catch-all for computing power regardless of how it is achieved. Second, data center providers, and those who support them, may need to consider whether any specific data center could conceivably meet this computing power threshold.
- Temporary General License (15 C.F.R. Part 736, Supplement No. 1)
Taken together, these new sets of RS, FDP, and ECCN-defined controls will have a significant impact on the ability of China-headquartered companies to obtain access to the commodities, technology and software required to manufacture ICs and Supercomputers. But a larger policy comes into focus when one considers a Temporary General License (“TGL”) that BIS issued alongside these controls.
The TGL authorizes companies headquartered in the United States or in a subset of other countries (those not headquartered in Country Groups D:1 or D:5 or E) to continue exporting certain ICs and associated software and technology for specified purposes to their affiliates and subsidiaries located in China through April 7, 2023, provided that none of the ultimate recipients of the items being manufactured with these products are located in China. The announced objective for the TGL is to mitigate the immediate disruption that these new controls will have on users of the TGL’s supply chains. Once the TGL expires in April 2023, exporters will need to apply for an individually validated export license to export such advanced computing chips, assemblies containing them, and related software and technology to China for supply chain-related activities, such as assembly, inspection, quality assurance, and distribution. These applications will carry a presumption of denial, although license applications for semiconductor manufacturing items destined to end users in China that are headquartered in the United States or in certain closely allied nations listed in Country Groups A:5 and A:6 will be reviewed on a case-by-case basis.
The TGL allows, at least until April 7, 2023, companies to continue exporting the following items:
- ECCNs 3A090, 4A090, and associated software and technology in ECCNs 3D001, 3E001, 4D090, or 4E001; and
- any item that is a computer, IC, “electronic assembly” or “component” and associated software and technology, specified elsewhere on CCL which meets or exceeds the performance parameters of ECCNs 3A090 or 4A090.
The TGL’s expiry in April 2023 provides but a short time for U.S. and other Group A:5 and A:6 headquartered companies to find alternative fabricators for ICs. Other non-China based fabricators may already be at capacity, and the timeline for bringing new fabrication facilities online and qualifying them to produce new ICs is far longer than the timelines currently contemplated by the TGL.
New End-User/End-Use Controls (15 C.F.R. §§ 744.1 and 744.23)
The new regulations also restrict China’s access to ICs and supercomputing through the imposition of new end-user and end-use controls. These controls are knowledge-based controls that require exporters to seek BIS licensing when they know, are informed, or are otherwise unable to determine that their exports will be put to certain end uses.
On October 7, 2022, these end-user/end-use prohibitions were extended to the following:
- any item subject to the EAR used in the “development” or “production” of ICs at a semiconductor fabrication “facility” located in China which fabricates certain ICs such as advanced logic, NAND, and DRAM ICs;
- any item subject to the EAR and classified in an ECCN in Product Groups B, C, D, or E in Category 3 of the CCL when the individual or entity knows the item will be used in the “development” or “production” of ICs at any semiconductor fabrication “facility” located in China, but for which the individual or entity does not know whether such semiconductor fabrication “facility” fabricates advanced ICs; and
- any item subject to the EAR for which the individual or entity will be used in the “development” or “production” in China of any “parts,” “components” or “equipment” specified under ECCNs 3B001, 3B002, 3B090, 3B611, 3B991, or 3B992.
On October 21, 2022, these end-user/end-use prohibitions also will apply to certain “supercomputers” as defined under the EAR, namely:
- any IC subject to the EAR and specified in ECCNs 3A001, 3A991, 4A994, 5A002, 5A004, or 5A992 when the individual or entity knows the item will be used in (1) the “development,” “production,” “use,” operation, installation (including on-site installation), maintenance (checking), repair, overhaul, or refurbishing of a “supercomputer” located in or destined to China; or (2) incorporation into, or the “development” or “production” of any “component” or “equipment” that will be used in a “supercomputer” located in or destined to China; and
- any computer, “electronic assembly,” or “component” subject to the EAR and specified in ECCNs 4A003, 4A004, 4A994, 5A002, 5A004, or 5A992 when the individual or entity knows the item will be used for the activities described above.
Commerce notes that it will review all end-user/end-use license applications with a presumption of denial, but that it will consider license applications for semiconductor manufacturing items destined to end users in China that are headquartered in the United States or in certain closely allied nations listed in Country Groups A:5 and A:6 on a case-by-case basis.
Activities of U.S. Persons (15 C.F.R. § 744.6)
Effective October 12, U.S. persons will be prohibited from engaging in certain activities, even when dealing with items that are non-U.S. origin.
Specifically, BIS will now require U.S. persons to apply for licenses to facilitate or engage in shipping, transmitting or transferring to or within China the following products:
- any item not subject to the EAR that the individual or entity knows will be used in the “development” or “production” of ICs at a semiconductor fabrication “facility” located in China that fabricates certain ICs such as advanced logic, NAND, and DRAM ICs; or in the servicing of any such items;
- any item not subject to the EAR and meeting the parameters of any ECCN in Product Groups B, C, D, or E in Category 3 of the CCL that the individual or entity knows will be used in the “development” or “production” of ICs at any semiconductor fabrication “facility” located in China, but for which the individual or entity does not know whether such semiconductor fabrication “facility” fabricates certain ICs such as advanced logic, NAND, and DRAM ICs; or in the servicing of any such items; or
- any item not subject to the EAR and meeting the parameters of ECCNs 3B090, 3D001 (for 3B090), or 3E001 (for 3B090) regardless of end use or end user; or in the servicing of any such items.
Commerce will review all such license applications with a presumption of denial, although license applications for semiconductor manufacturing items destined to end users in China that are headquartered in the United States or in certain closely allied nations listed in Country Groups A:5 and A:6 will be reviewed on a case-by-case basis.
Additions to Unverified List (“UVL”) and Changes to Entity List Designation Criteria (15 C.F.R. § 744.11(b))
The new final rule adds specific criteria for designation to the more restrictive Entity List:
- an entity precludes access to, refuses to provide, or provides false or misleading information related to the parties to the export transaction or the underlying item; or
- where there is a sustained lack of cooperation by the entity’s host government to facilitate end-use checks of entities on the UVL.
In a related statement of a new policy in line with these changes in the final rule, BIS laid out a two-step process whereby companies that do not complete requested end-use checks within 60 days will be added to the UVL, and if those companies are added to the UVL due to the host country’s interreference, after a subsequent 60 days of the end-use check not being completed, the company on the UVL will be transferred to the Entity List.
The new policy states that for all companies currently on the UVL as of the date of the policy (October 7, 2022), including the 31 new China company additions, the 60-day “escalation” clock begins immediately.
________________________
[1] As a reminder, under current U.S. export controls, China also includes the Hong Kong Special Administrative region after the United States revoked Hong Kong’s special status under U.S. law in 2020.
The following Gibson Dunn lawyers prepared this client alert: Christopher Timura, Chris Mullen, Judith Alison Lee, David A. Wolber, Adam M. Smith, and Stephenie Gosnell Handler.
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, the authors, or the following members and leaders of the firm’s International Trade practice group:
United States
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Annie Motto – Washington, D.C. (+1 212-351-3803, amotto@gibsondunn.com)
Chris R. Mullen – Washington, D.C. (+1 202-955-8250, cmullen@gibsondunn.com)
Sarah L. Pongrace – New York (+1 212-351-3972, spongrace@gibsondunn.com)
Samantha Sewall – Washington, D.C. (+1 202-887-3509, ssewall@gibsondunn.com)
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)
Asia
Kelly Austin – Hong Kong (+852 2214 3788, kaustin@gibsondunn.com)
David A. Wolber – Hong Kong (+852 2214 3764, dwolber@gibsondunn.com)
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Beijing – (+86 10 6502 8534, qyue@gibsondunn.com)
Europe
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Nicolas Autet – Paris (+33 1 56 43 13 00, nautet@gibsondunn.com)
Susy Bullock – London (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris – London (+44 (0) 207 071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly – London (+44 (0) 20 7071 4205, sharber-kelly@gibsondunn.com)
Penny Madden – London (+44 (0) 20 7071 4226, pmadden@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33 180, mwalther@gibsondunn.com)
© 2022 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Today the U.S. Department of Labor issued a proposed rule regarding who is an “independent contractor” under the Fair Labor Standards Act (the “FLSA” or “Act”), and thus not subject to the minimum wage and overtime requirements the Act applies to “employees.” The proposal defines independent contractor more narrowly than the 2021 Trump Administration rule it is intended to replace. Interested parties will have 45 days from the proposal’s expected October 13 Federal Register publication to submit comments.
The proposal would codify a six-factor, totality-of-the-circumstances test for who qualifies as an independent contractor, similar in some respects to the approach the Department often used before the 2021 rule. Under DOL’s proposal, independent contractor status would be determined by looking to the following factors: the worker’s opportunity for profit or loss; the worker’s investments; the permanency of the relationship; the degree of control by the employer over the worker; whether the work is an integral part of the employer’s business; and the skill and initiative required to do the work. The proposed test would not assign special weight to any of the six factors, and instead consider them “in view of the economic reality of the whole activity” in which the worker in question is engaged.
Apart from jettisoning the framework of the 2021 rule—which relied on five factors, not six, and gave particular weight to “control” and the “opportunity for profit or loss”—the new proposal would make important adjustments to how the six traditional factors are applied. For example, DOL proposes considering the worker’s investments on a relative basis with the employer’s investments. The proposed rule states, “If the worker’s investment does not compare favorably to the employer’s investment, then that fact suggests that the worker is economically dependent and an employee of the employer.” Likewise, the proposal would reformulate the factor concerning whether a worker’s activities are part of an “integrated unit of production” into an assessment of whether the activity is important or “central” to a business’s operations. The proposal would also treat control measures implemented by a company to comply with “legal obligations, safety or health standards, or requirements to meet contractual or quality control obligations” as indicative of employee status.
The proposed rule does not adopt either the common-law test or the “ABC test” for determining independent contractor status. DOL stated that it “continues to believe that legal limitations prevent the Department from adopting either of those alternatives.”
If finalized, these changes could reduce the number of workers who can be treated as independent contractors.
In its proposal, DOL acknowledges that the proposed rule is an “interpretive” rule, meaning that if finalized it would be entitled only to “Skidmore deference” from the courts, rather than the more robust “Chevron deference” that sometimes is given to binding substantive rules.
The terms of the Department’s final rule will depend on its response to comments submitted by interested parties during the notice-and-comment period, including legal objections raised to the Department’s proposed six-part test, and commenters’ description and substantiation of any significant adverse consequences expected under the proposed approach. Until a final rule is issued—possibly in mid-to-late 2023—the Department’s 2021 rule will remain in place. Legal challenges are possible once a final rule is adopted.
The following Gibson Dunn attorneys assisted in preparing this client update: Gene Scalia, Michael Holecek, and Blake Lanning.
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 or Administrative Law and Regulatory practice groups, or the following authors or practice leaders:
Eugene Scalia – Co-Chair, Administrative Law and Regulatory Group, Washington, D.C. (+1 202-955-8210, escalia@gibsondunn.com)
Michael Holecek – Los Angeles (+1 213-229-7018, mholecek@gibsondunn.com)
Blake Lanning – Washington, D.C. (+1 202-887-3794, blanning@gibsondunn.com)
Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C.
(+1 202-955-8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles
(+1 213-229-7107, ksmith@gibsondunn.com)
Helgi C. Walker – Co-Chair, Administrative Law and Regulatory Group, Washington, D.C. (+1 202-887-3599, hwalker@gibsondunn.com)
© 2022 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On September 27, 2022, Governor Newsom signed California’s new pay transparency and pay scale disclosure law. This Alert summarizes the new requirements and enforcement mechanisms, including how they depart from California’s previous pay transparency laws, as well as their impact on employers’ pay reporting and disclosure obligations.
The new requirements are set to become effective January 1, 2023, with the first pay data reports due to the California Civil Rights Department (the “Department,” formerly the Department of Fair Employment and Housing) in May 2023.
Pay Scale Disclosures in Job Postings to Employees and Applicants
The law expands California’s existing salary history law to impose new pay scale disclosure requirements on covered employers.
Under the existing law, California employers were required to provide the pay scale, meaning the salary or hourly wage range, only upon request by an applicant who completed an initial interview. The new law maintains that applicant disclosure requirement and adds that, upon a current employee’s request, covered employers will be required to provide the pay scale the employer reasonably expects to pay for such employee’s currently-held position.
California employers with 15 or more employees will also be required to include a position’s pay scale, meaning the salary or hourly rate an employer reasonably expects for the position, in any job posting, whether the employer itself posts the job or engages a third party to manage job postings.
The new law also imposes recordkeeping requirements on all employers, regardless of size, in that employers must maintain job title and salary history for all employees during their employment and for three years thereafter.
New Enforcement Mechanisms, Including Private Right of Action and Civil Penalties
The California Labor Commissioner is authorized to order civil penalties ranging from $100 to $10,000 for violations of the pay scale disclosure requirements. The Labor Commissioner will determine the penalty based on the totality of the circumstances, including prior violations.
Fortunately, the law provides that the Labor Commissioner will not assess a penalty for the first violation of the job posting requirements so long as the employer demonstrates that all job postings are updated to include the required disclosures.
Employers must also make available job title and salary history records for inspection upon request by the Labor Commissioner, with violations being subject to the same civil penalties as the pay data disclosure provisions, ranging from $100 to $10,000.
Finally, the Legislature created a private right of action for violations of the pay scale transparency law within a year of learning of such violations, giving aggrieved parties the right to seek injunctive and “any other appropriate relief.” Perhaps most significantly, the law creates a rebuttable presumption in favor of an employee’s claim should an employer fail to maintain the records of each employee’s job titles and pay rate history for the specified timeframe.
More Employers Covered, and Additional Data Required
The new law also dramatically expands the scope of potential employers covered as well as their pay data reporting obligations.
Covered Employers
Previously, only private employers with 100 or more employees were required to submit pay data reports to the Department if they were already required to file an annual EEO-1 Employer Information Report. Employers were also permitted to submit their annual EEO-1 report to satisfy the state’s pay data reporting obligations.
Now, all private employers with 100 or more employees will be required to submit pay data reports, without regard to federal EEO-1 reporting status. And employers are no longer permitted to submit an EEO-1 in lieu of a pay data report.
Although the Department has not yet published guidance interpreting the new law, the Department’s guidance on the existing law provides that employers are covered by these requirements if they have 100 or more total employees with at least one employee in California. Existing guidance also directs employers to include remote employees in the pay data reports if the employees are assigned to a California establishment, regardless whether they reside in California, or the employees reside in California but are assigned to an establishment in another state.
In addition, under the new law, employers with multiple establishments must continue to submit a separate report for each establishment. Employers will no longer be required to submit a consolidated report that includes all employees across establishments as the existing law required.
Data Required
Similar to requirements under existing law, employers’ pay data reports are to be based on a “snapshot” of W-2 earnings during a single pay period from October through December of the previous calendar year.
The pay data report must break out the number of employees by race, ethnicity, and sex in a series of job categories, and must report the number of employees by race, ethnicity, and sex whose earnings fall within each of the pay bands prescribed in the Bureau of Labor Statistics’ Occupational Employment Statistics survey. Significantly, there is a new requirement that employers identify the median and mean hourly pay rate for each combination of race, ethnicity and sex (inter-sectionally) for each job category.
Contract Workers
In a further departure from existing requirements, private employers with over 100 employees hired through labor contractors in the prior year will also be required to submit a separate pay data report covering contract workers. The new law broadly defines “labor contractors” to include both individuals and entities “that supply workers, either with or without a contract,” “to perform labor within the client employer’s usual course of business.”
Although the new law requires each labor contractor to provide employers with the necessary pay data to complete the reports, covered employers are ultimately responsible for the reports and must disclose the ownership names of any labor contractors who supplied workers in the previous year.
New Civil Penalties
Starting next year, employers who fail to submit the required annual reports may face fines of up to $100 per employee for initial violations, and up to $200 per employee for subsequent violations, in addition to potentially being responsible for the Department’s costs associated with obtaining a court order to ensure compliance.
Key Takeaways
Covered employers should take steps to comply with the new requirements, including to disclose pay scales in job postings, as well as to maintain job title and pay rate history records, in advance of the January 1, 2023 effective date. Covered employers should be mindful of the fact that obtaining the required information from labor contractors may prove time consuming so employers should plan in advance of the May reporting deadline. In addition, preparing the requisite pay data reports will also require careful consideration and preparation to comply with the Department’s guidance. Employers located in multiple states should also be mindful of other state salary transparency requirements such as those for Washington, Colorado, and New York City.
The following Gibson Dunn attorneys assisted in preparing this client update: Amanda R. Sansone, Jason C. Schwartz, Katherine V.A. Smith, Danielle J. Moss, Harris M. Mufson and Tiffany Phan.
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:
Tiffany Phan – Los Angeles (+1 213-229-7522, tphan@gibsondunn.com)
Harris M. Mufson – New York (+1 212-351-3805, hmufson@gibsondunn.com)
Danielle J. Moss – New York (+1 212-351-6338, dmoss@gibsondunn.com)
Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)
© 2022 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
In making a winding-up order against Carnival Group International Holdings Limited (the “Company”), Hong Kong Court emphasizes the importance for the directors of an insolvent company to carefully consider whether they should procure the company to oppose the winding-up petition otherwise they could be personally liable to pay costs arising from the opposition.[1]
The Hon Linda Chan J ordered the winding up of the Company after hearing the petition (the “Petition”) presented in March 2020 by one of the unsecured creditors of the Company (the “Petitioner”), which the Company opposed on the basis that there were pending restructuring proposals. The Court noted that there is a duty on the directors to protect and safeguard the interests of the unsecured creditors. In circumstances where the directors became aware that the restructuring proposals would not come to fruition, it would be incumbent upon them to cause the Company to be wound up. As the directors had failed to do so and incurred costs to oppose the Petition, the Court considered that it may be appropriate to make an adverse costs order against the directors personally, and they were directed to file evidence/submissions to demonstrate why they should not be liable. After considering the directors’ submissions, the Court ordered that the four directors who remained in office on the date of the winding-up order to be personally liable for the costs of and occasioned by Company’s opposition to the Petition at the hearing before the Hon Linda Chan J on 23 August 2022.[2]
1. Background
The Company was listed on The Stock Exchange of Hong Kong. It was incorporated in Bermuda and, until its being wound up, had since February 1994 been registered as an oversea company in Hong Kong under the former Companies Ordinance. The Company was an investment holding company and held a number of subsidiaries incorporated in Hong Kong, the Mainland and the BVI (together, the “Group”).
Since 2018, the Company and the Group had been in financial difficulty and they were unable to meet their debts using the income generated from the business. As at 31 December 2019, the Company’s net liabilities were HK$1 billion, and the total outstanding interest-bearing debts of the Group (consisting of both secured and unsecured debts) was RMB 7.6 billion.
The Petitioner was a holder of a number of unsecured bonds (with an outstanding principal of over HK$30 million at the date of the Petition) which the Company had defaulted. The Petition was supported by other unsecured creditors (the “Supporting Creditors”) to whom an aggregate amount of over HK$878 million was owed by the Company. In addition, one of the 12 institutional (and secured) creditors which had in the past signed letters to support an adjournment of the Petition also indicated support of the Petition before the hearing. No creditor had filed any notice to oppose the Petition.
2. Winding-up order made by the Court
The Petition averred, among other things, that the three core requirements for the Court to exercise its discretionary jurisdiction to wind up the Company were satisfied.[3] Even though in all of its affirmation filed in opposition to the Petition, the Company did not dispute such averments and only relied upon the ground that there had been ongoing restructuring effort which, if implemented, would result in higher return to the unsecured creditors, the Company sought to contend at the hearing (held on 23 August 2022) that the second core requirement (i.e. there must be a reasonable possibility that the winding-up order would benefit those applying for it) was not satisfied.
The Court held that it was not open to the Company to raise the jurisdictional challenge 2.5 years after the Petition was presented and, in any event, there was no merit in such argument.
The Court also noted that there was no evidence to show that the Company had made any real effort in pursuing the restructuring proposals, and that the history of the matter showed that the Company had used the so-called restructuring effort to obtain multiple adjournments and yet failed to comply with a number of orders requiring the Company to file affidavit evidence to deal with the progress of such restructuring.
In the circumstances, the Court was satisfied that it should exercise its discretionary jurisdiction under s.327(3) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (“CWUO”) and made a winding-up order against the Company.
3. Duty of the directors of an insolvent company and potential costs order against the Company’s directors
The Hon Linda Chan J emphasized that the directors of an insolvent company are duty bound to (a) consider whether there is any reasonable prospect of the company avoiding going into insolvent liquidation, and (b) take step to put the company into liquidation where there is no viable restructuring proposal supported by the requisite majorities of creditors. Such duty is enshrined in the avoidance provisions under the CWUO (such as s.266, which renders debts paid subject to unfair preferences voidable, and s.275, which imposes liability on directors for fraudulent trading). Where a company is insolvent or of doubtful solvency, the directors in carrying out their duty to the company must take into account the interests of the creditors, which should be regarded as paramount. This is because the interests of the company are in reality the interests of the creditors, whose money is at stake.
The Court held that it must have been clear to the directors of the Company, who were said to be in discussion with the institutional creditors concerning the restructuring proposals, that there was no reasonable prospect for the Company to be able to implement any proposals to compromise its debts so as to avoid liquidation. As soon as they became aware that the restructuring proposal would not be implemented, the directors should have taken step to cause the Company to be wound up so as to protect and safeguard the interests of the unsecured creditors. When pressed upon by the Court, the Company was unable to identify any justification as to how it was in the interests of the Company and the creditors to oppose the Petition, mindful of the Company’s insolvent state, the directors’ duty to protect the interests of the creditors and the lack of any viable restructuring proposals.
4. Adverse costs order against the directors
The Court further criticized the directors for causing the Company to continue to oppose the Petition by raising the jurisdictional challenge that was devoid of merits. The Court concluded that it may be appropriate to depart from the usual costs order (which is that the costs of the Petitioner and one set of costs for the Supporting Creditors be paid out of the assets of the Company) and to consider ordering the directors to pay for the costs of and occasioned by the Company’s opposition to the Petition from the time when they became aware that the restructuring proposals would not be implemented. The directors of the Company were joined as respondents to the Petition for costs purpose only, and the Court directed them to file and serve evidence and/or submission to explain why they should not be liable for costs.
Upon considering the submissions subsequently filed by the six relevant directors, the Hon Linda Chan J concluded that there was no basis for them to cause the Company to oppose the petition on jurisdictional ground, which was advanced as the only ground in opposition to the Petition at the 23 August 2022 hearing.
The Court ordered three Independent Non-Executive Directors and an Executive Director, who were directors of the Company at the materials times and who remained in office on the date when the Company was ordered to wind up, to pay to the Petitioner, the Supporting Creditors (with one set of costs) and the Official Receiver their costs of and occasioned by the Company’s opposition to the Petition at the hearing on 23 August 2022. As to the two Executive Directors who had ceased to be directors of the Company from 4 September 2021 and 15 May 2021 respectively, the Court was satisfied that after their resignation, they were not involved in causing the Company to oppose the Petition, and hence they were not ordered to pay the costs occasioned by such opposition.
5. Conclusion
This judgment serves as a useful reminder of the directors’ duty where a company is insolvent or of doubtful solvency. When discharging their duty, directors of an insolvent company must consider the creditors’ interests as paramount and take those into account in exercising their discretion. They are duty bound to consider whether there is any reasonable prospect of the company avoiding insolvent liquidation, and should take step to wind up the company where there is no viable option.
If the directors fail to discharge such duty and yet cause the company to oppose a winding-up petition unreasonably, they may face adverse costs consequence and may be held liable for the costs of and occasioned by opposing the winding-up petition.
________________________
[1] Re Carnival Group International Holdings Limited [2022] HKCFI 2668, available here.
[2] Re Carnival Group International Holdings Limited [2022] HKCFI 3097, available here.
[3] Please refer to paragraph 2 of our client alert “Hong Kong Court of Final Appeal Confirms That ‘Leverage’ Satisfies the ‘Benefit’ Requirement for Winding Up Foreign Companies”, available here, for an explanation of the three core requirements.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, or the authors and the following lawyers in the Litigation Practice Group of the firm in Hong Kong:
Brian Gilchrist (+852 2214 3820, bgilchrist@gibsondunn.com)
Elaine Chen (+852 2214 3821, echen@gibsondunn.com)
Alex Wong (+852 2214 3822, awong@gibsondunn.com)
Celine Leung (+852 2214 3823, cleung@gibsondunn.com)
© 2022 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On October 3, 2022, in In re Stream TV Networks, Inc. Omnibus Agreement Litigation,[1] Vice Chancellor Laster of the Delaware Court of Chancery issued an extraordinary order unwinding a transaction by divesting a party’s ownership of shares in a Delaware corporation and vesting ownership of those same shares in another litigant. Finding the divested party in contempt because of its efforts to undermine the Court of Chancery’s earlier orders in the case, Vice Chancellor Laster accomplished this result in reliance on a Court of Chancery rule that does not appear to have been relied on in any previously reported decision, but which empowers the Court to reassign ownership of Delaware property. This decision should serve as a powerful wake-up call to Delaware litigants as to both the extent of the Court of Chancery’s authority and the dangers of being “too clever by half” in attempting to narrowly construe its orders.
Facts and Procedural History
In re Stream involved an agreement between Stream TV Networks, Inc. (“Stream”), its secured creditors, including Hawk Investment Holdings Ltd. (“Hawk”), and certain of its shareholders, that was entered into after Stream had defaulted on its secured debt. The creditors’ debt was secured by all of Stream’s assets, which primarily consisted of shares in an operating subsidiary incorporated in Delaware (the “Shares”). In the agreement, Stream agreed to transfer all of its assets to SeeCubic, Inc. (“SeeCubic”), a newly formed entity controlled by the secured creditors, while Stream’s minority shareholders received the right to exchange their shares in Stream for shares in SeeCubic.[2] Stream’s majority shareholders objected, leading to litigation in the Delaware Court of Chancery concerning the agreement’s validity.
In December 2020, the Court of Chancery held that the agreement was enforceable and preliminarily enjoined the parties from “taking any action to interfere with it,”[3] after which SeeCubic acquired Stream’s assets, including the Shares. The Court of Chancery subsequently granted summary judgment as to the validity of the agreement and issued a permanent injunction in September 2021.[4] The Delaware Supreme Court reversed, however, holding that the agreement was invalid because it had not been approved by Stream’s majority shareholders, and remanded the case for further proceedings.[5] Because the agreement was invalid, the Court of Chancery directed that the disputed assets be returned to Stream, including the Shares.[6] Hawk then sought permission to immediately exercise its rights as a secured creditor prior to that transfer, which the Court of Chancery denied.[7] Vice Chancellor Laster explained that returning the parties to the same positions they had enjoyed prior to the since-reversed rulings was “not possible” due to the passage of time, but “unwinding the transfer of the [assets was] nevertheless the closest possible alternative” and would allow Stream “to conduct business and make efforts to satisfy the claims of Hawk and Stream’s other creditors.”[8]
According to the Court of Chancery, on September 30, 2022, SeeCubic and Hawk next engaged in “a series of coordinated acts in which SeeCubic would transfer the Shares to Stream in a manner that would enable Hawk to seize them by acting before Stream could respond,” ensuring that they would end up in Hawk’s possession.[9]
First, SeeCubic informed the Court that the assets had been returned to Stream. Next, twenty-three minutes later, Hawk sent a letter consisting of “dense legalese”—replete with defined terms, as well as citations to and quotations from several contracts and court orders—that “could not have been drafted in the twenty-three minutes that [had] elapsed,” which demanded that title to the Shares immediately be registered in Hawk’s name.[10] That registration occurred three minutes after the letter was sent, so quickly that the letter’s recipient “could not have reviewed Hawk’s letter, considered its implications, and updated [its] stock ledger.”[11] Finally, one hour later after the shares were registered in Hawk’s name, Hawk wrote to the Court that it now owned the Shares and had exercised various rights as shareholder of the operating subsidiary, including changing the subsidiaries bylaws and the constitution of its board of directors.
In all, “[t]he choreographed sequence of events took place during an extended lunch hour, starting at 11:45am and ending at 1:18 p.m.,” causing Vice Chancellor Laster to comment that “[i]t was not possible for [the parties] to have taken the actions they did without advance notice, preparation, and an overarching plan.”[12] Later that same day, Stream filed an emergency motion with the Court of Chancery, which the Court granted.
The Court’s Ruling
On October 3, 2022, the Court of Chancery held SeeCubic and Hawk in contempt because they had acted in concert to undermine the Court’s earlier orders. Vice Chancellor Laster divested Hawk’s ownership of the Shares, vested their ownership in Stream, and temporarily enjoined SeeCubic and Hawk from interfering with Stream’s ownership of the Shares.
The Delaware Court of Chancery exercises discretion in imposing contempt sanctions, employing an equitable standard in deciding whether a party failed to obey the court’s orders “in a meaningful way.”[13] SeeCubic argued that it complied with the earlier order because it had transferred the Shares to Stream, but the Court focused on the intentionally transitory nature of Stream’s ownership, which lasted for only minutes before title was further transferred to Hawk as a result of SeeCubic and Hawk’s coordination. Vice Chancellor Laster explained that he had intended for Stream to have ownership of the Shares that afforded it a meaningful opportunity to engage with its secured creditors.[14] SeeCubic and Hawk deprived Stream of this intended opportunity, however, ignoring that Vice Chancellor Laster’s earlier decisions “did not envision a choreographed transfer” by SeeCubic and Hawk to “seize the Shares before Stream could react.”[15] By purposefully frustrating the intended result, SeeCubic and Hawk acted in contempt.
Employing an apparently unprecedented remedy, the Court of Chancery divested Hawk’s ownership of the Shares, vesting their ownership in Stream instead. The Court’s rules provide that, “in proper cases” in which a “party [is] in contempt,” the Court “may enter a judgment divesting the title of any party” to “real or personal property . . . within the jurisdiction of the Court” and “vesting it in others.”[16] Because “[s]hares of stock in a Delaware corporation are personal property within the jurisdiction of the Court,” it was empowered to transfer the Shares’ ownership.[17] Vice Chancellor Laster commented that the pertinent rule has never before been invoked in a reported Court of Chancery opinion. He reasoned that “[e]xtraordinary facts will sometimes call for extraordinary remedies” in order “to give the parties that to which they are entitled,” however, and “the fact that a particular form of relief is unprecedented does not mean it is unwarranted or unavailable.”[18]
Further, the Court of Chancery granted a ten-day injunction barring SeeCubic and Hawk from interfering with Stream’s ownership of the Shares, in an effort to restore the parties to roughly the same state they had occupied before the Court of Chancery’s since-reversed December 2020 decision.[19] Because Hawk had not yet exercised its rights as a secured creditor at that time, Stream was entitled to some period of time to act as owner of the Shares without Hawk’s interference. Reassigning the Shares’ ownership and granting a temporary injunction, Vice Chancellor Laster explained, would achieve the outcome envisioned by the earlier order that SeeCubic and Hawk sought to evade.
CONCLUSION
Despite the Delaware Court of Chancery’s observation that this case involved “[e]xtraordinary facts,” In re Stream may have significant implications. And, at a minimum, is a powerful reminder to litigants in all courts of the dangers inherent in playing fast and loose in adherence with court orders. As demonstrated by In re Stream, technical attempts to abide by the letter of the law while ignoring its spirit may not end well.
_____________________________
[1] — A.3d —-, 2022 WL 4675753 (Del. Ch. 2022) (“In re Stream”).
[2] Id.
[3] Stream TV Networks, Inc. v. SeeCubic, Inc., 250 A.3d 1016 (Del. Ch. 2020).
[4] Stream TV Networks, Inc. v. SeeCubic, Inc., 2021 WL 4352732 (Del. Ch. Sept. 23, 2021).
[5] Stream TV Networks, Inc. v. SeeCubic, Inc., 279 A.3d 323 (Del. 2022).
[6] Stream TV Networks, Inc. v. SeeCubic, Inc., 2022 WL 3283863 (Del. Ch. Aug. 22, 2022).
[7] In re Stream TV Networks, Inc. Omnibus Agreement Litig., 2022 WL 4491925 (Sept. 28, 2022).
[8] Id. at *3-4.
[9] In re Stream, 2022 WL 4675753 , at *6.
[10] Id. at *4.
[11] Id.
[12] Id. at *7.
[13] Id. at *6.
[14] Id. at *7.
[15] Id. at *1.
[16] Ct. Ch. R. 70(a).
[17] In re Stream, 2022 WL 4675753, at *8.
[18] Id.
[19] Id. at *9.
The following Gibson Dunn attorneys assisted in preparing this client update: Shireen Barday, Michael Nadler, Priya Datta, and Emma Li*.
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, any member of the firm’s Securities Litigation practice group, or the authors:
Shireen A. Barday – New York (+1 212-351-2621, sbarday@gibsondunn.com)
Michael Nadler – New York (+1 212-351-2306, mnadler@gibsondunn.com)
Securities Litigation Group:
Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, mloseman@gibsondunn.com)
Brian M. Lutz – Co-Chair, San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com)
Craig Varnen – Co-Chair, Los Angeles (+1 213-229-7922, cvarnen@gibsondunn.com)
Shireen A. Barday – New York (+1 212-351-2621, sbarday@gibsondunn.com)
Christopher D. Belelieu – New York (+1 212-351-3801, cbelelieu@gibsondunn.com)
Jefferson Bell – New York (+1 212-351-2395, jbell@gibsondunn.com)
Michael D. Celio – Palo Alto (+1 650-849-5326, mcelio@gibsondunn.com)
Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com)
Jennifer L. Conn – New York (+1 212-351-4086, jconn@gibsondunn.com)
Thad A. Davis – San Francisco (+1 415-393-8251, tadavis@gibsondunn.com)
Ethan Dettmer – San Francisco (+1 415-393-8292, edettmer@gibsondunn.com)
Jason J. Mendro – Washington, D.C. (+1 202-887-3726, jmendro@gibsondunn.com)
Alex Mircheff – Los Angeles (+1 213-229-7307, amircheff@gibsondunn.com)
Robert F. Serio – New York (+1 212-351-3917, rserio@gibsondunn.com)
Jessica Valenzuela – Palo Alto (+1 650-849-5282, jvalenzuela@gibsondunn.com)
Robert C. Walters – Dallas (+1 214-698-3114, rwalters@gibsondunn.com)
* Emma Li is a recent law graduate practicing in the firm’s New York office and not yet admitted to practice law.
© 2022 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On September 23, 2022, the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) issued General License D-2 (“GL D-2”), expanding a prior authorization to further facilitate the free flow of information over the internet to, from, and among residents of Iran. GL D-2 authorizes the exportation to Iran of certain services, software, and hardware incident to the exchange of internet-based communications. GL D-2 supersedes and replaces an existing license, General License D-1 (“GL D-1”), that had been in place without update for over eight years. According to the Treasury Department, the updated license is designed to bring the scope of the license in line with modern technology and ultimately to expand internet access for Iranians, providing them with “more options of secure, outside platforms and services.” As noted below, even though GL D-2 certainly expands upon the types of software and services allowed to be exported, one of its principal effects will likely be the enhanced comfort parties may have in providing such technology to Iran. GL D-1 was often not fully leveraged by the exporting community that was concerned about the extent of coverage. GL D-2 is an evident attempt to right this balance, making sure that exporters remain aware of limitations while also providing more certainty to those who wish to leverage the exemption.
GL D-2 is the latest Biden Administration effort to support the Iranians protesting the death of Mahsa Amini, a 22-year-old woman who was arrested by Iran’s Morality Police for allegedly violating the country’s laws on female dress and who died in police custody on September 16. Iranian protest-related videos and messages on the internet and social media have captured local and global attention. The United Nations Secretary-General, among others, has called for an independent investigation into Amini’s death. The Iranian government, meanwhile, has violently responded to protests and cut off internet access for most of its nearly 80 million citizens. OFAC’s initial response on September 22 was to impose blocking sanctions on Iran’s Morality Police and on seven senior leaders of Iran’s security organizations that have overseen the suppression of peaceful protests. The next day, OFAC issued GL D-2 and published accompanying FAQ guidance. The State Department highlighted the development as a step toward ensuring that the “Iranian people are not kept isolated and in the dark.”
GL D-2 retains much of the core operative language from GL D-1, including certain limitations. For example, the expansion in authorized services does not apply to the Government of Iran, for which there is still no authorization for fee-based services, and the license does not authorize services to most Iranian Specially Designated Nationals (“SDNs”). At the same time, as described by the Treasury Department, GL D-2 has modernized and broadened the authorization originally granted in GL D-1 in a number of meaningful ways. We highlight below the most notable updates.
Authorized Communications No Longer Need to Be “Personal”
As mentioned, GL D-2 authorizes the exportation to Iran of certain services, software, and hardware incident to the exchange of “communications over the [i]nternet.” Notably absent throughout the license is the requirement, previously present in GL D-1, that required the internet-based communications be “personal.” This is a significant change, because what exactly qualified as a “personal communication” under GL D-1 has been a gray area that caused many compliance questions. Indeed, a Treasury Department official confirmed that the change was motivated by feedback from industry that the “personal” limitation was “a sticking point.” This update makes clear that technology companies need not assess the “personal” nature of communications, which may make such companies and others more comfortable relying on the license.
This is also not the first time OFAC has omitted or removed the “personal” requirement in a communications-related general license authorizing internet-based activities. This past July, for example, OFAC issued General License No. 25C under its Russia Harmful Foreign Activities Program (promulgated in response to Russia’s invasion of Ukraine). This General License also allows the exportation of communications-related services to Russia without requiring that such communications be “personal.” Another example is the 2015 amendment by OFAC of the Cuba sanctions regulations which also dropped the “personal” requirement from that program’s internet-communications license.
Casting a Wider Net Over Supporting Software
The new license has also further expanded the authorization of software. GL D-2 now allows the export of certain supporting software that is “incident to” or “enables” internet communications. Previously, GL D-1 only permitted software “necessary to enable” internet communications. By removing the requirement that software be “necessary” to support authorized services, GL D-2 expands the types of software covered by the exemption and provides an additional measure of confidence to exporters of internet-based communications software.
Additional Activities Are Now Expressly Covered
Compared to its predecessor license, the authorizing language in GL D-2 is broader and more explicit regarding the types of services that U.S. persons may offer to people in Iran. Previously, OFAC’s guidance listed only six examples of permitted activities: “instant messaging, chat and email, social networking, sharing of photos and movies, web browsing, and blogging.” GL D-2 expands on that illustrative list, adding “social media platforms, collaboration platforms, video conferencing, e-gaming, e-learning platforms, automated translation, web maps, and user authentication services.” In our view, many of the newly added activities were likely already authorized under the prior GL D-1, but their addition to GL D-2 helps to confirm that they are indeed covered.
Entirely New Cloud-Based Authorization That Extends Beyond GL D-2
GL D-2 authorizes the provision of cloud-based services in support of both the activities enumerated in GL D-2 and “any other transaction authorized or exempt under the [Iranian Transactions and Sanctions Regulations (‘ITSR’)].” As a Treasury Department official explained, cloud-based services are key to aiding Iranians’ access to the internet because “today so many VPNs and other [sorts] of anti-surveillance tools are delivered via cloud.”
This cloud-based authorization is among the most significant expansions of GL D-1’s original authorization, because it applies to a variety of transactions, parties, and services beyond those listed in GL D-2. For instance, as described in FAQ 1087, the cloud-based services provision applies to “news outlets and media websites covered by the exemption for information or informational materials in section 560.210(c) of the ITSR.” Treasury also highlights that the cloud-based services provision applies to other transactions authorized under the ITSR, including:
- transactions “necessary and ordinarily incident to publishing authorized pursuant to [ITSR] section 560.538”;
- transactions “for the conduct of the official business of certain international organizations pursuant to [ITSR] section 560.539”;
- the “sale and exportation of agricultural commodities, medicine, medical devices, and certain software and services pursuant to [ITSR] section 560.530”; and
- transactions “authorized pursuant to any [other] general or specific licenses issued under the ITSR.”
Coverage of “No-Cost” Services and Software
Under the prior regime, GL D-1 authorized fee-based services and software, while the general license at ITSR section 560.540 contained a parallel authorization for services and software provided at no cost. GL D-2 explicitly covers both fee-based and no-cost activity, but no-cost services to the Government of Iran continue to be limited to those described in Section 560.540, which retains the “personal” communications requirement that has been dropped from GL D-2. This combination of restrictions means that it is permissible, for example, to provide the Government of Iran with a no-cost instant messaging service, but not with a fee-based collaboration platform supporting a commercial endeavor.
Clarification of Providers’ Due Diligence Obligations
In conjunction with the expansion of permitted activities under GL D-2, the Treasury Department released guidance regarding cloud-based providers’ due diligence obligations under the new license. In FAQ 1088, OFAC explained that providers whose non-Iranian customers provide services or software to persons in Iran may rely on GL D-2 as long as the provider conducts due diligence based on information available to it in the “ordinary course of business.” This “ordinary course of business” formulation is not new, and OFAC has increasingly used this standard in describing its due diligence expectations. See, for example, FAQ 901 on complying with the Chinese Military Companies Sanctions under Executive Order 13959.
In FAQ 1088, OFAC provides several hypotheticals to further articulate its expectations: If a U.S.-based provider supports non-Iranian customers that supply access to activities authorized under GL D-2—such as providing access to Iranian news sites or VPNs—then the U.S.-based provider need not evaluate whether providing access to Iranian end users is related to communications. On the other hand, if a U.S.-based provider supports non-Iranian customers providing services or software not incident to communications under GL D-2—for instance, if the non-Iranian customer provides payroll-management software to Iran—then the U.S.-based provider must evaluate whether the service or software is a prohibited export.
Expansion of Specific Licensing Policy
GL D-2 also expands OFAC’s policy for reviewing applications for specific licenses for activities not authorized by the license. In FAQ 1089, the Treasury Department encourages specific license applications by those seeking to export items or “conduct other activities in support of internet freedom in Iran” that are not authorized by GL D-2.
In particular, GL D-2 expands OFAC’s specific licensing policy by encouraging applications for specific licenses for “activities to support internet freedom in Iran, including development and hosting of anti-surveillance software by Iranian developers.” A Treasury Department official described the agency’s specific licensing policy under GL D-2 as “forward-leaning” and “supportive,” noting that “OFAC will expedite [specific license applications]” by working with the State Department for foreign policy guidance.
Key License Features That Have Remained the Same
While GL D-2 uses a number of mechanisms to increase internet access for Iranians, certain exceptions and other limitations have carried over from GL D-1:
- The updated license still provides (1) no coverage for most Iranian SDNs and (2) coverage of only no-cost services or software for the Iranian government (as opposed to those that are fee-based). These exclusions do not represent a change in OFAC’s licensing scheme, as GL D-1 contained the same prohibitions.
- The license’s Annex—which contains the various categories of additional authorized software and hardware—is unchanged. GL D-2 continues to permit the provision of anti-virus, anti-malware, and anti-tracking software, as well as VPN client software and anti-censorship tools under certain conditions.
- GL D-2’s software/hardware authorization is still largely limited to items either classified as EAR99 or mass-market (i.e., 5D992.c or 5A992.c) under the Commerce Control List, or to items that would be so classified if in the United States.
* * *
GL D-2 is a welcome upgrade and enhancement to GL D-1, and should encourage the private sector to be more forward leaning with respect to tools and technologies incident to internet-based communications that are now listed or otherwise covered by the license. It remains to be seen whether corresponding changes will be made to communications-related licenses under other OFAC programs. We will continue to report on, and advise on, these nuances as well as any further developments in this evolving area of sanctions law.
The following Gibson Dunn lawyers prepared this client alert: Audi Syarief, Samantha Sewall, Lanie Corrigan*, Judith Alison Lee, Adam M. Smith, and Stephenie Gosnell Handler.
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, the authors, or the following members and leaders of the firm’s International Trade practice group:
United States
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
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Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com)
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Asia
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Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Beijing – (+86 10 6502 8534, qyue@gibsondunn.com)
Europe
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Nicolas Autet – Paris (+33 1 56 43 13 00, nautet@gibsondunn.com)
Susy Bullock – London (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)
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Sacha Harber-Kelly – London (+44 (0) 20 7071 4205, sharber-kelly@gibsondunn.com)
Penny Madden – London (+44 (0) 20 7071 4226, pmadden@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33 180, mwalther@gibsondunn.com)
* Lanie Corrigan is a recent law graduate practicing in the firm’s Washington, D.C. office and not yet admitted to practice law.
© 2022 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Finally, some welcome news for employers who utilize automated employment decision tools (“AEDT”) in New York City: the Department of Consumer and Worker Protection (“DCWP”) has proposed rules in an attempt to clarify numerous ambiguities in New York City’s Artificial Intelligence (“AI”) law, which takes effect on January 1, 2023.[1]
New York City’s law will restrict employers from using AEDT in hiring and promotion decisions unless it has been the subject of a bias audit by an “independent auditor” no more than one year prior to use.[2] The law also imposes certain posting and notice requirements to applicants and employees.
As detailed below, the DCWP’s proposed rules are currently under consideration and may well invite more questions than answers as uncertainty about the requirements lingers. Comments can be submitted to the DCWP, and a public hearing will be held on October 24, 2022 to determine whether any or all of the rules will be formally adopted. Below is a brief summary of the proposed rules.
Clarifying Definitions: Several key terms that are not defined in the law itself will be defined if the proposed rules are passed.
For example, the proposed rules define “independent auditor” as “a person or group that is not involved in using or developing an AEDT that is responsible for conducting a bias audit of such AEDT.” Although the proposed definition signals that a vendor who developed the AEDT may not be a sufficiently “independent” auditor (depending on the facts and circumstances), the proposed rules provide an example of a vendor permissibly providing data for a bias audit. It remains to be seen whether there will be further clarification regarding which vendors may conduct the required bias audit.
The proposed rules define “candidate for employment” as “a person who has applied for a specific employment position by submitting the necessary information and/or items in the format required by the employer or employment agency.” As such, the proposed rules clarify that potential applicants who have not yet applied for a position would not be covered by the new law.
The AI law itself defines an AEDT as “any computational process, derived from machine learning, statistical modeling, data analytics, or artificial intelligence, that issues simplified output, including a score, classification, or recommendation, that is used to substantially assist or replace discretionary decision making for making employment decisions that impact natural persons.” The proposed rules clarify that the phrase “to substantially assist or replace discretionary decision making” means that the covered tool (a) relies “solely on a simplified output,” (b) uses “a simplified output as one set of criteria where the output is weighted more than any other criterion in the set,” or (c) uses “a simplified output to overrule or modify conclusions derived from other factors including human decision-making.”
Bias Audit: The proposed rules also specify the requirements for a bias audit, which include calculating the selection rate and impact ratio for each EEO-1 category on an employer’s Equal Employment Opportunity Commission Employer Information Report (i.e., race, ethnicity, and sex).
The calculations set forth in the proposed rules are generally consistent with the EEOC’s Uniform Guidelines on Employee Selection Procedures. Notably, the proposed rules explain that the selection rate is “the rate at which individuals in a category are either selected to move forward in the hiring process or assigned a classification by an AEDT” as compared to the total number of individuals in the category who applied for a position or were considered for promotion. Meanwhile, the impact ratio is defined as “either (1) the selection rate for a category divided by the selection rate of the most selected category or (2) the average score of all individuals in a category divided by the average score of individuals in the highest scoring category.”
The proposed rules provide examples of bias audits that indicate that such audits must conduct an intersectional analysis of protected categories (e.g., examining the impact rate for race and sex combined) in addition to analyzing each category independently. The proposed rules do not address situations in which data may be incomplete for certain categories. Nor do the proposed rules address circumstances where the data set is too small to give rise to a statistically significant impact ratio.
With respect to publishing the results of the bias audit, the proposed rules would require the posting be made “publicly available on the careers or job section of their website in a clear and conspicuous manner,” and include the date of the audit, the distribution date of the tool, and the selection rates and impact ratios for all categories.
Notice: The New York City law requires employers to provide advance notice to individuals who reside in New York City at least 10 business days before use of the AEDT, the opportunity to request an alternative selection process or accommodation, the job qualifications or characteristics that the AEDT will use in connection with the assessment, the employer’s retention policy, and the type and source of data collected for the AEDT. The proposed rules outline several different ways by which, if passed, employers may provide notice for candidates and employees.
For the law’s requirement of notice regarding the use of an AEDT, instructions for how to request an alternative selection process or accommodation, and the job qualifications and characteristics used by the AEDT, the proposed rules would allow employers to provide notice to applicants (a) “on the careers or jobs section” of an employer’s website, (b) “in a job posting,” or (c) “via U.S. mail or e-mail” at least 10 business days prior to use of the AEDT. For employees, employers would be able to provide this notice “in a written policy or procedure” at least 10 business days prior to use or through the mechanisms outlined in (b) and (c) above.
Under the proposed rules, an employer would satisfy the law’s requirement of notices regarding the type of data collected, the source of the data, and the data retention policy by posting this information “on the careers or jobs section” of their website or by providing it in writing “via U.S. mail or e-mail” within 30 days of receiving a request to provide such information.
* * *
Legislatures and regulatory agencies have continued to focus on employers’ use of AEDT.[3] Most recently, on September 13, 2022, the EEOC co-hosted an event with the OFCCP titled Decoded: Can Technology Advance Equitable Recruiting and Hiring?. During the event, EEOC Chair Charlotte A. Burrows and OFCCP Director Jenny R. Yang underscored the need for employers to think carefully about the factors that AEDT are assessing, including whether those factors are tailored to the skills and abilities required by the specific position, and to ensure that AEDT do not have a disparate impact based on protected categories. Accordingly, employers who have already implemented or may implement AEDT in the workplace should consider the impact of these legislative and regulatory developments to ensure compliance with upcoming laws and enhanced regulatory scrutiny.
_________________________
[1] NYC Dep’t Consumer & Worker Prot., Notice of Public Hearing and Opportunity to Comment on Proposed Rules, https://rules.cityofnewyork.us/wp-content/uploads/2022/09/DCWP-NOH-AEDTs-1.pdf.
[2] For more details, please see Gibson Dunn’s New York City Enacts Law Restricting Use of Artificial Intelligence in Employment Decisions.
[3] For more details, please see Gibson Dunn’s Keeping Up with the EEOC: Artificial Intelligence Guidance and Enforcement Action and Danielle Moss, Harris Mufson, and Emily Lamm, Medley Of State AI Laws Pose Employer Compliance Hurdles, Law360 (Mar. 30, 2022), available at https://www.gibsondunn.com/wp-content/uploads/2022/03/Moss-Mufson-Lamm-Medley-Of-State-AI-Laws-Pose-Employer-Compliance-Hurdles-Law360-Employment-Authority-03-30-2022.pdf.
The following Gibson Dunn attorneys assisted in preparing this client update: Harris Mufson, Danielle Moss, and Emily Maxim Lamm.
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:
Harris M. Mufson – New York (+1 212-351-3805, hmufson@gibsondunn.com)
Danielle J. Moss – New York (+1 212-351-6338, dmoss@gibsondunn.com)
Jason C. Schwartz – Co-Chair, Labor & Employment Group, Washington, D.C.
(+1 202-955-8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Co-Chair, Labor & Employment Group, Los Angeles
(+1 213-229-7107, ksmith@gibsondunn.com)
© 2022 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On September 15, 2022, Deputy Attorney General Lisa Monaco announced updates, new policies, and clarifications to the U.S. Department of Justice’s (“DOJ”) corporate criminal enforcement policies. After seeking feedback from industry stakeholders and practitioners, the announcement touches on six key areas: (1) voluntary self-disclosure; (2) cooperation credit; (3) compliance programs; (4) prior corporate misconduct; (5) corporate monitors; and (6) individual prosecutions.[1]
This announcement was followed by the release of a memorandum, titled Further Revisions to Corporate Criminal Enforcement Policies Following Discussions With Corporate Criminal Advisory Group.[2] The announcement and memorandum (collectively, the “New Policy”) also builds upon and clarifies the Deputy Attorney General’s policy announcements from October 2021 (collectively, the “2021 Policy”), following the Deputy Attorney General’s consultation with key stakeholders including members of the defense bar.[3] Later speeches by Assistant Attorney General Kenneth Polite[4] and Principal Associate Deputy Attorney General Marshall Miller[5] further expounded on the New Policy.
Based on our collective experience and tracking of DOJ actions over decades, the New Policy is notable for both what it does and what it does not do. As discussed below, for example, while the New Policy broadens the use of written policies on voluntary self-disclosure credit across the Department, it leaves undisturbed DOJ’s prior guidance that cooperation credit cannot be conditioned on waiver of attorney-client privilege. And the New Policy does not rescind or revisit one of the prior administration’s more notable criminal policy pronouncements, the so-called anti-“piling on” policy that directs DOJ to avoid duplicative fines or penalties for the same underlying conduct. Moreover, much of what the New Policy articulates underscores priorities and guidance previously enunciated by the Department.
Nevertheless, both its language and the precision of some elements make clear that the Department intends for the New Policy to be viewed as a meaningful pivot in several important ways. Accordingly, the New Policy is bound to affect how companies conduct risk assessments; build, test, and refine their compliance programs; investigate potential misconduct; and structure compensation plans and the type of incentives and clawbacks implemented. It will also change the voluntary self-disclosure calculus. For prosecutors, the New Policy will likely affect charging assessments and the imposition and management of corporate monitorships.
Below we provide a summary of the key policy changes and clarifications, along with our observations regarding their potential implications.
1. Voluntary Self-Disclosure
- DOJ will institute transparent policies and procedures ensuring that voluntary self-disclosure will result in more favorable resolutions than if DOJ learned of the misconduct through other means and that the benefit of such a disclosure is clear and predictable.
- To this end, every DOJ component that prosecutes corporate crime must have a formal written policy that incentivizes voluntary self-disclosure.
- Absent “aggravating factors,” prosecutors will not seek a guilty plea in instances where the company has voluntarily self-disclosed the misconduct, cooperated, and remediated the misconduct. The Department will not require an independent compliance monitor for such a corporation if, at the time of resolution, it has also implemented and tested an effective compliance program.
Although DOJ has long strived to incentivize voluntary self-disclosure, this is the first policy statement that articulates the promised benefits so clearly and concretely and on a Department-wide basis. Although some individual DOJ components have policies encouraging self-disclosure, such as the Foreign Corrupt Practices Act (“FCPA”) Unit’s Program, the National Security Division’s disclosure policy, and the Antitrust Division’s Leniency Program, this is the first time DOJ has required all components that prosecute corporate crime to draft and publicly share a formal written voluntary self-disclosure policy. DOJ components that currently investigate and prosecute corporate crime without such a policy include, for example, the Consumer Protection Branch, the Money Laundering & Asset Forfeiture Section, and U.S. Attorneys’ Offices.
Although DOJ has committed not to seek a guilty plea in instances where the company has self-disclosed, cooperated, and remediated, DOJ has preserved some flexibility for itself with the phrase “absent the presence of aggravating factors.”[6] Assistant Attorney General Polite clarified that the aggravating factors the Criminal Division will consider include involvement of executive management in the misconduct, significant profit to the company from the misconduct, or “pervasive or egregious” misconduct.[7] Notwithstanding the considerable flexibility this leaves the Department, this commitment is significant if for no other reason than that it appears to foreclose, absent aggravating factors, the possibility of the Department seeking a guilty plea even from a subsidiary—a course that DOJ has sometimes taken instead of parent-level guilty pleas. Voluntary self-disclosure has now become the fundamental gating issue under the New Policy. Consequently, consideration of whether disclosure is truly voluntary will be hotly debated in this context.
2. Cooperation Credit
- DOJ will update its Justice Manual, a comprehensive collection of standards that guide prosecutors from the start of an investigation through prosecution, to ensure greater consistency across components regarding the standard to receive maximum cooperation credit.
- Regarding the 2021 Policy’s reinstatement of a requirement that corporations must provide all non-privileged information about all culpable individuals to qualify for cooperation credit, DOJ now expects prompt delivery of such information.
- DOJ will provide cooperation credit to companies that find solutions to address data privacy laws, blocking statutes, and other foreign restrictions and may draw adverse inferences if companies improperly use such restrictions to prevent detection or hinder a DOJ investigation.
Updating the Justice Manual to create consistent standards for cooperation credit across DOJ components and U.S. Attorney’s Offices is a welcome change that will better ensure corporate defendants are not held to uneven standards by different components.
DOJ’s willingness to provide cooperation credit to companies that find creative solutions to address privacy laws, blocking statutes, and other restrictions to evidence collection in foreign jurisdictions is likely an outgrowth of DOJ’s perception, albeit mistaken, that companies are hiding behind foreign legal restrictions for self-serving purposes. When DOJ proposes a potential solution to address complications presented by foreign law restrictions—based at least in part on DOJ’s experience with cooperating companies in other investigations—companies risk losing cooperation credit in rejecting such solutions without a persuasive explanation as to why they are infeasible.
In his speech, Principal Deputy Attorney General Marshall Miller underscored the importance of “timeliness” in obtaining cooperation credit, noting that “delay is the prosecutor’s enemy.”[8]
3. Corporate Compliance Programs
- When assessing a company’s compliance program, prosecutors must consider whether the company’s compensation systems include clawback or deferred compensation provisions for bad actors and incentivize compliant behavior.
- The Department will scrutinize policies and procedures to ensure that business-related communications on employees’ personal devices and third-party messaging platforms are preserved and provided to DOJ in an investigation.
Deputy Attorney General Monaco directed the Criminal Division to provide further guidance by the end of this year on how to reward corporations that develop and apply compensation clawback policies and place the burden of financial penalties onto those responsible for misconduct. The day after the guidance was released, Assistant Attorney General Polite further noted that the DOJ would work with agency partners and experts on executive compensation to help develop this guidance.[9]
The New Policy’s changes regarding the preservation and production of communications are likely a manifestation of DOJ’s frustration with companies that are unable to retrieve communications stored on employees’ personal devices or third-party platforms. The use of personal devices for work has become an increasingly challenging issue in corporate criminal investigations. Assistant Attorney General Polite offered more background on this policy, noting that the Criminal Division has seen a rise in companies and individuals using messaging applications offering ephemeral (or disappearing) messaging and that companies must ensure the ability to appropriately monitor and retain these communications.[10] DOJ is now willing to offer the carrot of cooperation credit to companies that have policies to retain and provide such communications. To obtain cooperation credit, companies will be expected to implement company-wide policies and procedures that prevent employees from using personal devices and third-party messaging applications to conduct business or otherwise find a way to preserve such communications. The Criminal Division will examine whether additional guidance is needed regarding best practices on use of personal devices and third-party messaging applications.
Also notable is the fact that the New Policy does not address certifications regarding a company’s compliance program, a topic that has raised concerns from industry experts and the defense bar. In his March 2022 speech, Assistant Attorney General Polite stated that he was considering requiring that both the Chief Executive Officer and the Chief Compliance Officer certify as part of any settlement that the company’s compliance program is effective, reasonably designed, and implemented to detect and prevent legal violations.[11] Assistant Attorney General Polite also addressed this issue in his speech on September 16, following the announcement of the New Policy. DOJ has imposed these certifications in prior resolutions on a case-by-case basis, including in two recent resolutions, but has not gone so far as to adopt a policy of requiring such certifications in every resolution. The New Policy leaves that approach undisturbed.
4. Prior Misconduct
- With respect to the 2021 Policy announcement that prosecutors must consider a corporation’s full criminal, civil, and regulatory record, even if dissimilar from the conduct at issue, DOJ articulated standards regarding the kind of prior misconduct that will receive greater weight—for example, conduct involving the same personnel or management.
- Dated prior conduct, measured by the time that conduct was addressed in a resolution, will be afforded less weight—in the case of a criminal or civil/regulatory resolution, the timing is 10 years and 5 years, respectively.
DOJ’s clarification that the history of highly regulated companies should be compared to other similarly situated companies is particularly important. This messaging is an important clarification of Deputy Attorney General Monaco’s announcement in October 2021 that prosecutors should consider “all” prior civil and regulatory actions in assessing whether a company is a recidivist. Many in the white-collar defense bar have been concerned about the consequences of such an open-ended inquiry into prior non-criminal actions involving our largest, most heavily regulated clients, and the delineation of which prior actions should be given greater weight is welcome.
5. Corporate Monitorships
- Regarding the 2021 Policy announcement that prosecutors are free to impose monitors whenever appropriate, the Deputy Attorney General clarified that there is no presumption in favor of monitorships and that it will not seek to impose a monitor if the company has implemented and tested an effective compliance program.
- All DOJ components will adopt a consistent, transparent and public monitor selection process that ensures there are no conflicts of interest in the selection of the monitor and the process adheres to DOJ’s commitment to diversity and inclusion. Prosecutors must follow new standards to ensure the monitorship is tailored to the misconduct, adheres to its anticipated scope, and remains on budget.
The New Policy significantly ratchets up incentives for companies to create robust compliance programs by reducing the specter of prolonged and costly compliance monitorships. DOJ has previously commented on what it means to have an effective and “tested” compliance program. In March 2022, Assistant Attorney General Polite noted the importance of seeing a company’s compliance program working in practice and “compliance success stories,” including rewarding positive behavior, disciplining poor behavior, rejecting transactions due to compliance risk, positive trends in whistleblower reporting, and other positive developments.[12]
6. Individual Prosecutions
- In the Deputy Attorney General’s speech, she noted that the “Department’s number one priority is individual accountability” and linked expedited voluntary self-disclosures and production of key documents and information involving individuals to cooperation credit.[13]
- Prosecutors must seek warranted criminal charges against individuals prior to or at the same time as entering a resolution against a corporation or, if it makes more sense to resolve the corporate case first, have a full investigation plan to bring individual charges.
The extent to which this new guidance practically affects the outcomes of particular criminal investigations remains unclear. The Yates Memorandum, issued during the Obama Administration in 2015, called for a similar work plan where corporate cases should not be resolved without a clear plan to resolve related individual cases, though the Yates Memorandum did not explicitly require prosecutors to work toward sequencing their investigations in this way.[14] In addition, one advantage of corporate resolutions is that prosecutors and corporate defendants need only reach a generally agreed-upon understanding of the facts and legal standard. This approach allows for speedier resolutions while avoiding endless and costly investigations. But the level of investigation to resolve a corporate matter is often insufficient to prevail against individuals who are far more inclined to fight charges in court. Thus, it remains to be seen whether prosecutors will actually succeed in bringing individual criminal charges before or concurrently with corporate resolutions.
As a result of this DOJ reset, we recommend:
- An examination of compensation policies to more tightly align compliance goals with pay;
- An implementation of a clawback policy for misconduct that would mirror in material respect the clawback policies associated with financial restatements;
- Refreshing the board of directors of its Caremark responsibilities;
- Updating compliance training materials to underscore an employee’s obligation to escalate to the company’s legal and compliance departments any problematic conduct; and
- Broadening values and compliance training company wide and to selected third parties (consultants, lobbyists, logistical advisors, technical experts, etc.).
* * *
Over the coming weeks and months, we will carefully monitor DOJ’s implementation of these aspects of the revised guidance.
_____________________________
[1] Speech, U.S. Dep’t of Justice, Deputy Attorney General Lisa O. Monaco Delivers Remarks on Corporate Criminal Enforcement, (September 15, 2022), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-o-monaco-delivers-remarks-corporate-criminal-enforcement [hereinafter Deputy Attorney General Monaco Speech (September 15, 2022)].
[2] Memorandum, Dep’t of Justice, Further Revisions to Corporate Criminal Enforcement Policies Following Discussions with Corporate Crime Advisory Group (September 15, 2022), https://www.justice.gov/opa/speech/file/1535301/download [hereinafter DOJ Memorandum (September 15, 2022)].
[3] See Client Alert, Gibson Dunn, Deputy Attorney General Announces Important Changes to DOJ’s Corporate Criminal Enforcement Policies (October 29, 2021), https://www.gibsondunn.com/deputy-attorney-general-announces-important-changes-to-doj-corporate-criminal-enforcement-policies/.
[4] Speech, U.S. Dep’t of Justice, Assistant Attorney General Kenneth A. Polite Delivers Remarks at the University of Texas Law School (September 16, 2022), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-delivers-remarks-university-texas-law-school [hereinafter Assistant Attorney General Polite Speech (September 16, 2022)].
[5] Speech, U.S. Dep’t of Justice, Principal Associate Deputy Attorney General Marshall Miller Delivers Live Keynote Address at Global Investigations Review (September 20, 2022), https://www.justice.gov/opa /speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-live-keynote-address [hereinafter Principal Associate Deputy Attorney General Miller Speech (September 20, 2022)].
[6] DOJ Memorandum (September 15, 2022).
[7] Assistant Attorney General Polite Speech (September 16, 2022).
[8] Principal Associate Deputy Attorney General Miller Speech (September 20, 2022).
[9] Id.
[10] Assistant Attorney General Polite Speech (September 16, 2022).
[11] Speech, U.S. Dep’t of Justice, Assistant Attorney General Kenneth A. Polite Jr. Delivers Remarks at NYU Law’s Program on Corporate Compliance and Enforcement (PCCE) (March 25, 2022), https://www.justice.gov/opa/speech/assistant-attorney-general-kenneth-polite-jr-delivers-remarks-nyu-law-s-program-corporate [hereinafter Assistant Attorney General Polite Speech (March 25, 2022)].
[12] Assistant Attorney General Polite Speech (March 25, 2022).
[13] Deputy Attorney General Monaco Speech (September 15, 2022).
[14] Memorandum, Dep’t of Justice, Individual Accountability for Corporate Wrongdoing (September 9, 2015), https://www.justice.gov/archives/dag/file/769036/download.
The following Gibson Dunn lawyers assisted in preparing this client update:
F. Joseph Warin, Stephanie Brooker, Joel M. Cohen, Nicola T. Hanna, Charles Stevens, Kendall Day, Robert K. Hur, Nicholas Murphy*, Jason H. Smith, and Sarah Hafeez.
Gibson Dunn has deep experience with corporate criminal enforcement matters. We have more than 250 attorneys, including a number of former federal prosecutors and SEC and other regulatory agency enforcement officials, spread throughout the firm’s domestic and international offices. For assistance navigating white collar or regulatory enforcement issues, please contact any of the authors, the Co-Chairs of the White Collar Defense and Investigations practice group Stephanie Brooker, Joel Cohen, Nicola Hanna, Charles Stevens, and F. Joseph Warin, or any of the following:
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Kelly Austin (+852 2214 3788, kaustin@gibsondunn.com)
Oliver D. Welch (+852 2214 3716, owelch@gibsondunn.com)
Singapore
Joerg Biswas-Bartz (+65 6507 3635, jbiswas-bartz@gibsondunn.com)
* Nicholas Murphy is of counsel practicing in the firm’s Washington, D.C. office who currently is admitted only in New York.
© 2022 Gibson, Dunn & Crutcher LLP
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The German Ministry of Economic Affairs and Climate Action published the draft of the 11th amendment to the Act against Restraints on Competition. It will further strengthen the German competition watchdog’s powers to investigate market sectors and to impose remedies even in the absence of an infringement of competition law.
On 26 September 2022, the German Ministry of Economic Affairs and Climate Action (“Ministry”) published the first draft of the 11th amendment of the Act against Restraints on Competition (“German Competition Act”) (the “draft bill”). The draft bill is not an immediate reaction to the current crisis on the energy markets but is a longer planned amendment, which has already been reflected in the 2021 coalition agreement between the government parties SPD, Bündnis 90/Die Grünen and FDP. The draft bill marks another step in the direction of a new era of antitrust law enforcement in Germany. This trend continues to shift competition law enforcement from a more traditional approach, where an infringement of competition law (e.g., a cartel/abuse of dominance) is required, to a more extensive market protection tool intended to address perceived distortions to competition that can already operate below the “infringement threshold”. The draft bill in particular refers to experiences of the UK competition authority CMA and to the European Commission’s Impact Assessment for the New Competition Tool (NCT).
The main aspects of the draft bill are: (i) a complete revision of the sector inquiry tool of the Federal Cartel Office (“FCO”); (ii) the implementation of the DMA in the national framework of public and private enforcement; and (iii) the facilitation of benefits disgorgements:
(i) Sector inquiries. The sector inquiries tool enables the FCO to investigate the competitive conditions on markets unrelated to a specific competition law infringement. The tool was initially introduced in 2005 and has been used around twenty times, inter alia in the sectors fuels, buyer power in food retailing, cement and ready-mix concrete, waste disposal and hospitals. In 2007 the tool was also extended into the area of consumer protection – in particular in the digital space. The draft bill identifies and addresses two main weaknesses of the current tool:
- Timing. Sector inquiries usually take a very long time. According to the draft bill, this has a negative impact on the usability of the findings. The draft bill now sets a time limit for sector inquiries of 18 months.
- Remedies. The FCO currently does not have the power to impose remedial actions in response to the results of a sector inquiry. The draft bill changes this – for a time period of (another) 18 months after the publication of the respective sector inquiry report:
- Merger control. The FCO can impose an obligation on specific undertakings to notify concentrations under the German merger control regime, even if they are below the regular notification thresholds. The prerequisite is that there are “objectively verifiable indications that future mergers could significantly impede effective competition in Germany in one or more of the economic sectors” specified in the sector inquiry report. A de minimis exception applies to transactions in which the buyer generated turnover with customers in Germany in its last completed financial year of less than EUR 50 million and/or the target of less than EUR 500,000. This “special notification obligation” expires after three years, but it can be renewed.
- Structural/behavioral remedies. The FCO can impose remedies of behavioral or structural nature, if there is a “significant, [i] continuous or [ii] repeated disturbance of competition in at least one market or across markets”. The draft bill provides the following examples for potential objectives of such remedies: access to data, rights of use to intellectual property, requirements for certain types of contracts or the organizational separation of business units.
- Unbundling. Lastly, the FCO will also get the ultima ratio power to unbundle undertakings, if no other remedy of structural or behavioral nature would be equally effective or if such alternative remedy would impose an even greater burden on the undertaking. This ultima ratio remedy will be subject to a comprehensive proportionality assessment. Also, the FCO cannot impose an obligation to divest assets which have been subject to a final merger control clearance by the European Commission or by the FCO in the past five years.
(ii) Digital Markets Act. The Digital Markets Act (DMA) of the European Union has just been adopted by the EU Council and is expected to be published in the EU Official Journal soon. It will come into force 20 days later and then fully applies to so-called “gatekeepers” six months after it entered into force.
- Public enforcement. The European Commission is the sole authority empowered to enforce the DMA but the DMA left a possibility for EU Member States to empower their national competition authorities to conduct investigations of possible non-compliance of gatekeepers with DMA rules. The draft bill paves the way for a public enforcement of the DMA by the FCO in Germany. However, the FCO can only conduct investigations and forward the results to the European Commission. It has no powers of its own to sanction non-compliance with the DMA.
- Private enforcement. The DMA is an EU Regulation and therefore directly (e., without the need for transposition) applies in all EU Member States. In addition, various DMA provisions prerequisite its private enforceability in national courts. The draft bill implements the relevant provisions of the DMA into the German Competition Act’s provisions on private antitrust enforcement (injunctive relief, damage claims).
(iii) Disgorgement of economic benefit. The draft bill also improves the FCO’s possibilities to order the disgorgement of economic benefits resulting from the violation of competition law. In order to do that, the draft bill removes the requirement for the authority to prove that the violation of competition law has been carried out intentionally or negligently. Furthermore, the draft bill provides for a statutory presumption that a competition law infringement caused an economic benefit of at least 1% of the turnover generated in Germany with the products or services connected to the infringement. A rebuttal of this presumption requires that neither the legal entity directly involved in the infringement nor its group (the undertaking) generated a profit in the respective amount in the relevant period. However, the amount to be paid must not exceed 10% of the total turnover of the undertaking in the fiscal year preceding the decision of the authority.
Conclusions and outlook. The draft bill follows the overall trend in Europe and overseas to equip competition authorities with more powers beyond the “classic” competition law enforcement tools. It can be expected that the draft bill will be passed by the government’s cabinet rather soon so that the readings in the German parliament can begin. When (and whether) an 11th amendment will eventually come into force is currently hard to predict given various other political priorities and economic challenges.
The Ministry is already working on a draft for a 12th amendment of the German Competition Act (!) which shall implement topics mentioned in a White Paper on competition law priorities from February this year (Wettbewerbspolitische Agenda des BMWK bis 2025). Details are yet unknown but the focus could be, inter alia, on establishing more legal certainty for sustainability cooperation between companies as well as stronger consumer protection.
The following Gibson Dunn lawyers assisted in preparing this client update: Georg Weidenbach, Michael Walther, Kai Gesing, Jan Vollkammer, Linda Vögele, and Elisa Degner.
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 or members of the firm’s Antitrust and Competition practice group:
Kai Gesing – Munich (+49 89 189 33 180, kgesing@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33 180, mwalther@gibsondunn.com)
Georg Weidenbach – Frankfurt (+49 69 247 411 550, gweidenbach@gibsondunn.com)
Christian Riis-Madsen – Co-Chair, Brussels (+32 2 554 72 05, criis@gibsondunn.com)
Ali Nikpay – Co-Chair, London (+44 (0) 20 7071 4273, anikpay@gibsondunn.com)
Rachel S. Brass – Co-Chair, San Francisco (+1 415-393-8293, rbrass@gibsondunn.com)
Stephen Weissman – Co-Chair, Washington, D.C. (+1 202-955-8678, sweissman@gibsondunn.com)
© 2022 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
U.S. anti-corruption enforcement has continued apace through the first eight months of 2022. Although some will point to declining numbers of Foreign Corrupt Practices Act (“FCPA”) enforcement actions in 2022 to date, particularly against corporations, as compared to the heights of recent years, our view from the trenches is that enforcement is evolving, not fading. As evidenced by the bevvy of activity catalogued in the pages that follow, our experience is prosecutors at the U.S. Department of Justice (“DOJ”) and enforcers at the U.S. Securities and Exchange Commission (“SEC”) remain acutely focused on international anti-corruption enforcement and that the compliance challenges faced by global corporations are as complicated today as they have ever been. In addition, the expanded employment of money laundering charges has broadened prosecutors’ reach.
This client update provides an overview of the FCPA and other domestic and international anti-corruption enforcement, litigation, and policy developments from the first eight months of 2022. In January 2023, we will publish our comprehensive year-end update on 2022 FCPA developments.
FCPA OVERVIEW
The FCPA’s anti-bribery provisions make it illegal to corruptly offer or provide money or anything else of value to officials of foreign governments, foreign political parties, or public international organizations with the intent to obtain or retain business. These provisions apply to “issuers,” “domestic concerns,” and those acting on behalf of issuers and domestic concerns, as well as to “any person” who acts while in the territory of the United States. The term “issuer” covers any business entity that is registered under 15 U.S.C. § 78l or that is required to file reports under 15 U.S.C. § 78o(d). In this context, foreign issuers whose American Depositary Receipts (“ADRs”) or American Depositary Shares (“ADSs”) are listed on a U.S. exchange are “issuers” for purposes of the FCPA. The term “domestic concern” is even broader and includes any U.S. citizen, national, or resident, as well as any business entity that is organized under the laws of a U.S. state or that has its principal place of business in the United States.
In addition to the anti-bribery provisions, the FCPA also has “accounting provisions” that apply to issuers and those acting on their behalf. First, there is the books-and-records provision, which requires issuers to make and keep accurate books, records, and accounts that, in reasonable detail, accurately and fairly reflect the issuer’s transactions and disposition of assets. Second, the FCPA’s internal accounting controls provision requires that issuers devise and maintain reasonable internal accounting controls aimed at preventing and detecting FCPA violations. Prosecutors and regulators frequently invoke these latter two sections when they cannot establish the elements for an anti-bribery prosecution or as a mechanism for compromise in settlement negotiations. Because there is no requirement that a false record or deficient control be linked to an improper payment, even a payment that does not constitute a violation of the anti-bribery provisions can lead to prosecution under the accounting provisions if inaccurately recorded or attributable to an internal accounting controls deficiency.
International corruption also may implicate other U.S. criminal laws. Frequently, prosecutors from DOJ’s FCPA Unit charge non-FCPA crimes such as money laundering, mail and wire fraud, Travel Act violations, tax violations, and even false statements, in addition to or instead of FCPA charges. Without question, the most prevalent amongst these “FCPA-related” charges is money laundering—a generic term used as shorthand for statutory provisions that generally criminalize conducting or attempting to conduct a transaction involving proceeds of “specified unlawful activity” or transferring funds to or from the United States, in either case to promote the carrying on of specified unlawful activity, to conceal or disguise the nature, location, source, ownership or control of the proceeds, or to avoid a transaction reporting requirement. “Specified unlawful activity” includes over 200 enumerated U.S. crimes and certain foreign crimes, including the FCPA, fraud, and corruption offenses under the laws of foreign nations. Although this has not always been the case, in recent history, DOJ has frequently deployed the money laundering statutes to charge “foreign officials” who are not themselves subject to the FCPA. It is not unusual for DOJ to charge the alleged provider of a corrupt payment under the FCPA and the alleged recipient with money laundering violations.
FCPA AND FCPA-RELATED ENFORCEMENT STATISTICS
The below table and graph detail the number of FCPA enforcement actions initiated by DOJ and the SEC, the statute’s dual enforcers, during the past 10 years.
But as our readers know, the number of FCPA enforcement actions represents only a piece of the robust pipeline of international anti-corruption enforcement efforts by DOJ. Indeed, the increasing proportion of “FCPA-related” charges in the overall enforcement docket of FCPA prosecutors is a trend we have been remarking upon for years. In total, DOJ brought 11 such FCPA-related actions in the first eight months of 2022, bringing the overall count to 22 cases that DOJ’s FCPA unit filed, unsealed, or otherwise joined since the beginning of the year. The past 10 years of FCPA plus FCPA-related enforcement activity is illustrated in the following table and graph.
2022 MID-YEAR FCPA + FCPA-RELATED ENFORCEMENT ACTIONS
CORPORATE ENFORCEMENT ACTIONS
Through August, there were three corporate FCPA enforcement actions from each of DOJ and the SEC in 2022, which is on par with the corporate enforcement activity for all of 2021 but still down from recent historical trends. There have been additional resolutions in September not covered herein, and we will continue tracking the pace of corporate FCPA enforcement in our forthcoming year-end update and beyond to see if this is a momentary lull or a longer-term trend. In the meantime, the five companies subject to FCPA enforcement in the year to date follow.
Tenaris S.A.
Most recently, on June 2, 2022, Luxemburg-based global steel pipe supplier Tenaris, an ADR-issuer, consented to the entry of an administrative cease-and-desist order by the SEC to resolve FCPA bribery, books and records, and internal controls charges. According to the SEC’s Order, between 2008 and 2013, agents and employees of Tenaris’s Brazilian subsidiary paid approximately $10.4 million in bribes to a high-ranking procurement manager at Brazil’s state-owned oil and gas company Petróleo Brasileiro S.A. (“Petrobras”) to persuade the procurement manager not to open up the subsidiary’s ongoing pipe supply project to competition, ultimately leading to the award of over $1 billion in contracts. To resolve the charges, Tenaris agreed to pay more than $78 million, consisting of approximately $42.84 million in disgorgement, $10.26 million in prejudgment interest, and a $25 million civil money penalty. Tenaris also agreed to self-report to the SEC for two years on the status of its remediation and implementation of compliance measures related to its compliance program and accounting controls. As we have discussed in earlier updates, Gibson Dunn represented Petrobras and successfully negotiated a non-prosecution agreement with DOJ and an SEC resolution and navigated seamlessly a three-year self-monitorship.
According to a statement released by Tenaris, DOJ closed its investigation into this matter without taking action. Notably, this is Tenaris’s second brush with the FCPA, having resolved dual FCPA enforcement actions with DOJ and the SEC in 2011 arising out of alleged corruption in Uzbekistan.
Glencore International A.G.
Undoubtedly the bombshell FCPA enforcement matter of 2022-to-date came on May 24, when Swiss multinational commodity trading and mining company Glencore resolved criminal FCPA bribery charges in seven African and Latin American countries. Simultaneously, Glencore entered into a parallel criminal and civil market manipulation resolution with a different unit of DOJ’s Fraud Section and the U.S. Commodity Futures Trading Commission (“CFTC”) founded, in part, on the same conduct, in addition to separate anti-corruption resolutions with Brazilian and UK authorities. According to the corruption-related allegations, from 2007 to 2018, Glencore provided more than $100 million in payments and other items of value to intermediaries for the purpose of bribing foreign officials in Brazil, Cameroon, the Democratic Republic of the Congo, Equatorial Guinea, Ivory Coast, Nigeria, and Venezuela to obtain contracts and other benefits.
The assessment of criminal and civil penalties against Glencore for the web of related resolutions involves a complex set of credits and offsets, but in total Glencore is expected to pay approximately $1.5 billion to resolve all of the matters. The total payment to U.S. enforcement agencies is expected to be $1.02 billion, of which approximately $700.7 million is allocable to the FCPA case comprised of a criminal fine of $428.521 million and criminal forfeiture of $272.186 million. On top of that, Glencore agreed to pay $39.6 million to the Brazilian Federal Prosecutor’s Office, and as discussed below in our UK Enforcement Update, a subsidiary pleaded guilty to UK Bribery Act charges and is scheduled to be sentenced in November 2022. Glencore has stated that the resolution in the UK, and other pending proceedings in the Netherlands and its home country of Switzerland, are together expected to increase the overall resolution to $1.5 billion. Additionally, Glencore agreed to a three-year compliance monitor in connection with the FCPA resolution and a separate three-year compliance monitor in connection with the market manipulation resolution, the scope of which are still being negotiated.
Beyond the sheer size of the matter, there are numerous notable aspects to the Glencore resolution:
- First, Glencore is neither a U.S. company nor issuer (hence, no SEC resolution), and DOJ’s FCPA jurisdiction appears to be premised loosely on the approval of certain payments by employees (including former West African oil trader Anthony Stimler, who pleaded guilty to FCPA charges as covered in our 2021 Year-End FCPA Update) while in the United States, the transmittal of at least one email from the United States by Stimler, and the use of U.S. correspondent banking accounts for at least some of the alleged bribe payments. The details of DOJ’s allegations and jurisdictional theories are not fully fleshed out in the corporate charging documents, but DOJ’s approach seems to be that a multi-country corruption conspiracy taking place largely outside of the United States may be brought within U.S. jurisdiction in its entirety due to correspondent banking transactions or through a single act taken by one co-conspirator while in the United States, potentially even a low-level trader involved in one spoke of the alleged conspiracy.
- Second, although there is precedent in corporate FCPA enforcement actions for relatively modest criminal forfeiture actions to accompany criminal fines, generally offset in the criminal fine calculation, Glencore is the first of which we are aware in which the amount of gain was used by DOJ both as the primary input for the Guidelines fine and, on top of that, disgorged by DOJ through parallel forfeiture. In this manner, DOJ not only applied a criminal penalty, which is customary, but it also disgorged all allegedly tainted profits, which is not customary in a non-issuer case (i.e. where the SEC is not involved). While DOJ has applied forfeiture in a limited way in some FCPA cases, this appears to be the first time it has required a company to disgorge all ill-gotten gain in the absence of a parallel SEC action. This practice has precedent in other types of white collar corporate cases, particularly by prosecutors in the Southern District of New York, but not to our knowledge in the FCPA cases.
- Third, as noted above, a part of the CFTC’s charges were founded on the same alleged corruption conduct covered in the DOJ FCPA resolution, making this the second time that the CFTC has charged corruption as “manipulative and deceptive conduct” under the Commodity Exchange Act. The first instance was the case against Vitol, Inc., covered in our 2020 Year-End FCPA Update, which arose out of the same fact pattern.
Stericycle, Inc.
The only dual FCPA enforcement action to date in 2022 came on April 20, when Illinois-based waste management company Stericycle resolved FCPA bribery and accounting charges with DOJ and the SEC arising from allegations of corruption in Argentina, Brazil, and Mexico. The charging documents collectively allege that, between 2011 and 2016, Stericycle representatives paid approximately $10.5 million in bribes to government officials to obtain contracts and other benefits that cumulatively netted the company approximately $21.5 million in profits.
To resolve the criminal charges, Stericycle entered into a deferred prosecution agreement with a $52.5 million penalty and requiring the imposition of a compliance monitor for a two-year term. The SEC resolution requires the disgorgement of approximately $28 million in profits and prejudgment interest, together with the imposition of the same compliance monitor. In addition, Stericycle entered into a parallel $9.3 million resolution with Brazil’s Controladoria-Geral da União and the Advocacia-Geral de União, which after offsets in the DOJ / SEC resolutions will net out to a total resolution of approximately $84 million. Parallel United States and Brazilian enforcement actions, such as seen here, have become commonplace.
Jardine Lloyd Thompson Group Holdings Ltd.
On March 18, 2022, DOJ announced its first “declination with disgorgement” FCPA resolution in nearly two years, with UK insurance company JLT Group. DOJ’s declination letter asserted that it had found evidence that JLT Group, through an employee and its agents, paid approximately $3.15 million in alleged bribes to Ecuadorian officials between 2014 and 2016, through an intermediary based in Florida, in order to obtain or retain insurance contacts with Ecuadorian state-owned surety Seguros Sucre. The underlying conduct is the same covered in our 2020 Mid-Year FCPA Update where we reported on the prosecution of four defendants—including former JLT Group executive Felipe Moncaleano Botero—in the Southern District of Florida for money laundering conspiracy.
DOJ declined to prosecute based on JLT Group’s voluntary disclosure of the misconduct, full and proactive cooperation, prompt and comprehensive remediation, and agreement to disgorge just over $29 million in alleged improper gains. JLT Group affiliates also reached resolutions with Colombian and UK authorities, as covered below in our international enforcement developments section. Gibson Dunn represented JLT Group in obtaining the DOJ declination, and in the international resolutions.
KT Corporation
First in but last up, the initial FCPA corporate enforcement action of 2022 came on February 17, when Korea’s largest telecommunications operator and ADS issuer KT Corporation resolved FCPA books-and-records and internal controls charges with the SEC. According to the administrative cease and desist order, KT Corporation maintained multiple “slush funds” between 2009 and 2017, from which it made illegal contributions to legislative officials in Korea who sat on committees with influence over the telecommunications industry and also to Vietnamese government officials to receive contracts.
Without admitting or denying the allegations, KT Corporation agreed to settle with a $3.5 million civil penalty and the disgorgement of $2.8 million in profits plus prejudgment interest. KT Corporation also will self-report on FCPA compliance remediation for a two-year term. There is no indication to date of a parallel DOJ enforcement action.
INDIVIDUAL ENFORCEMENT ACTIONS
There were FCPA and FCPA-related charges filed or unsealed, or in which DOJ FCPA prosecutors first entered an appearance, against 19 individual defendants during the first eight months of 2022.
Additional PDVSA Charges
In recent years, we have covered numerous corruption-related fact patterns arising out of international business dealings with Venezuela’s state-owned and state-controlled oil company, Petróleos de Venezuela, S.A. (“PDVSA”). The first eight months of 2022 was no exception to this longstanding trend.
On March 8, 2022, a grand jury sitting in the Southern District of Florida indicted two former senior prosecutors from the anti-corruption division of the Venezuelan Attorney General’s Office, Daniel D’Andrea Golindano and Luis Javier Sanchez Rangel, for allegedly laundering $1 million in bribes through a bank account in Florida. The indictment asserts that Rangel and Golindano accepted payments from a contractor that was itself under investigation by the Attorney General’s Office for allegedly receiving over $150 million in contracts from PDVSA entities, in exchange for closing the investigation without seeking criminal charges against the contractor. The defendants have yet to make an appearance in court and have been transferred to fugitive status.
In a separate alleged PDVSA-related scheme, on June 23, 2022, Jhonnathan Marin, former Mayor of Guanta, Venezuela, pleaded guilty to a single count of money laundering conspiracy. According to the criminal information, between 2015 and 2017, Marin accepted $3.8 million in bribes from an unnamed PDVSA contractor to influence several PDVSA joint ventures operated in the port town area to award tens of millions of dollars’ worth of business to the contractor. Marin currently awaits a September 2022 sentencing date before the Honorable Robert N. Scola, Jr. of the U.S. District Court for the Southern District of Florida.
In a third case involving PDVSA, on July 12, 2022 a grand jury sitting in the Southern District of Florida returned an indictment charging financial asset managers—Ralph Steinmann and Luis Fernando Vuteff—with participating in the $1.2 billion “Operation Money Flight” PDVSA currency conversion / embezzlement scheme that we first covered in our 2018 Year-End FCPA Update. The genesis of the scheme arises from the substantial difference between the official and unofficial rates at which Venezuelan bolivars could be exchanged for U.S. dollars, with members of the scheme causing PDVSA to enter into contracts to convert bolivars at the “unofficial rate” of 60:1, then back into dollars at the official rate of 6:1, thereby instantly increasing the outside investment tenfold at the expense of PDVSA and with the assistance of corrupt payments. For their part, Steinmann and Vuteff are each charged with one count of money laundering, with the indictment alleging that between 2014 and 2018 they laundered more than $200 million in proceeds from the scheme, including by opening bank accounts on behalf of Venezuelan government officials to receive the alleged bribe payments. Vuteff has reportedly been arrested and is pending extradition from Switzerland. Steinmann is not before the court and DOJ has asserted that he is a fugitive.
Finally, in yet another case involving a still different PDVSA corruption fact pattern, on August 24, 2022, a grand jury sitting in the Southern District of Florida returned an indictment charging Venezuelan businessman Rixon Rafael Moreno Oropeza with money laundering offenses in connection with an alleged bribery scheme involving Petropiar, a joint venture between PDVSA and a U.S. oil company. Moreno is alleged to have paid millions in bribes from bank accounts in Florida to a senior Venezuelan government official and senior Petropiar employees to obtain as much as $30 million in contracts from Petropiar at prices that were inflated as much as 100-times market value. Based on public records, it does not appear that Moreno is yet in U.S. custody.
Additional Vitol & Sargeant Marine Defendants
We have been covering ongoing, and at times overlapping, investigations in Latin America involving energy trading firm Vitol Inc. and asphalt company Sargeant Marine, Inc., as well as numerous individual defendants, since our 2020 Year-End Update. In March 2022, there were several additional developments, including new charges and new FCPA Unit connections to existing charges.
On March 16, 2022, DOJ charged Dutch citizen and former Vitol trader Lionel Hanst with a single count of conspiracy to commit money laundering alleging that, from November 2014 to September 2020, Hanst laundered bribes from and on behalf of Vitol for the benefit of officials at Ecuadorian, Mexican, and Venezuelan state oil companies Empresa Publica de Hidrocarburos del Ecuador (“PetroEcuador”), Petróleos Mexicanos (“PEMEX”), and PDVSA. Hanst pleaded guilty and is awaiting sentencing before the Honorable Eric N. Vitaliano of the U.S. District Court for the Eastern District of New York.
Right around the same time, from March through May 2022, DOJ FCPA Unit prosecutors involved in the Hanst case entered appearances in several ongoing cases. Although these cases were filed in earlier years, there were no press releases nor entries of appearance by FCPA Unit members to identify them as FCPA-related enforcement actions—until this year.
In May 2021, Eastern District of New York prosecutors charged Gonzalo Guzman Manzanilla and Carlos Espinosa Barba, former employees of PEMEX’s procurement subsidiary, with conspiracy to commit money laundering in connection with the Vitol bribery scheme. The allegations are that, between 2017 and 2020, Guzman and Espinosa agreed to provide a Vitol trader with confidential, inside information on PEMEX-related bids in exchanges for bribes. Both have pleaded guilty to single counts of conspiracy to commit money laundering and also await sentencing before Judge Vitaliano.
The same DOJ FCPA Unit prosecutors entered their appearances in March 2022 in 2020 cases against brothers Antonio and Enrique Ycaza, who have each been charged with conspiracy to violate the FCPA and money laundering statutes in connection with alleged bribery that straddles the Sargeant Marine and Vitol investigations. The allegations are that, between 2011 and 2019, the brothers operated purported consulting companies that were used to funnel approximately $22 million in bribes to PetroEcuador officials on behalf of Sargeant Marine and Vitol. Like the others, the Ycaza brothers have pleaded guilty and await sentencing before Judge Vitaliano.
Finally, in May 2022, FCPA Unit prosecutors entered their appearances in additional 2020 cases against a different set of brothers, Bruno and Jorge Luz. The Luz brothers have each pleaded guilty to a single count of conspiracy to violate the FCPA’s anti-bribery provisions, associated with a scheme to create shell companies that were allegedly used to launder more than $5 million in bribes to Petrobras officials on behalf of Sargeant Marine. Like the others, the Luz brothers await sentencing before Judge Vitaliano.
Additional Odebrecht-Related Charges
We have been covering an ongoing stream of corruption charges arising from the 2016 blockbuster FCPA resolution with Brazilian construction conglomerate Odebrecht S.A. since our 2016 Year-End FCPA Update, including most recently in our 2021 Year-End FCPA Update. On March 24, 2022, another case was added to the pile with the indictment of former Comptroller General of Ecuador Carlos Ramon Polit Faggioni on six counts of money laundering. According to the indictment, between 2010 and 2016, Polit solicited and received over $10 million in bribes from Odebrecht in exchange for using his political position to benefit Odebrecht’s business in Ecuador. Although the bribery scheme took place substantially outside of the United States, the U.S. nexus is that Polit allegedly directed a member of the conspiracy to launder certain of the payments through Florida-based companies to be used to purchase and renovate properties in Florida.
Polit has pleaded not guilty and currently awaits a May 2023 trial date in the U.S. District Court for the Southern District of Florida.
Additional Corsa Coal Defendant
We covered in our 2021 Year-End FCPA Update the FCPA guilty plea of Frederick Cushmore, Jr., former Head of International Sales for an unnamed Pennsylvania-based coal company. That coal company has since identified itself as Corsa Coal, and on March 31, 2022 further charges were announced. On that date, a grand jury sitting in the U.S. District Court for the Western District of Pennsylvania indicted former Vice President Charles Hunter Hobson on seven counts of FCPA bribery, money laundering, and wire fraud conspiracy. The indictment alleges that Hobson participated in a scheme to pay $4.8 million to an agent with the intention that a portion would be used to pay bribes to officials of state-owned Egyptian company Al Nasr Company for Coke and Chemicals to procure $143 million in coal delivery contracts, and also sought to procure a percentage of the illicit payments as kickbacks for his own benefit. The indictment further alleges that Hobson and his co-conspirators communicated via encrypted messaging services, such as WhatsApp, and personal email addresses in an effort to conceal the scheme.
Hobson has pleaded not guilty and no trial date has yet been set. Corsa Coal has reported that it is cooperating with DOJ and also the Royal Canadian Mounted Police, but no public charges have yet been filed against the entity as of the date of publication.
Additional Seguros Sucre Defendants
We covered above DOJ’s ongoing investigation of suspected corruption involving Seguros Sucre, Ecuador’s state-owned insurance company, with the corporate JLT Group declination with disgorgement. Seemingly independent of that matter, at least in part, we saw developments in two other Seguros Sucre-related corruption cases during the first eight months of 2022.
First, on March 24, 2022, financial advisor Fernando Martinez Gomez pleaded guilty to one count of money laundering associated with alleged corrupt payments to officials of Seguros Sucre and Seguros Rocafuerte, another Ecuadorian state-owned insurer, as well as a separate wire fraud scheme involving the misuse of client assets held by Martinez’s employer, Biscayne Capital, in a pyramid scheme that ultimately led to the liquidation of Biscayne. The FCPA-related money laundering charge arises out of the same scheme leading to the charges against four individuals—including Chairman of Seguros Sucre and Rocafuerte Juan Ribas Domenech—covered in our 2020 Mid-Year FCPA Update. Martinez awaits sentencing before the Honorable Carol Bagley Amon of the U.S. District Court for the Eastern District of New York.
On July 14, 2022, in another seemingly separate Seguros Sucre investigation, a grand jury sitting in the Southern District of Florida returned an indictment against three insurance brokers—Luis Lenin Maldonado Matute, Esteban Eduardo Merlo Hidalgo, and Christian Patricio Pintado Garcia—charging them each with seven counts of FCPA and money laundering violations associated with alleged bribes paid to officials of Seguros Sucre and Seguros Rocafuerte. Merlo, a Florida resident, has been arrested and currently faces a September 2022 trial date. Maldonado and Pintado, both Ecuadorian citizens residing in Costa Rica, have been transferred to fugitive status, although Pintado has made an appearance through counsel.
2022 MID-YEAR CHECK-IN ON FCPA-RELATED ENFORCEMENT LITIGATION
As our readership knows, following the filing of FCPA or FCPA-related charges, criminal and civil enforcement proceedings can take years to wind their way through the courts. The substantial number of enforcement cases from prior years, especially involving contested criminal indictments of individual defendants, has led to an active first eight months of enforcement litigation in 2022. A selection of prior-year matters that saw material enforcement litigation developments follows.
Second Circuit Affirms Dismissal of Hoskins FCPA Charges
For years, we have been following the case of Lawrence Hoskins, the UK citizen working for a UK subsidiary of French multinational Alstom S.A. on a project in Indonesia without ever setting foot in the United States and who yet somehow ended up in U.S. court answering FCPA and money laundering charges. Most recently, in our 2020 Mid-Year FCPA Update, we covered the grant of Hoskins’s Rule 29 Motion for a Judgment of Acquittal on the FCPA charges, but denial as to the money laundering charges, by the Honorable Janet Bond Arterton of the U.S. District Court for the District of Connecticut, following the jury trial conviction on all of those counts in November 2019. Cross-appeals followed and the case wound its way back to the U.S. Court of Appeals for the Second Circuit for a second time.
On August 12, 2022, in an opinion authored by the Honorable Rosemary S. Pooler, a split panel of the Second Circuit affirmed the district court’s ruling rejecting the jury’s FCPA convictions but affirming the jury’s money laundering convictions. To understand this opinion, however, one must go back to the first time Hoskins’s case was before the Second Circuit. As covered in our 2018 Year-End FCPA Update, the Second Circuit in large part affirmed the lower court’s pretrial ruling that DOJ could not charge a defendant under the FCPA based on conspiracy or aiding-and-abetting theories if that defendant does not himself fall within one of the “three clear categories of persons who are covered by [the FCPA’s anti-bribery] provisions,” which Hoskins as a foreign national acting outside of the United States did not himself fall into. The Second Circuit did, however, hold that the government should be permitted to make a showing that Hoskins acted as an agent of a domestic concern (namely, Alstom’s U.S. subsidiary), which would bring him within the statute’s reach. That set the stage for the 2019 trial, where DOJ persuaded the jury that Hoskins acted on behalf of Alstom Power, Inc. (the U.S. entity), but could not then get over the hurdle of Judge Arterton’s searching exegesis of the FCPA on Rule 29. This was the decision now up for review by the Second Circuit.
Fundamentally, the Second Circuit majority agreed with Judge Arterton that there was no agency relationship as between Hoskins and the U.S. Alstom entity. There was no real question after the trial as to whether corrupt payments were made to Indonesian government officials to assist Alstom obtain a major power plant contract, or whether Hoskins participated in procuring the agents through which those payments were made, knowing the purpose of those payments. The question, rather, was whether under common law principles of agency, the U.S. subsidiary and Hoskins established a fiduciary relationship whereby Hoskins would act as an agent on behalf of the U.S. entity as the principal. And the Second Circuit majority found that “[c]onspicuously missing from the evidence is anything indicating that [Alstom Power] representatives actually controlled Hoskins’s actions as Hoskins and his [] counterparts operated under separate, parallel employment structures.” Although Hoskins received certain tasks from Alstom Power representatives, the Second Circuit found insufficient evidence for the jury to find beyond a reasonable doubt that Hoskins had authority to act on behalf of the U.S. entity or that the U.S. entity was able to hire, fire, or otherwise control him. The one dissenting vote, from the Honorable Raymond J. Lohier, Jr., focused principally on the deference accorded to jury verdicts coupled with a belief that there was sufficient (if not uncontroverted) evidence of agency in this case.
Although the case represents an important affirmance of the limits of FCPA jurisdiction and agency law, for Hoskins himself it must not be lost that the money laundering counts were affirmed by all three judges on the panel. The Second Circuit turned away his Speedy Trial Act and related Sixth Amendment claims, finding that although more than six years elapsed from indictment to trial, the vast majority of that time was properly excludable for Speedy Trial Act purposes and insufficient prejudice was shown from the delay. And the Court affirmed the jury instructions on withdrawal from conspiracy and venue for the money laundering counts. On that last point, as DOJ’s money laundering appetite grows it is noteworthy that the Second Circuit held that for venue purposes a multi-part wire transfer (in this case from Alstom Power in Connecticut to the agent in Maryland and then on to Indonesia) may be prosecuted as a single, continuing transaction in any of the U.S. districts through which the transaction traversed.
Roger Ng Trial Conviction
On April 8, 2022, following a nearly two-month trial and three days of deliberation, a federal jury in Brooklyn returned a guilty verdict on all three counts against former Goldman Sachs affiliate managing director Ng Chong Hwa (“Roger Ng”). The convictions of conspiracy to commit FCPA bribery, conspiracy to commit money laundering, and knowing circumvention of the FCPA’s internal controls provision, arose from the massive corruption scheme involving 1Malaysia Development Bank (“1MDB”) that we have been following for years.
According to the Government’s trial evidence, between 2009 and 2014, Ng participated in a scheme to launder billions of dollars from the Malaysian state-controlled economic development fund, including by misleading his firm into backing three bond transactions that were, in part, procured through the payment of more than $1 billion in bribes to government officials in Malaysia and the United Arab Emirates. The fund proceeds were allegedly laundered through the U.S. banking system, including famously for backing Hollywood blockbuster “The Wolf of Wall Street,” and other high-profile investments. Ng himself reportedly received $35 million for his role in the scheme.
As discussed in our 2021 Year-End FCPA Update, the Court previously denied Ng’s pretrial motion to dismiss the internal controls count, which argued that Ng could not have circumvented issuer Goldman Sachs’s internal accounting controls because the alleged bribes used 1MDB (and not bank) funds. The Honorable Margo K. Brodie of the U.S. District Court for the Eastern District of New York affirmed that ruling in denying Ng’s Rule 29 motion for a judgment of acquittal from the bench at the close of DOJ’s case, and explained her reasoning in a written post-trial opinion issued on April 8, the day of the jury’s verdict. Judge Brodie explained that the trial evidence was sufficient to show beyond a reasonable doubt that Ng and cooperating co-defendant Timothy Leissner, who testified against Ng, purposefully hid from various approval committees within the bank the involvement of well-known politically exposed person Low Taek Jho (“Jho Low”) in the 1MDB investment, as well as that the approval of various government officials in the investment was procured through bribery. While acknowledging that the term “internal accounting controls” could be read literally to apply only to safeguards concerning an issuer’s own accounting entries, the Court held that such a narrow reading would frustrate the overall intent of the statute and read out the explicit requirement in the statute that issuers establish controls to authorize specific transactions.
Ng is currently scheduled to be sentenced in November 2022.
Baptiste and Boncy FCPA Charges Dismissed on the Eve of Retrial
We covered in our 2021 Year-End FCPA Update the reversal of FCPA jury trial convictions of retired U.S. Army colonel Joseph Baptiste and businessperson Roger Richard Boncy, premised on an FBI sting simulating a bribery scheme involving Haitian port project investments, based on the ineffective assistance of Baptiste’s counsel infecting the fundamental fairness of the joint trial. The retrial was set to begin in July, but on June 27, 2022 DOJ moved to dismiss all charges with prejudice, and DOJ’s motion was granted by the Honorable Allison D. Burroughs of the U.S. District Court for the District of Massachusetts the following day.
The cause for the collapse of the prosecution stems from a December 2015 phone call with Boncy that an undercover FBI agent recorded during the investigation. The FBI inadvertently did not preserve the recording, which became a flashpoint during the initial trial as Boncy insisted that he made exculpatory statements during that conversation that would show he did not believe the investment in question was corrupt. That claim found late vindication when, leading up to the second trial, the FBI discovered text messages on an FBI server that contemporaneously described the contents of the December 2015 phone call, including a statement by Boncy that the money at issue would not be used to pay bribes. Aggressive discovery requests were the key driver to achieve this dismissal.
Baptiste and Boncy are now discharged and free from charges.
Eleventh Circuit Remands Case to Address Foreign Diplomat Immunity Defense
In our 2021 Year-End FCPA Update we covered the denial of motion to make a special appearance and challenge the money laundering indictment facing Alex Nain Saab Moran, a joint Colombian and Venezuelan national charged with money laundering offenses in connection with a $350 million construction-related bribery scheme in Venezuela. The Honorable Robert N. Scola, Jr. of the U.S. District Court for the Southern District of Florida rejected the motion on the basis of the fugitive disentitlement doctrine, given that Saab was not present in the United States himself.
On June 2, 2022, the U.S. Court of Appeals for the Eleventh Circuit in a per curiam order declined to address the merits of Saab’s appeal. With respect to the request to make a special appearance to challenge the indictment, the issue had been mooted by Saab’s interceding extradition from Cabo Verde. But with respect to Saab’s claim that he was a foreign diplomat immune from prosecution, the Eleventh Circuit remanded the case for the district court to address that issue in the first instance. Saab’s renewed motion to dismiss is now set for a week-long evidentiary hearing back before Judge Scola, beginning in October 2022.
District Court Finds Broad Privilege Waiver From Cooperation with DOJ
In our 2019 Year-End and 2020 Mid-Year FCPA updates, we covered the FCPA charges against and extensive post-indictment litigation involving the former Cognizant Technology Solutions President and Chief Legal Officer. The case is currently set for trial in the U.S. District Court for the District of New Jersey in October 2022, but the pretrial disputes continue apace. The individual defendants have moved to compel discovery on a number of issues, which the Honorable Kevin McNulty addressed in five separate memorandum opinions dated January 24 (two), March 23, April 27, and July 19, 2022.
Chief among the issues in dispute concerns the recurring dilemma of how companies are to navigate cooperation with government investigations without waiving the attorney-client privilege. Here, as part of its substantial cooperation efforts that ultimately led to a criminal declination, Cognizant provided DOJ with “detailed accounts” of numerous company employee witness interviews conducted by outside counsel. The individual defendants sought access to all materials associated with those interviews, which Judge McNulty in large part granted. The Court held that by disclosing privileged information to DOJ, Cognizant waived attorney-client privilege and work product protection “as to all memoranda, notes, summaries, or other records of the interviews themselves,” regardless of whether the interview summaries were conveyed orally or in writing. Further, “to the extent the summaries directly conveyed the contents of documents or communications, those underlying documents or communications themselves are within the scope of the waiver.” Finally, Judge McNulty held that “the waiver extends to documents and communications that were reviewed and formed any part of the basis of any presentation, oral or written, to the DOJ in connection with this investigation.”
As noted above, the former executives are currently scheduled to go to trial in October 2022. But this date may be imperiled by defendants’ recent motion to conduct numerous Rule 15 depositions in India, including through the compulsion of letters rogatory. We will undoubtedly return to this matter in future FCPA updates.
SEC Obtains Default Judgment in 2019 Case
In another development this year in a case initiated in 2019, on June 27, 2022 the Honorable J. Paul Oetken of the U.S. District Court for the Southern District of New York issued a default judgment against Yanliang “Jerry” Li. As discussed in our 2019 Year-End FCPA Update, Li, the former China Managing Director of a “multi-level marketing company,” later identified as Herbalife Nutrition Ltd., was indicted by DOJ and charged by the SEC for FCPA bribery and accounting violations arising from an alleged scheme to bribe Chinese government officials to obtain direct sales licenses and stifle negative media coverage about the company. Li has yet to make an appearance in U.S. court, even though he was served with the SEC’s complaint in China, and Judge Oetken assessed an Exchange Act Tier II penalty (ranging from $80,000 to $97,523) for each of five violations—(1) falsifying an expense report; (2) falsifying a SOX sub-certification; (3) endorsing a false audit report; (4) submitting a second false SOX certification; and (5) giving false testimony to the SEC—for a total of $550,092 in penalties.
PDVSA-related Defendants Move to Dismiss Indictments on Jurisdictional Grounds
We covered in our 2021 Year-End FCPA Update the seismic grant of Daisy Teresa Rafoi Bleuler’s motion to dismiss the FCPA and money laundering charges against her in the U.S. District Court for the Southern District of Texas by the Honorable Kenneth M. Hoyt. Judge Hoyt found that, as a matter of law, the indictment was deficient in alleging the actions abroad by Swiss citizen Rafoi, who did not set foot in the territory of the United States during the alleged PDVSA-related corruption scheme (and was challenging her indictment from abroad), were insufficient to bring her within the scope of U.S. jurisdiction. DOJ has appealed this dismissal, arguing that “a foreign national who actively participated in a US-linked scheme to pay bribes, can be liable for FCPA conspiracy even if she is not an enumerated FCPA actor who is liable as a principal,” and further that whether Rafoi qualified as an agent was a question of fact for a jury to decide.
On the heels of Judge Hoyt’s decision in the Rafoi case, co-defendant Paulo Jorge Da Costa Casqueiro Murta filed a motion to dismiss his own charges, raising many of the same jurisdictional arguments. On July 11, 2022, Judge Hoyt granted the motion for much the same reasoning as in the Rafoi case, but additionally on statute-of-limitations grounds and also granting a motion to suppress statements made by Casqueiro during a custodial interview in Spain. With respect to the statute-of-limitations matter, the Court waded through the complexities of multiple 28 U.S.C. § 3292 tolling orders and found that the return of an indictment against a co-defendant in 2017 ended the tolling period as to the subsequently indicted Casqueiro even though a later tolling order was issued and further Mutual Legal Assistance Treaty responses were filed by Swiss authorities. With respect to the suppression of statements, Judge Hoyt found that the circumstances of Casqueiro’s interview were impermissibly coercive where the defendant was summoned to the interview in Portugal by a local prosecutor, did not feel like he was permitted to leave the interview under Portuguese law, and was not advised of his protections under the U.S. constitution by the U.S. Department of Homeland Security agents who conducted the interview.
DOJ immediately filed a motion to stay the Casqueiro dismissal pending appeal, arguing that the defendant had been extradited to the United States to face these charges and would likely leave the United States if he was not maintained on pretrial release pending appeal. Judge Hoyt denied the stay request at the district court level, but on August 3, 2022 the U.S. Court of Appeals issued a stay pending resolution of the merits appeal, coupled with an order to expedite that appeal. On DOJ’s request, the Casqueiro and Rafoi appeals were then consolidated for argument, which is currently scheduled for October 2022. We expect these appeals will lead to a further important appellate ruling on the breadth of FCPA and money laundering statutes’ jurisdiction over foreign nationals, supplementing the Second Circuit’s decision in Hoskins discussed above.
Finally, a third co-defendant in the same sprawling case—Nervis Gerardo Villalobos Cárdenasg—filed his own motion to dismiss the indictment in February 2022, like Rafoi doing so from abroad. For reasons that may only be explained in a series of sealed orders, the Villalobos motion has proceeded on a slower track than the Casqueiro motion. DOJ makes many of the same arguments opposing dismissal as in the other cases, including renewing the same “fugitive disentitlement” challenge to the propriety of a court addressing a motion to dismiss filed by a so-called fugitive not before the court as it made (and was rejected) in Rafoi’s case. The motion to dismiss remains pending as of the date of publication.
Former Venezuelan National Treasurer Extradited; Motion to Dismiss Denied
On May 24, 2022, former Venezuelan National Treasurer Claudia Patricia Díaz Guillén made her initial appearance in the U.S. District Court for the Southern District of Florida and entered a not guilty plea to the money laundering charges against her. As described in our 2020 Year-End FCPA Update, Díaz is alleged to have accepted bribes to facilitate more favorable rates for foreign exchange transactions. Promptly following her extradition, Díaz moved to dismiss the charges on jurisdictional grounds similar to those raised by the PDVSA defendants in Houston described above. But the Honorable William P. Dimitrouleas, unpersuaded by Judge Hoyt’s rulings in Rafoi and Casqueiro, made short work of the motion by disposing of the matter as an issue for the jury in a two-page opinion dated July 12, 2022. Díaz currently faces an October 2022 trial date.
Fourth Circuit Affirms Lambert FCPA Trial Conviction
In our 2019 Year-End FCPA Update we covered the trial conviction of former Transport Logistics International, Inc. President Mark T. Lambert. On July 21, 2022, the U.S. Court of Appeals for the Fourth Circuit, in a per curiam opinion, affirmed the FCPA bribery and wire fraud convictions. The court found no error by the trial court in ruling on various evidentiary exclusions, nor in issuing an Allen charge when the jury initially could not agree on a verdict. On the substance of the charges, the Fourth Circuit found sufficient evidence to support the wire fraud convictions based on DOJ’s evidence that Lambert actively concealed material facts from the victim customer by virtue of quoting inflated costs that secretly included the costs of bribing one of the customer’s representatives, Vadim Mikerin, who also was prosecuted by DOJ.
Fifth Circuit Declares SEC Practice of Imposing Civil Monetary Penalties in Administrative Proceedings Unconstitutional
Those who have followed our client updates over the years may recall that many of the SEC’s settled FCPA enforcement actions for the first three decades of the statute were filed as civil complaints in federal district court. That all changed with the Dodd-Frank Wall Street Reform Act of 2010 (“Dodd-Frank”), which among many other important reforms granted the SEC authority to impose civil monetary penalties in administrative proceedings in which the SEC seeks a cease-and-desist order. Soon thereafter, the vast majority of settled enforcement actions (in FCPA and other cases) began being filed as administrative cease-and-desist proceedings.
Potentially imperiling that practice, on May 18, 2022 a three-judge panel from the U.S. Court of Appeals for the Fifth Circuit held in Jarkesy v. SEC that the SEC imposing civil monetary penalties in administrative proceedings is unconstitutional because Congress delegated its legislative power to the SEC without providing an intelligible principle by which the SEC could exercise that power. The Honorable Jennifer Walker Elrod, writing for the Court, recognized that Congress had authority to assign disputes to agency adjudication in “special circumstances,” but here found that Congress had given the SEC “exclusive authority and absolute discretion to decide whether to bring securities fraud enforcement actions within the agency instead of in an Article III court” while saying “nothing at all indicating how the SEC should make that call.” The Fifth Circuit further concluded that the SEC’s in-house adjudication violated the Petitioners’ Seventh Amendment right to a jury trial.
This decision does not involve FCPA enforcement directly, but its reverberations will certainly be felt in FCPA as well as other SEC enforcement areas until the law settles. For more on the Jarkesy decision, please see our separate article, “Jarkesy Wins Relief from ALJ Control After Years of Fighting for his Right to a Jury Trial.”
Continued Deferred Prosecution Agreement Scrutiny
We covered in our 2021 Year-End FCPA Update Deputy Attorney General Lisa O. Monaco’s October 2021 announcement that DOJ was modifying certain of its corporate criminal enforcement policies, and simultaneously highlighting increasing scrutiny that DOJ was giving to companies’ compliance with pretrial diversion (deferred and non-prosecution) agreements. The thrust of Monaco’s statements in the latter category was to express a concern that some companies continued to violate the law or otherwise failed to live up to their obligations during the period of their deferred and non-prosecution agreements. As we noted in our last update, close in time to this speech a number of companies announced that DOJ was conducting so-called “breach investigations,” including in the FCPA context such as the following example (among others):
- On March 3, 2022, Mobile TeleSystems Public Joint Stock Company (“MTS”) announced a one-year extension of its 2019 FCPA deferred prosecution agreement (also covered in our 2019 Year-End FCPA Update), together with the monitorship that accompanied it. MTS reported that there had been no determination that it had breached the terms of its agreement, but that the extension was due to a variety of factors, including the COVID-19 pandemic and to allow sufficient time for MTS to implement enhancements to its anti-corruption compliance program and have those enhancements reviewed by the monitor.
There is no question that DOJ and the SEC are applying increased scrutiny to companies under the supervision (active as in a monitorship, or passive as in self-reporting) that comes with deferred and non-prosecution agreements. We expect additional developments in this area in the months and years to come.
CEO and CCO Certifications of Compliance Programs
When the May 2022 Glencore FCPA resolution described above required the company’s Chief Executive Officer and Chief Compliance Officer each to certify at the conclusion of the three-year term of the monitorship that the company’s compliance program is reasonably designed and implemented to meet the requirements of the plea agreement the compliance industry sat up and took notice. Compliance-focused advocacy organizations have argued that imposing this requirement on CCOs puts them in an untenable position, and, in effect, puts a target on their back for any imperfections in the corporate compliance program they oversee.
DOJ officials have gone on the speaking circuit in defense of this new policy. On May 26, 2022, Deputy Attorney General Monaco asserted at a SIFMA event that this was in fact DOJ’s “effort to empower the gatekeepers” and ensure that CCOs are kept in the loop on compliance matters. Echoing this sentiment, DOJ FCPA Unit Chief David Last said at a June 14, 2022 International Bar Association event that this certification “is not meant to be a gotcha game,” but rather designed to “incentivize” CEOs and CCOs to “make sure they’re checking that [their] compliance program is up to snuff.” And DOJ Fraud Section Assistant Chief Lauren Kootman said at a Women’s White Collar Defense Association event on June 22, 2022 that “[t]he intention is not to put a target on the back of a chief compliance officer,” but rather to ensure that companies appropriately resource their compliance departments. These assurances have provided cold comfort to many in the compliance industry, and likely this will be a continuing source of discussion as the policy is implemented more broadly. On that note, Kootman has confirmed that this requirement “most likely” will be incorporated into all corporate FCPA resolutions going forward.
2022 MID-YEAR FCPA-RELATED LEGISLATIVE AND POLICY DEVELOPMENTS
In addition to the enforcement developments covered above, the first eight months of 2022 saw numerous important developments in FCPA-related legislative and policy areas.
DOJ Issues Increasingly Rare FCPA Opinion Procedure Release (22-01)
By statute, DOJ must provide a written opinion at the request of an issuer or domestic concern stating whether DOJ would prosecute the requestor under the anti-bribery provisions for prospective (not hypothetical) conduct it is considering. Once a common staple of FCPA practice, this procedure has seen seldom use in recent years. Indeed, DOJ’s last opinion procedure release (covered in our 2020 Year-End FCPA Update) was issued in August 2020, and was itself then the first since 2014. On January 21, 2022, DOJ issued a new opinion procedure release (its 63rd overall) interpreting how the FCPA applies to payments made under physical duress in response to extortionate demands by foreign officials.
Requestor is a U.S. domestic concern that owns and operates maritime vessels. While awaiting entry to the port of Country B, one of Requestor’s vessels inadvertently anchored in the territorial waters of Country A, where it was intercepted by that country’s navy. The vessel’s captain was detained in a local jail without access to care needed to address his “serious medical conditions,” at which point a third party who claimed to be acting on behalf of Country A’s navy contacted Requestor and demanded $175,000 in cash in exchange for the captain’s release and permission to leave Country A’s territorial waters. After unsuccessfully trying to obtain formal documentation explaining the legal basis for the payment, and failed attempts at obtaining intervention by other agencies of the U.S. government, Requestor sought DOJ’s opinion that it would not be prosecuted for making the payment to obtain the release of its vessel’s captain and crew.
In light of the exigent, life-threatening circumstances, DOJ acted swiftly and issued an initial response within two days of the October 2021 request, following up with the full opinion in January 2022 upon the submission of additional information. DOJ concluded that it would not pursue an enforcement action on these facts because “Requestor would not be making the payment ‘corruptly’ or to ‘obtain or retain business.’” With respect to the “corrupt intent” element of the FCPA, DOJ concluded it would not be met here because Requestor’s primary motivation in making this payment was to “avoid imminent and potentially serious harm to the captain and the crew.” Notably, DOJ distinguished this circumstance of physical duress from the more commonly experienced circumstance of economic duress—where companies are “shaken down” for corrupt payments at the risk of unjust financial consequences—observing that payments made in response to financially coercive demands may well be illegal under the FCPA. With respect to the “obtain or retain business” element of the FCPA, DOJ concluded that it would not be met here because Requestor had no ongoing or anticipated business in Country A. DOJ further noted Requestor’s transparent efforts to address this situation in response to the payment demand, which did not evince a corrupt intent.
While FCPA Opinion Procedure Release 2022-01 does not break any genuinely new ground and, like other opinion releases, is expressly limited to the specific facts at hand, it does nonetheless offer useful guidance to companies and practitioners alike regarding DOJ’s interpretation of these two important elements of the FCPA. In particular, the ability to make even a large cash payment under questionable circumstances to preserve the physical safety and wellbeing of employees is genuinely helpful. Nonetheless, we must caution our readers to exercise caution in expanding the logic of this opinion into the realm of economic coercion, which DOJ does treat differently as expressed in its opinion.
FinCEN Advisory Regarding Kleptocracy and Foreign Public Corruption
On April 14, 2022, the Department of Treasury’s Financial Crimes Enforcement Network (“FinCEN”) released its “Advisory on Kleptocracy and Foreign Public Corruption,” which was developed to provide guidance to financial institutions in identifying and disclosing transactions involving the proceeds of foreign public corruption. As detailed in our 2021 Year-End FCPA Update and standalone client alert, “U.S. Strategy on Countering Corruption Signals Focus on Enforcement,” in December 2021, the Biden Administration—which previously identified the fight against corruption as a “core national security interest of the United States”—released a United States Strategy on Countering Corruption, articulating an ambitious, whole-of-government approach to combating corruption and its downstream societal effects. FinCEN describes this latest Advisory as part of the Biden Administration’s broader anti-corruption efforts.
Unsurprisingly, the Advisory describes Russia as a jurisdiction of “particular concern” in this area given “the nexus between corruption, money laundering, malign influence and armed interventions abroad, and sanctions evasion,” which is consistent with the United States’ broader efforts to combat and disrupt Russia-related financial activity following its invasion of Ukraine, including asset freezes and seizures conducted through Task Force KleptoCapture, discussed further in our separate client alert “United States Responds to the Crisis in Ukraine with Additional Sanctions and Export Controls.” The Advisory describes two typologies and patterns of activity associated with kleptocracy and foreign public corruption. First, “wealth extraction,” or the “siphoning off” of national resources by oligarchs and elites, is characterized as being conducted through bribery and extortion schemes involving foreign public officials or the misappropriation of embezzlement of public assets for private enrichment, which can commonly be accomplished through public procurement in the defense and health sectors or through bribes and kickbacks paid in the context of large infrastructure or development projects. Second, the Advisory notes that kleptocrats and other corrupt public officials will engage in similar activity to drug traffickers or other criminal actors to launder the proceeds of corruption, such as through the use of complex networks of shell companies or offshore accounts or the conversion of ill-gotten gains into the purchase of high-value assets such as luxury real estate, private jets and yachts, art and antiquities, or hotels.
The Advisory concludes with a set of 10 common “red flag” indicators that financial institutions should look out for in an effort to identify, prevent, and report potentially suspicious transactions involving the proceeds of kleptocracy or foreign public corruption. These include transactions involving multiple government contracts being awarded to the same entity or entities with common ownership, transactions in which government business is being conducted through personal accounts, transactions involving foreign public officials and the purchase of high-value or luxury assets and/or jurisdictions with which the officials do not have known ties, the use of third parties or shell companies to obscure the involvement of foreign public officials, transactions involving excessive charges or inconsistent or incomplete documentation, and transactions involving entities beneficially owned by individuals connected to known kleptocrats or their family members.
2022 MID-YEAR CHECK-IN ON THE FCPA SPEAKER’S CORNER
U.S. government anti-corruption enforcement personnel were active on the speaking circuit in the first eight months of 2022, offering a glimpse into DOJ and SEC priorities and expectations for the companies that appear before them. In many instances, these statements are more broadly focused on white collar crime in general, but the lessons may be applied in the FCPA context. We will cover the September 15, 2022 speech by U.S. Deputy Attorney General Lisa Monaco in a separate, forthcoming client alert.
Attorney General Merrick Garland
Speaking to the ABA Institute on White Collar Crime in Washington D.C. on March 3, 2022, Attorney General Merrick Garland made clear that DOJ’s first priority in corporate criminal cases is the prosecution of individuals who “commit and profit from corporate malfeasance.” Garland stated that DOJ’s focus on individual accountability is the best way to deter corporate crimes in the first place because corporations are only able to act through individuals. In addition, Garland argued that the prosecution of individuals is necessary because it bolsters Americans’ trust in the rule of law. Toward the end of his remarks, Garland noted that over the long course of his career he has seen DOJ’s interest in prosecuting corporate crime “wax and wane,” and concluded that “today, it is waxing again.”
Assistant Attorney General Kenneth Polite
In a March 25, 2022 speech before NYU Law’s Program on Corporate Compliance and Enforcement, Assistant Attorney General for the Criminal Division Kenneth Polite provided details on how DOJ evaluates corporate compliance programs. He stated that DOJ’s goal with such evaluations is to ensure that “companies are designing and implementing effective compliance systems and controls, creating a culture of compliance, and promoting ethical values.” First, according to Polite, a company’s compliance program must be well-suited to the company’s specific risk profile. Second, a compliance program must demonstrate a company’s commitment to compliance at all levels of the company. Third, DOJ wants to see evidence that the corporate compliance program actually works in practice. Finally, Polite emphasized that companies should be able to demonstrate an “ethical culture” that permeates all areas of the corporate structure.
Principal Deputy Assistant Attorney General Nicholas McQuaid
In a speech delivered at a forum hosted by the American Conference Institute on January 27, 2022, Criminal Division Principal Deputy Assistant Attorney General Nicholas McQuaid admonished attendees to not focus on the number of prosecutions of FCPA violations in the last year. Although as noted in our 2021 Year-End FCPA Update, FCPA resolutions in 2021 fell to their lowest level since 2015, McQuaid stated that DOJ entered 2022 with a “robust pipeline” of cases and that he expects there to be “significant resolutions” over the next year.
2022 MID-YEAR CHECK-IN ON FCPA-RELATED PRIVATE CIVIL LITIGATION
Although the FCPA does not provide for a private right of action, our readership knows well that civil litigants have pursued a variety of causes of action in connection with FCPA-related conduct, with varying degrees of success. A selection of matters with material developments in the first eight months of 2022 follows.
Select Shareholder Lawsuits / Class Actions
- Mobile TeleSystems PJSC – As covered in our 2021 Year-End FCPA Update, shortly following MTS’s 2019 joint FCPA resolution with DOJ and the SEC for alleged corruption in Uzbekistan, the company found itself a defendant in a class action suit filed in the U.S. District Court for the Eastern District of New York, alleging that the company issued false and misleading statements about the its inability to predict the outcome of the U.S. government’s investigations, the effectiveness of its internal controls and compliance systems, and its cooperation with U.S. regulatory agencies. In March 2021, the Honorable Ann M. Donnelly dismissed the lawsuit, finding that the plaintiffs did not demonstrate that the challenged claims were false or misleading, that MTS could have predicted the outcome of the investigation, or that its disclosures about the existence of the investigation were insufficient. Just over a year later, on March 31, 2022, the U.S. Court of Appeals for the Second Circuit issued a summary order affirming Judge Donnelly’s dismissal. The Second Circuit held that the complaint was “devoid of any factual allegations that with particularity establish that MTS executives knew that they could reasonably estimate their potential liability arising from the government investigations but opted not to do so.”
Select Civil Fraud / RICO Actions
- Stryker / Zimmer Biomet – In March 2022, Mexican government healthcare agency Instituto Mexican del Seguro Social (“IMSS”) lost two appeals of lawsuits involving alleged bribery of foreign officials. In both suits, one in the Sixth Circuit (Stryker) and the other in the Seventh Circuit (Zimmer Biomet), the Circuit Court affirmed the respective district court’s decision to grant a motion to dismiss on forum non conveniens grounds in cases where the relevant agents, evidence, and injury were all found to be based in Mexico and there was no showing that the Mexican court system was an inadequate forum.
- Olympus Latin America – IMSS suffered another litigation defeat, this time for different reasons and in the U.S. District Court for the Southern District of Florida, when on August 31, 2022 the Honorable Kathleen M. Williams dismissed with prejudice the Mexican state agency’s fraud claim against Olympus arising from a portion of the facts that led to Olympus’s 2016 FCPA resolution described in our 2016 Year-End FCPA Update. Judge Williams determined that IMSS’s 2021 complaint was untimely because it was filed more than four years after Olympus’s 2016 deferred prosecution agreement. The Court rejected IMSS’s arguments that it did not know that its contracts with Olympus were covered in the FCPA resolution because they were not named specifically, holding that there was a duty to exercise diligence upon the public release of the deferred prosecution agreement.
- Odebrecht S.A. – We last caught up on the bevvy of civil litigation filed against Brazilian construction conglomerate Odebrecht in the wake of its 2016 anti-corruption settlements with U.S., Brazilian, and Swiss authorities in our 2018 Year-End FCPA Update. On July 19, 2022, in a civil fraud case brought by bond purchasers that was allowed to proceed to discovery, U.S. Magistrate Judge Barbara Moses of the U.S. District Court for the Southern District of New York imposed severe sanctions on Odebrecht for discovery violations. The Court had previously ordered Odebrecht to provide discovery to the bondholders concerning materials previously provided to U.S. and Brazilian authorities but, without seeking a protective order or otherwise objecting, Odebrecht simply failed for more than a year to turn over the documents on the grounds that they were prohibited from doing so under Brazilian law. As a consequence, Judge Moses imposed Rule 37 sanctions establishing as a fact in the matter that the Odebrecht defendants made material misrepresentations to plaintiff bondholders with scienter. One week later the parties requested a settlement conference with Judge Moses.
Select Anti-Terrorism Act Suits
- Certain Pharmaceutical and Medical Device Companies – We reported in our 2020 Year-End FCPA Update on a decision by the Honorable Richard J. Leon of the U.S. District Court for the District of Columbia dismissing a lawsuit brought by U.S. service members and their families alleging that certain pharmaceutical and medical device companies violated the Anti-Terrorism Act (“ATA”) by paying bribes to officials at the Iraqi Ministry of Health, which was controlled by the terrorist group Jaysh al-Mahdi (“JAM”), which JAM then used to fund attacks against the plaintiffs. Judge Leon ruled that the Court lacked personal jurisdiction over the foreign defendants, and the plaintiffs had failed to adequately plead a violation under the ATA as to the rest. On January 4, 2022, the U.S. Court of Appeals for the District of Columbia, in an opinion by Honorable Cornelia T.L. Pillard, reversed the dismissal and revived the case, finding that causation was adequately alleged and the district court’s jurisdictional analysis was “unduly restrictive.” Defendants have petitioned for a rehearing en banc, which remains pending as of the date of publication.
Other Civil Lawsuits
- Cicel (Beijing) Science & Tech. Co. – We last covered the breach-of-contract lawsuit brought by Cicel against Misonix, Inc. in our 2017 Year-End FCPA Update. Cicel claimed wrongful termination of a distribution contract with Misonix, which then defended by arguing that it terminated only after discovering potentially corrupt conduct and disclosing it to DOJ and the SEC. On October 7, 2017, the Honorable Arthur D. Spatt of the S. District Court for the Eastern District of New York denied Misonix’s motion to dismiss, allowing the case to proceed to discovery. But earlier this year, on January 20, 2022, the Honorable Gary R. Brown granted Misonix’s motion for summary judgment, finding that undisputed facts conclusively proved Cicel’s involvement in illegal conduct, which Misonix moved swiftly to remediate upon discovery by conducting an internal investigation, terminating the relationship, and disclosing the matter to DOJ and the SEC. No prosecution was brought against Misonix, as both DOJ and the SEC closed their investigations in 2019.
2022 MID-YEAR INTERNATIONAL ANTI-CORRUPTION DEVELOPMENTS
World Bank
The World Bank has been quite active during the first eight months of 2022 in debarring companies and individuals for corrupt practices:
- On January 4, 2022, the World Bank announced a 12-month debarment followed by a 12-month conditional non-debarment of ADP International S.A., a French-based airport developer, operator, and manager, for allegedly attending improper meetings with government officials during the tender for a contract and failing to disclose that fees paid to a retained agent were partially transferred to a non-contracted consultant. Colas Madagascar S.A. was also debarred for two years for arranging the improper meetings with government officials, and Bouygues Bâtiment Int’l was sanctioned with conditional non-debarment for 12 months for attending the meetings.
- On February 23, 2022, the World Bank announced a 34-month debarment followed by an 18-month conditional non-debarment of AIM Consultants Limited, a consultancy company based in Nigeria, and its managing director, Amin Moussali. According to the World Bank, AIM through Moussali paid approximately $45,500 in kickbacks to various project officials after receiving payment for a service contract in connection with a $908 million World Bank-funded project designed to reduce soil vulnerability and erosion in certain sub-watersheds in Nigeria. As part of a settlement agreement, Moussali agreed to complete corporate ethics training, and AIM agreed to implement an integrity compliance program in accordance with the principles set out in the World Bank Group’s Integrity Compliance Guidelines.
- On March 30, 2022, the World Bank debarred a Nigerian technology consulting company and its managing director for 50 months and 5 years, respectively, for acting as a consultant and making “appreciation” payments to project officials. According to the World Bank, SofTech IT Solutions and Services Ltd., under the direction of its managing director Isah Salihu Kantigi, served as a conduit through which he and other consultants made illegal payments to project officials in connection with a $1.8 billion project funded by the World Bank, which was designed to provide targeted cash transfers to poor and vulnerable households under an expanded national social safety net. As part of a settlement, Kantigi committed to taking corporate ethics training that demonstrates a commitment to personal integrity and business ethics, and SoftTech committed to implementing a corporate ethics training program.
- On April 14, 2022, the World Bank sanctioned Germany-based Voith Hydro Holding GmbH & Co. KG and two subsidiaries for their alleged corrupt practices in power projects in the Democratic Republic of The Congo and Pakistan. According to the World Bank, between 2012 and 2016, Voith Hydro took actions to gain unfair tender advantages, including making improper payments to a commercial agent to gain favorable decisions in contract executions and failing to disclose those payments. The Voith Hydro entities face a range of 15-34 months of debarment, followed by conditional non-debarment terms.
Inter-American Development Bank
On March 18, 2022, The Inter-American Development Bank (“IDB”), which provides financing in Latin America, announced a three-year debarment of Brazilian construction company Construtora COESA and 26 subsidiaries for simulating competition for a contract, failing to act upon knowledge of corruption, and making illicit payments totaling $1.7 million to public officials involved in supervising and managing the contracts. In 2019, an affiliated entity settled with Brazilian authorities in relation to these and other matters for $460 million. The IDB credited the prior fine and Construtora COESA’s cooperation for a reduced sanction.
Europe
United Kingdom
JLT Specialty Limited
On June 22, 2022, the UK Financial Conduct Authority (“FCA”) announced a resolution with JLT Specialty, a UK subsidiary of JLT Group which, as noted above, reached a declination with disgorgement resolution with the U.S. DOJ and, as covered below, also reached a resolution with Colombian authorities. JLT Specialty agreed to pay the FCA £7.8 million for alleged failings concerning the risk management systems that it had in place between 2013 and 2017 that were responsible for countering the risks of bribery and corruption, which fine was reduced based on the assistance the company provided throughout the investigation, as well its self-report to relevant authorities and remediation. The FCA also commented that this was its second anti-corruption enforcement action against JLT Specialty, with the first occurring in 2013 as covered in our 2013 Year-End FCPA Update. Gibson Dunn represented JLT Group in connection with the FCA and U.S. investigations.
Glencore Energy (UK) Limited
On June 21, 2022, UK Glencore subsidiary Glencore Energy pleaded guilty to seven counts of bribery in connection with the same coordinated, multi-jurisdictional resolution with the U.S. DOJ and Brazilian authorities described above, but with the slightly different five-country line-up of Cameroon, Equatorial Guinea, Ivory Coast, Nigeria, and South Sudan. The SFO alleged that Glencore Energy paid over $28 million in bribes for preferential access to oil in these countries, including increased cargoes, valuable grades of oil, and preferable dates of delivery. Sentencing is currently scheduled to take place in November 2022.
KPMG Audit plc and Anthony Sykes
On May 24, 2022, the UK Financial Reporting Council (“FRC”) announced that it had imposed sanctions against a KPMG network firm in the United Kingdom and the responsible Audit Engagement Partner Anthony Sykes, in relation to the 2010 statutory audit of Rolls-Royce Group plc. According to the FRC, the respondents did not adequately respond to matters arising during the audit that indicated a risk of corruption by Rolls-Royce, including payments made by Rolls-Royce to agents in India that formed part of the company’s 2017 resolution with the Serious Fraud Office (“SFO”) and other authorities as covered in our 2017 Mid-Year FCPA Update.
Petrofac-Related Seizures
On April 28, 2022, the SFO recovered over £567,000 from three personal bank accounts linked to deceased UAE businessman Basim Al Shaikh, who allegedly paid bribes to secure contracts for Petrofac while working as a so-called “fixer agent.” As covered in our 2021 Year-End FCPA Update, in October 2021 Petrofac admitted to failing to prevent former senior executives of the group’s subsidiaries from using agents to pay bribes of £32 million to win oil contracts worth approximately £2.6 billion in Iraq, Saudi Arabia, and the United Arab Emirates between 2011 and 2017 and was ordered to pay over £77 million to settle the claims.
Unaoil Defendants Convictions Overturned
We covered most recently in our 2021 Year-End FCPA Update the several individual prosecutions arising out of the SFO’s Unaoil-related investigation of corruption in Iraq. For example, SBM Offshore Sales Manager Paul Bond was convicted in March 2021, though that conviction was then called into question when the conviction of co-defendant and former Unaoil Manager Ziad Akle was overturned in December 2021. The issue leading to the conviction reversal was the interaction between senior SFO officials and a “fixer” working on behalf of Unaoil founders Cyrus Allen Ahsani and Saman Ahsani, who themselves pleaded guilty to FCPA charges in the United States as discussed in our 2019 Year-End FCPA Update and hired the so-called fixer to place pressure on other defendants, unbeknownst to their lawyers, to likewise plead guilty. On March 24, 2022, the Court of Appeal of England and Wales also overturned Bond’s conviction. Then, on July 21, 2022, a third defendant, former SBM Offshore Vice President Stephen Whiteley, had his conviction overturned.
The same day as the reversal of Whiteley’s conviction, the UK Attorney General’s Office released a 100-plus-page report it commissioned by former high court judge Sir David Calvert-Smith detailing the lapses in the SFO’s handling of the case and making recommendations for enhanced controls going forward, which enhancements the SFO has said are in the process of being implemented. Notably, the report includes the nugget that Ata Ahsani—father to Cyrus and Saman—himself reached a non-prosecution agreement with the U.S. DOJ pursuant to which he agreed to a penalty of $2.25 million but suffer no further sanction. This non-prosecution agreement with Ata Ahsani has not been made public nor, to our knowledge, been confirmed by DOJ.
UK Government Guidance regarding Bribery and Corruption in Trade
On May 20, 2022, the UK government published new guidance for international businesses to demonstrate that their business and supply chain is free from bribery and corruption in order to trade with UK partners. The guidance notes that UK businesses must comply with the UK Bribery Act 2010, which extends to trading relationships and supply chains. Therefore, UK businesses expect international partners to be “aware of the risks of bribery and corruption” and “committed to communicating awareness to [their] employees and business partners.” To avoid bribery and corruption, businesses are advised to assess their risks; conduct thorough due diligence on potential trading partners; train staff to identify and avoid the risks of bribery and corruption; and keep records of avoidance, training, and mitigation procedures as proof that appropriate action has been taken where necessary.
European Union
European Public Prosecutor`s Office
The European Public Prosecutor’s Office (“EPPO”), the newly established authority charged with investigating criminal offenses affecting the financial interests of the European Union, has left its mark in its first year. Since its inception in June 2021, it has processed more than 4,000 crime reports and opened more than 900 investigations. Its efforts have led to 28 indictments, four convictions, and several orders to freeze assets valued at €259 million. One of the EPPO’s first anti-corruption cases concerned an official of the Bulgarian State Agriculture Fund who was indicted for accepting bribes. Further investigations in Bulgaria led to the arrest of several politicians in March 2022, including the former Prime Minister of Bulgaria.
Germany
The so-called “COVID-19 mask scandal” has been a source of great controversy in Germany, where it is alleged that politicians of federal and state parliaments used their influence and their connections to have ministries buy protective masks at inflated costs, allegedly in return for personal commissions. In several decisions, the Federal Court of Justice and the Higher Regional Court of Munich has held that the conduct did not meet the definition of elected officials taking bribes because it was not sufficiently clear that the defendants were acting in their capacity as members of parliament. The judges in unusually clear words called upon the legislature to change the law.
New Plans on Corporate Sanctions, Compliance, and Internal Investigations
Although the recently proposed Corporate Criminal Sanctions bill did not pass, the coalition agreement of the new federal government still plans to reform corporate criminal sanctions law. In this context, the coalition is also determined to enhance legal certainty with respect to compliance duties and to establish a precise legal framework for internal investigations. In a recent media statement, Federal Minister of Justice Marco Buschmann stated that the government intends to systematically revise the Criminal Code and Criminal Procedure Code in 2023, specifically highlighting changes relating to corporate criminal liability.
Russia & Former CIS
Kazakhstan
In June 2022, the Council of Europe’s Group of States Against Corruption (“GRECO”) published its first evaluation report on Kazakhstan. The report found that corruption in Kazakhstan remains a serious concern and is not limited to a specific sector or sphere. Although Kazakhstan’s Agency for Civil Service Affairs and Corruption was transformed into the Anti-Corruption Agency in 2019, and this agency has undertaken a number of positive initiatives such as establishing a hotline where the public can report allegations of corruption, much remains to be done. The report pointed to a flawed anti-corruption framework, state control of the media, and lack of responsiveness in policymaking as the key issues prohibiting Kazakhstan’s advancement on the anti-corruption front. GRECO will reevaluate Kazakhstan’s progress at the end of 2023.
Kyrgyzstan
In January 2022, the head of Kyrgyzstan’s State Customs Service, Adilet Kubanychbekov, was arrested on accusations of corruption. The State Committee for National Security announced that Kubanychbekov and his subordinates accepted bribes from certain private companies in exchange for allowing favorable conditions on the import of these companies’ goods. The Customs Service has been criticized for widespread corruption and this arrest occurred only three years after the disclosure of an estimated $700-million bribery scheme that implicated the former deputy chief of the Customs Service in allegations of bribery, evasion of customs fees, and money laundering.
Russia
Following Russia’s invasion of Ukraine, as part of its effort to quell dissent, the Russian government initiated an aggressive crackdown on essentially all independent media outlets, blocking access in Russia to websites of key investigative journalism outfits. As a side effect of these actions, access to independent information about anti-corruption efforts in Russia has been curtailed, particularly as the remaining media outlets devote much of their coverage to the war.
Russia’s General Prosecutor’s Office reported 12,000 corruption-related crimes in the first three months of 2022, roughly flat as compared to the same period a year ago, with bribery accounting for more than half of all corruption-related offenses. The total reported damage from all crimes in this period was 77.8 billion rubles (approximately $113 million).
On the legislative front, on February 16, 2022 the Russian Duma adopted an amendment to the laws “On Banks and Banking Activities” and “On Combating Corruption.” Under this amendment, the government is empowered to confiscate funds from government officials or employees of state-owned entities—as well as their spouses and minor children—if the legality of the source of these funds cannot be confirmed and if the amount in the account exceeds the income of the official for the past three years.
Ukraine
The focus of the Ukrainian government in the first part of 2022 has been on repelling the Russian invasion. Accordingly, progress on domestic policies—including with regards to rooting out corruption—has come to a halt except where those policies have a direct impact on the war effort. Certain anti-corruption policies have, however, become part of the war effort as they are conditions of Ukraine’s potential entry into the European Union—which Ukraine views as vital to its future success.
On June 17, 2022, the European Commission praised Ukraine for its progress in ensuring political and economic stability, but outlined seven steps that Ukraine should take in order to be further considered for acceptance into the European Union. Those steps include implementing laws that Ukraine has already passed, such as by appointing a new head of the Specialized Anti-Corruption Prosecutor’s office and by applying the Anti-Oligarch law to limit the excessive influence of oligarchs in economic, political, and public life. Other steps require Ukraine to further enact new legislation which would guarantee an independent media and judiciary. Although before the war, President Zelensky struggled to pursue his anti-corruption agenda with only 30% public support, the president now enjoys 90% approval among Ukrainians and appears to be highly motivated to take all steps that will allow Ukraine to prevail in the war and rebuild after, including through EU membership.
The Americas
Argentina
On April 25, 2022, the Transparency Policy Planning Directorate of Argentina’s Anti-Corruption Office approved a sweeping new System for Monitoring Private and Public Activities Before and After the Exercise of Public Function (“MAPPAP,” per its initials in Spanish). The purpose of the MAPPAP is collating and verifying compliance with public ethics regulations of individuals who enter and leave high-ranking public positions in the National Executive Branch. One of the stated goals of the MAPPAP is to limit potentially improper information sharing and the possible lack of impartiality that comes from so-called “revolving-door” employment in the private sector of former public sector officials.
Brazil
Our prior updates have covered at length the ongoing saga of Operation Car Wash, or Lava Jato, undoubtedly the most influential anti-corruption probe in Brazil’s history and one of the most significant globally as well. Perhaps the highest-profile target of the probe was former Brazilian President Luiz Inácio Lula da Silva, who was initially convicted and sentenced to nine years in prison in 2017. But then in 2021, Lula’s conviction was vacated by the Supreme Federal Court on the grounds that the original judge lacked jurisdiction to investigate and try the cases, and further was not considered to be impartial.
In the latest chapter, Lula brought his case to the U.N. Office of the High Commissioner on Human Rights, which in April 2022 found that “[t]he investigation and prosecution of former President Lula da Silva violated his right to be tried by an impartial tribunal, his right to privacy and his political rights,” and “that the actions and public statements by the former judge and the prosecutors violated his right to presumption of innocence.” The Commission further concluded that a prohibition against a future run for another presidential term was “arbitrary” and “urged Brazil to ensure that any further criminal proceedings against Lula comply with due process guarantees and to prevent similar violations in the future.”
Lula announced his pre-candidacy for president on May 7, 2022, and was officially nominated in July 2022 as Brazil’s Workers Party candidate to run against Brazil’s incumbent president in the October election.
Canada
As reported in our 2021 Year-End FCPA Update, Montreal-based engineering and construction firm SNC-Lavalin was charged together with two of its executives—Normand Morin and Kamal Francis—by the Royal Canadian Mounted Police (“RCMP”) with fraud and forgery in connection with a $100 million contract to refurbish a significant bridge in Montreal. At the time, SNC-Lavalin’s CEO reported it was the first company to receive an offer to negotiate for the settlement of charges under the new deferred prosecution agreement legislation passed in Canada, which was confirmed when, on May 6, 2022, the company announced that it agreed to a settlement and remediation agreement with the Quebec Crown Prosecutors’ Office. Pursuant to the deferred prosecution agreement, which was approved by Quebec’s Superior Court a week later, SNC-Lavalin will pay approximately $29.5 million and undergo a three-year compliance monitorship. The case against Morin and Francis remains ongoing.
Colombia
As discussed above, in March 2022 DOJ announced a declination with disgorgement resolution with British multinational insurance corporation JLT Group arising from alleged corruption involving Ecuadorian state surety company Seguros Sucre. Affiliated company Carpenter Marsh Fac Colombia agreed to a settlement with Colombian authorities pursuant to which it agreed to pay $2.1 million to resolve allegations arising from the same conduct.
Asia
China
In January 2022, the Nineteenth Central Commission for Discipline Inspection (“CCDI”) of the Chinese Communist Party held its Sixth Plenary Session, which emphasized the Party’s continued commitment to combating corruption. In particular, the communiqué of the plenary session highlighted anti-corruption efforts involving state-owned entities and in the financial and the public infrastructure sectors.
In March 2022, the National Supervisory Commission and the Supreme People’s Procuratorate (“SPP”) published synopses of five recent prosecutions as illustrative cases, each of which was focused on criminal liability of those providing bribe payments. The publication is in line with the ongoing shift in the government enforcement focus to the “supply side” of bribery. The cases concerned bribe-giving in various sectors, such as public procurement and healthcare, and all individual bribe-givers in these cases were found criminally liable. In addition, a precious metal company in Zhejiang province was found criminally liable for a bribe payment provided by its legal representative, with the Procuratorate arguing that the representative made the improper payment for the entity’s benefit and the funds for bribe-giving were generated from the entity’s operating business.
We continue to see active anti-corruption enforcement actions in China’s financial sector. Dozens of government officials and senior executives of state-owned banks have been investigated, charged, and/or penalized since the beginning of 2022. For example, in April 2022, enforcement authorities announced a corruption probe into Tian Huiyu, the former president of China Merchants Bank, and arrested Zeng Changhong, a former official at the China Securities Regulatory Commission, on suspicion of accepting bribes. In May 2022, Sun Guofeng, the former head of the monetary policy department at the People’s Bank of China, was removed from office and investigated on suspicion of accepting bribes. In the same month, the Beijing Municipal People’s Procuratorate charged He Xingxiang, the former vice president of China Development Bank, for allegedly accepting bribe payments, and in August 2022, he pleaded guilty to accepting bribe payments and valuables worth over $9.6 million.
The healthcare sector likewise remains at the center of China’s anti-corruption campaign. In May 2022, nine ministries of the Chinese Central Government jointly issued the 2022 Key Tasks on Safeguarding the Integrity of Medical Procurement and Medical Services. This document instructs local governments to identify and rectify misconduct in the healthcare sector and highlights the government’s focus on combating corruption in the healthcare sector, including illegal kickbacks and commercial bribery. In June 2022, the National Healthcare Security Administration added five medical device and pharmaceutical companies to a “blacklist” as a result of kickbacks and other improper payments allegedly provided to hospital employees through sales representative. Companies added to the “blacklist” may be prohibited or restricted from participating in the government’s public procurement process.
Finally, as reported in our 2021 Year-End FCPA Update, China’s SPP, along with other national authorities, launched the Third-Party Supervision and Evaluation Mechanism under which the SPP can refer a company that qualifies for the program to a third-party organization to investigate, evaluate, supervise, and inspect compliance commitments made by the company. In 2022, additional national authorities, including the China Securities Regulatory Commission, joined the Third-Party Supervision and Evaluation Mechanism. As of June 2022, the mechanism has been applied in over 1,000 cases involving both entities and individuals.
India
In January 2022, India’s Central Bureau of Investigation (“CBI”) arrested six executives of the Gas Authority of India Limited (“GAIL”), a state-owned natural gas explorer and producer. The executives are alleged to have demanded and received bribes from private companies in return for providing them with discounts on products sold by GAIL. The bribe payments are reported to be valued at INR 5 million (approximately $64,000).
In April 2022, the CBI arrested former Home Minister of the State of Maharashtra Anil Deshmukh in connection with allegations of corruption and money laundering. The case is one of the most high-profile corruption enforcement actions involving action by the CBI against a former member of the state cabinet. In June, the CBI filed a 59-page charge sheet with the special court, alleging that the former minister directed senior police officers in Mumbai to extort large sums of money from bars and restaurants.
Also in April 2022, the CBI registered its first anti-corruption case based on directions from the Lokpal, India’s anticorruption ombudsman tasked with investigating complaints of corruption against public servants. Despite enabling legislation for the Lokpal being passed in 2014, its functioning has been stalled by a lack of political will. Members of the Lokpal were only appointed in 2019 and key officers in its prosecution wing are still yet to be appointed. The allegations in this first Lokpal’s anti-corruption case involve irregularities in the tender, award, and execution of a construction contract between VK Singh Construction Company and the National Research Laboratory for Conservation of Cultural Property. The case was filed against the former director-general of the NRLC and the owner of the construction company.
Finally, on February 21, 2022, the Supreme Court of India reiterated that conclusive proof of demand and acceptance of a bribe by a public servant is essential in order convict that public servant for the offense of taking bribes under India’s Prevention of Corruption Act. The case involved a commercial tax officer who was arrested after undercover officers offered her cash in exchange for the favourable assessment. But the Supreme Court held that she could not be convicted of the offence of accepting a bribe since the prosecution had not established that the defendant had demanded a bribe in the first place.
Indonesia
In June 2022, Indonesia’s Corruption Eradication Commission (“KPK”) launched a grass-roots program to fight corruption nationwide. Under the pilot scheme, the KPK selected 10 pilot villages, each from a different province, to take part in the Village Anti-Corruption Program, which aims to educate participants about the importance of integrity and increase participation of rural communities in efforts to prevent and eradicate corruption. Speaking at the launch event, the KPK’s Deputy for Education and Community Participation noted that from 2015 to 2021, the Indonesian central government disbursed IDR 468.9 trillion (~ $32 million) to villages throughout Indonesia, and that much of these funds were misused as a result of corrupt practices by village officials. According to a KPK press release, there were 601 corruption cases involving village funds with a total of 686 suspects during the period from 2015 to 2021.
Japan
In June 2022, amendments to Japan’s Whistleblower Protection Act came into force, creating a mandatory obligation for companies with over 300 regular employees to establish an internal whistleblowing system. Under the amended law, covered companies must designate personnel to receive whistleblowing reports, investigate allegations, take corrective measures, and establish an internal report response system. Japan’s Consumer Affairs Agency will have authority to, inter alia: (i) make inquiries; (ii) give guidance to business operators who fail to meet the requirements; and (iii) publish the names of business operators who fail to follow their recommendations. By contrast, companies with 300 employees or less must “make efforts” to establish a whistleblowing system, but are not required to do so.
Malaysia
In January 2022, the Malaysian Anti-Corruption Commission (“MACC”) charged Mohd Yusof Ab Rahman, a manager of Aker Solutions, an engineering company listed on the Oslo Stock Exchange, for allegedly submitting false documents to Petronas, a Malaysian state-owned energy company, to secure a license renewal. Rahman pleaded not guilty to the allegations. The charge followed a similar case against an Aker manager in June 2021, which was ultimately dropped.
As reported in our 2020 Year-End FCPA Update, in 2020, former Prime Minister Najib Razak was found guilty of three counts of money laundering, three counts of breach of trust, and one count of abuse of power and sentenced to 12 years imprisonment in connection with the 1MDB corruption scheme. After two years of appeals, in August 2022, Malaysia’s highest court upheld his convictions, and Razak began his sentence. On September 1, 2022, Razak’s wife, Rosmah Mansor, was found guilty of three charges of soliciting and receiving bribes and sentenced to 10 years imprisonment arising from a matter unrelated to 1MDB in which Mansor allegedly assisted a company in receiving government contracts. Mansor also faces 17 charges of money laundering and tax evasion in a separate matter linked to 1MDB that has not yet begun. Mansor has pleaded not guilty to those charges.
South Korea
In May 2022, Korea’s new Act on the Prevention of Public Officials’ Conflict of Interest came into force. The key purpose of the law is to prohibit public officials from using their official authority or confidential information gained in the course of their public duties for personal gain. The law was passed following a string of high-profile conflicts of interest cases in South Korea, including a scandal involving Korea’s state run housing developer, Korea Land & Housing Corporation. In addition to the prohibition on the use of confidential confirmation, the new law creates requirements for public officials to disclose and report their ownership of real estate assets, their private sector work, and any contact with retired public officials. The maximum penalties under the law are seven years in prison or a fine of KRW 70 million ($55,000).
Africa
South Africa
South Africa’s Judicial Commission of Inquiry into Allegations of State Capture, Corruption, and Fraud in the Public Sector including Organs of State, also known as the “Zondo Commission,” released its report in 2022. The Commission was established in 2018 to investigate allegations of high-level corruption in the administration of former president Jacob Zuma. After more than 400 days of formal hearings, over 300 witness testimonies, and more than 1.7 million pages of documentary evidence, the Commission’s work has culminated in a five-part report.
The Zondo Commission report accuses high-ranking officials, including Zuma, of adversely interfering in the operations of important government departments and state-owned enterprises to make them amenable to their private interests and those of close allies. Among these allies is the Gupta family, whose many businesses held lucrative contracts with the South African government and state-owned enterprises. The Commission alleges that members of the Gupta family exerted significant influence over Zuma and played a central role in the state-capture of South Africa. While the Commission does not hold prosecutorial powers, it recommends that Zuma, members of the Gupta family, and several senior government officials be subjected to further investigations and prosecution. The report prescribes various reforms to address corruption in South Africa, including major changes to the public procurement system and strengthened protections for whistleblowers. Notably, it recommends the establishment of an independent anti-corruption body dedicated to combating misconduct and corruption.
The following Gibson Dunn lawyers participated in preparing this client update: F. Joseph Warin, John Chesley, Richard Grime, Patrick Stokes, Kelly Austin, Patrick Doris, Matthew Nunan, Oleh Vretsona, Oliver Welch, Claire Aristide, Ella Alves Capone, Josiah Clarke, Bobby DeNault, Andreas Dürr, Nathan Eagan, Derek Kraft, Nicole Lee, Allison Lewis, Ramona Lin, Andrei Malikov, Jacob McGee, Megan Meagher, Katie Mills, Sandy Moss, Jaclyn Neely, Ning Ning, Rick Roeder, Jason Smith, Hayley Smith, Pedro Soto, Laura Sturges, Karthik Ashwin Thiagarajan, Katie Tomsett, Alyse Ullery-Glod, Dillon Westfall, and Caroline Ziser Smith.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. We have more than 110 attorneys with Anti-Corruption and FCPA experience, including a number of former federal prosecutors and SEC officials, spread throughout the firm’s domestic and international offices. Please contact the Gibson Dunn attorney with whom you work, or any of the following:
Washington, D.C.
F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com)
Richard W. Grime (+1 202-955-8219, rgrime@gibsondunn.com)
Patrick F. Stokes (+1 202-955-8504, pstokes@gibsondunn.com)
Judith A. Lee (+1 202-887-3591, jalee@gibsondunn.com)
David P. Burns (+1 202-887-3786, dburns@gibsondunn.com)
David Debold (+1 202-955-8551, ddebold@gibsondunn.com)
Michael S. Diamant (+1 202-887-3604, mdiamant@gibsondunn.com)
John W.F. Chesley (+1 202-887-3788, jchesley@gibsondunn.com)
Daniel P. Chung (+1 202-887-3729, dchung@gibsondunn.com)
Stephanie Brooker (+1 202-887-3502, sbrooker@gibsondunn.com)
M. Kendall Day (+1 202-955-8220, kday@gibsondunn.com)
Robert K. Hur (+1 202-887-3674, rhur@gibsondunn.com)
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Gibson Dunn’s Supreme Court Round-Up provides a preview of cases set to be argued during the October 2022 Term and other key developments on the Court’s docket. During the October 2021 Term, the Court heard argument in 63 cases, including 1 original-jurisdiction case.
Spearheaded by former Solicitor General Theodore B. Olson, the Supreme Court Round-Up keeps clients apprised of the Court’s most recent actions. The Round-Up previews cases scheduled for argument, tracks the actions of the Office of the Solicitor General, and recaps recent opinions. The Round-Up provides a concise, substantive analysis of the Court’s actions. Its easy-to-use format allows the reader to identify what is on the Court’s docket at any given time, and to see what issues the Court will be taking up next. The Round-Up is the ideal resource for busy practitioners seeking an in-depth, timely, and objective report on the Court’s actions.
To view the Round-Up, click here.
Gibson Dunn has a longstanding, high-profile presence before the Supreme Court of the United States, appearing numerous times in the past decade in a variety of cases. During the Supreme Court’s 6 most recent Terms, 9 different Gibson Dunn partners have presented oral argument; the firm has argued a total of 15 cases in the Supreme Court during that period, including closely watched cases with far-reaching significance in the areas of intellectual property, separation of powers, and federalism. Moreover, although the grant rate for petitions for certiorari is below 1%, Gibson Dunn’s petitions have captured the Court’s attention: Gibson Dunn has persuaded the Court to grant 33 petitions for certiorari since 2006.
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On August 11, 2022, the Federal Trade Commission (the “FTC” or the “Commission”) launched one of the most ambitious rulemaking processes in agency history with its 3-2 vote to initiate an Advance Notice of Proposed Rulemaking (“ANPR”) on “commercial surveillance” and data security.[1] On September 8, the Commission continued the rulemaking process by hosting a virtual “Commercial Surveillance and Data Security Public Forum (the “Public Forum”)” to gather public feedback on the proposed rulemaking.[2]
As explained in more detail in our prior article, the ANPR lays out a sweeping project to rethink the regulatory landscape governing nearly every facet of the U.S. internet economy, from advertising to anti-discrimination law, and even to labor relations. Any entity that uses the internet, even for internal purposes, is likely to be affected by this FTC action.
FTC Rulemaking Process
The FTC is undertaking this rulemaking under Section 18 of the FTC Act (also known as “Magnuson-Moss”), a hybrid rulemaking process that goes beyond the Administrative Procedure Act’s standard notice-and-comment procedures.[3] The FTC may promulgate a trade regulation rule to define acts or practices as unfair or deceptive “only where it has reason to believe that the unfair or deceptive acts or practices which are the subject of the proposed rulemaking are prevalent.” 15 U.S.C. § 57a(b)(3) (emphasis added). The FTC may make a determination that unfair or deceptive acts or practices are prevalent only if: “(A) it has issued cease and desist orders regarding such acts or practices, or (B) any other information available to the Commission indicates a widespread pattern of unfair or deceptive acts or practices.” 15 U.S.C. § 57a. That means that the agency must show (1) the prevalence of the practices, (2) how they are unfair or deceptive, and (3) the economic effect of the rule, including on small businesses and consumers.
Since the FTC published the ANPR, the Commission has posted 123 comments received thus far.[4] The Commission will continue to accept public comments until October 21. After the FTC’s review of comments, the next step in the Magnuson-Moss rulemaking process would be to publish a Notice of Proposed Rulemaking (“NPR”), which would set forth the proposed rule text, a description of its reasons supporting the proposed rules, any alternatives, and a preliminary regulatory analysis assessing the costs and benefits of the proposal and alternatives. This proposal would be submitted to Congress 30 days before public issuance. The FTC would then be required to convene a public comment opportunity after the issuance of the NPR and provide interested parties an opportunity for an informal hearing to present its views and resolve disputed factual issues. Finally, the FTC would publish its Final Rule, accompanied by a Statement of Basis of Purpose detailing the prevalence of the practices being regulated, how they are unfair or deceptive, and the economic effect of the rule, including an assessment of the rule’s costs and benefits and why it was chosen over alternatives. Any person could then seek review of the rule in the D.C. Court of Appeals within 60 days of promulgation. If an NPR is published, challenges will be likely.
Commercial Surveillance and Data Security Public Forum
The September 8 Public Forum included (i) statements from Chair Lina M. Khan, Commissioners Rebecca Slaughter and Alvaro Bedoya, and the Commission’s Assistant General Counsel Josephine Liu; (ii) a panel of industry representatives; (iii) a panel of consumer advocates; and (iv) over 65 public commenters.
Key topics discussed during the Public Forum included data minimization, data security, algorithmic discrimination and ethical Artificial Intelligence (“AI”), and the protection of teenagers over 13 years old, among others.
Below are highlights from the sessions:
Commissioner Statements.
- Chair Lina Khan noted that the hearing will inform whether the agency proceeds with the rulemaking process. She noted that the FTC has a long record of using its enforcement tools to combat commercial surveillance and “lax” data security practices in instances where they are illegal, but that the FTC is “seeking to determine whether unfair or deceptive data practices may now be so prevalent that we need to move beyond case by case adjudication and instead have market wide rules.” She explained that the public record will be “critical” for the Commission to determine if it has the evidentiary basis to proceed with rulemaking, and meet the legal requirements to craft those rules. Chair Khan also stated that these issues are “urgent” given the ability for companies to track and surveil individuals throughout their day to day lives, without transparency for the average consumer regarding the data collection and use, and without any real power for Americans to opt-out of that surveillance.
- The Commission’s Assistant General Counsel Josephine Liu provided an overview of the rulemaking process, and in particular highlighted three of the questions from the ANPR on which the Commission most wants public input:
- Which practices used to surveil customers are most prevalent? She explained that this question will help the FTC focus on particular areas of concern, for both enforcement purposes and determining whether rulemaking will occur. To move on in the rulemaking process, the FTC needs reason to believe such surveillance practices are prevalent.
- How should the Commission identify and evaluate commercial surveillance harms or potential harms? Public input on this will help the FTC identify and address specific ways Americans are being harmed.
- Lastly, which areas or kinds of harm has the FTC failed to address through enforcement? Public input on this will provide the FTC with evidence about the areas in which it has less enforcement experience, and areas that rulemaking may better address.
- Commissioner Rebecca Slaughter remarked that she supports strong federal privacy legislation, but until it is passed, the Commission has a duty to act to address and investigate unlawful behavior. She encouraged industry representatives to engage with the Commission to ensure that the rules are effective and not merely a burdensome compliance exercise.
- Commissioner Alvaro Bedoya emphasized that the Commission is not just looking for a collection of “expert” opinions, but instead wants to hear from the public how it is has been impacted by commercial surveillance and poor data security practices. He also noted that the ANPR goes beyond the conception of notice and choice, the usual “caricature” of American privacy law.
Commissioners Phillips and Wilson did not participate in the Public Forum.
Industry Representative Panel.
In addition to the Commissioners’ remarks, the FTC convened a panel of industry representatives moderated by Professor Olivier Sylvain, now Senior Advisor on Technology to Chair Khan. Professor Sylvain, whose academic work has focused on Section 230 of the Communications Decency Act, joined the FTC in 2021 from Fordham University where he served as Professor of Law.
Panelists included four senior executives and policy counsel from (1) a trade association for the digital content industry; (2) a web browser provider; (3) a retail trade association; and (4) a nonprofit coalition researching the use of artificial intelligence. Below are key themes from the industry panel:
- Context Matters. The panel’s key theme was that the Commission should calibrate future rulemaking to different levels of risk presented by particular types of data collection and uses. Specifically, several panelists emphasized the need for future regulations to treat first-party data collected and used by consumer-facing apps and websites differently from third-party data collected by third parties for behavioral advertising. The Commission was urged to be careful not to inadvertently craft such broad regulations that they interfere with consumer freedoms and choices on the Internet.
- Shift Away From Behavioral Advertising. Similar to the above, panelists emphasized the need to shift away from behavioral advertising completely. Instead, they recommended shifting towards other methods of advertising that utilize first-party data.
- Big Data. One panelist mentioned that the “terms” of data use are established by “just a few big companies,” and that special attention needs to be paid to the dominant companies in the industry, who can set the tone for how rules are interpreted and implemented.
- Best Practices. The Commission moderator asked panelists what “best practices” and business models have been developed to mitigate consumer harm and protect data. Responses included: (i) maintaining internal and public-facing documentation and benchmarking across the AI lifecycle; (ii) implementing risk assessment processes and basic security controls, such as encryption in transit, strong access controls (such as multi-factor authentication and strong password requirements), and security awareness training.
- Global Insight. Panelists encouraged the FTC to review global legislation, such as the EU’s General Data Protection Regulation (“GDPR”) and the UK’s Children’s Code for guidance on what has worked, and has not worked, globally.
- Protecting Teens Over 13. Protecting teens online over 13 years old, who have aged out of protections by the Children’s Online Privacy Protection Act (“COPPA”), was another key theme. Panelists urged the Commission to be sure the rules do not just create child safety “theater.”
- Global Privacy Control/Single Opt-Out. Lastly, a key theme was implementing a browser setting, called a Global Privacy Control, that lets consumers tell websites their privacy preferences through a single opt-out, without having to manually reach out or make choices on each website. The Global Privacy Control was touted by some panelists as an important measure to protect privacy and choice. Others, however, worried that the single opt-out approach creates the potential to frustrate consumer choice and efforts for businesses to serve customers if consumers want to specifically consent to data collection and use for particular businesses.
Consumer Advocate Panel.
The Consumer Advocate Panel was moderated by Rashida Richardson, an Attorney Advisor to Chair Khan. This panel included members of non-profits and thinktanks focused on consumer privacy and digital innovation. In general, the moderator’s questions assumed harmful impacts of data use to consumers.
- Algorithmic Discrimination. Panelists expressed that the FTC should protect disadvantaged communities. Panelists claimed that barriers in housing and employment are exacerbated by targeted advertisements.
- Sensitive Information and Dark Patterns. The Supreme Court decision in Dobbs was discussed extensively. Concerns were raised about data brokers being able to sell consumer data to foreign governments, with consumers allegedly being harmed through an inability to opt-out of data being collected and companies selling sensitive health information.
- API Misuse. The panelists stated that unwanted observation – through a single Software Development Kit (“SDK”) that can be found in hundreds of apps – can lead to sensitive data being transferred across many companies without consent. Alleged associated harms include data breaches, misuse, unwanted secondary data uses, and inappropriate government access.
- Data Minimization and Targeted Advertisements. Data minimization, increased transparency, and regulating third-party targeted advertisements were key ideas raised throughout the panel as a means to FTC enforcement in this area. However, one panelist highlighted that targeted advertisements can actually play a positive role in society, such as to build community, mobilize voters, and disseminate health information to groups most likely to be effected. In this way, while data minimization is positive in theory, “color blindness” towards all data collection and use is not always the answer, as data can be used for good.
- Harm to Minors. Panelists raised the harms of targeted advertising to teens who allegedly cannot distinguish between commercial content and entertainment content online. A key recommendation was raising protections for minors beyond COPPA, in line with global trends, such as instituting a mechanism for teens to easily delete their online data.
- Consent Framework. Panelists generally expressed that, in their view, the concept of “notice and consent” is not a useful framework given the alleged power dynamics between consumers and those collecting their data online, and the purportedly asymmetric information provided to consumers when making those choices.
- Concepts Missing From the ANPR. In response to the moderator’s question on whether the ANPR was missing anything, panelists raised the following topics: the FTC should (i) explore enumerating a list of sensitive categories of data, and define how precise location data needs to be for its collection to count as “unfair”; (ii) promulgate rules to regulate service provider relationships; (iii) set forth standards for data deidentification; and (iv) implement rules to prevent discrimination of marginalized communities, combined with strengthening the FTC’s civil rights expertise.
Public Commenters.
- The FTC presented an array of public commenters after the two panels. Commenters included individuals from organizations like the U.S. Chamber of Commerce Technology Engagement Center, TechFreedom, the Centre for Information Policy Leadership, the Center for Democracy and Technology, Human Rights Watch, and the Electronic Privacy Information Center (“EPIC”). Some commenters were deeply concerned by the FTC’s broad-based expansion of its enforcement authority, while other commenters noted that the FTC’s expansion of its authority was necessary because of the privacy harms that the public allegedly suffers.
- Industry participants emphasized that the FTC was mandating economy-wide changes relating to privacy, data security, and algorithms which would step on Congressional authority. According to these participants, this would trigger the Supreme Court’s Major Questions doctrine since the FTC does not have clear authorization from Congress to make such a broad-based rule.
- Other members of the public noted that the FTC should take far-reaching action to protect personal data, with an emphasis on controls to safeguard children, student, health, and education data.
The ANPR and the public workshop are just initial steps in the lengthy FTC rulemaking process. Given the broad-based scope of the potential rules, the rulemaking process will be closely watched and analyzed. Gibson Dunn attorneys are closely monitoring these developments, and are available to discuss these issues as applied to your particular business.
__________________________
[1] Federal Trade Commission Press Release, FTC Explores Rules Cracking Down on Commercial Surveillance and Lax Data Security Practices (Aug. 11, 2022), https://www.ftc.gov/news-events/news/press-releases/2022/08/ftc-explores-rules-cracking-down-commercial-surveillance-lax-data-security-practices.
[2] Federal Trade Commission Event, Commercial Surveillance and Data Security Public Forum (Sept. 8, 2022), https://www.ftc.gov/news-events/events/2022/09/commercial-surveillance-data-security-anpr-public-forum.
[3] Magnuson-Moss Warranty Federal Trade Commission Improvement Act, 15 U.S.C. § 57a(a)(1)(B). The FTC had largely abandoned the promulgation of new trade regulation rules because the Magnuson-Moss process was perceived as too cumbersome and the agency generally preferred case-by-case enforcement over rulemaking. The Biden Administration, however, has revitalized the interest in promulgating trade regulation rules, to “provide much needed clarity about how our century-old statute applies to contemporary economic realities [allowing] the FTC to define with specificity what acts or practices are unfair or deceptive under Section 5 of the FTC Act.” Statement of Commissioner Rebecca Kelly Slaughter, Regarding the Adoption of Revised Section 18 Rulemaking Procedures (July 1, 2021), here.
[4] Public comments are available at, https://www.federalregister.gov/documents/2022/08/22/2022-17752/trade-regulation-rule-on-commercial-surveillance-and-data-security.
This alert was prepared by Svetlana S. Gans, Samantha Abrams-Widdicombe, and Kunal Kanodia.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the firm’s Privacy, Cybersecurity & Data Innovation practice group:
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As the global economy gradually emerges from the COVID-19 pandemic, lawmakers and regulators in Asia continue to confront the aftermath of the pandemic and the challenges it presents to anti-corruption enforcement. In this webcast, we will explore the approaches taken by Asian countries to address the current environment and examine the current trends in FCPA and local anti-corruption enforcement, with a focus on Asia.
In China, while the government continues to crack down on bribery in the financial and the healthcare sectors, the anti-corruption campaign has expanded to encompass an increasingly broader swath of the national economy, such as the semiconductor industry and the insurance industry. The corporate criminal compliance regime in China has rapidly evolved in 2022, with additional national authorities joining the Third-Party Supervision and Evaluation Mechanism, which has been applied in over 1,000 cases since its launch in 2021. India has seen a number of high-profile corruption cases, including enforcement actions in the transportation and biotechnology sectors. And while Korea has seen a drastically increased focus on rooting out corruption in its public and private sectors, citizens wonder whether actual change is possible as high-profile officials and executives continue to receive pardons for past, headline-grabbing misconduct.
While domestic politics and legislative amendments have made it more difficult to commence and complete anti-corruption enforcement actions in certain markets, recent cases underscore the compliance risks of doing business of in many of Asia’s biggest markets. Join our team of experienced international anti-corruption attorneys to learn more about how to do business in China, India, Korea and other countries in Asia without running afoul of anti-corruption laws, including the Foreign Corrupt Practices Act (“FCPA”).
Topics discussed include:
• An overview of FCPA enforcement statistics and trends for 2022;
• The corruption landscape in Asia, including recent headlines and scandals;
• Lessons learned from local anti-corruption enforcement in China, India, Korea, and South East Asia;
• Key anti-corruption, data privacy and regulatory compliance changes across Asia; and
• Mitigation strategies for businesses operating in Asian markets.
PANELISTS:
Kelly Austin leads Gibson, Dunn & Crutcher’s White Collar Defense and Investigations practice for Asia, is a global co-chair of the Firm’s Anti-Corruption & FCPA practice, and is a member of the Firm’s Executive Committee. Ms. Austin is ranked annually in the top-tier by Chambers Asia Pacific and Chambers Global in Corporate Investigations/Anti-Corruption: China. Her practice focuses on government investigations, regulatory compliance and international disputes. Ms. Austin has extensive expertise in government and corporate internal investigations, including those involving the FCPA and other anti-corruption laws, and anti-money laundering, securities, and trade control laws.
Oliver Welch is a partner in the Hong Kong office, where he represents clients throughout the Asia Pacific region on a wide variety of compliance and anti-corruption issues and trade control laws. Mr. Welch regularly counsels multi-national corporations regarding their anti-corruption compliance programs and controls, and assists clients in drafting policies, procedures, and training materials designed to foster compliance with global anti-corruption laws. Mr. Welch frequently advises on anti-corruption due diligence in connection with corporate acquisitions, private equity investments, and other business transactions.
Karthik Ashwin Thiagarajan, an of counsel in the Singapore office, assists clients with investigations in the financial services, information technology, electronics and fast-moving consumer goods sectors in India and Southeast Asia. He advises clients on internal investigations and anti-corruption reviews in the region. A client praised him for being “on top of his trade” in the India Business Law Journal’s 2019 “Leaders of the pack” report.
Ning Ning, an associate in the Hong Kong office, advises clients on government and internal investigations, compliance counseling, and compliance due diligence matters across the Asia-Pacific region. Ms. Ning has represented clients before the U.S. Department of Justice (DOJ) and the U.S. Securities and Exchange Commission (SEC) involving potential violations of the U.S. Foreign Corrupt Practices Act (FCPA), securities laws, and other white collar defense matters. Ms. Ning regularly advises clients on internal investigations relating to allegations of corruption, fraud, and accounting irregularities. Ms. Ning also counsels clients on designing and continuously improving their anti-corruption and compliance programs, and on anti-corruption and compliance risk assessments.
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Human rights are a shared concern of international trade compliance professionals and those responsible for developing policies to implement the Social (“S”) element of company ESG programs, but the leads for each are not always in conversation. However, recent developments, especially with respect to international trade regulation, require both to be in the same room and to work together to integrate due diligence, monitoring, and reporting across business functions. In this CLE webinar, we review several areas of convergence in export control, sanctions, and import regulation and S-focused ESG standards, and share practical strategies International Trade and ESG professionals can follow to make the most of this convergence in their compliance and ESG programs.
PANELISTS:
Ronald Kirk is Senior Of Counsel in Gibson, Dunn & Crutcher’s Dallas and Washington, D.C. offices. He is Co-Chair of the International Trade Practice Group and a member of the Sports Law, Public Policy, Crisis Management and Private Equity Practice Groups. Ambassador Kirk focuses on providing strategic advice to companies with global interests. Prior to joining the firm in April 2013, Ambassador Kirk served as the 16th United States Trade Representative and was a member of President Obama’s Cabinet, serving as the President’s principal trade advisor, negotiator and spokesperson on trade issues. Ambassador Kirk draws upon more than 30 years of diverse legislative and economic experience on local, state and federal levels.
Christopher T. Timura is Of Counsel in Gibson Dunn’s Washington, D.C. office and a member of the firm’s International Trade and White Collar Defense and Investigations Practice Groups. Mr. Timura helps clients solve regulatory, legal and political problems that arise at the intersection of national security, trade, and foreign policy, and develop corporate social responsibility and environmental, social, and governance strategies, policies and procedures. His clients span economic sectors and range from start-ups to Global 500 companies.
Sean J. Brennan is an associate in Gibson Dunn & Crutcher’s Washington, D.C. office. He practices in the firm’s Litigation Department, with a focus on white collar criminal defense and investigations, international trade, and public policy. Mr. Brennan regularly advises clients on human rights due diligence and supply chain issues, including compliance with the Uyghur Forced Labor Prevention Act. He has also conducted internal investigations involving alleged violations of cybersecurity, national security, and anti-money laundering laws.
Eric Clark is Nokia’s lead counsel for trade compliance, including laws and regulations around export controls, international sanctions, and import/customs controls. In addition, he also now serves as counsel for Nokia’s human rights program and due diligence process. Eric has been working on trade and sanctions topics for more than 15 years in both government and the private sector.
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The Court of Appeal (the “CA”) has recently handed down its judgment in CACV 483, 484 & 485/2018 (Shine Grace Investment Ltd v Citibank, N.A. & Anor), upholding the decision of the Court of First Instance in rejecting the plaintiffs’ claims for alleged mis-selling of equity accumulator contracts by Citibank, N.A. (the “Bank”).
The CA’s decision re-affirms the principle that in ascertaining the scope of a bank’s duty of care towards a customer, the Court places significant weight on the relevant factual circumstances (including the nature of the parties’ dealings and the relative sophistication of the customer) as well as the terms of contractual documentation. Of particular note is that the mere fact of the bank volunteering advice to a customer cannot be taken to mean that it has assumed the legal duty to advise on the suitability of investments.
- Background
The dispute involved three related actions. The main action concerned claims made by Shine Grace Investment Ltd (“Shine Grace”), an investment vehicle owned and controlled by Mrs Anita Chan (“Mrs Chan”) until her sudden death on 17 October 2007, that the Bank had mis-sold nine equity accumulator contracts (the “Disputed ACs”) to Shine Grace on 15 and 16 October 2007. The other two actions were brought by Shine Grace’s two guarantors, Shinning International Holdings Limited (“Shinning”) and Bonds & Sons International Limited (“BSI”), seeking to challenge the Bank’s transfer of funds from the accounts of Shinning and BSI to meet the outstanding liability of Shine Grace.
Three of the nine Disputed ACs were knocked out in October/November 2007. Since 20 November 2007, the Bank had demanded Shine Grace to deposit additional margin security, but Shine Grace (then controlled by the children of Mrs Chan following her death) disclaimed the Disputed ACs and asserted that they were invalid and unenforceable. The remaining six Disputed ACs were closed out and unwound by the Bank in January 2008. Shine Grace suffered losses totaling around HK$478 million, which included the costs of unwinding the Disputed ACs (exceeding HK$427 million) and losses of around HK$51 million from the sale of shares accumulated under the Disputed ACs.
The trial of the three actions took place before the Honourable Mr Justice Ng (“Ng J”) in November and December 2017, lasting 13 days. On 30 July 2018, Ng J handed down his judgment dismissing all three actions, finding that (i) the Bank did not owe to Shine Grace the alleged duty to advise, (ii) even if there was such a duty, the Bank did not breach the same and (iii) the alleged breach of duty did not cause Shine Grace’s losses. Shine Grace, Shinning and BSI appealed against Ng J’s judgment.
- The CA’s Judgment
The CA dismissed the appeal on 9 September 2022, upholding Ng J’s findings in respect of each element of Shine Grace’s claims.
2.1 Duty of care
The CA confirmed that the Bank was not under a duty to advise Shine Grace on the suitability and risks of Disputed ACs, regardless of what recommendations or suggestions might have been made to Shine Grace during the course of their relationship.
With reference to Chang Pui Yin v Bank of Singapore Ltd [2017] 4 HKLRD 458, the CA noted that the starting point is that banks are not normally under a duty to advise customers on the prudence or risks of their investments. However, the scope of a bank’s duty of care is highly fact-sensitive, and turns on the precise nature of its relationship with the customer.
The CA observed that an enormous body of evidence (including no less than 680 items of audio recordings) was available before the trial judge as to the parties’ dealings, and it would not be appropriate for the CA to embark on its own fact findings in an unfocused review of such evidence. The trial judge was entitled to find on the evidence that Mrs Chan, being a sophisticated and experienced investor, had her own investment strategy and did not rely on any investment advice from the Bank; the Bank was primarily following Mrs Chan’s instructions in facilitating execution of trades.
The CA also agreed with Ng J’s interpretation of Clause 4.12 of the Master Derivative Agreement, which had the clear effect of disclaiming any duty on the part of the Bank to give advice or make recommendations to Shine Grace. The material parts of the clause provided the following:
“You understand and agree that:
(a) the above brief statement cannot disclose all the risks and other significant aspects of the derivatives market and you should therefore carefully study derivative transactions before you trade;
(b) in respect of services rendered by us on a non discretionary basis,
(i) you make your own judgment in relation to the transactions;
(ii) we assume no duty to give advice or make recommendations;
(iii) if we make any suggestions, we assume no responsibility for your portfolio or for any investment or transaction made;
…
(d) in either of the above cases,
(i) we and our affiliates may hold positions for ourselves or other clients which may not be consistent with our officers’ or employees’ suggestions or discretionary management for you; and
(ii) any risks associated with and any losses suffered as a result of our entering into any transactions for you are for your account.”
The CA emphasised that the mere fact that the bank had volunteered to give advice cannot be taken to mean that the bank must have assumed the legal responsibility to advise a customer on the suitability of his/her investment.
The CA also rejected the argument that the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “SFC Code”) should inform the common law duties to which the Bank was subject. The SFC Code cannot ‘create’ a duty of care which does not exist under common law.
2.2 Breach of duties
Having found that there was no duty on the Bank to advise Shine Grace on the Disputed ACs, it was not strictly necessary to consider the issue on breach of duties. Nevertheless, the CA held that there was no breach of duty on the part of the Bank.
The CA upheld Ng J’s evaluative conclusion that the Disputed ACs were not unsuitable for Shine Grace. Mrs Chan was a sophisticated investor, and had her own team of staff to monitor her investments and make regular reports. It is not the Bank’s job to ‘micromanage’ Mrs Chan’s financial affairs, and it cannot be regarded as having breached its duty in failing to advise her in these circumstances.
The CA also rejected the argument that there was inadequate or unsatisfactory disclosure of material risks of the Disputed ACs in the contractual documentation.
2.3 Causation
The CA held that Ng J was entitled to conclude, on the available evidence, that Mrs Chan would have entered into the Disputed ACs anyway; to suggest that the Bank could have somehow dissuaded Mrs Chan from entering into the Disputed ACs by advising that they were unsuitable was wholly speculative. Accordingly, Shine Grace has not established the causation element.
- Comments
The CA’s decision re-affirms the long established legal principle that the appellate court will only intervene in respect of findings of fact if there are palpable errors identified which are sufficiently material to undermine the trial judge’s conclusion. In this case, the trial judge’s task involved going through voluminous audio recordings and receiving days of oral testimony, and was entitled to come to the evaluative conclusions that he did. The CA found that Shine Grace has not identified any palpable error made by the trial judge to disturb his factual findings.
Of note is that since the reforms to the Professional Investor Regime by the Securities and Futures Commission (which came into effect on 9 June 2017), where a written client agreement is required, it must include a suitability clause to the following effect:
“If we [the intermediary] solicit the sale of or recommend any financial product to you [the client], the financial product must be reasonably suitable for you having regard to your financial situation, investment experience and investment objectives. No other provision of this agreement or any other document we may ask you to sign and no statement we may ask you to make derogates from this clause.”
The requirement of a mandatory suitability clause would undermine the effect of non-reliance provisions such as the one in the Master Derivative Agreement referred to above.
In any event, Shine Grace remains an important case that illustrates the value of having clear contractual documentation and contemporaneous records of dealings, which would inform the scope of any legal duties assumed by a bank towards its customers.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, or the authors and the following lawyers in the Litigation Practice Group of the firm in Hong Kong:
Brian Gilchrist (+852 2214 3820, bgilchrist@gibsondunn.com)
Elaine Chen (+852 2214 3821, echen@gibsondunn.com)
Alex Wong (+852 2214 3822, awong@gibsondunn.com)
Andrew Cheng (+852 2214 3826, aocheng@gibsondunn.com)
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The number of securities lawsuits filed since January has remained steady compared to the first half of 2021. We have already seen many notable developments in securities law this year. This mid-year update provides an overview of the major developments in federal and state securities litigation in the first half of 2022:
- We explore what to watch for in the Supreme Court, including the upcoming decision in SEC v. Cochran, which addresses an important jurisdictional question; the decision in West Virginia v. Environmental Protection Agency, which could impact the SEC’s proposed climate disclosure rule; and the future of gag rules.
- We examine a number of developments in the Delaware Court of Chancery, including the applicability of Blasius and Schnell when board action implicates the stockholder franchise; a novel, but “likely rare,” claim that a board’s wrongful refusal of a stockholder demand constituted a breach of fiduciary duty; and when an activist-appointed director might be conflicted by an expectation of future directorships.
- The Second Circuit in SEC v. Rio Tinto held that in order to allege a claim of scheme liability, plaintiffs must show something more than just the misstatements or omissions themselves, such as dissemination. Although it is too early to see the application of Rio Tinto at the district court level, lower courts had previously continued to grapple with the scope of Lorenzo.
- We again survey securities-related litigation arising out of the coronavirus pandemic, including securities class actions alleging that defendants made false claims about the efficacy of their COVID-19 vaccines, treatments, and tests. Notably, since the beginning of the year, the SEC has filed multiple lawsuits related to the pandemic.
- We explore the lower courts’ application of the Supreme Court’s decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, which concerned liability based on a false opinion, often to evaluate the sufficiency of pleadings in response to defendants’ motions to dismiss. Recent decisions emphasize that the context surrounding the opinion is a key consideration for determining whether that opinion is actionable. As such, other statements made contemporaneously to an opinion, the reason why an opinion is being offered, and the knowledge level of the speaker can be just as important as the syntax and meaning of the opinion itself.
- We examine various developments in federal securities litigation involving special purpose acquisition companies (“SPACs”), including a surge in Section 10(b) claims against companies reporting under-promised financial results after being acquired by SPACs. We also preview how the SEC’s newly proposed SPAC rules and amendments may potentially impact this litigation.
- Finally, we address several other notable developments in the federal courts, including:
- the Second Circuit’s holding that a company had a duty to disclose a governmental investigation for purposes of a claim under Section 10(b) of the Exchange Act of 1934;
- the Ninth Circuit’s further guidance as to when a general corporate statement by a company is nonactionable;
- the Second Circuit’s affirming the dismissal of a securities class action after reaffirming the PSLRA’s requirements for pleading falsity with sufficient particularity;
- the Ninth Circuit’s clarification and tightening of its loss causation standard; and
- the Eleventh Circuit’s holding that informal mass online communication, such as YouTube videos, can count as “soliciting” the purchase of an unregistered security, affecting the sale of new cryptocurrencies reliant on such methods for traction.
I. Filing And Settlement Trends
According to Cornerstone Research, although new filings remain consistent with the first half of 2021, the number of approved settlements is up over 30% from the same time last year, and the median settlement amount has rebounded from the low that we reported in our 2021 Mid-Year Securities Litigation Update. SPAC and crypto-related filings continue to be a focus of plaintiffs’ attorneys, even as the nature of these suits continues to evolve.
A. Filing Trends
Figure 1 below reflects the semi-annual filing rates dating back to 2013 (all charts courtesy of Cornerstone Research). For the third six-month period in a row, new filings remained below the historical semi-annual average. Notably, at 110, filings in the first half of 2022 barely top 50% of the average semi-annual filing rates seen between 2017 and 2019, though this deficit is largely driven by a substantial decrease in M&A filings. The 105 total new “core” cases—i.e., securities cases without M&A allegations—filed in the first half of 2022 represent a modest increase from both the first and second half of 2021 and are closer to, though still below, other recent periods.
Figure 1:
Semiannual Number of Class Action Filings (CAF Index®)
January 2013 – June 2022
As illustrated in Figure 2 below, SPAC-related filings are on track to meet or exceed last year’s chart-topping performance and already exceed the total SPAC-related filings in all of 2019 and 2020 combined. This increase is driven primarily by SPAC-related actions in the technology and industrial sectors that have offset a potential decline in actions in the consumer space. Cryptocurrency-related actions are also on pace to increase in 2022, driven in part by the continued increase in actions against crypto exchanges and allegations related to securitization in the first half of the year. On the other hand, cybersecurity filings, along with opioid and cannabis cases, are on pace to decrease significantly.
Figure 2:
Summary of Trend Cases—Core Federal Filings
2018 – June 2022
B. Settlement Trends
More settlements were approved in the first half of 2022 than have been in any half-year in the last five years. Additionally, as reflected in Figure 3, the total settlement value in the first half of 2022 is nearly twice that of this time last year, almost meeting the total value of 2021. Of the 55 approved settlements, four topped $100 million, relative to only two this time last year. And the median value of settlements approved is up 56% from the first half of 2021 to $12.5 million.
Figure 3:
Total Settlement Dollars
January 2017 – June 2022
(Dollars in Billions)
II. What To Watch For In The Supreme Court
Although it has been a relatively quiet first half of 2022 for securities litigators in the Supreme Court, one decision has a potential impact on rulemaking and several other decisions could be on the horizon.
A. Cochran To Address Jurisdictional Questions Of Administrative Law Judges
On November 7, 2022, the Supreme Court will hear argument in SEC v. Cochran, No. 21-1239 (5th Cir., 20 F.4th 194; cert. granted, May 16, 2022). The question presented is procedural—whether a federal district court has jurisdiction to hear a suit in which the respondent in an ongoing SEC administrative proceeding seeks to enjoin that proceeding, based on an alleged constitutional defect in the provisions of the Exchange Act that govern the removal of the administrative law judge who will conduct the proceeding.
Following an enforcement action against Respondent that alleged she failed to comply with federal auditing standards, the ALJ determined Respondent had, indeed, violated the Exchange Act. Then, however, the Supreme Court’s decision in Lucia v. SEC, 138 S. Ct. 2044 (2018), held that the SEC’s ALJs are officers of the United States and that their appointments must comply with the Constitution’s Appointments Clause. Id. at 2049. Thus, in Cochran, the SEC remanded all pending administrative actions for new proceedings before constitutionally appointed ALJs. Cochran v. U.S. Sec. & Exch. Comm’n, 20 F.4th 194, 198 (5th Cir. 2021), cert. granted sub nom. Sec. & Exch. Comm’n v. Cochran, 142 S. Ct. 2707 (2022). Respondent brought suit in the federal district court, seeking (1) a declaration that the SEC’s ALJs are unconstitutionally insulated from the president’s removal power and (2) an injunction barring the SEC from continuing the administrative proceedings against her. Id. at 213. The district court dismissed the action for lack of subject-matter jurisdiction, holding that the Exchange Act implicitly strips district courts of jurisdiction to hear challenges—including structural constitutional claims like the Respondent’s—to ongoing SEC enforcement proceedings. Id. at 198. The Fifth Circuit panel affirmed. Id.
The Fifth Circuit, en banc, reversed, holding that Respondent could bring her removal claim in federal court without waiting for a final determination by the SEC. Cochran, 20 F.4th at 212. The Fifth Circuit’s en banc decision created a split from the Second, Fourth, Eleventh, and D.C. Circuits, which held that the Exchange Act implicitly divests federal courts from jurisdiction to hear constitutional challenges to ongoing SEC administrative proceedings.
Two days after the Supreme Court granted certiorari in Cochran, the Fifth Circuit issued a 2-1 decision in Jarkesy v. Sec. & Exch. Comm’n, 34 F.4th 446 (5th Cir. 2022), which also discussed a challenge to the constitutionality of SEC proceedings before an ALJ in similar circumstances. In its decision, the Fifth Circuit issued three findings: (1) the SEC, through its decision to proceed before an ALJ, deprived Petitioner of his constitutional right to a jury trial for a securities fraud action seeking civil penalties, (2) Congress impermissibly granted legislative authority to the SEC by empowering it to decide whether to bring an enforcement action before a federal court or an ALJ and, therefore, which defendants should receive certain legal processes guaranteed in an Article III proceeding, and (3) because of the insulation provided by the removal restrictions for the SEC’s ALJs, the President cannot take care that the laws are faithfully executed in violation of Article II of the Constitution. Id. at 465. On July 1, 2022, the SEC petitioned the Fifth Circuit for rehearing en banc. A petition for certiorari may follow.
The Supreme Court’s decision in Cochran is unlikely to address the Seventh Amendment and non-delegation questions discussed in Jarkesy. Nonetheless, both Cochran and Jarkesy will potentially have significant implications for defendants in other enforcement proceedings, for other federal agencies that utilize in-house courts, and for parties seeking to challenge ALJ authority. As the SEC continues to face constitutional challenges against its proceedings before ALJs, defendants confronting enforcement actions should expect to see the SEC opting to proceed in federal court when possible.
In Cochran, attorneys from Gibson Dunn submitted amicus briefs supporting Cochran in the Supreme Court on behalf of Raymond J. Lucia, Sr., George R. Jarkesy, Jr., and Christopher M. Gibson, and in the Fifth Circuit on behalf of the Texas Public Policy Foundation. In Lucia, attorneys from Gibson Dunn represented petitioners Lucia and Raymond J. Lucia Companies, Inc.
B. EPA Decision Could Impact SEC’s Proposed Climate Disclosure Rule
On June 30, 2022, in a 6-3 split decision, the Supreme Court held that the Environmental Protection Agency (“EPA”) lacks the authority to change the Clean Air Act’s definition of “best system of emission reduction.” West Virginia v. Environmental Protection Agency, 142 S. Ct. 2587, 2610 (2022). Relying on the Major Questions Doctrine, which requires “a clear statement [] necessary for a court to conclude that Congress intended to delegate [broad economic authority to an agency],” id. at 2594, the Court examined, among other things, Congress’s repeat rejection of an analogous scheme. Id. at 2610.
While appearing irrelevant to securities at first blush, the decision in West Virginia v. EPA has the potential to halt the SEC’s recently proposed climate risk disclosure rule in its tracks. The SEC seeks to “require registrants to include certain climate-related disclosures in their registration statements and periodic reports.” U.S. Securities and Exchange Commission, SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors. Congress, however, has repeatedly failed to authorize such legislation in the past (e.g., Climate Disclosure Act of 2021 [HR 2570], Climate Disclosure Risk Act of 2019 [HR 3623], Climate Disclosure Act of 2018 [S 3481]). It is therefore possible that the SEC’s new proposed rule could run awry of the Supreme Court’s decision.
C. The Court Once Again Asked To Consider Gag Rule In Novinger
On July 12, 2022, the Fifth Circuit issued an order in SEC v. Novinger, 40 F.4th 297 (2022). There, Novinger sought to strike a provision in his 2016 settlement agreement with the SEC, preventing him from saying anything in public that might dispute any of the SEC’s allegations against him. Id. at 300. Novinger argued that such a provision is an unconstitutional restriction of speech by the government, while the SEC argued that even if the gag rule violates Novinger’s constitutional rights, settlement agreements which include voluntary waivers of constitutional rights are not per se invalid, including settlement agreements which waive a right to a jury trial. Id. at 303.
Without dissent, the Fifth Circuit denied Novinger’s challenge, teeing up an opportunity for the Supreme Court to consider the issue. Id. at 308. Less than a month before the Fifth Circuit ruled against Novinger, the Supreme Court declined to hear Romeril v. SEC, 15 F.4th 166 (2d Cir. 2021), cert. denied, 142 S. Ct. 2836 (2022), which challenged a similar gag rule, but from a much older settlement. Even though Novinger’s petition probably will suffer the same fate as Romeril’s, it is clear that challenges to these gag rules will continue. In a concurrence to the Fifth Circuit’s opinion in Novinger, two of the three judges on the panel highlighted that the SEC “never responded” to “a petition to review and revoke the SEC policy [that] was filed nearly four years ago,” and predicted that “it will not be long before the courts are called on to fully consider this policy.” Novinger, 40 F.4th at 30.
Attorneys from Gibson Dunn wrote an amicus brief on behalf of the CATO Institute in support of Romeril’s petition for certiorari.
III. Delaware Developments
A. Court Of Chancery Again Upholds Board’s Rejection Of Non-Compliant Dissident Nomination Under Intermediate Standard Of Review
In February, the Delaware Court of Chancery reiterated that “[f]undamental principles of Delaware law mandate that the court . . . conduct an equitable review of [a] board’s rejection of [a director] nomination” notice pursuant to advance notice bylaws even if such rejection is “contractually proper.” Strategic Investment Opportunities LLC v. Lee Enterprises, Inc., 2022 WL 453607, at *1 (Del. Ch. Feb. 14, 2022). In Lee Enterprises, a beneficial owner of the company sought to nominate several directors as part of a takeover attempt, but it failed to comply with unambiguous advance notice bylaws requiring it to become a record holder and submit the company’s nominee questionnaire forms before the nomination deadline. Id. Denying the beneficial owner’s request to permit its candidates to stand for election, Vice Chancellor Lori W. Will held that the board’s rejection of the non-compliant nomination notice was contractually proper and equitable under the circumstances. Id.
Echoing the court’s recent decision in Rosenbaum v. CytoDyn Inc., 2021 WL 4775140, at *1 (Del. Ch. Oct. 13, 2021), which we discussed in our 2021 Year-End Securities Litigation Update, the court declined to apply both the stringent review of Blasius Industries, Inc. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988), and the deferential business judgment rule. See Lee Enterprises, 2022 WL 453607, at *14–15. Instead, the court applied enhanced scrutiny—Delaware’s intermediate standard of review first set forth in Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985)—which requires directors to “identify the proper corporate objectives served by their actions” and “justify their actions as reasonable in relation to those objectives.” Lee Enterprises, 2022 WL 453607, at *16 (quoting Mercier v. Inter-Tel (Del.), Inc., 929 A.2d 786, 810 (Del. Ch. 2007)). The court ultimately held for the defendants, finding that the bylaws were “validly enacted on a clear day,” and the board “did not unfairly apply” them or make “compliance [with them] difficult.” Id. at *18.
B. Court Of Chancery Offers Guidance On “Vague” Schnell Standard
In Coster v. UIP Companies, Inc., 2022 WL 1299127 (Del. Ch. May 2, 2022), the court upheld a board’s decision to dilute a stockholder’s 50% ownership stake under the “compelling justification” standard of review set forth in Blasius Industries, Inc. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988). Offering helpful guidance on how the Blasius standard interacts with precedents interpreting Schnell v. Chris-Craft Industries, Inc., 285 A.2d 437 (Del. 1971), when a board’s disenfranchising actions are at issue, the court held that Blasius applied—and Schnell did not—because the board’s disenfranchising action “did not totally lack a good faith basis.” Coster, 2022 WL 1299127, at *10.
In Coster, upon the death of plaintiff’s husband, plaintiff became a 50% shareholder of UIP. Id. at *1. UIP’s two 50% stockholders deadlocked regarding the composition of UIP’s board. Id. To cause UIP to buy her stake for 30 times UIP’s total equity value, plaintiff filed a lawsuit asking the court to appoint a custodian with full control of the company. Id. at *3. For its part, the UIP board believed that the appointment of a custodian “rose to the level of an existential crisis for UIP” because it could “trigger broad termination provisions in key contracts and threaten a substantial portion of UIP’s revenue.” Id. at *12. Thus, in response to the lawsuit, the board issued one-third of the total outstanding shares “to reward and retain an essential employee” who had long been promised them. Id. at *5. Coster then sued again to invalidate the issuance as a per se breach of fiduciary duty. Id. at *1.
After trial, the court entered judgment in favor of the director defendants, finding their actions were motivated at least in part by good faith under the entire fairness standard. Id. at *10. The Delaware Supreme Court reversed and remanded, however, holding the court of Chancery should have extended its inquiry to determine whether the board acted for inequitable reasons, as laid out in Schnell and Blasius. Id. at *1.
On remand, the court offered new guidance on Schnell, which holds that “inequitable action does not become permissible simply because it is legally possible,” and embodies the Delaware doctrine that “director actions are ‘twice-tested,’ first for legal authorization, and second for equity.” Id. at *6. “Heeding the [Delaware Supreme Court’s prior] policy determination that Schnell should be deployed sparingly,” the court interpreted Schnell to apply only where “directors have no good faith basis for approving … disenfranchising action.” Id. at *8. Crediting the UIP board’s good-faith belief that avoiding the appointment of a custodian and rewarding and retaining an essential employee were in UIP’s best interests, the court concluded that the board did not act “exclusively for an inequitable purpose,” and Schnell did not apply. Id. at *10.
Next, the court considered Blasius. Assuming the UIP board acted “for the primary purpose of impeding the exercise of stockholder voting power,” the court focused on “whether the board establishe[d] a compelling justification for [its] action[s]” and “[its] actions were reasonable in relation to [its] legitimate objective.” Id. at *11–12. The court answered the first question in the affirmative: it agreed with the UIP board that the appointment of a custodian was “an existential crisis,” and preventing that crisis was a “compelling justification.” Id. at *12. It also found that diluting two deadlocked stockholders equally was “appropriately tailored” to achieving that goal. Id. at *13. Because it found that the UIP board had a compelling justification for diluting the plaintiff, the court entered judgment in favor of the defendants.
C. The Court Of Chancery Recognizes A “Novel” Wrongful Demand Refusal Claim
In May, the Delaware Court of Chancery in Garfield v. Allen, C.A. No. 2021-0420-JTL, 277 A.3d 296 (Del. Ch. May 24, 2022), declined to dismiss a claim for breach of fiduciary duty arising from a board’s wrongful rejection of a stockholder demand letter. In Garfield, a stockholder of ODP Corporation sent the company a letter demanding that performance share grants awarded to the company’s CEO be modified as they violated the equity compensation plan’s (the “2019 Plan”) share limitation. Id. at 313–14. After the company refused to act on the demand, the stockholder filed claims against the company’s directors and its CEO alleging that their actions breached the 2019 Plan and their fiduciary duties. Id. at 314.
All of the plaintiff’s claims survived the defendants’ motion to dismiss. Although most were governed by settled law, one theory the plaintiff advanced was novel: all of the directors “breached their fiduciary duties by not fixing the obvious violation after the plaintiff sent a demand letter calling the issue to their attention.” Id. at 305; see also id. at 340. “The making of demand has not historically given rise to a new cause of action,” Vice Chancellor J. Travis Laster explained, because “a stockholder who makes demand tacitly concedes that the board was disinterested and independent for purposes of responding to the demand.” Id. at 339. In Garfield, however, the court found that the plaintiff overcame the tacit-concession doctrine because he adequately pleaded facts demonstrating that the board refused the demand in bad faith. Id. at 338–40 (citing City of Tamarac Firefighters’ Pension Tr. Fund v. Corvi, 2019 WL 549938 (Del. Ch. Feb. 12, 2019)). Observing that “[t]he conscious failure to take action to address harm to the corporation animates a type of Caremark claim,” id. at 336–37, the court found that the “conscious decision to leave a violative award in place support[ed] a similar inference that the decision-maker[s] acted disloyally and in bad faith.” Id. at 337–38. It therefore held that this was one of the “likely rare” scenarios in which plaintiff’s claims that all directors acted in bad faith in rejecting the demand—and thus breached their fiduciary duties—were viable. Id. at 340.
Finally, Vice Chancellor Laster was careful to note the dangerous implications of this “novel” theory, which, among other things, include expanding opportunities for plaintiffs to create new claims with demand letters. Id. at 338–39. The court explained that the facts at issue were exceptional, however, because the problem identified by the demand was “obvious,” and established precedent supported an inference that the directors acted in bad faith. Id. at 306, 340.
D. Court Considers Whether Activist-Appointed Outside Directors Lack Independence From Activist
The Court of Chancery recently held that an activist’s practice of rewarding directors with repeat appointments can be sufficient to call a director’s independence into question. In Goldstein v. Denner, 2022 WL 1671006, at *2 (Del. Ch. May 26, 2022), a stockholder plaintiff adequately pleaded that certain members of Bioverativ’s board breached their fiduciary duties during a process to sell the company to Sanofi. Initially, the activist was approached by Sanofi with an initial offer to buy Bioverativ, but rather than alerting the board, the activist engaged in conduct violating Bioverativ’s insider trading policy. Id. at *1. Months later and after multiple offers that were not disclosed to the board, Sanofi submitted another offer to the entire board, and, eventually, the merger was effected at a price below Bioverativ’s standalone valuation under its long-range plan. Id. at *1, *13–*14.
Reviewing the independence of two activist-appointed outside directors, the court credited allegations that the activist had a practice of rewarding supportive directors with additional lucrative directorships and that each director hoped to cultivate such a repeat-player relationship with the activist. Id. at *2. One of the activist-appointed outside directors had a professional relationship with the activist and, shortly before joining the company’s board, allegedly received a lucrative payout for helping the activist complete the sale of another company. Id. at *2, *49. Likewise, another activist-appointed director, who allegedly was unemployed and looking to restart his career at the time the activist appointed him, was quickly appointed to the board of a second company that the activist hoped to put in play. Id. at *2, *50. The court concluded that these allegations were enough to make it reasonably conceivable that the two directors supported a sale of the company based on an expectation of future rewards, rather than because the transaction was in the best interests of the company. Id. at *2–3, *46, *50.
Aspects of the decision in Goldstein suggest this is a topic that the court may be interested in exploring more in the future. Id. at *2, *47. First, the court relied predominantly on scholarship, and not case law, to support its holding that an activist’s practice of rewarding directors with repeat appointments can be sufficient to call a director’s independence into question. Id. at *47–48. Second, the court itself thought its findings regarding the independence of the two activist-appointed directors discussed above were a “close call.” Id. at *46, *50.
IV. Lorenzo Disseminator Liability
As initially discussed in our 2019 Mid-Year Securities Litigation Update, the Supreme Court held in Lorenzo v. SEC, 139 S. Ct. 1094 (2019), that those who disseminate false or misleading information to the investing public with the intent to defraud can be liable under Section 17(a)(1) of the Securities Act and Exchange Act Rules 10b-5(a) and 10b-5(c), even if the disseminator did not “make” the statement within the meaning of Rule 10b-5(b). As a result of Lorenzo, secondary actors—such as financial advisors and lawyers—could face “scheme liability” under Rules 10b-5(a) and 10b-5(c) simply for disseminating the alleged misstatement of another so long as a plaintiff can show that the secondary actor knew the alleged misstatement contained false or misleading information.
The biggest development in this space came from the Second Circuit, which decided SEC v. Rio Tinto Plc., 41 F.4th 47 (2d Cir. 2022). Gibson Dunn represents Rio Tinto in this and other litigation. Several trial courts have also attempted to grapple with the implications of Lorenzo.
In July 2022, as we reported in a Client Alert, the Second Circuit held in Rio Tinto that in order to allege a claim of scheme liability, plaintiffs must show more than just the misstatements or omissions themselves. Id. at 48. The decision in Rio Tinto concerned scheme liability claims made by the SEC against mining company Rio Tinto and its former CEO and CFO under Rule 10b-5(a) and (c) and Section 17(a)(1) and (3) of the Securities Act. Id. at 48. The SEC claimed that Rio Tinto’s financial statements and accounting papers included representations about a newly acquired mining asset that defendants knew were incorrect, that those papers misstated the mining asset’s valuation, and that the company should have taken an impairment on the mining asset at an earlier time. Id. at 50–51. Relying on Lentell v. Merrill Lynch & Co., 396 F.3d 161 (2d Cir. 2005), the Southern District of New York dismissed the scheme liability claims on the basis that the SEC did not allege any fraudulent conduct beyond any misstatements or omissions. Rio Tinto, 41 F.4th at 48. The SEC filed an interlocutory appeal, claiming that Lorenzo abrogated Lentell and its scheme claims based only on misstatements or omissions should be reinstated. Id. at 48–49.
The Second Circuit rejected the SEC’s expansive reading of Lorenzo, holding that “Lentell remains vital” and that even post-Lorenzo, “misstatements and omissions can form part of a scheme liability claim, but an actionable scheme liability claim also requires something beyond misstatements and omissions, such as dissemination.” Rio Tinto, 41 F.4th at 53, 49. (emphasis in original). To hold otherwise, the court reasoned, would impose primary liability not only upon the maker of a statement, but also on those who participated in the making of the misstatements, and would undermine the principle that primary liability under Rule 10b-5(b) is limited to those actors with ultimate control and authority over the false statement. Id. at 54 (citing Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011)). Unlike Lorenzo, where the dissemination constituted conduct beyond any misstatement or omission, the SEC did not allege that the defendants did “something extra” that would be sufficient to find scheme liability. Id.
Multiple federal district courts also recently considered the scope of Lorenzo. In SEC v. Johnson, 2022 WL 423492, at *1–5 (C.D. Cal. Feb. 11, 2022), the SEC alleged that defendants—who created, managed, and controlled two issuers—misled and deceived investors with regard to their compensation and misappropriated significant investor funds. All but one defendant consented to judgment. Id. at *1. The district court relied primarily on undisputed material facts as to negligence and scienter in denying summary judgement on the SEC’s theories of scheme liability, in part, because the SEC did not sufficiently brief the issue and provided “little analysis” as to whether the alleged misstatements and omissions “also support scheme liability,” while noting the “considerable overlap” among the subsections of Rules 10(b) and 17(a). Id. at *7.
Then, in Strougo v. Tivity Health, Inc., 2022 WL 2037966, at *10 (M.D. Tenn. June 7, 2022), the defendant was accused of a scheme involving the launching of a diet programming company and misleading investors about the company’s performance. The district court in Tennessee rejected defendant’s argument that “scheme claims must be independent and distinct from misrepresentations claims.” Id. Rather, the court held that scheme liability “can be based upon misrepresentations or omissions and not just deceptive acts.” Id.
Although it is too early to determine the impact of Rio Tinto, these decisions preview how the scope of Lorenzo may develop in other circuits. We will continue to monitor this space.
V. Survey Of Coronavirus-Related Securities Litigation
As we move through the third year of the COVID-19 pandemic, courts continue to work through the aftermath of the wave of coronavirus-related securities litigation that began in 2020. As we discussed in our 2021 Year-End Securities Litigation Update, many cases remain focused on misstatements concerning the efficacy of COVID-19 diagnostic tests, vaccinations, and treatments. In addition, there are a number of cases involving false claims about pandemic and post-pandemic prospects, including premature claims that the pandemic would be “good for business.” Many such cases are moving into the motion to dismiss stage or already have fully briefed motions to dismiss.
It is also worth noting that the SEC has been active since the beginning of the year, for example, by filing securities enforcement actions relating to a CEO’s alleged misstatements concerning the purchase of two million COVID-19 diagnostic tests, as well as individual defendants’ alleged decision to trade on insider information suggesting that a cloud computing company’s earnings were unexpectedly—and artificially—inflated in light of the pandemic.
Additional resources related to the impact of COVID-19 can be found in the Gibson Dunn Coronavirus (COVID-19) Resource Center.
A. Securities Class Actions
1. False Claims About Vaccinations, Treatments, And Testing for COVID-19
In re Chembio Diagnostics, Inc. Sec. Litig., No. 20-CV-2706, 2022 WL 541891 (E.D.N.Y. Feb. 23, 2022): Plaintiffs filed four lawsuits, which were consolidated, against defendant Chembio, a corporation that developed an antibody test during the COVID-19 pandemic. 2022 WL 541891, at *1. More specifically, the plaintiffs sued the company’s executives and underwriters, claiming they overstated the efficacy of the antibody test and its prospects. Id. at *2–5. In a February 2022 decision, the court found that the plaintiffs had not alleged scienter with sufficient specificity against the corporate defendants. Id. at *8–11. The court let certain claims against the underwriters proceed, however, finding that the plaintiffs sufficiently pled that the underwriter defendants made a material misstatement by declaring in the Registration Statement and Prospectus that the test was “100% accurate after eleven days while omitting to disclose the other data in Chembio’s possession that indicated a lower accuracy.” Id. at *17. Accordingly, the court found, “the Registration Statement did not disclose one of the most significant risks to Chembio’s business: the potential loss of sales and marketing authorization in the United States for their flagship product.” Id. On March 9, the plaintiffs moved for reconsideration, and on July 21, 2022, the court denied the motion. See Dkt. No. 106. The court stayed all deadlines in this case on August 31, 2022, given that the parties have reached a settlement in principle. See Minute Order, No. 20-CV-2706 (E.D.N.Y. Aug. 31, 2022).
Sinnathurai v. Novavax, Inc. et al., No. 21-cv-02910 (D. Md. Apr. 25, 2022) (Dkt. No. 64): In this case, plaintiffs alleged that representatives of defendant Novavax made false and misleading statements by overstating the regulatory and commercial prospects for its vaccine, including by overstating its manufacturing capabilities and downplaying manufacturing issues that would impact the company when its COVID vaccine received regulatory approval. On April 25, 2022, defendant Novavax moved to dismiss the complaint, arguing that the alleged misstatements constituted nonactionable puffery and mere statements of opinion. See Dkt. No. 64. Novavax also argued that the PSLRA’s safe harbor—which immunizes from liability statements regarding “the plans and objectives of management for future operations” or “the assumptions underlying or relating” to those plans and objectives—insulates Novavax from liability regarding certain challenged statements about the vaccine’s launch. Id. at 14. In addition, Novavax contended that the complaint does not adequately plead that certain statements about clinical trials and manufacturing issues were false or misleading. Id. at 17–23. In response, plaintiffs argued that the statements are actionable because Novavax touted its business (with statements such as “nearly all major challenges” had been overcome, and “all of the serious hurdles” were eliminated), but failed to disclose known facts contradicting those representations. Dkt. No. 65 at 11. The plaintiffs also disputed that certain statements were opinion, arguing that they are “virtually all flat assertions of fact that falsely assured investors that Novavax was ready to file its [emergency use authorization] quickly” and “had overcome the regulatory and manufacturing hurdles that had delayed that filing.” Id. at 19–20. The motion to dismiss is fully briefed, but the court has yet to issue a decision.
In re Sorrento Therapeutics, Inc. Sec. Litig., No. 20-cv-00966 (S.D. Cal. Apr. 11, 2022) (Dkt. No. 68): We began following this case in our 2020 Mid-Year Securities Litigation Update. Defendant Sorrento Therapeutics, Inc. is a biopharmaceutical company that “purports to develop treatments for cancer, pain, and COVID-19.” During the class period—May 15, 2020 through May 21, 2020—Sorrento was developing a monoclonal antibody treatment and made a number of statements about its efficacy and promise. The plaintiffs argued that the defendants’ statements were misleading because the treatment was still in preclinical testing stages. On April 11, 2022, the court dismissed the complaint in full (with leave to replead), finding that it did not adequately allege that the defendants actually lied to or misled investors about the treatment’s preclinical testing status. Dkt. No. 68 at 15. The court also found that the defendants’ statements that “there is a cure” and “[t]here is a solution that works 100 percent” were unactionable statements of corporate optimism. Id. at 11. Finally, the court concluded that the complaint failed to establish a strong inference of scienter and that the plaintiffs failed to make specific allegations showing that the defendants had any intent to deceive investors or manipulate the preclinical trials. Id. at 13. The decision granting the motion to dismiss has been appealed to the Ninth Circuit.
Yannes v. SCWorx Corp., No. 20-cv-03349 (S.D.N.Y. June 29, 2022) (Dkt. No. 90): This case stems from allegations that defendant SCWorx, a hospital supply chain company, artificially inflated its stock price with a false claim in an April 13, 2020 press release that SCWorx had a “committed purchase order” to buy two million COVID rapid test kits, after which the SCWorx stock price increased 434% from the prior trading day. Dkt. No. 1 at 4–5. In June 2021, Judge Koeltl found that the complaint was adequately pleaded. Dkt. No. 52 at 1–3. After that decision, the parties reached a settlement. On June 29, 2022, Judge Koeltl granted final certification of the settlement class, consisting of all persons or entities who acquired common stock of SCWorx between April 13, 2020 and April 17, 2020. Dkt. No. 90 at 3. Public reports indicate that under the settlement agreement, the insurers for SCWorx and its former CEO, Marc Schessel, will make a payment to the class plaintiffs and issue $600,000 worth of common stock to them. As described below, the SEC announced in May 2022 that it had filed a complaint against SCWorx and Schessel and that the company agreed to a $125,000 civil penalty. Schessel is also facing criminal charges.
In re Emergent Biosolutions Inc. Sec. Litig., No. 21-cv-00955 (D. Md. July 19, 2022) (Dkt. No. 77): This case involves allegations that certain high-level employees at Emergent, a biopharmaceutical company that provides manufacturing services for vaccines and antibody therapies, misled the public about the company’s vaccine manufacturing business. Dkt. No. 54 at 1–8. In June 2020, Emergent received funds from the federal government’s Operation Warp Speed program, which it used to reserve space for COVID vaccine manufacturing at Emergent’s Baltimore facilities. Dkt. No. 54 at 2. Emergent also entered into agreements with J&J and AstraZeneca to support the mass production of their vaccines. Id. The plaintiffs claim that, contrary to Emergent’s public proclamations of, inter alia, “manufacturing strength” and “expertise,” Emergent did not disclose myriad issues at the facilities, including that up to 15 million doses of the J&J vaccine became contaminated at the Baltimore facilities. Id. at 5–6, 74, 98. In response to reports that problems at the facilities were not isolated incidents, the government placed J&J in charge of the plant and prohibited it from producing the AstraZeneca vaccine. Id. at 6. Emergent’s stock fell drastically as a result. Id. at 7. On May 19, 2022, Emergent moved to dismiss the complaint for failure to state a claim. Dkt. No. 72. Lead plaintiffs sought judicial notice of a newly published Congressional report and related materials that the plaintiffs contend show that many more doses of the vaccine were destroyed due to Emergent’s quality control failures and that Emergent hid evidence of contamination in an attempt to evade oversight from government regulators. Dkt. No. 77. That motion, as well as the motion to dismiss, remain pending.
Wandel v. Gao, No. 20-CV-03259, 2022 WL 768975 (S.D.N.Y. Mar. 14, 2022): This lawsuit was brought by shareholders of Phoenix Tree, a residential rental company based in China with operations in Wuhan, which went public in January 2020 on the New York Stock Exchange, just as the pandemic was in its earliest stages. 2022 WL 768975 at *1. At bottom, the plaintiffs alleged that “by January 16, 2020 (when the offering documents became effective) and certainly by January 22, 2020 (when the IPO ended),” Phoenix Tree “had enough information to know that China—and Wuhan, in particular—was already under siege by the coronavirus, and that it was reasonably likely to have a material adverse effect on the Company’s operations and revenues.” Id. at *2 (internal quotation marks omitted). Unsurprisingly, the COVID-19 pandemic impacted the company, which saw the early termination of rental leases. Defendants moved to dismiss, and in a March 14, 2022 opinion and order, the court granted their motion in full. Id. at *12. The court dove deep into the timeline of COVID-19 in the region, finding that COVID-19 had not sufficiently escalated by January 17 (the day after the offering documents became effective) such that Phoenix should have been aware, then, of the material risks its business would face as a result. Id. at *6–9. The court rejected arguments that Phoenix was in a “unique position” to recognize the threat of COVID-19 because it had operations in Wuhan. Id. at *7. After the plaintiffs did not amend their complaint, on April 21, 2022, the court entered judgment, dismissing the case with prejudice. Dkt. No. 83.
2. Failure To Disclose Specific Risks
Martinez v. Bright Health Grp. Inc., No. 22-cv-00101 (E.D.N.Y. June 24, 2022) (Dkt. No. 38): As discussed in our 2021 Year-End Securities Litigation Update, in this case, the plaintiffs allege that Bright Health, a company that delivers and finances U.S. health insurance plans, made a series of materially false or misleading statements about itself in its IPO registration statement and prospectus, which overstated the company’s prospects, failed to disclose that it was unprepared to handle the impact of COVID-19-related costs, and failed to disclose that it was experiencing a decline in premium revenue. In April 2022, the court granted one of six competing motions to appoint a lead plaintiff. Dkt. No. 31. Then, plaintiffs filed an amended complaint on June 24, 2022 adding nine new parties as defendants and claiming that although Bright Health warned of potential risks in its IPO documents, it was already experiencing those risks and their adverse impacts “would foreseeably manifest further near-immediately after the IPO.” Dkt. No. 38 at 5. Defendants’ motion to dismiss is due by October 12, 2022. See Minute Order, No. 22-cv-00101 (E.D.N.Y. Sept. 12, 2022).
3. False Claims About Pandemic And Post-Pandemic Prospects
Dixon v. The Honest Co., Inc., No. 21-cv-07405 (C.D. Cal. July 18, 2022) (Dkt. No. 71): This is a putative class action against The Honest Company, a seller of “clean lifestyle” products, alleging that the company’s registration statement omitted that the company’s results were skewed by a multimillion-dollar increase in demand by COVID-19 at the time of its IPO and that the company was experiencing decreasing demand for its products. Dkt. No. 59 at 2–3. Recently, the court denied defendants’ motion to dismiss in part, finding that the plaintiffs plausibly alleged that COVID-19-related product demand was declining at the time the company published the offering documents, which claimed that the pandemic was good for the Honest Company’s business. Dkt. No. 71 at 4–5. On August 1, 2022, defendant moved for partial reconsideration of the court’s decision on the motion to dismiss. Dkt. No. 75. The court denied that motion on August 25, 2022 without further discussion. Dkt. No. 84.
Douvia v. ON24, Inc., No. 21-cv-08578 (N.D. Cal. May 2, 2022) (Dkt. No. 83): In this case, the plaintiffs allege that offering documents promulgated by defendant ON24, Inc., a “cloud-based digital experience platform,” were materially inaccurate, misleading, and incomplete because they failed to disclose that the company’s surge in new customers due to COVID-19 did not fit the company’s traditional customer profile and that those new customers were thus unlikely to renew their contracts. Dkt. No. 80 at 2–3. This case was consolidated with another action against ON24 asserting similar allegations. In May 2022, the defendants moved to dismiss the consolidated class action complaint, claiming that the statements at issue were inactionable puffery, statements of opinion, merely forward-looking, or protected by the bespeaks-caution doctrine. Dkt. No. 83 at 7–12. The motion is fully briefed and awaiting a decision.
City of Hollywood Police Officers’ Ret. Sys. v. Citrix Sys., Inc., No. 21-cv-62380 (S.D. Fla. Aug. 8, 2022) (Dkt. No. 75): Citrix is a software company that provides digital workspaces to businesses. See Dkt. No. 62 at 7. The plaintiffs claim that during the pandemic, Citrix hid numerous corporate problems and sold heavily discounted, short-term licenses that boosted its sales. Id. at 2–3. The plaintiffs allege that the company’s transition to subscription licenses was not as successful as the company had disclosed, as customers failed to make the transition, instead preferring short-term on-premise licensing due to the COVID-19 pandemic. Id. The defendants have moved to dismiss, claiming that the operative complaint inadequately alleges scienter and that the statements at issue were forward-looking statements, opinion, and/or puffery. Dkt. No. 68 at 10–23. The court will hear arguments on the motion to dismiss on September 29, 2022. Dkt. No. 77.
Leventhal v. Chegg, Inc., No. 21-cv-09953 (N.D. Cal.): The plaintiffs claim that Chegg, a textbook, tutoring, and online research provider, falsely claimed that as a result of its “unique position to impact the future of the higher education ecosystem” and “strong brand and momentum,” Chegg would continue to grow post-pandemic. Dkt. No. 1 at 1. The complaint alleges that Chegg knew that its growth was a temporary effect of the pandemic and was not sustainable. Id. In April 2022, the case was consolidated with a similar action (Robinson v. Rosensweig, No. 22-cv-02049 (N.D. Cal.)). On September 7, 2022, the court appointed joint lead plaintiffs and lead co-counsel. Dkt. No. 105.
In re Progenity, Inc., No. 20-cv-1683 (S.D. Cal.): In this case, the plaintiffs allege that Progenity, a biotechnology company that develops testing products, made misleading statements and omitted material facts in its registration statement, including that Progenity failed to disclose that it had overbilled government payors and that it was experiencing negative trends in its testing volumes, selling prices, and revenues as a result of the COVID-19 pandemic. On September 1, 2021, the court dismissed the case with leave to file a second amended complaint, finding no actionable false or misleading statements. See Dkt. No. 48. The plaintiffs then filed a second amended complaint on September 22, 2021. See Dkt. No. 49. The company filed a second motion to dismiss on November 15, 2021, which remains pending, Dkt. No. 52, and the parties participated in a settlement conference in May 2022, Dkt. No. 58. Gibson Dunn represents the company and its directors and officers in this litigation.
Weston v. DocuSign, Inc., No. 22-cv-00824 (N.D. Cal. July 8, 2022) (Dkt. No. 59): The plaintiffs allege that DocuSign, a software company that enables users to electronically sign documents, made false and misleading statements that the “massive surge in customer demand” brought on by the pandemic was “sustained” and “not a short term thing.” Dkt. No. 59 at 2. The plaintiffs allege that the defendants knew that the demand was unsustainable after the pandemic subsided, and that the defendants made corrective disclosures revealing that the company had missed billings-growth expectations after the initial surge of demand dissipated. Id. The court appointed lead plaintiff and lead counsel on April 18, 2022, see Dkt. No. 42, and plaintiffs filed the amended complaint on July 8, 2022, see Dkt. No. 59.
4. Insider Trading And “Pump And Dump” Schemes
In re Eastman Kodak Co. Sec. Litig., No. 21-cv-6418, 2021 WL 3361162 (W.D.N.Y. Aug. 2, 2021): We have been following the consolidated cases captioned under the heading In re Eastman Kodak Co. Securities Litigation since our 2020 Year-End Securities Litigation Update. The plaintiffs in this putative class action allege that Eastman Kodak and certain of its current and former directors and select current officers violated securities laws by failing to disclose that its officers were granted stock options prior to the company’s public announcement that it had received a loan to produce drugs to treat COVID-19. Dkt. No. 116 at 2. The defendants moved to dismiss earlier this year, arguing in part that the stock options grants did not constitute insider trading because the complaint lacked any allegation that the company and the individual defendants did not have the same information before the options grants were issued, which is necessary “[b]ecause an option grant is a ‘trade’ between a company and an officer,” Dkt. No. 159-1 at 21. The defendants also argued that the plaintiffs failed to allege that the “timing of the [o]ptions [g]rants was manipulated to provide additional compensation to the officers.” Id. The court recently heard oral argument on the pending motion, but has yet to issue a decision. Dkt. No. 196.
In re Vaxart Inc. Sec. Litig., No. 20-cv-05949, 2021 WL 6061518 (N.D. Cal. Dec. 22, 2021): Stockholders allege that Vaxart insiders—directors, officers, and a major stockholder—profited from misleading statements that (1) overstated Vaxart’s progress toward a successful COVID-19 vaccine and (2) implied that Vaxart’s “supposed vaccine” had been “selected” by the federal government’s Operation Warp Speed program. Dkt. No. 1 at 6–7. After Vaxart’s stock price rose in response to these statements, the insiders “cashed out,” exercising options and warrants worth millions of dollars. Id. at 7–8. As we discussed in the 2021 Year-End Securities Litigation Update, the court concluded that the complaint adequately alleged that certain defendants committed securities fraud, but the plaintiffs failed to allege securities fraud on the part of a hedge fund that was the company’s major stockholder because the complaint did not demonstrate that the entity was a “maker” of the misleading statements or controlled Vaxart’s public statements. 2021 WL 6061518 at *8. The parties engaged in discovery, and the plaintiffs recently reached a settlement with all remaining defendants, except two individual representatives from the hedge fund. Dkt. No. 215 at 6; Dkt. No. 216. The two individual defendants sought to stay additional discovery, arguing that the plaintiffs improperly used discovery from the other defendants to seek to amend their pleadings to raise new allegations against the two individual defendants and bring new claims against the hedge fund. Dkt. No. 215 at 6. The plaintiffs, in turn, sought leave to extend the time to amend the complaint until 30 days after the two individual defendants substantially completed document production, Dkt. No. 216, which was opposed by the two defendants, Dkt. No. 219. On September 8, 2022, the court granted the motion to stay further discovery and noted that the deadline to file the amended complaint could be discussed further at a hearing scheduled for September 29, 2022. Dkt. No. 235.
B. Stockholder Derivative Actions
In re Vaxart, Inc. Stockholder Litig., No. 2020-0767-PAF, 2022 WL 1837452 (Del. Ch. June 3, 2022): Unlike the Vaxart securities class action discussed above, this case was filed derivatively on behalf of the Vaxart corporate entity. In particular, Vaxart stockholders alleged that the officers, directors, and purported controlling stockholder kept private the announcement regarding the company’s selection to participate in Operation Warp Speed so that they could keep the stock price artificially low before exercising their options. 2021 WL 5858696, at *1, *13. As discussed in our 2021 Year-End Securities Litigation Update, the court granted the defendants’ motion to dismiss as to the derivative claims because the plaintiffs failed to plead demand futility, but requested supplemental briefing on the plaintiffs’ remaining claims. Id. at *24. The court recently dismissed the plaintiffs’ remaining breach of fiduciary duty claim relating to an amendment to the equity incentive plan and their unjust enrichment claim arising from compensation decisions made before and after the approval of the amendment. 2022 WL 1837452, at *1. The case is now fully dismissed.
In re Emergent Biosolutions Inc. Derivative Litig., No. 2021-0974 (Del. Ch.): In addition to the putative securities class action discussed above, the directors of Emergent BioSolutions Inc. and its current and former CEO are facing a shareholders’ derivative suit in the Delaware Court of Chancery. See Compl. at 1–8. The complaint alleges fiduciary duty breaches, unjust enrichment, corporate waste against all defendants, and an insider trading claim on the part of the current CEO. See id. at 96–97. The plaintiffs claim that the defendants failed to put in place any compliance structures to monitor its vaccine-manufacturing business, resulting in significant quality control issues with its COVID-19 vaccine. See id. at 94. The case is currently stayed pending the outcome of the securities lawsuit discussed above.
C. SEC Cases
SEC v. Berman, No. 20-cv-10658, 2021 WL 2895148 (S.D.N.Y. June 8, 2021): In both our 2020 Year-End Securities Litigation Update and our 2021 Year-End Securities Litigation Update, we discussed a related civil and criminal case filed against the CEO of Decision Diagnostics Corp. In the criminal case, a federal grand jury indicted the CEO on December 15, 2020 for allegedly attempting to defraud investors by making false and misleading statements about the development of a new COVID-19 rapid test. Dkt. No. 1 at 6–7. The CEO allegedly claimed the test was on the verge of FDA approval even though the test had not been developed beyond the conceptual stage. Id. at 6–7, 9. Only two days after the indictment in the criminal case, the SEC filed a civil enforcement action based on the same underlying facts against both Decision Diagnostics Corp. and its CEO. The SEC claims that the defendants violated Section 10(b) of the Exchange Act and Rule 10b-5. 2021 WL 2895148, at *1. The court stayed discovery in June 2021 in the civil case in light of the parallel criminal case against the CEO. Id. Discovery remains stayed, and the criminal trial is set for this coming December. Dkt. No. 30.
SEC v. SCWorx Corp., No. 22-cv-03287 (D.N.J. May 31, 2022): In addition to the private securities lawsuit discussed above, the SEC recently filed a securities enforcement action against hospital supply chain SCWorx and its CEO, alleging that the defendants falsely claimed in a press release to have a “committed purchase order” from a telehealth company for “two million COVID-19 tests” amounting to $840 million when the “committed purchase order” was, in reality, only a “preliminary summary draft.” Dkt. No. 1 at 2–3. SCWorx has agreed to pay a penalty of $125,000, in addition to disgorgement of approximately $500,000. The CEO was also indicted in a parallel criminal fraud case arising from the same allegations. 2:22-cr-00374-ES, Dkt. No. 1. On August 17, 2022, the court ordered that the SEC’s enforcement action be stayed until the parallel criminal case is completed. Dkt. No. 20.
SEC v. Sure, No. 22-cv-01967 (N.D. Cal. Mar. 28, 2022): The SEC filed this civil enforcement action in March against a group of employees at Twilio, a cloud computing company, and their friends and family, alleging that they violated Section 10(b) and Rule 10b-5 by engaging in insider trading in May 2020. Dkt. No. at 1. The SEC alleges that the employees learned that Twilio’s customers unexpectedly increased their usage of the cloud computing services because of the COVID-19 pandemic, leading to significantly increased earnings for the company that exceed its revenue guidance. Id. at 5–6. According to the SEC’s complaint, the employees informed the other defendants about Twilio’s anticipated performance in advance of its May 6, 2020 earnings announcement, who, in turn, traded on this information. Id. at 8–9. Parallel criminal charges were also announced against one of the defendants.
VI. Falsity Of Opinions – Omnicare Update
As readers will recall, in Omnicare, the Supreme Court held that “a sincere statement of pure opinion is not an ‘untrue statement of material fact,’ regardless whether an investor can ultimately prove the belief wrong,” but that an opinion statement can form the basis for liability in three different situations: (1) the speaker did not actually hold the belief professed; (2) the opinion contained embedded statements of untrue facts; and (3) the speaker omitted information whose omission made the statement misleading to a reasonable investor. 575 U.S. at 184–89. Since that decision was handed down in 2015, there has been significant activity with respect to “opinion” liability under the federal securities laws, and the first half of 2022 has been no exception.
A. Survival At The Motion To Dismiss Stage
In the first half of 2022, cases with claims premised on allegedly misleading opinions survived motions to dismiss based on Omnicare. For example, in Fryman v. Atlas Financial Holdings Inc., No. 18-cv-01640, 2022 WL 1136577, at *9–21 (N.D. Ill. Apr. 18, 2022), an Illinois district court held that plaintiff investors adequately stated a Section 10b-5 claim against a financial services holding company based on misleading statements by company executives. The plaintiffs alleged that the company misled investors with regard to a substantial increase in its loss reserves. Id. at *2–4. The complaint alleged a number of misstatements, including statements by the CEO that the reserve increases were caused by isolated issues, that “[w]e feel very strongly that we’ve isolated the issue,” and that the reserves were sufficient and “appear to be holding up consistent with the expectations we had.” Id. at *14. Despite being phrased as a belief (“[w]e feel strongly”), the court considered the pleading sufficient. Id. at *14–15. In the court’s view, the statements omitted material facts that “conflict[ed] with what a reasonable investor would take from the statement[s]” themselves. Id. at *14 (internal quotation omitted). The court concluded the defendants’ “contemporaneous knowledge surrounding the reserve deficiencies” evidenced that they “did not actually believe” the reserves were adequate or that the “increases were caused by isolated incidents.” Id. “Thus, the opinion statements concerning the cause or adequacy of [the company’s] reserves could still be misleading under Omnicare because the defendants did not hold the beliefs professed.” Id. (internal quotation and corrections omitted).
The Fryman court further considered the significance of the context surrounding the statements at issue to determine the opinion was actionable under Omnicare. “Context matters,” and whether an opinion is actionable under Omnicare depends on its “full context.” Omnicare, 575 U.S. at 190; see Fryman, 2022 WL 1136577, at *11, 20. The court rejected the defendants’ assertions that the CEO’s statements were nothing more than inactionable puffery; “when assessed in context,” those statements were “not puffery because they are not vague or unimportant to a reasonable investor, who would want to know if future reserve increases would be needed which could diminish [the company]’s net income.” Id. at *20.
Context is a common thread running through recent Omnicare cases. In City of Sterling Heights Police & Fire Retirement System v. Reckitt Benckiser Group PLC, No. 20-cv-10041, 2022 WL 596679, at *18–19 (S.D.N.Y. Feb. 28, 2022), plaintiffs plausibly alleged that some of the defendant pharmaceutical company’s statements of opinion were actionable as “more than mere puffery or statements of opinion” in light of the full context in which the statements were made. The company’s CEO made several factual statements about a product’s market share and “commercial success” without disclosing it had carried out anticompetitive practices. Id. at *2, 6. The court identified a number of adequately pleaded misstatements, including: (1) “the data has already demonstrated that [the specific product] is very clearly the preferred product”; (2) the product’s “resilience” and “market share performance” demonstrated it was “the top choice” on the market; (3) the product was “designed with the intent of being a lower potential for abuse and misuse than the previous products on the market”; and (4) “we’re not in the business of forcing the market or patients to do anything.” Id. at *18–20 (internal quotations omitted). In the court’s view, the CEO “placed at issue the reason for the [product’s] strong sales” and therefore “had a duty to disclose that sales were derived at least in part from allegedly untruthful statements and anticompetitive conduct.” Id. at *18. This was information “a reasonable investor would have considered . . . material to know.” Id. at *19. The CEO thereby “materially mispresented the reasons for the strong market position” of the product. Id. at *20.
B. Omnicare As A Pleading Barrier
In another line of cases, defendants have used Omnicare to successfully argue for the dismissal of inadequately pleaded claims relying on allegedly false or misleading opinions. In In re Peabody Energy Corp. Securities Litigation, the Southern District of New York dismissed claims against Peabody—an energy company—given the “broader surrounding context,” among other reasons. No. 20-CV-8024, 2022 WL 671222, at *18 (S.D.N.Y. Mar. 7, 2022). There, the court examined multiple statements made by Peabody and its executives regarding a fire at a mine in Queensland, Australia. One statement by an executive, that the “vast majority of the mine is unaffected,” was held to be non-actionable because, read in “the appropriate context,” the opinion was an estimate based on available data and was not “rendered misleading and actionable just because Peabody was actually unable” to ascertain damages to all parts of the mine. Id. at *18.
In In re Ascena Retail Group, Inc. Securities Litigation, the District of New Jersey relied on Omnicare to dismiss Section 10(b) and Rule 10b-5 claims against a retail clothing brand and two of its executives. Civ. No. 19-13529, 2022 WL 2314890, at *9 (D.N.J. June 28, 2022). According to the plaintiffs, the defendants made false statements about the value of the company’s goodwill and tradename. Id. at *6. They argued that defendants overstated the value of these assets in public statements and financial disclosures under GAAP, despite contemporaneous indicators of impairment, including (1) deteriorating performance; (2) changes in “consumer behavior and spending;” (3) changes in the company’s commercial strategy; and (4) falling share price. Id. Defendants countered that plaintiffs did not allege “a single particularized allegation” that they “disbelieved” the challenged statements or “omitted material non-public information.” Id.
The court agreed with defendants, finding plaintiffs had not shown the defendants “disbelieved their own statements, conveyed false statements of fact, or omitted material facts going to the basis of their opinions.” Id. at *7. The statements did little more than show the defendants were “aware” of the company’s “increasingly difficult business environment.” Id. The company’s statements about goodwill and tradenames “rest[ed] on the accounting procedures outlined by GAAP for evaluating and testing these assets,” which “require the exercise of subjective judgment.” Id. Applying Omnicare, the court held that the challenged statements were not false or misleading because, even though the company knew of its challenging business environment, GAAP granted it discretion. Id. The size of the impairment “suggests that Defendants’ valuations were overly optimistic and that an impairment could or even should have been recorded earlier,” but the company’s “impairment charge appears better explained as a result of Defendants’ mistakes, bad luck, or poor performance, not a longstanding effort by Defendants to dupe investors and fraudulently inflate Ascena’s share price.” Id. at *8. Accordingly, the court dismissed the complaint. Id. at *9; see also Nacif v. Athira Pharma, Inc., No. C21-861, 2022 WL 3028579, at *1, 15 (W.D. Wash. July 29, 2022) (holding that “laudatory opinions” about a biopharmaceutical company’s CEO, where the company allegedly misled investors by omitting “material facts concerning [the CEO’s] prior research,” were not actionable where plaintiffs failed to show “that the opinions were either provided without reasonable investigation or in conflict with then-known information”) (emphasis in original); Building Trades Pension Fund of Western Pennsylvania v. Insperity, Inc., 20 Civ. 5635, 2022 WL 784017, at *10 (S.D.N.Y. Mar. 15, 2022) (finding an “overly optimistic” statement “exuding confidence while acknowledging risk does not constitute a misstatement” actionable under Omnicare, particularly where such statements are “predictions, not guarantees”); In re Peabody Energy Corp. Securities Litigation, 2022 WL 671222, at *19 (finding a statement concerning an expected production timeline non-actionable where defendants had separately “cautioned that . . . production estimates were subject to reevaluation”).
We will continue to monitor developments in these and similar cases.
VII. Federal SPAC Litigation
The use of special purpose acquisition companies (“SPACs”) surged during the coronavirus pandemic. Using a SPAC to go public has several perceived advantages, including a more streamlined path than a traditional IPO. The surge in SPAC transactions generated new opportunities for start-ups, high-growth companies, and retail investors to access the public markets. The first half of 2022 saw both a corresponding spike in SPAC-related securities litigation and a set of newly proposed SPAC-related rules and amendments from the SEC.
Section 10(b) material misstatement or omission claims proved to be the most common avenue for SPAC-related securities claims. Such claims frequently are filed against operating companies that are acquired by SPACs and begin reporting financial results that aren’t aligned with prior, more optimistic business projections. The SEC, meanwhile, has proposed a set of new rules and amendments that seek to impose traditional IPO concepts and regulations on the SPAC transaction process. Complying with the proposed rules, which are explained in depth in our recent Client Alert, will curtail SPAC flexibility and increase the complexity and cost of completing a de-SPAC transaction. These litigation trends, alongside the SEC’s increased interest in regulating SPAC transactions, underline the importance of robust disclosure controls and disciplined due diligence throughout the SPAC process.
A. Clover Health: Prototypical 10(b) And 20(a) Claims In The SPAC Context
A notable number of claims involving SPACs survived motions to dismiss in the first half of 2022, several of which were based on fairly routine allegations of misleading statements made during pre-merger and post-merger disclosures. See, e.g., In re Romeo Power Inc. Sec. Litig., 2022 WL 1806303 (S.D.N.Y. June 2, 2022) (alleging misleading statements in the relevant registration statement, proxy statement, and prospectus); In re XL Fleet Corp. Sec. Litig., 2022 WL 493629 (S.D.N.Y. Feb. 17, 2022) (alleging misleading statements in press releases and SEC filings starting the date the de-SPAC merger agreement was announced). The recent decision in Bond v. Clover Health Investments, Corp. is a prototypical example with a fulsome opinion; it appears to be the first time a federal court has expressly credited a fraud-on-the-market theory when deciding a motion to dismiss federal securities claims arising from a SPAC-related offering. 2022 WL 602432 (M.D. Tenn. Feb. 28, 2022).
B. The Northern District Of California Continues To Apply The PSLRA’s “Safe Harbor” Provision For Forward-Looking Statements
Although use of the PSLRA’s safe harbor provision for “forward-looking statements” has been questioned in the context of SPACs due to their speculative nature, courts have continued applying the safe harbor to dismiss claims involving SPACs. The Northern District of California, for example, recently dismissed claims of alleged misstatements related to business growth and anticipated revenue under the safe harbor. Moradpour v. Velodyne Lidar, Inc., 2022 WL 2391004, at *14–16 (N.D. Cal. July 1, 2022). The court found that the defendants’ statements related to business growth and anticipated revenue from existing contracts were, in fact, forward-looking and accompanied by appropriate cautionary language, as the PSLRA requires. Id.
Although no court has yet found that the “forward-looking statement” safe harbor does not apply to SPAC transactions, the safe harbor’s future in federal SPAC litigation remains uncertain. The SEC has recently proposed a rule that would disqualify SPACs from the safe harbor by revising the definition of “blank check company” to omit the requirement that the company issue “penny stock.” If the proposed rule were to become effective, the term “blank check company” would encompass any development-state company with no specific business plan or purpose, or which has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies, or other entity or person—including SPACs. Because the forward-looking statement safe harbor would not be available for statements made in connection with an offering by a “blank check company,” the change would eliminate a vital defense against SPAC-related claims.
C. One Plaintiff Is Pursuing New Theories Of Liability Against SPACs And Their Advisers
One plaintiff has gained attention by filing three actions asserting violations of the Investment Company Act of 1940 (the “ICA”) and the Investment Advisers Act of 1940 (the “IAA”). These suits attempt to classify SPACs as investment companies and certain involved individuals as investment advisers, which would subject them to different sets of regulations and theories of liability. One action was voluntarily dismissed because the target company ceased operations, and another is stayed. A third, Assad v. E.Merge Technology Acquisition Corp., No. 1:21-cv-07072 (S.D.N.Y. Aug. 20, 2021), is active and pending in the Southern District of New York.
In Assad, a stockholder plaintiff alleged that E.Merge, the defendant SPAC, is subject to liability under the ICA as “an investment company . . . whose primary business is investing in securities” because “this is all E.Merge has ever done with its assets.” Dkt. No. 1 at ¶ 4. The plaintiff in the case has asserted that E.Merge—as an “investment company”—violated the ICA’s rule against issuing shares of common stock for less than their net asset value by providing shares of common stock as compensation to its sponsors and directors. Id. ¶¶ 82–90. E.Merge has moved to dismiss the claims, arguing that (1) the ICA does not confer a private right of action; (2) E.Merge is not an investment company, namely because it does not engage primarily in the business of investing in securities; and (3) plaintiff has not alleged any violation of the ICA. See Dkt. No. 31. In light of E.Merge’s forthcoming dissolution and liquidation, during which it intends to return all investor funds, this case was stayed on September 2, 2022 pending the submission of a stipulation of dismissal, which is the parties anticipate filing by the end of September. See Dkt. No. 56–57.
In September 2021, shortly after the plaintiff began filing these claims, more than sixty law firms—including Gibson Dunn—issued a joint statement urging that no legal or factual basis exists for classifying SPACs as investment companies. It appears the SEC agrees. As we discussed in our recent Client Alert, the SEC’s proposed rules relating to SPACs provide a safe harbor that will exempt SPACs from the ICA. To qualify for the safe harbor, the SPAC (1) must maintain assets consisting solely of cash items, government securities, and certain money market funds; (2) seek to complete a single de-SPAC transaction where the surviving public company will be “primarily engaged in the business of the target company;” and (3) must enter into an agreement with a target company to engage in a de-SPAC transaction within 18 months after its IPO and complete its de-SPAC transaction within 24 months of such offering.
VIII. Other Notable Developments
A. Second Circuit Holds That Company Has Duty To Disclose SEC Investigation
In May, the Second Circuit, in Noto v. 22nd Century Grp., Inc., 35 F.4th 95 (2d Cir. 2022), issued an opinion that may raise questions as to when a company must disclose a governmental investigation. The plaintiffs in Noto alleged that 22nd Century Group “reported material weaknesses in its internal financial controls” in several public SEC filings over a two-year period, and they claimed that the company’s statements regarding these accounting weaknesses were misleading because the company did not disclose the existence of an SEC investigation into those same accounting weaknesses. Id. at 105.
On appeal, the Second Circuit reversed the district court’s dismissal on this point. The court reasoned, “[b]ecause defendants here specifically noted the deficiencies [in their internal financial controls] and that they were working on the problem, and then stated that they had solved the issue, the failure to disclose the investigation would cause a reasonable investor to make an overly optimistic assessment of the risk.” Id. (quotation marks and brackets omitted). The court emphasized that the Company “represented that it had rectified the problem” even though “the SEC investigation was ongoing.” Id. at 106.
It remains to be seen whether the Second Circuit’s ruling in Noto will be confined to that case’s unique facts, which included the company’s public statement that it had “solved” the accounting weaknesses while the SEC’s investigation into those weaknesses was still ongoing. Id. at 105. The decision is also silent on precisely when the Company should have disclosed the SEC investigation into its accounting practices. Nevertheless, Noto creates some potential risks for companies that report a material weakness in their internal controls and then face a related SEC investigation into those same accounting issues.
B. Ninth Circuit Further Clarifies Standard For Non-Actionable Corporate ‘Puffery’
In March, the Ninth Circuit in Weston Family Partnership LLLP v. Twitter, Inc., 29 F.4th 611 (9th Cir. 2022), took yet another opportunity to clarify the types of general corporate statements that may be actionable under federal securities laws.
Twitter concerned several public statements by the company regarding the development of an update to its Mobile App Promotion (“MAP”) product. These included, in particular, statements by Twitter that “MAP work is ongoing” and that Twitter was “continuing [its] work to increase the stability, performance, and flexibility of [MAP] . . . but we’re not there yet.” Twitter, 29 F.4th at 616–17.
When Twitter later disclosed that it had discovered software bugs with the updated MAP product, its stock price decreased, and a putative shareholder class action followed soon thereafter. The plaintiffs in Twitter alleged, among other things, that Twitter’s general statements about the development of its MAP product were misleading because the company did not also disclose the existence of the software bugs. Twitter, 29 F.4th at 615. The plaintiffs claimed that these bugs delayed development of the updated MAP product, leading to lost revenues. Id. at 621. The district court rejected this theory and granted Twitter’s motion to dismiss.
On appeal, the Ninth Circuit agreed with the district court and upheld dismissal. Among other things, the court held that Twitter’s statements that its development of MAP was “continuing” and “ongoing” were “vague” expressions of corporate optimism—i.e., non-actionable corporate “puffery”—because they were “so imprecise and noncommittal that they are incapable of objective verification.” Id. at 620–21. As part of its reasoning, the Ninth Circuit also stressed that “companies do not have an obligation to offer an instantaneous update of every internal development, especially when it involves the oft-tortuous path of product development.” Id. at 620.
C. Second Circuit Reaffirms Requirements For Pleading Falsity Under PSLRA
Also in March, the Second Circuit, in Arkansas Public Employees Retirement System v. Bristol-Myers Squibb Co., 28 F.4th 343 (2d Cir. 2022), upheld the dismissal of a securities class action against a pharmaceutical company based, in part, on a failure to plead falsity under the PSLRA.
Bristol-Myers Squibb involved statements that the pharmaceutical company had made about a lung cancer drug that it was developing. Id. at 347. A clinical trial for the drug sponsored by Bristol-Myers Squibb targeted patients whose cancer cells had a certain level of a particular protein called PD-L1; this was referred to as an “expression” of the protein, and it could be measured as a percentage value. Id. at 347–49. In public disclosures, Bristol-Myers Squibb described these patients as “strongly expressing” the protein, but, for competitive reasons the company did not disclose the exact expression threshold for eligibility in the clinical trial, which was 5%. Id. at 347, 353. When the clinical trial later failed, Bristol-Myers Squibb publicly disclosed for the first time that the threshold was 5% and later attributed the trial’s failure to its use of this threshold. Id. at 347.
The plaintiffs in Bristol-Myers Squibb claimed, among other things, that the company’s description of the clinical trial participants as “strongly expressing” the PD-L1 protein was misleading because the company had not also disclosed that the exact percentage of expression was 5%. Id. at 350. On appeal, the Second Circuit rejected this argument, agreeing with the district court that the pharmaceutical company “had no obligation to disclose the precise percentage of [protein] expression which defined ‘strong’ expression in the . . . trial.” Id. at 353.
The Second Circuit also held that the plaintiffs failed to allege with particularity why the company’s use of “strong expression” was misleading under the PSLRA. Id. at 353. The plaintiffs claimed that there was “a general consensus that ‘strong’ expression meant 50% expression or could not mean 5% expression” and pointed to a subsequent clinical trial for a similar drug by Merck & Co., another pharmaceutical company, in which Merck defined “strong” expression to mean “greater than 50%.” Id. at 353–54. The Second Circuit disagreed, finding that that the complaint lacked allegations showing the existence of any industry “consensus on the meaning of strong or high expression,” in part because the complaint mentioned industry observers and participants who used definitions for “strong” ranging from 10% to 50%. Id.
D. Ninth Circuit Offers Additional Guidance On Loss Causation Standard While Affirming Grant Of Motion To Dismiss On Loss Causation Grounds
In May, the Ninth Circuit, in In re Nektar Therapeutics Sec. Litig., 34 F.4th 828 (9th Cir. 2022), offered additional guidance on its standard for loss causation under the Exchange Act, providing detail as to how that standard should be applied to pharmaceutical contexts and reiterating its “high bar” for the use of “short-seller” reports to satisfy the standard generally. Id. at 840.
The plaintiffs in Nektar Therapeutics alleged that certain published test results from a clinical trial for a cancer drug that Nektar Therapeutics was developing were false or misleading, and they claimed to have suffered losses when the company’s stock dropped following the publication of “disappointing test results” from a second clinical trial involving the same drug. Id. at 838–39. On appeal, the Ninth Circuit affirmed the district court’s dismissal of the case, holding, among other things, that the plaintiffs had failed to allege loss causation because “only a tenuous causal connection exists between the alleged falsehoods” in the first clinical trial and the second, “different” clinical trial involving the same drug. Id. at 389.
As we discussed in our 2018 Mid-Year Securities Litigation Update, the standard for loss causation in the Ninth Circuit does not require a “[r]evelation of fraud in the marketplace” before any claimed loss. Mineworkers’ Pension Scheme v. First Solar Inc., 881 F.3d 750, 753–54 (9th Cir. 2018). Instead, the plaintiffs in Nektar Therapeutics were required to show “a causal connection between the fraud and the loss by tracing the loss back to the very facts about which the defendant lied.” Nektar Therapeutics Sec. Litig., 34 F.4th at 838 (quoting First Solar Inc., 881 F.3d at 753). The Ninth Circuit in Nektar Therepeutics held that the complaint’s allegations did not satisfy this test either. In particular, the court reasoned that the alleged results from the second clinical trial—although “not as promising”—did not suggest that the data from the first clinical trial was “improperly manipulated, or that the methodology for collecting and analyzing that data was flawed.” Id. at 839.
The Ninth Circuit in Nektar Therapeutics also clarified its recent holding on the adequacy of short-seller reports in In re BofI Holding, Inc. Sec. Litig., 977 F.3d 781 (9th Cir. 2020), rejecting the plaintiffs’ argument that a short-seller report regarding the company satisfied the loss causation element of plaintiffs’ claim. Instead, the Ninth Circuit held that, even if such a report “provide[d] new information to the market,” it was “rendered . . . inadequate” by the fact that it was published by “anonymous and self-interested short-sellers who disavowed any accuracy.” Nektar Therapeutics, 34 F.4th at 840. As the Ninth Circuit explained, these two features alone are sufficient to “render” a short-seller report “inadequate.” Id.
E. Eleventh Circuit Holds YouTube Videos And Other Mass Online Communications Suffice As Solicitations Under Securities Act
In February, the Eleventh Circuit, in Wildes v. BitConnect International PLC, 25 F.4th 1341 (11th Cir. 2022), addressed one of the potential pitfalls in the area of new cybercurrencies, holding that the promotion of an unregistered security in a mass online communication constitutes the ‘solicitation’ of the purchase of such a security for purposes of Section 12 of the Securities Act of 1933.
The plaintiffs in BitConnect International were purchasers of BitConnect coin, a cryptocurrency that was alleged to be a Ponzi scheme. Id. at 1343. To keep the scheme going, investors were incentivized by commissions to promote the coin to others. Id. Some of these “promoters” created extensive online marketing schemes, which included, for instance, thousands of YouTube videos extolling the coin. Id. Plaintiffs sued the promoters under Section 12, alleging they were liable for selling unregistered securities through their online videos. Id. Some of the promoters moved to dismiss, arguing they had not solicited the purchase of unregistered securities because their videos did not “directly communicate” with plaintiffs. Id. at 1344. The district court agreed and dismissed the case. Id.
On appeal, the Eleventh Circuit reversed, reasoning that “nothing in the Securities Act makes a distinction between individually targeted sales efforts and broadly disseminated pitches,” such as those made through podcasts, social media posts, online videos, and web links. Id. at 1345. The court also noted past cases where solicitations were found to have occurred through newspaper advertisements and radio announcements. Id. at 1346. The court concluded that “[a] new means of solicitation is not any less of a solicitation,” so “when the promoters urged people to buy Bitconnect coins in online videos, they solicited the purchases that followed.” Id.
The following Gibson Dunn attorneys assisted in preparing this client update: Craig Varnen, Monica K. Loseman, Brian M. Lutz, Jefferson E. Bell, Shireen Barday, Christopher D. Belelieu, Michael D. Celio, Jennifer L. Conn, Jessica Valenzuela, Lissa Percopo, Mark H. Mixon, Jr., Lindsey Young, Kevin J. White, Timothy Deal, Marc Aaron Takagaki, Rachel Jackson, Mari Vila, Brian Anderson, Jacob Usher Arber, Chris Ayers, Katy Baker, Chase Beauclair, Sam Berman*, Nathalie Gunasekera*, Daniel A. Guttenberg, Ina Kosova, Viola Li, Jenny Lotova, Lydia Lulkin, Adrian Melendez-Cooper, Dana E. Sherman, Hannah Stone, Erin K. Wall, and Sophie White*.
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 members of the Securities Litigation practice group:
Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, mloseman@gibsondunn.com)
Brian M. Lutz – Co-Chair, San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com)
Craig Varnen – Co-Chair, Los Angeles (+1 213-229-7922, cvarnen@gibsondunn.com)
Shireen A. Barday – New York (+1 212-351-2621, sbarday@gibsondunn.com)
Christopher D. Belelieu – New York (+1 212-351-3801, cbelelieu@gibsondunn.com)
Jefferson Bell – New York (+1 212-351-2395, jbell@gibsondunn.com)
Michael D. Celio – Palo Alto (+1 650-849-5326, mcelio@gibsondunn.com)
Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com)
Jennifer L. Conn – New York (+1 212-351-4086, jconn@gibsondunn.com)
Thad A. Davis – San Francisco (+1 415-393-8251, tadavis@gibsondunn.com)
Ethan Dettmer – San Francisco (+1 415-393-8292, edettmer@gibsondunn.com)
Jason J. Mendro – Washington, D.C. (+1 202-887-3726, jmendro@gibsondunn.com)
Alex Mircheff – Los Angeles (+1 213-229-7307, amircheff@gibsondunn.com)
Robert F. Serio – New York (+1 212-351-3917, rserio@gibsondunn.com)
Jessica Valenzuela – Palo Alto (+1 650-849-5282, jvalenzuela@gibsondunn.com)
Robert C. Walters – Dallas (+1 214-698-3114, rwalters@gibsondunn.com)
* Sam Berman, Nathalie Gunasekera, and Sophie White are associates working in the firm’s New York office who currently are not admitted to practice law.
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