From the Financial Institutions Practice Group: We are pleased to provide you with the April edition of Gibson Dunn’s monthly U.S. bank regulatory update. This update covers recent federal banking agency initiatives and legal news updates on the Community Reinvestment Act final rules and Federal Reserve Bank master accounts.
KEY NEW DEVELOPMENTS
FDIC Board Members Withdraw Proposals to Monitor Asset Managers for Compliance with Change in Bank Control Act
At the Federal Deposit Insurance Corporation’s (FDIC) board meeting on April 25, 2024, FDIC Directors Jonathan McKernan and Rohit Chopra (Director of the Consumer Financial Protection Bureau) each put forth proposals to monitor large asset managers’ compliance with the Change in Bank Control Act with respect to their investments in depository institution holding companies and, indirectly, their insured depository institution subsidiaries. Director McKernan’s proposal would have required the FDIC’s Director of the Division of Risk Management Supervision to submit within 90 days for the review and approval of the FDIC Board a plan to (i) monitor compliance with any passivity commitment or other condition of any FDIC comfort provided to a “covered fund complex” and (ii) annually determine whether any covered fund complex controls, or has controlled, directly or indirectly an FDIC-supervised institution. Director Chopra’s proposal would have removed the exemption from the Change in Bank Control Act’s prior notice requirement for acquisitions of voting securities of a depository institution holding company with an FDIC-supervised subsidiary institution for which the Board of Governors of the Federal Reserve System (Federal Reserve) reviews a notice, thus requiring duplicative notices to be filed with both the Federal Reserve and FDIC.
- Insights: Director McKernan’s proposal garnered the support of Vice Chair Travis Hill and Director Chopra’s proposal garnered the support of FDIC Chairman Martin J. Gruenberg. Ultimately, though, neither had the support of Director Michael J. Hsu, Acting Comptroller of the Currency, who pushed for any proposed rulemaking to be done on an interagency basis. Although neither proposal was acted upon, given concerns raised by members of the FDIC Board, continued regulatory scrutiny on passivity commitments and the ownership of shares in financial institutions by large asset managers will undoubtedly remain.
FDIC Releases Comprehensive Report on Orderly Resolution of Global Systemically Important Banks
On April 10, 2024, the Federal Deposit Insurance Corporation (FDIC) released a comprehensive report regarding the orderly resolution of a large, complex financial company under Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The report first outlines the resolution-related provisions of the Dodd-Frank Act before describing key measures for planning and strategy in the event of a bank failure, with a particular eye towards the resolution of global systemically important banks (G-SIBs).
- Insights: In issuing the report, the FDIC aims to promote transparency around the G-SIB resolution process, a topic of significant relevance in light of recent regulatory reforms aimed at aligning the regulatory framework across the largest banks, including both G-SIBs and non-G-SIBs. Most notably, the FDIC affirmed its commitment to the Single Point of Entry strategy. By providing such clarity, G-SIBs can continue to better structure their organizations to account for a potential resolution scenario, which may in turn provide opportunities for realizing operational efficiencies. Moreover, the FDIC’s report can serve as a blueprint for those firms that are not G-SIBs but which, over time, may become subject to a regulatory framework that more closely aligns with the framework currently applicable to G-SIBs.
Federal Reserve Board Publishes Financial Stability Report
On April 19, 2024, the Board of Governors of the Federal Reserve System (Federal Reserve) published the its semi-annual Financial Stability Report. According to the Federal Reserve Bank of New York’s industry survey, persistent inflation and monetary policy tightening; policy uncertainty, including trade policy, foreign policy issues related to escalating geopolitical tensions and uncertainty associated with the upcoming elections; and commercial real estate market stress were the three most commonly cited potential risks to financial stability over the next 12 to 18 months. Though commercial real estate concerns and banking sector stress did decrease as financial stability risks compared to the fall 2023 semi-annual survey.
- Insights: In a nod to the Financial Stability Oversight Council’s (FSOC) focus on the potential risks to financial stability stemming from the use of leverage by certain hedge funds, the Federal Reserve’s report cites that “measures of hedge fund leverage increased in the third quarter of 2023 to the highest level observed since the beginning of data availability, with the increase driven primarily by the largest hedge funds.” This focus of course follows the FSOC’s easing of its process to designate nonbank financial companies as systemically important financial institutions, subject to any potential legal challenges. It remains to be seen whether in an election year any designations will be made by the FSOC.
Preliminary Injunction Delays Revised CRA Rules
In early February, seven industry and business associations sued the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (collectively, the Agencies) in the Northern District of Texas, seeking to block the Agencies’ final rules interpreting the Community Reinvestment Act of 1977 that were approved on October 24, 2023 and due to take effect beginning on April 1, 2024. According to the industry and business associations’ complaint, the Agencies exceeded their authority because the final rules provided that the Agencies would (1) “begin assessing banks’ activities outside of the locations where they maintain a physical presence and accept deposits, thus ignoring the critical geographic limits that Congress incorporated into the CRA,” and (2) “assess banks’ deposit products rather than the credit products that Congress targeted in the statute.” Finding that the trade associations “demonstrate[d] a substantial likelihood of success on the merits,” the District Court granted a preliminary injunction on March 29, 2024 and enjoined the Agencies from enforcing the final rules against the industry and business associations pending the resolution of the suit, and tolled the effective date and all associated implementation dates while the preliminary injunction remains in place. The Agencies are appealing the decision to the Fifth Circuit.
- Insights: Although the District Court prohibited the Agencies from enforcing the new CRA regulations against the specific plaintiffs to the case, those seven trade associations collectively represent a majority of U.S. banks. The Agencies have noticed their intent to challenge the injunction before the Fifth Circuit and also moved to stay further proceedings before the District Court, indicating that both the final rules, and the compliance efforts required to comply with them, may remain on hold for at least the near future.
Federal Reserve Prevails Against Depository Institutions Seeking Master Accounts
In late March, two U.S. District Courts upheld decisions by the Federal Reserve Bank of Kansas City (FRBKC) and the Federal Reserve Bank of San Francisco (FRBSF) to deny master account applications from two depository institutions. In Custodia Bank, Inc. v. Federal Reserve Board of Governors and Federal Reserve Bank of Kansas City, Custodia Bank sued FRBKC challenging the denial of its master account application in 2023. Custodia argued that FRBKC was statutorily required to grant master accounts to all legally eligible depository institutions. The U.S. District Court for the District of Wyoming disagreed, granting summary judgment in favor of FRBKC and finding that FRBKC had discretion to grant or deny master account applications. In a similar case involving the FRBSF, the applicant lost on a similar argument regarding FRBSF’s denial of its master account application in 2023. The applicant brought three claims against FRBSF, each ultimately predicated on the existence of a nondiscretionary duty to make a master account available to the applicant. The U.S. District Court for the District of Idaho found that no such duty exists, and that FRBSF accordingly exercised its lawful discretion in denying the application.
- Insights: In denying Custodia Bank’s application for a master account, FRBKC characterized Custodia’s business model as “unprecedented” in that it “proposes to focus almost exclusively on offering products and services related to novel crypto-asset activities and to accept entirely uninsured deposits.” FRBKC concluded that accepting deposits from Custodia into a master account would therefore “introduce undue risk” to the Reserve Bank and the economy at large. Likewise, FRBSF denied the pending application on the grounds that the applicant’s “novel, monoline business model” focusing largely on transactions that are either foreign in nature or involve mostly foreign participants “presents undue risk to the Reserve Bank.” FRBSF also considered the applicant’s risk management framework “insufficient” to address the heightened risks associated with its business model, and cited particular concerns with respect to money laundering, terrorism financing risks, and the potential for the applicant to allow the master account to fund or facilitate such illicit activities. While the District Courts’ decisions are not binding on other courts and are likely to be appealed, they do presently support the conclusion that the Federal Reserve maintains discretion to reject master account applications even in those cases involving eligible applicants. This may be especially true when those applicants are proposing novel business models that the Federal Reserve determines pose undue risk to financial stability or the efforts of the United States in combatting money laundering and the financing of terrorism.
FDIC’s Final Rule on Simplification of Deposit Insurance Rules for Trust and Mortgage Servicing Accounts Goes Effective April 1, 2024
On January 21, 2022, the Federal Deposit Insurance Corporation (FDIC) approved a final rule to amend the deposit insurance regulations for trust accounts and mortgage servicing accounts. The final rule became effective April 1, 2024. Under the final rule, irrevocable and revocable trusts are combined into a single category known as “Trust Accounts” for purposes of the deposit insurance coverage rules. Each Trust Account owner is insured up to $250,000 per eligible primary beneficiary, up to a maximum of five beneficiaries. The FDIC published a presentation highlighting the final here.
- Insights: Although insured depository institutions have had more than two years to prepare for changes in coverage, not all Trust Account owners or their beneficiaries may be aware of the changes to the new rule, which could reduce deposit insurance coverage in those cases where Trust Account owners (1) own both revocable and irrevocable trust accounts; and/or (2) have more than five beneficiaries. Clear communication to new and existing customers will be critical in ensuring that customers have an adequate understanding of the impacts, if any, of the new rules on their deposit insurance coverage. In other cases, deposit insurance limits will increase for irrevocable trust owners, which will be calculated in the same manner as revocable trusts, up to a maximum of five beneficiaries.
Speech by Board of Governors of the Federal Reserve System Governor Michelle W. Bowman on Bank Mergers and Acquisitions
On April 2, 2024, Federal Reserve Governor Michelle W. Bowman gave a speech titled “Bank Mergers and Acquisitions, and De Novo Bank Formation: Implications for the Future of the Banking System” in which she was critical of the “broad-based and insufficiently focused reform agenda” of the federal bank regulatory agencies which creates higher barriers to entry for de novo banks, reduces efficiencies in bank M&A, and increases opportunities for “regulation by application” rather than relying on statutes, regulations, and rulemakings.
- Insights: Governor Bowman’s speech highlights the obstacles to de novo bank formation and Bowman stressed that the “absence of de novo bank formation over the long run will create a void in the banking system.” She also highlighted her “more immediate concern” with the “dramatically evolving” approach” to bank M&A by prudential regulators. She concluded by reiterating her consistent message of the need to rationalize competing regulatory approaches to ensure the long-term viability of banks.
Federal Reserve Board Governor Bowman Speaks on Bank Liquidity, Regulation and the Federal Reserve’s Role as Lender of Last Resort
On April 3, 2024, Federal Reserve Board Governor Michelle W. Bowman gave a speech titled “Bank Liquidity, Regulation, and the Fed’s Role as Lender of Last Resort.” In her speech, Governor Bowman highlighted the Federal Reserve’s role as a lender of last result, including with respect to potential changes to the liquidity framework supporting the U.S. banking system. Governor Bowman acknowledged that the spring 2023 bank failures have created pressure to pass additional regulations relating to regulatory capital and/or liquidity, but Governor Bowman cautioned that, “…we should think about the response to banking stress more broadly….” In order to do so, Governor Bowman urged the Federal Reserve to analyze the challenges facing, and tools available to, the Federal Reserve’s liquidity and regulatory capital frameworks. With respect to the former, Governor Bowman highlighted the “perception of stigma” associated with utilizing the Federal Reserve discount window. With respect to the latter, Governor Bowman highlighted both available technology and the Federal Reserve’s prudential regulatory authority. Governor Bowman also discussed potential requirements relating to the pre-positioning of collateral with the Federal Reserve in order to access the discount window, reiterating the need to analyze the “important but as yet unanswered questions” associated with such requirements.
- Insights: Governor Bowman is clear in her remarks that the “expectation should not be that the Federal Reserve replaces existing sources of market liquidity for banks in normal times” and reiterated the Fed’s discount window as a “source of backup liquidity.” She reiterated her consistent message of the need for the agencies to “focus on improving the targeted approach of supervision, to enhance the ‘prevention’ of banking system stress,” and described the need to consider the liquidity framework in a “broad-based manner” so that “the available tools, resources, and requirements are working in a complementary way.”
New York Fed Announces Participation in Joint International Research Effort on Tokenization and Cross-Border Payments
On April 3, 2024, the Federal Reserve Bank of New York (FRBNY) announced that it will participate in an international technical research project, Project Agorá, that will explore whether the tokenization of central bank money and commercial bank deposits operating on a shared programmable ledger can improve wholesale cross-border payments. Project Agorá, a new effort led by the Bank for International Settlements Innovation Hub in partnership with the Institute of International Finance, will bring together seven central banks and financial institutions from each of their respective jurisdictions to research ways to increase the speed and transparency of international wholesale payments and lower associated costs and risks. The project will focus on overcoming common structural inefficiencies in cross-border payments today related to differing legal, regulatory, and technical requirements, operating hours and time zones, and varying financial integrity controls. Including the FRBNY, the seven participating central banks are the Bank of England, Bank of France, Bank of Japan, Bank of Korea, Bank of Mexico, and the Swiss National Bank.
- Insights: Integration of tokenized commercial bank deposits with tokenized wholesale central bank money could lead to improvements in the monetary system’s functionality and offer innovative solutions utilizing smart contracts and programmability, all while preserving its existing two-tier structure. While the FRBNY’s participation in Project Agorá is explicitly limited to research and experimentation, the participation alone marks a significant milestone for cross border Central Bank Digital Currency (CBDC) initiatives. Unlike early adoptions of a CBDC, like the Bahamas’ Sand Dollar or Uruguay’s e-Peso pilot plan, the United States has been hesitant to commit to the development or use of a CBDC. The United States’ involvement in Project Agorá does signify the United States’ further involvement in exploring the cross-border use for a CBDC but should not be read as a commitment to develop a US Dollar CBDC.
OTHER DEVELOPMENTS / RELEVANT LINKS
- FDIC Board releases the first semiannual update of 2024 on the Restoration Plan for the agency’s Deposit Insurance Fund (see also Statement by FDIC Chairman Martin J. Gruenberg; Memorandum to the FDIC Board),
- Federal Reserve staff publishes FEDS Notes article titled, “Tokenized Assets on Public Blockchains: How Transparent is the Blockchain?”
- Federal Reserve Bank of New York publishes a Liberty Street Economics blog post titled, “Can I Speak to Your Supervisors? The Importance of Bank Supervision.”
- Federal Reserve Bank of New York publishes a Liberty Street Economics blog post titled, “Internal Liquidity’s Value in a Financial Crisis.”
- Federal Reserve Bank of New York publishes a Staff Report titled, “Investor Attention to Bank Risk During the Spring 2023 Bank Run.”
The following Gibson Dunn attorneys contributed to this issue: Jason Cabral, Rachel Jackson, Zach Silvers, Karin Thrasher, Andrew Watson, and Nathan Marak.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Financial Institutions or Global Financial Regulatory practice groups, or the following:
Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)
Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)
M. Kendall Day, Washington, D.C. (202.955.8220, kday@gibsondunn.com)
Jeffrey L. Steiner, Washington, D.C. (202.887.3632, jsteiner@gibsondunn.com)
Sara K. Weed, Washington, D.C. (202.955.8507, sweed@gibsondunn.com)
Ella Capone, Washington, D.C. (202.887.3511, ecapone@gibsondunn.com)
Rachel Jackson, New York (212.351.6260, rjackson@gibsondunn.com)
Chris R. Jones, Los Angeles (212.351.6260, crjones@gibsondunn.com)
Zack Silvers, Washington, D.C. (202.887.3774, zsilvers@gibsondunn.com)
Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)
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We are pleased to provide you with the April 2024 edition of Gibson Dunn’s digital assets regular update. This update covers recent legal news regarding all types of digital assets, including cryptocurrencies, stablecoins, CBDCs, and NFTs, as well as other blockchain and Web3 technologies. Thank you for your interest.
ENFORCEMENT ACTIONS
UNITED STATES
- Mango Markets Exploitation Jury Finds Avraham Eisenberg Guilty of Fraud and Market Manipulation
On April 18, jurors in the Southern District of New York found Avraham Eisenberg, a cryptocurrency trader, guilty of fraud and market manipulation following a two-week jury trial. In October 2022, Eisenberg executed several purchases on Mango Markets, a decentralized exchange, in an effort to artificially raise the price of the MNGO token relative to the USD Coin, while holding MNGO perpetual futures. Eisenberg then used his perpetual futures as collateral to borrow and withdraw approximately $116 million worth of various crypto assets from Mango Markets, effectively draining all available assets from the platform. Eisenberg claimed he legally obtained the funds, and he returned $67 million in crypto to Mango Markets. He was arrested in Puerto Rico in December 2022. U.S. Attorney Damian Williams said the conviction was the first ever in a cryptocurrency market manipulation case. In addition to these criminal charges, Eisenberg faces civil charges from the SEC and CFTC for violations of the anti-fraud and market manipulation provisions of the securities laws. Reuters; Law360; Cointelegraph; Business Insider; Cointelegraph [2]. - SEC Warns of Potential Enforcement Action Against Uniswap Labs
On April 9, Uniswap Labs published a blog post that it had received a Wells notice from the SEC, indicating that the SEC staff would be recommending legal action against Uniswap Labs. The Uniswap Protocol is the largest decentralized trading and automated market making protocol on Ethereum, having reportedly processed over $2 trillion worth of transactions since first launching in 2018. Uniswap Labs builds products to support the Uniswap ecosystem. Uniswap Labs vowed to fight the charges.Uniswap Labs, as with other firms that receive a Wells notice, is permitted to respond in writing concerning why litigation by the SEC would be inappropriate. The SEC has not yet commented on any actions against Uniswap Labs, and no further details on potential litigation were currently available at publishing. Uniswap Labs Blog Post; Reuters; WSJ; Cointelegraph. - DOJ Arrests and Charges Founders and CEO of Bitcoin Mixing Service Samourai Wallet With Money Laundering and Unlicensed Money Transmitting Offenses
On April 24, federal prosecutors charged the founders of Samourai Wallet, a crypto-mixing firm, with conspiracy to commit money laundering and operating an unlicensed money transmitter business. The government alleges that Samourai executed over $2 billion in unlawful transactions and laundered more than $100 million via illegal dark web markets. The government alleges that the founders encouraged and invited users to launder criminal proceeds, citing tweets and private messages; and that the platform was used to wash funds connected to Silk Road and Hydra Market. The DOJ also seized Samourai Wallet, which was hosted in Iceland, and has issued a warrant for its mobile app. The app is still available in Europe. Indictment; DOJ Press Release; Axios; CoinDesk; CoinDesk [2]. - Jury Returns Verdict in SEC’s Case against Do Kwon, Terraform Labs
On April 5, a New York jury began deliberations and returned a verdict the same day in the SEC’s case against Terraform Labs and its founder, Do Kwon, finding both liable on civil fraud charges following a two-week trial. The SEC accused the defendants of misleading investors about the stability of Terra USD (USDT), an “algorithmic stablecoin” that was supposed to maintain a peg to the U.S. dollar. In May 2022, USDT unpegged, resulting in a loss of about $40 billion in market value. CoinDesk; CNBC; Reuters. - Federal Court Rejects SEC’s Claim that Coinbase Acted as Unregistered Broker, But Permits Remainder of SEC’s Case Against Coinbase to Proceed; Coinbase Requests Interlocutory Appeal
On March 27, U.S. District Court Judge Katherine Polk Failla (SDNY) granted in part and denied in part Coinbase’s motion for judgment on the pleading in the SEC’s enforcement action against the company. Judge Failla rejected the SEC’s claim that Coinbase acted as an unregistered broker by making its Wallet application available to its customers. Judge Failla also ruled that the rest of the SEC’s claims—including that Coinbase engaged in unregistered sales of securities—could proceed to discovery. On April 12, Coinbase asked the district court to certify an interlocutory appeal that would allow the Second Circuit to immediately consider whether the SEC may regulate as “investment contracts” digital asset transactions that involve no obligation running to the purchaser beyond the point of sale. CNBC; Pymnts; Bitcoin.com; CoinDesk. - Sam Bankman-Fried Files Appeal of Conviction and Sentence
On April 12, less than two weeks after receiving a 25-year prison sentence, Bankman-Fried appealed his conviction and sentence to the Second Circuit. This followed Bankman-Fried’s request to Judge Kaplan to remain at the Metropolitan Detention Center in Brooklyn, rather than transfer to a federal prison in the Bay Area, to pursue the appeal. Bankman-Fried’s lawyers have not indicated the grounds for appeal, though Bankman-Fried noted in emails to ABC News that new evidence existed that was not considered during the trial, that there were procedural flaws, and that there were improper collaborations between FTX’s bankruptcy counsel and federal prosecutors. Notice of Appeal; Forbes; ABC News; Cointelegraph; Daily Coin. - OneCoin’s Legal Boss Gets Four Years in Jail for $4 Billion Crypto Scam
On April 4, the former head of legal and compliance for OneCoin, Irina Dilkinska, was sentenced to four years in jail for her role in the infamous $4 billion crypto Ponzi scheme after admitting she helped launder millions of dollars. Judge Edgardo Ramos (SDNY) also imposed one month of supervised release and a forfeiture of $111 million as restitution. Dilkinska pled guilty to wire fraud and money laundering charges in the Southern District of New York in November 2023. This comes after OneCoin’s co-founder, Karl Sebastian Greenwood, was sentenced to 20 years in prison and ordered to pay $300 million in restitution for his involvement in the scam. The other main co-founder, Ruja Ignatova, remains at large. US Attorneys’ Office Press Release; Reuters; Bloomberg; CoinDesk.
INTERNATIONAL
- Filecoin Foundation Investigating Reported Detention of Filecoin Liquid Staking (STFIL) Team Members in China
On April 8, Filecoin Foundation, a nonprofit that promotes the development of Web3 storage protocol Filecoin, reported that core technical members of its STFIL team were detained by Chinese authorities. Filecoin is a decentralized storage protocol that allows PC owners to rent out their hard disk space to users with data storage needs. Filecoin reported that withdrawals from the STFIL protocol stopped working at the same time, after a developer wallet made several unscheduled upgrades, and moved $23 million worth of Filecoin tokens to an address whose owner is unknown. Filecoin noted that it has local counsel in China looking into the incident. The Foundation has been unable to confirm whether authorities have taken possession of the funds, or to determine who is holding the STFIL team in custody. Filecoin is the latest in a set of Web3 platforms that have encountered criminal legal action in China. Cointelegraph; The Block.
REGULATION AND LEGISLATION
UNITED STATES
- IRS Releases Draft Form to Report Crypto Gains in 2025
On April 19, the IRS released draft Form 1099-DA, to be used by crypto brokers to report taxable gains or losses regarding crypto trades. The form, which is similar to Form 1099-B, has an array of individual token codes that can be filled in, as well as spaces for wallet addresses and where to find transactions on the relevant blockchain. This version of the form asks the filer to check a box that describes the type of broker they are: kiosk operator, digital asset payment processor, hosted wallet provider, unhosted wallet provider or “other.” The unhosted wallet provider option appears to refer to self-custodial crypto addresses unaffiliated with any third party. Some commentators have suggested that these fields mean that the IRS aims to classify DeFi protocols as brokerage firms, revealing personal information, and potentially undermining the benefits of pseudonymity that the crypto industry offers. Some in the crypto industry have expressed interest in litigating the issue. The form, however, remains in draft, and may change before 2025. As part of the drafting process, the IRS has invited public comment. Draft Form; Reuters; Politico; CoinDesk, DeCrypt. - SEC Calls for Comments on Spot Ether ETF Applications
On April 2, the SEC solicited comments from the public regarding the proposed listing of spot Ether ETF applications on the New York Stock Exchange (“NYSE”). Under the proposed rule, the Ethereum ETF would be listed as a commodity-based trust share on the NYSE. The public had until April 23 to comment. SEC Request; Cointelegraph. - CFPB Flags Risks in Virtual Crypto Economies
On April 4, the CFPB released its report on banking in the gaming and virtual worlds. The report highlighted the growth of crypto-assets in both sectors, and stated that online video games and virtual worlds are becoming akin to traditional banking but lack federal protections. The agency received complaints regarding hacking attempts, account theft, and assets lost within games, with consumers expressing dissatisfaction over the lack of support from gaming companies. This report comes after the CFPB proposed a rule in November 2023 titled “Defining Larger Participants of a Market for General-Use Digital Consumer Payment Applications.” This rule grants the agency oversight over “larger nonbank firms” providing digital wallet and payment app services. Crypto industry insiders suggest that such reports could signal upcoming actions by the CFPB. CFPB Report; CFPB Proposed Rule; Cointelegraph. - SEC Delays Decision on Bitcoin ETF Options
On April 8, the SEC postponed its decision on the NYSE proposed rule change to amend Rule 915 to permit the listing and trading of options on any trust that holds Bitcoin. The proposed rule change was published for comment in the Federal Register on February 29, 2024. Citing the need for more time in order to adequately consider the proposed rule change, the SEC designated May 29, 2024, as the day by which the commission would make a decision on the NYSE’s proposed rule. SEC Filing; Cointelegraph. - Senators Gillibrand and Lummis Introduce Stablecoin Bill
On April 17, Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) introduced the Lummis-Gillibrand Payment Stablecoin Act, which would prohibit “unbacked, algorithmic stablecoins,” require one-to-one cash reserves for issuers, create state and federal regulatory regimes for firms and prevent illicit uses of stablecoins. Other provisions would permit state non-depository trust companies to issue up to $10 billion in payment stablecoins, with authorized institutions able to issue stablecoins “up to any amount” under a limited-purpose state charter. The bill also aims to uphold the current system of state and federal charters and established rules on custody for non-depository trust companies. Finally, the bill deals with insolvency: should a stablecoin issuer experience insolvency, the FDIC can be granted conservatorship and resolution. Senator Sherrod Brown (D-OH) and Representative Patrick McHenry (R-NC) both expressed cautious optimism regarding advancing the bill. Gillibrand Press Release; Bloomberg; Cointelegraph; The Block; CoinDesk; CoinDesk [2]. - Arkansas Senate Passes Two Bills Restricting Cryptocurrency Mining
On April 18, amended legislation aiming to prohibit the establishment of crypto mining facilities and activities involving the creation, preservation, storage, and trade of cryptocurrencies passed the Arkansas Senate. The legislation aims to limit crypto mining operations in the state through a variety of regulations, including through noise limits on mining operations, prohibitions on ownership by foreign entities, grants of authority to local governments to pass ordinances regulating mines, licensing of crypto mining operations by the State Department of Energy and Environment, and special requirements on electricity rates. Arkansas Senate; Arkansas Advocate; Arkansas Democrat Gazette.
INTERNATIONAL
- Hong Kong Regulator Approves Bitcoin and Ether ETFs
On April 15, Hong Kong’s Securities and Futures Commission (SFC) approved Bitcoin and Ether exchange traded funds (ETFs), permitting three firms to (conditionally) offer spot Bitcoin and Ether ETFs. The three firms are ChinaAMC, Harvest Global, and Bosera International. While no timeline has been provided for when the batch of approved ETFs can begin trading on regulated exchanges, the conditional approval signals that Hong Kong is becoming a hub for crypto market innovation. CNBC; Reuters; Elliptic. - South African Crypto Exchange VALR Has Received Regulatory Approval from the Country’s Financial Watchdog
On April 15, South African crypto exchange VALR reported that it had obtained a license from the country’s financial regulator. The company, which was valued at $240 million two years ago, is part of the first batch of crypto firms—along with exchange platform Luno and crypto social investment platform Zignaly—to obtain approvals from South Africa’s Financial Sector Conduct Authority (FSCA). VALR now has both Category I and Category II crypto asset service provider (CASP) licenses. A Category I license is the standard financial service provider required for a CASP; a Category II license enables customers to give VALR and other licensed Category II financial service providers (FSPs) a mandate to use its discretion to structure customers’ portfolio, among other things. VALR serves over 1,000 corporate and institutional clients and more than half a million crypto traders worldwide. VALR Blog; CoinDesk; Cointelegraph. - Norwegian Government Introduces Law for Data Centers, to Block Energy-Intensive Crypto Mining
On April 15, a local news outlet in Norway reported that the Norwegian government is attempting to restrict crypto mining in the country by regulating data centers, according to two ministers. Both lawmakers stated that they did not want crypto mining in the country, because of the emissions caused by mining. CoinDesk; Crypto News; VG Norway. - As Markets in Crypto-Assets (MiCA) Regulation to Take Effect, Germany’s Largest Federal Bank to Offer Crypto Custody Services
Banks in Germany are preparing for the European Union’s MiCA regulation that will take full effect in December 2024 as the first comprehensive legal framework for the crypto industry. MiCA will make crypto exchanges fully regulated entities, but the bill is still being finalized. Hand-in-hand with this forthcoming regulation, on April 15,the Landesbank Baden-Wurttemberg announced that it would start offering crypto custody services to institutional clients, in partnership with the Austria-based Bitpanda cryptocurrency exchange, beginning in the second half of 2024. The Landesbank Baden-Württemberg will tap Bitpanda’s institutional custody solution for its offering. Bitpanda Custody is a crypto custody platform with decentralized finance (DeFi) capabilities, registered with the United Kingdom’s Financial Conduct Authority (FCA). Cointelegraph; Coinedition. - Sweden Demands $90 Million in Outstanding Tax from Crypto Miners
On April 18, the Swedish Tax Agency announced that 18 crypto miners filed misleading or incomplete information to benefit from tax incentives. Some businesses provided the government with misleading business descriptions in order to obtain exemptions to paying value added tax on taxable operations. Others found ways to skirt import tax requirements and income tax on mining revenue. The crypto mining companies appealed the tax bill; two companies won on appeal, while the remaining sixteen lost. Law360; Cointelegraph. - Binance Wins Dubai Cryptocurrency Virtual Asset Service Provider License
On April 18, Dubai granted Binance a full regulatory Virtual Asset Service Provider (“VASP”) license. The license will allow Binance to target retail clients, in addition to qualified and institutional clients. This allows the platform to extend its offerings beyond spot trading and fiat services, expanding to margin trading products and staking products. This stage of approval comes almost a year after Binance secured its third-stage license. Bloomberg; Reuters; CoinDesk.This comes while Dubai’s Virtual Asset Regulatory Authority (VARA) is considering alleviating the financial burdens for smaller crypto businesses, by reducing the cost of compliance for smaller entities. Cointelegraph.
CIVIL LITIGATION
UNITED STATES
- Consensys Files Suit Against SEC, Seeking Declaration that Ethereum is Not a Security
On April 25, software developer Consensys filed a lawsuit against the SEC in the Northern District of Texas, arguing that the SEC lacks authority to regulate the ether cryptocurrency (ETH) or the MetaMask wallet developed by Consensys, and that any investigation of Consensys based on the idea that ETH is a security would violate the Due Process Clause and the Administrative Procedure Act. Consensys also argued that MetaMask is not a broker and that its staking service does not violate the securities laws. The complaint seeks declaratory relief and injunction preventing the SEC from investigating or bringing an enforcement action premised on ETH transactions being securities or related to MetaMask’s swaps or staking functions. The complaint was filed after Consensys reportedly received a Wells notice from the SEC on April 10, indicating the SEC’s intention to bring an enforcement action against the company. Complaint; Reuters; Bloomberg; CoinDesk. - Blockchain Association and Crypto Freedom Alliance of Texas Challenge SEC’s Dealer Rule
On April 23, the Blockchain Association and the Crypto Freedom Alliance of Texas sued the SEC in the Northern District of Texas, challenging a rule that broadly defines a “dealer” of securities. Under the rule, entities newly deemed to be dealers would face significant new burdens and costs, including capital and registration requirements. The plaintiffs argue that the dealer rule is too broad in scope (affecting participants and traders in DeFi, rather than just dealers), does not properly explain the rule’s impact on crypto market participants, and ignores the feedback the SEC received during the rule’s public comment period. This case joins another challenge to the dealer rule filed in the same court earlier this year by three associations of private fund advisers. Complaint; WSJ; CoinDesk. - SEC Lawyers Forced to Resign After Utah Judge Censures SEC for Abuse of Power in Crypto Case
On March 18 a federal judge in Utah found that the SEC had abused its power in SEC v. Digital Licensing Inc., No. 2:23-cv-00482 (D. Utah, Mar. 18 2024), leading to the resignation of two SEC lawyers, Michael Welsh and Joseph Watkins. The SEC brought a case against Digital Licensing, which operates the blockchain company DEBT Box, accusing the company of defrauding investors of more than $50 million. But Chief District Judge Robert Shelby said that the SEC acted in “bad faith” and was “deliberately perpetuating falsehoods” in order to obtain an asset freeze and a temporary restraining order against the company. The judge also sanctioned the SEC, requiring it to pay attorneys’ fees and costs for DEBT Box. In December, SEC enforcement chief Gurbir Grewal apologized to the court for his department’s conduct. He said that he had appointed new attorneys to the case and mandated training for the agency’s enforcement staff. Opinion; Bloomberg; Reuters. - Former FTX Executives to Settle Class Action Lawsuit for $1.36 Million
On March 27, former FTX and Alameda executives came to a nearly $1.36 million settlement with a class action group of the crypto exchange’s former investors who are seeking compensation for allegedly being defrauded. Zixiao “Gary” Wang, FTX’s co-founder, Nishad Singh and Caroline Ellison each agreed to provide information in connection with the lawsuit to resolve claims against them. Notably, none of the executives admitted fault to any allegations made against them in the lawsuit, but the class group determined that their information would help strengthen its case against others it sued, including celebrities, companies, and venture capitalists. Wang, Singh and Ellison additionally agreed to provide records used in FTX’s bankruptcy case, generally make themselves available for hearings and depositions, and forfeit their assets in their criminal case. Under the settlement agreement, the executives may not oppose a request from FTX investors that their assets be distributed through the class suit rather than through FTX’s bankruptcy or other lawsuits. CoinTelegraph; Yahoo Finance. - Wyoming Federal District Court Upholds Federal Reserve’s Rejection of Custodia Bank’s Master Account Application
On March 29, the Federal District Court of Wyoming rejected Wyoming-based Custodia Bank’s argument that it is entitled to a Federal Reserve master account and membership with the Fed. Custodia Bank is a special purpose depository institution allowing a full suite of financial services both for U.S. dollars and digital assets. In the Opinion, the court held that federal laws do not require the nation’s central bank to give every eligible depository institution access to its master account system, nor did the provided evidence suggest that the Federal Reserve Board of Governors influence a regional branch of the Fed to deny its application for an account. Instead, the court found that the Kansas City Fed likely made the decision, not at the behest of the Board. In 2023, the Fed opined that it had concerns about the sustainability of a crypto-focused bank, despite Custodia’s sufficient capital and resources to launch. The Fed noted that Custodia had significant deficiencies in its ability “to manage the risks of its day-one activities,” and did not think that Custodia could handle basic safety measures or comply with banking laws regarding money laundering. Opinion; CoinDesk; CoinDesk (2023). - Google Files Lawsuit Against Alleged Crypto Scammers
On April 4, Google filed a lawsuit in the Southern District of New York against Yunfeng Sun and Hongnam Cheung for allegedly uploading fraudulent investment apps to Google Play and committing hundreds of acts of wire fraud, harming Google and approximately 100,000 Google users. Google argued that the defendants made numerous misrepresentations to be able to upload their apps to Google Play, including misrepresentations about their identity, location and the nature of the applications. Google alleges that its users were promised high returns for investing in crypto and related products, but that customers who made deposits through the defendants’ apps were unable to withdraw their funds and were required to pay various fees when they attempted to access their funds, which they were still unable to do even after paying such fees. CoinDesk; Blockworks.
SPEAKER’S CORNER
UNITED STATES
- Senators Elizabeth Warren and Chuck Grassley Demand that CFTC Chair Explain His Chats with Sam Bankman-Fried
Senator Warren (D-MA) and Senator Chuck Grassley (R-IA) are demanding more information from the CFTC Chair, Rostin Benham, regarding Benham’s contact with Sam Bankman-Fried, the former FTX CEO sentenced to 25 years. Benham has disclosed meetings with Bankman-Fried, but has not provided all the records regarding these meetings. Benham and his team met with Bankman-Fried ten times at the CFTC, and Benham told lawmakers that he’d also exchanged messages with Bankman-Fried. The written communication from the senators demands all written communications, plus minutes and timelines of their interactions. The CFTC has said it will provide the information the senators are asking for. Business Insider.
INTERNATIONAL
- New Zealand Minister of Commerce Andrew Bayly Says New Zealand Should Regulate Crypto Sector to Facilitate Growth of Industry
On April 10, 2024, New Zealand Minister of Commerce Andrew Bayly said that the country should support crypto industry growth and take an evidence-based approach to regulating the sector. Bayly noted that doing otherwise might risk New Zealand losing out on the industry, including the financial and technological benefits from the industry’s growth. Advisors to the ministry have proposed a variety of actions for New Zealand to catch up with the global trends towards crypto, including creating supportive policies for blockchain and digital assets, promoting government-industry collaboration, and adopting crypto-friendly measures such as educational initiatives and AML enhancements. Bayly Statement; CoinDesk. - UK Lawmakers Call for the Government to Further Develop Crypto and Blockchain Skills Pipeline
On April 17, UK Parliament’s MP Lisa Cameron called for the government to ensure that digital skills are taught from the early stages of education and in the workplace. Although the government has said it wants to make the country a hub for crypto, Cameron called for more to be done beyond recognizing crypto as a regulated activity. Cameron also noted that there should be greater partnerships with blockchain companies. CoinDesk. - Executive Director for UK’s FCA Emphasizes Crypto-User Protection Over Registration Speed
Despite these pro-crypto calls by UK lawmakers, members of the industry have said that the UK’s Financial Conduct Authority (FCA) takes too long to approve crypto application. Sarah Pritchard, the executive director for markets and international at the FCA, spoke at TheCityUK conference, noting that “[a] simple focus on numbers could undermine trust and reputation” and “[l]ower standards could leave open our market to abuse by those who seek to launder criminally made cash, damaging market integrity and confidence in financial markets,” Pritchard said. “Instead, we take a longer view. Crypto’s success – and the success of any base for crypto firms – relies on trust being built and maintained.” CoinDesk.
OTHER NOTABLE NEWS
- Immunefi’s Research Report Shows Crypto Industry Saw 23% Decline in Losses Due to Hacking and Scams in 1Q 2024, Compared to 2023
Immunefi, a leading Web3 bug bounty platform, released its Quarterly Report on March 30, which showed that the amount lost to hacking and fraud incidents in Q1 of 2024 amounted to approximately $336.3 million, down from $437.5 million in Q1 of 2023. The report covers 46 hacking incidents and 15 cases of fraudulent activities. Two projects accounted for the bulk of the losses, totaling $144.5 million, or 43% of the overall amount. The largest attack, causing $81.7 million in loss, targeted the cross-chain bridge protocol Orbit Bridge on New Year’s Eve. The second largest attack was a $62 million exploit on the nonfungible token game Munchables, but the funds were recovered within 24 hours. In total, almost $73.9 million (22%) of the stolen funds from seven exploits in Q1 were recovered. Hacks accounted for 95.6% of losses, with fraud, scams, and rug pulls accounting for the rest. Report; Cointelegraph; CoinDesk. - Shomari Figures, Alabama Democratic Candidate for House, Wins Primary After Receiving $2.7 Million in Outside Support from Digital Asset Industry’s Major Campaign Finance Operation
On April 16, Shomari Figures, a Washington insider, won the Alabama House Democratic Primary runoff with 61% of the vote. The crypto-friendly candidate dominated the field, and received $2.7 million from a political action committee (PAC) backed by the cryptocurrency industry, Protect Progress. CNN; Alabama Political Reporter; CoinDesk. - Security Alliance (SEAL) Has Recovered $50 Million in Assets Since Its Inception in 2023; Launches Threat-Sharing Platform to Support Crypto Space
SEAL, a team of white-hat hackers, said it recovered $50 million in assets since its inception in 2023. On April 17, the alliance announced its threat-sharing platform, SEAL Information Sharing and Analysis Center (ISAC), to support the crypto space. The platform is purpose-built for crypto aiming to protect against cyberattacks and financial crimes, and does so by providing security intelligence and connections to experts. Nearly twenty crypto organizations have joined the initiative. SEAL ISAC Website; Cointelegraph; Business Wire. - Moody’s Says Tokenization Could Boost Liquidity for Alternative Assets
A new Moody’s report found that tokenization could offer a solution to the liquidity issues facing alternative assets, such as natural resources and private equity, by converting them into digital tokens on blockchain networks. That process could lower barriers to entry, increase transparency, and facilitate fractionalized ownership, potentially creating a more liquid secondary markets for these assets. Although tokenization has the potential to reduce costs for investors and distributors, hurdles such as regulatory uncertainty, technical challenges, and interoperability issues need to be addressed in order to achieve widespread adoption. Report; Ledger Insights.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s FinTech and Digital Assets practice group, or the following:
FinTech and Digital Assets Group:
Ashlie Beringer, Palo Alto (650.849.5327, aberinger@gibsondunn.com)
Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com
Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)
Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)
Ella Alves Capone, Washington, D.C. (202.887.3511, ecapone@gibsondunn.com)
Grace Chong, Singapore (+65 6507 3608, gchong@gibsondunn.com)
M. Kendall Day, Washington, D.C. (202.955.8220, kday@gibsondunn.com)
Michael J. Desmond, Los Angeles/Washington, D.C. (213.229.7531, mdesmond@gibsondunn.com)
Sébastien Evrard, Hong Kong (+852 2214 3798, sevrard@gibsondunn.com)
William R. Hallatt, Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)
Martin A. Hewett, Washington, D.C. (202.955.8207, mhewett@gibsondunn.com)
Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)
Stewart McDowell, San Francisco (415.393.8322, smcdowell@gibsondunn.com)
Mark K. Schonfeld, New York (212.351.2433, mschonfeld@gibsondunn.com)
Orin Snyder, New York (212.351.2400, osnyder@gibsondunn.com)
Jeffrey L. Steiner, Washington, D.C. (202.887.3632, jsteiner@gibsondunn.com)
Eric D. Vandevelde, Los Angeles (213.229.7186, evandevelde@gibsondunn.com)
Benjamin Wagner, Palo Alto (650.849.5395, bwagner@gibsondunn.com)
Sara K. Weed, Washington, D.C. (202.955.8507, sweed@gibsondunn.com)
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The obligations apply with respect to a company’s own operations and those of its subsidiaries — but also to those carried out by a company’s “business partners” in the company’s “chain of activities”.
On 24 April 2024, the Corporate Sustainability Due Diligence Directive[1] (“CSDDD” or “Directive”) was finally passed by the European Parliament (“Parliament”), marking the end of the key stages of the legislative process, after four years. The CSDDD establishes far-reaching mandatory human rights and environmental obligations on both European Union (“EU”) and non-EU companies meeting certain turnover thresholds, starting from 2027. Those obligations apply with respect to a company’s own operations and those of its subsidiaries—but also to those carried out by a company’s “business partners” in the company’s “chain of activities”.[2] Generally, the CSDDD, one of the most debated pieces of European legislation of recent times, establishes an obligation on in-scope companies to:
- identify and assess (due diligence) adverse human rights and environmental impacts;
- prevent, mitigate and bring to an end / minimise such adverse impacts; and
- adopt and put into effect a transition plan for climate change mitigation which aims to ensure—through best efforts—compatibility of the company’s business model and strategy with limiting global warming to 1.5 °C in line with the Paris Agreement.
The CSDDD also sets out minimum requirements (including the ability for claims to be made by trade unions or civil society organisations) of a liability regime to be implemented by EU Member States for violation of the obligation to prevent, mitigate and bring to an end / minimise adverse impacts.
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Key Takeaways
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1. Legislative History
As reported in our earlier article,[3] in April 2020, the European Commission (“Commission”) proposed the adoption of a directive requiring companies to undertake mandatory human rights and environmental due diligence across their value chains, and a proposal followed in February 2022.[4] At that time, some Member States had already adopted national due diligence laws,[5] and the Commission considered it important to ensure a level playing field for companies operating within the internal market. The Directive was further intended to contribute to the EU’s transition towards a sustainable economy and sustainable development through the prevention and mitigation of adverse human rights and environmental impacts in companies’ supply chains.
After multiple rounds of negotiations and material amendments submitted by all EU institutions, as well as extensive negotiations between Member States, the Permanent Representative Committee of the Council of the European Union (“Council”) endorsed the draft Directive on 15 March 2024, with the Parliament voting in favour on 24 April 2024.[6]
Notably, the CSDDD crystallises into hard law at the EU level certain voluntary international standards on responsible business conduct, such as the UN Guiding Principles on Business and Human Rights (“UNGPs”), the OECD Guidelines for Multinational Enterprises, the OECD Guidance on Responsible Business Conduct, and sectoral direction. Prior to the CSDDD coming into force, these voluntary instruments will continue to offer valuable “best practice” guidance to in-scope companies.
2. Scope of Application and Timing
The Directive will apply to EU companies (i.e., companies formed in accordance with the legislation of a Member State) where a company meets the following thresholds (in each instance measured in the last financial year for which annual financial statements have been or should have been adopted):
- has more than 1,000 employees on average (including in certain circumstances, temporary agency workers) and a net worldwide turnover of more than EUR 450 million;[7] or
- is the ultimate parent company of a group that collectively reaches the thresholds in (a); or
- has entered into or is the ultimate parent company of a group that entered into franchising or licensing agreements in the EU in return for royalties where these royalties amount to more than EUR 22.5 million and provided that the company had or is the ultimate parent company of a group that had a net worldwide turnover of more than EUR 80 million.
The Directive has extra-territorial effect since it also applies to non-EU companies (i.e., companies formed in accordance with the legislation of a non-EU country), if that company:
- has generated a net turnover in the EU of more than EUR 450 million; or
- is the ultimate parent company of a group that collectively reaches the thresholds under (a); or
- has entered into or is the ultimate parent company of a group that entered into franchising or licensing agreements in the EU in return for royalties where these royalties amount to more than EUR 22.5 million in the EU and provided that the company had or is the ultimate parent company of a group that had a net turnover of more than EUR 80 million in the EU.
For the Directive to apply, for both EU and non-EU companies, the threshold conditions must have been satisfied for at least two consecutive financial years. Smaller companies operating in the “chain of activities” of in-scope companies will also be indirectly affected because of contractual requirements imposed on them by companies within the scope of the Directive (discussed further below).
It is notable that the scope of application of the CSDDD is more limited than that of the Corporate Sustainability Reporting Directive (“CSRD”),[8] which (save with respect to franchisors or licensors) applies both lower employee and turnover thresholds. Whilst the CSDDD is expected to apply to around 5,500 companies, the CSRD covers approximately 50,000 companies.
3. Obligations on In-scope Companies
(a) Adopt Human Rights and Environmental Due Diligence
The Directive introduces so-called human rights and environmental “due diligence obligations”. These apply to a company’s own operations, those of its subsidiaries, and those of its direct and indirect business partners throughout their “chain of activities”. The Directive defines “chain of activities” as activities of a company’s:
- upstream business partners,[9] relating to the production of goods or the provision of services by the company, including the design, extraction, sourcing, manufacture, transport, storage and supply of raw materials, products or parts of the products and development of the product or the service; and
- downstream business partners, relating to the distribution, transport and storage of the product, where the business partners carry out those activities for the company or on behalf of the company.[10]
Companies will be required to:
- develop a due diligence policy[11] that ensures risk-based due diligence, and integrate due diligence into their relevant policies and risk management systems;
- identify and assess actual or potential adverse human rights and environmental impacts (which are defined by reference to obligations or rights enshrined in international instruments),[12] including mapping operations to identify general areas where adverse impacts are most likely to occur and to be most severe; and
- prevent and mitigate potential adverse impacts and bring to an end / minimise the extent of actual adverse impacts. Where it is not feasible to prevent, mitigate, bring to an end or minimise all identified adverse impacts at the same time to their full extent, companies must prioritise the steps they take based on the severity and likelihood of the adverse impacts.
In each instance, companies will be required to take “appropriate measures”; that is, measures that “effectively addres[s] adverse impacts in a manner commensurate to the degree of severity and the likelihood of the adverse impact”.[13] Such measures must take into account the circumstances of the specific case, including the nature and extent of the adverse impact and relevant risk factors.
With regards to the prevention of potential adverse impacts, companies are required (amongst other obligations) to:
- develop and implement a prevention action plan, with reasonable and clearly defined timelines for the implementation of appropriate measures and qualitative and quantitative indicators for measuring improvement;
- seek contractual assurances from a direct business partner that it will ensure compliance with the company’s code of conduct / prevention action plan, including by establishing corresponding contractual assurances from its partners if their activities are part of the company’s chain of activities;
- make necessary financial or non-financial investments, adjustments or upgrades, such as into facilities, production or other operational processes and infrastructures; and
- provide targeted and proportionate support for an SME[14] which is a business partner of the company.
Similar obligations are imposed in the context of bringing actual adverse impacts to an end.
Notably, regarding (b), companies must verify compliance. To do so, the CSDDD states that companies “may refer to” independent third-party verification, including through industry or multi-stakeholder initiatives.[15]
The financial sector has more limited obligations. “Regulated financial undertakings” are only subject to due diligence obligations for their own operations, those of their subsidiaries and the upstream part of their chain of activities. Such undertakings are expected to consider adverse impacts and use their “leverage” to influence companies, including through the exercise of shareholders’ rights.
(b) Adopt / Put into Effect a Climate Transition Plan
Companies will also be required to adopt and put into effect a climate change mitigation transition plan (“CTP”), to be updated annually, which aims to ensure that a company’s business model and strategy are compatible with limiting global warming to 1.5°C in line with the Paris Agreement and the objective of achieving climate neutrality, including intermediate and 2050 climate neutrality targets. The CTP should also address, where relevant, the exposure of the company to coal-, oil- and gas-related activities.
The CTP must contain: (a) time-bound targets in five-year steps from 2030 to 2050 including, where appropriate, absolute greenhouse gas emission reduction targets for scope 1, 2 and 3 emissions; (b) description of decarbonisation levers and key actions planned to reach the targets identified in (a); (c) details of the investments and funding supporting the implementation of the CTP; and (d) a description of the role of the administrative, management and supervisory bodies with regard to the CTP.[16]
Companies which report a CTP in accordance with the CSRD or are included in the CTP of their parent undertaking are deemed to have complied with the CSDDD’s CTP obligation. Regulated financial undertakings will also have to adopt a CTP ensuring their business model complies with the Paris Agreement.
(c) Provide Remediation
Consistent with the right to a remedy under the UNGPs, Member States must ensure that where a company has caused or jointly caused an actual adverse impact, it will provide “remediation”.[17] This is defined in the Directive as “restoration of the affected person or persons, communities or environment to a situation equivalent or as close as possible to the situation they would be in had an actual adverse impact not occurred”.[18] Such remediation should be proportionate to the company’s implication in the adverse impact, including financial or non-financial compensation to those affected and, where applicable, reimbursement of any costs incurred by public authorities for necessary remedial measures.
(d) Meaningfully[19] engage with Stakeholders
Companies are required to effectively engage with stakeholders. This includes carrying out consultations at various stages of the due diligence process, during which companies must provide comprehensive information.
(e) Establish a Notification Mechanism and Complaints Procedure
Member States must ensure that companies provide the possibility for persons or organisations with legitimate concerns regarding any adverse impacts to submit complaints.[20] There should then be a fair, publicly available, accessible, predictable and transparent procedure for dealing with complaints, of which relevant workers, trade unions and other workers’ representatives should be informed. Companies should take reasonably available measures to avoid any retaliation.
Notification mechanisms must also be established through which persons and organisations can submit information about adverse impacts.
Companies will be allowed to fulfil these obligations through collaborative complaints procedures and notification mechanisms, including those established jointly by companies, through industry associations, multi-stakeholder initiatives or global framework agreements.
(f) Monitor and Assess Effectiveness
Member States shall ensure that companies carry out periodic assessments of their own operations and measures, those of their subsidiaries and, where related to the chain of activities of the company, those of their business partners. These will assess implementation and monitor the adequacy and effectiveness of the identification, prevention, mitigation, bringing to an end and minimisation of the extent of adverse impacts.
Where appropriate, assessments are to be based on qualitative and quantitative indicators and carried out without undue delay after a significant change occurs, but at least every 12 months and whenever there are reasonable grounds to believe that new risks of the occurrence of those adverse impacts may arise.[21]
(g) Communicate Compliance
Companies will be required to report on CSDDD-matters by publishing an annual statement on their website within 12 months of the end of their financial year, unless they are subject to sustainability reporting obligations under the CSRD. The CSDDD does not introduce any new reporting obligations in addition to those under the CSRD.[22]
The contents of the annual statement will be defined by the Commission through a subsequent implementing act.
4. Enforcement and Sanctions
The Directive requires Member States to designate independent “supervisory authorities” to supervise compliance (“Supervisory Authority”).[23] A Supervisory Authority must have adequate powers and resources, including the power to require companies to provide information and carry out investigations. Investigations may be initiated by the Supervisory Authorities’ own motion or as a result of substantiated concerns raised by third parties.
Supervisory Authorities are to be empowered to “at least”: (a) order the cessation of infringements, the abstention from any repetition of the relevant conduct and the taking of remedial measures; (b) impose penalties; and (c) adopt interim measures in case of imminent risk of severe and irreparable harm.
Sanctions regimes adopted by Member States must be effective, proportionate and dissuasive. This includes pecuniary penalties with a maximum limit of not less than 5% of the in-scope company’s worldwide net turnover.[24] Additionally, the Directive stipulates that any decision of a Supervisory Authority containing penalties is: (a) published, (b) publicly available for at least five years; and (c) sent to the “European Network of Supervisory Authorities” (“naming and shaming”).[25]
Besides these sanctions, compliance with the CSDDD’s obligations can be used as part of the award criteria for public and concession contracts.
5. Civil Liability of Companies
Member States must establish a civil liability regime for companies which intentionally or negligently fail to comply with the CSDDD’s obligations and where damage has been caused to a person’s legal interest (as protected under national law) as a result of that failure.[26] However, a company cannot be held liable if the damage was caused only by its business partners in its chain of activities.
Member States must provide for “reasonable conditions” under which any alleged injured party may authorize a trade union, non-governmental human rights or environmental organization or other NGO or national human rights institution, to bring actions to enforce the rights of the alleged injured party.[27]
The Directive requires a limitation period for bringing actions for damages of at least five years and, in any case, not shorter than the limitation period laid down under general civil liability regimes of Member States.
Regarding compensation, Member States are required to lay down rules that fully compensate victims for the damage they have suffered as a direct result of the company’s failure to comply with the Directive. However, the Directive states that deterrence through damages (i.e., punitive damages) or any other form of overcompensation should be prohibited.
6. Next Steps / Implementation
The Directive must now be formally adopted by the Council and will subsequently come into force on the 20th day following that of its publication in the Official Journal of the EU, which is expected to occur in the first half of 2024. Once the Directive enters into force, Member States will need to transpose it into national law within two years, i.e., by mid-2026.
Depending on their size, companies will have between three to five years from the Directive entering into force to implement its requirements (i.e., likely until between 2027 and 2029):
- three years (i.e., likely in 2027) for (a) EU companies with more than 5,000 employees and EUR 1,500 million net worldwide turnover, and (b) non-EU companies with more than EUR 1,500 million net turnover generated in the EU.
- four years (i.e., likely in 2028) for: (a) companies with more than 3,000 employees and EUR 900 million net worldwide turnover and (b) non-EU companies with more than EUR 900 million net turnover generated in the EU; and
- five years (i.e., likely in 2029) for companies with more than 1,000 employees and EUR 450 million turnover.
7. Relationship between the CSDDD and other EU Laws Protecting Human Rights and the Environment
The Directive is part of a series of EU regulations which aim to protect human rights and the environment through both reporting and due diligence obligations. Such regulations include the CSRD and the Sustainable Finance Disclosure Regulation, which impose mandatory reporting obligations, as well as the Regulation on Deforestation-free Products, the Conflicts Minerals Regulation, the Batteries Regulation and the Forced Labour Ban Regulation (which, coincidentally, was also approved by the European Parliament on 24 April 2024),[28] which impose due diligence requirements on companies in certain sectors / circumstances.
In this context, the CSDDD will become the “default” EU due diligence regime. The Directive expressly provides that its obligations are without prejudice to other, more specific EU regimes, meaning that if a provision of the CSDDD conflicts with another EU regime providing for more extensive or specific obligations, then the latter will prevail.
8. Practical Considerations for In-Scope Companies
Given the significance of expectations and liabilities in the CSDDD, in-scope companies would be well advised to commence preparation now, notwithstanding the implementation timeframe. Indeed, the types of measures that the CSDDD requires to be implemented will take time to operationalise. Functions and entities across multinationals will need to be engaged in that implementation, and it is prudent to involve key internal stakeholders (including legal and compliance functions) in that process from the outset.
The types of next steps in-scope companies should be considering now include:
First, mapping current and potentially future upstream and downstream business relationships to understand where any human rights and environmental risks exist. Any gaps or concerns should be addressed. Additionally, effective systems should be implemented to continually monitor risks within the chain of activities.
Second, putting in place a risk-based due diligence policy containing a description of the company’s approach, as well as supplier codes of conduct, which describe the rules and principles to be followed throughout the company and its subsidiaries. Codes of conduct should apply to all relevant corporate functions and operations, including procurement, employment and purchasing decisions.
Third, considering whether it is appropriate to involve lawyers in the development of internal due diligence systems in order to seek to apply privilege to relevant communications and documentation. This is particularly important given the: (a) matrix of legal regulation which applies in this space; and (b) envisaged regulatory and civil liability regimes.
Fourth, inserting appropriate contractual language into business partner contracts. The CSDDD requires the Commission, in consultation with Member States and stakeholders, to adopt guidance in this regard. However, the Commission has 30 months from the entry into force of the CSDDD to adopt such guidance.
Fifth, training employees—and being cognisant that training should not be limited just to those persons directly involved with sustainability compliance and reporting. Employees should understand how to spot adverse human rights and environmental impacts and understand the actions to be taken when they do.
Sixth, establishing operational level grievance mechanisms for rights holders, their representatives and civil society organisations. Such mechanisms act not only as a tool to remedy and redress but can be harnessed preventively as an early warning system for the identification and analysis of adverse impacts.
Seventh, meaningfully engaging with stakeholders will require identification of who relevant stakeholders are and require companies to design effective engagement processes.
Last, given the overlapping nature of some of the EU directives and regulations in this space (as well as laws at the Member State level), mapping all relevant obligations to ensure consistent compliance and drive efficiencies where practicable. It is notable that the Directive explicitly states that it does not prevent Member States from imposing further, more stringent obligations on companies—so companies will want to keep this under review.
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[1] European Parliament legislative resolution of 24 April 2024 on the proposal for a directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937.
[2] Art. 1(a) of the Directive.
[3] See our previous client alert addressing Mandatory Corporate Human Rights Due Diligence.
[4] See our previous client alert addressing the European Commission’s draft directive on “Corporate Sustainability Due Diligence”.
[5] See for example, France’s “Loi de Vigilance” enacted in 2017, which inserted provisions into the French Commercial Code imposing substantive requirements on companies in relation to human rights and environmental due diligence. Specifically, companies with more than 5,000 employees in France (or 10,000 employees in France or abroad) are required to establish, implement and publish a “vigilance plan” to address risks within their supply chains or which arise from the activities of direct or indirect subsidiaries or subcontractors. Such plans should also include action plans to mitigate those risks and prevent damage, as well as a monitoring system to ensure that the plan is effectively implemented. (See our previous client alert addressing global legislative developments and proposals in the bourgeoning field of mandatory corporate human rights due diligence). Meanwhile in Germany, the Supply Chain Due Diligence Act 2023 (the “SCCDA”) was enacted, imposing due diligence obligations on companies with a statutory seat in Germany and more than 1,000 employees, regardless of revenue. In many instances, the CSDDD and the SCDDA obligations overlap, although there are some differences. For example, whilst the CSDDD extends obligations to the company’s “chain of activities”, the SCDDA focuses primarily on direct suppliers. An in-scope company may also be required to conduct due diligence on its indirect suppliers if the company has substantiated knowledge of grievances or violations of the law. The German legislator is expected to align the obligations under the CSDDD and the SCDDA, as it did in relation to CSRD.
[6] Press Release of the European Parliament, 24 April 2024, “Due diligence: MEPs adopt rules for firms on human rights and environment”.
[7] Turnover of branches of the relevant entity are also to be taken into account when calculating whether a threshold has been reached.
[8] See our previous client alert addressing the CSRD.
[9] See Art. 3(1)(f) of the Directive, which defines “business partner” as “an entity (i) with which the company has a commercial agreement related to the operations, products or services of the company or to which the company provides services pursuant to point (g) (‘direct business partner’), or (ii) which is not a direct business partner but which performs business operations related to the operations, products or services of the company (‘indirect business partner’)”.
[10] See Art. 3(1)(g) of the Directive.
[11] See Art. 5 of the Directive. The company’s risk-based due diligence policy should be developed in consultation with its employees and their representatives and be updated after a significant change or at least every 24 months (Art. 7(3) of the Directive). It shall contain all of the following: (a) a description of the company’s approach, including in the long term, to due diligence; (b) a code of conduct describing rules and principles to be followed throughout the company and its subsidiaries, and the company’s direct or indirect business partners; and (c) a description of the processes put in place to integrate due diligence into the relevant policies and to implement due diligence, including the measures taken to verify compliance with the code of conduct and to extend its application to business partners.
[12] See Art. 3(1)(b) and (c). Adverse environmental impacts are defined as an adverse impact on the environment resulting from the breach of the prohibitions and obligations listed in Part I, Section 1, points 15 and 16 (the prohibition of causing any measurable environmental degradation and the right of individuals, groupings and communities to lands and resources and the right not to be deprived of means of subsistence), and Part II of the Annex to the Directive, which includes, for example, the obligation to avoid or minimise adverse impacts on biological diversity, interpreted in line with the 1992 Convention on Biological Diversity and applicable law in the relevant jurisdiction. Adverse human rights impacts are defined as an adverse impact on one of the human rights listed in Part I, Section 1, of the Annex to the Directive, as those human rights are enshrined in the international instruments listed in Part I, Section 2, of the Annex to the Directive, for example, The Convention on the Rights of the Child and The International Covenant on Civil and Political Rights.
[13] See Art. 3(1)(o) of the Directive.
[14] This is defined in Art. 3(1)(i) of the Directive as “a micro, small or a medium-sized undertaking, irrespective of its legal form, that is not part of a large group…”.
[15] Art. 10(5) of the Directive.
[16] Art. 22 of the Directive.
[17] Art. 12 of the Directive.
[18] Art. 3(1)(t) of the Directive.
[19] Whilst the text of Art. 13(1) of the Directive refers to “effective” engagement with stakeholders, the title of provision refers to “meaningful” engagement, which is also found in the Recitals.
[20] Art. 14 of the Directive.
[21] Ar. 15 of the Directive.
[22] Art. 16 of the Directive.
[23] Art. 24(1) of the Directive. For France and Germany, we expect the “Supervisory Authority” to be the same authority as is currently overseeing compliance with their analogous due diligence regimes.
[24] Art. 27(4) of the Directive.
[25] Art. 27(5) of the Directive.
[26] Art. 29 of the Directive.
[27] Art. 29(3)(d) of the Directive.
[28] See Press Release of the European Parliament on 23 April 2024, “Products made with forced labour to be banned from EU single market”.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you wish to discuss any of the matters set out above, please contact the Gibson Dunn lawyer with whom you usually work, any member of Gibson Dunn’s Environmental, Social and Governance (ESG) practice group, or the following authors in London, Paris and Munich:
London:
Selina S. Sagayam – London (+44 20 7071 4263, ssagayam@gibsondunn.com)
Susy Bullock – London (+44 20 7071 4283, sbullock@gibsondunn.com)
Stephanie Collins – London (+44 20 7071 4216, scollins@gibsondunn.com)
Alexa Romanelli – London (+44 20 7071 4269, aromanelli@gibsondunn.com)
Harriet Codd (+44 20 7071 4057, hcodd@gibsondunn.com)
Paris:
Robert Spano – Paris/London (+33 1 56 43 14 07, rspano@gibsondunn.com)
Munich:
Ferdinand Fromholzer (+49 89 189 33-270, ffromholzer@gibsondunn.com)
Markus Rieder (+49 89 189 33-260, mrieder@gibsondunn.com)
Katharina Humphrey (+49 89 189 33-217, khumphrey@gibsondunn.com)
Julian von Imhoff (+49 89 189 33-264, jvonimhoff@gibsondunn.com)
Carla Baum (+49 89 189 33-263, cbaum@gibsondunn.com)
Melina Kronester (+49 89 189 33-225, mkronester@gibsondunn.com)
Julian Reichert (+49 89 189 33-229, jreichert@gibsondunn.com)
Marc Kanzler (+49 89 189 33-269, mkanzler@gibsondunn.com)
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
The Final Regulations modify the “look-through” rule for certain domestic C corporations, and introduce a new ten-year transition rule.
On April 24, 2024, the IRS and Treasury issued final regulations for determining whether a real estate investment trust (a “REIT”)[1] qualifies as a “domestically controlled qualified investment entity” (a “DREIT,” and the final regulations, the “Final DREIT Regulations”). These regulations modify certain provisions of the regulations proposed by the IRS and Treasury in December 2022 (the “Proposed DREIT Regulations”), detailed in our previous Client Alert.
Compared with the Proposed DREIT Regulations, the Final DREIT Regulations:
(1) increase the threshold of foreign ownership required to look through a domestic C corporation that owns a REIT from 25 percent or more to more than 50 percent for purposes of determining whether the REIT qualifies as a DREIT (the “C Corporation Look-Through Rule”);
(2) provide a ten-year transition rule for application of the C Corporation Look-Through Rule to existing REITs, subject to certain restrictions; and
(3) clarify or modify certain rules relating to publicly traded entities, qualified foreign pension funds (“QFPFs”), and withholding taxes.
Background
Subject to certain exceptions discussed below, section 897[2] and related sections added to the Code by the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) require foreign persons that recognize gain from the sale or disposition of a United States real property interest (a “USRPI”) to file U.S. federal income tax returns reporting that gain and pay U.S. federal income tax on that gain at regular graduated rates, even if the gain is not otherwise effectively connected with the conduct of a U.S. trade or business.
The definition of a USRPI is broad. In addition to including a wide array of interests in U.S. real estate (which itself is a very broad term) and interests in disregarded entities and certain partnerships that own U.S. real estate, USRPIs include equity interests in domestic corporations that are United States real property holding corporations (“USRPHCs”). Generally, a USRPHC is any corporation, including a REIT, if the value of its USRPIs represents at least 50 percent of the aggregate value of its real estate (both U.S. and non-U.S.) and business assets.
Even though equity interests in domestic USRPHCs generally are treated as USRPIs, section 897(h)(2) provides that an interest in a DREIT is not a USRPI. Under section 897(h)(4), a REIT is a DREIT if less than 50 percent of the value of its stock is held “directly or indirectly” by “foreign persons” at all times during the shorter of (1) the 5-year period ending on the relevant determination date and (2) the period during which the REIT was in existence (the “Testing Period”). Importantly, gain recognized by a foreign person on the disposition of an interest in a DREIT is not subject to U.S. federal income tax under FIRPTA, even if the DREIT is a USRPHC. Foreign persons often seek to invest in U.S. real estate through DREITs because, in these structures, foreign persons can exit the investment via a sale of DREIT stock without being subject to U.S. tax on the gain or being required to file a U.S. tax return.
Proposed Regulations
Before the promulgation of the Proposed DREIT Regulations, there was relatively little guidance regarding when the stock of a REIT owned by one person was treated as held “indirectly” by another person for purposes of determining DREIT status.[3] The Proposed DREIT Regulations included a broad look-through rule for this purpose that applied to various types of passthrough and quasi-passthrough entities, including REITs, partnerships (other than publicly traded partnerships), S corporations, and RICs (the “Proposed Look-Through Rule”).[4] The Proposed Look-Through Rule would have been implemented by imputing ownership of REIT stock to the owners of such entities pro rata based on the owners’ proportionate interests in such entities.[5]
Diverging from informal IRS guidance that treated domestic C corporations as non-foreign owners of REITs for purposes of determining DREIT status, the Proposed Look-Through Rule also would have applied to “foreign-owned domestic corporations.”[6] Specifically, a “foreign-owned domestic corporation” was defined as any non-publicly traded domestic C corporation if foreign persons held directly or indirectly 25 percent or more of the value of its outstanding stock, applying certain look-through rules.[7] Thus, a “foreign-owned domestic corporation” would not have been treated as a domestic owner of a REIT; rather, ownership of the REIT’s stock would have been imputed to the owners of the “foreign-owned domestic corporation” to determine if the REIT qualified as a DREIT.
Final Regulations
The Final DREIT Regulations generally maintain the provisions of the Proposed Look-Through Rule, with certain changes described below.
Increased Ownership Threshold for Foreign-Controlled Domestic C Corporations
The IRS and Treasury narrowed the scope of the C Corporation Look-Through Rule. Specifically, the IRS and Treasury increased the threshold of foreign ownership required to qualify as a foreign-controlled domestic C Corporation from 25 percent or more to more than 50 percent.[8]
Ten-Year Transition Rule for Existing REITs
Generally, the C Corporation Look-Through Rule and other provisions of the Final DREIT Regulations apply to transactions (e.g., sales of REIT shares) occurring on or after April 25, 2024.[9] Importantly, however, the C Corporation Look-Through Rule does not apply to existing REITs until April 24, 2034, provided certain requirements are satisfied, as discussed below (the “Transition Rule”).[10]
Under the Transition Rule, the C Corporation Look-Through Rule does not apply until April 24, 2034 to a REIT in existence as of April 24, 2024, provided:
(1) the REIT qualifies at all times on and after April 24, 2024 as “domestically controlled”, taking into account all provisions of the Final DREIT Regulations other than the C Corporation Look-Through Rule;
(2) the REIT does not directly or indirectly acquire, on and after April 24, 2024, USRPIs with an aggregate fair market value exceeding 20 percent of the aggregate fair market value of the USRPIs it holds directly or indirectly as of April 24, 2024; and
(3) the percentage of the REIT’s stock held directly or indirectly by one or more “non-look-through persons” does not increase by more than 50 percentage points over the percentage of the REIT’s stock held directly or indirectly by such non-look-through persons as of April 24, 2024.[11]
For purposes of the second requirement, the fair market value of a REIT’s USRPIs as of April 24, 2024 is the value the REIT used for purposes of its REIT asset testing as of March 31, 2024.[12] The fair market value of any USRPI acquired after March 31, 2024 must be determined as of the date the USRPI is acquired “using a reasonable method,” as long as the REIT “consistently” uses the same method with respect to all of its USRPIs for purposes of the Transition Rule.[13]
If a REIT violates any of these requirements, the C Corporation Look-Through Rule will begin to apply to that REIT on the day after the REIT first violates the requirement.[14] Therefore, a REIT that becomes ineligible for the Transition Rule can still apply the Transition Rule to the portion of its Testing Period ending on the day the REIT violates the Transition Rule requirement.
Other Rules
In addition to the rules described above, the Final DREIT Regulations clarify or modify the following rules:
- Consistent with the Proposed DREIT Regulations, a QFPF and a “qualified controlled entity” is a foreign person for purposes of determining whether a REIT is domestically controlled.[15]
- In a departure from the Proposed DREIT Regulations, subject to the limitation described below, a publicly traded RIC generally is treated as a non-look-through person.[16] This aligns the treatment of publicly traded RICs with the treatment of publicly traded C corporations and publicly traded partnerships.
- Under a newly introduced rule, a publicly traded domestic C corporation, publicly traded RIC, or publicly traded partnership will be treated as a look-through person if the REIT being tested for DREIT status has actual knowledge that the public domestic C corporation, publicly traded RIC, or publicly traded partnership is foreign controlled.[17]
- A publicly traded REIT is permitted to treat as a U.S. person that is a non-look through person any person holding less than 5 percent of the REIT’s U.S. publicly traded stock (“5 Percent Person”), unless the REIT has actual knowledge that the 5 Percent Person is a non-U.S. Person or is foreign controlled (treating the 5 Percent Person as a non-public domestic C corporation for this purpose).[18]
- To avoid section 1445 withholding on the transfer, a transferee of an interest in a DREIT can rely on a statement issued by the DREIT certifying that the interest is not a USRPI.
The IRS and Treasury declined to provide guidance in the Final DREIT Regulations on how a domestic C corporation certifies to a REIT whether it is foreign controlled, or any other guidance on procedures for determining whether a REIT will qualify as a DREIT, including what records a REIT must maintain in this regard.
Takeaways
Sponsors of, and investors in, existing and new REITs intended to qualify as DREITs should consider evaluating whether those REITs qualify as DREITs under the Final DREIT Regulations.
Sponsors also should review the information, representations, and covenants that they request from investors in determining whether a REIT will qualify as a DREIT and should consider what records to maintain with respect to their determination of DREIT status. Further, REIT sponsors should consider any obligations they may have to cause a REIT to qualify as a DREIT.
Sponsors of and investors in existing REITs that seek to rely on the Transition Rule to continue to be classified as DREITs should consider limiting acquisitions of new USRPIs by, and changes of ownership in, these REITs so as not to cause the Transition Rule to cease to apply before April 24, 2034. In particular, sponsors and investors should be aware that seemingly innocuous changes in the indirect ownership of a REIT (e.g., restructurings that do not change the ultimate beneficial ownership of the REIT) could inadvertently cause the Transition Rule to cease to apply to the REIT.
__________
[1] The rules also apply to certain registered investment companies (“RICs”). In our discussion, however, we focus on REITs and DREITs because foreign persons are more likely to invest in U.S. real estate through REITs than through RICs.
[2] Unless indicated otherwise, all “section” references are to the Internal Revenue Code of 1986, as amended (the “Code”), and all “Treas. Reg. §” references are to the Treasury regulations promulgated under the Code.
[3] See our previous Client Alert for a discussion of the available guidance before the promulgation of the Proposed DREIT Regulations.
[4] Prop. Treas. Reg. § 1.897-1(c)(3)(ii)(B).
[5] Id.
[6] Id. See our previous Client Alert for more details.
[7] Prop. Treas. Reg. § 1.897-1(c)(3)(v)(B).
[8] Although the Proposed DREIT Regulations refer to these entities as “foreign-owned domestic corporations,” the Final DREIT Regulations refer to these entities as “foreign-controlled domestic corporations.” 89 F.R. 31621; Treas. Reg. § 1.897-1(c)(3)(v)(B).
[9] Treas. Reg. § 1.897-1(a)(2).
[10] Treas. Reg. § 1.897-1(c)(3)(vi).
[11] Treas. Reg. § 1.897-1(c)(3)(vi)(A). There is an exception for acquisitions of USRPIs or interests in the REIT pursuant to a written agreement that was binding before April 24, 2024. Treas. Reg. § 1.897-1(c)(3)(vi)(E).
[12] Treas. Reg. § 1.897-1(c)(3)(vi)(B)(1), (C).
[13] Treas. Reg. § 1.897-1(c)(3)(vi)(D).
[14] Id.
[15] See our previous Client Alert for further discussion of QFPFs and qualified controlled entities.
[16] For purposes of the Final DREIT Regulations, the term “public RIC” (that is, a publicly traded RIC) excludes a RIC that is also a “qualified investment entity.” Treas. Reg. § 1.897-1(c)(3)(v)(I); I.R.C. § 897(h)(4)(A).
[17] To test whether a RIC is foreign controlled, the Final DREIT Regulations treat the RIC as a non-public domestic C corporation. Treas. Reg. § 1.897-1(c)(3)(v)(I).
[18] Treas. Reg. § 1.897-1(c)(3)(iii)(A). Under the Proposed DREIT Regulations, 5 Percent Persons were considered non-look-through U.S. persons unless the REIT had actual knowledge that the 5 Percent Person was not a U.S. person.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Tax and Global Tax Controversy and Litigation practice groups:
Tax:
Dora Arash – Los Angeles (+1 213.229.7134, darash@gibsondunn.com)
Sandy Bhogal – Co-Chair, London (+44 20 7071 4266, sbhogal@gibsondunn.com)
Michael Q. Cannon – Dallas (+1 214.698.3232, mcannon@gibsondunn.com)
Jérôme Delaurière – Paris (+33 (0) 1 56 43 13 00, jdelauriere@gibsondunn.com)
Michael J. Desmond – Los Angeles/Washington, D.C. (+1 213.229.7531, mdesmond@gibsondunn.com)
Anne Devereaux* – Los Angeles (+1 213.229.7616, adevereaux@gibsondunn.com)
Matt Donnelly – Washington, D.C. (+1 202.887.3567, mjdonnelly@gibsondunn.com)
Pamela Lawrence Endreny – New York (+1 212.351.2474, pendreny@gibsondunn.com)
Benjamin Fryer – London (+44 20 7071 4232, bfryer@gibsondunn.com)
Evan M. Gusler – New York (+1 212.351.2445, egusler@gibsondunn.com)
Kathryn A. Kelly – New York (+1 212.351.3876, kkelly@gibsondunn.com)
Brian W. Kniesly – New York (+1 212.351.2379, bkniesly@gibsondunn.com)
Loren Lembo – New York (+1 212.351.3986, llembo@gibsondunn.com)
Jennifer Sabin – New York (+1 212.351.5208, jsabin@gibsondunn.com)
Eric B. Sloan – Co-Chair, New York/Washington, D.C. (+1 212.351.2340, esloan@gibsondunn.com)
Edward S. Wei – New York (+1 212.351.3925, ewei@gibsondunn.com)
Lorna Wilson – Los Angeles (+1 213.229.7547, lwilson@gibsondunn.com)
Daniel A. Zygielbaum – Washington, D.C. (+1 202.887.3768, dzygielbaum@gibsondunn.com)
Global Tax Controversy and Litigation:
Michael J. Desmond – Co-Chair, Los Angeles/Washington, D.C. (+1 213.229.7531, mdesmond@gibsondunn.com)
Saul Mezei – Washington, D.C. (+1 202.955.8693, smezei@gibsondunn.com)
Sanford W. Stark – Co-Chair, Washington, D.C. (+1 202.887.3650, sstark@gibsondunn.com)
C. Terrell Ussing – Washington, D.C. (+1 202.887.3612, tussing@gibsondunn.com)
*Anne Devereaux, of counsel in the firm’s Los Angeles office, is admitted to practice in Washington, D.C.
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
From the Derivatives Practice Group: This week, the CFTC approved final rules to amend its Swap Execution Facility regulations, and extended the deadline for public comment period on a proposed rule that makes certain modifications to rules for Swap Execution Facilities and Designated Contract Markets in Part 37 and 38.
New Developments
- “AI Day” To Be Held at May 2 CFTC Technology Advisory Committee Meeting. On April 24, Commissioner Christy Goldsmith Romero, sponsor of the Technology Advisory Committee (TAC), announced “AI Day” is to be held at the CFTC’s Washington, D.C. headquarters on May 2, 2024, during a TAC meeting. AI Day will take place from 1:00 p.m. to 4:00 p.m. (EDT). AI Day is a continuation of the TAC’s study of AI, and the concept of Responsible AI in financial markets. The TAC Subcommittee on Emerging and Evolving Technologies will present on the work and findings of the Subcommittee in its study of AI for financial markets. [NEW]
- CFTC Approves Final Rules on Swap Confirmation Requirements for SEFs. On April 23, the CFTC approved final rules to amend its swap execution facility (SEF) regulations related to uncleared swap confirmations to address issues which have been addressed in CFTC staff no-action letters, including the most recent CFTC No Action Letter No. 17-17, as well as associated conforming and technical changes. In particular, the final rules amend CFTC Regulation 37.6(b) to enable SEFs to incorporate terms of underlying, previously negotiated agreements between the counterparties by reference in an uncleared swap confirmation without being required to obtain such underlying, previously negotiated agreements. Further, the final rules amend CFTC Regulation 37.6(b) to require such confirmation to take place “as soon as technologically practicable” after the execution of the swap transaction on the SEF for both cleared and uncleared swap transactions. The final rules also amend CFTC Regulation 37.6(b) to make clear the SEF-provided confirmation under CFTC Regulation 37.6(b) shall legally supersede any conflicting terms in a previous agreement, rather than the entire agreement. The final rules make conforming amendments to CFTC Regulation 23.501(a)(4)(i) to correspond with the amendments to CFTC Regulation 37.6(b). Finally, the final rules make certain non-substantive amendments to CFTC Regulation 37.6(a)-(b) to enhance clarity. [NEW]
- CFTC to Hold a Commission Open Meeting April 29. On April 22, Chairman Rostin Behnam announced the Commission will hold an open meeting on Monday, April 29 at 9:30 a.m. (EDT) at the CFTC’s Washington, D.C. headquarters. The Commission will consider Final Rule “Capital and Financial Reporting Requirements for Swap Dealers and Major Swap Participants” and Final Rule “Adopting Amendments to the Large Trader Reporting Rules for Futures and Options.” [NEW]
- CFTC Extends Public Comment Period for Proposed Rule for Designated Contract Markets and Swap Execution Facilities Regarding Governance and Conflicts of Interest. On April 22, the CFTC announced it is extending the deadline for public comment period on a proposed rule that makes certain modifications to rules for Swap Execution Facilities and Designated Contract Markets in Part 37 and 38 that would establish governance requirements regarding market regulation functions, as well as related conflicts of interest standards. The deadline is being extended to May 13, 2024. [NEW]
- Chairman Behnam Announces CFTC’s First DEIA Strategic Plan. On April 18, CFTC Chairman Rostin Behnam announced the agency’s first Strategic Plan to Advance Diversity, Equity, Inclusion, and Accessibility (DEIA Plan). Chairman Behnam said that the two-year DEIA Plan represents a critical step forward in aligning the CFTC with a collective DEIA vision that not only provides genuine support for team members, but also ensures the CFTC is a source of future leaders. The CFTC designed the DEIA Plan to align with its 2022-2026 Strategic Plan and to focus on the following six goals: Inclusive Workplaces, Partnerships and Recruitment, Paid Internships, Professional Development and Advancement, Data, and Equity in Procurement and Customer Education and Outreach. Each goal includes objectives and strategies/actions to achieve the goal, and identifies the agency division(s)/office(s) that will lead and contribute to the implementation of the goal. The CFTC said that an internal DEIA Executive Council will support and guide the implementation of the DEIA Plan.
- CFTC Appoints Christopher Skinner as Inspector General. On April 10, the Commodity Futures Trading Commission announced that Christopher L. Skinner has been appointed CFTC’s Inspector General (IG). The CFTC stated that Mr. Skinner brings 15 years of IG experience, including leading and managing Offices of Inspector’s General (OIG), and conducting investigations, inspections, and audits. Mr. Skinner comes to the CFTC from the Federal Election Commission (FEC) where he served as IG since 2019.
New Developments Outside the U.S.
- Telbor Committee to Permanently Cease Publication of Telbor. On April 16, the Telbor Committee of the Bank of Israel decided that the publication of all tenor of Telbor will permanently cease following a final publication on June 30, 2025. The announcement constitutes an “Index Cessation Event” under the 2021 ISDA Interest Rate Derivatives Definitions and the November 2022 Benchmark Module of the ISDA 2021 Fallbacks Protocol. In February 2022, the Telbor Committee decided that the SHIR (Shekel overnight Interest Rate) rate would eventually replace the Telbor interest rate in shekel interest rate derivative transactions. The Bank of Israel said that the decision to switch to the SHIR rate is in accordance with the decisions reached in major economies worldwide, according to which IBOR type interest rates will be replaced by risk-free overnight interest rates. ISDA published cessation guidance for parties affected by the announcement.
- New Report Sheds Light on Quality and Use of Regulatory Data Across EU. On April 11, ESMA published the fourth edition of its Report on the Quality and Use of Data aiming to provide transparency on how the data collected under different regulations is used systematically by authorities in the EU, and clarifying the actions taken to ensure data quality. The report provides details on how National Competent Authorities, the European Central Bank, the European Systemic Risk Board and ESMA use the data that is collected through the year from different legislation requirements, including datasets from European Market Infrastructure Regulation, Securities Financing Transactions Regulation, Markets in Financial Instruments Directive, Securitization Regulation, Alternative Investment Fund Managers Directive and Money Market Funds Regulation.
New Industry-Led Developments
- ISDA and SIFMA Submit Addendum to Proposed FFIEC Reporting Revisions. On April 23, ISDA and the Securities Industry and Financial Markets Association (SIFMA) submitted an addendum to the joint response to the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency on the proposed reporting revisions of the call report, FFIEC 101 and FFIEC 102, which are designed to reflect the implementation of the Basel III endgame proposal. The addendum contains additional findings in the FFIEC 102 report, including end-of-week Fundamental Review of the Trading Book standardized approach average calculations and reported market risk risk-weighted assets in sub-parts D and E. [NEW]
- ISDA Launches Outreach Initiative on Proposed Notices Hub. On April 25 ISDA announced a major industry outreach initiative to establish support among dealers and buy-side firms for a new online platform that would allow the instantaneous delivery and receipt of critical termination-related notices, reducing the risk exposure and potential losses from a delay. Under the ISDA Master Agreement, termination-related notices must be delivered by certain prescribed methods, using company address details listed in the agreement. However, delays can occur if a company has moved and the documentation hasn’t been updated with the new details or if delivery to a physical location is not possible due to geopolitical shocks. The proposed ISDA Notices Hub would act as a secure central platform for firms to deliver notices, with automatic alerts sent to the receiving entity. Multiple designated people at each firm would be able to access the hub from anywhere in the world, regardless of the situation at its physical location. The platform would also allow market participants to update their physical address details via a single entry, providing a golden source of those details. [NEW]
- Four Directors Join ISDA Board. On April 18, ISDA announced that four directors have joined its Board, three directors were re-appointed, and 10 others have been re-elected at ISDA’s Annual General Meeting in Tokyo. The new directors are: Erik Tim Mueller, Chief Executive Officer, Eurex Clearing AG; Jared Noering, Managing Director, Head of Fixed Income Trading, NatWest Markets; Brad Tully, Managing Director and Global Head of Corporate Derivatives and Private Side Sales for J.P. Morgan; and Jan Mark van Mill, Managing Director of Multi Asset, APG Asset Management.
- ISDA Future Leaders in Derivatives Publishes Generative Artificial Intelligence Whitepaper. On April 17, ISDA published a whitepaper from ISDA Future Leaders in Derivatives (IFLD), its professional development program for emerging leaders in the derivatives market. The whitepaper, GenAI in the Derivatives Market: a Future Perspective, was developed by the third cohort of IFLD participants, who began working together in October 2023. According to ISDA, the 38 individuals in the group represent buy- and sell-side institutions, law firms, and service providers from around the world. After being selected for the IFLD program, they were asked to engage with stakeholders, develop positions, and produce a whitepaper on the potential use of generative artificial intelligence (genAI) in the over-the-counter derivatives market. The participants were also given access to ISDA’s training materials, resources, and staff expertise to support the project and their own professional development. ISDA said that, drawing on industry expertise and academic research, the whitepaper identifies a range of potential use cases for genAI in the derivatives market, including document creation, market insight, and risk profiling. ISDA also indicated that it explores regulatory issues in key jurisdictions and addresses the challenges and risks associated with the use of genAI. The paper concludes with a set of recommendations for stakeholders, including investing in talent development, fostering collaboration and knowledge sharing with technology providers, prioritizing ethical AI principles and engaging with policymakers to promote an appropriate regulatory framework.
- ISDA Publishes Research Paper on Interest Rate Derivatives, Benchmark Rates and Development Financial Markets in EMDEs. On April 17, ISDA published a research paper in which it outlines the role of interest rate derivatives (IRDs) in supporting the development of financial markets in emerging markets and developing economies (EMDEs). It also examines the significance of reliable, robust interest rate (IR) benchmarks. ISDA indicated that the paper draws valuable lessons from the transition from LIBOR to overnight risk-free rates in advanced economies and applies those insights to the context of EMDEs. Through case studies, ISDA attempts to show how various EMDE jurisdictions have successfully adopted and implemented more robust and transparent IR benchmarks.
- ISDA Extends Digital Regulatory Reporting Initiative to New Jurisdictions. On April 17, ISDA announced that it is extending its Digital Regulatory Reporting (DRR) initiative to several additional jurisdictions in an effort to enable firms to implement changes to regulatory reporting requirements. The DRR is being extended to cover rule amendments being implemented under the UK European Market Infrastructure Regulation and by the Australian Securities and Investments Commission and the Monetary Authority of Singapore. Those rule changes are due to be implemented in the UK on September 30, 2024, and October 21, 2024 in Australia and Singapore. The DRR code for all three sets of rules is currently available for market participants to review and test. ISDA said that the DRR will be further extended to cover rule changes in Canada and Hong Kong, both due in 2025, and the DRR for the CFTC rules will also be updated to include further anticipated updates, currently under consultation at the commission. Firms can either use the DRR as the basis for implementation or to validate an independent interpretation of the rules.
- ISDA Publishes Margin Survey. On April 16, ISDA published its latest margin survey, which shows that $1.4 trillion of initial margin (IM) and variation margin (VM) was collected by 32 leading derivatives market participants for their non-cleared derivatives exposures at the end of 2023, unchanged from the previous year. The survey also reports the amount of IM posted by all market participants to major central counterparties.
- ISDA Establishes Suggested Operational Practices for EMIR Refit. On April 16, through a series of discussions held within the ISDA Data and Reporting EMEA Working Group, market participants established and agreed to Suggested Operational Practices (SOP) for over-the-counter derivative reporting in preparation for the commencement of the EMIR Refit regulatory reporting rules on April 29. ISDA said that the SOP matrix was established based on the EMIR Refit validation table, (as published by ESMA), which contains the Regulatory Technical Standards (RTS), the Implementation Technical Standards (ITS) and validation rules. Additional tabs have been added to supplement to SOPs, including product-level SOPs for several of the underlier fields, and listing names of floating rate options. There are also tabs to reflect updates made to the matrix (‘Updates’) and a tab to track questions raised by the ISDA Data and Reporting EMEA Working Group (‘WG Questions’). ISDA indicated that the document will continue to be reviewed and updated as and when required. While the intention of these SOPs is to provide an agreed and standardized market guide for firms to utilize, no firm is legally bound or compelled in any way to follow any determinations made within these EMIR SOPs.
- ISDA and IIF Respond to BCBS-CPMI-IOSCO Consultation on Margin Transparency. On April 12, ISDA and the Institute of International Finance (IIF) submitted a response to the Basel Committee on Banking Supervision (BCBS), Committee on Payments and Market Infrastructures (CPMI) and International Organization of Securities Commissions (IOSCO) consultation on transparency and responsiveness of initial margin in centrally cleared markets. In their response, the associations expressed support for enhancing transparency on cleared margin for all market participants, which they expect will help with liquidity preparedness and increase resilience of the system, noting it should start with central counterparties (CCPs) making fundamental disclosures about their margin models. In this regard, both associations highlight their support in the response to recommendations one through eight. Regarding recommendation nine, the associations indicated that they are supportive of clients having necessary transparency on clearing member (CM) margin requirements. Regarding recommendation 10, the associations said in the response that they are generally supportive of the principle that CCPs should have visibility into the risk profile of their clearing participants but warned that, in their opinion, the information required under recommendation 10 may raise legal, confidentiality, or competition concerns. Finally, the associations noted that they believe further work should be done on the fundamentals of CCP margin models, for example on the appropriateness of margin periods of risk and the calibration of anti-procyclicality tools, to ensure that margins do not fall too low during low volatility periods.
- IOSCO Publishes Updated Workplan. On April 12, IOSCO published its updated 2024 Workplan, which directly supports its overall two-year Work Program published on April 5, 2023. The 2024 Workplan announced new workstreams, reflecting increased focus on AI, tokenization and credit default swaps, and additional work on transition plans and green finance. The 2024 Workplan set out priorities under five themes: Protecting Investors, Address New Risks in Sustainability and Fintech, Strengthening Financial Resilience, Supporting Market Effectiveness and Promoting Regulatory Cooperation and Effectiveness
- ISDA, AIMA, GFXD Publish Paper on Transition to UPI. On April 9, ISDA, the Alternative Investment Management Association (AIMA) and the Global Foreign Exchange Division (GFXD) of the Global Financial Markets Association published a paper on the transition to unique product identifiers (UPI) as the basis for over-the-counter (OTC) derivatives identification across the Markets in Financial Instruments Regulation (MIFIR) regimes. The paper has been sent to the European Commission, which is working on legislation to address appropriate identification of OTC derivatives under MiFIR.
- ISDA Submits Addendum to US Basel III NPR Comment Letter. On April 8, ISDA submitted an addendum to the joint US Basel III ‘endgame’ notice of proposed rulemaking response along with the Securities Industry and Financial Markets Association. The addendum contains a more developed proposal for the index bucketing approach for equity investment in funds and an update to the Fundamental Review of the Trading Book Standardized Approach Quantitative Impact Study numbers.
The following Gibson Dunn attorneys assisted in preparing this update: Jeffrey Steiner, Adam Lapidus, Marc Aaron Takagaki, Hayden McGovern, and Karin Thrasher.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Derivatives practice group, or the following practice leaders and authors:
Jeffrey L. Steiner, Washington, D.C. (202.887.3632, jsteiner@gibsondunn.com)
Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com)
Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)
Darius Mehraban, New York (212.351.2428, dmehraban@gibsondunn.com)
Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)
Adam Lapidus – New York (+1 212.351.3869, alapidus@gibsondunn.com)
Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)
Roscoe Jones Jr., Washington, D.C. (202.887.3530, rjones@gibsondunn.com)
William R. Hallatt, Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)
David P. Burns, Washington, D.C. (202.887.3786, dburns@gibsondunn.com)
Marc Aaron Takagaki, New York (212.351.4028, mtakagaki@gibsondunn.com)
Hayden K. McGovern, Dallas (214.698.3142, hmcgovern@gibsondunn.com)
Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
On April 20, 2024, New York lawmakers approved the State’s 2024-2025 budget. As a part of the budgetary vote, lawmakers passed three notable amendments to New York Labor Law of which employers should be aware.
PAID PRENATAL LEAVE: In a first-of-its-kind law in the country, lawmakers amended the New York Labor Law’s sick leave provisions to require all employers (regardless of size) to provide employees twenty (20) hours of paid prenatal leave per year. Employees may use this leave to obtain healthcare services during or related to pregnancy – for example, for physical examinations, medical procedures, monitoring and testing, and discussions with a health care provider concerning their pregnancy.
This leave bank must be separate from other leave accruals, including the forty (40) or fifty-six (56)[1] hours of sick leave that New York employers are currently required to provide employees for their own illness or need for medical care (including mental illness), the care or treatment of certain covered family members, and for certain safety concerns (such as domestic violence).
The law prohibits employers from discriminating or retaliating against employees because they requested or utilized prenatal leave and requires employees who use prenatal leave to be restored to the same position they held prior to such leave. The amendment does not address, for example, whether and under what circumstances employers may require advance notice or documentation regarding the use of prenatal leave, though the labor commissioner has the authority to adopt regulations and issue guidance to address these and other questions. The requirements to provide prenatal leave become effective on January 1, 2025.
PAID NURSING BREAKS: The New York Labor Law was also amended to require all employers (regardless of size) to provide paid nursing breaks. This marks a notable change from the current law, which only requires reasonable unpaid breaks for expressing breast milk. Under the new law, which is effective June 19, 2024, employers must provide thirty (30) minute paid breaks each time an employee has a reasonable need to express breast milk for up to three (3) years following childbirth. The law also requires employers to permit employees to use other existing paid break and mealtime (e.g., under wage and hour laws) to express breast milk when breaks longer than thirty (30) minutes are needed.
The statute does not address how often employees may take paid nursing breaks. However, the state interpreted the prior iteration of the statute to allow employees to take unpaid breaks at least once every three hours, with accommodations made for employees that need more frequent breaks. The state might take a similar approach with the new iteration of the law requiring paid breaks.
COVID-19 SICK LEAVE: Finally, New York’s COVID-19 leave law will be deemed repealed as of July 31, 2025. The State’s COVID-19 leave law presently requires employers to provide employees up to fourteen (14) days of paid leave, separate from other leave accruals, when they are subject to a mandatory or precautionary order of quarantine or isolation due to COVID-19. Although employees with COVID-19 may still qualify for leave under the State’s sick leave law after July 31, 2025, New York employers will no longer be required to provide a separate COVID-19 leave bank after that date.
New York employers should review and revise their existing leave and break policies to ensure compliance with these new requirements by the effective dates.
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[1] The State’s sick leave law currently requires: (i) employers with one hundred (100) or more employees to provide fifty-six (56) hours of paid sick leave per year; (ii) employers with between five (5) and ninety-nine (99) employees to provide forty (40) hours of paid sick leave per year; and (iii) employers with less than five (5) employees to provide forty (40) hours of unpaid sick leave per year, unless the employer has a net income of greater than $1 million per year, in which case, such sick leave must be paid.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment practice group, or the following authors:
Harris M. Mufson – Partner, New York (+1 212.351.3805, hmufson@gibsondunn.com)
Danielle J. Moss – Partner, New York (+1 212.351.6338, dmoss@gibsondunn.com)
Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202.955.8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Co-Chair, Los Angeles (+1 213.229.7107, ksmith@gibsondunn.com)
*Andrew Webb, a recent law graduate in the New York office, is not admitted to practice law.
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
This near categorical ban on non-compete agreements marks an abrupt departure from existing law in many jurisdictions and has drawn almost immediate legal challenges.
On April 23, 2024, the FTC voted 3-2 to adopt a sweeping final rule banning the use of non-compete agreements nationwide, impacting 30 million workers by the FTC’s own estimates.[1] The final rule is presently set to become effective 120 days after its publication in the Federal Register, which is expected to occur in the next two weeks, with the possibility that the effective date may be delayed or enjoined in light of the pending litigation challenging the rule. It prohibits any new non-compete agreements and renders existing non-compete agreements with workers unenforceable, with limited exceptions. In addition to banning new non-competes, the rule requires employers to provide workers with notice that their existing non-compete agreements are no longer enforceable, but employers are not required to formally rescind the agreements.[2] Employers should be aware that the rule defines “worker” broadly, encompassing persons working as employees, independent contractors, interns, externs, volunteers, and sole proprietors.[3]
This near categorical ban on the non-compete agreements is an abrupt contrast from a regime in which these agreements had been recognized to have potential procompetitive value and therefore were reviewed for reasonableness. It also marks a sharp departure from the state law in many jurisdictions.
I. Narrow Exceptions
Notably, the final rule does not invalidate existing non-compete agreements with senior executives, one of the few changes from the proposed rule.[4] A “senior executive” is defined as a worker who: (1) earns more than $151,164 annually; and (2) is in a “policy-making position,” which is defined narrowly to mean “a business entity’s president, chief executive officer or the equivalent, any other officer of a business entity who has policy-making authority, or any other natural person who has policy-making authority for the business entity similar to an officer with policy-making authority.” The final rule also does not bar causes of action related to a non-compete that accrued prior to the effective date of the final rule. And enforcing or attempting to enforce a non-compete is not considered an unfair method of competition where an employer has a good-faith basis to believe the final rule is inapplicable.
The final rule’s general prohibition on non-competes is also not applicable to non-competes entered pursuant to the sale of a business. While the Commission had earlier proposed an exception for certain non-competes between the seller and the buyer of a business that applied only to a substantial owner, member, or partner, defined as an owner, member, or partner with at least 25% ownership interest in the business entity being sold, in response to public comments, the final rule no longer includes the proposed requirement that the restricted party be “a substantial owner of, or substantial member or substantial partner in, the business entity” to fall under the exception.
II. Functional Non-Competes
The final rule defines a “non-compete clause” as “a term or condition of employment that prohibits a worker from, penalizes a worker for, or functions to prevent a worker from (1) seeking or accepting work in the United States with a different person where such work would begin after the conclusion of the employment that includes the term or condition; or (2) operating a business in the United States after the conclusion of the employment that includes the term or condition.” In assessing the impact of the final rule on other kinds of restrictive covenants, the FTC emphasizes three prongs of the “non-compete clause” definition—”prohibit,” “penalize,” and “functions to prevent.” Although the FTC declined to create a categorical prohibition on non-disclosure, non-solicitation, and similar restrictive covenants, it explained that the “functions to prevent” language applies to any term or condition of employment adopted by an employer that is so broad or onerous as to have the same functional effect as a term or condition prohibiting or penalizing a worker from seeking or accepting other work or starting a business after their employment ends.
The FTC explained its view that a “garden-variety NDA,” in which a worker agrees not to disclose certain confidential information to a competitor, would not prevent that worker from seeking or accepting work with a competitor after leaving their job. However, the FTC would consider an NDA that spans such a wide swath of information so as to functionally prevent a worker from seeking or accepting other work to be a “non-compete clause.” Examples of problematic NDAs provided by the final rule include: (1) an agreement barring a worker from disclosing any information “usable in” or relating to the industry in which they work; and (2) an agreement barring a worker from disclosing any information obtained during their employment, including publicly available information.
Non-solicitation agreements and training repayment provisions are subject to the same fact-specific analysis. In particular, the FTC stated that agreements that impose substantial out-of-pocket costs upon workers for departing may effectively prevent them from seeking or accepting other work or starting a business and be functionally deemed a non-compete agreement.
The FTC also clarified that in its view a “garden leave” agreement—where the worker is “still employed and receiving the same total annual compensation and benefits on a pro rata basis—is not a non-compete clause,” since such an agreement does not restrict the worker post-employment. For the same reason, the FTC explained that the final rule is not meant to prohibit agreements under which a worker who does not meet a condition foregoes a particular aspect of their expected compensation, which would seemingly remove retention bonuses from the rule’s purview. Similarly, the FTC stated that agreements requiring workers to repay a bonus or forfeit accrued sick leave after leaving a job would not meet the definition of “non-compete clause” under the final rule, so long as they do not penalize or function to prevent a worker from seeking or accepting work or operating a business after the worker leaves the job.
III. Republican Dissents
Yesterday’s Special Open Commission Meeting marked the first for incoming Republican Commissioners Melissa Holyoak and Andrew Ferguson, who both dissented on constitutional and statutory grounds, among other reasons. Although their written dissents are not yet available, they stated in oral remarks[5] that the final rule exceeds the FTC’s authority and is barred by the major questions doctrine because Congress did not authorize the FTC to promulgate legislative rules (much less rules of such sweeping consequence) through either Section 6(g) or Section 5 of the FTC Act. According to Commissioner Ferguson, the FTC majority relies on “oblique or elliptical language that cannot justify the redistribution of half a trillion dollars of wealth within the general economy by regulatory fiat.” Commissioner Ferguson further stated the Rule is (1) unlawful under the non-delegation doctrine, and (2) arbitrary and capricious under the Administrative Procedure Act because the evidence on which the agency relies cannot justify the nationwide ban of non-competes irrespective of their terms, conditions, and particular effects.
IV. Immediate Legal Challenges
Within minutes of the vote, the final rule was the subject of a legal challenge filed by Gibson Dunn in the Northern District of Texas. Consistent with the dissenting views of Commissioners Holyoak and Ferguson, Gibson Dunn’s complaint argues that the FTC lacks the statutory authority to issue the rule, that any such grant of authority would be an unconstitutional delegation of legislative power, and that the FTC is unconstitutionally structured. The U.S. Chamber of Commerce also filed a lawsuit today. These cases raise the substantial questions surrounding the FTC’s authority to promulgate rules in this area and whether the agency’s rulemaking complied with the Administrative Procedure Act.
V. Employer Considerations
The final rule is presently set to become effective 120 days after its publication in the Federal Register. Given the pending litigation challenging the rule, it is possible that this effective date may be delayed or enjoined, and that the rule may ultimately be invalidated and never take effect. Accordingly, employers have, at a minimum, several months before the rule takes effect and may find it appropriate to watch how the pending legal challenges develop. Notwithstanding that uncertainty, however, businesses subject to the final rule[6] should consider using this time to: (1) review their existing non-compete agreements and be prepared to provide the required notice to non-senior executive workers, in accordance with the rule’s requirements, if and when necessary; (2) likewise, be prepared if necessary to amend existing antitrust compliance programs to provide guidance to avoid violating the rule; (3) consult with outside counsel; and (4) carefully consider the potential impact on future mergers and acquisitions, as the Hart-Scott-Rodino Act rules proposed by the FTC last year require disclosure of transaction-related agreements (including non-competes).
Gibson Dunn attorneys are closely monitoring these developments and available to discuss these issues as applied to your particular business.
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[1] The text of the FTC’s “Non-Compete Clause Rule” is available here.
[2] The rule includes model language that satisfies this notice requirement.
[3] The definition also includes persons working for a franchisee or franchisor but does not extend to a “franchisee” in the context of a franchisee-franchisor relationship.
[4] The FTC estimates that fewer than 0.75% of workers will qualify as senior executives according to the rule.
[5] A recording of the Special Open Commission Meeting is available here.
[6] The FTC stated that the “final rule applies to the full scope” of its jurisdiction, which it stated would exclude many non-profits. However, the preamble makes clear that the FTC will not treat an organization’s tax-exempt status as dispositive for purposes of evaluating its authority. Section 5 of the FTC Act also does not apply to the following entities: banks, savings and loan institutions, federal credit unions, common carriers, air carriers, and persons and businesses subject to the Packers and Stockyards Act.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, any leader or member of the firm’s Labor and Employment, Administrative Law and Regulatory, or Antitrust and Competition practice groups, or the following:
Labor and Employment:
Andrew G.I. Kilberg – Partner, Washington, D.C. (+1 202.887.3759, akilberg@gibsondunn.com)
Karl G. Nelson – Partner, Dallas (+1 214.698.3203, knelson@gibsondunn.com)
Jason C. Schwartz – Co-Chair, Washington, D.C. (+1 202.955.8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Co-Chair, Los Angeles (+1 213.229.7107, ksmith@gibsondunn.com)
Administrative Law and Regulatory:
Eugene Scalia – Co-Chair, Washington, D.C. (+1 202.955.8673, escalia@gibsondunn.com)
Helgi C. Walker – Co-Chair, Washington, D.C. (+1 202.887.3599, hwalker@gibsondunn.com)
Antitrust and Competition:
Rachel S. Brass – Co-Chair, San Francisco (+1 415.393.8293, rbrass@gibsondunn.com)
Svetlana S. Gans – Partner, Washington, D.C. (+1 202.955.8657, sgans@gibsondunn.com)
Cynthia Richman – Co-Chair, Washington, D.C. (+1 202.955.8234, crichman@gibsondunn.com)
Stephen Weissman – Co-Chair, Washington, D.C. (+1 202.955.8678, sweissman@gibsondunn.com)
Chris Wilson – Partner, Washington, D.C. (+1 202.955.8520, cwilson@gibsondunn.com)
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
Gibson Dunn’s Workplace DEI Task Force aims to help our clients develop creative, practical, and lawful approaches to accomplish their DEI objectives following the Supreme Court’s decision in SFFA v. Harvard. Prior issues of our DEI Task Force Update can be found in our DEI Resource Center. Should you have questions about developments in this space or about your own DEI programs, please do not hesitate to reach out to any member of our DEI Task Force or the authors of this Update (listed below).
Key Developments:
On April 17, 2024, the Supreme Court held in Muldrow v. City of St. Louis, No. 22-193, that plaintiffs who challenge employers’ job transfer decisions as discriminatory under Title VII do not need to demonstrate that the harm suffered was “significant,” “material,” or “serious.” But plaintiffs must still show “some harm respecting an identifiable term or condition of employment,” such as hiring, firing, or transferring employees. A plaintiff also must show that her employer acted with discriminatory intent and that the transfer was based on a characteristic protected under Title VII. The Court emphasized that the decision does not reach retaliation or hostile work environment claims. The Court did not address how the decision might impact corporate DEI programs. For a more detailed discussion of this decision, see our April 17 Client Alert .
On April 12, 2024, Arkansas teachers and students, along with the Arkansas State Conference of the NAACP (NAACP-AR), filed a complaint against Governor Sarah Huckabee Sanders, challenging the constitutionality of Section 16 of Arkansas’s Literacy, Empowerment, Accountability, Readiness, Networking and School Safety Act (the “LEARNS Act”) and seeking to enjoin its enforcement. In Walls v. Sanders, No. 4:24-cv-002 (E.D. Ark. April 12, 2024), the plaintiffs allege that the LEARNS Act “expressly bans” the teaching of “Critical Race Theory” (which the Act refers to as “forced indoctrination”) in violation of their First Amendment and Fourteenth Amendment rights. After the Act was passed, Arkansas Secretary of Education Jacob Oliva revoked state approval for the AP African American Studies course, alleging that the course and educational materials violated Section 16. The plaintiffs allege that Section 16 chills speech, impermissibly regulates speech based on viewpoint discrimination, and violates the equal protection guarantees of the Fourteenth Amendment because it was motivated by racial animus and “created, in part, to target Black students and educators on the basis of race.” On April 17, 2024, the court denied the plaintiffs’ request for expedited briefing but scheduled a preliminary injunction hearing for April 30, 2024.
April continues to be a busy month for state legislation on both sides of the DEI debate. On April 22, 2024, Tennessee Governor Bill Lee signed H.B. 2100—a “social credit score” bill—into law. The bill limits factors that insurers and financial institutions can consider in decisions about the provision or denial of services. Specifically, the bill prohibits insurers and financial institutions from denying services or otherwise discriminating against persons for failure to satisfy ESG standards, corporate composition benchmarks, or compliance with DEI training policies. Meanwhile, on April 8, 2024, Virginia Governor Glenn Youngkin signed H.B. 1452 into law. This new law takes effect on July 1, 2024, and will require state agency heads to maintain comprehensive diversity, equity, and inclusion strategic plans. Strategic plans will need to integrate DEI goals into each agency’s mission and detail best practices for addressing equal opportunity barriers and promoting equity in operational activities including pay, hiring, and leadership. Agencies will be required to submit annual reports to enable the Governor and the General Assembly to monitor progress.
Media Coverage and Commentary:
Below is a selection of recent media coverage and commentary on these issues:
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- The Wall Street Journal, “Diversity goals are disappearing from companies’ annual reports” (April 21): The Wall Street Journal’s Ben Glickman and Lauren Weber report on shifts in how companies are discussing DEI in their annual reports as a result of increased scrutiny of DEI initiatives. Glickman and Weber conclude that “[d]ozens of companies [have] altered descriptions of diversity, equity and inclusion initiatives in their annual reports to investors,” citing several examples. Glickman and Weber note that these shifts do not necessarily mean companies are abandoning their commitment to DEI, just that they are choosing to be less public about their DEI programs. Ivy Feng, an accounting professor at the University of Wisconsin, observed, “What gets disclosed gets managed. So if they don’t say anything, it’s more difficult for outsiders to find out what’s really going on.” Jason Schwartz, Gibson Dunn partner and co-head of the firm’s Labor and Employment practice group, concludes that many companies are just trying to determine what is lawful: “Forget about any ideological agenda. [Companies are] just trying to figure out, how do I follow the law? You don’t want to overcommit or undercommit or misdescribe where you’ll eventually land.”
- The Washington Post, “DEI ‘lives on’ after Supreme Court ruling, but critics see an opening” (April 19): Julian Mark of The Washington Post writes on the potential impact on DEI programs following the Supreme Court’s decision in Muldrow v. City of St. Louis, Missouri. Mark notes the divergence of views on the scope of the Court’s ruling. Some practitioners interpret Muldrow narrowly. But EEOC Commissioner Andrea Lucas contends that DEI programs are now more susceptible to legal challenges than ever. Lucas asserts leadership development or training programs that are restricted to certain racial groups are now “high risk,” as are employers’ efforts to foster diverse hiring slates, opining that “the ‘some harm’ standard will [not] be the saving grace for a DEI program.”
- Bloomberg Law, “The Supreme Court Just Complicated Employer DEI Programs” (April 18): Writing for Bloomberg Law, Simon Foxman examines the Supreme Court’s ruling in Muldrow v. City of St. Louis, Missouri, in which the Supreme Court unanimously held that an employee could bring suit under Title VII based on her reassignment to a position of the same pay but less favorable workdays and other benefits. The Court explained that an employee only has to suffer “‘some harm’ under the terms of their employment,” but that harm “doesn’t need to be ‘material,’ ‘substantial’ or ‘serious.’” Foxman reports that racial justice groups like the Legal Defense Fund celebrated the decision but expressed fears that “opponents of DEI programs likely will see this as an opening to launch new attacks on diversity programs.”
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- The New York Times, “What Researchers Discovered When They Sent 80,000 Fake Résumés to U.S. Jobs” (April 8): Claire Cain Miller and Josh Katz of The New York Times report on a social experiment performed by a group of economists on roughly 100 of the largest companies in the country. The economists submitted thousands of fake “résumés with equivalent qualifications but different personal characteristics,” changing the name on each application to suggest whether an applicant was “white or Black, and male or female.” Miller and Katz report that the results were striking, with one company contacting “presumed white applicants 43 percent more often” than minority applicants with the same credentials. The study identifies other trends, including potential biases against older workers, women, and LGBTQ individuals. Miller and Katz note the study found various measures companies use in an effort to reduce discrimination, such has employing a chief diversity officer, offering diversity training, or having a diverse board, had no effect on the outcome of their experiment. But there was one thing all the companies who exhibited the least bias had in common: a centralized human resources function.
- The New York Times, “With State Bans on D.E.I., Some Universities Find a Workaround: Rebranding” (April 12): Writing for The New York Times, Stephanie Saul reports on what she terms the “rebranding” many state universities have undertaken in the wake of legislation targeting DEI programs in higher education. Saul writes that, as an example, the University of Tennessee’s “campus D.E.I. program is now called the Division of Access and Engagement,” and at LSU, what was once the Division of Inclusion, Civil Rights and Title IX is now called the Division of Engagement, Civil Rights and Title IX. Saul states that some, like LSU VP of Marketing Todd Woodward, celebrate this “rebranding” as an effort to retain the impact of the departments and avoid job cuts. Woodward explained that the switch from “inclusion” to “engagement” better signifies the “university’s strategic plan.” But others, like Professor David Bray at Kennesaw State University, express skepticism, saying moves like this are little more than “the same lipstick on the ideological pig.”
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- AP News, “Texas diversity, equity and inclusion ban has led to more than 100 job cuts at state universities” (April 13): Writing for AP News, Acacia Coronado examines the effect that SB17, Texas’ ban on DEI initiatives, has had in higher education. According to Coronado, the bill, which prohibits training and activities that reference race, color, ethnicity, gender identity, or sexual orientation, “has led to more than 100 job cuts across university campuses in Texas.” SB17 does not “apply to academic course instruction and scholarly research” positions, but Professor Aquasia Shaw, the only person of color in the Kinesiology Department at the University of Texas at Austin, suspects SB17 was responsible for the University’s decision not to renew her contract.
- The Hill, “Republican states urge Congress to reject DEI legislation” (April 16): The Hill’s Cheyanne Daniels reports on Representatives Ayanna Pressley (D-MA) and Jamie Raskin’s (D-MD) introduction of the Federal Government Equity Improvement and Equity in Agency Planning Acts in the wake of “attempts to limit DEI programs . . . around the country.” These bills are designed to encourage federal agencies to enact policies focused on “providing equal opportunity for all, including people of color, women, rural communities and individuals with disabilities.” The legislation has not been welcomed by all, with Republican West Virginia Attorney General Patrick Morrisey penning a letter to Raskin and Representative James Comer (R-KY), Chairman of the Committee on Oversight and Accountability, declaring the bills “divisive.”
- Law360, “Anti-DEI Complaints Filed With EEOC Carry No Legal Weight” (April 15): In an op-ed for Law360, Rutgers law professor and former EEOC counsel David Lopez asserts that the series of EEOC complaints conservative organizations like America First Legal Foundation (“AFL”) are filing against companies “carry no legal weight.” He describes these complaints as mere attempts to “weaponize the [public’s] lack of knowledge as a means of bullying employers into retreating from core values.” He encourages employers “not [to] be intimidated” by AFL’s tactics but to continue “develop[ing] workplace practices focused on rooting out entrenched and ongoing discriminatory practices against Black people, women and others in the workplace.”
Case Updates:
Below is a list of updates in new and pending cases:
1. Contracting claims under Section 1981, the U.S. Constitution, and other statutes:
- Suhr v. Dietrich, No. 2:23-cv-01697-SCD (E.D. Wis. 2023): On December 19, 2023, a dues-paying member of the Wisconsin Bar filed a complaint against the Bar over its “Diversity Clerkship Program,” a summer hiring program for first-year law students. The program’s application requirements had previously stated that eligibility was based on membership in a minority group. After SFFA v. Harvard, the eligibility requirements were changed to include students with “backgrounds that have been historically excluded from the legal field.” The plaintiff claims that the Bar’s program is unconstitutional even with the new race-neutral language, because, in practice, the selection process is still based on the applicant’s race or gender. The plaintiff also alleges that the Bar’s diversity program constitutes compelled speech and compelled association in violation of the First Amendment.
- Latest update: Under a partial settlement agreement, the Bar agreed to “make clear that the Diversity Clerkship Program is open to all first-year law students.” In exchange, the plaintiff will drop his claims about the clerkship program and file an amended lawsuit challenging only the mandatory dues and how they are spent.
- Do No Harm v. Pfizer, No. 1:22-cv-07908 (S.D.N.Y. 2022), aff’d, No. 23-15 (2d Cir. 2023): On September 15, 2022, conservative medical advocacy organization Do No Harm (DNH) filed suit against Pfizer, alleging that Pfizer discriminated against white and Asian students by excluding them from its Breakthrough Fellowship Program. To be eligible for the program, applicants must “[m]eet the program’s goals of increasing the pipeline for Black/African American, Latino/Hispanic and Native Americans.” DNH alleged that the criteria violate Section 1981, Title VI of the Civil Rights Act, the Affordable Care Act, and multiple New York state laws banning racially discriminatory internships, training programs, and employment. In December 2022, the Southern District of New York dismissed the case for lack of subject matter jurisdiction, finding that DNH did not have standing because it did not identify at least one member by name. On March 6, 2024, the United States Court of Appeals for the Second Circuit affirmed the district court’s dismissal, holding that an organization must name at least one affected member to establish Article III standing under the “clear language” of Supreme Court precedent. On March 20, 2024, DNH petitioned the court for a rehearing en banc.
- Latest update: On April 3, 2024, four amicus briefs were filed in support of DNH’s petition for a rehearing en banc. Briefs were filed by: (1) Speech First, an organization “committed to restoring freedom of speech on college campuses,” (2) Pacific Legal Foundation, an organization which “defend[s] individual liberty and limited government,” (3) Young America’s Foundation, which supports “individual freedom, a strong national defense, free enterprise, and traditional values,” The Manhattan Institute, “whose mission is to develop and disseminate new ideas that foster economic choice and individual responsibility,” and Southeastern Legal Foundation, which is “dedicated to defending liberty and Rebuilding the American Republic,” and (4) the American Alliance for Equal Rights, which is “dedicated to challenging distinctions and preferences made on the basis of race and ethnicity.” The four briefs argue that prohibiting anonymity in sensitive cases with “vulnerable plaintiffs” violates the First Amendment and negates the purpose of associational standing in the public interest litigation context.
2. Employment discrimination and related claims:
- Bowen v. City and County of Denver, No. 1:24-cv-00917 (D. Colo. 2024): On April 5, 2024, Joseph Bowen, a sergeant in the Denver Police Department, sued the Department and the City and County of Denver alleging that the Department’s 30×30 initiative, which pledges that 30% of all police recruits will be women by 2030, caused him to lose out on a promotion to captain to three less-qualified women. Bowen alleges that the Department discriminated against him on the basis of his sex, in violation of Title VII of the Civil Rights Act of 1964.
- Latest update: A scheduling conference is scheduled for June 25, 2024.
- Renault v. Adidas, No. 2024-CP-420-1549 (Court of Common Pleas, South Carolina, April 15, 2024): On April 15, 2024, pro se plaintiff Peter Renault sued Adidas in South Carolina state court for employment discrimination after he was rejected for a supply chain analyst position. Renault alleges that he was qualified but not hired due to the company’s DEI policies.
- Latest update: The docket does not reflect that Adidas has been served.
3. Challenges to agency rules, laws, and regulatory decisions:
- Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir. 2021): On October 18, 2023, a unanimous Fifth Circuit panel rejected petitioners’ constitutional and statutory challenges to Nasdaq’s Board Diversity Rules and the SEC’s approval of those rules. Gibson Dunn represents Nasdaq, which intervened to defend its rules. Petitioners sought a rehearing en banc.
- Latest update: On March 21, 2024, petitioners’ briefs were filed. On March 28, 2024, Arizona, Alabama, Alaska, Arkansas, Florida, Indiana, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Montana, Nebraska, Oklahoma, South Carolina, Texas, and Utah filed an amicus brief in support of petitioners, arguing that Nasdaq’s rules violate the Equal Protection Clause and states’ rights. Nasdaq and the SEC will file their briefs on April 29, and oral argument is scheduled for May 14.
4. Actions against educational institutions:
- Elliott v. Antioch University, No. 2:24-cv-502 (W.D. Wash.): On April 15, 2024, the plaintiff, a white woman, sued Antioch University for suspending her account after she criticized the school’s decision to have students sign a “civility pledge” committing to anti-racism. Elliott made a series of public videos and online posts expressing her criticisms of the policy changes at Antioch and alleges that when she refused to sign the civility pledge, she was excluded from courses necessary for her to graduate with her degree. Elliott sued Antioch under Title VI of the Civil Rights Act, breach of contract, and defamation.
- Latest update: The docket does not reflect that Antioch University has been served.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment practice group, or the following practice leaders and authors:
Jason C. Schwartz – Partner & Co-Chair, Labor & Employment Group
Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Partner & Co-Chair, Labor & Employment Group
Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)
Mylan L. Denerstein – Partner & Co-Chair, Public Policy Group
New York (+1 212-351-3850, mdenerstein@gibsondunn.com)
Zakiyyah T. Salim-Williams – Partner & Chief Diversity Officer
Washington, D.C. (+1 202-955-8503, zswilliams@gibsondunn.com)
Molly T. Senger – Partner, Labor & Employment Group
Washington, D.C. (+1 202-955-8571, msenger@gibsondunn.com)
Blaine H. Evanson – Partner, Appellate & Constitutional Law Group
Orange County (+1 949-451-3805, bevanson@gibsondunn.com)
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
From the Derivatives Practice Group: The Bank of Israel announced that it will cease publication of Telbor next year and four new directors joined ISDA’s board this week.
New Developments
- Chairman Behnam Announces CFTC’s First DEIA Strategic Plan. On April 18, CFTC Chairman Rostin Behnam announced the agency’s first Strategic Plan to Advance Diversity, Equity, Inclusion, and Accessibility (DEIA Plan). Chairman Behnam said that the two-year DEIA Plan represents a critical step forward in aligning the CFTC with a collective DEIA vision that not only provides genuine support for team members, but also ensures the CFTC is a source of future leaders. The CFTC designed the DEIA Plan to align with its 2022-2026 Strategic Plan and to focus on the following six goals: Inclusive Workplaces, Partnerships and Recruitment, Paid Internships, Professional Development and Advancement, Data, and Equity in Procurement and Customer Education and Outreach. Each goal includes objectives and strategies/actions to achieve the goal, and identifies the agency division(s)/office(s) that will lead and contribute to the implementation of the goal. The CFTC said that an internal DEIA Executive Council will support and guide the implementation of the DEIA Plan. [NEW]
- CFTC Appoints Christopher Skinner as Inspector General. On April 10, the Commodity Futures Trading Commission announced that Christopher L. Skinner has been appointed CFTC’s Inspector General (IG). The CFTC stated that Mr. Skinner brings 15 years of IG experience, including leading and managing Offices of Inspector’s General (OIG), and conducting investigations, inspections, and audits. Mr. Skinner comes to the CFTC from the Federal Election Commission (FEC) where he served as IG since 2019.
New Developments Outside the U.S.
- Telbor Committee to Permanently Cease Publication of Telbor. On April 16, the Telbor Committee of the Bank of Israel decided that the publication of all tenor of Telbor will permanently cease following a final publication on June 30, 2025. The announcement constitutes an “Index Cessation Event” under the 2021 ISDA Interest Rate Derivatives Definitions and the November 2022 Benchmark Module of the ISDA 2021 Fallbacks Protocol. In February 2022, the Telbor Committee decided that the SHIR (Shekel overnight Interest Rate) rate would eventually replace the Telbor interest rate in shekel interest rate derivative transactions. The Bank of Israel said that the decision to switch to the SHIR rate is in accordance with the decisions reached in major economies worldwide, according to which IBOR type interest rates will be replaced by risk-free overnight interest rates. ISDA published cessation guidance for parties affected by the announcement. [NEW]
- New Report Sheds Light on Quality and Use of Regulatory Data Across EU. On April 11, ESMA published the fourth edition of its Report on the Quality and Use of Data aiming to provide transparency on how the data collected under different regulations is used systematically by authorities in the EU, and clarifying the actions taken to ensure data quality. The report provides details on how National Competent Authorities, the European Central Bank, the European Systemic Risk Board and ESMA use the data that is collected through the year from different legislation requirements, including datasets from European Market Infrastructure Regulation, Securities Financing Transactions Regulation, Markets in Financial Instruments Directive, Securitization Regulation, Alternative Investment Fund Managers Directive and Money Market Funds Regulation.
New Industry-Led Developments
- Four Directors Join ISDA Board. On April 18, ISDA announced that four directors have joined its Board, three directors were re-appointed, and 10 others have been re-elected at ISDA’s Annual General Meeting in Tokyo. The new directors are: Erik Tim Mueller, Chief Executive Officer, Eurex Clearing AG; Jared Noering, Managing Director, Head of Fixed Income Trading, NatWest Markets; Brad Tully, Managing Director and Global Head of Corporate Derivatives and Private Side Sales for J.P. Morgan; and Jan Mark van Mill, Managing Director of Multi Asset, APG Asset Management. [NEW]
- ISDA Future Leaders in Derivatives Publishes Generative Artificial Intelligence Whitepaper. On April 17, ISDA published a whitepaper from ISDA Future Leaders in Derivatives (IFLD), its professional development program for emerging leaders in the derivatives market. The whitepaper, GenAI in the Derivatives Market: a Future Perspective, was developed by the third cohort of IFLD participants, who began working together in October 2023. According to ISDA, the 38 individuals in the group represent buy- and sell-side institutions, law firms, and service providers from around the world. After being selected for the IFLD program, they were asked to engage with stakeholders, develop positions, and produce a whitepaper on the potential use of generative artificial intelligence (genAI) in the over-the-counter derivatives market. The participants were also given access to ISDA’s training materials, resources, and staff expertise to support the project and their own professional development. ISDA said that, drawing on industry expertise and academic research, the whitepaper identifies a range of potential use cases for genAI in the derivatives market, including document creation, market insight, and risk profiling. ISDA also indicated that it explores regulatory issues in key jurisdictions and addresses the challenges and risks associated with the use of genAI. The paper concludes with a set of recommendations for stakeholders, including investing in talent development, fostering collaboration and knowledge sharing with technology providers, prioritizing ethical AI principles and engaging with policymakers to promote an appropriate regulatory framework. [NEW]
- ISDA Publishes Research Paper on Interest Rate Derivatives, Benchmark Rates and Development Financial Markets in EMDEs. On April 17, ISDA published a research paper in which it outlines the role of interest rate derivatives (IRDs) in supporting the development of financial markets in emerging markets and developing economies (EMDEs). It also examines the significance of reliable, robust interest rate (IR) benchmarks. ISDA indicated that the paper draws valuable lessons from the transition from LIBOR to overnight risk-free rates in advanced economies and applies those insights to the context of EMDEs. Through case studies, ISDA attempts to show how various EMDE jurisdictions have successfully adopted and implemented more robust and transparent IR benchmarks. [NEW]
- ISDA Extends Digital Regulatory Reporting Initiative to New Jurisdictions. On April 17, ISDA announced that it is extending its Digital Regulatory Reporting (DRR) initiative to several additional jurisdictions in an effort to enable firms to implement changes to regulatory reporting requirements. The DRR is being extended to cover rule amendments being implemented under the UK European Market Infrastructure Regulation and by the Australian Securities and Investments Commission and the Monetary Authority of Singapore. Those rule changes are due to be implemented in the UK on September 30, 2024, and October 21, 2024 in Australia and Singapore. The DRR code for all three sets of rules is currently available for market participants to review and test. ISDA said that the DRR will be further extended to cover rule changes in Canada and Hong Kong, both due in 2025, and the DRR for the CFTC rules will also be updated to include further anticipated updates, currently under consultation at the commission. Firms can either use the DRR as the basis for implementation or to validate an independent interpretation of the rules. [NEW]
- ISDA Publishes Margin Survey. On April 16, ISDA published its latest margin survey, which shows that $1.4 trillion of initial margin (IM) and variation margin (VM) was collected by 32 leading derivatives market participants for their non-cleared derivatives exposures at the end of 2023, unchanged from the previous year. The survey also reports the amount of IM posted by all market participants to major central counterparties. [NEW]
- ISDA Establishes Suggested Operational Practices for EMIR Refit. On April 16, through a series of discussions held within the ISDA Data and Reporting EMEA Working Group, market participants established and agreed to Suggested Operational Practices (SOP) for over-the-counter derivative reporting in preparation for the commencement of the EMIR Refit regulatory reporting rules on April 29. ISDA said that the SOP matrix was established based on the EMIR Refit validation table, (as published by ESMA), which contains the Regulatory Technical Standards (RTS), the Implementation Technical Standards (ITS) and validation rules. Additional tabs have been added to supplement to SOPs, including product-level SOPs for several of the underlier fields, and listing names of floating rate options. There are also tabs to reflect updates made to the matrix (‘Updates’) and a tab to track questions raised by the ISDA Data and Reporting EMEA Working Group (‘WG Questions’). ISDA indicated that the document will continue to be reviewed and updated as and when required. While the intention of these SOPs is to provide an agreed and standardized market guide for firms to utilize, no firm is legally bound or compelled in any way to follow any determinations made within these EMIR SOPs. [NEW]
- ISDA and IIF Respond to BCBS-CPMI-IOSCO Consultation on Margin Transparency. On April 12, ISDA and the Institute of International Finance (IIF) submitted a response to the Basel Committee on Banking Supervision (BCBS), Committee on Payments and Market Infrastructures (CPMI) and International Organization of Securities Commissions (IOSCO) consultation on transparency and responsiveness of initial margin in centrally cleared markets. In their response, the associations expressed support for enhancing transparency on cleared margin for all market participants, which they expect will help with liquidity preparedness and increase resilience of the system, noting it should start with central counterparties (CCPs) making fundamental disclosures about their margin models. In this regard, both associations highlight their support in the response to recommendations one through eight. Regarding recommendation nine, the associations indicated that they are supportive of clients having necessary transparency on clearing member (CM) margin requirements. Regarding recommendation 10, the associations said in the response that they are generally supportive of the principle that CCPs should have visibility into the risk profile of their clearing participants but warned that, in their opinion, the information required under recommendation 10 may raise legal, confidentiality, or competition concerns. Finally, the associations noted that they believe further work should be done on the fundamentals of CCP margin models, for example on the appropriateness of margin periods of risk and the calibration of anti-procyclicality tools, to ensure that margins do not fall too low during low volatility periods. [NEW]
- IOSCO Publishes Updated Workplan. On April 12, IOSCO published its updated 2024 Workplan, which directly supports its overall two-year Work Program published on April 5, 2023. The 2024 Workplan announced new workstreams, reflecting increased focus on AI, tokenization and credit default swaps, and additional work on transition plans and green finance. The 2024 Workplan set out priorities under five themes: Protecting Investors, Address New Risks in Sustainability and Fintech, Strengthening Financial Resilience, Supporting Market Effectiveness and Promoting Regulatory Cooperation and Effectiveness. [NEW]
- ISDA, AIMA, GFXD Publish Paper on Transition to UPI. On April 9, ISDA, the Alternative Investment Management Association (AIMA) and the Global Foreign Exchange Division (GFXD) of the Global Financial Markets Association published a paper on the transition to unique product identifiers (UPI) as the basis for over-the-counter (OTC) derivatives identification across the Markets in Financial Instruments Regulation (MIFIR) regimes. The paper has been sent to the European Commission, which is working on legislation to address appropriate identification of OTC derivatives under MiFIR.
- ISDA Submits Addendum to US Basel III NPR Comment Letter. On April 8, ISDA submitted an addendum to the joint US Basel III ‘endgame’ notice of proposed rulemaking response along with the Securities Industry and Financial Markets Association. The addendum contains a more developed proposal for the index bucketing approach for equity investment in funds and an update to the Fundamental Review of the Trading Book Standardized Approach Quantitative Impact Study numbers. [NEW]
- IOSCO Seeks Feedback on the Evolution of Market Structures and Proposed Good Practices. On April 4, the International Organization of Securities Commissions (IOSCO) published a consultation report on Evolution in the Operation, Governance and Business Models of Exchanges: Regulatory Implications and Good Practices. The consultation report analyzes the structural and organizational changes within exchanges, focusing on business models and ownership structures. It highlights a shift towards more competitive, cross-border, and diversified operations as exchanges integrate into larger corporate groups. The consultation report discusses regulatory considerations, particularly in the organization of individual exchanges and exchange groups and the supervision of multinational exchange groups. It addresses potential conflicts of interest arising from matrix structures and the challenges of overseeing individual exchanges within exchange groups. Additionally, it outlines a set of six proposed good practices for regulators to consider in the supervision of exchanges, particularly when they provide multiple services and/or are part of an exchange group. The good practices are also complemented by a non-exclusive list of supervisory tools used by IOSCO jurisdictions to address the issues under discussion, in the form of “toolkits”. While the Consultation Report focuses on equities listing trading venues, the findings are also relevant to other trading venues, including non-listing trading venues and derivatives trading venues. IOSCO is seeking input from market participants on the major trends and risks observed, and the proposed good practices on or before July 3, 2024.
- ISDA Submits Response to CFTC Proposed Operational Resilience Rules. On April 1, ISDA submitted comments on the CFTC’s notice of proposed rulemaking on requirements to establish an Operational Resilience Framework for Futures Commission Merchants, Swap Dealers and Major Swap Participants, which was published in the Federal Register on January 24, 2024. ISDA recommended that the CFTC adjust adjust portions of the proposed rules relating to governance, third-party relationships, incident notification and implementation period.
The following Gibson Dunn attorneys assisted in preparing this update: Jeffrey Steiner, Adam Lapidus, Marc Aaron Takagaki, Hayden McGovern, and Karin Thrasher.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Derivatives practice group, or the following practice leaders and authors:
Jeffrey L. Steiner, Washington, D.C. (202.887.3632, jsteiner@gibsondunn.com)
Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com)
Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)
Darius Mehraban, New York (212.351.2428, dmehraban@gibsondunn.com)
Jason J. Cabral, New York (212.351.6267, jcabral@gibsondunn.com)
Adam Lapidus – New York (+1 212.351.3869, alapidus@gibsondunn.com)
Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)
Roscoe Jones Jr., Washington, D.C. (202.887.3530, rjones@gibsondunn.com)
William R. Hallatt, Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)
David P. Burns, Washington, D.C. (202.887.3786, dburns@gibsondunn.com)
Marc Aaron Takagaki, New York (212.351.4028, mtakagaki@gibsondunn.com)
Hayden K. McGovern, Dallas (214.698.3142, hmcgovern@gibsondunn.com)
Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
We are pleased to provide you with Gibson Dunn’s Accounting Firm Quarterly Update for Q1 2024. The Update is available in .pdf format at the below link, and addresses news on the following topics that we hope are of interest to you:
- SEC Voluntarily Stays Climate-Disclosure Rules Pending Appellate Review
- PCAOB Issues Proposed Rule on Firm Metric Reporting
- SolarWinds Moves to Dismiss SEC Amended Complaint
- Alabama Federal Court Declares Corporate Transparency Act Unconstitutional
- SEC Adopts Final Rules Relating to SPACs
- House Oversight Committee Examines PCAOB Treatment of China-Based Firms
- PCAOB Proposes New Rule on False or Misleading Statements Concerning PCAOB Registration and Oversight
- PCAOB Reopens Comment Period and Holds Roundtable on NOCLAR Proposal
- NCLA Sues PCAOB Claiming Unconstitutional Disciplinary Proceedings
- SEC Commissioner Speaks on Materiality and Engagement with the SEC
- Illinois Appellate Court Issues Verein Ruling in Legal Malpractice Case
- Southern District Rules That PCAOB Inspection Information Is Not “Property”
- Other Recent SEC and PCAOB Enforcement and Regulatory Developments
Please let us know if there are topics that you would be interested in seeing covered in future editions of the Update.
Warmest regards,
Jim Farrell
Monica Loseman
Michael Scanlon
Chairs, Accounting Firm Advisory and Defense Practice Group, Gibson, Dunn & Crutcher LLP
In addition to the practice group chairs, this update was prepared by David Ware, Timothy Zimmerman, Benjamin Belair, Adrienne Tarver, and Monica Limeng Woolley.
Accounting Firm Advisory and Defense Group:
James J. Farrell – Co-Chair, New York (+1 212-351-5326, jfarrell@gibsondunn.com)
Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, mloseman@gibsondunn.com)
Michael Scanlon – Co-Chair, Washington, D.C.(+1 202-887-3668, mscanlon@gibsondunn.com)
© 2023 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
On April 15, 2024, the U.S. Equal Employment Opportunity Commission (“EEOC”) issued regulations implementing the Pregnant Workers Fairness Act (“PWFA”). The final rule comes after considering extensive comments on the August 2023 draft rulemaking, and will go into effect on June 18, 2024.
The PWFA was signed into law on December 29, 2022. It was intended to fill gaps in the federal and state legal landscape regarding protections for employees affected by pregnancy, childbirth, or related medical conditions. Specifically, the PWFA requires most employers with 15 or more employees to provide reasonable accommodations for a qualified employee’s or applicant’s known limitations related to, affected by, or arising out of pregnancy, childbirth, or related medical conditions, unless the accommodation will cause an undue hardship on the operation of the employer’s business. The requirements apply even when the medical limitations giving rise to the need for an accommodation would not constitute a disability under the Americans with Disabilities Act (“ADA”). (For a detailed analysis of the PWFA’s requirements and differences between the PWFA and existing federal and state law with respect to the accommodation of pregnancy-related medical restrictions, please see our prior alert.)
The PWFA has been in effect since June 27, 2023, but the final rule and accompanying guidance clarify (and in some ways expand) the obligations that were explicit in the statute itself. Below are 10 key takeaways for employers.
10 Key Takeaways for Employers
- Certain Identified Accommodations Are Assumed To Be Reasonable: The final rule specifies that the following four pregnancy accommodations are reasonable and should be granted in almost every circumstance without documentation: (1) additional restroom breaks, (2) food and drink breaks, (3) allowing water and other drinks to be kept nearby, and (4) allowing sitting or standing, as necessary. Other possible reasonable accommodations specified by the final rule, although not presumptively required, include job restructuring, modifying work schedules, use of paid leave, and reassignment to a vacant position.
- Broad Scope of Covered Conditions: The EEOC’s “non-exhaustive list” of conditions that can give rise to a request for accommodation under the PWFA include: current pregnancy, past pregnancy, lactation (including breastfeeding and pumping), use of birth control, menstruation, postpartum depression, gestational diabetes, preeclampsia, infertility and fertility treatments, endometriosis, miscarriage, stillbirth, and having or choosing not to have an abortion, among other conditions. The breadth of this list has drawn criticism for exceeding the EEOC’s authority—including a public dissent from EEOC Commissioner Andrea Lucas—and the abortion-related aspect in particular has attracted strong attention (and is likely to be litigated).
- Applicants/Employees May Need To Be Excused From Essential Functions For Extended Periods: Under the ADA, only a “qualified individual” is entitled to a reasonable accommodation, and a qualified individual is one who can perform the essential functions of the job with or without a reasonable accommodation. By contrast, under the PWFA, an individual is still qualified—and therefore entitled to a reasonable accommodation—even if they cannot perform an essential function of the job now, so long as the limitation is for “a temporary period” and the essential function can be performed in the “near future.”
- Employers Cannot Seek Documentation For Certain Requests: The final rule generally prohibits employers from seeking documentation in many circumstances, including: (1) when the limitation and need for a reasonable accommodation is obvious; (2) when the employer already has sufficient information to support a known limitation related to pregnancy; (3) when the request is for one of the four identified reasonable accommodations listed above (i.e., additional restroom breaks; food/drink breaks; beverages near the work station; and sitting or standing as needed); (4) when the request is for a lactation accommodation; and (5) when the accommodation is available without documentation for other employees seeking the same accommodation for non-PWFA reasons.
- Informal Requests Can Trigger Statutory Obligations: The guidance accompanying the final rule indicates that verbal conversations with direct supervisors can trigger accommodation obligations, and an employee’s failure to fill out paperwork or speak to the “right” supervisor or designated department is not grounds for either delaying or not providing the accommodation. In other words, the initial request (or statement of need for an accommodation) alone may be sufficient to place the employer on notice and trigger the interactive accommodation process.
- Account For Accommodations In Reporting And Metrics: Where a reasonable accommodation is granted (e.g., extra bathroom or water breaks), employers should ensure that technologies are appropriately adjusted to integrate the accommodation. Given that employers are increasingly using technology in the workplace for purposes such as monitoring attendance or tracking productivity and performance, it is important that employers develop policies that contemplate how a reasonable accommodation might impact the accuracy of these tools. For example, the EEOC suggests that calculations on productivity for a given shift may need to be adjusted to account for the additional excused break periods.
- Act With Expediency And Consider Interim Accommodations: Although the PWFA’s interactive process largely tracks that of the ADA, the final rule provides that employers must respond to requests under the PWFA with “expediency” and notes that granting an interim accommodation will decrease the likelihood that an unnecessary delay will be found.
- Unpaid Leave As A Last Resort: As the PWFA itself makes clear, employers may only require an employee to take leave as a last resort if there are no other reasonable accommodations that can be provided absent undue hardship. The final rule and guidance continue this theme, underscoring that requiring an employee to take unpaid leave or to use their leave after they ask for an accommodation and are awaiting a response could also violate the PWFA if, for example, there is paid work that the employee could have been provided during the interactive process.
- Overlap With The ADA: Overlap With The ADA: The final rule acknowledges that there may be circumstances in which a qualified individual may be entitled to an accommodation under either the PWFA or the ADA for a pregnancy-related limitation. The interpretive guidance emphasizes that employees are not required to identify the statute under which they are requesting a reasonable accommodation, so employers should train human resources and management professionals to identify and apply the applicable framework.
- Don’t Forget About Applicants: The PWFA prohibits employers from refusing to hire a pregnant applicant because they assume that the applicant will soon need to leave to recover for childbirth. In addition, the interpretive guidance flags that the accommodation process is often more difficult to navigate for applicants than for existing employees. As such, employers should consider training recruiting and onboarding professionals on how to best ensure that an applicant understands the process for requesting a reasonable accommodation during the hiring process. The guidance notes that an applicant may not know enough about, for example, the equipment used by the employer or the application process itself to request an accommodation and the employer may likewise not have enough information to suggest an appropriate accommodation. Accordingly, employers might consider trying to anticipate potential hurdles to accessibility during the hiring process and either remedy the obstacles, if feasible, or provide advanced notice during the early stages of the process so that the applicant can identify any potential issues and request a reasonable accommodation.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Labor and Employment practice group, or the following authors and practice leaders:
Molly T. Senger – Partner, Labor & Employment
Washington, D.C. (+1 202.955.8571, msenger@gibsondunn.com)
Jason C. Schwartz – Partner & Co-Chair, Labor & Employment
Washington, D.C. (+1 202.955.8242, jschwartz@gibsondunn.com)
Katherine V.A. Smith – Partner & Co-Chair, Labor & Employment
Los Angeles (+1 213.229.7107, ksmith@gibsondunn.com)
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
Muldrow v. City of St. Louis, No. 22-193 – Decided April 17, 2024
Today, the Supreme Court held that a Title VII plaintiff challenging a forced job transfer as discriminatory must show some harm from the transfer, but need not show that the harm was “significant,” “material,” or “serious.”
“Although an employee must show some harm from a forced transfer to prevail in a Title VII suit, she need not show that the injury satisfies a significance test.”
Justice Kagan, writing for the Court
Background:
The Civil Rights Act of 1964 (“Title VII”) prohibits discrimination in the “terms, conditions, or privileges of employment” because of an individual’s race, religion, sex, or national origin. 42 U.S.C. § 2000e-2(a)(1). In 2017, following a change in leadership in the St. Louis Police Department, Sergeant Jatonya Muldrow was transferred from the Intelligence Division to another unit. The transfer did not affect Muldrow’s regular pay or rank, but she was allegedly “moved from a plainclothes job in a prestigious specialized division giving her substantial responsibility over priority investigations and frequent opportunity to work with police commanders . . . to a uniformed job supervising one district’s patrol officers, in which she was less involved in high-visibility matters and primarily performed administrative work. Her schedule became less regular, often requiring her to work weekends; and she lost her take-home car.” She alleged that no male sergeants were transferred out of the Intelligence Division and that she was replaced with a male sergeant.
Muldrow brought a Title VII claim against the Department, alleging that the transfer was discriminatory because of her sex. The district court and the Eighth Circuit held that the transfer was not an adverse employment action because it did not result in a “materially significant disadvantage” to Muldrow.
Issue:
Does Title VII prohibit discrimination in transfer decisions where the transfer does not result in a “materially significant disadvantage”?
Court’s Holding:
To prevail on a Title VII claim challenging a forced job transfer, a plaintiff must show some harm from the transfer, but need not show that the harm was “significant,” “material,” or “serious.”
What It Means:
- The Court’s decision is a win for Title VII plaintiffs who challenge employers’ job-transfer decisions as discriminatory based on race, sex, or some other protected characteristic. According to the six Justices who joined the Court’s decision, “this decision changes the legal standard used in any circuit that has previously required ‘significant,’ ‘material’ or ‘serious’ injury. It lowers the bar Title VII plaintiffs must meet.” Majority op. 7 n.2.
- At the same time, the Court noted that there is “reason to doubt that the floodgates will open” for new Title VII claims, and that lower courts “retain multiple ways to dispose of meritless Title VII claims challenging transfer decisions.” Majority op. 9, 10. Most significantly, Title VII plaintiffs must show “some harm respecting an identifiable term or condition of employment,” such as hiring, firing, or transferring employees. Id. at 6. Justice Alito, concurring in the Court’s judgment, predicted that this requirement will mean that “careful lower court judges will mind the words they use but will continue to do pretty much just what they have done for years.” Alito op. 2.
- The Court also held that a Title VII plaintiff still must show that her employer acted with discriminatory intent and the internal transfer was made on the basis of a protected characteristic such as race, color, religion, sex, or national origin. Employers should document the business reasons for an internal transfer, which will assist in defeating allegations that a transfer was based on a protected characteristic.
- The Court also noted that lower courts “may consider whether a less harmful act is, in a given context, less suggestive of intentional discrimination.” Majority op. 10. Thus, lower courts appear to retain latitude to consider whether the facts alleged in a Title VII complaint are more suggestive of lawful conduct than unlawful conduct, consistent with ordinary pleading standards.
- The Court emphasized that its holding did not reach Title VII retaliation claims, for which the “materially adverse” standard still applies. Majority op. 9. Nor did the Court’s decision address hostile work environment claims, or the application of ordinary pleading standards at the motion to dismiss stage.
- Finally, the Court did not address how its new standard might apply to corporate Diversity, Equity, and Inclusion (“DEI”) programs. Plaintiffs challenging DEI programs under Title VII must still show that such programs caused them some harm because of a protected characteristic and with respect to a term or condition of employment.
Gibson Dunn represented the Chamber of Commerce of the United States of America, National Federation of Independent Business Small Business Legal Center, Inc., Restaurant Law Center, Inc., and National Retail Federation as Amici Supporting Respondent.
The Court’s opinion is available here.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders:
Appellate and Constitutional Law Practice
| Thomas H. Dupree Jr. +1 202.955.8547 tdupree@gibsondunn.com |
Allyson N. Ho +1 214.698.3233 aho@gibsondunn.com |
Julian W. Poon +1 213.229.7758 jpoon@gibsondunn.com |
| Lucas C. Townsend +1 202.887.3731 ltownsend@gibsondunn.com |
Bradley J. Hamburger +1 213.229.7658 bhamburger@gibsondunn.com |
Brad G. Hubbard +1 214.698.3326 bhubbard@gibsondunn.com |
Related Practice: Labor and Employment
| Jason C. Schwartz +1 202.955.8242 jschwartz@gibsondunn.com |
Katherine V.A. Smith +1 213.229.7107 ksmith@gibsondunn.com |
Molly T. Senger +1 202.955.8571 msenger@gibsondunn.com |
This alert was prepared by associates Cate McCaffrey and Salah Hawkins.
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
Under the final rule, domestic or foreign “resource extraction issuers” are required to annually disclose information about certain payments made to foreign governments or the U.S. federal government on Form SD.
As previously reported on our Securities Regulation and Corporate Governance Monitor on December 16, 2020 (available here), the Securities and Exchange Commission (the “SEC”) adopted the final rule (available here) requiring additional disclosures by public companies that engage in the commercial development of oil, natural gas or minerals. Under the final rule, domestic or foreign “resource extraction issuers” are required to annually disclose information about certain payments made to foreign governments or the U.S. federal government on Form SD.
The final rule became effective on March 16, 2021 allowing for a two-year transition period after the effective date, with initial Form SD filings due no later than 270 calendar days after the end of an issuer’s next completed fiscal year (e.g., September 26, 2024 for issuers with a December 31, 2023 fiscal year end). While the adopting release specifically referred to September 30, 2024 as the due date for a company with a fiscal year end of December 31, 2023 (274 days after year end), we recommend filing the Form SD by September 26, 2024 to ensure timely compliance with the rule’s deadline. We note that for 2025, 2026 and 2027, the form will be due by September 27 for companies with a December 31 fiscal year end (270 days after the fiscal year end in non-leap years), unless September 27 is a Saturday, Sunday or holiday, in which case the deadline is the next business day.
What kind of information is required to be disclosed?
The final rule implements Section 13(q) of the Securities Exchange Act of 1934, as amended, which requires disclosure of company-specific, project-level information on Form SD (available here and on page 212 of the adopting release), including the:
- type and total amount of payments made for each project of the resource extraction issuer relating to the commercial development of oil, natural gas or minerals;
- type and total amount of such payments for all projects made to a government, as well as the country in which each such government is located;
- currency used and the fiscal year in which the payments were made;
- fiscal year in which the payments were made;
- business segment of the issuer that made the payments;
- specific projects to which such payments relate and the resources that are being developed;
- method of extraction used in the project and the major subnational political jurisdiction of each project; and
- payments made by a subsidiary or entity controlled by the issuer.
What kinds of activities does the rule apply to, and to whom does the rule apply?
The adopted rule applies to any resource extraction issuer. Resource extraction includes: the commercial development of oil, natural gas or minerals; the exploration, extraction, processing and export of oil, natural gas or minerals; or the acquisition of a license for any such activity.
For example, companies engaged in oil exploration and production operations and the mining industry will generally be subject to the rule.
For resource extraction joint ventures or arrangements where no one party has control, the operator of the venture or arrangement must report all of the payments. Non-operator members are only required to report payments that, as resource extraction issuers, they make directly to governments.
Who is exempt from the rule?
There are exemptions for:
- issuers that are unable to comply with the final rule without violating the laws of the jurisdiction where the project is located;
- issuers that are unable to comply with the final rule without violating the terms in a contract that became effective before the final rule was adopted;
- smaller reporting companies, meaning issuers with a public float of less than $250 million and issuers with annual revenues of less than $100 million for previous year and public float of less than $700 million; and
- emerging growth companies, meaning issuers with total annual gross revenues of less than $1,235,000,000 during their most recently completed fiscal year and that have not sold common equity securities under a registration statement.
We note that the final rule includes transitional relief for recently acquired companies that were not previously subject to the rule and for issuers that completed their initial public offering within their last full fiscal year.
What relief is afforded to acquisitions?
Form SD reporting obligations for an acquired entity will depend on whether the acquired entity was subject to Section 13(q) for the fiscal year prior to the acquisition. If the acquired entity was not subject to Section 13(q) (or an alternative reporting regime) for the issuer’s last full fiscal year prior to the acquisition, then the issuer will be required to begin reporting payment information for that acquired entity starting with the Form SD submission for the first full fiscal year immediately following the effective date of the acquisition. The issuer will therefore not be required to provide the (excluded) payment disclosure for the year in which it acquired the entity.
However, this transition period does not apply to acquisitions of entities that were already subject to Section 13(q)’s disclosure requirements. In these instances, disclosure is required for the fiscal year of the acquisition.
By way of example, if an acquisition of an entity that was not subject to Section 13(q) closes in November 2024, assuming a December 31 fiscal year end, then the acquired entity’s payments will be first reported on the Form SD covering fiscal year 2025, which must be filed by September 28, 2026, given that September 27, 2026 is a Sunday. However, if the acquired entity was already subject to Section 13(q), then the acquired entity’s payments will be reported on the Form SD covering fiscal year 2024, which must be filed by September 29, 2025, given that September 27, 2025 is a Saturday.
What about interpretive questions raised by the rule and adopting release but left unanswered?
As resource extraction issuers analyze their disclosure obligations on Form SD, various interpretative questions have arisen. We recommend coordinating discussions on these questions with your peers and industry groups. In addition, Gibson Dunn lawyers are available to assist in addressing any questions that you may have regarding compliance with this new rule and related Form SD filing requirements, as we have been working through questions with our various clients that operate in the oil and gas and mining industries.
Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. To learn more, please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Securities Regulation and Corporate Governance practice group, or the following authors:
Hillary H. Holmes – Houston (+1 346.718.6602, hholmes@gibsondunn.com)
James J. Moloney – Orange County (+1 949.451.4343, jmoloney@gibsondunn.com)
Harrison Tucker – Houston (+1 346.718.6643, htucker@gibsondunn.com)
Please also view Gibson Dunn’s Securities Regulation and Corporate Governance Monitor.
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
The Climate Change Cases are the first of their kind decided by the Court and constitute a significant legal development requiring considered analysis and reflection.
On 9 April 2024, the Grand Chamber of the European Court of Human Rights (“Court”) rendered its rulings in the “Climate Change Cases”: (i) Verein KlimaSeniorinnen Schweiz and Others v. Switzerland (“KlimaSeniorinnen”), (ii) Carême v. France (“Carême”), and (iii) Duarte Agostinho and Others v. Portugal and 32 Others (the “Portuguese Youth Climate Case”). The Climate Change Cases are the first of their kind decided by the Court. They constitute a significant legal development requiring considered analysis and reflection.
In KlimaSeniorinnen, the Court held that Switzerland had not implemented the measures necessary to fulfil its positive obligations to cut greenhouse gas (“GHG”) emissions in conformity with the requirements under Article 8 (the right to private and family life and the right to a home) of the European Convention on Human Rights (“Convention”). The Convention does not spell out an autonomous right to a clean and healthy environment. However, KlimaSeniorinnen creates what may be seen as a novel right accompanied by a new positive duty on the 46 member States of the Council of Europe (“Convention States”) in the field of climate change. As the Convention is incorporated into the national laws of all Convention States, this finding may directly affect domestic legislation within these jurisdictions.
By contrast, the applications in both Carême and the Portuguese Youth Climate Case were declared inadmissible. In the former, the Court held that the applicant did not have victim status as he no longer had a link to Grande-Synthe, the area of France allegedly affected by the climate crisis where he had served as mayor. In the latter case, the application was dismissed on both jurisdictional grounds and for non-exhaustion of domestic remedies. Below, these decisions are considered separately to KlimaSeniorinnen although it is important to view these rulings as a trilogy of climate cases decided by the Court on the same date.
Overall, the judgment in Klimaseniorinnen, which is the most significant of the three rulings, may have the potential to reverberate on a global level—including exerting a considerable influence on other pending climate change cases both nationally and internationally. Inversely, the findings in Carême and the Portuguese Youth Case are well in line with the existing case law of the Court.
This alert provides an overview of the Court’s findings in each of the three Climate Change Cases and offers our thoughts on some of the potential impacts.
1. KlimaSeniorinnen
(a) Background
The KlimaSeniorinnen proceedings against Switzerland began over nine years ago before the Swiss national courts. The claims were dismissed at all levels (including before the Swiss Federal Supreme Court) on jurisdictional grounds, including for lack of standing (the claims constituting an actio popularis), and were therefore not examined on the merits. Proceedings were then lodged before the Court in 2020.
The applicants (“Applicants”) in the case were: (i) “KlimaSeniorinnen”, a Swiss-registered association established to promote and implement effective climate protection on behalf of its 2,000 female members who all live in Switzerland, and who have an average age of 73 years (the “Association”), and (ii) four individual women who are members of the Association (“Individual Applicants”).
The Applicants argued that they were part of the most vulnerable group affected by climate change owing to their age and sex. They submitted testimony and medical evidence demonstrating, in their view, the negative effects of global warming on their health (including suffering from cardiovascular and respiratory diseases). According to the Applicants, there was no doubt that climate change-induced heatwaves in Switzerland had caused, were causing and would cause further deaths and illnesses to older people and particularly women, in Switzerland.
The Applicants further submitted that Switzerland’s actions to tackle climate change through domestic legislative measures were inadequate, despite being aware of the relevant risks and scientific evidence such as reports by the United Nations Intergovernmental Panel on Climate Change (“IPCC”).
Against this background, the Applicants contended that Switzerland had failed and continued to fail to protect them effectively in violation of Articles 2 (right to life) and 8 of the Convention. Specifically, they argued that the State had a positive duty to put in place the necessary regulatory framework to mitigate climate change, taking into account its particularities and the level of risk. Further, the Applicants complained of a lack of access to a court in violation of Article 6(1) of the Convention, and the lack of an effective remedy in violation of Article 13.
As an evidentiary matter, the Court began by accepting that “anthropogenic climate change exists” and that “the relevant risks are projected to be lower if the rise in temperature is limited to 1.5oC above pre-industrial levels and if action is taken urgently, and that current global mitigation efforts are not sufficient to meet the latter target”. The Court attached importance to relevant international standards, the decisions of domestic courts and the conclusions of reports and studies by relevant international bodies, such the IPCC (the findings of which had not been called into doubt by Switzerland or intervening States (of which there were a number)). On this basis, the Court examined the admissibility and merits of the complaints.
(b) The Issue of Standing Before the Court
“Victim status”, which is the Court’s threshold standing requirement as set out in Article 34 of the Convention, was one of the salient issues in all three of the Climate Change Cases.
Under Article 34 to the Convention, the Court may receive applications from any person, NGO or group of individuals claiming to be the victim of a violation under the Convention. Therefore, the Court’s well-established case law requires an applicant to establish causation between the alleged violation and the harm allegedly suffered. A complaint to the Court must thus identify a concrete and particularised harm directly or indirectly suffered by the applicant. A so-called actio popularis, in which the applicant only asserts a general public interest in bringing proceedings, is in principle prohibited.
In KlimaSeniorinnen, the Court emphasised that, in accordance with its case law, victim status “cannot be applied in a rigid, mechanical and inflexible way” and that the concept of “victim” must be interpreted in an “evolutive” fashion. The Court considered that in the climate change context, a special approach to victim status was warranted, reasoning that there exists a causal link between State actions or omissions (causing or failing to address climate change) and the harm affecting individuals.
The Court then went on to establish novel tests to be applied to the victim status of applicants in the context of climate change. First, with respect to individual applicants, the Court established the following “Individual Victim Status Criteria”:
(a) the applicant must be subject to a high intensity of exposure to the adverse effects of climate change, that is, the level and severity of (the risk of) adverse consequences of governmental action or inaction affecting the applicant must be significant; and
(b) there must be a pressing need to ensure the applicant’s individual protection, owing to the absence or inadequacy of any reasonable measures to reduce harm.
The Court emphasised that the threshold for fulfilling the Individual Victim Status Criteria “is especially high” and will depend on circumstances such as the prevailing local conditions and individual specificities and vulnerabilities. The Individual Applicants in KlimaSeniorinnen did not, in the Court’s view, meet the high threshold, as it could not be said that they suffered from any critical medical condition whose possible aggravation linked to climate change could not be alleviated through adaptation measures available in Switzerland.
Second, with respect to associations, the Court took an inverse approach, setting out a new and accommodating test for determining their standing in the climate change context—the Court considering that associations play a particularly important function in this context since recourse to such bodies may be “the only mean[s] available” to certain groups of applicants (such as “future generations”, a consideration borrowed from environmental law). Namely, the association must fulfil the following “Associations Victim Status Criteria”:
(a) be lawfully established in the jurisdiction concerned or have standing to act there;
(b) be able to demonstrate that it pursues a dedicated purpose in accordance with its statutory objectives in the defence of the human rights of its members or other affected individuals within the jurisdiction concerned; and
(c) be able to demonstrate that it can be regarded as genuinely qualified and representative to act on behalf of members or other affected individuals within the jurisdiction who are subject to specific threats or adverse effects of climate change on their lives, health or well-being as protected under the Convention.
However, the Court then also went further, holding that the standing of an association to act on behalf of members or other affected individuals will not be subject to a separate requirement of showing that those on whose behalf the case has been brought would themselves have met the Individual Victim Status Criteria.
Applying this novel Criteria to the Association, the Court found that these were met, and noted that this represented “a vehicle of collective recourse aimed at defending the rights and interests of individuals against the threats of climate change in the respondent State”. Therefore, the Court proceeded with examining the merits of the application on this basis.
(c) The Merits: Articles 2 and 8
Assessing the Court’s margin of appreciation (i.e., the deference that it would accord to Convention States) in the climate change context, the Court made a distinction between (i) the State’s commitment to the necessity of combating climate change, and the setting of the requisite aims and objectives in this respect on the one hand, and, on the other, (ii) the choice of means designed to achieve those objectives. As regards (i), the Court explained that the nature and gravity of the threat of climate change, and the general international consensus around the need to reduce GHG emissions through targets, called “for a reduced margin of appreciation”. However, as regards (ii)—the choice of means (including operational choices and policies)—Convention States should be accorded a wide margin of appreciation.
The Court then set out the scope of the Article 2 and 8 Convention rights as considered in previous environmental harm cases before the Court but noted that given the special nature of climate change “the general parameters of the positive obligations must be adapted to th[is] specific context”.
As regards Article 2, the Court referred to the established test that there must be a “real and imminent” risk to life, which may extend to complaints of State action and/or inaction in the context of climate change. In the climate change context, it would be possible to assume this threshold had been met where victim status had been established. That said, the Court examined the Association’s complaint primarily on the basis of Article 8, noting that to a great extent the Court had in its case law applied the same principles to both articles in the context of environmental claims. As such, the Court found that it was unnecessary to examine the applicability of Article 2 in the present case.
Then, for the first time in its history, the Court prescribed the content of the States’ positive obligations under Article 8 in the context of climate change. Significantly, the Court held that Article 8 affords individuals a right to enjoy effective protection by State authorities from serious adverse effects on their life, health, well-being and quality of life arising from the harmful effects and risks caused by climate change. Accordingly, under Article 8, States must “do [their] part” to ensure such protection. As such, States’ primary duty is to adopt, and to effectively apply in practice, “general measures specifying a target timeline for achieving carbon neutrality and the overall remaining carbon budget for the same timeframe”. This includes setting out intermediate GHG emissions reduction targets and pathways (to be updated through due diligence), including by sector, and providing evidence that States have duly complied with the relevant GHG reduction targets. Importantly, States’ positive obligations include acting in “good time and in an appropriate and consistent manner when devising and implementing the relevant legislation and measures”. Unprecedently, the Court then held that States should have “a view to reaching net neutrality within, in principle, the next three decades”.
Furthermore, the Court explained that effective protection of the rights of individuals from serious adverse effects on their life, health, well-being and quality of life requires that the above-noted mitigation measures be supplemented by adaptation measures aimed at alleviating the most severe or imminent consequences of climate change, taking into account any relevant particular needs for protection.
Applied to the case, the Court concluded that Switzerland had failed to fulfil its positive obligation derived from Article 8 to devise a regulatory framework setting out the requisite objectives and goals. In particular, the Court pointed to the fact that the 2025 and 2030 period remains unregulated in Switzerland in terms of GHG emissions, pending the enactment of new legislation, and that Switzerland had not quantified national GHG emissions limitations through, for example, a carbon budget. Furthermore, Switzerland had previously failed to meet its past GHG emission reduction targets. As such, the Court found that there had been a violation of Article 8 of the Convention.
(d) Articles 6 and 13: Victim Status and the Merits
In addition to the substantive complaints made under Articles 2 and 8 of the Convention, the Applicants brought complaints under Articles 6 and 13 alleging a failure of the Swiss national courts to grant them access to court. In KlimaSeniorinnen, the Applicants complained that they had been denied being heard on the merits on jurisdictional grounds, including for lack of standing.
The Court examined the Applicants’ victim status with respect to Article 6 finding that the Association had victim status under this provision because the domestic litigation was “directly decisive” for its “rights” under the Convention. By contrast—and in line with its victim status findings pursuant to Articles 2 and 8—the Court found that the Individual Applicants lacked standing because the dispute they pursued was not directly decisive for their specific rights, and had a tenuous connection with the rights relied upon under national law.
Applied to the merits of the Association’s case, the Court found a violation of its Article 6 right of access to the national courts. The Court furthermore found it unnecessary to examine the Association’s Article 13 complaint, having found in its favour on Article 6.
(e) The Dissenting Opinion of Judge Eicke
Judge Eicke of the United Kingdom issued a strongly worded dissent in KlimaSeniorinnen, opining that the majority had gone “well beyond what I consider to be, as a matter of international law, the permissible limits of evolutive interpretation”. In particular, he questioned the Court’s unnecessary expansion of “victim status” and unjustifiable creation of (i) “a new right (under Article 8 and, possibly, Article 2)”; and (ii) a new “primary duty” on Convention States. He was of the view that neither of these “have any basis in Article 8 or any other provision of or Protocol to the Convention”.
He further expressed concern that, at a policy level, there is a significant risk that the new right / obligation created by the majority (alone or in combination with the much enlarged standing rules for associations) would prove an unwelcome and unnecessary distraction for the national and international authorities in that “it detracts attention from the on-going legislative and negotiating efforts being undertaken as we speak to address the – generally accepted – need for urgent action”. He specifically referred to the “significant risk” that national authorities “will now be tied up in litigation about whatever regulations and measures they have adopted (whether as a result or independently) or how those regulations and measures have been applied in practice…”.
As regards Article 6, although Judge Eicke agreed with the majority that there had been a violation of the right of access to court, his conclusion was on a different (and what he called “more orthodox”) approach. In Judge Eicke’s view, the Individual Applicants’ victim status as it related to Article 6 had been clearly established and not challenged by the Swiss Government. As such, it would “have been more obvious and more appropriate to address the complaint about the denial of access to court first; before then, if necessary, moving on to consider the complaint(s) under Articles 2 and 8 of the Convention”. In his view, such an approach could have vitiated the need for developing a “novel approach” to the issue of the Applicants’ victim status under Articles 2 and 8.
(f) Key Takeaways
As stated at the outset, the Climate Change Cases are the first of their kind decided by the Court. They constitute a significant legal development. At this stage, there are a number of observations which can be highlighted.
First, due to the fact that the Convention is incorporated into the national laws of all 46 Convention States, the findings of the Court in KlimaSeniorinnen may require such States to consider amending national laws to take account of the expansion of victim status. In other words, some Convention States may have to amend their standing laws to reflect the Association Victim Status Criteria in cases leveraging Convention rights in the context of climate change cases.
Second, the Court in KlimaSeniorinnen found, for the first time, an independent actionable right to effective protection by the State for climate change-related harms under Article 8 (leaving the scope and content of any such right under Article 2 undetermined for the time being). This right includes the imposition of positive obligations on Convention States. While these positive obligations remain general on their face, they may be interpreted to require that climate change mitigation measures are “incorporated into a binding regulatory framework”, and, the Court expressly referred to the aim of reaching net neutrality “within, in principle, the next three decades”. This finding may prompt Convention States to enact more rigorous national legislation relating to GHG reductions. This could, in turn, have a significant impact on the private sector operating within those States.
Third, such regulatory changes could also prompt new investor State claims, if such legislative changes (for example, the phase out of production of electricity from certain fossil fuels) were implemented in such a manner that could be considered a breach of the States’ investment treaty obligations. In that context, Convention States may attempt to use the positive obligations imposed by the Court in KlimaSeniorinnen as a defence to such claims. However, we note that the Court’s judgment seems to leave States flexibility in how they seek to accomplish their climate targets.
Lastly, this ruling may influence other pending climate change litigation—especially where claimants are advancing human rights-based arguments. This includes cases pending before the Court which have been adjourned awaiting the rulings in the Climate Change Cases, including Greenpeace Nordic and Others v. Norway (no. 34068/21) (which relates to the issuance of new licenses for oil and gas exploration in the Barents Sea), amongst others—but also proceedings against State parties currently pending before national European courts. In addition, whilst the judgment in KlimaSeniorinnen is limited in application to Convention States as a jurisdictional matter, NGOs and other claimants may seek to leverage the judgment to support new and existing climate lawsuits against private parties. This could, in turn, have an effect on domestic standing laws related to climate change actions. Notably, there have already been examples of claims against private actors in the climate change context in Convention State courts where Convention-based arguments have been put forward.
In jurisdictions outside of the Council of Europe, Klima Seniorinnen may also prove influential where human rights arguments have been raised by the claimant(s). Further, on the international plane, KlimaSeniorinnen may have a persuasive effect on the International Court of Justice’s (“ICJ”) pending decision in connection with UN General Assembly’s request for an advisory opinion relating to States’ international law obligations to ensure protection from climate change for present and future generations. The ICJ is expected to deliver its opinion in this judgment in early 2025.
2. Carême and The Portuguese Youth Climate Case
(a) The Court’s Findings
Carême concerned an action by an individual, Mr Carême, acting on his own behalf and in his capacity as mayor of Grande-Synthe, and in the name and on behalf of the latter municipality. In proceedings before the French courts, the Conseil d’État declared admissible the action brought by the municipality and inadmissible the action brought by Mr Carême. The Conseil d’État found that the measures taken by the French authorities to tackle climate change had been insufficient and ordered the authorities to take additional measures by 31 March 2022 to meet the GHG emissions reduction targets set out in the domestic legislation and Annex I of Regulation (EU) 2018/842.
The Grand Chamber concluded that the complaint in Carême was inadmissible on the basis that Mr Carême lacked “victim status” as required by Article 34 of the Convention. This was because Mr Carême had moved away from Grande-Synthe, the area in France that he alleged was affected by climate change, to Brussels, and otherwise had no other links to Grande-Synthe for the purposes of Articles 2 and 8 of the Convention (which were the articles upon which Mr Carême relied).
Meanwhile, the Portuguese Youth Climate Case was brought by six young persons (who all resided in Portugal) against Portugal and 32 other Convention States, alleging that the respondents had violated human rights by failing to take sufficient action on climate change in violation of Articles 2 and 8, with particular reference to forest fires and heatwaves in Portugal in 2017 and 2018. The applicants sought an order from the Court requiring the respondent States to take more ambitious climate change action.
The Court concluded that although Portugal had territorial jurisdiction for the purposes of Article 1 of the Convention, extra-territorial jurisdiction could not be established in respect of the other 32 respondent States. The Court thus confirmed its existing jurisprudence on extra-territorial jurisdiction and refused to expand that jurisprudence in the climate change context. The claims against the 32 other respondent Convention States were declared inadmissible on that basis. Additionally, the Court declared the claim inadmissible on a second ground: that the applicants had not exhausted domestic remedies available in Portugal.
(b) Key Takeaways
First, and importantly, the Court’s refusal to extend its case law on extraterritorial jurisdiction in the Portuguese Youth Climate Case on the basis of specific arguments grounded on climate change considerations means that climate change related claims brought under the Convention will, in principle, have to be directed at and first resolved in the State in which the individual persons alleging harms are situated.
Second, the Court’s emphasis that domestic remedies must be exhausted in the context of climate change confirms that climate change litigation is, first and foremost, a matter for the national courts in the respective Convention State.
The Gibson Dunn team would be very happy to discuss the wide-ranging ramifications of the Climate Change Cases in more detail with clients.
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 leader or member of the firm’s International Arbitration or Transnational Litigation practice groups, or the following authors:
Robert Spano – London/Paris (+33 1 56 43 14 07, rspano@gibsondunn.com)
Stephanie Collins – London (+44 20 7071 4216, SCollins@gibsondunn.com)
Alexa Romanelli – London (+44 20 7071 4269, aromanelli@gibsondunn.com)
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
We are pleased to provide you with Gibson Dunn’s ESG monthly updates for March 2024. This month our update covers the following key developments. Please click on the links below for further details.
- France and Brazil launch EUR 1.1 billion program to protect Amazon rainforest
On March 26 in Belém, Brazil, the Brazilian and French presidents launched a joint investment program to protect the Brazilian and Guyanese Amazon rainforest “with the aim of leveraging EUR 1 billion in public and private investments in the bioeconomy over the next four years.” The investment plan will involve Brazilian state-run banks, such as the National Bank for Economic and Social Development (BNDES) and Banco da Amazonia (BASA), as well as the French investment agency.
According to the signed declaration the presidents “consider it urgent to focus our efforts on establishing, by COP30, a bioeconomy model that considers the three dimensions of sustainable development — social, economic, and environmental — and allows us to reverse biodiversity loss and tackle climate change.” This pledge to stop deforestation in the Amazon by 2030 comes two years before Brazil hosts the COP30 climate negotiations talks in Belém.
- Net Zero Banking Alliance tightens guidelines for banks’ climate targets
On March 13, members of the bank-led, UN-convened Net-Zero Banking Alliance (“NZBA”) voted to adopt a new version of the Guidelines for Climate Target Setting for Banks. One key change is the expanded scope, which now includes not only lending and investment activities but also capital markets arranging and underwriting activities. This extension aims to provide a more comprehensive approach to climate target setting, acknowledging the significant role these activities play in banking portfolios as well as the scientific, regulatory, and methodological changes that have occurred since the original April 2021 Guidelines.
According to the UNEP FI website, the guidelines are a product of an NZBA member bank-led review informed by their own experience of applying the original guidelines, setting and implementing climate targets, and financing transitions in different sectors. The new version “reinforces the guidelines, further outlining key principles to underpin the setting of credible and ambitious targets in line with achieving the objectives of the Paris Agreement”. The updated version of the guidelines will apply to all new targets and any new iterations of existing targets set by NZBA member banks after April 22, 2024.
- Saudi Arabia introduces Green Financing Framework to drive sustainability
On March 28, Saudi Arabia announced its Green Financing Framework, which seeks to attract funding for a range of sustainable investment opportunities. The Framework identifies eight types of projects eligible for funding from so-called “green” debt sales, ranging from support for cleaner transportation and renewable energy to projects that may help the desert kingdom adapt to climate change.
The Ministry of Finance stated the structure will allow the government to sell green bonds and sukuk (Sharia compliant bonds) for projects that meet the criteria. Any sale of such debt would be a first for the central government as it aims to cut its greenhouse gas emissions by 278 million tonnes per year by 2030 and have net zero emissions by 2060.
This announcement follows a number of recent initiatives which include the Saudi Green Initiative (“SGI”) to combat the adverse effects of climate change over the past few years. On March 27, the Kingdom celebrated its first Saudi Green Initiative Day organised under the theme “For Our Today and Their Tomorrow: KSA Together for a Greener Future” which aimed to highlight the collaboration of the more than 80 public and private sector projects that are part of the SGI.
- HM Treasury announces consultation on new regulatory regime for ESG ratings
The UK Government confirmed on 6 March, as part of the Spring Budget, that it will regulate providers of ESG ratings to users within the UK. ESG ratings providers will fall within the regulatory perimeter of the Financial Conduct Authority.
This follows the UK Government’s publication in March 2023 of a consultation on the future regulatory regime for ESG ratings providers alongside an updated Green Finance Strategy. Both publications were part of a wider set of ESG-related publications such as the Powering Up Britain – Net Zero Growth Plan and Energy Security Plan and the more recent consultation on addressing carbon leakage risk to support decarbonisation.
- UK to enforce tougher emission reduction rules on the oil and gas industry
On March 27, the North Sea Transition Authority (“NSTA”), the UK government’s oil and gas regulator, published new guidelines for emissions reduction in the North Sea. These stricter guidelines for oil and gas producers follows from the 2021 NSTA (then “OGA”) strategy which placed an obligation on the industry to assist “in meeting the net zero carbon by 2050 target”.
The NSTA’s new guidelines set out “four clear contributing factors to decarbonising the industry” — including asset electrification, investment and efficiency and action on flaring and venting. It will also look at “inventory as a whole”, ramping up scrutiny on assets with high emissions intensity. New developments with “a first oil or gas after 1 January 2030 must be either fully electrified or run on alternative low carbon power with near equivalent emission reductions”, the NSTA said. New developments with a first oil or gas date before 2030 should be electrification-ready at minimum.
- European Council approves Corporate Sustainability Due Diligence Directive
On March 15, the EU Council approved a revised version of the Corporate Sustainability Due Diligence Directive (“CS3D”). The CS3D imposed obligations on companies to conduct thorough due diligence encompassing identification, assessment, prevention, and mitigation of negative environmental and human rights impacts. To mitigate these, the CS3D stipulates that a broad range of elements must be addressed, including child and forced labour, greenhouse gas emissions and deforestation. Importantly, companies are required to examine and document findings beyond their immediate operations, encompassing both indirect business partners and subsidiaries.
The CS3D has two key objectives: (i) to require companies to carry out due diligence to avoid adverse environmental and human rights impacts and (ii) to ensure accountability in case of actual adverse impacts being caused. The key obligations endorsed by the council in relation to due diligence are set out below:
“Chain of activities”: This definition of a company’s downstream and upstream activities in respect of due diligence obligations has now been further narrowed, by excluding downstream activities performed by indirect business; and downstream activities at the product disposal stage (such as dismantling, recycling, composting and landfilling).
Financial institutions: The provisional agreement was stated to cover only the upstream but not the downstream activities of financial institutions (thus excluding the investment and lending activities of such institutions). The review clause of the compromise text nonetheless continues to provide that the Commission shall prepare, within two years of the directive’s adoption, a report on the need for additional due diligence requirements tailored to the financial sector.
Groups of companies: As per the provisional agreement, ultimate parent companies are responsible for meeting the due diligence obligations of the directive, save where the parent company’s main activity is holding shares in operational subsidiaries—and now, pursuant to an additional exemption introduced in the concession text, where the parent company does not engage in taking “management, operational or financial decisions” affecting the group or its subsidiaries. The parent company must also now apply to the competent supervisory authority for any such exemption.
Civil liability: The civil liability regime has been further adjusted by making it clear that Member States are free to decide the conditions under which trade unions, non-governmental organizations or national human rights institutions can initiate collective redress mechanisms on behalf of victims. In particular, language referring to the ability of such a body to bring a claim “in its own capacity” has been deleted and the possibility for third-party intervention in support of victims in lieu of direct representation explicitly provided for.
- Corporate Sustainability Reporting directive and disclosure of climate risk information
Another of the key obligations endorsed by the European Council under CS3D is the requirement to “adopt and put into effect a transition plan for climate change mitigation” (“Climate Plan”), which must have specific features. Paragraph 50 of the Directive states that Climate Plan must aim “to ensure, through best efforts, that the business model and strategy of the company are compatible with” (i) the transition to a sustainable economy; (ii) limiting global warming to 1.5 °C in line with the Paris Agreement; (iii) the objective of achieving climate neutrality as established in the EU Climate Law, including its intermediate and 2050 targets; and (iv) where relevant, the exposure of the undertaking to coal, oil and gas-related activities.
It must include the following company-specific targets and reporting standards: (i) climate targets including specifically in terms of Scopes 1-3; (ii) identification of decarbonisation levers; (iii) an explanation of transition funding for the Climate Plan; and (iv) description of leadership accountability which must be defined specifically with regard to the Climate Plan.
- U.S. Securities and Exchange Commission adopts final Climate Change Rules
On March 6, the U.S. Securities and Exchange Commission (“SEC”) approved final climate change rules. More information on these rules is available in our client alert available here. The rules were immediately challenged in court by various parties, including several states and the Sierra Club. On March 15, the Fifth Circuit Court of Appeals granted an emergency administrative stay of the SEC’s rules. On March 21, the Judicial Panel on Multidistrict Litigation selected the Eighth Circuit as the court that will consider the petitions for review challenging the SEC’s rule, and on March 22, the administrative stay was dissolved when the Fifth Circuit cases were transferred to the Eighth Circuit. (Subsequently, on April 4, the SEC issued an Order a stay of its final rule “pending the completion of judicial review” of the consolidated Eighth Circuit petitions.)
- U.S. introduces bill to exclude ESG factors from Retirement Investment Plans
On March 21, Congressman Greg Murphy introduced the Safeguarding Investment Options for Retirement Act, legislation to prohibit tax-advantaged retirement plan trustees from considering factors other than financial risk and return when making investment decisions on behalf of workers, retirees, and their beneficiaries. In his official press release, the Congressman explained the background to his decision. He stated that in recent years some retirement plans prioritising ESG factors had “performed more poorly compared to traditional investments, raising questions about trustees’ priorities for investment.” Under this legislation, if plans are found to be using non-financial risk and return factors, they risk losing their tax-advantaged status.
The bill proposes to counteract “the left’s environmental and equity agendas”. Specifically, the Department of Labor’s (“DOL”) reversal under the Biden administration of the restrictions imposed under predecessor Donald Trump on retirement plans considering ESG factors when selecting investments. In November 2022, the DOL finalised rules under ERISA that permit fiduciaries of retirement plans governed by ERISA to consider ESG in the selection process for investments of such retirement plans. Congressman Murphy’s bill is indicative of much of the wider Republican response to the DOL’s 2022 rule and follows the January 2023 lawsuit filed in the Northern District of Texas by attorney generals from 25 states which challenges the 2022 rule.
- U.S. Government commits $750 million for growth of hydrogen industry in U.S.
On March 14, the Department of Energy (“DOE”) announced that it will allocate $750 million to a series of projects aimed at dramatically reducing the cost of clean hydrogen. Focused on advancing electrolysis technologies, manufacturing and recycling capabilities for clean hydrogen systems, this commitment is indicative of the Biden Administration’s approach to hydrogen as crucial in reducing fossil fuels and emissions from hard to decarbonize industries such as aluminium and cement.
The announcement follows the Biden administration’s release in June 2023 of the U.S. National Clean Hydrogen Strategy and Roadmap, aimed at significantly increasing the production, use, and distribution of low carbon hydrogen in energy intensive industries. It outlines the commitment to scale U.S. clean hydrogen production and use to 10 million metric tonnes by 2030, and as much as 50 million tonnes by 2050.
The new allocations by the DOE will be funded by the Bipartisan Infrastructure Law, which was passed in November 2021 and allocates $9.5 billion to clean hydrogen. The law gives authority to the DOE to allocate the funding, which includes up to $1 billion for research and development of reducing the cost of clean hydrogen produced via electrolysis; as well as $500 million to research and development of improved processes and technologies for manufacturing and recycling clean hydrogen systems and materials.
- South Korea unveils $313 billion green financing plan to combat climate change
South Korea has vowed to provide loans worth $313.4 billion to finance carbon-cutting projects, in a joint statement by the government and major banks on 19 March. By 2030, five state financial institutions including Korea Development Bank (“KDB”) will provide those loans to encourage companies to switch to low carbon production, the announcement said. By 2030, these measures are anticipated to achieve a reduction of 85.97 million metric tonnes of greenhouse gases, fulfilling nearly 30% of the government’s ambitious target.
The plan to step up the fight against climate change was unveiled in a meeting between government officials and heads of South Korea’s five major banks. The KDB and other big banks including Woori Bank and Kookmin Bank, will also create a new fund worth KRW 9 trillion for building new green energy facilities, the government added.
- Chinese stock exchanges consult on mandatory sustainability reporting requirements for listed companies
China’s three major stock exchanges, the Shanghai Stock Exchange, the Shenzhen Stock Exchange and the Beijing Stock Exchange, have announced new sustainability reporting guidelines for listed companies to begin mandatory disclosure on ESG related topics in 2026.
The reporting requirements will cover four core topics, including governance, strategy, impact and risk and opportunity management, along with indicators and goals. The exchanges are taking a “double materiality” approach, which includes reporting on both the risks and impacts of sustainability issues, along with the companies’ impacts on the environment and society.
The mandatory reporting requirements will capture more than 450 companies listed across the three exchanges, with the reporting set to begin in 2026 for the 2025 reporting period.
Warmest regards,
Susy Bullock
Elizabeth Ising
Perlette M. Jura
Ronald Kirk
Michael K. Murphy
Selina S. Sagayam
Chairs, Environmental, Social and Governance Practice Group, Gibson Dunn & Crutcher LLP
For further information about any of the topics discussed herein, please contact the ESG Practice Group Chairs or contributors, or the Gibson Dunn attorney with whom you regularly work.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any leader or member of the firm’s Environmental, Social and Governance practice group:
Environmental, Social and Governance (ESG):
Susy Bullock – London (+44 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)
Patricia Tan Openshaw – Hong Kong (+852 2214-3868, popenshaw@gibsondunn.com)
Selina S. Sagayam – London (+44 20 7071 4263, ssagayam@gibsondunn.com)
*Helena Silewicz, a trainee solicitor in the London office, is not admitted to practice law.
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
Macquarie Infrastructure Corp. v. Moab Partners, L.P., No. 22-1165 – Decided April 12, 2024
On April 12, the Supreme Court unanimously held that a company’s failure to disclose information required under SEC regulations—such as Item 303 of Regulation S-K—cannot support a private securities-fraud claim unless the omission makes the company’s affirmative statements misleading.
“Pure omissions are not actionable under Rule 10b-5(b).”
Justice Sotomayor, writing for the Court
Background:
Regulation S-K requires public companies to provide disclosure on certain prescribed topics. Item 303 of the regulation, the “Management’s Discussion and Analysis of Financial Condition and Results of Operation” (MD&A), specifically requires companies to disclose “known trends or uncertainties that have had or that are reasonably likely to have” a material impact on net sales, revenue, or income. 17 C.F.R. § 229.303(b)(2)(ii). And Rule 10b-5(b) makes it unlawful for companies “[t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” Id. § 240.10b-5(b). Both the SEC and private parties can sue companies for violations of Rule 10b-5(b).
Several circuits had held that failure to make a disclosure under Item 303 cannot support a securities fraud claim under Rule 10b-5(b) without an affirmative statement that is made misleading by the omission. But the Second Circuit disagreed, holding that an Item 303 violation alone can give rise to a securities-fraud claim. The Supreme Court granted review to resolve the conflict.
Issue:
Whether a failure to make a disclosure required under Item 303 of Regulation S-K can support a private claim under Rule 10b-5(b) even in the absence of an otherwise misleading statement.
Court’s Holding:
No. Rule 10b-5(b) does not prohibit pure omissions, so a failure to disclose information required under Item 303 does not support a private securities-fraud claim under Rule 10b-5(b) without an affirmative statement made misleading by the omission.
What It Means:
- The Court’s holding clarifies that Rule 10b-5(b) does not allow private lawsuits based on pure omissions, including omitted information required to be disclosed under SEC regulations like Item 303. Instead, Rule 10b-5(b) permits lawsuits based only on affirmative misrepresentations and “half-truths” that are misleading because they omit critical qualifying information.
- The Court rejected the plaintiff’s and government’s argument that the omission of any information required by Item 303 is necessarily misleading because investors expect companies to disclose all known trends or uncertainties. The Court clarified, however, that “private parties remain free to bring claims based on Item 303 violations that create misleading half-truths.” The Court also contrasted Rule 10b-5(b)’s language with Section 11(a) of the Securities Act of 1933, under which the Court observed that Congress expressly imposed liability for pure omissions.
- The Court’s decision represents an important check on claims under Rule 10b-5(b), reaffirming that the private right of action the Court recognized many decades ago should not be further extended.
- Although the Court framed the question presented in terms of “private” rights of action, the Court’s interpretation of Rule 10b-5(b) does not appear to be limited to that context. Accordingly, the Court’s decision likely means that the SEC itself also will not be able to bring enforcement actions alleging fraud under Rule 10b-5(b) based on a pure omission theory. The Court did make clear, however, that the SEC retains authority to prosecute violations of Item 303 and the SEC’s other regulations that mandate what disclosures must be made in public filings.
- The Court did not opine on any issue other than whether a pure omission is actionable under Rule 10b-5(b). It did not address what would qualify as a statement made misleading by an omission, or whether the other parts of Rule 10b-5—the “scheme liability” provisions of Rules 10b-5(a) and 10b-5(c)—support liability for pure omissions. Those issues will likely be the subject of further litigation.
The Court’s opinion is available here.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders:
Appellate and Constitutional Law Practice
| Thomas H. Dupree Jr. +1 202.955.8547 tdupree@gibsondunn.com |
Allyson N. Ho +1 214.698.3233 aho@gibsondunn.com |
Julian W. Poon +1 213.229.7758 jpoon@gibsondunn.com |
| Lucas C. Townsend +1 202.887.3731 ltownsend@gibsondunn.com |
Bradley J. Hamburger +1 213.229.7658 bhamburger@gibsondunn.com |
Brad G. Hubbard +1 214.698.3326 bhubbard@gibsondunn.com |
Related Practice: Securities Litigation
| Monica K. Loseman +1 303.298.5784 mloseman@gibsondunn.com |
Brian M. Lutz +1 415.393.8379 blutz@gibsondunn.com |
Craig Varnen +1 213.229.7922 cvarnen@gibsondunn.com |
| Jason J. Mendro +1 202.887.3726 jmendro@gibsondunn.com |
Michael D. Celio +1 650.849.5326 mcelio@gibsondunn.com |
Related Practice: Securities Regulation and Corporate Governance
| Elizabeth Ising +1 202.955.8287 eising@gibsondunn.com |
James J. Moloney +1 949.451.4343 jmoloney@gibsondunn.com |
Lori Zyskowski +1 212.351.2309 lzyskowski@gibsondunn.com |
| Thomas J. Kim +1 202.887.3550 tkim@gibsondunn.com |
Brian J. Lane +1 202.887.3646 blane@gibsondunn.com |
Ronald O. Mueller +1 202.955.8671 rmueller@gibsondunn.com |
This alert was prepared by associates Patrick Fuster, Matt Aidan Getz, and Robert Batista.
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
Bissonnette v. LePage Bakeries Park St., LLC, No. 23-51 – Decided April 12, 2024
Today, the Supreme Court unanimously held that the applicability of the Federal Arbitration Act’s exemption for transportation workers in interstate commerce turns on whether a worker is a transportation worker, not whether they work in the transportation industry.
“A transportation worker need not work in the transportation industry to fall within the exemption from the FAA provided by §1 of the Act.”
Chief Justice Roberts, writing for the Court
Background:
The Federal Arbitration Act (“FAA”) broadly requires courts to enforce arbitration agreements but exempts from its application arbitration “contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce.” 9 U.S.C. § 1. The Supreme Court in Circuit City Stores, Inc. v. Adams, 532 U.S. 105 (2001), held that this exemption applies only to transportation workers.
Neal Bissonnette and Tyler Wojnarowski worked as distributors for Flower Foods, Inc., a baked-goods producer and marketer. After they sued Flowers for allegedly violating state and federal wage laws, Flowers moved to compel arbitration under the FAA pursuant to the arbitration clauses in their distribution agreements.
Bissonnette and Wojnarowski resisted arbitration, arguing that they were exempt under Section 1 of the FAA because they were “workers engaged in foreign or interstate commerce.”
The district court compelled arbitration on the ground that the distributors were not transportation workers but had much broader responsibilities. The Second Circuit affirmed, but on different reasoning: it held that the distributors worked in the bakery industry, not the transportation industry, and therefore did not qualify for the Section 1 exemption.
Issue:
Whether a transportation worker must work for a company in the transportation industry to qualify for the arbitration exemption in Section 1 of the FAA.
Court’s Holding:
No. To qualify as a transportation worker under Section 1 of the FAA, a worker does not have to work for a company in the transportation industry, and can qualify for the exemption if they play “a direct and ‘necessary role in the free flow of goods’ across borders.”
What It Means:
- The Court’s decision is narrow. The Court rejected a “transportation industry” test for Section 1 of the FAA. The Court’s decision largely follows from Southwest Airlines Co. v. Saxon, 596 U.S. 450 (2022), which held that Section 1 “focuses on the performance of work, rather than the industry of the employer.”
- The Court’s decision did not address whether the workers at issue were transportation workers or whether they were engaged in interstate commerce.
- This ruling does not meaningfully alter the FAA Section 1 landscape, given that Saxon had already held that the Section 1 inquiry focuses on whether the workers’ job duties render them “transportation workers.” Regardless of industry, employers who use arbitration agreements should consider workers’ job duties when assessing whether the Section 1 exemption might apply.
The Court’s opinion is available here.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders:
Appellate and Constitutional Law Practice
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Allyson N. Ho +1 214.698.3233 aho@gibsondunn.com |
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Theane Evangelis +1 213.229.7726 tevangelis@gibsondunn.com |
Bradley J. Hamburger +1 213.229.7658 bhamburger@gibsondunn.com |
| Brad G. Hubbard +1 214.698.3326 bhubbard@gibsondunn.com |
Related Practice: Labor and Employment
| Jason C. Schwartz +1 202.955.8242 jschwartz@gibsondunn.com |
Katherine V.A. Smith +1 213.229.7107 ksmith@gibsondunn.com |
Theane Evangelis +1 213.229.7726 tevangelis@gibsondunn.com |
Related Practice: Class Actions
| Christopher Chorba +1 213.229.7396 cchorba@gibsondunn.com |
Kahn A. Scolnick +1 213.229.7656 kscolnick@gibsondunn.com |
This alert was prepared by associates Elizabeth Strassner and Salah Hawkins.
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
Sheetz v. County of El Dorado, No. 22-1074 – Decided April 12, 2024
Today, the Supreme Court held unanimously that land-development permit exactions subject to the Takings Clause must bear an essential nexus and rough proportionality to the expected impacts of the development, even if the exaction is imposed pursuant to legislation.
“The Takings Clause … prohibits legislatures and agencies alike from imposing unconstitutional conditions on land-use permits.”
Justice Barrett, writing for the Court
Background:
The Supreme Court’s prior decisions in Nollan v. California Coastal Commission and Dolan v. City of Tigard held that certain land-development exactions violate the Fifth Amendment’s Takings Clause unless the government can show that the exaction bears (1) an “essential nexus” and (2) a “rough proportionality” to the expected impacts from the development.
George Sheetz applied for a permit from the County of El Dorado, California to build a house on his property. County legislation required Mr. Sheetz to pay a traffic impact mitigation fee as a condition of obtaining a permit, which was set according to a legislatively determined fee schedule that did not account for an individual project’s actual impact on roads. Mr. Sheetz challenged the exaction as an unconstitutional taking under Nollan and Dolan. The California Court of Appeal held that the exaction was immune from constitutional scrutiny because it was authorized by generally applicable legislation, as opposed to an administratively imposed exaction.
Issue:
Is a building permit exaction authorized by legislation exempt from constitutional scrutiny under the test set forth in Nollan and Dolan?
Court’s Holding:
No. The Takings Clause does not distinguish between legislative and administrative land-use permit conditions, and therefore legislatively mandated exactions are not exempt from the “essential nexus” and “rough proportionality” standards established by Nollan and Dolan.
What It Means:
- The Court’s decision means that land-development exactions do not evade review under Nollan and Dolan merely because they are authorized pursuant to legislation.
- The Court’s ruling gives property developers more opportunities to challenge legislative exactions as unconstitutional takings. The decision could lead to greater predictability in legislative exactions and a reduction in the types and amounts of impact fees and other exactions imposed, as local governments will need to assess whether legislation imposing exaction fees on private property development, if subject to the Takings Clause, comply with Nollan and Dolan’s mandates.
- The Court’s decision unanimously declares that “[t]he Constitution’s text does not limit the Takings Clause to a particular branch of government,” which is consistent with the conclusion of Justice Scalia’s 2010 plurality opinion in Stop the Beach Renourishment, Inc. v. Florida Department of Environmental Protection that judicial actions are subject to the Takings Clause.
- Justice Kavanaugh’s concurring opinion, joined by Justices Kagan and Jackson, emphasized that the Court today expressly left open the question whether a permit condition imposed on a class of properties is subject to the same standard as a permit condition that targets a particular development. Justice Gorsuch, in another concurrence, offered his answer: Nollan and Dolan should not operate differently when an alleged taking affects a class of properties rather than a specific development, as neither of those precedents involved the targeting of a particular development.
- Justice Sotomayor’s concurring opinion, joined by Justice Jackson, expressed the view that the Court had not decided the threshold question whether the traffic impact fee in this case would be a compensable taking if imposed outside of the permitting context.
The Court’s opinion is available here.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact the following practice leaders:
Appellate and Constitutional Law Practice
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Allyson N. Ho +1 214.698.3233 aho@gibsondunn.com |
Julian W. Poon +1 213.229.7758 jpoon@gibsondunn.com |
| Lucas C. Townsend +1 202.887.3731 ltownsend@gibsondunn.com |
Bradley J. Hamburger +1 213.229.7658 bhamburger@gibsondunn.com |
Brad G. Hubbard +1 214.698.3326 bhubbard@gibsondunn.com |
Related Practice: Real Estate
| Eric M. Feuerstein +1 212.351.2323 efeuerstein@gibsondunn.com |
Alan Samson +44 20 7071 4222 asamson@gibsondunn.com |
Jesse Sharf +1 310.552.8512 jsharf@gibsondunn.com |
Related Practice: Land Use and Development
| Mary G. Murphy +1 415.393.8257 mgmurphy@gibsondunn.com |
Benjamin Saltsman +1 213.229.7480 bsaltsman@gibsondunn.com |
This alert was prepared by associates Connie Lee and Robert Batista.
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
From the Derivatives Practice Group: The CFTC has appointed a new Inspector General, Christopher Skinner. The Office of the Inspector General is an independent organizational unit of the CFTC, with the mission to detect waste, fraud, and abuse and to promote integrity, economy, efficiency, and effectiveness in the CFTC’s programs and operations.
New Developments
- CFTC Appoints Christopher Skinner as Inspector General. On April 10, the Commodity Futures Trading Commission announced that Christopher L. Skinner has been appointed CFTC’s Inspector General (IG). The CFTC stated that Mr. Skinner brings 15 years of IG experience, including leading and managing Offices of Inspector’s General (OIG), and conducting investigations, inspections, and audits. Mr. Skinner comes to the CFTC from the Federal Election Commission (FEC) where he served as IG since 2019. [NEW]
- SEC Adopts Reforms Relating to Investment Advisers Operating Exclusively Through the Internet. On March 27, the SEC adopted amendments to the rule permitting certain internet investment advisers to register with the Commission (the “internet adviser exemption”). The amendments will require an investment adviser relying on the internet adviser exemption to have at all times an operational interactive website through which the adviser provides digital investment advisory services on an ongoing basis to more than one client. The amendments will also eliminate the current rule’s de minimis exception by requiring an internet investment adviser to provide advice to all of its clients exclusively through an operational interactive website and to make certain corresponding changes to Form ADV.
New Developments Outside the U.S.
- New Report Sheds Light on Quality and Use of Regulatory Data Across EU. On April 11, ESMA published the fourth edition of its Report on the Quality and Use of Data aiming to provide transparency on how the data collected under different regulations is used systematically by authorities in the EU, and clarifying the actions taken to ensure data quality. The report provides details on how National Competent Authorities, the European Central Bank, the European Systemic Risk Board and ESMA use the data that is collected through the year from different legislation requirements, including datasets from European Market Infrastructure Regulation, Securities Financing Transactions Regulation, Markets in Financial Instruments Directive, Securitization Regulation, Alternative Investment Fund Managers Directive and Money Market Funds Regulation. [NEW]
- UK’s Accelerated Settlement Taskforce Publishes Report on the Path to T+1. On March 28, the UK’s Accelerated Settlement Taskforce published its report on the path to a T+1 settlement cycle. The report finds there is a clear consensus on the need for the UK to move to a T+1 settlement cycle and this shift will require substantial investment in greater automation and standardization. In addition, the report emphasizes a need for ongoing engagement with stakeholders during the transition period and the opportunity to learn from the U.S. move to T+1 in May 2024. The report recommends the immediate creation of a technical group to identify the challenges of transition and formulate solutions and suggests a two-step transition to T+1 before the end of 2027, with the exact date to be determined by the technical group.
- ESMA Clarifies Application of Certain MIFIR Provisions, Including Volume Cap. On March 27, the European Securities and Markets Authority (ESMA) published a statement, including practical guidance supporting the transition and the consistent application of the revised Markets in Financial Instruments Regulation (MiFIR).The statement covers guidance on equity transparency and non-equity transparency; the systematic internaliser (SIs) regime; designated publishing entities (DPEs); and reporting. Regarding the volume cap, following the publication by the European Commission, ESMA confirmed that DVC data will continue to be published, with the next publication scheduled for early April.
- ESMA Provides Market Participants with Guidance on the Clearing Obligation for Trading with 3rd Country Pension Schemes. On March 27, ESMA issued a public statement on deprioritizing supervisory actions linked to the clearing obligation for third-country pension scheme arrangements (TC PSA), pending the finalization of the review of EMIR. ESMA expects National Competent Authorities (NCAs) not to prioritize supervisory actions in relation to the clearing obligation for derivative transactions conducted with TC PSAs exempted from the clearing obligation under their third-country’s national law. Additionally, ESMA recommends that NCAs apply their risk-based supervisory powers in their day-to-day enforcement of applicable legislation in this area in a proportionate manner. The Council and the European Parliament reached a provisional agreement on February 7. The political agreement on the EMIR 3 text provides for an exemption regime from the EMIR clearing obligation when the TC PSA is exempted from the clearing obligation under that third country’s national law.
- ESMA Finalizes First Rules on Crypto-Asset Service Providers. On March 25, ESMA published the first Final Report under the Markets in Crypto-Assets Regulation (MiCA). ESMA stated that Tthe report, which aims to foster clarity and predictability, promote fair competition between crypto-asset service providers (CASPs) and a safer environment for investors across the Union, includes proposals on: (1) information required for the authorization of CASPs; (2) the information required where financial entities notify their intent to provide crypto-asset services; (3) information required for the assessment of intended acquisition of a qualifying holding in a CASP, and (4) how CASPs should address complaints.
- ESMA Launches the Third Consultation Under MiCA. On March 25, ESMA published its third consultation package under the MiCA. In the consultation package, ESMA is seeking input on four sets of proposed rules and guidelines, covering: (1) detection and reporting of suspected market abuse in crypto-assets; (2) policies and procedures, including the rights of clients, for crypto-asset transfer services; (3) suitability requirements for certain crypto-asset services and format of the periodic statement for portfolio management; and (4) ICT operational resilience for certain entities under MiCA.
- SGX Issues Consultation on Revised Limit on Clearing Members’ Liability for Multiple Defaults. On March 22, Singapore Exchange (SGX) issued a consultation paper proposing to refine the existing cap on a clearing member’s liability to meet default losses arising from multiple events of default. The cap is imposed on clearing members of Singapore Exchange Derivatives Clearing Limited (SGX-DC) and The Central Depository (Pte) Limited (CDP). The proposal purports to limit a non-defaulting clearing member’s liability to meet multiple default losses arising within a 30-day period to three times the aggregate of its funded and unfunded clearing fund contributions (prescribed contribution) as determined at the start of the 30-day period. The revised limit is intended to be independent of the clearing member’s resignation. SGX has also proposed changes to the SGX-DC clearing rules set out in Appendix B of the consultation. SGX is seeking views and comments on: (1) capping the limit for multiple defaults at three times a clearing member’s clearing fund contribution amount for all defaults occurring within a 30-day period; (2) the methodology for calculating the amount of a non-defaulting clearing member’s clearing fund contributions available to meet losses suffered by the SGX central counterparty arising from or in connection with an event of default (as set out in SGX-DC Clearing Rule 7A.06.9.2); and (3) the rule amendments to effect the proposed change. The consultation closes on April 24, 2024.
- SFC and HKMA Further Consult on Enhancements to Hong Kong’s OTC Derivatives Reporting Regime. On March 22, 2024, the Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) launched a joint-further consultation on enhancements to the over-the-counter (OTC) derivatives reporting regime in Hong Kong. This further consultation follows an earlier joint-consultation in April 2019, in which the SFC and HKMA proposed a requirement to identify transactions submitted to the Hong Kong Trade Repository (HKTR) for the reporting obligation by a Unique Transaction Identifier. The current joint-further consultation consults on the implementation of the Unique Transaction Identifier, together with the mandatory use of Unique Product Identifier and Critical Data Elements for submission of transactions to the HKTR. The Interested parties are encouraged to submit responses to the SFC or HKMA on the consultation by May 17, 2024.
New Industry-Led Developments
- ISDA, AIMA, GFXD Publish Paper on Transition to UPI. On April 9, ISDA, the Alternative Investment Management Association (AIMA) and the Global Foreign Exchange Division (GFXD) of the Global Financial Markets Association published a paper on the transition to unique product identifiers (UPI) as the basis for over-the-counter (OTC) derivatives identification across the Markets in Financial Instruments Regulation (MIFIR) regimes. The paper has been sent to the European Commission, which is working on legislation to address appropriate identification of OTC derivatives under MiFIR. [NEW]
- IOSCO Seeks Feedback on the Evolution of Market Structures and Proposed Good Practices. On April 4, the International Organization of Securities Commissions (IOSCO) published a consultation report on Evolution in the Operation, Governance and Business Models of Exchanges: Regulatory Implications and Good Practices. The consultation report analyzes the structural and organizational changes within exchanges, focusing on business models and ownership structures. It highlights a shift towards more competitive, cross-border, and diversified operations as exchanges integrate into larger corporate groups. The consultation report discusses regulatory considerations, particularly in the organization of individual exchanges and exchange groups and the supervision of multinational exchange groups. It addresses potential conflicts of interest arising from matrix structures and the challenges of overseeing individual exchanges within exchange groups. Additionally, it outlines a set of six proposed good practices for regulators to consider in the supervision of exchanges, particularly when they provide multiple services and/or are part of an exchange group. The good practices are also complemented by a non-exclusive list of supervisory tools used by IOSCO jurisdictions to address the issues under discussion, in the form of “toolkits”. While the Consultation Report focuses on equities listing trading venues, the findings are also relevant to other trading venues, including non-listing trading venues and derivatives trading venues. IOSCO is seeking input from market participants on the major trends and risks observed, and the proposed good practices on or before July 3, 2024.
- ISDA Submits Response to CFTC Proposed Operational Resilience Rules. On April 1, ISDA submitted comments on the CFTC’s notice of proposed rulemaking on requirements to establish an Operational Resilience Framework for Futures Commission Merchants, Swap Dealers and Major Swap Participants, which was published in the Federal Register on January 24, 2024. ISDA recommended that the CFTC adjust adjust portions of the proposed rules relating to governance, third-party relationships, incident notification and implementation period.
- ISDA Submits Response to IOSCO Consultation on Post-Trade Risk Reduction. On March 29, ISDA submitted a response to IOSCO consultation on post-trade risk reduction (PTRR) services. According to ISDA, PTRR services are intended to optimize bilateral and cleared derivatives portfolios to minimize the build-up of notional amounts and trade count, counterparty risk, and basis risk respectively, which in turn reduces systemic risk. ISDA stated that it is broadly supportive of IOSCO’s proposed sound practices.
- ISDA Submits Joint Response to PRA on Approach to Policy. On March 28, ISDA and the Association for Financial Markets in Europe (AFME) submitted a joint response to the Prudential Regulation Authority (PRA) consultation on its approach to policy. The associations highlighted the importance of considering UK market specificities in meeting the secondary competitiveness and growth objective, and in the implementation of international standards. The associations expressed support for the continuation of structured policy development in dialogue with the industry, while also advocating for the enhancement of the PRA’s stakeholder engagement by re-establishing standing groups and horizon risk scanning groups, and greater industry cooperation during the initiation phase of the policy cycle. ISDA highlighted certain other points in the response, including recommendations on clustering regulatory principles and suggested improvements to the cost-benefit analysis and data collection processes to achieve greater transparency.
- ISDA Submits Joint Response to BCBS Crypto Standard Amendments Consultation. On March 28, ISDA, with the Global Financial Markets Association, the Futures Industry Association, the Institute of International Finance and the Financial Services Forum, submitted a joint response to the Basel Committee on Banking Supervision (BCBS) consultation on proposed crypto asset standard amendments. ISDA and the other trade associations stated that they welcome the BCBS’s continued focus on designing and improving the prudential framework for crypto assets. The key topics in the consultation response include public permissionless blockchains, classification condition 2 and settlement finality and Group 1b eligibility.
The following Gibson Dunn attorneys assisted in preparing this update: Jeffrey Steiner, Adam Lapidus, Marc Aaron Takagaki, Hayden McGovern, and Karin Thrasher.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Derivatives practice group, or the following practice leaders and authors:
Jeffrey L. Steiner, Washington, D.C. (202.887.3632, jsteiner@gibsondunn.com)
Michael D. Bopp, Washington, D.C. (202.955.8256, mbopp@gibsondunn.com)
Michelle M. Kirschner, London (+44 (0)20 7071.4212, mkirschner@gibsondunn.com)
Darius Mehraban, New York (212.351.2428, dmehraban@gibsondunn.com)
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Stephanie L. Brooker, Washington, D.C. (202.887.3502, sbrooker@gibsondunn.com)
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William R. Hallatt, Hong Kong (+852 2214 3836, whallatt@gibsondunn.com)
David P. Burns, Washington, D.C. (202.887.3786, dburns@gibsondunn.com)
Marc Aaron Takagaki, New York (212.351.4028, mtakagaki@gibsondunn.com)
Hayden K. McGovern, Dallas (214.698.3142, hmcgovern@gibsondunn.com)
Karin Thrasher, Washington, D.C. (202.887.3712, kthrasher@gibsondunn.com)
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.
The number of federal agencies that have joined the pledge and the scope of regulatory and enforcement priorities outlined in the joint statement are the strongest signals yet from the federal government that it intends to proactively monitor and regulate use cases of AI.
On April 4, 2024, the Department of Justice (DOJ) announced[1] that five additional cabinet-level federal agencies have joined a pledge to investigate unfair or discriminatory conduct involving artificial intelligence (AI). The joint statement—which was initially released in April 2023 by DOJ’s Civil Rights Division, the Consumer Financial Protection Bureau, the Equal Employment Opportunity Commission, and the Federal Trade Commission—now includes the Department of Education, the Department of Health and Human Services, the Department of Homeland Security, the Department of Housing and Urban Development, and the Department of Labor. DOJ’s Consumer Protection Branch also joined the pledge.
The announcement follows an April 3, 2024 meeting of senior government officials to enhance coordination on AI-related issues. This was the second such meeting following President Biden’s Executive Order on the Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence, which directs federal agencies to use their authorities to prevent and address harms that may result from AI.
These actions highlight federal agency efforts to coordinate and pursue actions using existing legal authorities. The addition of DOJ’s Consumer Protection Branch to the pledge particularly signals the likelihood of new criminal investigations into AI-related conduct affecting consumers. Companies involved in the development and use of AI should be thoughtful about planning and avoidance of issues of concern identified in the pledge, including biased inputs, design opacity, and unintended uses.
The Pledge
The joint statement emphasizes the agencies’ focus on their responsibility to ensure that automated systems are “developed and used in a manner consistent with existing federal laws.” Signing agencies also pledge to “monitor the development and use of automated systems,” promote responsible innovation, and “vigorously” protect individuals’ rights. This pledge stems from Section 8 of the President’s Executive Order, which directed federal agencies “to consider using their full range of authorities to protect American consumers from fraud, discrimination, and threats to privacy and to address other risks that may arise from the use of AI.”[2]
Agency Highlights
Existing Federal Laws Apply to AI. The joint statement reiterates the view expressed in the initial April 2023 statement that the federal government believes that regulation of AI falls squarely within the ambit of existing federal laws and the agencies’ collective authority to enforce civil rights, non-discrimination, fair competition, and consumer protection. Indeed, the statement declares that “existing legal authorities apply to the use of automated systems and innovative new technologies just as they apply to other practices.”
Emphasis on Unfair or Discriminatory Conduct. As noted by DOJ in announcing the pledge:
“Federal agencies are sending a clear message: we will use our collective authority and power to protect individual rights in the wake of increased reliance on artificial intelligence in various aspects of American life. As social media platforms, banks, landlords, employers and other businesses choose to rely on artificial intelligence, algorithms, and automated systems to conduct business, we stand ready to hold accountable those entities that fail to address the unfair and discriminatory outcomes that may result.”[3]
This joint statement identifies the following particular issues of governmental concern with AI systems:
- Data and Datasets—The agency signers of the pledge note that automated system outcomes can be skewed by unrepresentative or imbalanced datasets, datasets that incorporate historical bias, or datasets that contain other types of errors. Making it clear that avoiding the use of protected characteristics as inputs is not enough, they also express concern that automated systems may correlate data with protected classes, which could lead to discriminatory outcomes.
- Model Opacity and Access—The agencies also worry that many automated systems are “black boxes” whose internal workings may not be clear even to the developer of the system. This lack of transparency, the agencies assert, could makes it more difficult for developers, businesses, and individuals to know whether an automated system is fair.
- Design and Use—Developers do not always understand or account for the contexts in which private or public entities will use their automated systems, the agencies state. Developers, they explain, may design a system on the basis of flawed assumptions about its users, relevant context, or the underlying practices or procedures it may replace.
Business Implications
The number of federal agencies that have joined the pledge and the scope of regulatory and enforcement priorities outlined in the joint statement are the strongest signals yet from the federal government that it intends to proactively monitor and regulate use cases of AI. Other recent actions of note include the FTC’s blanket authorization—which “will be in effect for 10 years”—of compulsory process in investigations of any products or services “that use or claim to be produced using artificial intelligence or claim to detect its use.”[4] The Department of Justice also has established an Emerging Technology Board[5] and Chief AI Officer[6] to spearhead AI investigations and initiatives.
Companies that develop or use AI (whether directly or indirectly) should take steps to ensure that they are compliant with federal law to the extent applicable to AI-related conduct in the absence of AI-specific requirements. In practice, this includes ensuring that AI systems and business processes that rely on AI are designed with compliance in mind and in accordance with an AI governance framework. Such framework should include, to the extent applicable, processes to stay aligned with current regulatory developments and priorities, including those identified in the pledge and accompanying joint statement.
Gibson Dunn’s leading AI, Privacy and Cybersecurity, and White Collar Investigations and Defense Practice Groups stand ready to help clients design and implement dynamic compliance programs and respond to agency actions.
__________
[1] U.S. Department of Justice Office of Public Affairs, Five New Federal Agencies Join Justice Department in Pledge to Enforce Civil Rights Laws in Artificial Intelligence, April 4, 2024, available here.
[2] Executive Order on the Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence, Sec. 8 (October 8, 2023), available at https://www.whitehouse.gov/briefing-room/presidential-actions/2023/10/30/executive-order-on-the-safe-secure-and-trustworthy-development-and-use-of-artificial-intelligence/.
[3] Id.
[4] FTC, FTC Authorizes Compulsory Process for AI-related Products and Services, November 21, 2023, available at https://www.ftc.gov/news-events/news/press-releases/2023/11/ftc-authorizes-compulsory-process-ai-related-products-services.
[5] See U.S. Department of Justice, Deputy Attorney General Lisa Monaco Announcement, November 9, 2023, available at https://www.justice.gov/opa/pr/readout-deputy-attorney-general-lisa-monacos-trip-new-york-and-connecticut
[6] See U.S. Department of Justice, Attorney General Garland Designates Jonathan Mayer to Serve as Chief AI Officer, February 22, 2024, available at https://www.justice.gov/opa/pr/attorney-general-merrick-b-garland-designates-jonathan-mayer-serve-justice-departments-first.
Gibson, Dunn & Crutcher’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 leader or member of the firm’s Artificial Intelligence, Privacy, Cybersecurity & Data Innovation, or White Collar Defense & Investigations practice groups, or the authors:
Gustav W. Eyler – Washington, D.C. (+1 202.955.8610, geyler@gibsondunn.com)
Svetlana S. Gans – Washington, D.C. (+1 202.955.8657, sgans@gibsondunn.com)
Vivek Mohan – Palo Alto (+1 650.849.5345, vmohan@gibsondunn.com)
Rosemarie T. Ring – San Francisco (+1 415.393.8247, rring@gibsondunn.com)
Alexander H. Southwell – New York (+1 212.351.3981, asouthwell@gibsondunn.com)
Jay Mitchell – Palo Alto (+1 650.849.5214, jmitchell@gibsondunn.com)
Artificial Intelligence:
Cassandra L. Gaedt-Sheckter – Palo Alto (+1 650.849.5203, cgaedt-sheckter@gibsondunn.com)
Vivek Mohan – Palo Alto (+1 650.849.5345, vmohan@gibsondunn.com)
Robert Spano – Paris/London (+33 1 56 43 14 07, rspano@gibsondunn.com)
Eric D. Vandevelde – Los Angeles (+1 213.229.7186, evandevelde@gibsondunn.com)
Privacy, Cybersecurity and Data Innovation:
Ahmed Baladi – Paris (+33 1 56 43 13 00, abaladi@gibsondunn.com)
S. Ashlie Beringer – Palo Alto (+1 650.849.5327, aberinger@gibsondunn.com)
Joel Harrison – London (+44 20 7071 4289, jharrison@gibsondunn.com)
Jane C. Horvath – Washington, D.C. (+1 202.955.8505, jhorvath@gibsondunn.com)
Rosemarie T. Ring – San Francisco (+1 415.393.8247, rring@gibsondunn.com)
White Collar Defense and Investigations:
Stephanie Brooker – Washington, D.C. (+1 202.887.3502, sbrooker@gibsondunn.com)
Winston Y. Chan – San Francisco (+1 415.393.8362, wchan@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213.229.7269, nhanna@gibsondunn.com)
F. Joseph Warin – Washington, D.C. (+1 202.887.3609, fwarin@gibsondunn.com)
© 2024 Gibson, Dunn & Crutcher LLP. All rights reserved. For contact and other information, please visit us at www.gibsondunn.com.
Attorney Advertising: These materials were prepared for general informational purposes only based on information available at the time of publication and are not intended as, do not constitute, and should not be relied upon as, legal advice or a legal opinion on any specific facts or circumstances. Gibson Dunn (and its affiliates, attorneys, and employees) shall not have any liability in connection with any use of these materials. The sharing of these materials does not establish an attorney-client relationship with the recipient and should not be relied upon as an alternative for advice from qualified counsel. Please note that facts and circumstances may vary, and prior results do not guarantee a similar outcome.