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.

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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.

© 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 9, 2022, the U.S. Department of the Treasury (“Treasury”) published Preliminary Guidance on Implementation of a Maritime Services Policy and Related Price Exception for Seaborne Russian Oil (the “Guidance”),[1] taking a step toward implementing the commitment made at the G7 Finance Ministers Meeting on September 2, 2022 to institute a comprehensive prohibition of services that enable maritime transportation of Russian-origin oil and petroleum products unless such oil is purchased below an agreed-upon price cap.[2]  The Guidance outlines the United States’ forthcoming policy and anticipated regulations from Treasury’s Office of Foreign Assets Control (“OFAC”) on the U.S. treatment of services related to the maritime transportation of Russian Federation-origin crude oil and petroleum products (“seaborne Russian oil”).

The mechanisms described in the Guidance will operate quite differently from the way other U.S. sanctions programs have targeted the oil trade and oil producing countries, such as the ‘waiver’ program under the Iran sanctions program whereby certain countries are excepted from sanctions targeting the purchases of Iranian oil if those countries have agreed to eliminate or substantially reduce their consumption of Iranian oil over time.[3]  This forthcoming policy and regulation in the Russia context will create additional sanctions compliance obligations and challenges for companies across many sectors wherever there are services being provided relating to the maritime transportation of oil.

1. Focus of the policy

The policy seeks to establish a framework whereby the provision of services for Russian oil being exported by sea is prohibited unless the oil was purchased below the price cap, with the goal of reducing Russia’s overall revenues from its oil exports while maintaining a reliable supply of seaborne Russian oil to the global market and reducing upward pressure on energy prices.  In the wake of the Ukraine invasion, Russian oil is increasingly transported via maritime tankers as opposed to land-based pipelines, with reported estimates that such tankers carry about 70% of Russian crude oil exports.[4]

The prohibitions will take effect (i) on December 5, 2022 with respect to maritime transportation of crude oil, and (ii) on February 5, 2023 with respect to maritime transportation of petroleum products.

2. Implementation

To implement the policy, OFAC anticipates issuing a determination pursuant to Executive Order 14071,[5] which will prohibit the exportation, re-exportation, sale, or supply, directly or indirectly, from the United States, or by a U.S. person, wherever located, of services related to the maritime transportation of seaborne Russian oil if the oil is purchased above the price cap.

The price cap will be set by a coalition of countries including the G7 and EU. The coalition will conduct a technical exercise to consider a range of factors with a rotating lead coordinator, in order to reach consensus on setting the price cap level. OFAC will issue additional guidance on how the price cap level will be published and updated.

Treasury and the U.S. Government broadly anticipate working with other members of the coalition implementing the maritime services policy to enforce the price cap.

Note, even with the new policy, the United States will continue to prohibit the importation of Russian-origin crude oil, petroleum and petroleum fuels, oils and products of their distillation into the United States, in accordance with Executive Order 14066.[6]

3. Anticipated compliance guiderails

In order to steer clear of a potential OFAC enforcement action, service providers dealing with seaborne Russian oil will need to be able to provide certain evidence that the price cap was not breached in regard to the shipment they are servicing.  The specific evidence and level of diligence required will vary depending on the role the service provider is playing in the supply chain, as noted below.  If the service provider satisfies the applicable requirements, the service provider can avail itself of a “safe harbor” from the ordinarily strict liability of sanctions, in the event of an inadvertent provision of services related to a purchase of seaborne Russian oil above the price cap.  This process, of course, is in addition to standard due diligence procedures a service provider may already be carrying out for sanctions risks.

The Guidance describes the following three tiers of service providers, with examples and recommended evidentiary and diligence best practices. OFAC expects each covered service provider to retain relevant records for five years.

• Tier 1 Actors: service providers who regularly have direct access to price information in the ordinary course of business should retain and share necessary documents showing that seaborne Russian oil was purchased at or below the price cap (“necessary price cap documents”). Examples of Tier 1 Actors include commodities brokers and refiners. Relevant documentation includes invoices, contracts, or receipts/proofs of accounts payable. Recommended risk-based measures to comply with the price cap include updating terms and conditions of contracts.

• Tier 2 Actors: service providers who are sometimes able to request and receive price information from their customers in the ordinary course of business should (i) when practicable, request, retain and share necessary price cap documents or (ii) if not practicable, provide customer attestations in which the customer commits to not purchase seaborne Russian oil above the price cap (“customer price cap attestations”). Examples of Tier 2 Actors include financial institutions. Recommended risk-based measures include providing guidance to trade finance departments, relationship managers and compliance staff.

• Tier 3 Actors: service providers who do not regularly have direct access to price information in the ordinary course of business should obtain and retain customer price cap attestations. Examples of Tier 3 Actors include insurers and protection and indemnity clubs. Insurers may request customer price cap attestations that cover the entire period a policy is in place, rather than requesting separate attestations for each shipment. Recommended risk-based measures include updating policies and terms and conditions.

Companies that make significant purchases of oil above the price cap and knowingly rely on service providers subject to the maritime services policy, or those that knowingly provide false information, documentation, or attestations to a service provider, will have potentially violated the maritime services policy and may be a target for a U.S. sanctions enforcement action.

4. Red flags to identify evasive or violating transactions

U.S. companies and banks are required to reject transactions that violate or seek to evade the maritime services policy and price cap, and report any such a transaction to OFAC. The Guidance provides the following red flags which service providers should consider:

• Evidence of deceptive shipping practices: The Treasury, U.S. Department of State and U.S. Coast Guard issued a global advisory in 2020 to alert the maritime industry to deceptive shipping practices used to evade sanctions (the “2020 Maritime Sanctions Advisory”).[7] The indicators included in the 2020 Maritime Sanctions Advisory, such as falsifying cargo and vessel documents and complex ownership / management, are also relevant for the Russia oil price cap. Recommended business practices to address such red flags include institutionalizing sanctions compliance programs, adopting know-your-customer practices and exercising supply chain due diligence. Please consult the 2020 Maritime Sanctions Advisory for more information.

• Refusal or reluctance to provide requested price information: A customer’s refusal or reluctance to provide the necessary documentation or attestation, as well as requests for exceptions to established practice, may indicate that they have purchased seaborne Russian oil above the price caps.

• Unusually favorable payment terms, inflated costs or insistence on using circuitous or opaque payment mechanisms: Seaborne Russian oil purchased so far below the price cap as to be economically non-viable for the Russian exporter or excessively high service costs may be indicators the purchaser has made a back-end arrangement to evade the price cap. Attempts to use opaque payment mechanisms may also indicate that the counterparty is avoiding creating payment documentation.

• Indications of manipulated shipping documentation, such as discrepancies of cargo type, voyage numbers, weights or quantities, serial numbers, shipment dates: Any indication of manipulated shipping documentation may be a red flag which should be fully investigated before providing services.

• Newly formed companies or intermediaries, especially if registered in high-risk jurisdictions: Firms should exercise appropriate due diligence when providing services to new counterparties, particularly if such entities were recently formed or registered in high-risk jurisdictions and do not have a demonstrated history of legitimate business.

• Abnormal shipping routes: Using shipping routes or transshipment points that are abnormal for shipping seaborne Russian oil to the intended destination may indicate attempts to conceal the true history of an oil shipment in violation of the price cap.

We will continue to closely monitor developments in this area, and will provide a more detailed analysis when OFAC publishes the forthcoming determination implementing this policy.

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[1] Preliminary Guidance on Implementation of a Maritime Services Policy and Related Price Exception for Seaborne Russian Oil, published by the U.S. Department of the Treasury (Sept. 9, 2022), https://home.treasury.gov/system/files/126/cap_guidance_20220909.pdf.

[2] See “G7 Finance Ministers´ Statement on the united response to Russia´s war of aggression against Ukraine,” Sept. 2, 2022, https://www.bundesfinanzministerium.de/Content/EN/Downloads/G7-G20/2022-09-02-g7-ministers-statement.pdf?__blob=publicationFile&v=7.

[3] See our prior publication, “Iran Sanctions 2.0: The Trump Administration Completes Its Abandonment of the Iran Nuclear Agreement,” Nov. 9, 2018, https://www.gibsondunn.com/iran-sanctions-2-0-the-trump-administration-completes-abandonment-of-iran-nuclear-agreement/#_ftn28.

[4] “The story behind the proposed price cap on Russian oil,” D. Wessel, Brookings (July 5, 2022).

[5] Executive Order 14071, 87 Fed. Reg. 20999 (Apr. 6, 2022), https://home.treasury.gov/system/files/126/14071.pdf.

[6] Executive Order 14066, 87 Fed. Reg. 13625 (Mar. 8, 2022), https://home.treasury.gov/system/files/126/eo_14066.pdf.

[7] Sanctions Advisory for the Maritime Industry, Energy and Metals Sectors, and Related Communities, published by the U.S. Department of the Treasury, U.S. Department of State and U.S. Coast Guard (May 14, 2020), https://home.treasury.gov/system/files/126/05142020_global_advisory_v1.pdf.

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The following Gibson Dunn lawyers prepared this client alert: Felicia Chen, David A. Wolber, Judith Alison Lee, Stephenie Gosnell Handler, Scott Toussaint and Adam M. Smith.

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)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@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)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@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)
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)
Richard W. Roeder – Munich (+49 89 189 33 115, rroeder@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.

We recently marked the one-year anniversary of the Taliban’s takeover of Afghanistan. Many of you will remember the frantic days between August 15, when the Taliban seized Kabul, and August 31, the date U.S. forces set for their withdrawal. The United States ultimately evacuated approximately 125,000 people from Afghanistan before completing its withdrawal. Unfortunately, many more were unable to evacuate and have been in hiding, on the run, and living in constant fear of Taliban reprisals ever since.

As these events unfolded, a firmwide team of Gibson Dunn attorneys immediately jumped into action. Especially in those early days, we had attorneys and staff across the Firm working day and night to help individuals and families trying to escape Afghanistan and find safety in the United States or elsewhere. Our initial efforts focused on a handful of families with direct connections to the Firm, such as interpreters who had worked with Gibson Dunn attorneys who previously served in the U.S. military. However, what began as a very personal mission to help several families at risk of Taliban violence quickly evolved into something much bigger.

Over the last year, our attorneys have worked alongside our nonprofit and corporate partners to help Afghans seeking to flee Afghanistan, as well as those who already had traveled to the UK, the United States, and elsewhere. Since August 2021, the firmwide Afghanistan Task Force has grown to well over 200 attorneys who collectively have devoted more than 11,000 pro bono hours to the mission—work valued at approximately $10 million. If you’d like to learn more about the Firm’s work on behalf of hundreds of Afghan clients, please watch a short video found here.

View Newsletter

On September 15, 2022, the President issued the first Executive Order (“E.O.”) in the nearly 50-year history of the interagency Committee on Foreign Investment in the United States (“CFIUS” or the “Committee”) to provide explicit guidance for CFIUS in conducting national security reviews of covered transactions.[1]  The E.O. does not legally alter CFIUS processes or legal jurisdiction, but rather elaborates on certain existing factors that the Committee is mandated by statute to consider,[2] and adds further national security factors for the Committee to consider, when it is evaluating transactions.  The E.O. comes as the U.S. Government is increasingly focused on strategic competition—particularly regarding the national security implications of critical technologies, critical infrastructure, and sensitive personal data—and builds on the expansive CFIUS authorities codified in the Foreign Investment Risk Review Modernization Act of 2018 and implementing regulations.[3]  Importantly, the E.O. continues the momentum established with recent legislation enacted by Congress,[4] as well as other Biden administration initiatives,[5] and comes in the midst of broader discussions about regulating both inbound and outbound technology transfers.  This E.O. plays an important role in the U.S. Government approach to achieving national security objectives in protecting U.S. technological competitiveness and curbing U.S. reliance on foreign supply chains involving critical technologies.

Specifically, the E.O. directs CFIUS to consider the following five factors:

• The resilience of critical U.S. supply chains that may have national security implications, including those outside of the defense industrial base;
• U.S. technological leadership in areas affecting U.S. national security, including but not limited to microelectronics, artificial intelligence, biotechnology and biomanufacturing, quantum computing, advanced clean energy, and climate adaptation technologies;
• Aggregate industry investment trends that may have consequences for a given transaction’s impact on U.S. national security;
• Cybersecurity risks that threaten to impair national security; and
• Risks to U.S. persons’ sensitive data.

We discuss each of these five factors and their impact on the CFIUS process in turn below, as well as the common concern relating to third-party ties highlighted by the E.O. in each of these factors.

The Resilience of Critical U.S. Supply Chains

With respect to the first factor, the E.O. directs CFIUS to consider supply chain resiliency, inside and outside the defense sector, and whether a transaction could pose a threat of future supply disruptions of goods and services critical to the United States.  Specific elements the Committee should consider are whether a supply chain is sufficiently diversified with alternative suppliers including in allied and partner countries, the concentration of ownership or control in the supply chain by the foreign investor, and whether the U.S. party to the transaction supplies to the U.S. Government.

U.S. Technological Leadership

The second factor focuses CFIUS’ attention on a transaction’s potential effect on U.S. leadership in certain critical sectors that are fundamental to national security, including microelectronics, artificial intelligence, biotechnology and biomanufacturing, quantum computing, advanced clean energy and climate adaptation technologies.  Not surprisingly, the specific technologies identified in this E.O. align with the most recent list of Critical and Emerging Technologies (“CET”) published by the U.S. National Science and Technology Council,[6] in line with the U.S. Government’s overall focus on protecting and developing these technologies.  Along these lines, part of the CFIUS review of this factor will need to include not only the current state of the U.S. business and technology being acquired, but also now whether the transaction could reasonably result in future advancements and applications in technology that could undermine U.S. national security, according to the E.O.

Consideration of Aggregate Industry Trends

The third factor—directing CFIUS to consider the consequences of industry investment trends on a particular transaction’s national security impact—grants the Committee express authority to block a transaction even where the covered transaction itself might not constitute a national security risk.  In other words, the assessed national security risk of a covered transaction, standing alone, could be low when viewed on a case-by-case basis.  But, under this Presidential direction, CFIUS would also consider broader industry trends, such as whether a specific foreign actor is acquiring or investing in multiple companies in a sector that, in the aggregate, could impact U.S. national security.  This factor has significant disruptive potential for deal certainty given that it formally broadens CFIUS review beyond the specific facts of the transaction itself, and we assess this factor and the next (discussed below) to be among the most significant in the E.O. in terms of impact on the CFIUS process.

Cybersecurity Risks

Building on President Biden’s E.O. on “Improving the Nation’s Cybersecurity,”[7] the fourth factor instructs the Committee to consider whether a covered transaction may provide a foreign person or their third-party ties with access and ability to conduct cyber intrusions or other malicious cyber activity.  CFIUS’ interest in cybersecurity risks is longstanding; however, this factor appears to give more weight to the growing risk of supply chain compromise that threaten broader national security.  This makes sense given the context of the devastating SolarWinds Sunburst attack, in which a malicious nation-state actor leveraged unauthorized access to build a backdoor into a software update for a widely used network monitoring and management software.  This backdoor was then used to gain unprecedented access to networks, systems, and data of thousands of organizations—including the U.S. Government.  While critical technologies are a well-recognized priority of CFIUS, this factor appears to direct increased attention to technologies that would not necessarily be considered emerging or foundational, but are core to business operations in a manner that could have national security implications should they be compromised by a malicious actor.  We therefore anticipate that CFIUS will look more closely at transactions involving the acquisition of basic management systems or software used across key industries and critical sectors, with an emphasis on transactions that may provide a foreign person or their third-party ties with the ability to leverage these systems or software to breach supply chains in those industries and/or sectors.

Access to U.S. Persons’ Sensitive Data

The fifth and final factor in the E.O. directs CFIUS to consider whether a covered transaction involves a U.S. business with access to U.S. persons’ sensitive data, and whether the foreign investor has, or the foreign investor’s ties have, the ability to exploit that data through commercial or other means to the detriment of U.S. national security.  This factor reflects longstanding CFIUS concerns over access to sensitive personal data, and specifically recognizes that the transfer to foreign persons of large data sets can enable foreign persons or countries to conduct surveillance, tracing, tracking, and targeting of U.S. individuals or groups.

A Consistent Theme: National Security Concerns of Third Party Ties

Throughout all five factors, the E.O. directs that CFIUS should be scrutinizing transactions that involve foreign persons with any “third-party ties” which could add to the potential threat to U.S. national security, be it through providing those third parties access to critical technology or the opportunity to disrupt supply chains, engage in malicious cyber activity or misuse U.S. personal data.  While no specific third-party ties are identified as riskier than others, it would be no surprise if in the current geopolitical environment ties involving Russia, China and other U.S. strategic competitors would be targeted for enhanced review.

Key Takeaways

In sum, while this is the first-ever E.O. providing guidance concerning the CFIUS review process, most of the direction builds upon the existing policy trendlines of the U.S. Government and the increasing concerns surrounding the national security implications of foreign investments in and acquisitions of U.S. businesses.  It is no surprise that advanced technologies, cybersecurity risks, supply chains, and sensitive data remain at the forefront of national security considerations, but this E.O. directs the CFIUS’s national security risk analysis in a way that, as a practical matter, will continue to expand the Committee’s review authority.  It is also being released amidst a series of efforts on the legislative and regulatory fronts to improve the competitiveness and resilience of U.S. technology, including discussions of additional Presidential directives concerning outbound technology transfers and capital, as well as enhanced protections of sensitive personal data.  Given this breadth based on the five factors elucidated in the E.O., combined with the Biden administration’s goals of prioritizing U.S. competitiveness in certain critical technology sectors, we expect that the number of transactions reviewed by the Committee will continue to grow.  Prior to engaging in any M&A activity or investments involving U.S. businesses operating within the sectors implicated by the factors outlined in this week’s E.O., transaction parties should carefully assess the likelihood of CFIUS review and the potential need to file a notice or declaration.

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[1] Executive Order on Ensuring Robust Consideration of Evolving National Security Risks by the Committee on Foreign Investment in the United States (Sept. 15, 2022), available at https://www.whitehouse.gov/briefing-room/presidential-actions/2022/09/15/executive-order-on-ensuring-robust-consideration-of-evolving-national-security-risks-by-the-committee-on-foreign-investment-in-the-united-states/.

[2] See Section 721(f) of the Defense Production Act of 1950, 50 U.S.C. § 4565(f).

[3] Foreign Investment Risk Review Modernization Act of 2018, Pub. L. No. 115-232 (2018); 31 C.F.R. Parts 800 to 802.

[4] The CHIPS and Science Act of 2022, recently signed into law by President Biden, is intended to “ensure the United States maintains and advances its scientific and technological edge,” by “boost[ing] American semiconductor research, development, and production”—”technology that forms the foundation of everything from automobiles to household appliances to defense systems.” The White House, FACT SHEET: CHIPS and Science Act Will Lower Costs, Create Jobs, Strengthen Supply Chains, and Counter China (Aug. 9, 2022), available at

https://www.whitehouse.gov/briefing-room/statements-releases/2022/08/09/fact-sheet-chips-and-science-act-will-lower-costs-create-jobs-strengthen-supply-chains-and-counter-china/.

[5] On September 14, 2022, President Biden announced that the U.S. will invest $40 billion to expand biomanufacturing for key materials needed to produce essential medications, as well as develop and cultivate healthy supply chains to support the advanced development of bio-based materials, such as fuels, fire-resistant composites, polymers and resins, and protective materials. The White House, FACT SHEET: The United States Announces New Investments and Resources to Advance President Biden’s National Biotechnology and Biomanufacturing Initiative (Sept. 14, 2022), available at https://www.whitehouse.gov/briefing-room/statements-releases/2022/09/14/fact-sheet-the-united-states-announces-new-investments-and-resources-to-advance-president-bidens-national-biotechnology-and-biomanufacturing-initiative/.

[6] National Science and Technology Council, Critical and Emerging Technologies Update List (Feb. 2022), available at https://www.whitehouse.gov/wp-content/uploads/2022/02/02-2022-Critical-and-Emerging-Technologies-List-Update.pdf.

[7] Executive Order on Improving the Nation’s Cybersecurity (May 2021), available at https://www.whitehouse.gov/briefing-room/presidential-actions/2021/05/12/executive-order-on-improving-the-nations-cybersecurity/.

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The following Gibson Dunn lawyers prepared this client alert: Stephenie Gosnell Handler, David A. Wolber, Annie Motto, Scott Toussaint, and Claire Yi.

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)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@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)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@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)
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)
Richard W. Roeder – Munich (+49 89 189 33 115, rroeder@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 the current environment, public companies may find it more challenging to raise capital through traditional public offerings. Despite market volatility, private placements of various securities afford issuers the opportunity to support liquidity and bridge valuation gaps. These private investment in public equity deals (PIPEs) offer a quick, bespoke and discrete option in capital raising. The securities issued in PIPEs, such as common stock, preferred stock and convertible notes, can be easily tailored to the goals and risks of both the issuer and the investors. Please join our panel as they discuss current developments in private investment in PIPEs, including deal structures, legal considerations, business and governance terms, and special regulatory requirements as a result of the recent market volatility.

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PANELISTS:

Hillary Holmes is a partner in the Houston office of Gibson, Dunn & Crutcher, Co-Chair of the firm’s Capital Markets Practice Group, and a member of the firm’s Securities Regulation and Corporate Governance, Energy, M&A and ESG Practice Groups. Ms. Holmes’ practice focuses on capital markets, securities regulation, corporate governance and ESG counseling. She is Band 1 ranked by Chambers USA in capital markets for the energy industry and a recognized leader in Energy Transactions nationwide. Ms. Holmes represents issuers and underwriters in all forms of capital raising transactions, including sustainable financings, IPOs, registered offerings of debt or equity, private placements, and structured investments. Ms. Holmes also frequently advises companies, boards of directors, special committees and financial advisors in M&A transactions, conflicts of interest and special situations.

Eric Scarazzo is a partner in Gibson Dunn’s New York office. He is a member of the firm’s Capital Markets, Securities Regulation and Corporate Governance, Energy, M&A and Global Finance Practice Groups. As a key member of the capital markets practice, Mr. Scarazzo is involved in some of the firm’s most complicated and high-profile securities transactions. Additionally, he has been a certified public accountant for over 20 years. His deep familiarity with both securities and accounting matters permits Mr. Scarazzo to play an indispensable role supporting practice groups and offices throughout the firm. He provides critical guidance to clients navigating the intersection of legal and accounting matters, principally as they relate to capital markets financings and M&A disclosure obligations.

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MCLE CREDIT INFORMATION:

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.0 credit hour, of which 1.0 credit hour may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit.

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

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

In a major development on 13 September 2022, the UAE Ministry of Justice called upon the Dubai Courts to enforce judgments of the English Courts in the UAE going forward, based on principles of reciprocity.

The English Courts were historically reluctant to enforce UAE-issued judgments; and the UAE courts had for decades used the lack of reciprocity as a bar to the enforcement of English judgments. The English High Court’s recent decision in Lenkor Energy Trading DMCC v Puri (2020) EWHC 75 (QB) was a welcome development. In that seminal case, which was upheld on appeal, the High Court enforced a ‘bounced cheque’ judgment of the Dubai Court of Cassation. The High Court and Court of Appeal both ruled that the Dubai judgment was a final and conclusive judgment of a court of competent jurisdiction, which did not offend English public policy.

Days ago, on 13 September 2022, the UAE Ministry of Justice issued an official communication to the Dubai Courts, confirming that the Lenkor decision “constitutes a legal precedent and a principle binding on all English Courts according to their judicial system”.

In an unprecedented move, the UAE Ministry of Justice therefore asked the Dubai Courts to:

“take the relevant legal actions regarding any requests for enforcement of judgments and orders issued by the English Court, in accordance with the laws in force in both countries, as a confirmation of the principle of reciprocity initiated by the English Courts and assurance of its continuity between the English Courts and the UAE Courts.”

This important development provides confidence for creditors looking to enforce English Court judgments in the UAE. It is an encouraging development in terms of the ongoing judicial cooperation between the English and Dubai courts.

It also opens additional avenues for the enforcement of arbitral awards. Creditors of London-seated arbitral awards may now consider proceeding directly to the Dubai courts after enforcing their awards at the seat of arbitration under s. 66 of the Arbitration Act. This is a useful alternative to the traditional path of asking the Dubai Courts to recognise and enforce arbitral awards under the New York Convention, which has produced mixed results. It is also an alternative to the to the well-trodden path of using the (award creditor-friendly) DIFC Courts as a gateway to the enforcement of London-seated arbitral awards in Dubai and beyond.

The context: no applicable enforcement and recognition treaties between the UK and the UAE

There is no bilateral treaty between the UAE and the UK for the reciprocal recognition and enforcement of judgments (other than the Treaty between the UK and the UAE on Judicial Assistance in Civil and Commercial Matters, which lacks an enforcement mechanism, and the memoranda of understanding issued by the Courts of the DIFC and the ADGM).

In the absence of a treaty, judgment creditors must bring a claim to enforce a UAE judgment in England and Wales under common law. Under the common law test, the English court must be satisfied that the relevant UAE court: (i) had original jurisdiction to render its judgment; (ii) issued a final and conclusive judgment; and (iii) issued a judgment for a definite and calculable sum. If that is proven, then there are only limited defences available to a judgment debtor – chief amongst which is that enforcement of the foreign judgment would contravene English public policy.

Likewise, in the absence of a bilateral enforcement treaty, the UAE Courts will only enforce foreign judgments “under the same conditions laid down in the jurisdiction issuing the order”—in other words, when reciprocity exists with the issuing jurisdiction. This is set out in Article 85 of Cabinet Resolution No. 57 of 2018 concerning the Executive Regulations of Federal Law No. 11 of 1992 (as amended). Prior to the Lenkor decision, the English Courts were not in the practice of readily enforcing Dubai Court judgments; and the UAE courts had treated this lack of reciprocity as a bar to enforcement.

The Lenkor decision: a landmark decision of the English court to enforce a judgment of the UAE court

The English High Court enforced a ‘bounced cheque’ judgment from the Dubai court in Lenkor.

Mr Puri, a UK citizen, was the principal and controller of IPC Dubai. He had signed two security cheques in favour of Lenkor on IPC’s behalf. Lenkor and IPC then fell into dispute. Lenkor prevailed in an arbitration against IPC, and when IPC failed to satisfy the resulting arbitral award, Lenkor attempted to cash the cheques. When the cheques bounced, Lenkor brought Dubai court proceedings against Mr Puri personally.

The Dubai courts—including the final appellate court, the Dubai Court of Cassation—found that Mr Puri had contravened Article 599/2 of the UAE Commercial Transactions Law (UAE Federal Law No. 18 of 1993). Under that provision, the person who draws a cheque is deemed personally liable for the amount of the cheque; and a cheque may not be issued unless the drawer has, at the time of drawing the cheque, sufficient funds to meet it. The Dubai Court of First Instance entered judgment against Mr Puri for an AED equivalent of about USD 33.5 million, plus 9% interest per annum. This was upheld on multiple rounds of appeal, including ultimately by the Dubai Court of Cassation.

Mr Puri challenged the enforcement of the Dubai judgment in the English Courts. He argued that the judgment offended English public policy, on the bases that: (i) the underlying transaction between IPC and Lenkor was tainted by illegality; (ii) unlike Dubai law, English would not find Mr Puri personally liable for IPC’s debt and would not permit the piercing of the corporate veil; and (iii) the 9% interest awarded was unduly high and an unenforceable penalty.

The English High Court dismissed these arguments, because: (i) the question was whether the UAE Court’s judgment offended public policy, not the underlying transaction; (ii) the finding of Mr Puri’s personal liability was a question of Dubai law; and (iii) the interest rate awarded was not unduly high or an unenforceable penalty.

The English Court of Appeal upheld the decision on appeal in Lenkor Energy Trading DMCC v Puri [2021] EWCA Civ 770.

The 13 September 2022 direction from the UAE Ministry of Justice

The Lenkor decision is seminal in that it has demonstrated reciprocity between the UAE and the UK—certainly from the perspective of the UAE Ministry of Justice. The 13 September 2022 communication, issued from Judge Abdul Rahman Murad Al-Blooshi, Director of International Cooperation Department of the Ministry of Justice, to His Excellency Tarish Eid Al-Mansoori, Director General of the Dubai Courts, confirms (in an unofficial translation) that:

“…based on the Treaty between the United Kingdom of Great Britain and Northern Ireland and the United Arab Emirates on Judicial Assistance in Civil and Commercial Matters, and the desire to strengthen fruitful cooperation in the legal and judicial field;

Whereas, the aforementioned Treaty does not provide for enforcement of foreign judgments, and states that the judgments should be enforced according to the relevant applicable mechanism set forth in the local laws of both countries;

Whereas, Article (85) of the Executive Regulation of the Civil Procedures Law, as amended in 2020, stipulates that judgments and orders issued in a foreign country may be enforced in the State under the same conditions prescribed in the law of that country, and the legislator does not require an agreement for judicial cooperation to enforce foreign judgments, and such judgments may be enforced in the State according to the principle of reciprocity; and

Whereas, the principle has been considered by the English Courts upon previous enforcement of a judgment issued by Dubai Courts by virtue of a final judgment issued by the High Court of the United Kingdom in Lenkor Energy Trading DMCC v Puri (2020) EWHC 75 (QB), which constitutes a legal precedent and a principle binding on all English Courts according to their judicial system,

Therefore, we kindly request you to take the relevant legal actions regarding any requests for enforcement of judgments and orders issued by the English Court, in accordance with the laws in force in both countries, as a confirmation of the principle of reciprocity initiated by the English Courts and assurance of its continuity between the English Courts and the UAE Courts.”

The Arabic original is available below:

Closing comment

This development provides confidence for creditors looking to enforce English Court judgments in the UAE. It also opens additional avenues for arbitral award creditors to proceed directly to the Dubai courts once a London-seated award has been enforced at the seat of arbitration (as an alternative to the standard New York Convention route or the use of the DIFC Courts as a gateway). It remains to be seen whether the courts of Abu Dhabi will adopt a similar view. Either way, this is an important development given the close trade links between the UAE and the UK, and it demonstrates a pro-enforcement stance from the UAE Ministry of Justice, which is welcome news.

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The following Gibson Dunn lawyers assisted in the preparation of this client update: Penny Madden KC and Nooree Moola.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s International Arbitration, Judgment and Arbitral Award Enforcement or Transnational Litigation practice groups, or any of the following practice leaders and members:

Cyrus Benson – London (+44 (0) 20 7071 4239, CBenson@gibsondunn.com)
Penny Madden KC – London (+44 (0) 20 7071 4226, PMadden@gibsondunn.com)
Jeff Sullivan KC – London (+44 (0) 20 7071 4231, Jeffrey.Sullivan@gibsondunn.com)
Nooree Moola – Dubai (+971 (0) 4 318 4643, nmoola@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.

The European Commission (the “EC”) is expected to announce a proposal shortly that will ban products made using forced labour. The move follows a public consultation earlier this year by the EC seeking public opinion on an initiative “to keep the EU market free from products made, extracted or harvested with forced labour, whether they are made in the EU or elsewhere in the world.”[1] The proposal could have a significant impact on corporates’ supply chain management and approach to human rights due diligence; areas which are already under close scrutiny by the EU.

While the EU’s proposal has not yet been released, several media outlets report to have seen an EU document which states that a ban should apply to products (including their components) for which forced labour has been used at any stage of production, manufacture, harvest or extraction, including working or processing.

The proposed prohibition is also expected to apply regardless of the origin of the products, whether they are domestic or imported, or placed or made available on the EU market or exported outside of the EU.

It is understood that each EU member state will be responsible for detection and enforcement and that national authorities will be tasked with proving that relevant products were made or processed using forced labour. At least one report suggests that a database of forced labour risk in specific geographic areas or specific products made with forced labour imposed by state authorities will be set up and made available to the public as part of implementation.

A step further than the U.S.

The enactment of the Uyghur Forced Labor Prevention Act (the “UFLPA”) on 21 June, 2022, introduced a presumptive ban on all imports to the U.S. from China’s Xinjiang Uyghur Autonomous Region (the “XUAR”) and from certain entities designated by the U.S. Department Homeland Security Customs and Border Protection. The UFLPA’s presumptive ban modified Section 307 of the U.S. Tariff Act of 1930, which generally bans the importation of any products mined, produced or manufactured wholly or in part by forced or indentured child labour.

While the EU will follow the U.S. in legislating to end forced labour practices, it appears that the geographic scope of the EU proposal will be broader than current U.S. law, because it also applies internally to products made within the EU.

Next steps

Details of the proposal will need to be addressed with lawmakers and EU countries, but the intended prohibition looks set to be sweeping and significant. We will monitor these developments and provide further details as the draft law evolves.

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[1] https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/13480-Effectively-banning-products-produced-extracted-or-harvested-with-forced-labour_en

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The following Gibson Dunn lawyers prepared this client alert: Susy Bullock, Perlette Jura, Christopher Timura, Sean J. Brennan*, and Rebecca McGrath.

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 Environmental, Social and Governance (ESG) or International Trade practice groups:

Environmental, Social and Governance (ESG) Group:
Susy Bullock – London (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Perlette M. Jura – Los Angeles (+1 213-229-7121, pjura@gibsondunn.com)
Ronald Kirk – Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Michael K. Murphy – Washington, D.C. (+1 202-955-8238, mmurphy@gibsondunn.com)
Selina S. Sagayam – London (+44 (0) 20 7071 4263, ssagayam@gibsondunn.com)
Rebecca McGrath – London (+44 (0) 20 7071 4219, rmcgrath@gibsondunn.com)

International Trade 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)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@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)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@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)
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)
Richard W. Roeder – Munich (+49 89 189 33 115, rroeder@gibsondunn.com)

* Sean Brennan is an associate working in the firm’s Washington, D.C. office who currently is admitted only in New York.

© 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.

Following the settlement of an Attorney General enforcement action, defendants often face new and expensive private lawsuits for the same conduct. These subsequent private lawsuits often result in years of additional litigation, legal fees, and further monetary penalties and damages.  Due to the likelihood of follow-on suits, we suggest clients consider taking several proactive and strategic steps when structuring a settlement with the California Attorney General in order to mitigate the risk of subsequent civil lawsuits and associated penalties.

The following strategic considerations provide a general framework to consider in maximizing the possibility of barring subsequent lawsuits: (1) taking steps to negotiate which statute will be used in the complaint accompanying the consent judgment;  (2) including a broad statement of facts in the settlement agreement and complaint; and (3) structuring and characterizing any settlement payment with a preclusion strategy in mind.  Though courts in California ultimately engage in a case-specific inquiry as to whether private litigants’ claims are barred by prior settlement of a government action, all of these factors influence the likelihood of a successful claim preclusion defense, and have important underlying strategic advantages.[1]

Statutes Underlying the Government Enforcement Action

The statutes underlying the California Attorney General’s enforcement action, and identified in the settlement agreement, impact the likelihood of success of a future res judicata defense in subsequent private litigation.  If the statute underlying the Attorney General’s action provides a private right of action, subsequent private litigation redressing individual harms is unlikely to be barred.  For example, in CS Wang & Assoc. v. Wells Fargo Bank, N.A., the California Attorney General brought an enforcement action under the California Unfair Competition Laws (“UCL”) asserting claims through the California Invasion of Privacy Act (“CIPA”).  The government action sought to protect the public from unfair and harmful business practices resulting from Wells Fargo’s alleged failure to disclose the recording of communications with California residents.[2]  Despite the fact that the enforcement action sought to redress public harm, CIPA created a private right of action which allowed a subsequent class action to move forward.  The inability to bar the private litigation hinged on CIPA’s dual enforcement mechanism – the explicit private right of action within the statute, and the UCL’s authorization to enforce CIPA on behalf of the People.[3]

To the extent possible, settling parties looking to maximize the success of precluding subsequent private suits should attempt to negotiate with the Attorney General regarding the underlying statutory basis for the enforcement action.  Because certain statutes allow both private and public enforcement for the same conduct, it is advantageous to specify statutes that do not contain private rights of action in the settlement agreement in order to encompass potential private plaintiffs’ claims.  Although the private plaintiff may still attempt to recover under different statutes to avoid a res judicata defense, if the prior government action was based on the same primary right asserted by the private party, the subsequent suit is more likely to be precluded.[4]

Broadening the Statement of Facts  

Parties should also consider including a broad and comprehensive statement of facts within the settlement documents in order to cover most or all claims underlying the state’s investigation. The more claims and factual allegations that are encompassed in the settlement with the government, the less likely that a private plaintiff will be able to justify how their claims are sufficiently distinct from the government’s case to withstand dismissal.

Illustratively, in Villalobos, the defendant settled the entirety of an Attorney General enforcement action that alleged poor workplace conditions and wage violations, agreeing to pay an undisclosed amount in restitution to cover all claims related to the unlawful employment practices.  In precluding the subsequent private litigation, the court noted that the government action and settlement broadly addressed the terms of employment and work conditions that gave rise to the plaintiffs’ new claims, despite the lack of factual specificity in the settlement and government complaint.  The expansive coverage of the settlement precluded the private litigants’ lawsuit because the prior action ultimately encompassed the plaintiffs’ claims.[5]

This approach is not risk-free even in the context of no-admit settlements.  For example, a broader statements of facts makes public, and puts potential follow-on plaintiffs on notice of, more factual allegations than necessary to effectuate the settlement.  These risks should be weighed against the cost of potential follow-on private litigation due to narrow admissions that do not cover the private litigant’s claims.

Paying Restitution rather than Civil Penalties  

In structuring a settlement with the California Attorney General, and in cases where a settlement includes monetary payment, it is generally preferable that the payment be in the form of restitution, rather than civil penalties.  In assessing the preclusive effect of a settlement reached by the state, the court pays particular attention to the specific terms of the agreement and the types of relief obtained on behalf of consumers.  Courts in California look at whether or not the government properly represented a private litigant’s interests in a prior action, and in that analysis courts consider the type of relief sought by the government.[6]  Courts have found that in instances where the Attorney General seeks predominantly injunctive relief and civil penalties, the government action serves a law enforcement function to protect the public, rather than to vindicate the rights of private plaintiffs.[7]  In such instances, a res judicata defense fails because the interests of the government and private plaintiff differ.[8]

On the other hand, when a settlement involves paying restitution and the restitution constitutes all or most of the monetary relief specified in the settlement agreement, courts are more likely to find an identity of interests between the government and private plaintiffs.  However, the private plaintiffs in the subsequent litigation must fall within the class of restitution recipients as defined by the government action and settlement.  The settling defendant should define the class of restitution recipients as broadly as possible to encompass future private plaintiffs, risking a greater payment to the government but potentially precluding future private lawsuits.  For example, in Villalobos, the court barred a private lawsuit following an enforcement action partly because the Attorney General dedicated monetary relief solely to restitution and the plaintiffs fell within the class of recipients.[9]  The government recovered restitution on behalf of all Calandri Sonrise Farm workers, and the private plaintiffs were eligible for such relief because of their employment at Calandri.  Because the government exclusively sought restitution, the court found that government represented the private plaintiffs’ interests since the Attorney General enforcement action compensated the plaintiffs for their alleged harms.

To the extent possible, a settling defendant should negotiate restitution that encompasses potential plaintiffs over other types of relief when settling with the Attorney General to optimize the success of a future claim preclusion defense.  Where restitution constitutes a small portion of the overall monetary settlement, courts are less likely to find that the government represented the private litigants’ interests, whereas paying out more in restitution strengthens such a finding.[10]  Thus, there is a tension between the instinct to limit the settlement amount and paying out more to the government to bar future claims.  That said, if civil penalties cannot be avoided, a settling defendant should ensure that restitution relief is clearly delineated and remains a large part of the settlement to tip the scale toward the government representing the private plaintiff’s interests.

Conclusion

In order to mitigate the potential risk of costly follow-on litigation after the settlement of an Attorney General enforcement action, it is important for a party to consider structuring a government settlement with an eye toward strategic factors that can impact future preclusion arguments.  Engaging in negotiations with the Attorney General regarding the statute underlying the government’s complaint, structuring the settlement to encompass potential private claims through a broad statement of facts, and pushing to pay restitution rather than injunctive relief or civil penalties, all bolster the efficacy of a future res judicata defense.  Though such strategies may potentially increase the degree of factual disclosure and ultimate payout in settling government claims, the ability to preclude private litigation may very will lead to overall cost savings in the long term.

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   [1]   The California Attorney General often carves-out private litigation and private rights of action from the release of liability provision in a settlement.  For example, in a recent settlement between the California Attorney General and Dermatology Industry Inc., the release of liability provision specifically excluded “any liability which any … Released Part[y] has or may have to individual consumers.”  Stipulation for Entry of Final J. and Permanent Inj., Ex. 1, at 10-11, People v. Dermatology Indus., Inc., No. 37-2022-00009826-CU-MC-CTL (Cal. Super. Ct. 2022).  Though this language may leave open the possibility for private follow-on litigation, it is not dispositive.  Courts ultimately assess the claim preclusive effect of a government action through a three-part test: whether there is (1) the same cause of action; (2) final judgment on the merits; and (3) privity between the parties. Boeken v. Philip Morris USA, Inc., 48 Cal. 4th 788, 797 (2010).

   [2]   No. 16-C-11223, 2020 WL 5297045, at *6, *9 (N.D. Ill. Sept. 4, 2020).

   [3]   See id. at *9.

   [4]   See Villalobos v. Calandri Sonrise Farms LP, No. CV 12-2615, 2012 WL 12886832, at *7 (C.D. Cal. Sept. 11, 2012) (barring a plaintiffs’ lawsuit for asserting injuries already redressed in a prior Attorney General enforcement action despite raising claims under different statutes).

   [5]   See id. at *5.

   [6] It may also be helpful to include a provision in the agreement to demonstrate that the Attorney General provided adequate representation to the citizens it purported to represent.  See Taylor v. Sturgell, 128 S. Ct. 2161, 2176 (2008) (“[a] party’s representation of a nonparty is ‘adequate’ for preclusion purposes only if, at a minimum: (1) the interests of the nonparty and her representative are aligned, and (2) either the party understood herself to be acting in a representative capacity or the original court took care to protect the nonparty’s interests”).  This can be demonstrated by noting that the Attorney General received some preliminary discovery sufficient to assess the adequacy of any proposed relief.

   [7]   See Payne v. Nat’l Collection Sys. Inc., 91 Cal. App. 4th 1037, 1045 (2001).

   [8]   See People v. Pac. Land Rsch. Co., 20 Cal. 3d 10, 17 (1977).

   [9]   2012 WL 12886832, at *2, *7.

  [10]   See id.; cf. CS Wang & Assoc. v. Wells Fargo Bank, N.A., No. 16-C-11223, 2020 WL 5297045, at *6 (N.D. Ill. Sept. 4, 2020) (rejecting cy pres restitution as an indication of privity because it “constituted a small portion” of the overall settlement).

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The following Gibson Dunn lawyers assisted in preparing this client update: Winston Chan, Charles Stevens, and Justine Kentla.

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 any of the following members of the firm’s White Collar Defense and Investigations practice group in California:

Los Angeles
Nicola T. Hanna (+1 213-229-7269, nhanna@gibsondunn.com)
Debra Wong Yang (+1 213-229-7472, dwongyang@gibsondunn.com)
Marcellus McRae (+1 213-229-7675, mmcrae@gibsondunn.com)
Michael M. Farhang (+1 213-229-7005, mfarhang@gibsondunn.com)
Douglas Fuchs (+1 213-229-7605, dfuchs@gibsondunn.com)
Eric D. Vandevelde (+1 213-229-7186, evandevelde@gibsondunn.com)

Palo Alto
Benjamin B. Wagner (+1 650-849-5395, bwagner@gibsondunn.com)

San Francisco
Winston Y. Chan (+1 415-393-8362, wchan@gibsondunn.com)
Thad A. Davis (+1 415-393-8251, tadavis@gibsondunn.com)
Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com)
Michael Li-Ming Wong (+1 415-393-8234, mwong@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.

Gibson Dunn’s D.C. Circuit Foreign Sovereign Immunities Act Enforcement Update summarizes recent decisions within the D.C. Circuit that are relevant to the enforcement of judgments and arbitral awards against foreign states.

This edition summarizes:

(1) the D.C. Circuit’s decision in Estate of Levin v. Wells Fargo Bank, N.A., Nos. 21-7036, 21-7041, 21-7044, 21-7052, 21-7053, 2022 WL 3364493, addressing the attachment of electronic fund transfers (“EFTs”) by victims of state-sponsored terrorism;

(2) the district court’s decision in Chiejina v. Federal Republic of Nigeria, No. 21-2241, 2022 WL 3646377 (D.D.C.), addressing the proper framework that applies when a foreign state opposes enforcement of an arbitral award by disputing the existence of a valid arbitration agreement between the parties; and

(3) the district court’s decisions in ConocoPhillips Petrozuata B.V. v. Bolivarian Republic of Venezuela, No. 19-0683, 2022 WL 3576193 (D.D.C.) and Tethyan Copper Co. PTY Ltd. v. Islamic Republic of Pakistan, No. 19-2424, 2022 WL 715215 (D.D.C.), addressing the enforcement of arbitral awards issued pursuant to the International Convention on the Settlement of Investment Disputes between States and Nationals of Other States (“ICSID Convention”).

D.C. Circuit Opens The Door For Victims Of Terrorism To Attach Blocked Assets Of State Sponsors Of Terrorism

On August 16, 2022, the D.C. Circuit broke with the Second Circuit and issued a significant decision for victims of terrorism in Estate of Levin v. Wells Fargo Bank, N.A., Nos. 21-7036, 21-7041, 21-7044, 21-7052, 21-7053, 2022 WL 3364493.  Ruling in favor of terrorism victims represented by Matt McGill (argued) and Jessica Wagner of Gibson Dunn, the court unanimously reversed the district court’s dissolution of orders of attachment on nearly $10 million in blocked Iranian funds.  The decision opens the door for victims of terrorism to attach blocked funds of state sponsors of terrorism under the Terrorism Risk Insurance Act (“TRIA”) more generally.

Background

Victims of terrorism often struggle to collect on judgments against state sponsors of terrorism.  Even when those states’ funds surface in U.S. financial institutions and are blocked by sanctions laws, sovereign immunity can place them beyond the reach of judgment creditors.  To address these enforcement challenges, Congress enacted TRIA, codified at 28 U.S.C. §  1610 Note.  This law ensures that when funds of state sponsors of terrorism are blocked by sanctions, those funds remain available for “execution or attachment” by plaintiffs holding judgments against those states—”[n]otwithstanding any other provision of law.”  TRIA, § 201(a).

In order for blocked funds to fall within the protection of TRIA, they must be “blocked assets of” the relevant state or its agency or instrumentality.  TRIA, § 201(a).  The Second Circuit, however, has adopted a narrow view of ownership in the context of EFTs, in which funds move quickly from one account to another through a series of intermediary banks.  Relying on Article 4A of the Uniform Commercial Code (“UCC”), the Second Circuit has held that the only entity with an ownership interest in funds blocked at an intermediary bank is the entity immediately preceding that bank in the chain of electronic transfers—even if the chain of transfers was initiated by a state sponsor of terrorism.  See Doe v. JPMorgan Chase Bank, N.A., 899 F.3d 152 (2d Cir. 2018).  Until Levin, however, the D.C. Circuit had not decided this issue.

In Levin, two groups of terrorism victims—including nearly 90 victims represented by Gibson Dunn (the “Owens victims”)—who hold approximately $1 billion in judgments against the Islamic Republic of Iran obtained writs of attachment against funds blocked at Wells Fargo by the Office of Foreign Assets Control (“OFAC”) during an attempted EFT initiated by an agent of Iran seeking to purchase an oil tanker.  The United States—which had earlier sought forfeiture of the same funds—intervened and moved to quash the writs.  Adopting the Second Circuit’s approach in Doe, the district court granted the government’s motion, holding that the funds were not subject to attachment under TRIA because only the bank immediately preceding Wells Fargo in the chain of transfers held an ownership interest.

Decision

The D.C. Circuit unanimously reversed, rejecting the Second Circuit’s reliance on UCC Article 4A in favor of a broader rule grounded in tracing principles.  The court explained—as Gibson Dunn had argued on behalf of the Owens victims­—that “[w]hile [Article 4A] seeks to minimize disruptions in electronic funds transfers, OFAC’s blocking does the opposite—its purpose is to disrupt terrorist [EFTs].”  Given this mismatch, the court concluded that Article 4A is a poor fit for determining ownership of blocked EFTs.  Instead, the court held that ownership should be determined according to tracing principles: under TRIA, “terrorist victims may attach OFAC blocked electronic funds transfers if those funds can be traced to a terrorist owner,” and “no intermediary or upstream bank asserts an interest as an innocent third party.”

Judge Pillard filed a concurrence arguing that a tracing rule—which accounts for the funds’ path through the financial system—does not, on its own, accomplish the statutorily required showing of ownership.  Judge Pillard would have adopted, “instead of or in addition to tracing,” the common law rule of agency that the Owens victims proposed, which would have treated banks as agents rather than owners when they effectuate EFTs originated by state sponsors of terrorism.

The D.C. Circuit’s decision has significant implications for judgment enforcement actions brought by victims of terrorism.  It clears the way for victims to attach blocked funds that would have been unreachable under the Second Circuit’s rule, and effectuates Congress’ intent to make blocked funds of state sponsors of terrorism available—”notwithstanding any other provision of law”—to victims holding judgments against those states.  By creating a circuit split, moreover, the decision may provide an avenue for terrorism victims to challenge the prevailing standard in the Second Circuit.

D.D.C. Reaffirms Arbitrability Disputes Do Not Implicate U.S. Courts’ Jurisdiction

On August 23, 2022, a district court in the D.C. Circuit issued a decision reaffirming that arbitrability disputes do not implicate subject-matter jurisdiction under the arbitration exception of the Foreign Sovereign Immunities Act (“FSIA”).  See Chiejina v. Federal Republic of Nigeria, No. 21-2241, 2022 WL 3646377 (D.D.C. Aug. 23, 2022).  In Chiejina, Nigeria opposed confirmation of an arbitration award against it on the grounds that one of the petitioners was not a party to the underlying agreement to arbitrate.  Consistent with “every case” the district court has decided on this issue, the court determined that arbitrability disputes such as this one implicate the merits of the petition and not the court’s subject-matter jurisdiction under the FSIA.  The court thus denied Nigeria’s motion to dismiss, which means that Nigeria’s arbitrability challenge will have to be litigated at the merits stage under a more deferential standard of review, rather than decided de novo as an issue of subject-matter jurisdiction.

Background

Petitioners seeking to confirm a foreign arbitral award issued against a foreign state typically must overcome two obstacles.  First, under the FSIA, 28 U.S.C. § 1605(a), foreign states are presumptively immune from suit in U.S. court unless one of the FSIA’s enumerated exceptions to jurisdictional immunity is satisfied.  One such exception, the FSIA’s arbitration exception, 28 U.S.C. § 1605(a)(6), provides for subject-matter jurisdiction in an action against a foreign state to “confirm an award made pursuant to” an arbitration agreement.  Second, once jurisdiction is established, the petitioner must establish on the merits that the award is subject to confirmation under the applicable legal framework—typically, either the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the “New York Convention”) or the ICSID Convention.  Both Conventions limit a court’s authority to review the merits of the arbitral award or question the determinations of the tribunal that issued it.

To avoid the New York and ICSID Conventions’ limits on judicial review, foreign states often attempt to frame their challenges to enforcement of an arbitral award as raising issues of subject-matter jurisdiction under the FSIA, rather than the merits.  In particular, in a number of recent cases, foreign states have argued that the FSIA’s arbitration exception does not apply—and the state is therefore immune from suit—because there is no valid arbitration agreement between the parties.  The D.C. Circuit and the D.D.C. have repeatedly held, however, that issues of “arbitrability”—including the existence of a valid arbitration agreement—go to the merits rather than to subject-matter jurisdiction under the FSIA.  See, e.g., LLC SPC Stileks v. Republic of Moldova, 985 F.3d 871, 877-78 (D.C. Cir. 2021); Chevron Corp. v. Ecuador, 795 F.3d 200, 204 (D.C. Cir. 2015).

In Chiejina, petitioners are seeking to confirm and enforce under the New York Convention a $2.9 million award, plus interest, issued against the Federal Republic of Nigeria.  Like the defendants in Stileks, Chevron, and Tethyan, Nigeria moved to dismiss for lack of subject-matter jurisdiction, arguing that the FSIA’s arbitration exception did not apply because one of the petitioners was not a party to the relevant arbitration agreement.  Nigeria also argued that the court lacked personal jurisdiction because the petitioners failed to properly effect service of process consistent with the FSIA’s service provision, 28 U.S.C. § 1608(e).

Decision

The district court rejected Nigeria’s challenge to subject-matter jurisdiction, explaining that under the D.C. Circuit’s decisions in Stileks and Chevron, arbitrability “is a question that goes to the merits of whether the award should be confirmed pursuant to the New York Convention,” rather than “a basis on which to conclude that the Court lacks jurisdiction under the FSIA.”  For that reason, Nigeria could not challenge subject-matter jurisdiction by arguing that petitioners’ claims in the arbitration were “not encompassed by the underlying agreement to arbitrate” because one of the petitioners was not a party to that agreement.   Instead, the court indicated that it would address arbitrability—including the existence of a valid arbitration agreement between the parties—at the merits stage under the deferential standard for confirmation of foreign arbitral awards under the New York Convention.  The decision thus reaffirms the principle that arbitrability is not an issue of subject-matter jurisdiction.

The court also addressed service of process.  When a plaintiff enters into a “special arrangement” for service on a foreign state, the FSIA, 28 U.S.C. § 1608(a)(1), requires the plaintiff to attempt service through that arrangement before proceeding with other methods of service.  In Chiejina, the underlying construction contract at issue in the arbitration included a notice provision specifying a method for serving notices related to the contract.  Rather than follow that notice provision, the petitioner served Nigeria through a separate method applicable in the absence of a “special arrangement” between the parties.  The court held that service was properly effected on Nigeria because the contractual notice provision applied only to notices that were “‘required or authorized’ by the Contract itself,” not service of process in the lawsuit.  In doing so, the court reaffirmed the principle that a notice provision in an underlying contract creates a “special arrangement” for purposes of FSIA service “only where the language is ‘all encompassing’ rather than ‘confined to the contract or agreement at issue.’”  Berkowitz v. Republic of Costa Rica, 288 F. Supp. 3d. 166, 173 (D.D.C. 2018) (quoting Orange Middle East & Africa v. Republic of Equatorial Guinea, No. 1:15-CV-849 2016 WL 2894857, at *4 (D.D.C. May 18, 2016)).

D.D.C. Reaffirms U.S. Courts’ Obligation To Enforce ICSID Awards

On August 19, 2022, a district court in the D.C. Circuit issued a decision reaffirming the obligation of U.S. courts to enforce arbitral awards issued pursuant to the ICSID Convention.  See ConocoPhillips Petrozuata B.V. v. Bolivarian Republic of Venezuela, No. 1:19-cv-683, 2022 WL 3576193 (D.D.C. Aug. 19, 2022).  Consistent with precedent and federal law, the court held that it had subject-matter jurisdiction under both the arbitration and waiver exceptions of the FSIA on account of Venezuela’s decision to join the ICSID Convention.  In doing so, the court reaffirmed the principle that a foreign state that joins the ICSID Convention waives immunity to the enforcement of ICSID awards in U.S. court.

Background

The ICSID Convention is a treaty signed by the United States and 164 other nations of the world that provides a comprehensive framework for resolving investment disputes between participating nations and the private investors of other participating nations.  The Convention provides for arbitration before an international tribunal and streamlined enforcement procedures for any resulting arbitral award.  Each contracting party agrees to “recognize an award rendered pursuant to [the] Convention as binding and enforce the pecuniary obligations imposed by that award within its territories as if it were a final judgment of a court in that State.” ICSID Convention, art. 54(1).  The United States has implemented this treaty obligation through legislation providing that an ICSID award “shall be enforced and shall be given the same full faith and credit as if the award were a final judgment of a court of general jurisdiction of one of the several States.”  22 U.S.C. § 1650a(a).

Despite this congressional mandate, foreign states often attempt to oppose enforcement of ICSID awards by challenging the U.S. court’s subject-matter jurisdiction under the FSIA.  But the D.C. Circuit held in Tatneft v. Ukraine that when a foreign state joins a treaty that “contemplate[s] arbitration-enforcement actions in other signatory countries, including the United States”—as the ICSID Convention does—it “waives its immunity from arbitration-enforcement actions” under the FSIA.  771 F. App’x 9, 10 (D.C. Cir. 2019).  The Second Circuit has applied this principle in the context of the ICSID Convention, holding that a foreign states “waive[s] its sovereign immunity” from enforcement of an ICSID award “by becoming a party to the ICSID Convention.”  Blue Ridge Invs., L.L.C. v. Republic of Argentina, 735 F.3d 72, 84 (2d Cir. 2013).  These decisions provide an alternative basis—in addition to the arbitration exception at issue in Chiejina—for establishing subject-matter jurisdiction in an action to enforce an ICSID award.

Decision

The petitioners in ConocoPhillips sought to confirm and enforce an ICSID award issued against the Bolivarian Republic of Venezuela.  When Venezuela failed to timely respond to the enforcement petition, the petitioners sought entry of a default judgment, and the district court granted the motion.  Although the motion was not opposed, the district court addressed subject-matter jurisdiction under the FSIA, holding that Venezuela was not immune from suit—and the court therefore had subject-matter jurisdiction—on two grounds:  (1) the FSIA’s arbitration exception; and (2) the FSIA’s waiver exception, 28 U.S.C. § 1605(a)(1), which provides jurisdiction where a foreign state has waived its immunity to suit in U.S. court.

First, the court concluded that when a foreign state agrees to arbitration pursuant to the ICSID Convention, the arbitration exception permits enforcement even if the state subsequently withdraws from the Convention, so long as “the relevant rights and obligations of the parties arose before [the] denunciation took effect.”  This holding means that a foreign state cannot evade its obligations to parties holding ICSID awards by withdrawing from the ICSID Convention.

Second, the court confirmed that the waiver exception also applied because “Venezuela implicitly waived its sovereign immunity with respect to suits to recognize and enforce ICSID awards by becoming a Contracting State to the ICSID Convention.”  The court emphasized that “[t]o hold otherwise would be to disrespect Venezuela’s choice (at the time) to be a Contracting State, and it would diminish other Nations’ ability to attract investment in the future by committing themselves to resolving investment disputes through arbitration.”  The court thus referenced one of the key purposes of the ICSID Convention:  By providing investors with a remedy through arbitration and strong guarantees that any resulting award will be subject to enforcement, the Convention helps contracting parties attract foreign investment.  ConocoPhillips thus strengthens the chorus of decisions recognizing that parties to the ICSID Convention and other arbitration enforcement treaties waive their immunity from enforcement of arbitral awards issued pursuant to those treaties.

D.D.C. Clears The Way For Landmark $6.5 Billion Judgment Enforcing Arbitration Award Against Pakistan

On March 10, 2022, a district court in the D.C. Circuit issued a groundbreaking decision on behalf of Tethyan Copper Company PTY Limited (“Tethyan”), an Australian mining company represented by Matt McGill, Robert Weigel, Jason Myatt, and Matt Rozen of Gibson Dunn in its long-running efforts to enforce a $4 billion plus interest arbitration award issued against Pakistan pursuant to the ICSID Convention.  Tethyan Copper Co. PTY Ltd. v. Islamic Republic of Pakistan, No. 1:19-cv-2424, 2022 WL 715215 (D.D.C. Mar. 10, 2022).  In its opinion and accompanying order, the court denied Pakistan’s motion to dismiss or, in the alternative, to stay enforcement proceedings, and directed the parties to submit a proposed judgment, clearing the way for the entry, after interest and costs, of a more than $6.5 billion judgment as of this writing, which would be one of the largest judgments ever entered by the D.C. federal district court.  The decision reinforces three principles concerning the enforcement of ICSID awards.

First, the decision emphatically rejects the recurring argument that enforcement of such awards should universally be stayed while the losing party tries to vacate or set aside the award in parallel proceedings.  Under the ICSID Convention, only an ICSID tribunal or committee—not the courts of any contracting state—may decide whether an award should be set aside, either through revision by the original tribunal pursuant to Article 51 of the Convention, or through annulment by an ad hoc committee pursuant to Article 52 of the Convention.  Article 54 of the Convention expressly provides that ICSID awards are immediately enforceable as “final judgment[s]” even while revision or annulment proceedings are pending, and it tasks the ICSID tribunal or committee overseeing those proceedings with deciding whether a stay of enforcement is appropriate.

In TCC, Pakistan sought both revision and annulment, but the tribunal and committee overseeing those proceedings allowed enforcement to proceed.  Pakistan then moved in the district court to stay the U.S. enforcement proceedings.  But the district court rejected that request.  The court acknowledged some prior decisions from the same district that had stayed enforcement proceedings pending set aside proceedings.  In the court’s view, however, the interest in judicial economy and the potential hardship to Tethyan from a stay clearly outweighed any potential hardship to Pakistan from denying a stay.  Tethyan had waited over a decade for compensation, and the court concluded that “[a] stay only prolongs justice denied.”

Second, the court rejected the state’s attempt to relitigate in enforcement proceedings jurisdictional arguments already raised before and rejected by the arbitral tribunal.   Specifically, Pakistan had challenged the tribunal’s jurisdiction on the ground that there was no valid arbitration agreement, because Pakistan purportedly had not properly consented to arbitration under the ICSID Convention.  The tribunal rejected the argument.  In the subsequent enforcement proceedings, Pakistan attempted to renew the same objection—that there was no valid arbitration agreement between the parties—as a challenge both to the district court’s jurisdiction under the FSIA and its authority to grant full faith and credit to the award.  Relying on the above-described principles from the D.C. Circuit’s decisions in Stileks and Chevron, however, the TCC court refused to second-guess the tribunal’s rulings on arbitrability—including the existence of a valid agreement to arbitrate.   The court held that once such issues have been resolved in arbitration, they cannot be revisited through a collateral attack on the tribunal’s rulings, whether in the guise of a challenge to jurisdiction under the FSIA or to the merits of the enforcement petition.

Finally, the court’s order, directing the parties to promptly meet and confer and submit a proposed judgment, with interest, recognizes that once the court has determined that it has subject-matter jurisdiction to enforce an ICSID award, the award holder is entitled to prompt entry of judgment as soon as interest is calculated.   (In an effort to facilitate settlement, the court later granted the parties’ joint request for an extension of time to submit a proposed judgment until December 15, 2022.)  If followed elsewhere, the court’s order may greatly streamline efforts by future litigants to enforce arbitral awards against foreign sovereigns in U.S. courts.

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Gibson Dunn’s Judgment and Arbitral Award Enforcement Practice Group offers top-tier international arbitral award and judgment enforcement strategies and solutions, deep proficiency in cross-border litigation and international arbitration, and best-in-class advocacy that not only applies the law, but, time and again, has crafted and shaped new law to achieve our clients’ objectives.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the D.C. Circuit.  Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Judgment and Arbitral Award Enforcement practice group, or the following:

Matthew D. McGill – Co-Chair, Washington, D.C. (+1 202-887-3680, mmcgill@gibsondunn.com)
Robert L. Weigel – Co-Chair, New York (+1 212-351-3845, rweigel@gibsondunn.com)
Jason Myatt – New York (+1 212-351-4085, jmyatt@gibsondunn.com)
Matthew S. Rozen – Washington, D.C. (+1 202-887-3596, mrozen@gibsondunn.com)

This client update was prepared by Matt McGill, Robert Weigel, Jason Myatt, Matt Rozen, Jessica Wagner, Jeff Liu, Luke Zaro, and Sam Speers.

© 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 an August 11, 2022 letter to the Department of Justice (“DOJ”), Senators Elizabeth Warren (D-Mass) and Ben Ray Lujan (D-N.M.) signaled renewed congressional interest in the Government’s right to suspend or debar government contractors and federal financial assistance recipients from obtaining new business, and pressed for DOJ to boost its use of this administrative remedy in connection with its prosecution of criminal or fraud cases.

The bases for discretionary suspension and debarment include “making false statements” and “any other offense indicating a lack of business integrity or business honesty.”[1] It is no surprise, then, that companies subject to investigations, litigation, and resolutions under the civil False Claims Act (“FCA”) often find themselves faced with the prospect of suspension or debarment from future government work—even when they dispute the merits of the FCA allegations in question.

In most cases, government agencies have significant discretion to decide whether there are sufficient grounds to exclude an entity from receiving government contracts or financial assistance awards. DOJ has traditionally taken an agnostic approach to the interplay between its FCA investigations and the suspension and debarment authority of the government agency affected by the underlying conduct. The Warren-Lujan letter, however, presses DOJ to take a more activist role in suspending or debarring not just the companies it is pursuing as “corporate criminals,” but companies that are the subject of “corporate fraud cases” like those under the civil FCA.

While DOJ’s response to this congressional outreach remains to be seen, any attempt by the Department to address the Senators’ concerns as articulated in the letter would represent a meaningful change in policy and would undoubtedly affect companies’ evaluation of whether to litigate or settle FCA claims with the Government. Companies subject to FCA investigations, litigation, and resolutions should be particularly mindful of how they approach mitigating the risk of suspension or debarment in the context of DOJ investigations and resolutions, in light of the Warren-Lujan letter.

Discretionary Suspension and Debarment

The ability to compete for new Government work is critical to the success of any government contractor. So too for companies that depend on Government funding – whether directly, through government grants or cooperative agreements, or indirectly, through state, local, or educational institution projects.

Suspension and debarment are administrative actions taken by the U.S. Government to disqualify a contractor from contracting with or receiving funding from the Federal Government based upon the Government’s determination that the contractor is not “presently responsible” (i.e., that it lacks the necessary integrity to be a business partner of the Government). Suspensions and debarments are not meant to be employed by the Government “for purposes of punishment.”[2]  Notably, suspending and debarring officials (“SDOs”) often have complete discretion as to whether to exercise the right to suspend or debar.[3]  Even when a Government agency finds some past violation that could provide a basis for suspension or debarment, an agency SDO is not required to, and should not, suspend or debar a contractor that is “presently responsible.”  In addition, an SDO could also decline to suspend or debar a contractor, even where grounds exist to do so, because it would not be in the Government’s best interest.[4]

The grounds for suspension and for debarment are substantially similar to one another, with different evidentiary thresholds. Both the suspension and debarment frameworks permit the exclusion of a company based on “adequate evidence” (suspension) or a civil judgment (debarment) for civil fraud, or other conduct that affects an entity’s present responsibility, or an offense that indicates a lack of business integrity or business honesty.[5]

FCA Violations as Grounds for Suspension or Debarment

The FCA is the government’s primary tool for addressing alleged fraud related to government funds.  Under the FCA, both DOJ and would-be whistleblowers (who may file FCA lawsuits on the government’s behalf and obtain a percentage of any recovery) can pursue lawsuits against companies that do business with the government, and if successful, obtain treble damages, per-claim penalties, and attorneys’ fees and costs.

The FCA creates liability for any party that submits a false claim for payment to the federal government, or who makes a false statement that is material to a false claim.  31 U.S.C. § 3729(a)(1)(A), (B).  The Government often takes the position that a violation of contract requirements can create fraud liability under the FCA if it is done with knowledge and is material to payment.  Under the “reverse” false claims provision, liability also exists for anyone who “knowingly makes, uses, or causes to be made or used, a false record or statement material to an obligation to pay or transmit money or property to the Government, or knowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the Government.”  Id. § 3729(a)(1)(G).

Therefore, the potential bases for FCA liability substantially overlap with the grounds for potential suspension or debarment—i.e., “making false statements” and “any other offense indicating a lack of business integrity or business honesty.”[6] Accordingly, the consequences of being found liable in an FCA case can be catastrophic, resulting in suspension or debarment from government contracts or exclusion from participation in government programs.

As a matter of policy, DOJ attorneys are required to coordinate with the Government’s relevant criminal, civil, regulatory, and administrative attorneys when initiating an FCA suit or investigation, including with regard to suspension and debarment.[7]  A 2012 DOJ memorandum, for example, stresses the importance of “[e]ffective and timely communication with representatives of the agency . . . including suspension and debarment authorities,” to ensure that appropriate remedies are pursued at the correct time.[8] The Interagency Suspension and Debarment Committee (“ISDC”) is tasked with overseeing and coordinating all executive agencies’ implementation of suspension and debarment regulations.[9] One such coordination activity involves the designation of a “lead” agency where a case may affect the missions of multiple agencies.[10]  Under the current system, the lead agency is the ultimate decision maker as to what suspension or debarment action, if any, will be taken.

The Warren-Lujan Letter

The Warren-Lujan letter to Attorney General Merrick Garland and Deputy Attorney General Lisa O. Monaco criticizes DOJ for not using its authority to suspend or debar “corporate criminals” from the government contracting process, and urges DOJ to “pursue more robust use of its suspension and debarment authority.” Notably, the letter advocates for DOJ to use its suspension and debarment authority even for “companies that it does not directly do business with,” rather than relying on the contracting or lead agencies to pursue suspension or debarment, and calls for DOJ to “adopt policies that call for [DOJ] prosecutors to systematically refer corporate misconduct to” DOJ’s own “debarring officials for review in all appropriate cases.”

Senators Warren and Lujan propose four ways in which DOJ should “expand its use of debarment”:

1. 1. Use debarment authority for corporate entities, not just individuals.
   2. Use debarment government-wide (i.e., DOJ should suspend or debar entities that contract with any federal agency, rather than just its own contractors).
   3. Consider debarment for all corporate misconduct, including “defraud[ing] the government…[t]ax evasion, bribery, unsatisfactory performance, and other harmful conduct,” “in any contract—whether the government was harmed or not….”
   4. Use suspension authority while an investigation is pending.

The Senators’ letter betrays a failure to appreciate several critical facets of the suspension and debarment regime—particularly the non-punitive nature of such exclusions, the focus on present responsibility rather than past misconduct, and the primacy of the government’s interest in making such exclusion decisions.  Moreover, these proposals introduce the possibility for a sea change in DOJ policy that would have dire impacts for companies subject to FCA prosecution.

Implications for FCA Defendants

If adopted as a matter of practice or policy by DOJ, the Warren-Lujan approach could have significant effects for companies facing FCA lawsuits and investigations.

The potential for FCA liability is already a significant risk for government contractors in light of the potential for massive treble damage awards and civil penalties.  Indeed, FCA settlements and judgments total billions of dollars every year, with individual settlements often reaching tens or even hundreds of millions of dollars.  But debarment or suspension for companies that depend on government business would be ruinous, because those penalties would effectively put companies out of business altogether.  The Warren-Lujan approach to suspension and debarment significantly heightens these risks, and makes resolving FCA suits considerably more difficult in several regards:

• Imposing a Suspension During an Investigation May Force Unfavorable Settlements. In many cases, companies settle or otherwise resolve FCA lawsuits before trial as part of a negotiated resolution, in part precisely because of the risk that an adverse judgment on the merits could result in debarment.  This is so even where companies dispute the merits of the FCA claim but wish to avoid the cost and uncertainty of a trial and the resulting collateral consequences of suspension or debarment.  Through a negotiated resolution, companies can ensure there is no formal judgment of a false statement, and negotiate a path forward that does not include any suspension or debarment, for example through entering into a Corporate Integrity Agreement (CIA) or other administrative agreement.  But the Warren-Lujan approach would encourage DOJ to increase its use of its authority to suspend contractors while an investigation is pending, which would significantly increase pressure on companies to quickly settle cases.  FCA investigations can last years, and few companies could weather a multi-year suspension while defending against an FCA investigation.  Moreover, uncertainties regarding when an investigation might result in “adequate evidence” to suspend an entity may lead even companies that have strong defenses and have done nothing wrong to enter into hasty settlements, without a full opportunity to defend themselves, to avoid an interim suspension – though as discussed below, the resolution itself may still raise the specter of exclusion.

• Government-Wide, Corporate-Level Suspensions and Debarment Could Disincentivize Any Settlements Whatsoever. Even in cases where debarment or suspension is on the table, FCA defendants typically negotiate to keep those penalties carefully circumscribed.  For example, companies may engage with agency SDOs early in settlement negotiations in an effort to limit any suspension or debarment to individual wrongdoers or corporate divisions (as opposed to the entire company).  The Warren-Lujan approach would make this far more difficult by calling for DOJ to impose suspensions and debarments at the corporate level.  When broad, unlimited penalties of that nature are on the table, a contractor may be unable or unwilling to even consider a negotiated resolution, since it would be a death knell to most government contractors if the corporation was barred from all government business.

• Supplanting Lead Agency Discretion with DOJ’s Could Result in Suspensions or Debarments That Are Not in the Government’s Interest. Furthermore, by advocating for DOJ to pursue suspension or debarment directly—instead of working through the lead contracting agency—the Warren-Lujan approach ignores an important consideration in the use of suspension and debarment.  Agencies that work directly with contractors are best placed to understand the work those contractors do, and often rely deeply on the contractors to compete for new work to serve the agencies’ missions.  Those agencies are therefore attuned to the practical, disruptive implications of suspending or debarring a contractor.  Indeed, the suspension and debarment regulations specifically contemplate that SDOs must consider the government’s interest in making suspending or debarring decisions.[11] Moreover, those agencies are also in the best position to assess whether a contractor is “presently responsible.”  DOJ attorneys are likewise supposed to take into account “the adequacy and effectiveness of the corporation’s compliance program at the time of the offense, as well as at the time of a charging decision” when evaluating corporate settlements,[12] but the Warren-Lujan approach would have DOJ pursue a suspension and debarment decision apparently with little regard for either corporate compliance improvements or whether an agency is “presently responsible” despite past misconduct.  Supplanting an agency’s judgment with DOJ’s judgment could mean that suspension and debarment decisions are made without a full appreciation of these practical realities, and without consideration of the governmental interests.

Although whether and to what extent DOJ will heed the Warren-Lujan admonitions remains to be seen, clients facing FCA investigations, litigation, and potential resolutions must consider how a possible shift in Department policy could impact the appropriate steps to be taken to mitigate against the corporate “death sentence” of suspension or debarment.

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[1] FAR 9.406-2; FAR 9.407-2; 2 C.F.R. § 180.800.

[2] FAR 9.402(b); 2 C.F.R. § 180.125(c).

[3] FAR 9.406-1(a), 9.407-1(a); 2 C.F.R. § 180.700; 2 C.F.R. § 180.800.

[4] FAR 9.406; see 2 C.F.R. § 180.845(a).

[5] See FAR 9.406-2; FAR 9.407-2; 2 C.F.R. § 180.800.

[6] Id.

[7] Attorney General, Memorandum for All U.S. Attorneys, Director of the Federal Bureau of Investigation, All Assistant U.S. Attorneys, All Litig. Divs., and All Trial Attorneys, Coordination of Parallel Criminal, Civil, Regulatory, and Admin. Proceedings (Jan. 30, 2012), available at https://www.justice.gov/jm/organization-and-functions-manual-27-parallel-proceedings.

[8] Id.

[9] See Exec. Order No. 12549, Debarment and Suspension, 51 Fed. Reg. 6370 (Feb. 21, 1986).

[10] See Interagency Suspension and Debarment Committee, “About the ISDC,” available at https://www.acquisition.gov/isdc-home.

[11] FAR 9.406; see 2 C.F.R. § 180.845(a).

[12] U.S. Dep’t of Justice, Justice Manual § 9-28.300 (Dec. 2018), https://www.justice.gov/jm/jm-9-28000-principles-federal-prosecution-business-organizations#9-28.300.

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The following Gibson Dunn lawyers assisted in the preparation of this alert: Jonathan M. Phillips, Lindsay M. Paulin, Joseph D. West, and Reid F. Rector.

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 any member of the firm’s False Claims Act/Qui Tam Defense, Government Contracts, or White Collar Defense and Investigations practice groups.

Washington, D.C.
Jonathan M. Phillips – Co-Chair, False Claims Act/Qui Tam Defense Group (+1 202-887-3546, jphillips@gibsondunn.com)
F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com)
Joseph D. West (+1 202-955-8658, jwest@gibsondunn.com)
Robert K. Hur (+1 202-887-3674, rhur@gibsondunn.com)
Geoffrey M. Sigler (+1 202-887-3752, gsigler@gibsondunn.com)
Lindsay M. Paulin (+1 202-887-3701, lpaulin@gibsondunn.com)

San Francisco
Winston Y. Chan – Co-Chair, False Claims Act/Qui Tam Defense Group (+1 415-393-8362, wchan@gibsondunn.com)
Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com)

New York
Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com)
Mylan Denerstein (+1 212-351-3850, mdenerstein@gibsondunn.com)
Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com)
Brendan Stewart (+1 212-351-6393, bstewart@gibsondunn.com)
Casey Kyung-Se Lee (+1 212-351-2419, clee@gibsondunn.com)

Denver
John D.W. Partridge (+1 303-298-5931, jpartridge@gibsondunn.com)
Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com)
Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com)
Ryan T. Bergsieker (+1 303-298-5774, rbergsieker@gibsondunn.com)
Reid Rector (+1 303-298-5923, rrector@gibsondunn.com)

Dallas
Robert C. Walters (+1 214-698-3114, rwalters@gibsondunn.com)
Andrew LeGrand (+1 214-698-3405, alegrand@gibsondunn.com)

Los Angeles
Nicola T. Hanna (+1 213-229-7269, nhanna@gibsondunn.com)
Timothy J. Hatch (+1 213-229-7368, thatch@gibsondunn.com)
Deborah L. Stein (+1 213-229-7164, dstein@gibsondunn.com)
James L. Zelenay Jr. (+1 213-229-7449, jzelenay@gibsondunn.com)

Palo Alto
Benjamin Wagner (+1 650-849-5395, bwagner@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.

Following a three-month consultation period, the Securities and Futures Commission’s (“SFC”) Code of Conduct (“Code”) provision, paragraph 21, has come into effect on August 5, 2022.[1]  The provision outlines new conduct requirements for intermediaries carrying out bookbuilding and placing activities in equity and debt capital market transactions, including, the introduction of enhanced obligations applicable to an Overall Coordinator (“OC”).  This client alert discusses these new requirements and how they could raise certain sanctions-related questions for the OC as they consider their new obligations under the Code during their review of the order book.

1. 1. The Role of the Overall Coordinator

The OC is the “head of syndicates” responsible for the overall management of the share or debt offering, coordination of bookbuilding or placing activities, and exercise control over bookbuilding activities and market allocation recommendations to the issuer.  In order to address deficiencies in bookbuilding and allocation practices, the SFC has expanded the role of an OC in paragraph 21 of the Code.

In particular, in its Consultation Paper on (i) the Proposed Code of Conduct on Bookbuilding and Placing Activities in Equity Capital Market and Debt Capital Market Transactions and (ii) the “Sponsor Coupling” Proposal (“Consultation Paper”), the SFC highlighted the following key concerns:[2]

• Inflated demand: The SFC observed practices where intermediaries knowingly placed orders in the order book which they knew had been inflated. There had also been instances where heads of syndicate disseminated misleading book messages which overstated the demand for an Initial Public Offering (“IPO”).  The SFC considered that these inflated orders undermine the price discovery process and can mislead investors.
• Lack of transparency: In debt capital market bookbuilding activities, the SFC considered the use of “X-orders,” which are orders where the identities of investors are concealed, as problematic. In these cases, since investors’ identities are only known to the syndicate members who place the orders and to the issuers, the SFC was concerned that duplicated, or potentially fictitious orders might not be identified.
• Lack of documentation: Heads of syndicates did not properly maintain records of incoming client orders, important discussions with the issuer or the rest of the syndicate, or the basis for making allocation recommendations. The SFC criticized this practice as it undermined the integrity of the book-building process, which is meant to be the keeping of contemporaneous records to establish the position in case of any dispute.

In order to plug the gaps in the bookbuilding process identified above, the SFC has expanded the role of an OC to cover additional responsibilities, such as, consolidating orders from all syndicate members in the order book, taking reasonable steps to identify and eliminate duplicated orders, inconsistencies and errors, ensuring that identities of all investor clients are disclosed in the order book (except for orders placed on an omnibus basis), and making enquiries with capital market intermediaries[3] if any orders appear to be unusual or irregular.[4]

The OC is under an obligation to advise the issuer on pricing and allocation matters.  With respect to allocation, the OC is expected to develop and maintain an allocation policy which sets out the criteria for making allocation recommendations to the issuer, for example, the policy should take account into the types, spread, and characteristics of targeted investors, as well as the issuer client’s objectives, preferences and recommendations.  The OC should then make allocation recommendations in accordance with the policy.[5]  In practice, the OC’s powers are limited to providing recommendations or advice to the issuer on a best efforts basis, and do not go as far as preventing or rejecting an allocation.  The final decision on whether to make an allocation lies with the issuer.  Therefore, where an issuer decides not to adopt the OC’s advice or recommendations, the OC should explain the potential concerns of doing so (i.e., that the issuer’s decision may lead to a lack of open market, an inadequate spread of investors, or may negatively affect the orderly and fair trading of such shares in the secondary market), and advise the issuer against the decision.[6]

1. 2. Potential Sanctions Considerations

These new requirements, however, which aimed to plug the gaps in the bookbuilding process as noted above, may raise new risks or questions for OCs in other regulatory areas, namely whether there may be implications for the OC in terms of its compliance and legal obligations under the various economic and trade sanctions laws and regulations to which the OC may also be subject, such as those issued by the United Nations, United States (“U.S.”), European Union (“EU”), United Kingdom (“UK”) and others.  Specifically, because OCs will now be made aware of the identities of the ultimate investors in an allocation, a financial institution operating as an OC may have concerns about being able to perform its duties under the SFC requirements in cases where an investor has been identified as a possible subject of sanctions under laws that are applicable to the OC.

For example, under U.S. sanctions administered and enforced by the U.S. Department of the Treasury, Office of Foreign Assets Control (“OFAC”), U.S. financial institutions and their foreign branches are generally prohibited from engaging in, approving or otherwise facilitating transactions with individuals and entities designated to OFAC’s Specially Designated Nationals and Blocked Persons (“SDN”) List.  The contours of what kind of activity constitutes prohibited “facilitation” under U.S. sanctions law is not completely defined and is largely fact dependent.  Thus, it is unclear whether or not, under U.S. law, the subsequent actions a U.S. financial institution might perform in its role as OC after an investor has been identified as a potential sanctioned person could run afoul of U.S. sanctions regulations.  Similar issues may exist under the laws of other jurisdictions such as the EU or UK, depending on the jurisdictional hooks over the OC in question.

Whether or not there is risk here will depend on a variety of factors, including but not limited to: the precise nature of the OC’s actions subsequent to the identification of a sanctions concern (is the OC “approving” or “recommending” action, merely passing along information, recusing itself, etc.); the role, if any, of the OC in actual transactions involving the sanctioned person; the ability of the OC to affect or direct the actual allocation; the precise nature of the sanctions in question; and potentially any contractual protections that may be in place in the underlying operative agreements governing the OC’s role.

In addition, OCs will need to weigh the extent to which any potential sanctions obligations, including anti-boycott / blocking statute related, could conflict with the OC’s obligations under the Code, to provide adequate allocation advice to the issuer with due skill, care and diligence.[7]

Our view is that ultimately both sets of risks and obligations can be effectively managed and met, and we are working with clients and industry to understand and address the impact of these new regulations on the policies and procedures of financial institutions serving in the OC capacity.

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[1] Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (August 2022), published by the Securities and Futures Commission, 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.

[2] Consultation Paper on (i) the Proposed Code of Conduct on Bookbuilding and Placing Activities in Equity Capital Market and Debt Capital Market Transactions and (ii) the “Sponsor Coupling” Proposal (February 2021), published by the Securities and Futures Commission, https://apps.sfc.hk/edistributionWeb/api/consultation/openFile?lang=EN&refNo=21CP1.

[3] “Capital Market Intermediaries” is defined as licensed or registered persons that engage in capital market activities, namely bookbuilding and placing activities and any related advice, guidance or assistance.  See paragraph 21.1.1 of the Code.

[4] Paragraph 21.4.4(a)(i) of the Code.

[5] Paragraph 21.4.4(c) of the Code.

[6] Paragraph 21.4.2(c) of the Code.

[7] Paragraph 21.4.2(a) of the Code.

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The following Gibson Dunn lawyers prepared this client alert: William Hallatt, David Wolber, Becky Chung, Richard Roeder and Jane Lu*.

If you wish to discuss any of these developments, please contact any of the authors of this alert, the Gibson Dunn lawyer with whom you usually work or any of the following leaders and members of the firm’s Global Financial Regulatory or International Trade teams:

Global Financial Regulatory Group:
William R. Hallatt – Co-Chair, Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)
Michelle M. Kirschner – Co-Chair, London (+44 (0) 20 7071 4212, mkirschner@gibsondunn.com)
Jeffrey L. Steiner – Co-Chair, Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)
Emily Rumble – Hong Kong (+852 2214 3839, erumble@gibsondunn.com)
Arnold Pun – Hong Kong (+852 2214 3838, apun@gibsondunn.com)
Becky Chung – Hong Kong (+852 2214 3837, bchung@gibsondunn.com)
Chris Hickey – London (+44 (0) 20 7071 4265, chickey@gibsondunn.com)
Martin Coombes – London (+44 (0) 20 7071 4258, mcoombes@gibsondunn.com)

International Trade Group:

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)
Richard W. Roeder – Munich (+49 89 189 33 115, rroeder@gibsondunn.com)

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)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
David P. Burns – Washington, D.C. (+1 202-887-3786, dburns@gibsondunn.com)
Stephenie Gosnell Handler – Washington, D.C. (+1 202-955-8510, shandler@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)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@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)
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)

* Jane Lu is a trainee solicitor working in the firm’s Hong Kong office who is 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 August 25, 2022, the Securities and Exchange Commission (“SEC” or “Commission”), in a 3-to-2 vote, adopted final rules implementing the pay versus performance disclosure requirement called for under Section 953(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The final rules require proxy statements or information statements that include executive compensation disclosures to include a new compensation table setting forth for each of the five most recently completed fiscal years, the “executive compensation actually paid” (as defined in the final rule) to the company’s principal executive officer (“PEO”) and the average of such amounts for the company’s other named executive officers (“NEOs”), total compensation as disclosed in the Summary Compensation Table for the PEO and the average of such amounts for the other NEOs, total shareholder return (TSR), peer group TSR, net income and a company-selected financial measure that represents the “most important financial measure” used by the company to link compensation actually paid to company performance. In addition, based on the information set forth in the new table, a company must provide a clear description of the relationship between each of (1) the executive compensation actually paid to the PEO and to the non-PEO NEOs and the company’s TSR, the company’s net income and the company-selected financial measure over the previous five years, and (2) the company’s TSR and the TSR of a peer group chosen by the company. Finally, the rule requires companies to provide a list of three to seven other financial performance measures that the company determines are its most important measures “used to link compensation actually paid . . . to company performance.”

The final rule release is available here, and the SEC’s pay versus performance fact sheet is available here. The final rule will become effective 30 days after its publication in the Federal Register, and companies will be required to comply with the requirements in proxy and information statements that are required to include executive compensation disclosures for fiscal years ending on or after December 16, 2022. Set forth below is a summary of the final rules and considerations for companies.

Summary of the Final Rules

New Tabular Disclosure under Item 402(v) of Regulation S-K. Section 953(a) of the Dodd-Frank Act instructs the Commission to adopt rules requiring companies to provide “a clear description of . . . information that shows the relationship between executive compensation actually paid and the financial performance of the issuer.” To address this mandate, Item 402(v) of Regulation S-K will now require companies to include a new table (set forth below) in any proxy statement or information statement setting forth executive compensation disclosure, reporting:

• The “executive compensation actually paid” to the PEO and the total compensation reported in the Summary Compensation Table for the PEO. If more than one person served as the PEO during the covered fiscal year, then each PEO would be reported separately in additional columns with information provided for the applicable year such individual was a PEO.
• An average of the “executive compensation actually paid” to the remaining NEOs and an average of the total compensation reported in the Summary Compensation Table for the remaining NEOs. Footnote disclosure of the names of individual NEOs and the years in which they are included is also required.
• The company’s cumulative annual TSR calculated and presented as the dollar value of an investment of $100 (i.e., in the same manner as in the Stock Price Performance Graph required under Item 201(e) of Regulation S-K).
• The cumulative annual TSR of the companies in a peer group chosen by the company (which must be the same index or peer group used for the purposes of Item 201(e) or, if applicable, the peer group used for purposes of the Compensation Discussion and Analysis disclosures). Footnote disclosure of any year-over-year changes in peer group constituent companies as well as the reasons for any such change will be required along with a comparison of the issuer’s cumulative annual TSR with that of both the new and prior fiscal year peer group.
• The company’s net income for the fiscal year calculated in accordance with U.S. GAAP.
• A financial performance measure chosen by the company (the “Company-Selected Measure”) that the company has determined represents the “most important financial performance measure” that the company uses to link compensation actually paid to the NEOs to company performance for the most recently completed fiscal year. If such measure is a non-GAAP measure, disclosure must be provided as to how the number is calculated from the issuer’s audited financial statements, but a full reconciliation is not required.

PAY VERSUS PERFORMANCE

Year (a)	Summary Compensation Table Total for PEO (b)	Compensation Actually Paid to PEO (c)	Average Summary Compensation Table Total for Non-PEO NEOs (d)	Average Compensation Actually Paid to Non-PEO NEOs (e)	Value of Initial Fixed $100 Investment Based On:		Net Income (h)	[Company-Selected Measure] (i)
					Total Shareholder Return (f)	Peer Group Total Shareholder Return (g)

The table is required to set forth this information for each of the five most recently completed fiscal years, subject to a transition rule and certain exceptions described below.

The final rule requires companies to provide disclosure accompanying the table that “use[s] the information provided in the table . . . to provide a clear description of the relationship” between:

• Executive compensation actually paid to the PEO and the other NEOs and the company’s TSR across the last five fiscal years;
• Executive compensation actually paid to the PEO and the other NEOs and the company’s net income across the last five fiscal years;
• Executive compensation actually paid to the PEO and the other NEOs and the Company-Selected Measure; and
• The company’s TSR and the peer group TSR.

These descriptions could include narrative or graphic disclosure (or a combination of the two). If any additional, voluntary performance measures are included in the table, the disclosure must also include a description of the relationship between executive compensation actually paid to the PEO and the other NEOs and the additional performance measure across the last five fiscal years.

In addition, under the final rule companies must provide a tabular list of three to seven other financial performance measures that the company has determined represent the most important financial performance measures used to link compensation actually paid for the most recent fiscal year to company performance. So long as at least three of the measures are financial performance measures, the company may include non-financial performance measures in the tabular list. If fewer than three financial performance measures were used by the company to link compensation and performance, such list must include all such measures, if any, that were used.

Companies will also be required to tag each value disclosed in the table, block-text tag the footnote and relationship disclosure, and tag specific data points within the footnote disclosures in interactive data format using eXtensible Business Reporting Language, or XBRL.

“Executive Compensation Actually Paid.” Under the final rule, “executive compensation actually paid” is somewhat of a misnomer, as it includes both amounts paid or earned, as well as incremental accounting valuations for unvested equity awards that may never be earned or that could have different intrinsic values when earned. For these purposes, “executive compensation actually paid” is defined as the total compensation reported in the Summary Compensation Table, with adjustments made to the amounts report for pension values and equity awards.

Pension Values. With respect to pension values, the aggregate change in the actuarial present value of all defined benefit and actuarial pension plans will be deducted from the reported total compensation, and instead “executive compensation actually paid” will include both (1) the actuarially determined service cost for services rendered by the executive during the applicable year (“service cost”) and (2) the entire cost of benefits granted in a plan amendment (or initial plan adoption) during the applicable year that are attributed by the benefit formula to services rendered in periods prior to the plan amendment or adoption (“prior service cost”), in each case, calculated in accordance with U.S. GAAP. If the prior service cost is a negative amount as a result of an amendment that reduces benefits relating to prior periods of service, then such amount would reduce the compensation actually paid.

Equity Awards. With respect to the stock award and option award values, the amounts included in the Summary Compensation Table, representing the grant date fair value, will be deducted, and the following adjustments will be made, in each case, with fair value calculated in accordance with U.S. GAAP:

• For awards granted in the covered fiscal year:
  
  • add the year-end fair value if the award is outstanding and unvested as of the end of the covered fiscal year; and
  • add the fair value as of the vesting date for awards that vested during the year.
• For any awards granted in prior years:
  
  • add or subtract any change in fair value as of the end of the covered fiscal year compared to the end of the prior fiscal year if the award is outstanding and unvested as of the end of the covered fiscal year;
  • add or subtract any change in fair value as of the vesting date (compared to the end of the prior fiscal year) if the award vested during the year; and
  • subtract the amount equal to the fair value at the end of the prior fiscal year if the award was forfeited during the covered fiscal year.
• Add the dollar value of any dividends or other earnings paid on stock awards or options in the covered fiscal year prior to the vesting date that are not otherwise reflected in the fair value of such award or included in any other component of total compensation for the covered fiscal year.

Footnote disclosure is required to identify the amount of each adjustment, as well as valuation assumptions used in determining any equity award adjustments that are materially different from those disclosed as of the grant date of such equity awards.

Filings and Timing of Disclosures. Companies will be required to include the pay versus performance disclosure in all proxy and information statements that are required to include executive compensations disclosures under Item 402 of Regulation S-K for fiscal years ending on or after December 16, 2022. Under the transition rules, companies will only be required to provide disclosure for three years in the first proxy or information statement in which disclosure is provided, adding one additional year in each of the two subsequent years. In addition, disclosure is only required for fiscal years in which the company was a reporting company. The Item 402(v) disclosure will be treated as “filed” for the purposes of the Exchange Act and will be subject to the say-on-pay advisory vote under Exchange Act Rule 14a-21(a).

Issuers Subject to the Final Rules. The final rules require pay versus performance disclosure for all companies other than emerging growth companies (which are statutorily exempt from the requirements pursuant to the Jumpstart Our Business Startups Act), foreign private issuers, and registered investment companies.

Smaller reporting companies are subject to scaled disclosure requirements. They are not required to provide peer group TSR or any Company-Selected Measure, and the calculation of executive compensation actually paid may exclude amounts relating to pensions. In addition, smaller reporting companies are only required to provide disclosure for the most recent three years and are allowed initially to provide disclosure for two years, adding one additional year in the next year. Smaller reporting companies also are afforded a transition period with respect to XBRL requirements and are not required to provide inline XBRL data until the third filing in which it provides the pay versus performance disclosure.

Observations and Considerations for Companies

The new rules will require extensive calculations and disclosures. For many companies, however, the biggest challenge will be drafting disclosure that uses the information in the table to provide a clear description of the relationship between “compensation actually paid” and the prescribed performance measures. This disclosure is, appropriately, not presented in the Compensation Discussion and Analysis, as it will not necessarily relate to the performance measures utilized by a company’s compensation committee in designing and awarding executive compensation. Indeed, in our experience few compensation committees (if any) currently evaluate executive compensation based on the “compensation actually paid” formula prescribed under the new rules. As such, the required description may best be viewed as an after-the-fact review of whether and how this prescriptive and non-routine measure of “compensation actually paid” aligns with the discrete measures of corporate performance prescribed under the rule, if at all. In light of this disconnect between how compensation committees evaluate performance in awarding and paying out executive compensation and how compensation and performance will be presented under the new rules, some companies may determine to include additional voluntary disclosures that reflect how they view the connection between realized or realizable compensation and corporate performance. Indeed, while the final rules check the box in fulfilling a Dodd-Frank mandate to require a pay-for-performance presentation, it’s unclear whether the manner in which the Commission chose to implement the Dodd-Frank mandate justifies the time and expense that companies will need to expend to produce the disclosures and whether investors will expend the effort that would be needed to assess the disclosures.

For companies with calendar year fiscal years, the pay versus performance disclosures will be required in the 2023 proxy statement, and for companies that are not smaller reporting companies, the first year of disclosure will cover the 2022, 2021 and 2020 fiscal years. Given the substantial undertaking required to prepare the historical disclosures and the likelihood that significant interpretive questions will arise when applied to companies’ particular facts, companies should begin preparing for the new rules now by collecting the information that will be necessary for the disclosures, particularly with respect to the historical pension and equity award adjustments for calculating executive compensation actually paid, and should begin to mock up the required table now for historical periods. In addition, companies should begin discussions regarding what financial performance measure should be utilized as the Company-Selected Measure, understanding that it should be focused on the most recently completed fiscal year (i.e., 2022 for companies with calendar year fiscal years). Consultation with the company’s compensation committee and its independent compensation consultant will be key in ensuring that appropriate performance measures are utilized for both the Company-Selected Measure and in the tabular list. As well, companies should also consider whether any supplemental, voluntary disclosures or presentations may be appropriate. For instance, TSR amounts presented in the table may not align with the performance periods applicable to incentive and equity compensation awards.

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The following Gibson Dunn lawyers assisted in the preparation of this alert: Krista Hanvey, Thomas Kim, Ronald Mueller, and Gina Hancock.

Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Executive Compensation and Employee Benefits or Securities Regulation and Corporate Governance practice groups, or any of the following practice leaders and members:

Executive Compensation and Employee Benefits Group:
Stephen W. Fackler – Palo Alto/New York (+1 650-849-5385/+1 212-351-2392, sfackler@gibsondunn.com)
Sean C. Feller – Los Angeles (+1 310-551-8746, sfeller@gibsondunn.com)
Krista Hanvey – Dallas (+ 214-698-3425, khanvey@gibsondunn.com)
Gina Hancock – Dallas (+1 214-698-3357, ghancock@gibsondunn.com)

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Ron Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Michael Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com)
Lori Zyskowski – New York, NY (+1 212-351-2309, lzyskowski@gibsondunn.com)
Aaron Briggs – San Francisco, CA (+1 415-393-8297, abriggs@gibsondunn.com)
Julia Lapitskaya – New York, NY (+1 212-351-2354, jlapitskaya@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.

Towards the end of 2022, Europe will likely see a wave of class action legislation.  Many member states of the European Union (“EU”) will have to either devise new class action regimes or amend their existing provisions on collective redress.  They have until Christmas Day 2022 to implement the EU Directive on Representative Actions into national law.  The new procedural rules must be applied to new collective claims raised by 25 June 2023.

So far, only the Netherlands has voted to amend its class action regime to comply with the Directive.  Most other EU countries will have to take legislative action in the fall.  The EU directive, once implemented, will allow for more cross-border mass litigation throughout Europe.  Some states will use the opportunity to strengthen their jurisdiction by incentivizing plaintiffs to file cross-border representative actions in their courts, paving the way for cross-border forum shopping in Europe.

1.  The EU’s Directive on Representative Actions and Its Core Requirements

In 2020, the European Union issued a Directive on Representative Actions (EU Directive 2020/1828), which obliges all EU member states to amend their respective national rules of civil procedure to allow qualified entities to file collective actions for a class of consumers.

The member states enjoy considerable leeway to transfer the Directive’s broad requirements into their national legal system.  For example, member states are free to implement either an opt-in or an opt-out mechanism for consumers to join the collective action.  Consequently, national provisions on collective actions will still differ from country to country. However, for the first time, all of Europe will have some form of collective redress to allow consumers to directly claim compensation from a defendant.  Still, the Directive does not change the current European law on cross-border jurisdiction or conflict of laws.

The core requirements under the Directive which each member state must implement at a minimum are:

1. 1. Relief? Member states have to provide at least one procedural mechanism by which a qualified entity can sue on behalf of consumers for a variety of redress measures (compensation, repair, replacement, contract termination) or injunctive relief.  Some preexisting representative actions in Europe (i.e. in Germany) have so far allowed only declaratory judgments for consumers.
   2. Claimant? Only qualified entities have standing to sue on behalf of consumers; special criteria apply for entities bringing cross-border actions.  This procedural setup is designed to avoid abusive litigation.  In the legislative ideal, representative actions should be driven by consumer protection organizations who have the consumers’ best interests instead of their own financial interest in mind.
   3. Predicate Laws? The Directive requires that such representative actions can be filed for the violation of 66 EU laws for consumer protection, which are listed in the Directive’s annex.  Over the past 30 years, member states have transferred this EU consumer protection legislation into their national laws.  Today, core provisions in the member states’ civil codes (i.e. contract formation with consumers and defects liability) are based on the referenced EU legislation.  The scope of the Directive also includes more ancillary EU legislation regarding claims by consumers arising out of, inter alia, unfair commercial practices, air travel, financial services, loans, food safety, electronic communication, and data protection.  Seemingly every transaction with consumers in the EU could therefore be subject of a representative action in the future.
   4. Funding? Qualified entities may be funded by third parties as long as conflicts of interests are prevented.  When justified doubts regarding a conflict arise, qualified entities shall disclose their sources of funds used to support the representative action.
   5. Discovery? In accordance with pre-existing national and EU law, member states shall allow courts to order the defendant or third parties to disclose additional evidence which lies in the control of the defendant or a third party.  Some EU jurisdictions already have such procedural mechanisms in place.  These mechanisms are generally limited in scope compared to US discovery.  For example, in Germany, plaintiffs have to show that they require a specific document that would buttress their case before the court can order the defendant to turn it over.  The Directive ensures that member states can keep these pre-existing national procedural provisions.  They are also free, however, to vote for procedural rules more akin to US-style discovery, if they desire.
   6. Cost-Shifting? As is customary in the EU (and unlike the US), the losing party shall bear the costs of the litigation.  This is meant to discourage frivolous lawsuits.  So if the case is dismissed, the qualified entity that brought the lawsuit on behalf of consumers will have to bear the entire cost of the proceedings.  This – theoretically – includes the opposing party’s attorneys’ fees.  However, the recoupable amount for attorneys’ fees is often capped by national law.  The Directive does not affect these caps and it is unlikely that member states will change them to the detriment of qualified consumer protection entities.  Even if successful, defendants will therefore not be able to shift their costs entirely to the plaintiff.  The consumers behind the representative action generally will not bear any costs..
   7. Tolling of Statutes of Limitations? Pending representative actions (both for redress measures and injunctive relief) shall suspend or interrupt the national statutes of limitation for the consumers’ individual claims.
   8. Settlements? Similar to US class actions, all settlements in EU representative actions must be scrutinized by the court.  The court will not approve the settlement if it violates mandatory national law or includes unenforceable conditions.  Additionally, member states can allow the court to reject the settlement, if it is “unfair”.  Settlements are final and binding for the parties as well as the consumers.  However, consumers may opt-out of a settlement.

2.  The Netherlands Set the Tone with a Plaintiff-Friendly Interpretation of the Directive

Many European countries either remain hesitant to approach legislation on collective redress or are still debating how to allow consumers to effectively resolve their grievances without inviting the specter of a US-style “class action industry” into European courtrooms.

The Netherlands, on the other hand, have already embraced the new procedure and have taken a leading role in its implementation.  The Dutch parliament already passed class action legislation in 2020.  In June 2022, as the first country in the EU to do so, the Netherlands amended this regime to fully comply with the EU Directive.  Rather than simply implementing the Directive’s core requirements, the Netherlands have used the legislative leeway afforded by the EU to create a plaintiff-friendly class action regime which will strengthen the position of Dutch courts to resolve cross-border collective disputes.  The main staples of the new Dutch representative action are:

1. 1. Its scope goes far beyond the required minimum of sanctioning violations against EU consumer protection law.  All subject-matters fit for a civil lawsuit can be litigated.  Most notably, this includes climate change litigation, for which Dutch courts have built a plaintiff-friendly reputation with major verdicts against the Dutch Government in 2018 and Royal Dutch Shell in 2021.
   2. The representative action is not limited to consumers. Companies can join a representative action as well.
   3. For purely national litigation, the Netherlands pose very limited requirements for the representing qualified entities. Even entities which were founded for the sole purpose of bringing one particular representative action will have standing in Dutch courts.  In cross-border litigation the requirements will be stricter as set out by the Directive.
   4. Similar to a US class action, Dutch plaintiffs will have to opt-out of the class should they not want to participate in the litigation.  Dutch representative actions are also open to plaintiffs residing outside the Netherlands, as long as they belong to the class and actively opt-in. International plaintiffs will also be part of any settlement.  This will drive up the amounts in dispute compared to representative actions in neighboring countries like France and Germany, which favor opt-in mechanisms.  Consequently, representative actions in the Netherlands will be particularly attractive for plaintiffs and third-party litigation funders.
   5. Other than the Directive’s minimum requirements, the Netherlands have not imposed any restrictions on third-party funding. Litigation funders may not influence litigation strategy and the financial independence of the qualified entity must be safeguarded.

Some significant differences to US class actions still remain.  The Netherlands have not introduced US-style discovery into their representative action, which the Directive would have allowed for.  Plaintiffs will also not be able to sue for punitive damages.

3.  Outlook: A Diverse Litigation Landscape in Europe with Opportunities for Plaintiffs

The European landscape for collective redress will remain diverse even after 2023.  Not all EU member states will implement the Directive as broadly as the Dutch.  For example, the German Attorney General has already indicated he will propose legislation that will be more narrowly tailored to the underlying EU Directive instead of overhauling Germany’s collective redress mechanisms in one legislative swoop.

However, following the example set by the Netherlands, some countries might try to incentivize plaintiffs and litigation funders to sue multi-national companies in their own courts by devising plaintiff-friendly procedural rules.

Even if such a competition among member states will not ensue, any reform of Europe’s collective redress system will present new opportunities for plaintiffs, in particular if last-minute legislation to meet the deadline of 25 December 2022 results in loopholes or unprecise statutes.  Companies, courts, and law firms will have to adapt to the ensuing new legal challenges.  With no or little case law on the books after the reform, plaintiffs have particular incentives to file creative lawsuits.

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The following Gibson Dunn lawyers prepared this client alert: Markus Rieder, Patrick Doris, Alexander Horn, Kahn Scolnick, and Christopher Chorba.

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 in the firm’s Class Actions, Litigation, or Appellate and Constitutional Law practice groups, the authors, or any of the following leaders and members of the Class Actions Group:

Munich:
Markus Rieder (+49 89 189 33 162, mrieder@gibsondunn.com)
Alexander Horn (+49 89 189 33 161, ahorn@gibsondunn.com)

Paris:
Eric Bouffard (+33 (0) 1 56 43 13 00), ebouffard@gibsondunn.com)
Jean-Pierre Farges (+33 (0) 1 56 43 13 00, jpfarges@gibsondunn.com)
Pierre-Emmanuel Fender (+33 (0) 1 56 43 13 00, pefender@gibsondunn.com)

Brussels:
Christian Riis-Madsen (+32 2 554 72 05, criis@gibsondunn.com)

London:
Susy Bullock (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris (+44 (0) 20 7071 4276, pdoris@gibsondunn.com)
Osma Hudda (+44 (0) 20 7071 4247, ohudda@gibsondunn.com)
Ali Nikpay (+44 (0) 20 7071 4273, anikpay@gibsondunn.com)
Philip Rocher (+44 (0) 20 7071 4202, procher@gibsondunn.com)
Deirdre Taylor (+44 (0) 20 7071 4274, dtaylor2@gibsondunn.com)
Doug Watson (+44 (0) 20 7071 4217, dwatson@gibsondunn.com)

United States:
Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com)
Christopher Chorba – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com)
Theane Evangelis – Co-Chair, Litigation Practice Group, Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com)
Lauren R. Goldman – New York (+1 212-351-2375, lgoldman@gibsondunn.com)
Kahn A. Scolnick – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7656, kscolnick@gibsondunn.com)
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, bhamburger@gibsondunn.com)
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Decided August 18, 2022

Serova v. Sony Music Entertainment, S260736

The California Supreme Court held yesterday that a seller’s promotional statements about an artistic work of interest to the public amounted to commercial speech, regardless of whether the seller knew of the statements’ falsity.

Background: The plaintiff sued Sony under the Unfair Competition Law (UCL) and Consumers Legal Remedies Act (CLRA) on the theory that promotional materials for a posthumous Michael Jackson album misrepresented that Jackson was the lead singer. Sony filed a motion to strike under California’s anti-SLAPP statute, arguing that the plaintiff’s UCL and CLRA claims were unlikely to succeed because those statutes target only commercial speech, not noncommercial speech about art protected by the First Amendment.

The Court of Appeal held that the motion should be granted because the plaintiff’s claims targeted protected speech that was immune from suit under the UCL and CLRA. It reasoned that the promotional statements about the album related to a public issue—the controversy over whether Jackson was the lead singer on the album—and were more than just commercial speech because they were connected to music. The plaintiff’s allegation that the statements were false did not strip them of First Amendment protection, according to the Court of Appeal, because Sony didn’t know the statements were false.

Issues: Were Sony’s representations that Michael Jackson was the lead singer on Michael noncommercial speech subject to First Amendment protection (in which case California’s anti-SLAPP statute would apply) or commercial speech (in which case the plaintiff could pursue UCL and CLRA claims against Sony)?

Court’s Holding: 

Sony’s representations about the album constituted commercial speech, which can be prohibited entirely if the speech is false or misleading. And those representations did not lose their commercial nature simply because Sony made them without knowledge of their falsity or about matters that are difficult to verify.

“[C]ommercial speech does not lose its commercial nature simply because a seller makes a statement without knowledge or that is hard to verify.”

Justice Jenkins, writing for the Court

What It Means:

1. 1. Although artistic works often enjoy robust First Amendment protections, the marketing of such works can constitute commercial speech that is regulated by consumer-protection laws.
   2. It makes no difference whether a seller knew or didn’t know its statements are false, or whether the seller could or couldn’t find out whether its statements are false. If the seller’s speech is commercial, it will not receive full First Amendment protection in California.
   3. In deciding motions to strike under the anti-SLAPP statute, courts have discretion to skip over the question whether a claim arises from the exercise of free-speech rights and first analyze whether the movant has shown a probability of success.

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The Court’s opinion is available here.

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

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Carbon capture, utilization, and sequestration (“CCUS”) projects around the United States received a significant boost from the Inflation Reduction Act of 2022 (the “IRA”).[1]  The IRA, which President Biden recently signed into law, includes approximately $369 billion in incentives for clean energy and climate-related program spending, including CCUS projects.[2]

Notably, the IRA (1) substantially increases the availability of the federal income tax credits available for domestic CCUS projects (often referred to as “45Q credits”),[3] (2) makes it easier for CCUS projects to qualify for 45Q credits, and (3) provides significant new avenues for monetizing 45Q credits.[4]  The IRA also extends the deadline to begin construction on 45Q credit-eligible projects from 2026 to 2033.

Taken together, these changes are anticipated to significantly increase the number of CCUS projects that will enter service over the coming years.

Substantial Increases in Availability of 45Q Credits

The IRA substantially increases the availability of 45Q credits.  Under current law, qualified CCUS facilities that captured qualified carbon oxides (“QCO”) and either used the QCO in enhanced oil and gas recovery (“EOR”) or utilized the QCO in certain industrial applications would have been entitled to receive 45Q credits of up to $35/metric ton (“MT”), and facilities that otherwise disposed of QCO in secure geological storage would have been entitled to receive 45Q credits of up to $50/MT (both rates computed before inflation adjustments).

The IRA effectively increases the above rates to $60/MT and $85/MT (before inflation adjustments) respectively; however the IRA conditions the availability of these credit amounts on satisfying new prevailing wage and apprenticeship requirements (otherwise, the new rates are reduced by 80 percent).  At a high level, the prevailing wage and apprenticeship requirements are focused on making sure that projects provide well-paying jobs and training opportunities.  The new requirements will apply only to projects the construction of which begins within 60 days on or after the date on which Treasury issues regulatory guidance regarding the new requirements.

The IRA makes similar changes to 45Q credits for QCO captured by direct air capture (“DAC”) facilities, but the availability of 45Q credits for DAC facilities is even larger.  Under current law, DAC facilities were eligible for 45Q credits at the same rates as industrial facilities.  Under the IRA, DAC facilities are eligible for up to $130/MT for captured QCO used in EOR or utilized in certain industrial applications and $180/MT for other geologically sequestered QCO (subject to the same 80 percent haircut as other projects noted above if the DAC facility fails new prevailing wage and apprenticeship requirements).

The table below illustrates the extent to which the IRA is increasing the value of 45Q credits:

	2018 BBA 45Q Credit	2022 IRA 45Q Credit[5]
QCO Captured by Industrial Facility (Non-EOR/non-utilized)	$50/MT	$85/MT
QCO Captured by Industrial Facility (Used in EOR/utilized)	$35/MT	$60/MT
QCO Captured by DAC (Non-EOR/non-utilized)	$50/MT	$180/MT
QCO Captured by DAC (Used in EOR/utilized)	$35/MT	$130/MT

Expansion of Qualified Facilities

The IRA relaxes the annual thresholds that CCUS facilities must satisfy to be eligible for 45Q credits.  For electric generating facilities, the IRA lowers the annual threshold from 500,000MT of captured QCO to 18,750MTs of captured QCO.[6]  For DAC projects, the IRA lowers the annual threshold from 100,000MTs to just 1,000MTs.  The IRA reduces the capture quantity requirements for all other industrial facilities to 12,500MTs.  The high thresholds under prior law (combined with the cliff effect of failing to meet those thresholds) were major impediments to the financing of CCUS projects, so these reduced thresholds are a particularly welcome development for the industry.

Additional Options for Easier Monetization of 45Q Credits

The IRA also includes changes that could potentially result in significant adjustments to the manner in which 45Q credits are monetized, potentially diminishing the need for complicated tax equity structures to harvest the benefits of 45Q credits, which could expand the investor marketplace for CCUS projects.  Most importantly, the IRA allows an owner of a qualified CCUS project to monetize 45Q Credits by selling any portion of its 45Q credits to third parties for cash or (in certain years) seeking direct payment for 45Q credits from the Treasury.  In the case of a transfer, the cash payment received by the transferor will not be treated as taxable income, and the third party transferee may not deduct the cash payment.  Once a 45Q credit is transferred to a third party under this rule, the third party may not transfer it again.  Although expanded transferability of tax credits opens new potential monetization avenues, many practical questions (such as whether a purchaser that buys credits at a discount to face value would be required to recognize taxable income) remain unanswered and will likely require regulatory guidance. Moreover, the credit transfer regime contemplated by the IRA does not allow for depreciation deductions to be transferred, meaning that sponsors of projects who rely solely on the ability to transfer the 45Q credits will leave tax benefits on the table.

In addition to the new third-party transfer regime, direct payments from the Treasury in lieu of 45Q credits are available; however, with respect to claimants that are taxable entities, such direct payments are only available for the first five years of the twelve-year credit period, limiting the practical utility of the direct payment scheme.

It is important to note that additions to tax may apply to any “excessive credit transfer” (in the case of a credit transfer) or “excessive payments” (in the case of direct payments) in which the credit transferee or taxpayer, respectively, claims in excess of what the credit transferor or taxpayer could validly claim.  The addition to tax is 120 percent of the excessive credit transfer or excessive payment.  However, the 20 percent penalty component will not apply if the credit transferee or taxpayer can demonstrate reasonable cause for claiming the excessive credit transfer or excessive payment, respectively.  Regulatory guidance will be needed to flesh out the details of this reasonable cause exception and other details of how the excessive credit transfer and excessive payment rules will operate in practice.

Conclusion

The IRA potentially fundamentally alters the CCUS landscape in the U.S.  The substantially expanded availability of the 45Q credit, broadened scope of qualifying CCUS facilities, and simplified monetization of 45Q credits has the potential to incentivize current CCUS investors to increase the size of their investments, likely will encourage new investors to participate in CCUS projects, and should ensure that CCUS projects will be a significant feature of decarbonization efforts in the U.S.

________________________________

[1] As was the case with the so-called Tax Cuts and Jobs Act, the Senate’s reconciliation rules prevented Senators from changing the Act’s name and so the so-called Inflation Reduction Act is actually “An Act to provide for reconciliation pursuant to title II of S. Con. Res. 14.”

[2] https://www.democrats.senate.gov/imo/media/doc/inflation_reduction_act_one_page_summary.pdf

[3] 45Q credits are authorized by section 45Q of the Internal Revenue Code of 1986 (the “Code”).

[4] Inflation Reduction Act of 2022 (H.R. 5376), §§13104, 13801.

[5] These credit amounts are reduced by 80% unless new prevailing wage and apprenticeship requirements are satisfied (assuming those requirements apply to a project based on when it started construction).

[6] In addition to meeting this minimum requirement, the capture design capacity of the carbon capture equipment at the applicable electric generating unit at the CCUS project must be at least 75% of the baseline carbon oxide production of that unit.

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Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have about 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 Oil and Gas or Tax practice groups, or the following authors:

Oil and Gas Group:
Michael P. Darden – Co-Chair, Houston (+1 346-718-6789, mpdarden@gibsondunn.com)
Graham Valenta – Houston (+1 346-718-6646, gvalenta@gibsondunn.com)
Zain Hassan– Houston (+1 346-718-6640, zhassan@gibsondunn.com)

Tax Group:
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The Court of Final Appeal (the “CFA”) has recently confirmed that a director is not liable to penalty, by way of additional tax, arising from an incorrect tax return filed by the company which he/she has signed and declared to be correct, on the basis that he/she should not be regarded having made the company’s incorrect tax return.[1]

The CFA’s judgment provides clarity on the meaning and effect of s 82A(1)(a) of the Inland Revenue Ordinance (Cap. 112) (the “IRO”), which empowers the Commissioner of Inland Revenue (the “Commissioner”) to impose additional tax, commonly referred to as penalty tax, on any person who without reasonable excuse “makes” an incorrect tax return.

It should, however, be noted that the relevant provision has also recently been amended to cover a person who “causes or allows to be made on the person’s behalf, an incorrect return”, and it remains to be seen how this amendment will affect a director’s liability in relation to any company’s incorrect returns signed and declared to be correct by him/her.

1. Background and Procedural History

The CFA judgment was on the appeal by the Commissioner against a decision of the Court of Appeal (“CA”) in October 2019, in which the CA dismissed the Commissioner’s appeal against a decision of the Court of First Instance (the “CFI”) made in November 2018. The CFI ruled in favour of Mr Koo Ming Kown (“Mr Koo”) and Mr Murakami Tadao (“Mr Murakami”), who appealed against two earlier decisions of the Board of Review (the “Board”) upholding certain penalty tax assessed against them.[2]

Mr Koo and Mr Murakami were directors of Nam Tai Electronic & Electrical Products Limited (the “Company”) at the material times when the Company’s returns for the years 1996/97, 1997/98 and 1999/2000 were filed. Mr Koo and Mr Murakami respectively signed and declared to be correct the first and third, and the second, of these returns. Mr Murakami and Mr Koo ceased to be directors of the Company in 2002 and 2006 respectively.

Following a tax audit in 2002, the Inland Revenue Department (the “IRD”) disallowed claims for deductions made in the returns, and assessed the Company to undercharged tax under s 60 of the IRO, which the Company challenged unsuccessfully. The Company did not pay the amounts assessed and was eventually wound up in June 2012 by the court on the petition of the Commissioner.

In 2013, Mr Koo and Mr Murakami were assessed to additional tax under s 82A(1)(a) of the IRO in the amount of HK$12,600,000 and HK$5,400,000 respectively, on the basis that the Company’s returns were incorrect. They appealed to the Board, which found against them. The Board found the returns to have been incorrect and increased the overall amounts payable by Mr Koo and Mr Murakami.

Mr Koo and Mr Murakami appealed to the CFI, which accepted their primary argument that they did not fall within s 82A(1)(a) of the IRO. The CFI ordered the annulment of the additional tax assessments against Mr Koo and Mr Murakami. The Commissioner appealed to the CA, which upheld the CFI’s decision that Mr Koo and Mr Murakami were not required by the IRO to make the returns on behalf of the Company, and therefore could not be made liable to additional tax under s 82A(1)(a).

The Commissioner appealed to the CFA but Mr Koo and Mr Murakami informed the CFA that they did not intend to oppose the Commissioner’s appeal and would not attend the hearing in person or instruct lawyers to do so. The CFA appointed Mr Eugene Fung SC and Mr John Leung as amici curiae, who filed submissions addressing the questions before the CFA that supported the CA and CFI decisions.

2. The CFA’s Decision

Whether Mr Koo and Mr Murakami should be liable for the Company’s incorrect returns signed by them depends on whether they fall within the description, in the s 82A(1)(a) prevailing at the material times, of a “person who without reasonable excuse – (a) makes an incorrect return by omitting or understating anything in respect of which he is required by this Ordinance to make a return, either on his behalf or on behalf of another person…”[3]

The Commissioner contended that the individuals specified under s 57(1),[4] which included Mr Koo and Mr Murakami as directors of the Company, were “answerable” for doing all such acts as were required to be done by the Company under the IRO, and accordingly they were required to make the Company’s returns; and further that, by physically signing and declaring to be correct the relevant Company’s returns, they did make the Company’s return on behalf of the Company as a corporate taxpayer. On the case for the Commissioner, the individuals identified under s 57(1) to be “answerable” (for doing all such acts as required to be done by a corporate taxpayer) are required (secondarily) to do such acts which the corporate taxpayer is (primarily) required to do under the IRO.

Upon examining the legislative history and context, the CFA disagreed with the Commissioner’s construction of the relevant provisions in the IRO. The CFA confirmed the decisions of the CFI and the CA and concluded that the Company (being the entity to which the notice for making a return was issued under s 51(1)), rather than the individual who signed the return, was the “person” legally required to make, and did make, the return. There is a distinction between answerability under s 57(1), which means that the individuals specified under s 57(1) are responsible for seeing or ensuring the corporate taxpayer does the act in question, and an obligation or requirement to do such act on behalf of the company.

Accordingly, the CFA dismissed the Commissioner’s appeal.

3. Conclusion

The CFA judgment helpfully clarifies that a director of a company (or any other relevant individual specified under s 57(1)) is not required to “make” the tax return of the company, and does not make such tax return by reason that he/she has signed, and declared his/her belief in the correctness of the information in, the returns filed by the company. Therefore, such director or individual specified under s 57(1) does not incur liability under s 82A(1)(a) of the IRO.

However, as from 11 June 2021, s 82A(1)(a) has been amended to provide that “[a]ny person who without reasonable excuse—(a) makes, or causes or allows to be made on the person’s behalf, an incorrect return by omitting or understating anything in respect of which he is required by this Ordinance to make a return, either on his behalf or on behalf of another person…” (emphasis added to show the amendments).[5]

It remains to be seen whether, notwithstanding that a company’s director signing (or approving the filing of) the company’s tax return is not one who “makes” the tax return, he/she might be caught by the current s 82A(1)(a) as a person who has “caused” or “allowed” the tax return to be made on the company’s behalf, and hence may be exposed to liability should the company’s tax return be found to be incorrect.

_____________________________

[1] Koo Ming Kown & Murakami Tadao v Commissioner of Inland Revenue [2022] HKCFA 18. A copy of the judgment of the Court of Final Appeal is available here. The judgment in the Court of Appeal ([2021] HKCA 1037) is available here. The judgment in the Court of First Instance ([2018] HKCFI 2593) is available here.

[2] Board of Review, Cases D32/16 (available here) and D33/16 (available here).

[3] The current s 82A(1)(a) provides that “[a]ny person who without reasonable excuse—(a) makes, or causes or allows to be made on the person’s behalf, an incorrect return by omitting or understating anything in respect of which he is required by this Ordinance to make a return, either on his behalf or on behalf of another person…” (emphasis added to show the amendments).

[4] The then-prevailing s 57(1) provided that “[t]he secretary, manager, any director or the liquidator of a corporation and the principal officer of a body of persons shall be answerable for doing all such acts, matters or things as are required to be done under the provisions of this Ordinance by such corporation or body of persons”; whilst the current s 57(1) provides that “[t]he following person is answerable for doing all the acts, matters or things that are required to be done under the provisions of this Ordinance by a corporation or body of persons—(b) for any other corporation [that is not an open-ended fund company], the secretary, manager, any director or the provisional liquidator or liquidator of the corporation…”

[5] See the Inland Revenue (Amendment) (Miscellaneous Provisions) Ordinance 2021, Ord. No. 18 of 2021, Gazette published on 11 June 2021, No. 23 Vol. 25 – Legal Supplement No. 1, available here.

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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)

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On July 25, 2022, the U.S. Department of Justice (“DOJ”) entered into an $84.8 million settlement agreement[1] with several poultry processing companies over allegations that the poultry processors conspired with one another to share wage and benefits information through third-party data aggregation firms.[2] The companies entered the settlement without admitting any wrongdoing or liability. In addition to the $84.8 million restitution payment, the settlement agreement also imposed a court-appointed compliance monitor for ten years to ensure compliance with the proposed settlement decree.[3] Government enforcement actions based on information-sharing are rare,[4] and this settlement agreement includes important lessons for all companies that provide internal wage or benefits data to third parties, including consulting firms or trade groups that engage in other information sharing with competitors.

The DOJ’s settlement is the latest in a series of aggressive enforcement of the antitrust laws to protect labor markets. Since the DOJ and the Federal Trade Commission’s (“FTC’s”) 2016 Antitrust Guidance for Human Resource Professionals, the DOJ has been outspoken about intending to prosecute criminally stand-alone wage-fixing and no-hire, no-poach, and non-solicit agreements. Over the past two years, the DOJ has given these threats teeth, bringing criminal indictments against several companies and individuals for alleged wage-fixing, no-poach, and no-solicit agreements.

Here, the DOJ alleged that three poultry processors engaged in a long-running conspiracy to exchange information about wages and benefits for poultry processing plant workers and collaborated with their competitors to deprive “a generation of poultry processing plant workers of fair pay set in a free and competitive labor market.”[5] In addition, the government alleged that the processors coordinated the conspiracy by sharing information with third-party data consulting firms[6] and, importantly, that the information exchanged was “current or future, disaggregated, or identifiable in nature, which allowed the poultry processors to discuss the wages and benefits they paid their poultry processing plant workers.”[7] The data consulting firms also hosted in-person meetings where, the government further alleged, the poultry processors “shared additional compensation information and collaborated on compensation decisions.”[8]

Key to the government’s case, the complaint alleges that the poultry processors failed to abide by the safe-harbor requirements for sharing information outlined in the 2016 Guidance.[9] Under this Guidance, information sharing is unlikely to have anticompetitive effects when “[1] a neutral third party manages the exchange, [2] the exchange involves information that is relatively old, [3] the information is aggregated to protect the identity of the underlying sources, and [4] enough sources are aggregated to prevent competitors from linking particular data to an individual source.”[10] The DOJ alleged that the poultry processors did not qualify for the safe harbor because their information was current or future, disaggregated, and identifiable.[11]

Looking ahead, the safe harbor—which the DOJ and FTC have long used in contexts beyond labor markets—may be revised as a result of President Biden’s July 2021 Executive Order On Promoting Competition in the American Economy. Section 5(f) of the Order directs “the Attorney General and the Chair of the FTC . . . to consider whether to revise the Antitrust Guidance for Human Resource Professionals of October 2016” in order to “better protect workers from wage collusion.”[12] The Fact Sheet on the Executive Order suggests that those revisions may be aimed at information sharing: “the President . . . [e]ncourages the FTC and DOJ to strengthen antitrust guidance to prevent employers from collaborating to suppress wages or reduce benefits by sharing wage and benefit information with one another.”[13] To date, the guidance on information sharing has not been modified.

One other noteworthy aspect of the settlement agreement is the imposition of a ten-year monitorship. Monitorships for antitrust violations are uncommon and typically last only three years—even in the context of hard-core criminal cartels.[14] The groundbreaking agreement to a ten-year monitorship may be an indication that the new regime of antitrust enforcers will seek out monitorships, including lengthy ones, as part of future settlement agreements.

Take-aways

• Carefully assess benchmarking practices. Consider how sensitive information—including wages and benefits, as well as pricing and production data—is shared with others in the industry to ensure that it qualifies for the current safe harbor—that is, the exchange is managed by a third party, such as a trade group, and includes information that is historical, aggregated, and anonymized.[15]

• Monitor developments in DOJ and FTC guidance regarding information sharing, as the safe-harbor provision for human resources could change as a result of the Executive Order On Promoting Competition in the American Economy which directs DOJ and FTC leadership to “revise” the guidance to “better protect workers from wage collusion.”

• Recognize that antitrust enforcers will use the antitrust laws to protect labor markets. They are particularly interested in guarding low-wage workers from antitrust violations, but employers in other areas should not be complacent, as enforcement has included conduct involving specialized labor and highly compensated professionals.

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   [1]   See Proposed Final Judgment, U.S. v. Cargill Meat Solutions Corp., et al., (July 25, 2022), here, [hereinafter Proposed Settlement]. The data analysis firms and their executives entered into a separate settlement agreement.  See Proposed Final Judgment, U.S. v. Webber, Meng, Sahl and Company (July 25, 2022), here.

   [2]   See Complaint, U.S. v. Webber, Meng, Sahl and Company (July 25, 2022), at ¶ 5 [hereinafter Complaint].

   [3]   Proposed Settlement at 12-17.

   [4]   This is the first DOJ antitrust case involving information sharing since 2016. See Complaint, U.S. v. DirectTV Group Holdings, LLC and AT&T, Inc. (Nov. 2, 2016), here.

   [5]   See Complaint at ¶ 4.

   [6]   Id. at ¶¶ 75–152.

   [7]   Id. at ¶ 75.

   [8]   Id. at ¶ 85.

  [9]   Id. at ¶ 88.

  [10]   See Department of Justice, Antitrust Division & Federal Trade Commission, Antitrust Guidance for Human Resources Professionals (October 2016), here.

  [11]   Complaint at ¶ 75.

  [12]   Executive Order on Promoting Competition in the American Economy (July 9, 2021), here.

  [13]   FACT SHEET: Executive Order on Promoting Competition in the American Economy, (July 9, 2021), here.

  [14]   See Judgment, U.S. v. AU Optronics Corporation (Oct. 2, 2012) (imposing a three-year monitorship).

  [15]   See Department of Justice, Antitrust Division & Federal Trade Commission, Statements of Antirust Enforcement Policy in health Care (August 1996), here (providing that the collection of information qualifies for a “safety zone” when (1) the collection is managed by a third party, (2) the data is more than three months old, and (3) and the data is sufficiently aggregated such that recipients could not identify the data of any individual participant).

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The following Gibson Dunn lawyers prepared this client alert: Kristen Limarzi, Rachel Brass, Matt Butler, and Nick Marquiss.

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

Antitrust and Competition Group:
Kristen C. Limarzi – Washington, D.C. (+1 202-887-3518, klimarzi@gibsondunn.com)
Jeremy Robison – Washington, D.C. (+1 202-955-8518, wrobison@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)
Ali Nikpay – Co-Chair, London (+44 (0) 20 7071 4273, anikpay@gibsondunn.com)
Christian Riis-Madsen – Co-Chair, Brussels (+32 2 554 72 05, criis@gibsondunn.com)

Labor and Employment Group:
Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Co-Chair, Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)

© 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 July 27, 2022, Senator Joe Manchin (D-West Virginia) and Senator Majority Leader Chuck Schumer (D-New York) announced an agreement on a reconciliation package entitled the Inflation Reduction Act of 2022 (the “Act”) to address climate change, taxes, health care, and inflation.  The Act would, among other things, (1) establish a 15 percent corporate minimum tax, (2) expand the carried interest rules under section 1061 that apply ordinary income tax rates to investment gains earned by asset managers,[1] (3) establish multi-year IRS funding with a dramatic increase in funding for tax enforcement, and (4) extend and expand available clean energy tax incentives.

Legislative Outlook

As a reconciliation bill, Democrats can avoid a Republican filibuster in the Senate and pass the Act with a simple majority of only 51 votes, rather than the usual 60 votes.  With the Senate split 50-50, Democrats will need their entire caucus to remain unified, with Vice President Kamala Harris casting the deciding vote.  No Republican is expected to vote for the Act.

The Act could pass both chambers of Congress as soon as August.  The next step is for the nonpartisan Senate Parliamentarian to review the bill to ensure that everything within it relates directly to the budget, a robust floor debate featuring a “vote-a-rama,” with votes on amendments that could extend far beyond the energy, health care, and tax issues that make up the core of the Act, and then the Senate and House will vote on the bill.

Passage of the Act in an equally divided Senate could be blocked if Democrats lose even a single member of their Caucus.  Because Senator Kyrsten Sinema (D-Arizona) has blocked progress on similar issues in the past, her vote will be critical, and she has not yet announced her position.  The complicating factor in the House of Representatives—where Democrats hold a narrow majority—will be whether the Progressive Caucus signs off on the Act.  But Democrats understand the political reality that if either or both chambers flip in November to Republican control, the Act could be the last opportunity during the Biden Administration for Democrats to pass major legislation.  So, though passage of the Act is far more likely than ever before, its passage is not guaranteed.

Corporate Minimum Tax

The Act would subject corporations with book income in excess of $1 billion to a 15 percent alternative minimum tax (“AMT”).  The AMT is substantially similar to the revised version of the Build Back Better Act advanced by the Senate Finance Committee in late 2021.  Critics of the AMT have noted that imposing a tax on book income instead of taxable income undermines certain tax benefits, such as bonus depreciation, timing benefits, and other differences between financial and tax accounting standards, and could create other unintended mismatches.

The AMT would be imposed on any corporation with average applicable financial statement income (“AFSI”) in excess of $1 billion over any consecutive three-year period preceding the tax year at issue (the “Income Test”).  For a corporation (including predecessors) that has been in existence fewer than three years, the Income Test would be applied on an annualized basis.  AFSI would be determined by reference to the income (or loss) set forth on the corporation’s audited GAAP financial statements, subject to certain adjustments, including for income from controlled foreign corporations, partnerships, and disregarded entities, corporations filing consolidated returns, and certain taxes paid.  If a corporation is treated as a single employer with any other companies (corporate or non-corporate) pursuant to section 52, the AFSI of those other companies is taken into account for purposes of the Income Test.  This may cause a corporation that would not otherwise satisfy the Income Test to be subject to the AMT (by reason of its relationship with other entities through disparate ownership structures, such as portfolio companies of private equity funds).

A corporation subject to the AMT generally would be eligible to claim net operating losses and tax credits against its AMT liability, with the new and extended clean energy credits discussed below (and other business credits) generally limited to 75 percent of a corporation’s AMT.

The AMT would not apply to S corporations, regulated investment companies, and real estate investment trusts.  Other entities that would be excluded from the AMT include (1) corporations that experience an ownership change and (2) corporations that have not met the Income Test in a to-be-specified number of consecutive taxable years.  The contours of these exclusions, however, are to be determined by Treasury regulations, including what constitutes an “ownership change.”  A U.S. corporate subsidiary of a foreign-parented group would be subject to the AMT if that group meets the Income Test and that subsidiary has AFSI in excess of $100 million.

By incorporating financial accounting further into the tax law, the proposal would add substantial complexity to the Code.  The Act leaves critical details to be provided for by guidance from the Treasury Department and IRS.  That guidance will have significant tax consequences for taxpayers and will be subject to review in an era of heightened judicial scrutiny of agency rulemaking.  In addition, because the creation and modification of financial statement rules is not subject to Congressional approval or the notice-and-comment requirements of the Administrative Procedures Act, the proposal would result in the calculation of tax liability being determined by decisions made by a relatively small group of unelected, unregulated decision-makers.

These proposals, if enacted, would apply to tax years beginning after December 31, 2022.

Expansion of the Carried Interest Rules Under Section 1061

The Act proposes to modify the current rules relating to the taxation of certain carried interests[2] in the same manner as the House-passed version of the Build Back Better Act (H.R. 5376), most notably:

• denying long-term capital gain rates to holders of carried interests, unless the applicable holder meets the “holding period exception,” which generally would require a five year period of economic exposure to the relevant assets (three years in the case of real estate businesses or a taxpayer with adjusted gross income of less than $400,000);
• changing the manner in which the relevant holding period is determined;
• eliminating the exception from the carried interest rules for gains taxed at long-term gains rates under section 1231 and section 1256; and
• requiring full gain recognition on any transfer of an applicable carried interest, even if nonrecognition rules would otherwise apply.

The holding period exception has drawn attention for its departure from longstanding tax principles regarding holding period determinations.  Specifically, the holding period exception would look to the following dates – (i) the date on which the holder of a carried interest acquired “substantially all” of its carried interest, (ii) the date on which the partnership that issued the carried interest acquired “substantially all” of its assets, and (iii) in a tiered partnership, dates determined by applying (i) and (ii) to each partnership – and then would measure the applicable five-year period from the latest of those dates.[3]  The Act does not specify how the “substantially all” requirement is intended to be measured, and, because many investment funds (e.g., hedge funds and private equity funds) acquire assets at different times and have overlapping holding periods, it would be extraordinarily difficult for taxpayers to determine when these requirements have been satisfied.

The purpose of the proposed holding period exception is to ensure that ordinary income tax rates apply to any gain realized in respect of a carried interest if the gain is attributable to an asset to which the taxpayer has not been exposed economically for at least five years.  As currently drafted, the proposed holding period exception could be both under- and over-inclusive, permitting gain attributable to certain assets that have been held for fewer than five years to benefit from long-term capital gains rates and subjecting long-held assets to ordinary income tax rates.  Further, the proposed gain recognition rule would create a substantial trap for the unwary, particularly for indirect transfers of carried interests, including for estate planning purposes and ordinary course restructurings.

These proposals, if enacted, would apply to tax years beginning after December 31, 2022.

Additional IRS Funding – Enforcement

Consistent with the House-passed version of the Build Back Better Act (H.R. 5376), the Act provides nearly $80 billion of additional IRS funding for taxpayer services, enforcement, operations support, and modernization—with more than $45 billion earmarked for IRS tax enforcement over the next nine years.  Not only is the multi-year nature of the funding unique for the IRS, but the average-annual $5 billion increase to IRS enforcement also would double the IRS’s enforcement budget over prior years.   The art or science of estimating the revenue effects of tax legislation has led to significant disagreement recently, but per Congressional Budget Office analysis, the Senate estimates that IRS tax enforcement will generate $124 billion for the Federal fisc.  Furthermore, effective tax enforcement will be critical to the realization of the revenue estimates attributable to the Act’s AMT and modified taxation of carried interest provisions.

Clean Energy Tax Incentives

The Act includes numerous expansions and extensions of tax incentives for investments in clean energy by businesses and individuals.  If enacted, the Act would represent a significant commitment to the development of clean energy in the United States.

Certain portions of the Act were introduced in 2021 during discussions of the Green Act, the Clean Energy for America Act, and, ultimately, the Build Back Better Act, but the Act includes additions, subtractions, and refinements that depart from the Build Back Better Act and that could have significant positive impacts on the future of clean energy project development and finance.

Notably, the Act would permit the one-time sale of credits between certain taxpayers.  Under current law, clean energy tax credits generally are not transferable, subject to a narrow exception for the investment tax credit (which is transferrable to a lessee if certain requirements are met), but the Act would expand transferability beyond passthrough leases to other structures and credit classes (including production tax credits, carbon capture and sequestration credits, and several newly proposed credits).  Federal tax credit transferability could have a significant impact on the tax equity market, expanding the base of potential investors and potentially simplifying structures, although the continued non-transferability of other tax attributes (such as depreciation and amortization) means that legacy tax equity financing structures likely will continue to be relevant.  As drafted, however, the Act’s transferability regime raises numerous questions that likely would need to be addressed before enactment or through regulatory guidance.

In addition, the Act includes a number of significant macro-level changes to the clean energy credit system, some of which were first seen in the lead up to the Build Back Better Act, including:

• Wage and workforce eligibility requirements (applicable across clean energy credit classes) to qualify for credits at historic rates;
• Sweeteners for projects that satisfy domestic content or low-income community requirements;
• A limited direct-pay mechanism (conditioned for certain credits on phased-in domestic content requirements for projects one megawatt or greater);
• A three-year credit carryback; and
• Future transition to a technology-neutral credit regime.

In addition to these structural shifts, the Act includes the expansion of existing credits, the re-proposal of credits introduced in the discussions around the Build Back Better Act, and new credits, including:

• A new standalone investment tax credit and homeowner credit for battery storage facilities;
• Extension of the investment tax credit (and re-introduction of the production tax credit) and homeowner credit for solar projects;
• Extension of the production tax credit for on-shore and off-shore wind projects;
• A richer and broader credit regime for carbon capture and sequestration projects; and
• Extensions of legacy clean energy credits and the introduction of numerous new credits, including for clean hydrogen projects, zero-emission nuclear projects, and advanced manufacturing projects.

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[1]    Unless otherwise indicated, all “section” references are to the Internal Revenue Code of 1986, as amended (the “Code”).

[2]    These rules apply generally apply to any partnership interest transferred or held in connection with the performance of services in an “applicable trade or business,” other than certain capital interests, interests purchased by unrelated third parties and interests held by corporations.  The Act would clarify that the exception for partnership interests held by corporations would not be available for S corporations.

[3]    The Act states that section 1061 “shall be applied without regard to section 83 and any election in effect under section 83(b).”  The precise meaning of this portion of the proposed legislation is not entirely clear.

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This alert was prepared by Josiah Bethards, Michael D. Bopp, Michael Q. Cannon, Michael J. Desmond, Matthew J. Donnelly, Pamela Lawrence Endreny, Bree Gong*, Brian Hamano, Roscoe Jones Jr., Brian W. Kniesly, Jamie Lassiter*, Eric B. Sloan, C. Terrell Ussing, and Daniel A. Zygielbaum.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Public Policy, Tax, or Global Tax Controversy and Litigation practice groups:

Public Policy Group:
Michael D. Bopp – Co-Chair, Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)
Roscoe Jones, Jr. – Co-Chair, Washington, D.C. (+1 202-887-3530, rjones@gibsondunn.com)

Tax Group:
Dora Arash – Los Angeles (+1 213-229-7134, darash@gibsondunn.com)
Sandy Bhogal – London (+44 (0) 20 7071 4266, sbhogal@gibsondunn.com)
Michael Q. Cannon – Dallas (+1 214-698-3232, mcannon@gibsondunn.com)
Hanna Chalhoub – Dubai (+971 (0) 4 318 4634, hchalhoub@gibsondunn.com)
Michael J. Desmond – Los Angeles/Washington, D.C. (+1 213-229-7531, mdesmond@gibsondunn.com)
Matt Donnelly – Washington, D.C. (+1 202-887-3567, mjdonnelly@gibsondunn.com)
Pamela Lawrence Endreny – New York (+1 212-351-2474, pendreny@gibsondunn.com)
Benjamin Fryer – London (+44 (0) 20 7071 4232, bfryer@gibsondunn.com)
Brian R. Hamano – San Francisco (+1 415-393-8350 , bhamano@gibsondunn.com)
Kathryn A. Kelly – New York (+1 212-351-3876, kkelly@gibsondunn.com)
Brian W. Kniesly – New York (+1 212-351-2379, bkniesly@gibsondunn.com)
Jennifer Sabin – New York (+1 212-351-5208, jsabin@gibsondunn.com)
Eric B. Sloan – Co-Chair, New York (+1 212-351-2340, esloan@gibsondunn.com)
Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224 /+1 212-351-2344), jtrinklein@gibsondunn.com)
John-Paul Vojtisek – New York (+1 212-351-2320, jvojtisek@gibsondunn.com)
Edward S. Wei – New York (+1 212-351-3925, ewei@gibsondunn.com)
Lorna Wilson – Los Angeles (+1 213-229-7547, lwilson@gibsondunn.com)
Daniel A. Zygielbaum – Washington, D.C. (+1 202-887-3768, dzygielbaum@gibsondunn.com)

Global Tax Controversy and Litigation Group:
Michael J. Desmond – Co-Chair, Los Angeles/Washington, D.C. (+1 213-229-7531, mdesmond@gibsondunn.com)
Saul Mezei – Washington, D.C. (+1 202-955-8693, smezei@gibsondunn.com)
Sanford W. Stark – Co-Chair, Washington, D.C. (+1 202-887-3650, sstark@gibsondunn.com)
C. Terrell Ussing – Washington, D.C. (+1 202-887-3612, tussing@gibsondunn.com)

* Bree Gong is an associate working in the firm’s Palo Alto office who is admitted only in New York; Jamie Lassiter is an associate working in the firm’s Los Angeles office who is admitted only in New York and Texas.

© 2022 Gibson, Dunn & Crutcher LLP

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Is antitrust becoming HR’s biggest headache? The antitrust enforcement agencies and plaintiffs’ attorneys alike continue to prioritize competition enforcement in labor markets. The antitrust agencies have been keenly focused on a variety of labor issues, including wage collusion, non-compete, non-solicit and confidentiality agreements, worker classification, earnings claims, franchising arrangements, and merger deals that impact labor, just to name a few. And class actions continue to be filed pressing these issues. How will this trend play out? This panel provides insights from the trenches with a particular focus on pitfalls to avoid.

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PANELISTS:

Rachel S. Brass is a partner in the San Francisco office of Gibson, Dunn & Crutcher and co-chair of the Firm’s Antitrust and Competition Practice Group. She is a member of the firm’s Litigation Department where her practice focuses on investigations and litigation in the antitrust, labor, and employment areas. Ms. Brass also has extensive experience representing international and domestic clients in highstakes appellate litigation in the Supreme Court. She has special expertise in international matters and teaches an upper-level course in International Antitrust Law at Berkeley Law School.

Svetlana S. Gans is a partner in the Washington, D.C. office of Gibson, Dunn & Crutcher, where she helps clients navigate complex consumer protection, privacy, and competition related regulatory proceedings before the U.S. Federal Trade Commission (FTC), U.S. Department of Justice Antitrust Division, State Attorneys General and other enforcement bodies.  Ms. Gans also assists on litigation matters and provides strategic counseling and advice related to public policy issues.

Michael Holecek is a litigation partner in the Los Angeles office of Gibson, Dunn & Crutcher, where his practice focuses on complex commercial litigation, class actions, labor and employment law, and data privacy—both in the trial court and on appeal.  Mr. Holecek has first-chair trial experience and has successfully tried to verdict both jury and bench trials, he has served as lead arbitration counsel, and he has presented oral argument in numerous appeals.  Mr. Holecek has also authored articles on appellate procedure, civil discovery, corporate appraisal actions, data privacy, and bad-faith insurance litigation.

Julian W. Kleinbrodt is a litigation associate in the San Francisco office of Gibson, Dunn & Crutcher, where his practice focuses on antitrust and other complex civil litigation.  Mr. Kleinbrodt has successfully represented clients across several industries through trial and appeal.  He has represented clients in federal and state government investigations concerning employment, antitrust, and other competition issues.  Mr. Kleinbrodt also regularly counsels companies in these areas.

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This update provides an overview of key class action-related developments during the second quarter of 2022 (April through June).

Part I discusses noteworthy cases from the Ninth, Sixth, and Third Circuits regarding the requirements for class certification—including important decisions on how to address uninjured putative class members.

Part II covers two decisions from the Eighth and Seventh Circuits analyzing Article III standing in light of the U.S. Supreme Court’s decisions in Spokeo, Inc. v. Robins, 578 U.S. 330 (2016), and TransUnion LLC v. Ramirez, 141 S. Ct. 2190 (2021).

And Part III analyzes a recent decision from the Third Circuit regarding late removals of class actions to federal court under the Class Action Fairness Act of 2005 (“CAFA”).

I.   The Ninth, Sixth, and Third Circuits Discuss Rule 23 Requirements

This past quarter, the Ninth, Sixth, and Third Circuits issued significant decisions applying the Rule 23 class certification requirements.

As reported in our prior client alert, the Ninth Circuit released an important en banc opinion in Olean Wholesale Grocery Cooperative, Inc. v. Bumble Bee Foods LLC, 31 F.4th 651 (9th Cir. 2022).  The case involved three classes of tuna purchasers who alleged that tuna suppliers engaged in a price-fixing conspiracy in violation of federal and state antitrust laws.  In certifying the classes, the district court relied on the plaintiffs’ expert’s analysis purporting to show that the alleged conspiracy resulted in substantial price impacts that injured purchasers on a class-wide basis.

While the Ninth Circuit ultimately affirmed the granting of class certification in Olean, and rejected a per se ruling against certifying a class that contains more than a de minimis number of uninjured class members (a ruling which conflicts with decisions from the First and D.C. Circuits), the court’s opinion outlines a framework for class certification that creates significant hurdles for plaintiffs seeking to certify expansive classes, especially where proving injury at trial would require individualized adjudications.  Olean was covered in greater detail in our prior client alert, and we expect the case to impact all types of class actions in the Ninth Circuit, including consumer and employment cases.

The Sixth Circuit also confronted the issue of identifying injured class members in Tarrify Properties, LLC v. Cuyahoga County, 37 F.4th 1101 (6th Cir. 2022), which affirmed the denial of certification of a putative class of owners of abandoned properties to whom the defendant county failed to reimburse the remaining equity when it foreclosed on their properties.  Given the many factors that influence property values, the Sixth Circuit reasoned that determining whether any given property owner was owed money required “proof that is variable in nature and ripe for variation in application,” such that “mini-trials” would be necessary to determine the remaining equity in each foreclosed property.  Id. at 1106–07.  Moreover, the issue was one of determining injury—rather than damages—because “[t]he key impediment . . . is that the court must ask whether a given property’s fair market value exceeds the taxes owed at the time of the transfer to determine who is in the class.”  Id. at 1106.  The Sixth Circuit also rejected the plaintiff’s proposal to use tax appraisal values to determine whether each property owner had been harmed, calling that approach a “rough justice method” that failed to sufficiently account for “the vagaries of [determining] fair market value.”  Id. at 1106‒08.

Finally, the Third Circuit addressed the numerosity and commonality requirements of Rule 23 in Allen v. Ollie’s Bargain Outlet, Inc., 37 F.4th 890 (3d Cir. 2022), and vacated certification of an Americans with Disabilities Act class action against a retail operator with 400 retail stores across 29 states.  The plaintiffs had alleged that the retailer’s stores were inaccessible to disabled people using wheelchairs because the aisles were often blocked with merchandise.  To satisfy the numerosity requirement, the plaintiffs introduced census data estimating the number of people with ambulatory disabilities for each zip code with a store, 12 emails from patrons using wheelchairs, and evidence that 16 patrons using wheelchairs visited two stores in Pennsylvania over the course of one week.  To satisfy the commonality requirement, the plaintiffs argued that the retailer had nationwide store-layout policies that affected accessibility in its stores.  The district court granted certification, finding that the plaintiffs had proved there were at least 30 people in the putative class and that the proposed class members would have suffered the same injury stemming from the retailer’s alleged policies.

The Third Circuit reversed on both grounds.  On numerosity, the Third Circuit held that the plaintiffs’ evidence was “far too speculative” because the census data said nothing about the number of disabled people who actually shopped at the stores, the customer complaints were “few,” and there were no documented accessibility issues for those patrons recorded visiting the Pennsylvania stores.  Id. at 899–900.  In contrast to the plaintiffs’ “speculative” evidence, in order to satisfy numerosity, the plaintiffs would have needed to provide “concrete evidence of class members who have patronized a public accommodation and have suffered or will likely suffer common ADA injuries.”  Id. at 897.

On commonality, the Third Circuit held that “stitching together a corporate-wide class requires more” than showing “that [the defendant] has corporate policies and that some or all stores in Pennsylvania pay inadequate attention to aisle accessibility.”  Id. at 901.  Because the plaintiffs’ evidence of inaccessible aisles was limited to Pennsylvania, there was no way of knowing whether the retailer’s visual standards resulted in discrimination “in some regions” but not others.  Id. at 902.  It concluded that evidence from one state was not enough to support “[p]roceeding on a corporate-wide basis against a corporation with over four hundred stores in twenty-nine states.”  Id.

II.   The Eighth and Seventh Circuits Analyze Article III Standing in Light of Spokeo and TransUnion

As reported in prior updates, federal courts continue to assess whether named plaintiffs have adequately alleged Article III standing to bring a variety of claims commonly filed as class actions.  This past quarter was no different, with the Eighth Circuit and Seventh Circuit clarifying what constitutes a concrete Article III injury under Spokeo, Inc. v. Robins, 578 U.S. 330 (2016), and TransUnion LLC v. Ramirez, 141 S. Ct. 2190, 2200 (2021).

In Schumacher v. SC Data Center, Inc., 33 F.4th 504 (8th Cir. 2022), the Eighth Circuit held that the named plaintiff in a putative class action failed to sufficiently allege Article III standing based on a prospective employer’s purported failure to comply with several technical requirements of the Fair Credit Reporting Act (“FCRA”).  Siding with the Ninth Circuit—and disagreeing with the Third and Seventh Circuits—the Eighth Circuit first held that the prospective employer’s failure to provide the plaintiff with a copy of her consumer report before denying her employment did not qualify as an “injury in fact” sufficient to confer Article III standing.  Id. at 510–12.  Although the employer’s failure to provide the report deprived the plaintiff of an opportunity to explain prior convictions that had led to her denial of employment, the Eighth Circuit held that FCRA did not provide a right to explain an accurate consumer report.  Id. at 511‒12.  Second, the Eighth Circuit held that even though the employer violated FCRA by providing an improper disclosure form, that was only a “technical violation” of the statute that did not harm the plaintiff.  Id. at 512‒13.  Third, the Eighth Circuit held that the plaintiff lacked standing to challenge any alleged search of a sex-offender database without her authorization, since the plaintiff pled that it caused a mere “invasion of privacy,” which was not a sufficiently concrete harm.  Id. at 514.

The Seventh Circuit also addressed standing issues in Pierre v. Midland Credit Management, Inc., 29 F.4th 934 (7th Cir. 2022), where the court held that efforts to collect on a time-barred debt did not constitute injury for Article III standing.  The plaintiff in Pierre had defaulted on a credit card and was sued by the debt purchaser, but the lawsuit was subsequently dismissed.  After the statute of limitations had run on the debt collection, the defendant sent the plaintiff a letter seeking payment of the debt at a discount, while acknowledging that the plaintiff could not be sued over the debt because of its age.  The plaintiff claimed that the letter violated the Fair Debt Collection Practices Act (“FDCPA”) because it falsely represented the character of the debt.

The Seventh Circuit remanded with instructions to dismiss for lack of subject matter jurisdiction because the plaintiff had not established an Article III injury.  The Seventh Circuit held that, “critically,” the plaintiff “didn’t make a payment, promise to do so, or otherwise act to her detriment in response to anything in or omitted from the letter.”  Id. at 939.  Nor did psychological harm, such as the claimed “confusion” and “worry” arising from the letter, rise to a concrete injury.  Id.  “[A]t most,” the defendant’s letter created “a risk” of injury—which was “not enough to establish an Article III injury in a suit for money damages.”  Id. at 936 (citing TransUnion, 141 S. Ct. at 2210–11).

Judge David F. Hamilton, writing for three other judges dissenting from a subsequent denial of a petition for rehearing in Pierre, argued that intangible injuries, such as those advanced by the plaintiff, “could be concrete for purposes of standing” for violations of the FDCPA.  36 F.4th 728, 730 (7th Cir. 2022) (Hamilton, J., dissenting).

III.   The Third Circuit Upholds Late-Stage Removal Under CAFA

The Third Circuit issued a notable decision upholding a late-stage removal of a putative class action to federal court under CAFA, which normally requires defendants to file a notice of removal within 30 days from “receipt” of the “initial pleading setting forth the claim for relief.”  28 U.S.C. § 1446(b)(1).  CAFA also provides that “if the case stated by the initial pleading is not removable,” then a defendant’s removal is timely if filed within 30 days “after receipt by the defendant, through service or otherwise, of a copy of an amended pleading, motion, order or other paper from which it may first be ascertained that the case is one which is or has become removable.”  Id. § 1446(b)(3).

In McLaren v. UPS Store Inc., 32 F.4th 232, 241 (3d Cir. 2022), the Third Circuit held that the 30-day removal deadline under Section 1446(b)(3) is not triggered by the defendant’s possession of information about removability.  The litigation involved parallel state class actions alleging that the defendants’ stores charged an amount for notary services that exceeded the $2.50 fee permitted by New Jersey state law.  Id. at 234.  Neither state complaint alleged that the amount in controversy exceeded $5 million, as required for removal under CAFA.  Id. at 235.  During the course of the state litigation, one defendant produced a spreadsheet that disclosed the number of transactions at issue, revealing that each case had an amount in controversy exceeding $5 million.  Id.  Seven months later—and after an adverse appellate decision affirming denial of the defendants’ motion to dismiss—the defendants removed both complaints to federal court, asserting that CAFA’s jurisdictional requirements were met.  Id.  The district court remanded the cases back to state court, holding that the defendants’ removal was untimely under Section 1446(b).  Id.

The Third Circuit vacated the district court’s remand order, holding that the spreadsheet the defendant produced was not “recei[ved] by [d]efendant[s],” and thus did not trigger any 30-day removal clock.  Id. at 241.  The court reasoned that the removal clocks are triggered based only on what a defendant can ascertain from the four corners of a complaint or other paper the defendant “receives”—and that Section 1446(b) does not impose a duty to search company records to investigate possible removal.  Id. at 239.  Moreover, the statutory text “focuses only on what a defendant receives,” and “does not contemplate that the thirty-day clock would be triggered by information that the defendant already possesses or knows from its own records.”  Id. at 238.

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The following Gibson Dunn lawyers contributed to this client update: Katie Henderson, Sean Howell, Timothy Kolesk, Wesley Sze, Lauren Blas, Bradley Hamburger, Kahn Scolnick, and Christopher Chorba.

Gibson Dunn attorneys are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Class Actions, Litigation, or Appellate and Constitutional Law practice groups, or any of the following lawyers:

Theodore J. Boutrous, Jr. – Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com)
Christopher Chorba – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com)
Theane Evangelis – Co-Chair, Litigation Practice Group, Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com)
Lauren R. Goldman – New York (+1 212-351-2375, lgoldman@gibsondunn.com)
Kahn A. Scolnick – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7656, kscolnick@gibsondunn.com)
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, bhamburger@gibsondunn.com)
Lauren M. Blas – Los Angeles (+1 213-229-7503, lblas@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.