On November 12, 2020, President Trump issued Executive Order (“E.O.”) 13959 restricting the ability of U.S. persons to invest in securities of certain “Communist Chinese military companies.”[1] This E.O. alleges that under China’s national strategy of “Military-Civil Fusion,” China “exploits United States investors” to finance the development of its military, intelligence, and security capabilities. While the E.O. is only the latest in a flurry of actions by the Trump administration directed against Beijing, it is the first measure to focus on securities—including investments in securities of dozens of prominent Chinese companies, as well as mutual funds and index funds that hold such companies’ shares. Under the E.O., U.S. persons—including individual and institutional investors, stock exchanges, fund managers, investment advisers, broker-dealers, and insurance companies—will be prohibited from purchasing for value publicly traded securities of certain Chinese companies starting in early January 2021 and, absent a change in policy by the incoming Biden administration, will be incentivized to engage in divestment transactions through November 11, 2021.
The E.O. currently applies to 31 ostensibly civil companies that the United States alleges have ties to the Chinese military. The names of those companies appear on two lists published by the U.S. Department of Defense in June 2020 and August 2020, and reproduced below. The U.S. Department of the Treasury has yet to publish guidance indicating whether the E.O. extends to those companies’ subsidiaries; however, a plain-language reading of the E.O. suggests that it may only apply to subsidiaries (if any) that the U.S. Secretary of the Treasury identifies by name. Among the targeted entities are substantial enterprises such as China Mobile Communications and Hikvision, many of which have shares traded on mainland Chinese, Hong Kong, or U.S. stock exchanges. Additionally, several of the targeted companies were added earlier this year to the U.S. Department of Commerce’s Entity List and are therefore already subject to stringent restrictions on access to U.S.-origin goods, software, and technologies. In that sense, the new E.O. marks an expansion of U.S. pressure on Beijing from targeting suppliers of certain large Chinese firms to constricting their sources of financing, albeit in a relatively narrow manner. According to a leading China-focused research organization, of the 31 companies identified to date, only 13 are publicly traded components of the MSCI China Index and only Hikvision has substantial foreign ownership.[2]
Effective January 11, 2021—sixty days after the E.O. was issued—U.S. persons are prohibited from engaging in “any transaction in publicly traded securities, or any securities that are derivative of, or are designed to provide investment exposure to such securities, of any Communist Chinese military company.” “Transaction” is defined to mean the purchase for value of any publicly traded security and the prohibition applies to shares in such companies, as well as shares held indirectly through popular investment vehicles such as exchange traded funds. The E.O. also permits U.S. persons, until November 11, 2021—one year after the E.O. was issued—to engage in otherwise prohibited transactions in order to divest their existing holdings in any of the named Communist Chinese military companies. Although the E.O.’s narrow definition of prohibited transactions does not appear to require U.S. persons to divest holdings in these companies, the prospect of securities becoming illiquid after November 11, 2021 may lead many U.S. investors to divest their holdings during this time.
In this regard the surgical and staggered imposition of restrictions under the E.O. reflects prior approaches the United States used with Venezuela and Russia and is likely animated by similar concerns. When the United States acted to limit the Maduro regime’s access to finance starting in 2017, it, inter alia, restricted transactions associated with certain Venezuela bonds. But, in order to limit the collateral consequences on innocent parties that held significant numbers of those bonds, the United States allowed the limited divestment of those bonds. In the Russia context, following the Crimea incursion in 2014, the United States imposed sanctions on some of the largest enterprises in the Russian financial and energy sectors. However, due to the exposure of U.S. and allied interests to those enterprises, the United States similarly stopped short of imposing blocking sanctions on any of the targeted entities. As with the new China E.O., Russian “sectoral” sanctions prohibit U.S. persons from engaging in only certain types of financial transactions with identified firms. And, importantly, absent some other prohibition, the earlier Russian sectoral sanctions and the new China E.O. permit U.S. persons to continue engaging in all other lawful dealings with listed entities.
The new E.O. is the latest in a series of U.S. measures calculated to address perceived threats to U.S. national security posed by China’s policy of “Military-Civil Fusion.”[3] Like the U.S. Department of Commerce’s expansion of the Military End User Rule, the new Huawei-specific Direct Product Rule, and the recent spate of Entity List designations, as well as the U.S. Government’s procurement ban on certain technologies from several Chinese companies (including two companies that are subject to the new E.O.), this latest action is designed to curtail American support for Chinese companies that allegedly support the Chinese military. The E.O. also complements outreach by the U.S. State Department in August 2020 urging colleges and universities to divest from Chinese holdings more generally,[4] and President Trump’s Working Group on Financial Markets, which has developed guidance that would require companies to provide American regulators with access to audit work papers to remain listed on U.S. exchanges, access that China had historically refused.[5] White House officials are reportedly prioritizing further action against Beijing during President Trump’s final weeks in office.
While the E.O.’s prohibition will take effect shortly before President-elect Biden is sworn in, the apparent wind-down period for U.S. persons to divest their holdings in the listed Communist Chinese military companies extends nearly a year into the next president’s term. As such, in our assessment, the key date for this new policy is not only January 11, 2021, when the prohibition takes effect, but also nine days later when the new administration assumes power. Because the E.O. is not mandated by statute or any other requirement, once in office President Biden could engage with the E.O. as he sees fit: he could revoke the E.O. outright, narrow its reach through published guidance and the exercise of enforcement discretion, decline to target additional Chinese companies, or allow the E.O. to lapse on November 12, 2021 when the President is required by the International Emergency Economic Powers Act to renew the national emergency determination that allowed for the E.O.
However, even for a Biden administration that will be intent on changing the tone of U.S. foreign policy—including through closer coordination with traditional allies—rescinding or eliminating these and other restrictions on Beijing without receiving any concessions in return could spark bipartisan pushback in the U.S. Congress and potentially in the electorate. Moreover, even if President Biden were to narrow or revoke the new E.O., the measure may nevertheless serve its intended purpose of making U.S. persons (including U.S. financial institutions) less willing to hold securities or other financial instruments of, or do other business with, companies that have been linked to the Chinese military, intelligence, or security services. Furthermore, in light of China’s increasingly robust regulatory responses to U.S. unilateral measures—seen in the Hong Kong national security law, Beijing’s new export control law, and its continued threat of establishing an “unreliable” suppliers list for companies that choose to comply with U.S. regulations and cease certain sales to Chinese companies—we expect that China will also respond to this E.O. How China chooses to react will either reduce tensions between Beijing and Washington or continue to exacerbate the situation by potentially imposing costs on entities that choose to comply with this new measure.
* * *
As of November 12, 2020, the 31 Communist Chinese military companies to which the prohibition will apply are as follows:
- Aviation Industry Corporation of China (AVIC)
- China Aerospace Science and Technology Corporation (CASC)
- China Aerospace Science and Industry Corporation (CASIC)
- China Electronics Technology Group Corporation (CETC)
- China South Industries Group Corporation (CSGC)
- China Shipbuilding Industry Corporation (CSIC)
- China State Shipbuilding Corporation (CSSC)
- China North Industries Group Corporation (Norinco Group)
- Hangzhou Hikvision Digital Technology Co., Ltd. (Hikvision)
- Huawei
- Inspur Group
- Aero Engine Corporation of China
- China Railway Construction Corporation (CRCC)
- CRRC Corp.
- Panda Electronics Group
- Dawning Information Industry Co (Sugon)
- China Mobile Communications Group
- China General Nuclear Power Corp.
- China National Nuclear Corp.
- China Telecommunications Corp.
- China Communications Construction Company (CCCC)
- China Academy of Launch Vehicle Technology (CALT)
- China Spacesat
- China United Network Communications Group Co Ltd
- China Electronics Corporation (CEC)
- China National Chemical Engineering Group Co., Ltd. (CNCEC)
- China National Chemical Corporation (ChemChina)
- Sinochem Group Co Ltd
- China State Construction Group Co., Ltd.
- China Three Gorges Corporation Limited
- China Nuclear Engineering & Construction Corporation (CNECC)
_____________________
[1] Exec. Order No. 13959, 85 Fed. Reg. 73185 (Nov. 12, 2020), https://www.govinfo.gov/content/pkg/FR-2020-11-17/pdf/2020-25459.pdf.
[2] Another Trump Attack on Chinese Stocks, Gavekal Dragonomics (Nov. 13, 2020), https://research.gavekal.com/article/another-trump-attack-chinese-stocks.
[3] The Military-Civil Fusion policy is described in China’s national strategic plan “Made in China 2025,” which was announced by Premier Li Keqiang and his cabinet in May 2015.
[4] Kevin Cirilli & Shelly Banjo, U.S. Warns Colleges to Divest China Stocks on Delisting Risk, Bloomberg Quint (Aug. 19, 2020), https://www.bloombergquint.com/business/state-department-urges-colleges-to-divest-from-chinese-companies.
[5] Press Release, President’s Working Group on Financial Markets Releases Report and Recommendations on Protecting Investors from Significant Risks from Chinese Companies, U.S. Dep’t of Treasury (Aug. 6, 2020), https://home.treasury.gov/news/press-releases/sm1086.
The following Gibson Dunn lawyers assisted in preparing this client update: Judith Alison Lee, Adam Smith, Jose Fernandez, Chris Timura, Stephanie Connor, R.L. Pratt and Scott Toussaint.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above 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 International Trade practice group:
United States:
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Jose W. Fernandez – New York (+1 212-351-2376, jfernandez@gibsondunn.com)
Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, sconnor@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Ben K. Belair – Washington, D.C. (+1 202-887-3743, bbelair@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
Laura R. Cole – Washington, D.C. (+1 202-887-3787, lcole@gibsondunn.com)
Jesse Melman – New York (+1 212-351-2683, jmelman@gibsondunn.com)
R.L. Pratt – Washington, D.C. (+1 202-887-3785, rpratt@gibsondunn.com)
Samantha Sewall – Washington, D.C. (+1 202-887-3509, ssewall@gibsondunn.com)
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)
Asia and Europe:
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Beijing – (+86 10 6502 8534, qyue@gibsondunn.com)
Joerg Bartz – Singapore – (+65 6507 3635, jbartz@gibsondunn.com)
Peter Alexiadis – Brussels (+32 2 554 72 00, palexiadis@gibsondunn.com)
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Nicolas Autet – Paris (+33 1 56 43 13 00, nautet@gibsondunn.com)
Susy Bullock – London (+44 (0)20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris – London (+44 (0)207 071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly – London (+44 20 7071 4205, sharber-kelly@gibsondunn.com)
Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com)
Steve Melrose – London (+44 (0)20 7071 4219, smelrose@gibsondunn.com)
Matt Aleksic – London (+44 (0)20 7071 4042, maleksic@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com)
Richard W. Roeder – Munich (+49 89 189 33-160, rroeder@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Many UK regulated firms will be currently (re-)assessing staff as fit and proper and training staff on the FCA’s (or the PRA’s) Conduct Rules. The FCA has recently banned three individuals from working in the financial services industry for non-financial misconduct outside the workplace. The enforcement actions are, therefore, a timely reminder for regulated firms that the FCA has indicated it will bring an increased focus on how firms deal with non-financial misconduct by employees, both within and outside of the workplace.
Although these three specific cases followed criminal prosecutions for serious sexual offences, regulated firms are faced with particular challenges in determining how to deal with staff issues where the activities are not of the same degree of seriousness, take place outside of the workplace and are unconnected to any regulated activity undertaken by an individual.
Firms should consider what types of employee behaviour within and outside the workplace might be considered non-financial misconduct rendering an individual no longer “fit and proper” or alternatively constitute a breach of the FCA’s (or PRA’s) Conduct Rules reportable to the relevant regulator. Firms would be advised to appropriately document this assessment and consider how this is communicated to staff.
What enforcement action has the FCA taken ?
These individuals committed the offences whilst they were FCA approved persons. The FCA found that all three were not fit and proper and lacked the necessary integrity and reputation required to work in the regulated financial services sector. |
What are the FCA’s expectations as to how firms address non-financial misconduct?
In response to the recent Final Notices, Mark Steward, FCA Executive Director of Enforcement and Market Oversight, stated that: “The FCA expects high standards of character, probity and fitness and properness from those who operate in the financial services industry and will take action to ensure these standards are maintained.”[4] This indicates that the regulatory direction of travel is an increased focus on how firms address instances of non-financial misconduct. This is supported by other important FCA announcements on this topic.
In September 2018, Megan Butler, FCA Executive Director sent a letter to House of Commons’ Women and Equalities Committee.[5] The letter addressed the important issue of sexual harassment and noted that the FCA regarded it as misconduct that falls within the scope of the FCA’s regulatory framework. Tolerance of this sort of misconduct would be a clear example of a driver of poor culture. Megan Butler noted that sexual harassment and other forms of non-financial misconduct can amount to a breach of the FCA’s Conduct Rules and the Senior Managers and Certification Regime (“SMCR”) imposes requirements on firms to notify the FCA of Conduct Rule breaches. The letter was followed by a speech in December 2018 by Christopher Woolard, FCA Executive Director of Strategy and Competition.[6] Mr Woolard noted that “the way firms handle non-financial misconduct, including allegations of sexual misconduct, is potentially relevant to our assessment of that firm, in the same way that their handling of insider dealing, market manipulation or any other misconduct is.”
In January 2020 a “Dear CEO” letter[7] from Jonathan Davidson, FCA Executive Director of Supervision, Retail and Authorisations, was published regarding non-financial misconduct. Although the letter was addressed to the wholesale general insurance sector, it is indicative of the FCA’s approach to non-financial misconduct across the regulated sector. In particular, Mr Davidson noted that non-financial misconduct and an unhealthy culture is a key root cause of harm. How a firm handles non-financial misconduct throughout the organisation, including discrimination, harassment, victimisation and bullying, is regarded as being indicative of a firm’s culture. The FCA expects firms, and senior managers to embed healthy cultures by identifying and modifying the key drivers of their culture. Mr Davidson highlighted that the FCA’s Approach to Supervision document flags the 4 key drivers of culture. These drivers are: leadership; purpose; approach to rewarding and managing people; and governance, systems and controls.
What challenges do firms face relating to non-financial misconduct?
Where the actions of individuals result in convictions and custodial sentences the decision on the fit and proper test is often (but not always) straightforward and the enforcement actions above, together with the various FCA pronouncements also identified, make clear the FCA’s view in this area.
However, regulated firms can be faced with a number of challenges when assessing non-financial misconduct, particularly when it occurs outside of the workplace.
(1) Identifying non-financial misconduct
It is often difficult for firms to identify non-financial misconduct, particularly if it occurs outside of the office. This may be a result of employees incorrectly understanding a firm’s policies and procedures around what must be brought to the firm’s attention or a reluctance of staff to reveal such matters to the firm.
Firms are expected to be able to demonstrate to the FCA that they have that the right processes in place to handle and escalate such cases appropriately. At a time when many employees are working from home the challenge for firms is greater. Firms should ensure that:
- staff are trained and have an understanding of their obligations to inform the firm of relevant matters;
- guidance for staff is clear on the types of matters about which firms would expect to be notified; and
- such guidance should include examples of non-financial misconduct, and the guidance and training should be appropriately documented.
(2) Determining which matters need (immediate) escalation to the FCA
Principle 11 of the FCA’s Principles for Business requires a firm to maintain an open and cooperative relationship with regulators, as well as disclosing appropriately anything relating to the firm of which the FCA would reasonably expect to be notified. Senior Managers are also subject to a Senior Manager Conduct Rule and must disclose appropriately any information of which the FCA or PRA would reasonably expect notice.
Not all instances of misconduct would, however, require an immediate notification – firms will have a challenge in determining whether a matter is sufficiently material to warrant disclosure to a regulator. Factors to consider include:
- seniority or significance of the individual to the firm; and
- seriousness of conduct, potentially as represented by outcome.
(3) Undertaking “fit and proper” assessments
The recent enforcement actions all involved an assessment of the individual concerned under the FCA’s Fit and Proper Test for Employees and Senior Personnel. The most important considerations when assessing the fitness and propriety of a person are the person’s: (1) honesty, integrity and reputation; (2) competence and capability; and (3) financial soundness. Conviction for a serious sexual offence will clearly cause an individual to fail the test. The challenge for firms comes when the scenario is less clear cut. The concepts of “honesty” and “integrity” are inherently subjective and result in a regulated firm often having to make a difficult judgement in a given scenario.
(4) Interplay with the SMCR
The introduction of the SMCR marked a regulatory shift from collective responsibility to individual accountability. For staff subject to the FCA’s Conduct Rules, in addition to the fit and proper test, firms must also make an assessment as to whether any misconduct constitutes a breach of the Conduct Rules. The Conduct Rules are drafted to cover the activities of in-scope staff in both the regulated and unregulated parts of a business. The difficultly arises for firms in assessing when non-financial misconduct, particularly outside of the workplace, also amounts to a breach of the Conduct Rules.
This is important as firms are required to report any disciplinary action taken against an individual for a breach of the Conduct Rules. Firms are also required to include Conduct Rule breaches in regulatory references from new employers once staff have left the firm. It is, therefore, important that firms have a robust process in place for determining what types of employee behaviour within and outside the workplace might be considered a breach of the Conduct Rules and that all such decisions are clearly documented.
What practical steps can firms take to meet regulatory expectations?
It is clear that there is increasing regulatory focus on how regulated firms deal with non-financial misconduct and that failure to tackle such issues appropriately can be taken by the FCA as an indicator of poor culture. Firms would be advised to undertake an assessment as to how they in practice deal, or would deal, with instances of non-financial misconduct by staff.
The following practical steps are examples of matters that firms should consider to ensure that they meet regulatory expectations in this area.
- Fitness and propriety assessments of incoming and existing staff should consider a broad spectrum of indicators, including data around financial and non-financial conduct, inside and outside the workplace.
- Firms should proactively consider the types of non-financial misconduct that would trigger a fitness and propriety re-assessment and, as applicable, a review of whether a Conduct Rule has been breached.
- Appropriate escalation procedures, including whistleblowing, should be in place so that the firm can identify and appropriately investigate allegations of non-financial misconduct by employees both within and outside of the workplace.
- Staff must be appropriately trained on the importance of their behaviour within and outside of the workplace and when matters should be raised and to whom. Firms should also consider whether those to whom such matters may be raised also require training in handling what may be sensitive personal matters.
- Non-financial, as well as financial, metrics should be included in performance assessments.
- Sufficient management information regarding non-financial misconduct should be presented to management for management to receive a complete picture of risk, performance and conduct in the areas for which they are responsible.
_______________________
[1] https://www.fca.org.uk/publication/final-notices/russell-david-jameson-2020.pdf
[2] https://www.fca.org.uk/publication/final-notices/mark-horsey-2020.pdf
[3] https://www.fca.org.uk/publication/final-notices/frank-cochran-2020.pdf
[4] https://www.fca.org.uk/news/press-releases/fca-bans-three-individuals-working-financial-services-industry-non-financial-misconduct
[5] https://www.fca.org.uk/publication/correspondence/wec-letter.pdf
[6] https://www.fca.org.uk/news/speeches/opening-and-speaking-out-diversity-financial-services-and-challenge-to-be-met
[7] https://www.fca.org.uk/publication/correspondence/dear-ceo-letter-non-financial-misconduct-wholesale-general-insurance-firms.pdf
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 in the firm’s Financial Institutions practice group, or the following authors in London:
Matthew Nunan (+44 (0) 20 7071 4201, mnunan@gibsondunn.com)
Martin Coombes (+44 (0) 20 7071 4258, mcoombes@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On November 10, 2020, Governor Andrew Cuomo signed legislation that will expand First Amendment protections under New York’s anti-SLAPP law by providing new tools for defendants to challenge frivolous lawsuits. The bill was initially passed by the New York State Senate and Assembly on July 22, 2020. The bill amends and extends New York’s current statute (sections 70-a and 76-a the New York Civil Rights Law) addressing so-called strategic lawsuits against public participation (“SLAPPs”):[1] suits that seek to punish and chill the exercise of the rights of petition and free speech on public issues by subjecting defendants to expensive and burdensome litigation.[2] Prominent First Amendment and free speech advocates, including the Reporters Committee for Freedom of the Press,[3] Time’s Up Now,[4] the New York Civil Liberties Union,[5] and the Authors Guild[6] came out in its support, as did the Editorial Board of The New York Times.[7]
Anti-SLAPP laws currently exist in 30 states and the District of Columbia, yet despite being home to some of the world’s most prominent media and news organizations,[8] New York’s own anti-SLAPP law, enacted in 2008, has been narrowly limited to litigation arising from a public application or permit, often in a real estate development context.[9] The new law, sponsored by Senator Brad Hoylman and Assemblywoman Helene E. Weinstein, amends the civil rights law in several ways to expand and strengthen New York’s anti-SLAPP protections.
The following is a summary of the law’s changes, which take effect immediately upon enactment, and key continuing features:
- Expands the statute beyond actions “brought by a public applicant or permittee,” to apply to any action based on a “communication in a . . . public forum in connection with an issue of public interest” or “any other lawful conduct in furtherance of the exercise of the constitutional right of free speech in connection with an issue of public interest, or in furtherance of the exercise of the constitutional right of petition.”[10]
- Confirms that “public interest” should be construed broadly, including anything other than a “purely private matter.”[11]
- Requires courts to consider anti-SLAPP motions based on the pleadings and “supporting and opposing affidavits stating the facts upon which the action or defense is based.”[12]
- Provides that all proceedings—including discovery, hearings, and motions—shall be stayed while a motion to dismiss is pending, except that the court may order limited discovery where necessary to allow a plaintiff to respond to an anti-SLAPP motion.[13]
- Alters the formerly permissive standard (“may”) for awarding attorneys’ fees to provide that where the court grants such a motion, an award of fees and costs is mandatory: i.e., “costs and attorney’s fees shall be recovered.”[14]
While the amended statute provides welcome tools to defendants facing SLAPP suits, it remains to be seen how the revisions will function in practice. For example, while the revisions incorporate some of the key language and structure of California’s anti-SLAPP statute[15] —including a stay of discovery, and mandatory attorneys’ fees and costs to prevailing defendants—the proposed law preserves the standard for evaluating the merits: a motion to dismiss such an action “shall be granted” unless the plaintiff can show “that the cause of action has a substantial basis in law or is supported by a substantial argument for an extension, modification or reversal of existing law.”[16] In the context of the previous limited anti-SLAPP law, New York courts have interpreted that standard to impose a “heavy burden” on plaintiffs opposing anti-SLAPP motions,[17] requiring them to make an evidentiary showing of the facts supporting their claim and demonstrating that the defendant cannot establish a defense against it.[18] It will be up to courts to determine how that standard functions when applied to a broader range of cases, including defamation and other tort claims, that may present closer questions.
Separately, the status of the applicability of state anti-SLAPP statutes in federal court remains an open question, especially in light of the Second Circuit’s recent decision that California’s anti-SLAPP statute does not apply in federal court. La Liberte v. Reid, No. 19-3574, 2020 WL 3980223 (2d Cir. July 15, 2020). Whether New York’s revised anti-SLAPP law will be available to defendants in federal lawsuits in the Second Circuit is an open question that federal courts may soon need to confront.
Finally, courts will be asked to determine whether the revised statute is effective in currently pending actions, or if it will only have effect in actions filed after enactment. New York reserves this question as “a matter of judgment made upon review of the legislative goal,” based on “whether the Legislature has made a specific pronouncement about retroactive effect or conveyed a sense of urgency; whether the statute was designed to rewrite an unintended judicial interpretation; and whether the enactment itself reaffirms a legislative judgment about what the law in question should be.”[19] New York courts will likely conclude that the revised statute has “retroactive” effect and will apply in pending cases in light of the statute’s clear “remedial purpose.”[20] The legislature was careful to explain that the revisions intend to correct judicial “narrow[] interpret[ation]” of the existing anti-SLAPP statute and to remedy the courts’ “fail[ure] to use their discretionary power to award costs and attorney’s fees” in SLAPP suits, and that the revised statute “will better advance the purposes that the Legislature originally identified in enacting New York’s anti-SLAPP law.”[21] These factors all suggest that the revisions will take immediate effect in both pending and post-enactment lawsuits.
______________________
[1] 2020 N.Y. Senate Bill No. 52-A/Assembly Bill No. 5991A (July 22, 2020), https://www.nysenate.gov/legislation/bills/2019/s52/amendment/a.
[2] Understanding Anti-SLAPP Laws, Reporters Committee for Freedom of the Press, https://www.rcfp.org/resources/anti-slapp-laws/ (last visited August 3, 2020).
[3] Reporters Committee supports legislation that would strengthen New York’s anti-SLAPP law, Reporters Committee for Freedom of the Press, https://www.rcfp.org/briefs-comments/rcfp-supports-ny-anti-slapp-bills/(last visited August 3, 2020).
[4] TIME’S UP (@TIMESUPNOW), Twitter, https://twitter.com/TIMESUPNOW/status/1286031156446728193 (last accessed August 3, 2020).
[5] Senator Brad Hoylman (@bradhoylman), Twitter, https://twitter.com/bradhoylman/status/1286002251685863424 (last accessed August 3, 2020).
[6] Authors Guild Signs Letter in Support of Anti-SLAPP Statute, Authors Guild, https://www.authorsguild.org/industry-advocacy/authors-guild-signs-letter-in-support-of-anti-slapp-statute/ (last accessed August 3, 2020).
[7] The Legal System Should Not Be a Tool for Bullies, N.Y. Times, https://www.nytimes.com/2020/07/17/opinion/new-york-slapp-frivolous-lawsuits.html.
[8] Id.
[9] 2020 N.Y. Senate Bill No. 52-A/Assembly Bill No. 5991A (July 22, 2020), https://www.nysenate.gov/legislation/bills/2019/s52/amendment/a.
[15] Cal. Civ. Proc. Code § 425.16.
[16] 2020 N.Y. Senate Bill No. 52-A/Assembly Bill No. 5991A (July 22, 2020), https://www.nysenate.gov/legislation/bills/2019/s52/amendment/a (emphasis added).
[17] 161 Ludlow Food, LLC v. L.E.S. Dwellers, Inc., 107 N.Y.S.3d 618, at *4 (N.Y. Sup. Ct. 2018), aff’d, 176 A.D.3d 434 (1st Dep’t 2019).
[18] Edwards v. Martin, 158 A.D.3d 1044, 1048 (3d Dep’t 2018).
[19] Nelson v. HSBC Bank USA, 87 A.D.3d 995, 997–98 (2d Dep’t 2011).
[20] In re Gleason (Michael Vee, Ltd.), 96 N.Y.2d 117, 122–23 (2001).
[21] 2020 N.Y. Senate Bill No. 52-A/Assembly Bill No. 5991A (July 22, 2020), https://www.nysenate.gov/legislation/bills/2019/s52/amendment/a.
The following Gibson Dunn lawyers assisted in the preparation of this client update: Anne Champion, Nathaniel Bach, Connor Sullivan, Kaylie Springer, and Dillon Westfall.
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 the following leaders and members of the firm’s Media, Entertainment & Technology Practice Group:
Anne M. Champion – New York (+1 212-351-5361, achampion@gibsondunn.com)
Connor Sullivan – New York (+1 212-351-2459, cssullivan@gibsondunn.com)
Scott A. Edelman – Co-Chair, Media, Entertainment and Technology Practice, Los Angeles (+1 310-557-8061, sedelman@gibsondunn.com)
Kevin Masuda – Co-Chair, Media, Entertainment and Technology Practice, Los Angeles (+1 213-229-7872, kmasuda@gibsondunn.com)
Nathaniel L. Bach – Los Angeles (+1 213-229-7241, nbach@gibsondunn.com)
On October 29, 2020, the 16th amendment to the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung or “AWV”) entered into force. The amendment is the final step of implementing the EU-wide cooperation mechanism introduced by Regulation (EU) 2019/452 of March 19, 2019 establishing a framework for screening of foreign direct investments into the EU (the “EU Screening Regulation”).
New EU-Wide Cooperation Mechanism
The EU Screening Regulation directly applies as of October 11, 2020 which marks the beginning of a coordinated cooperation among EU member states on foreign direct investments (the “FDIs”). This means that, going forward, the German Federal Ministry for Economic Affairs and Energy (the “German Ministry”) will exchange information on FDIs undergoing screening in Germany with the European Commission and fellow EU member states which, in turn, may issue comments or, in case of the European Commission, an opinion. While such comments and/or opinions are non-binding, they need to be given ‘due consideration’ and, thus, may influence the screening decision rendered by the German Ministry. For details on the EU Screening Regulation, see our Client Alert of March 5, 2019.
In order for the German Ministry to be able to consider the potential impact of an FDI on the public order or security of one or more fellow EU member states as well as on projects or programs of EU interest, the grounds for screening under German FDI rules had to be expanded accordingly. For the same reason, the standard under which an FDI may be prohibited or restrictive measures may be imposed has been tightened from “endangering” (Gefährdung) to “likely to affect” (voraussichtliche Beeinträchtigung) the public order or security, as to reflect the EU Screening Regulation. More or less a side effect, this gives the German Ministry more discretion and room to maneuver as it no longer has to determine an “actual and serious threat” (tatsächliche und hinreichend schwere Gefährdung) but now could prohibit a transaction in order to prevent an impairment that has not yet materialized but that is likely to occur as a result of the contemplated FDI.
Recent Changes to German FDI Rules
In light of the implementation of the EU-wide cooperation mechanism, we want to use the opportunity to recap this year’s key changes to the German FDI screening process. We refer to our client alert of May 27, 2020 (available here) for an overview on the overall screening process and a detailed outline of the most relevant amendments (and contemplated changes) to German FDI rules thus far in 2020.
Changes Effective as of October 29, 2020
- Expanding the Grounds for Screening. As described above, the grounds for screening have been expanded to include public order or security of a fellow EU member state as well as effects on projects or programs of EU interest.
- Tightening the Standard. As described above, the standard under which an FDI may be prohibited or restrictive measures may be imposed has been tightened from “endangering” (Gefährdung) to “likely to affect” (voraussichtliche Beeinträchtigung) the public order or security.
Key Changes Effective as of June 3, 2020
- Health-Care Related Additions. As a response to the COVID-19 crisis, the catalog of select industries subject to cross-sector review was expanded to include personal protective equipment, pharmaceuticals that are essential for safeguarding the provision of healthcare to the population as well as medical products and in-vitro-diagnostics used in connection with life-threatening and highly contagious diseases.
- Governmental Communication Infrastructure. Also added to the catalog of select industries subject to cross-sector review, and thus, triggering mandatory notification to the German Ministry, have been FDIs acquiring 10% or more of the voting rights in companies providing services ensuring the interference-free operation and functioning of governmental communication infrastructure.
- Investor-Related Screening Factors. In line with the EU Screening Regulation, the German Ministry may now consider screening factors that focus on the background and activities of the individual investor. In particular, the German Ministry may now take into account whether the foreign investor (i) is directly or indirectly controlled by the government, including state bodies or armed forces, of a third country, including through ownership structure or more than insignificant funding, (ii) has already been involved in activities affecting the public order or security of the Federal Republic of Germany or of a fellow EU member state, or (iii) whether there is a serious risk that the foreign investor, or persons acting on behalf of it, were or are engaged in activities that, in Germany, would be punishable as a certain criminal or administrative offence, such as terrorist financing, money laundering, fraud, corruption, or violations of the foreign trade or war weapon control rules.
- Applicability to Share and Asset Deals. Since June 3, 2020 it has been codified that German FDI control is not limited to the acquisition of shares but equally applies to asset deals.
- Notification Modalities. It was further clarified that FDIs triggering a notification obligation are to be notified immediately after signing of the acquisition agreement. The notification generally has to be submitted by the direct acquirer (even if the acquisition vehicle itself is not “foreign”) but may also be made by the indirect acquirer instead.
Key Changes Effective as of July 17, 2020
- Effects on Consummating Transactions. In addition to transactions subject to sector-specific review (i.e., the defense industry and certain parts of the IT security industry), all transactions falling under cross-sector review that are notifiable (i.e., FDIs of 10% or more of the voting rights in companies active in industries listed in the catalog of select industries) may only be consummated upon conclusion of the screening process (condition precedent). Note that this has a tangible impact on the transaction practice given the broad range of notifiable FDIs in the cross-sector category, which are affected by this change. Foreign investors need to carefully assess if the target company operates in one of the listed industry categories. From a drafting perspective, acquisition agreements regarding notifiable FDIs should include a closing condition that the FDI is (deemed) cleared by the German Ministry. Buyers should further make sure to include a mechanism allowing for the amendment or termination of the acquisition agreement in case the German Ministry imposes (comprehensive) restrictive measures.
- Penalizing the Disclosure of Security-Relevant Information and Certain Consummation Actions Pending Screening. The following actions are now penalized by way of imprisonment of up to five years or fine (in case of willful infringements and attempted infringements) or with a fine of up to EUR 500,000 (in case of negligence):
- Enabling the investor to, directly or indirectly, exercise voting rights;
- Granting the investor dividends or any economic equivalent;
- Providing or otherwise disclosing to the investor information on the German target company with respect to company objects and divisions that are subject to screening on grounds of essential security interests of the Federal Republic of Germany, or of particular importance when screening for effects on public order and security of the Federal Republic of Germany, or that have been declared as ‘significant’ by the German Ministry;
- Non-compliance with enforceable restrictive measures (vollziehbare Anordnungen) imposed by the German Ministry.
The introduction of criminal liability will lead to even greater focus on whether or not the transaction requires FDI clearing. The seller de facto will be forced to include the clearing by the German Ministry as a closing condition to avoid exposure to criminal liability.
According to the explanatory notes (Gesetzesbegründung), the prohibition to disclose security-sensitive information as described above will usually not apply to purely or other company-related commercial information that is exchanged in the course of a transaction in order to allow the investor to conduct a sound evaluation of the economic opportunities and risks of the FDI. Nonetheless, the seller will need to be cautious when preparing the due diligence process, in particular when populating the virtual data room. Typically, security-sensitive information as described above will not be shared with potential buyers prior to closing of the transaction anyway. Should the need arise, however, the use of a red data room and special disclosure and confidentiality obligations based on a clean team agreement are advisable.
- Time Periods. In view of necessary adjustments to the timeframe of the screening process to integrate the EU-wide cooperation mechanism, the German legislator took the opportunity to overhaul the framework of screening periods altogether. Time periods are now set forth directly in the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz or “AWG”) instead of the AWV. This way, time periods can only be adjusted by way of legislative procedure, i.e. with involvement of the German parliament, and may no longer be changed unilaterally by executive order of the German government.Note the following changes to the timeline of the screening process (which will only apply to FDIs of which the German Ministry became aware of after July 17, 2020):
- Standardized Time Periods. The same review periods apply to sector-specific (i.e., the defense industry and certain parts of the IT security industry) and to cross-sector (i.e., all industry sectors except for defense/certain IT security) FDIs alike. The German Ministry now has two months from becoming aware of the reviewable FDI – instead of previously three months (sector-specific review) or even four months (cross-sector review) – to decide whether to initiate formal proceedings. Making a mandatory notification or filing for a certificate of non-objection will equally trigger the two-month pre-assessment period. In addition, the formal screening period was standardized and may now take up to four months regardless of the sector.
- Extension of Time Periods. The German Ministry may extend the four-month screening period by three months if the individual case is particularly difficult in either a factual or a legal manner. A further extension by one month is possible if the Federal Ministry of Defense puts forward that defense interests of Germany are notably affected. Moreover, periods may now be extended with the investor’s approval.
- Suspension of Time Periods. The screening period is suspended in case the German Ministry later requests further information on the FDI. Previously, the screening period was not set in motion before the German Ministry received all (initially or later) requested information on the FDI. This change most likely is meant to allow for requests of fellow EU member states for additional information on the FDI within the cooperation process under the EU Screening Regulation while, at the same time, keeping the delay in the screening process to a minimum.
- Resetting of Time Periods. Time periods will reset and start anew in the event that an FDI clearance or certificate of non-objection was revoked or altered (e.g., in case of willful deceit or the subsequent occurrence of facts). Equally, the time period will also reset if a restrictive measure or a contractual provision with the German Ministry is set aside, partly or in full, by a court decision.
- Submission of Information. Being a triggering point for the screening period, the submission of information also was moved from the AWV to the AWG and, therefore, may only be amended by the German parliament.
- Triggering of Screening Period. Previously, the screening period was only triggered once all information had been submitted to the German Ministry. It is now provided that the four-month screening period starts when all initially requested information has been submitted which includes, as before, all information set forth in the corresponding general ordinance issued by the German Ministry, and, as of now, all information that the German Ministry additionally may request in its decision to initiate formal screening proceedings.
- Subsequent Request for Additional Information. The German Ministry may, also later in the screening process, request further information from anyone directly or indirectly involved in the acquisition. Although the screening period will be suspended until submission of the requested information, the overall duration of the screening process remains calculable for the investor who can limit the suspension by actively working towards a speedy submission.
- More Effective Monitoring of Compliance with Measures. Investors and target companies are to expect more monitoring activity by the German Ministry which now has a right of information as well as a right to carry out examinations (including access to stored data, respective data processing systems, and business premises, in each case also by use of third-party representatives (Beauftragte)) in order to better monitor the investor’s and/or target company’s compliance with contractually agreed or imposed measures.
- Imposing Restrictive Measures without Consent of the German Government. Previously, restrictive measures regarding FDIs subject to cross-sector review could only be imposed with the consent of the German government. Now, restrictive measures may be imposed in agreement with and/or consultation of certain federal ministries instead. For the sake of clarity, the German Ministry still requires the consent of the German government if it wants to prohibit an FDI that is subject to cross-sector review. This has not changed.
What Is Next?
Further changes to the AWV are announced to follow in the 17th amendment to the AWV. In particular, the German Ministry plans to expand the catalog of critical industries which are notifiable and subject to cross-sector review from the acquisition of 10% or more of the voting rights. Based on earlier announcements by the German Ministry on this subject, we expect artificial intelligence, robotics, semiconductors, biotechnology and quantum technology to be potentially declared critical industries. The German Ministry stresses that it will take special consideration of feedback provided by the affected industry circles when proposing the expansion of critical industries to the German government.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. For further information, please feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of the team in Frankfurt or Munich, or the following authors:
Markus Nauheim – Munich (+49 89 189 33 122, mnauheim@gibsondunn.com)
Wilhelm Reinhardt – Frankfurt (+49 69 247 411 502, wreinhardt@gibsondunn.com)
Stefanie Zirkel – Frankfurt (+49 69 247 411 513, szirkel@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
This update provides an overview and summary of key class action developments during the third quarter of 2020 (July through September).
Part I discusses an important Second Circuit decision regarding claims for injunctive relief in false advertising class actions.
Part II describes an Eleventh Circuit opinion in which a divided panel held that 19th-century Supreme Court decisions prohibit the very common practice of providing incentive awards to class representatives.
Part III covers two decisions from the Ninth Circuit relating to the Class Action Fairness Act’s amount-in-controversy requirement.
I. The Second Circuit Holds That It Is Improper to Certify an Injunctive-Relief Class of Past Purchasers of an Allegedly Falsely Advertised Product
In a very significant decision impacting false advertising class actions, the Second Circuit in Berni v. Barilla S.p.A., 964 F.3d 141 (2d Cir. 2020), held that district courts cannot certify a Rule 23(b)(2) injunctive-relief class of past purchasers of products that were allegedly falsely advertised.
Berni involved the allegation that boxes of pasta they had purchased were underfilled in violation of New York’s General Business Law § 349(a), which prohibits “[d]eceptive acts or practices in the conduct of any business, trade or commerce.” Id. at 144. The parties reached a settlement in which the defendant agreed, among other things, to include disclosures on its boxes regarding the amount of pasta contained in them. Id. The district court certified an injunctive-relief class for settlement purposes under Rule 23(b)(2) and entered final approval of the settlement. An objector appealed.
The Second Circuit held that the objector had standing to appeal even though he was not personally deceived by the packaging, id. at 145–46, and it then reversed the grant of class certification, holding that a Rule 23(b)(2) class may be certified only where the injunctive relief sought would be “proper for each and every member of the group of past purchasers.” Id. at 146. In this case, such relief would not be proper, according to the court, because past purchasers were under no obligation to buy the product again, and, even if they did, would already have the information they claimed to lack at the time of their initial purchase. As such, they were “not likely to encounter future harm of the kind that makes injunctive relief appropriate.” Id. at 147–48.
The Berni decision is a critical ruling in favor of class-action defendants, as it will prevent the certification of Rule 23(b)(2) classes in many, if not most, false advertising class actions within the Second Circuit. Coupled with the Ninth Circuit’s decision in Sonner v. Premier Nutrition Corp., 971 F.3d 834 (9th Cir. 2020), which upheld the dismissal of equitable claims when an adequate legal remedy exists, plaintiffs should face more challenges asserting Rule 23(b)(2) class actions in two of the busiest jurisdictions for these lawsuits.
II. Relying on Longstanding Supreme Court Decisions, the Eleventh Circuit Rejects Incentive Awards for Class Representatives
The Eleventh Circuit caught the attention of practitioners this quarter on the permissibility of incentive payments for class representatives, which are almost customary in class settlements.
In Johnson v. NPAS Solutions, LLC, 975 F.3d 1244 (11th Cir. 2020), a putative class of consumers alleged that the defendant had violated the Telephone Consumer Protection Act, 47 U.S.C. § 227. The parties settled, and the district court eventually approved the settlement, overruling one class member’s objection that the class representative’s incentive award “contravened” the United States Supreme Court’s decisions in Trustees v. Greenough, 105 U.S. 527 (1882), and Central Railroad & Banking Co. v. Pettus, 113 U.S. 116 (1885), which are known for “establishing the rule . . . that attorneys’ fees can be paid from a common fund.” Johnson, 975 F.3d at 1250, 1255–56.
The frequency of class action “service awards” in modern practice did not persuade the majority of the Eleventh Circuit panel:
The class-action settlement that underlies this appeal is just like so many others that have come before it. And in a way, that’s exactly the problem. We find that, in approving the settlement here, the district court repeated several errors that, while clear to us, have become commonplace in everyday class-action practice . . . . We don’t necessarily fault the district court—it handled the class-action settlement here in pretty much exactly the same way that hundreds of courts before it have handled similar settlements. But familiarity breeds inattention, and it falls to us to correct the errors in the case before us.
Id. at 1248–49. The majority ruled that while Greenough and Pettus had permitted an award of class counsel’s fees, they had denied class representatives’ claims for a “salary” or “personal services” and for “private expenses” as “unsupported by reason or authority.” Id. at 1256–57. The majority held that incentive awards are “roughly analogous to a salary” and, “[i]f anything, . . . present even more pronounced risks than . . . salary and expense reimbursements” because they “promote litigation by providing a prize to be won.” Id. at 1257–58.
Judge Martin dissented and warned that the majority’s holding was unprecedented and would cause plaintiffs to “be less willing to take on the role of class representative in the future.” Id. at 1264.
III. The Ninth Circuit Reverses Remand Orders in Two Class Action Fairness Act Cases
The Ninth Circuit issued two significant decisions in appeals involving remand orders under the Class Actions Fairness Act (“CAFA”) that will make it easier for defendants to establish the $5 million amount in controversy needed for removal under CAFA.
In Salter v. Quality Carriers, Inc., 974 F.3d 959 (9th Cir. 2020), the court held that plausible allegations of CAFA’s amount-in-controversy requirement are sufficient unless the plaintiff challenges the truth of those allegations. In Salter, the defendant removed an action brought by a putative class of truck drivers alleging that they were misclassified as independent contractors. To establish that the amount in controversy exceeded $5 million, the defendant relied on a declaration from its Chief Information Officer that stated he was familiar with the company’s record-keeping practices and that the company had deducted expenses totaling over $14 million from putative class members’ paychecks. Id. at 961–62. The district court determined that the declaration was conclusory and faulted the defendant for failing to attach the underlying business records, and remanded the action to state court. Id. at 962. Citing Dart Cherokee Basin Operating Co. v. Owens, 574 U.S. 81, 88–89 (2014), the Ninth Circuit vacated the remand order because the district court erred in refusing to accept the truth of the declaration. Salter, 974 F.3d at 964–65. Because the plaintiff did not make a factual attack on the truth of the declaration, and instead argued only that the declaration was insufficiently detailed and did not attach supporting data, the declaration’s conclusions should have been accepted as true. Id. at 965.
In Greene v. Harley-Davidson, Inc., 965 F.3d 767 (9th Cir. 2020), the Ninth Circuit held that punitive damages can be factored into the amount in controversy calculation under CAFA if there is a “reasonable possibility” of such damages. The defendant argued that a jury might award punitive damages on a 1:1 ratio with compensatory damages, as juries had done in other cases brought under California’s Consumers Legal Remedies Act. Id. at 770–71. The district court refused to include punitive damages in the amount-in-controversy calculation because the defendant did not “analogize or explain” how the cited cases “[we]re similar to the instant action.” Id. at 771. The Ninth Circuit reversed. It reasoned that the amount in controversy for purposes of CAFA is the “amount at stake in the underlying litigation,” which “refers to possible liability.” Id. at 772 (first emphasis in original, second emphasis added). A defendant could meet its burden to show possible liability by “cit[ing] a case based on the same or a similar statute in which the jury or court awarded punitive damages based on the punitive-compensatory damages ratio relied upon by the defendant in its removal notice.” Id. Because the defendant had cited four such cases, it met its burden. Id.
The following Gibson Dunn lawyers contributed to this client update: Christopher Chorba, Theane Evangelis, Kahn Scolnick, Bradley Hamburger, Lauren Blas, Nathan Strauss, Vincent Eisinger, and Andrew Kasabian.
Gibson Dunn attorneys are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Class Actions or Appellate and Constitutional Law practice groups, or any of the following lawyers:
Theodore J. Boutrous, Jr. – Co-Chair, Litigation Practice Group – Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com)
Christopher Chorba – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com)
Theane Evangelis – Co-Chair, Class Actions Practice Group – Los Angeles (+1 213-229-7726, tevangelis@gibsondunn.com)
Kahn A. Scolnick – Los Angeles (+1 213-229-7656, kscolnick@gibsondunn.com)
Bradley J. Hamburger – Los Angeles (+1 213-229-7658, bhamburger@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
The UK Financial Conduct Authority (the “FCA”) has published a final notice (the “Final Notice”) detailing enforcement action taken against a Hong Kong asset manager for short selling disclosure rule breaches under the Short Selling Regulation (the “SSR”). The Final Notice provides a reminder to non-UK based asset managers of the extra-territorial reach of the SSR when trading in the UK and EU markets and of the need to ensure that they have the systems and controls in place to comply with the SSR. This client alert provides our clients with a refresher on the SSR and the key takeaways from this enforcement action.
Key takeaways
|
What is the SSR?
The SSR came into force on 1 November 2012 and is intended to provide a harmonised framework for requirements and regulatory powers relating to short selling and entering into sovereign credit default swaps (“CDS”). In summary, the SSR:
- requires investors to notify the relevant national competent authority (“NCA”) of any net short positions in EU sovereign debt instruments and shares admitted to a trading venue in the EU;
- restricts uncovered short sales of shares and EU sovereign debt instruments;
- prohibits the entry into uncovered sovereign CDS; and
- provides NCAs and the European Securities and Markets Authority (“ESMA”) with powers to, amongst others, suspend or prohibit short selling.
The SSR has extra-territorial effect and ESMA has confirmed that the location of a transaction and the domicile or location of the parties to the transaction are irrelevant when assessing whether or not the SSR applies.
This client alert will focus on the requirement of investors to notify the relevant NCA of the net short positions they hold with respect to in-scope shares. For these purposes, “in-scope shares” are the shares of companies admitted to trading on a regulated market or a multilateral trading facility and derivatives relating to such financial instruments.
Why is short-selling reporting regarded by regulators as being important?
In September 2020, the FCA published Market Watch 63, the latest version of its periodic newsletter on market conduct and transaction reporting issues. Market Watch 63 reiterated the FCA’s view that it considers that short selling can contribute usefully to liquidity and price discovery, and therefore support open, effective markets that operate with integrity. However, the FCA stated that it is important that market participants ensure that they continue to meet their obligations under the SSR as this give appropriates transparency to short selling activity and support the orderly functioning of the market.
What are the SSR notification thresholds for in-scope shares?
The SSR sets out transparency requirements for net short positions in relevant shares. There are two types of disclosure, private and public.
|
Private disclosure |
Public disclosure |
An investor must notify the relevant NCA of a net short position it has in relation to in-scope shares:
| An investor must notify the relevant NCA of a net short position it has in relation to in-scope shares:
|
What is the method and timing of private and public disclosures?
In the UK, the FCA has confirmed that disclosures of net short positions should be made by sending a completed notification form to it by email. A disclosure must be made by 3.30 pm on the trading day following the day on which the person reaches, falls below or passes through the relevant threshold. The key difference is that the SSR requires public disclosures to be published on a website maintained by the relevant NCA.
Will Brexit have an impact on the SSR as implemented in the UK?
The SSR, an EU regulation, is directly applicable and will form part of UK law at the end of the Brexit transition period under the European Union (Withdrawal) Act 2018. The SSR will be amended in the UK to ensure that it will operate effectively after 31 December 2020. There will, therefore, be two versions post-transition period, the EU SSR and the UK SSR. Investors will need to ensure that they have systems and controls in place to comply with both the EU SSR and the UK SSR.
Has COVID had an impact on the reporting thresholds?
On 16 March 2020, ESMA issued a decision to temporarily amend the threshold for notifying net short positions to NCA under the SSR from 0.2% of issued share capital to 0.1%. The FCA confirmed that this decision would apply in the UK. However, the FCA stated that systems changes would be required and firms should continue to report at the previous thresholds until further notice. On 31 March 2020, the FCA confirmed that the required changes to its systems had been made and that it would be ready to receive notifications at the lower threshold from 6 April 2020. Firms were not required to amend and resubmit notifications submitted to the FCA between 16 March 2020 and 3 April 2020.
On 11 June 2020, ESMA issued a decision renewing its original decision on 16 March 2020 amending the threshold from 17 June 2020 for a period of 3 months. On 16 September 2020, ESMA further renewed the March decision from 18 September 2020 for another period of 3 months. Firms should continue reporting at the lower threshold to the relevant NCA.
What enforcement action has the FCA taken?
On 14 October 2020, the FCA published the Final Notice it issued to Asia Research and Capital Management Ltd (“ARCM”), fining it £873,118 for breaches of short selling disclosure rules under the SSR. ARCM is a Hong Kong-based asset manager that trades infrequently in EU markets.
From February 2017 to July 2019, ARCM failed to make 155 notifications to the FCA and 153 disclosures to the public of its net short position in a UK listed company. By July 2019, ARCM had built a net short position equivalent to 16.85% of the issued share capital of the UK listed company. This position was held for a further 106 trading days before being notified to the FCA and disclosed to the public. ARCM agreed to resolve the matter and qualified for a 30% discount under the FCA’s executive settlement procedures.
The FCA considered the failings to be particularly serious given:
- the failures to comply with its obligations under the SSR were multiple and occurred over a long period of time;
- ARCM did not inform it promptly on discovering its failure and instead notified it only after it had reviewed and collated the relevant data for disclosure; and
- the size of the position was the largest net short position held in an issuer admitted to the FCA’s Official List with shares admitted to trading on the Main Market of the London Stock Exchange.
What steps should firms be taken to ensure ongoing compliance?
The enforcement action against ARCM demonstrates that the FCA is willing to take action against investors for breaches of the SSR, even if that investor only trades infrequently in the UK. All firms trading in the UK and EU markets should maintain systems and controls to ensure ongoing compliance with the SSR. Firms would be well advised to undertake a review of their current systems and controls. This will involve monitoring developments in the parallel UK and EU versions of the SSR after the end of the current Brexit transition period.
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 in the firm’s Financial Institutions practice group, or the following authors in London:
Michelle M. Kirschner (+44 (0) 20 7071 4212, mkirschner@gibsondunn.com)
Matthew Nunan (+44 (0) 20 7071 4201, mnunan@gibsondunn.com)
Martin Coombes (+44 (0) 20 7071 4258, mcoombes@gibsondunn.com)
Chris Hickey (+44 (0) 20 7071 4265, chickey@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
The third quarter of 2020 saw a noticeable surge in Artificial Intelligence (“AI”)-related regulatory and policy proposals. The European Union (“EU”) has emerged as a pacesetter in AI regulation, taking significant steps towards a long-awaited comprehensive and coordinated regulation of AI at EU level—evidence of the European Commission’s (the “Commission”) ambition to exploit the potential of the EU’s internal market and position itself as a major player in sustainable technological innovation. In this update, we review some of the recent policy initiatives in the EU ahead of the Commission’s long-awaited legislative proposals expected in early 2021.
In the U.S., the third quarter of 2020 saw a number of bipartisan bills passed in the U.S. House of Representatives seeking to develop and refine U.S. national AI policy and adopt measures promoting the ethical and equitable use of AI technologies and consumer protection measures.
As global AI policy develops, we are observing some interesting themes emerging, one of which is stakeholders’ varying levels of comfort with the lack of a universal definition of AI. Some commentators have suggested that undue effort should not be expended on defining AI since it is a dynamic technology that will continue to change.[1] At the same time, global lawmakers are already reviewing and passing regulations that focus on certain categories of AI, often in the absence of clear definitions and delineations between certain AI applications that will impact the scope of regulation (see, e.g., the European Parliament’s discussion about a possible regulation of “all” AI applications, discussed further at I. below), creating legal uncertainty for regulators and businesses alike. We will continue to monitor these policy trends and provide a comprehensive analysis in our forthcoming 2020 Artificial Intelligence and Automated Systems Annual Legal Review.
____________________
Table of Contents
U.S. Federal Legislation & Policy
____________________
I. EU LEGISLATION & POLICY
In past years, EU discussions about regulating AI technologies had been characterized by a restrictive “regulate first” approach.[2] However, the regulatory road map presented by the Commission in February under the auspices of its new digital strategy eschewed, for example, blanket technology bans and proposed a more nuanced “risk-based” approach to regulation, emphasizing the importance of “trustworthy” AI but also acknowledging the need for Europe to both remain innovative and competitive in a rapidly growing space and avoid fragmentation of the single market resulting from differences in national legislation. As discussed further below, there is some evidence of a growing dissonance between EU members with respect to the balance between technological innovation and risk, and a European consensus on a harmonized legal framework is far from realized.
The Commission’s “White Paper on Artificial Intelligence – A European approach to excellence and trust” (the “White Paper”) sets out a road map designed to balance innovation, ethical standards and transparency.[3] As noted in our client alert “EU Proposal on Artificial Intelligence Regulation Released,” the White Paper favors a risk-based approach with sector- and application-specific risk assessments and requirements, rather than blanket sectoral requirements or bans—earmarking a series of “high-risk” technologies for future oversight, including those in “critical sectors” and those deemed to be of “critical use.”[4] The Commission also released a series of accompanying documents: the “European Strategy for Data” (“Data Strategy”)[5] and a “Report on the Safety and Liability Implications of Artificial Intelligence, the Internet of Things and Robotics” (“Report on Safety and Liability”).[6]
While the Commission’s comprehensive legislative proposal is not anticipated before early 2021, the EU policy landscape remains dynamic. Companies active in AI should closely follow recent developments in the EU, given the proposed geographic reach of the future AI legislation, which is likely to affect all companies doing business in the EU.
A. European Commission’s AI White Paper Consultation and “Inception Impact Assessment”
As we reported in our Artificial Intelligence and Automated Systems Legal Update (1Q20), in January 2020, the EC launched a public consultation period and requested comments on the proposals set out in the White Paper and the Data Strategy, providing an opportunity for companies and other stakeholders to provide feedback and shape the future EU regulatory landscape. The consultation closed on June 14. In July, the Commission published a summary report on the consultation’s preliminary findings.[7] Over 1,250 stakeholders from all over the world responded, providing feedback on the proposed policy and regulatory framework on AI. Respondents raised concerns about the potential for AI to breach fundamental rights or lead to discriminatory outcomes, but they were divided on whether new compulsory requirements should be limited to high-risk applications.
On the heels of the White Paper Consultation, the Commission launched an “Inception Impact Assessment” initiative for AI legislation in July, aiming to define the Commission’s scope and goals for AI legislation with a focus on ensuring that “AI is safe, lawful and in line with EU fundamental rights.”[8] The Commission’s road map builds on the proposals in the White Paper and provides more detail on relevant policy options and policy instruments, from a “baseline” policy (involving no policy change at the EU level) through various alternative options following a “gradual intervention logic,” ranging from a nonlegislative, industry-led, “soft law” approach (Option 1) through a voluntary labelling scheme (Option 2), to comprehensive and mandatory EU-level legislation for all or certain types of AI applications (Option 3), or a combination of any of the options above taking into account the different levels of risk that could be generated by a particular AI application (Option 4).[9] Another core question relates to the scope of the initiative, notably how AI should be defined (narrowly or broadly) (e.g., machine learning, deep neural networks, symbolic reasoning, expert systems, automated decision-making).
Substantively, the road map reiterates that the Commission is particularly concerned with a number of specific, significant AI risks that are not adequately covered by existing EU legislation, such as cybersecurity, the protection of employees, unlawful discrimination or bias, the protection of EU fundamental rights, including risks to privacy, and protecting consumers from harm caused by AI (both through existing and new product safety legislation). Continued focus remains on the need for legal certainty, both for businesses marketing products involving AI in the EU, and for market surveillance and supervisory authorities. The feedback period for the road map closed in September, and the completion of the Inception Impact Assessment is scheduled for December 2020. As noted, these policy proposals are intended to culminate in proposed regulation, which is expected to be unveiled by the Commission in the first quarter of 2021.
B. European Parliament Votes on Proposals regarding the Regulation of Artificial Intelligence
Earlier this year, the European Parliament (the “Parliament”) set up a special committee to analyze the impact of artificial intelligence on the EU economy.[10] The new committee chair, Dragoș Tudorache, noted that “Europe needs to develop AI that is trustworthy, eliminates biases and discrimination, and serves the common good, while ensuring business and industry thrive and generate economic prosperity.”[11]
In April, the Parliament’s Legal Affairs Committee (“JURI”) published three draft reports to the Commission providing recommendations on a framework for AI liability, copyright protection for AI-assisted human creations, safeguards within the EU’s patent system to protect the innovation of AI developers, and AI ethics and “human-centric AI.”[12] The three legal initiatives, summarized in final reports and recommendations outlined in more detail below, were adopted by the plenary on October 20, 2020.[13]
1. Report with Recommendations to the Commission on a Framework of Ethical Aspects of Artificial Intelligence, Robotics and Related Technologies
The legislative initiative urges the Commission to present a legal framework outlining the ethical principles and legal obligations to be followed when developing, deploying and using artificial intelligence, robotics and related technologies in the EU including software, algorithms and data, protection for fundamental rights. The initiative also calls for the establishment of a “European Agency for Artificial Intelligence” and a “European certification of ethical compliance.”[14]
The proposed legal framework is premised on several guiding principles, including “human-centric and human-made AI; safety, transparency and accountability; safeguards against bias and discrimination; right to redress; social and environmental responsibility; and respect for privacy and data protection.”[15] High-risk AI technologies, which include machine learning and other systems with the capacity for self-learning, should be designed to “allow for human oversight and intervention at any time, particularly where a functionality could result in a serious breach of ethical principles and could be dangerous.”[16] Some of the high-risk sectors identified are healthcare, public sector and finance, banking and insurance.
2. Report with Recommendations to the Commission on a Civil Liability Regime for Artificial Intelligence
The Report calls for a future-oriented civil liability framework that makes front- and back-end operators of high-risk AI strictly liable for any resulting damage and provides a “clear legal framework [that] would stimulate innovation by providing businesses with legal certainty, whilst protecting citizens and promoting their trust in AI technologies by deterring activities that might be dangerous.”[17] While it does not take the position that a new EU liability regime is necessary, the Report identifies a gap in the existing EU product liability regime with respect to the liability of operators of AI-systems in the absence of a contractual relationship with potential victims, proposing a dual approach: (1) strict liability for operators of “high-risk AI-systems” akin to the owner of a car or pet; or (2) a presumption of fault towards the operator for harm suffered by a victim by a non-“high-risk” AI system, with national law regulating the amount and extent of compensation as well as the limitation period in case of harm caused by the AI-system.[18] Multiple operators would be held jointly and severally liable, subject to a maximum liability of €2 million. The Report defines criteria on which AI-systems can qualify as high-risk in the Annex, proposing that a newly formed standing committee, involving national experts and stakeholders, should support the Commission in its review of potentially high-risk AI-systems.
3. Report on Intellectual Property Rights for the Development of Artificial Intelligence Technologies
The Report emphasizes that EU global leadership in AI requires an effective intellectual property rights (“IP”) system and safeguards for the EU’s patent system in order to protect and incentivize innovative developers, balanced with the EU’s ethical principles for AI and consumer safety.[19] Notably, the Report distinguishes between AI-assisted human creations and AI-generated creations, taking the position that AI should not have a legal personality and that ownership of IP rights should only be granted to humans. Where AI is used only as a tool to assist an author in the process of creation, the current IP legal framework should remain applicable. Nonetheless, the Report recommends that AI-generated creations should fall under the scope of the EU IP regime in order to encourage investment and innovation, subject to protection under a specific form of copyright.
C. A Lack of Consensus between EU Members on the Balance to Be Struck between Innovation and Safety
Although the Commission is seeking to impose a comprehensive and harmonious framework for AI regulation across all member states, it is far from clear that consensus exists as to the scope of regulatory intervention. In October, 14 EU members (Denmark, Belgium, the Czech Republic, Finland, France, Estonia, Ireland, Latvia, Luxembourg, the Netherlands, Poland, Portugal, Spain and Sweden) published a joint position paper urging the Commission to espouse a “soft law approach” that takes into account the fast-evolving nature of AI technologies.[20] The paper calls for the adoption of “self-regulation, voluntary labelling and other voluntary practices as well as a robust standardisation process as a supplement to existing legislation that ensures that essential safety and security standards are met” to allow regulators to learn from technology and identify potential regulatory challenges without stymieing innovation.
This approach may be met with challenge from Germany, the current chair of the EU presidency, which has expressed concern over certain Commission proposals to apply restrictions on AI applications deemed to be of high-risk only, and would prefer a broader regulatory reach for technologies that would be subject to the new framework, as well as mandatory, detailed rules for data retention, biometric remote identification and human supervision of AI systems.[21]
On November 5, a German AI inquiry committee (Enquete-Kommission Künstliche Intelligenz des Deutschen Bundestages, hereafter the “Committee”) presented its final report, which provides broad recommendations on how society can benefit from the opportunities inherent in AI technologies (defined in the report as “lernende Systeme” or “self-learning systems”) while acknowledging the risks they pose. The Committee’s work placed a focus on legal and ethical aspects of AI and its impact on the economy, public administration, cybersecurity, health, work, mobility, and the media.[22] The Committee advocates for a “human-centric” approach to AI, a harmonious Europe-wide strategy, a focus on interdisciplinary dialog in policy-making, setting technical standards, legal clarity on testing of products and research, and the adequacy of digital infrastructure. At a high level, the Committee’s specific recommendations relate to (1) data-sharing and data standards; (2) support and funding for research and development; (3) a focus on “sustainable” and efficient use of AI; (4) incentives for the technology sector and industry to improve scalability of projects and innovation; (5) education and diversity; (6) the impact of AI on society, including the media, mobility, politics, discrimination and bias; and (7) regulation, liability and trustworthy AI. The committee was set up in late 2018 and comprises 19 members of the German parliament and 19 external experts. We will provide a more detailed analysis of the Committee’s final report in our forthcoming 2020 Artificial Intelligence and Automated Systems Annual Legal Review.
D. UK ICO Guidance on AI and Data Protection
On July 30, 2020, the UK Information Commissioner’s Office (“ICO”) published its final guidance on Artificial Intelligence (the “Guidance”).[23] Intended to help organizations “mitigate the risks of AI arising from a data protection perspective without losing sight of the benefits such projects can deliver,” the Guidance sets out a framework and methodology for auditing AI systems and best practices for compliance with the UK Data Protection Act 2018 and data protection obligations under the EU’s General Data Protection Regulation (“GDPR”). The Guidance proposes a “proportionate and risk-based approach” and recommends an auditing methodology consisting of three key parts: auditing tools and procedures for use in audits and investigations; detailed guidance on AI and data protection; and a tool kit designed to provide further practical support to organizations auditing the compliance of their own AI systems (which is forthcoming). The guidance addresses four overarching principles:
- Accountability and governance in AI—including data protection impact assessments (“DPIAs”), understanding the relationship and distinction between controllers and processors in the AI context, as well as managing, and documenting decisions taken with respect to competing interests between different AI-related risks (e.g., trade-offs);
- Fair, lawful and transparent processing—including how to identify lawful bases (and using separate legal bases for processing personal data at each stage of the AI development and deployment process), assessing and improving AI system performance, mitigating potential discrimination, and documenting the source of input data as well as any inaccurate input data or statistical flaw that might impact the output of the AI system.
- Data minimization and security—including guidance to technical specialists on data security issues common to AI, types of privacy attacks to which AI systems are susceptible, compliance with the principle of data minimization (the principle of identifying the minimum amount of personal data needed, and to process no more than that amount of information), and privacy-enhancing techniques that balance the privacy of individuals and the utility of a machine learning system during the training and inference stages.[24]
- Compliance with individual data subject rights—including data subject rights in the context of data input and output of AI systems, rights related to automated decision, and requirements to design AI systems to facilitate effective human review and critical assessment and understanding of the outputs and limitations of AI systems.
The Guidance also emphasizes that data protection risks should be considered at an early stage in the design process (e.g., “safety by design”) and that the roles of the different parties in the AI supply chain should be clearly mapped at the outset. Of note is also the recommendation that training data be stored at least until a model is established and unlikely to be retrained or modified. The Guidance refers to, but does not provide guidance on, the anonymization or pseudonymization of data as a privacy-preserving technique, but notes that the ICO is currently developing new guidance in this field.[25]
The ICO encourages organizations to provide feedback on the Guidance to make sure that it remains “relevant and consistent with emerging developments.”
II. U.S. FEDERAL LEGISLATION & POLICY
A. AI in Government Act of 2020 (H.R. 2575)
First introduced by Rep. Jerry McNerney (D-CA) on May 8, 2019, the AI in Government Act of 2020 (H.R. 2575) was passed by the House on September 14, 2020 by voice vote.[26] The bill aims to promote the efforts of the federal government in developing innovative uses of AI by establishing the “AI Center of Excellence” within the General Services Administration (“GSA”), and requiring that the Office of Management and Budget (“OMB”) issue a memorandum to federal agencies regarding AI governance approaches. It also requires the Office of Science and Technology Policy to issue guidance to federal agencies on AI acquisition and best practices.
Senators Rob Portman (R-OH) and Cory Gardner (R-CO) are cosponsoring an identical bill, S. 1363, which was approved by the U.S. Senate Homeland Security and Governmental Affairs Committee in November 2019.[27] Sen. Portman described the bipartisan legislation, which remains pending in the Senate, as “the most significant AI policy change ever passed by Congress.”
B. Consumer Safety Technology Act (H.R. 8128)
On September 29, the House passed the Consumer Safety Technology Act (H.R. 8128), previously named the “AI for Consumer Product Safety Act.” If enacted, the bill would direct the U.S. Consumer Product Safety Commission (“CPSC”) to establish a pilot program to explore the use of artificial intelligence for at least one of the following purposes: (1) tracking injury trends; (2) identifying consumer product hazards; (3) monitoring the retail marketplace for the sale of recalled consumer products; or (4) identifying unsafe imported consumer products. The bill has been referred to the Senate Committee on Commerce, Science, and Transportation.
C. Bipartisan U.S. Lawmakers Introduce Legislation to Create a National AI Strategy
On September 16, 2020, Reps. Robin Kelly (D-Ill.) and Will Hurd (R-Texas), after coordination with experts and the Bipartisan Policy Center, introduced a concurrent resolution calling for the creation of a national AI strategy.[28] This Resolution proposes four pillars to guide the strategy:[29]
- Workforce: Fill the AI talent gap and prepare American workers for the jobs of the future, while also prioritizing inclusivity and equal opportunity;[30]
- National Security: Prioritize the development and adoption of AI technologies across the defense and intelligence apparatus;
- Research and Development: Encourage the federal government to collaborate with the private sector and academia to ensure America’s innovation ecosystem leads the world in AI; and
- Ethics: Develop and use AI technology in a way that is ethical, reduces bias, promotes fairness, and protects privacy.
D. Artificial Intelligence Education Act
On September 24, 2020, Reps. Paul D. Tonko (D-NY) and Guy Reschenthaler (R-PA) introduced the Artificial Intelligence Education Act (H.R. 8390).[31] The bipartisan legislation would establish grant support within the National Science Foundation to fund the creation of easily accessible K-12 lesson plans for schools and educators.[32] The bill has been referred to the Committee on Science, Space, and Technology and the Committee on Education and Labor.
III. INTELLECTUAL PROPERTY
A. USPTO Releases Report on Artificial Intelligence and Intellectual Property Policy
On October 6, 2020, the U.S. Patent and Trademark Office (“USPTO”) published a report “Public Views on Artificial Intelligence and Intellectual Property Policy” (the “Report”).[33] The Report catalogs the roughly 200 comments received in response to the USPTO’s request for comments issued in October 2019 (as reviewed in our client alert USPTO Requests Public Comments On Patenting Artificial Intelligence Inventions).[34] The USPTO requested feedback on issues such as whether current laws and regulations regarding patent inventorship and authorship of copyrighted work should be revised to take into account contributions other than by natural persons.
A general theme that emerges from the report is concern over the lack of a universally acknowledged definition of AI, and a majority view that current AI (i.e., AI that is not considered to be artificial general intelligence, or “AGI”) can neither invent nor author without human intervention. The comments also suggested that existing U.S. intellectual property laws are “calibrated correctly to address the evolution of AI” (although commenters were split as to whether any new classes of IP rights would be beneficial to ensure a more robust IP system), and that “human beings remain integral to the operation of AI, and this is an important consideration in evaluating whether IP law needs modification in view of the current state of AI technology.”[35]
The key comments sound in eight categories:
1. Elements of an AI Invention
AI has no universally recognized definition, but can be understood as computer functionality that mimics human cognitive functions, e.g., the ability to learn. AI inventions include inventions embodying an advance in AI itself (e.g., improved models or algorithms), inventions that apply AI to a field other than AI, and inventions produced by AI itself. The current state of the art is limited to ‘narrow’ AI, as opposed to artificial general intelligence akin to human intelligence.
2. Conception and Inventorship
The vast majority of public commenters asserted that current inventorship law is equipped to handle inventorship of AI technologies and that the assessment of conception should remain fact-specific. The use of an AI system as a tool by a natural person does not generally preclude a natural person from qualifying as an inventor if he or she contributed to the conception of the claimed invention. Many commenters took issue with the premise that, under the current state of the art, AI systems were advanced enough to “conceive” of an invention. As one commenter put it, “the current state of AI technology is not sufficiently advanced at this time and in the foreseeable future so as to completely exclude the role of a human inventor in the development of AI inventions.”[36] Some commenters suggested that the USPTO should revisit the question when machines begin achieving AGI (i.e., when science agrees that machines can “think” on their own). A minority of commenters suggested that AGI was a present reality that needed to be addressed today.
3. Ownership of AI Inventions
The vast majority of commenters stated that no changes should be necessary to the current U.S. law—that only a natural person or a company (via assignment) should be considered the owner of a patent or an invention. However, a minority of responses stated that while inventorship and ownership rights should not be extended to machines, consideration should be given to expanding ownership to a natural person who trains an AI process, or who owns/controls an AI system.
4. Subject Matter Eligibility under 35 U.S.C. § 101
Many commenters asserted that there are no patent eligibility considerations unique to AI Inventions, and that AI inventions should not be treated any differently than other computer-implemented inventions. This is consistent with how the USPTO currently examines AI inventions today: claims to an AI invention that fall within one of the four statutory categories and are patent-eligible under the Alice/Mayo test[37] will be patent subject matter-eligible under 35 U.S.C. § 101. While some AI inventions may not pass muster under the subject matter eligibility analysis because they can be characterized as certain methods of organizing human activity, mental processes, or mathematical concepts, as one commenter noted, the complex algorithms that underpin AI inventions have the ability to yield technological improvements. In addition, claims directed to an abstract idea will still be patent-eligible if the additional claim elements, considered individually or as an ordered combination, amount to significantly more than the abstract idea so as to transform them into patent-eligible subject matter.
5. Written Description and Enablement under 35 U.S.C. § 112(a)
The majority of commenters agreed that there are no unique disclosure considerations for AI inventions. One commenter stated that the principles set forth in the USPTO’s examiner training materials regarding computer-implemented inventions “are similarly applicable to AI-related inventions as to conventional algorithmic solutions.” However, some commenters indicated that there are significant and unique challenges to satisfying the disclosure requirements for an AI invention since even though the input and output may be known by the inventor, the logic in between is in some respects unknown. Commenters noted that proper enforcement of the description requirement is imperative for patent quality. USPTO takes the position that whether a specification provides enabling support for the claimed invention is “intensely fact-specific.”
Commenters suggest that there are differing views on the predictability of AI systems. One commenter stated that “most current AI systems behave in a predictable manner and that predictability is often the basis for the commercial value of practical applications of these technologies.” Others noted that some AI inventions may operate in a black box because there is an “inherent randomness in AI algorithms,” making it appropriate to “apply the written description requirement and the enablement factors from In re Wands.”[38]
Commenters presented differing views as to the predictability of AI inventions. Some explained that AI inventions generally behave predictably in their practical applications (that fact being a basis for their commercial value), whereas some AI inventions might be less predictable due to inherent randomness in their algorithms. This unpredictability may make it appropriate to consider established factors such as the level of predictability in the art, amount of direction provided by the inventor, existence of working examples, and quantity of experimentation necessary to make or use the invention based on the content of the disclosure.
6. Level of Ordinary Skill in the Art
The USPTO noted that AI is capable of being applied to various disciplines, a tendency that requires an assessment of how it is affecting seemingly disparate fields of innovation since it may have “the potential to alter the skill level of the hypothetical ‘ordinary skilled artisan,’ thereby affecting the bar for nonobviousness.” Many commenters asserted that AI has the potential to affect the level of ordinary skill in an art and that the present legal framework for assessing the person of ordinary skill in the art is “adequate to determine the impact of AI-based tools in a given field.” However, commenters cautioned that widespread use of AI systems have not yet permeated all fields and discouraged the USPTO from declaring that the application of conventional AI is an exercise of ordinary skill in the art.
7. Prior Art Considerations
The majority of commenters stated that there were no prior art considerations unique to AI inventions and that current standards were sufficient. However, some commenters indicated that there were prior art considerations unique to AI inventions, many of which focused on the proliferation of prior art, such as the generation of prior art by AI, and the difficulty in finding prior art, such as source code related to AI. Others indicated that while no prior art considerations unique to AI inventions currently existed, depending on how sophisticated AI becomes in the future, unique AI prior art could become relevant. Among all the responses, a common theme was the importance of examiner training and providing examiners with additional resources for identifying and finding AI-related prior art.
8. New IP Protections for Data Protection and Other Issues
The USPTO noted that data protection under current U.S. law is limited in scope, and the U.S. does not currently have intellectual property rights protections solely focused on data for AI algorithms. In their responses to the question of whether any new forms of IP protections are needed for AI inventions, commenters noted the importance of “big data” in developing and training AI systems, but were equally divided between the view that new intellectual property rights were necessary to address AI inventions and the belief that the current U.S. IP framework was adequate to address AI inventions. Generally, however, commenters who did not see the need for new forms of IP rights suggested that developments in AI technology should be monitored to ensure needs were keeping pace with AI technology developments.
Those requesting new IP rights focused on the need to protect the data associated with AI, particularly in the context of machine learning systems. One opinion stated that companies that collect large amounts of data have a competitive advantage relative to new entrants to the market and that “[t]here could be a mechanism to provide access to the repositories of data collected by large technology companies such that proprietary rights to the data are protected but new market entrants and others can use such data to train and develop their AI.”[39] Commentators took the view that training data is currently protectable as a trade secret or, in the event that the training data provides some new and useful outcome, as a patent, but thought that there may be gaps in IP protection for trained models. Commenters did not provide concrete proposals on how any newly created IP rights should function, and many called on the USPTO to further consult the public on the issue. Commenters also stressed the need for examiner technical training and a call for memorializing guidance specific to AI for patent examiners.
Finally, in response to a question about whether policies and practices of other global patent agencies should inform the USPTO’s approach, there was a divide between commentators advocating for an evolution of global laws in a common direction, and those who cautioned against further attempts to harmonize international patent laws and procedures “because U.S. patent law is the gold standard.”[40]
We will continue to monitor developments in this space and report on any action USPTO may take in response to these comments.
IV. AUTONOMOUS VEHICLES
A. SELF-DRIVE Act Reintroduced in U.S. Congress
Federal regulation of autonomous vehicles had so far faltered in the new Congress, leaving the U.S. without a federal regulatory framework while the development of autonomous vehicle technology continues apace. However, on September 23, 2020, Rep. Bob Latta (R-OH) reintroduced the Safely Ensuring Lives Future Deployment and Research In Vehicle Evolution (“SELF DRIVE”) Act.[41] As we have addressed in previous legal updates,[42] the House previously passed the SELF DRIVE Act (H.R. 3388) by voice vote in September 2017, but its companion bill (the American Vision for Safer Transportation through Advancement of Revolutionary Technologies (“AV START”) Act (S. 1885)) stalled in the Senate.
The bill empowers the National Highway Traffic Safety Administration (“NHTSA”) with the oversight of manufacturers of Highly Automated Vehicles (“HAVs”) through enactment of future rules and regulations that will set the standards for safety and govern areas of privacy and cybersecurity relating to such vehicles. The bill also requires vehicle manufacturers to inform consumers of the capabilities and limitations of a vehicle’s driving automation system and directs the Secretary of Transportation to issue updated or new motor vehicle safety standards relating to HAVs.
One key aspect of the bill is broad preemption of the states from enacting legislation that would conflict with the Act’s provisions or the rules and regulations promulgated under the authority of the bill by the NHTSA. While state authorities would likely retain their ability to oversee areas involving human driver and autonomous vehicle operation, the bill contemplates that the NHTSA would oversee manufacturers of autonomous vehicles, just as it has with non-autonomous vehicles, to ensure overall safety. In addition, the NHTSA is required to create a Highly Automated Vehicle Advisory Council to study and report on the performance and progress of HAVs. This new council is to include members from a wide range of constituencies, including members of the industry, consumer advocates, researchers, and state and local authorities. The intention is to have a single body (the NHTSA) develop a consistent set of rules and regulations for manufacturers, rather than continuing to allow the states to adopt a web of potentially widely differing rules and regulations that may ultimately inhibit development and deployment of HAVs.
In a joint statement on the bill, Energy and Commerce Committee Republican Leader Rep. Greg Walden (R-OR) and Communications and Technology Subcommittee Republican Leader Rep. Bob Latta (R-OH) noted that “[t]here is a clear global race to AVs, and for the U.S. to win that race, Congress must act to create a national framework that provides developers certainty and a clear path to deployment.”[43] The bill has been referred to the House Energy and Commerce Committee and awaits further action.[44]
B. European Commission Report on the Ethics of Connected and Automated Vehicles
In September 2020, the Commission published a report by an independent group of experts on the ethics of connected and automated vehicles (“CAVs”).[45] The report—which promotes the “systematic inclusion of ethical considerations in the development and use of CAVs”[46]—sets out twenty ethical recommendations on road safety, privacy, fairness, AI explainability, responding to dilemma situations, clear testing guidelines and standards, the creation of a culture of responsibility for the development and deployment of CAVs, auditing CAV algorithmic decision-making reducing opacity, as well as the promotion of data, algorithm and AI literacy through public participation. The report applies a “Responsible Research and Innovation” approach that “recognises the potential of CAV technology to deliver the […] benefits [reducing the number of road fatalities and harmful emissions from transport, improving the accessibility of mobility services]” but also incorporates a broader set of ethical, legal and societal considerations into the development, deployment and use of CAVs and to achieve an “inherently safe design” based on a user-centric perspective.[47] The report builds on the Commission’s strategy on Connected and Automated Mobility.[48]
C. Proposed German Legislation on Autonomous Driving
The German government intends to pass a law on autonomous vehicles (“Gesetz zum autonomen Fahren”) by mid-2021.[49] The new law is intended to regulate the deployment of CAVs in specific operational areas by the year 2022 (including Level 5 “fully automated vehicles”), and will define the obligations of CAV operators, technical standards and testing, data handling, and liability for operators. The proposed law is described as a temporary legal instrument pending agreement on harmonized international regulations and standards.
Moreover, the German government also intends to create, by the end of 2021, a “mobility data room” (“Datenraum Mobilität”), described as a cloud storage space for pooling mobility data coming from the car industry, rail and local transport companies, and private mobility providers such as car sharers or bike rental companies.[50] The idea is for these industries to share their data for the common purpose of creating more efficient passenger and freight traffic routes, and support the development of autonomous driving initiatives in Germany.
_____________________
[1] United States Patent and Trademark Office, Public Views on Artificial Intelligence and Intellectual Property Policy (Oct. 2020), at 2 (summarizing responses by stakeholders to the USPTO’s request for public comment), available at https://www.uspto.gov/sites/default/files/documents/USPTO_AI-Report_2020-10-07.pdf.
[2] H. Mark Lyon, Gearing Up For The EU’s Next Regulatory Push: AI, LA & SF Daily Journal (Oct. 11, 2019), available at https://www.gibsondunn.com/wp-content/uploads/2019/10/Lyon-Gearing-up-for-the-EUs-next-regulatory-push-AI-Daily-Journal-10-11-2019.pdf.
[3] EC, White Paper on Artificial Intelligence – A European approach to excellence and trust, COM(2020) 65 (Feb. 19, 2020), available at https://ec.europa.eu/info/sites/info/files/commission-white-paper-artificial-intelligence-feb2020_en.pdf.
[4] Id. Industries in critical sectors include healthcare, transport, police, recruitment, and the legal system, while technologies of critical use include such technologies with a risk of death, damage or injury, or with legal ramifications.
[5] EC, A European strategy for data, COM (2020) 66 (Feb. 19, 2020), available at https://ec.europa.eu/info/files/communication-european-strategy-data_en.
[6] EC, Report on the safety and liability implications of Artificial Intelligence, the Internet of Things and robotics, COM (2020) 64 (Feb. 19, 2020), available at https://ec.europa.eu/info/files/commission-report-safety-and-liability-implications-ai-internet-things-and-robotics_en.
[7] EC, White Paper on Artificial Intelligence: Public consultation towards a European approach for excellence and trust, COM (2020) (July 17, 2020), available at https://ec.europa.eu/digital-single-market/en/news/white-paper-artificial-intelligence-public-consultation-towards-european-approach-excellence.
[8] EC, Artificial intelligence – ethical and legal requirements, COM (2020) (June 2020), available at https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12527-Requirements-for-Artificial-Intelligence.
[10] European Parliament, Setting up a special committee on artificial intelligence in a digital age, and defining its responsibilities, numerical strength and term of office (June 18, 2020), available at https://www.europarl.europa.eu/doceo/document/TA-9-2020-0162_EN.html; the European Parliament is also working on a number of other issues related to AI, including: the civil and military use of AI (legal affairs committee); AI in education, culture and the audio-visual sector (culture and education committee); and the use of AI in criminal law (civil liberties committee).
[11] European Parliament, News Report, AI rules: what the European Parliament wants (Oct. 21, 2020), available at https://www.europarl.europa.eu/news/en/headlines/society/20201015STO89417/ai-rules-what-the-european-parliament-wants.
[12] European Parliament, Parliament leads the way on first set of EU rules for Artificial Intelligence (Oct. 20, 2020), available at https://www.europarl.europa.eu/news/en/press-room/20201016IPR89544/.
[13] In addition, the Parliament announced that it had approved two separate legislative initiative reports calling on the Commission to address and tackle current shortcomings in the online environment in its Digital Services Act (“DSA”) package, due to be presented in December 2020. In particular, the Parliament noted that the EU aims to shape the digital economy at the EU level, as well as set the standards for the rest of the world. In addition, the Parliament outlined in its reports that all digital service providers established in non-EU must adhere to the DSA’s rules when their services are also aimed at consumers or users in the EU.
[14] European Parliament, Report with recommendations to the Commission on a framework of ethical aspects of artificial intelligence, robotics and related technologies (2020/2012 (INL)) (Oct. 8, 2020), available at https://www.europarl.europa.eu/doceo/document/A-9-2020-0186_EN.pdf; European Parliament, Resolution of 20 October 2020 with recommendations to the Commission on a framework of ethical aspects of artificial intelligence, robotics and related technologies (2020/2012 (INL)) (Oct. 20, 2020), available at https://www.europarl.europa.eu/doceo/document/TA-9-2020-0275_EN.pdf.
[15] Press Release, European Parliament, Parliament leads the way on first set of EU rules for Artificial Intelligence (Oct. 20, 2020), available at https://www.europarl.europa.eu/news/en/press-room/20201016IPR89544/.
[17] Press Release, European Parliament, Parliament leads the way on first set of EU rules for Artificial Intelligence (Oct. 20, 2020), available at https://www.europarl.europa.eu/news/en/press-room/20201016IPR89544/.
[18] European Parliament, Report with recommendations to the Commission on a civil liability regime for artificial intelligence (2020/2014 (INL)) (Oct. 5, 2020), available at https://www.europarl.europa.eu/doceo/document/A-9-2020-0178_EN.pdf; European Parliament, Resolution of 20 October 2020 with recommendations to the Commission on a civil liability regime for artificial intelligence (2020/2014 (INL)), available at https://www.europarl.europa.eu/doceo/document/TA-9-2020-0276_EN.pdf.
[19] European Parliament, Report on intellectual property rights for the development of artificial intelligence technologies (2020/2015(INI)) (Oct. 2, 2020), available at https://www.europarl.europa.eu/doceo/document/A-9-2020-0176_EN.pdf; European Parliament, Resolution of 20 October 2020 on intellectual property rights for the development of artificial intelligence technologies (2020/2015(INI)) (Oct. 20, 2020), available at https://www.europarl.europa.eu/doceo/document/TA-9-2020-0277_EN.pdf.
[20] Innovative And Trustworthy AI: Two Sides Of The Same Coin, Position paper on behalf of Denmark, Belgium, the Czech Republic, Finland, France, Estonia, Ireland, Latvia, Luxembourg, the Netherlands, Poland, Portugal, Spain and Sweden, available at https://em.dk/media/13914/non-paper-innovative-and-trustworthy-ai-two-side-of-the-same-coin.pdf; see also https://www.euractiv.com/section/digital/news/eu-nations-call-for-soft-law-solutions-in-future-artificial-intelligence-regulation/.
[21] Stellungnahme der Bundesregierung der Bundesrepublik Deutschland zum Weißbuch zur Künstlichen Intelligenz – ein europäisches Konzept für Exzellenz und Vertrauen, COM (2020) 65 (June 29, 2020), available at https://www.ki-strategie-deutschland.de/files/downloads/Stellungnahme_BReg_Weissbuch_KI.pdf; see also Philip Grüll, Germany calls for tightened AI regulation at EU level, Euractiv (July 1, 2020), available at https://www.euractiv.com/section/digital/news/germany-calls-for-tightened-ai-regulation-at-eu-level/.
[22] Deutscher Bundestag, Enquete-Kommission, Künstliche Intelligenz – Gesellschaftliche Verantwortung und wirtschaftliche, soziale und ökologische Potenziale, Kurzzusammenfassung des Gesamtberichts (Oct. 28, 2020), available at https://www.bundestag.de/resource/blob/801584/102b397cc9dec49b5c32069697f3b1e3/Kurzfassung-des-Gesamtberichts-data.pdf.
[23] UK ICO, Guidance on AI and data protection (July 30, 2020), available at https://ico.org.uk/for-organisations/guide-to-data-protection/key-data-protection-themes/guidance-on-ai-and-data-protection/.
[24] Examples of such privacy-enhancing techniques include perturbation or adding ‘noise’, synthetic data, and federated learning.
[25] On the topic of data minimization, see further the European Data Protection Board’s (“EDPB”) Draft Guidelines on the Principles of Data Protection by Design and Default under Article 25 of the GDPR, adopted on October 20, 2020 after a public consultation and available here.
[26] H.R. 2575, 116th Congress (2019-2020).
[27] The Ripon Advance, GOP senators praise House passage of AI in Government Act (Sept. 16, 2020), available at https://riponadvance.com/stories/gop-senators-praise-house-passage-of-ai-in-government-act/?_sm_au_=iVV6kKLFkrjvZrvNFcVTvKQkcK8MG; Rob Portman, House Passes Portman, Gardner Bipartisan Legislation to Improve Federal Government’s Use of Artificial Intelligence (Sept. 14, 2020), available at https://www.portman.senate.gov/newsroom/press-releases/house-passes-portman-gardner-bipartisan-legislation-improve-federal?_sm_au_=iVV6kKLFkrjvZrvNFcVTvKQkcK8MG.
[28] Robin Kelly, Kelly, Hurd Introduce Bipartisan Resolution to Create National Artificial Intelligence Strategy (Sept. 16, 2020), available at https://robinkelly.house.gov/media-center/press-releases/kelly-hurd-introduce-bipartisan-resolution-to-create-national-artificial?_sm_au_=iVV6kKLFkrjvZrvNFcVTvKQkcK8MG; H.Con.Res. 116, 116th Congress (2019-2020).
[29] Bipartisan Policy Center, A National AI Strategy (Sept. 1, 2020), available at https://bpcaction.org/wp-content/uploads/2020/09/1-Pager-on-National-AI-Strategy-Resolution-.pdf?_sm_au_=iVV6kKLFkrjvZrvNFcVTvKQkcK8MG.
[30] On September 10, the House Budget Committee held a hearing to discuss the impact of Artificial Intelligence on the U.S. economy, and specifically on what role technology should play in the country’s recovery post-COVID-19. Witness Darrell West, Ph.D., of Brookings Institution warned that the rapid integration of AI technologies developed in the private sector could affect the American workforce by causing job losses and job dislocation.
[31] H.R. 8390, 116th Congress (2019-2020).
[32] Paul D. Tonko, Tonko, Reschenthaler Introduce Artificial Intelligence Education Act (Sept. 24, 2020), available at https://tonko.house.gov/news/documentsingle.aspx?DocumentID=3142.
[33] United States Patent and Trademark Office, USPTO releases report on artificial intelligence and intellectual property policy (Oct. 6, 2020), available at https://www.uspto.gov/about-us/news-updates/uspto-releases-report-artificial-intelligence-and-intellectual-property?_sm_au_=iVV6kKLFkrjvZrvNFcVTvKQkcK8MG.
[34] United States Patent and Trademark Office, Public Views on Artificial Intelligence and Intellectual Property Policy (Oct. 2020), available at https://www.uspto.gov/sites/default/files/documents/USPTO_AI-Report_2020-10-07.pdf. On October 30, 2019, the USPTO also issued a request for comments on Intellectual Property Protection for Artificial Intelligence Innovation, on IP policy areas other than patent law. The October 2020 USPTO publication summarizes the responses by commentators at Part II from p. 19 of the Report onwards.
[37] Alice Corp. Pty. Ltd. v. CLS Bank Int’l, 573 U.S. 208, 221 (2014); Mayo Collaborative Servs. v. Prometheus Labs., Inc., 566 U.S. 66 (2012).
[38] In re Wands 858 F.2d 731 (Fed. Cir. 1988).
[41] H.R. __ 116th Congress (2019-2020).
[42] For more information, please see our legal updates Accelerating Progress Toward a Long-Awaited Federal Regulatory Framework for Autonomous Vehicles in the United States and 2019 Artificial Intelligence and Automated Systems Annual Legal Review.
[43] Energy & Commerce Committee Republicans, Press Release, E&C Republicans Continue Leadership on Autonomous Vehicles (Sept. 23, 2020), available at https://republicans-energycommerce.house.gov/news/press-release/ec-republicans-continue-leadership-on-autonomous-vehicles/.
[44] State regulatory activity has continued to accelerate, adding to the already complex mix of regulations that apply to companies manufacturing and testing HAVs. Over half of all U.S. states have enacted legislation related to autonomous vehicles; see further Nathan Benaich & Ian Hogarth, State of AI Report (Oct. 1, 2020), at 93, available at https://docs.google.com/presentation/d/1ZUimafgXCBSLsgbacd6-a-dqO7yLyzIl1ZJbiCBUUT4/edit#slide=id.g893233b74e_0_0; National Conference of State Legislatures, Autonomous Vehicles: Self-Driving Vehicles Enacted Legislation (Feb. 18, 2020), available at https://www.ncsl.org/research/transportation/autonomous-vehicles-self-driving-vehicles-enacted-legislation.aspx. As outlined in our 2019 Artificial Intelligence and Automated Systems Annual Legal Review, state regulations vary significantly. Also, in November 2020, Massachusetts voters are deciding on whether or not to add “mechanical” vehicle telematics data—real-time updates from a car’s sensors transmitted to an automaker’s private servers—to the list of information that Original Equipment Manufacturers (“OEMs”) have to share with independent mechanics under the state’s landmark “Right to Repair” law. Telematics data was purposefully excluded from the original 2013 law. If passed, the amendment would require automakers who want to do business in the state to make that data accessible through a smartphone app for owners starting in 2022. See Rob Stumpf, There’s Another Huge Right to Repair Fight Brewing in Massachusetts, The Drive (Oct. 13, 2020), available at https://www.thedrive.com/news/36980/theres-another-huge-right-to-repair-fight-brewing-in-massachusetts.
[45] European Commission, Press Release, New recommendations for a safe and ethical transition towards driverless mobility, COM (2020) (Sept. 18, 2020), available at https://ec.europa.eu/info/news/new-recommendations-for-a-safe-and-ethical-transition-towards-driverless-mobility-2020-sep-18_en.
[47] European Commission, Directorate-General for Research and Innovation, Independent Expert Report, Ethics of Connected and Automated Vehicles: Recommendations on road safety, privacy, fairness, explainability, and responsibility (Sept. 18, 2020), at 4, available here.
[48] EC, Connected and automated mobility in Europe, COM(2020) (June 22, 2020), available at https://ec.europa.eu/digital-single-market/en/connected-and-automated-mobility-europe.
[49] Bundesministerium für Verkehr und digitabe Infrastruktur, Gesetz zum autonomen Fahren (Oct. 2020), available at https://www.bmvi.de/SharedDocs/DE/Artikel/DG/gesetz-zum-autonomen-fahren.html; see also Josef Erl, Autonomes Fahren: Deutschland soll Weltspitze werden, Mixed.de (Oct. 31, 2020), available at https://mixed.de/autonomes-fahren-deutschland-soll-weltspitze-werden/.
[50] Daniel Delhaes, Deutsche Autoindustrie erwägt, ihre Datenschätze zu bündeln, Handelsblatt (July 9, 2020), available at https://www.handelsblatt.com/technik/sicherheit-im-netz/autonomes-fahren-deutsche-autoindustrie-erwaegt-ihre-datenschaetze-zu-buendeln/26164062.html?ticket=ST-2824809-tuIGjXYQywf7MHzRurpa-ap4.
The following Gibson Dunn lawyers prepared this client update: H. Mark Lyon, Frances Waldmann and Tony Bedel.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Artificial Intelligence and Automated Systems Group, or the following authors:
H. Mark Lyon – Palo Alto (+1 650-849-5307, mlyon@gibsondunn.com)
Frances A. Waldmann – Los Angeles (+1 213-229-7914,fwaldmann@gibsondunn.com)
Please also feel free to contact any of the following practice group members:
Artificial Intelligence and Automated Systems Group:
H. Mark Lyon – Chair, Palo Alto (+1 650-849-5307, mlyon@gibsondunn.com)
J. Alan Bannister – New York (+1 212-351-2310, abannister@gibsondunn.com)
Patrick Doris – London (+44 (0)20 7071 4276, pdoris@gibsondunn.com)
Kai Gesing – Munich (+49 89 189 33 180, kgesing@gibsondunn.com)
Ari Lanin – Los Angeles (+1 310-552-8581, alanin@gibsondunn.com)
Robson Lee – Singapore (+65 6507 3684, rlee@gibsondunn.com)
Carrie M. LeRoy – Palo Alto (+1 650-849-5337, cleroy@gibsondunn.com)
Alexander H. Southwell – New York (+1 212-351-3981, asouthwell@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Eric D. Vandevelde – Los Angeles (+1 213-229-7186, evandevelde@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33 180, mwalther@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
|
“As our planet increasingly faces the unpredictable consequences of climate change and resource depletion, urgent action is needed to adapt to a more sustainable model…To achieve more sustainable growth, everyone in society must play a role. The financial system is no exception. Re-orienting private capital to more sustainable investments requires a comprehensive rethinking of how our financial system works. This is necessary if the EU is to develop more sustainable economic growth, ensure the stability of the financial system, and foster more transparency and long-termism in the economy.” (Press release, European Commission: Sustainable Finance: Commission’s Action Plan for a greener and cleaner economy (8 March 2018)). |
The European Commission’s Sustainable Finance Action Plan[1] (the “Action Plan”) proposed a package of measures including, amongst other initiatives, a regulation imposing sustainability-related disclosures on financial market participants (“SFDR”[2]) and a regulation to establish an EU-wide common language (or taxonomy) to identify the extent to which economic activities can be considered sustainable (the “Taxonomy Regulation”[3]). This briefing note provides an overview of the Taxonomy Regulation and the SFDR and discusses their impact on private fund managers, including non-EU managers who market their funds into the EU and/or the United Kingdom under the applicable national private placement regimes.
Each of the Taxonomy Regulation and the SFDR apply to “financial market participants”, a term which is broadly defined and includes (amongst others): (i) alternative investment fund managers (“AIFMs”); and (ii) MiFID[4] investment firms that provide portfolio management services, and to “financial products” made available by them. “Financial products” include (amongst other things) alternative investment funds (“AIFs”) managed by AIFMs and portfolios managed by MiFID firms.
The term “financial market participant” clearly includes AIFMs which are authorised under the AIFMD[5]. There is a lack of clarity for non-EU AIFMs in the text of both pieces of legislation. However, according to guidance on the Taxonomy Regulation, the disclosure requirements on financial market participants, which build on the obligations in the SFDR should “apply to anyone offering financial products in the European Union, regardless of where the manufacturer of such products is based”. Consequently, it is clear that the disclosure obligations will apply to non-EU AIFMs that market their AIFs into the EEA (and the UK) pursuant to the national private placement regimes under Article 42 of the AIFMD.
SUSTAINABLE FINANCE DISCLOSURE REGULATION
The aim of the SFDR is to introduce harmonised requirements in relation to the disclosures to end investors on the integration of sustainability risks, on the consideration of adverse sustainability impacts, on sustainable investment objectives or on the promotion of environmental and/or social characteristics, in investment decision-making.
Many of the framework requirements under the SFDR will apply from 10 March 2021, although some of the requirements for funds with sustainable investment as an objective or which promote environmental and/or social characteristics will come into force on 1 January 2022 and 1 January 2023. In addition to the framework requirements, the SFDR is to be supplemented by more detailed requirements set out in the regulatory technical standards (“RTS”) which are yet to be finalised. The RTS should have applied from 10 March 2021. However, the European Commission has recently, in a letter addressed to certain trade associations, confirmed that there will be a delay in the application of the RTS requirements, although no date has yet been announced for their future application (there is some expectation that the application date will be closer to 1 January 2022).
The European Commission has, however, made clear that all of the requirements and general principles contained in the SFDR itself will remain applicable to firms from 10 March 2021. Fund managers are, therefore, expected to take a principles-based approach to compliance with the SFDR and evidence this on a best efforts basis. It is considered by the European Commission that firms are already likely complying with certain product-level disclosure requirements as a result of existing sectoral legislation. This seems, however, to be an overly optimistic view, as (for example) much of the sectoral legislation does not go into the level of prescription set out in the SFDR.
The disclosures required by the SFDR include both manager-level disclosures (i.e. at the level of the AIFM or MiFID investment firm) and also product-level disclosures (i.e. at the level of the AIF or portfolio). The disclosures must be made in pre-contractual information to investors, in periodic investor reporting and publicly on the manager’s website. Importantly, the SFDR does not apply only to managers of AIFs or portfolios with a sustainable investment objective or promoting environmental and/or social characteristics. While there are enhanced disclosures for such AIFs/portfolios, the SFDR requires disclosures to be made by all in-scope “financial market participants”.
Manager-level disclosures
At the level of the manager, a financial market participant must disclose the following:
- Information on its website about its policies on the integration of sustainability risks into its investment decision-making processes – in order to comply, managers will need to ensure that they integrate an assessment of not only all relevant financial risks, but also all relevant sustainability risks that may have a material negative impact on the financial return of investments made, into their due diligence processes[6]. This will require firms to review all relevant investment decision-making processes and policies in order to understand how sustainability risks are currently integrated (if at all).
- Information on its website regarding its consideration (or not) of principal adverse impacts of investment decisions on sustainability factors – firms will need to make a commercial decision on whether or not they will consider the principal adverse impacts of investment decisions on sustainability factors. To the extent that a firm decides to consider such impacts, it will be required to publish a statement on its website on its due diligence policies with respect to those impacts. Those firms who choose not to consider adverse impacts of investment decisions on sustainability factors will be required to publish and maintain on their websites clear reasons for why they do not do so, including (where relevant) information as to whether and when they intend to consider such adverse impacts.[7]
- Information in remuneration policy and on its website as to how its remuneration policy is consistent with the integration of sustainability risks – firms will be required to revisit their existing remuneration policies and include in those policies and on their websites information on how the remuneration policies promote sound and effective risk management with respect to sustainability risks and how the structure of remuneration does not encourage excessive risk-taking with respect to sustainability risks and is linked to risk-adjusted performance.
Product-level disclosures
At the level of each AIF/portfolio (regardless of whether the AIF/portfolio has a sustainable investment objective or promotes environmental and/or social characteristics), the following must be disclosed:
- Information in pre-contractual disclosures to investors about the manner in which sustainability risks are integrated into investment decision-making and the likely impacts of sustainability risks on the returns of the AIF/portfolio – a financial market participant may decide at product-level that sustainability risks are not relevant to the particular AIF/portfolio. In such case, clear reasons must be given as to why they are not relevant.
- Information in pre-contractual disclosures to investors as to whether and how the particular AIF/portfolio considers principal adverse impacts on sustainability factors (by 30 December 2022) – a financial market participant may decide not to consider principal adverse impacts of their investment decisions on sustainability factors at the level of the AIF/portfolio. In which case, clear reasons must be provided as to why they are not taken into account.
- Information in periodic reports on principal adverse impacts on sustainability factors (from 1 January 2022).
For an AIFM, the pre-contractual disclosures mean the disclosures which an AIFM is required to make to investors before they invest in an AIF pursuant to Article 23 of the AIFMD and the periodic reports mean the annual report which is required to be produced pursuant to Article 22 of the AIFMD. In the context of a MiFID investment firm, the pre-contractual disclosures mean the information that is required to be provided to a client before providing services pursuant to Article 24(4) of MiFID. The periodic reports for MiFID firms refer to the reports required to be provided to clients pursuant to Article 25(6) of MiFID.
Disclosures for sustainable products
The SFDR identifies that products with “various degrees of ambition” have been developed to date. Therefore, the SFDR draws a distinction between financial products which have a sustainable investment objective and those which promote environmental and/or social characteristics. Different disclosure requirements apply to each.
Products promoting environmental and/or social characteristics
In relation to financial products promoting environmental and/or social characteristics (provided that the investee companies in which investments are to be made follow good governance practices[8]) (“Article 8 AIFs/portfolios”), the following must be disclosed at product level in the investor pre-contractual disclosures:
- information on how those characteristics are met;
- where an index has been designated as a reference benchmark, information on whether and how the index is consistent with those characteristics; and
- information as to where than index can be found.
Information is also required in the periodic reports for the AIF/portfolio on the extent to which the environmental or social characteristics are met. As this information relates to complete financial years, this requirement will apply from 1 January 2022.
In addition, this information must be published and maintained on the manager’s website together with information on the methodologies used to assess, measure and monitor the environmental and/or social characteristics, including data sources, screening criteria for the underlying assets and the relevant sustainability factors used to measure the environmental or social characteristics.
Products with a sustainable investment objective
In the case of an AIF/portfolio with a sustainable investment objective (“Article 9 AIFs/portfolios”) where an index has been designated as a reference benchmark, product-level pre-contractual disclosures must include:
- information on how the designated index is aligned with the investment objective; and
- an explanation as to why and how the designated index aligned with the objective differs from a broad market index.
Where no index has been designated, pre-contractual disclosures will include an explanation of how the sustainable investment objective is to be attained. Where the AIF/portfolio has a reduction in carbon emissions as its objective, the information to be disclosed must include the objective of low carbon emission exposure in view of achieving the long-term global warming objectives of the Paris Agreement.
Information is also required to be disclosed in the periodic reports for the AIF/portfolio on: (i) the overall sustainability-related impact of the AIF/portfolio by means of relevant sustainability indicators; and (ii) where an index is designated as a reference benchmark, a comparison between the overall sustainability-related impact with the impacts of the designated index and of a broad market index through sustainability indicators.
In addition, this information must be published and maintained on the manager’s website together with information on the methodologies used to assess, measure and monitor the impact of the sustainable investments selected for the AIF/portfolio, including data sources, screening criteria for the underlying assets and the relevant sustainability factors used to measure the environmental or social characteristics.
TAXONOMY REGULATION
The Taxonomy Regulation establishes an EU-wide classification system to provide a common language (i.e. taxonomy) to define environmentally sustainable economic activities. It also sets out six environmental objectives, including climate change mitigation, climate change adaption and transition to a circular economy and provides that for an economic activity to be environmentally sustainable it must make a “substantial contribution” to at least one of the environmental objectives and not cause any significant harm to any of the others.
The Taxonomy Regulation also amends the SFDR in certain respects as regards disclosures required for financial products that have a sustainable investment objective or promote environmental characteristics and requires negative disclosure for those AIFs/portfolios which do not have such objectives/characteristics.
An economic activity is considered to be environmentally sustainable for the purposes of the Taxonomy Regulation if:
1) it makes a “substantial contribution” to one or more of the six environmental objectives;
2) it does “no significant harm” to any of the six environmental objectives;
3) it is carried out in accordance with certain minimum safeguards[9]; and
4) it complies with technical screening criteria[10].
The six environmental objectives are:
- climate change mitigation;
- climate change adaptation;
- sustainable use and protection of water and marine resources;
- transition to a circular economy;
- pollution prevention and control; and
- protection and restoration of biodiversity and ecosystems.
The Annex to this alert provides an overview of what “substantial contribution” and “significant harm” means for each of the six environmental objectives.
Amendments to the SFDR
The Taxonomy Regulation makes certain amendments to the SFDR in relation to the pre-contractual and periodic reporting requirements for Article 8 AIFs/portfolios and Article 9 AIFs/portfolios where they invest in an economic activity that contributes to one or more of the environmental objectives set out in the Taxonomy Regulation. Additional pre-contractual and periodic disclosures are required for such products, including: information on the environmental objective(s) which is contributed to and a description of how and to what extent the investments are in economic activities that qualify as environmentally sustainable under the Taxonomy Regulation.
The Taxonomy Regulation also makes changes for other financial products too which are neither an Article 8 AIF/portfolio or Article 9 AIF/portfolio by requiring a negative disclosure using the following words: “The investments underlying this financial product do not take into account the EU criteria for environmentally sustainable economic activities.”
The amendments made to the SFDR by the Taxonomy Regulation will apply from 1 January 2022 in some cases and 1 January 2023 in others, depending on which environmental objective is contributed to by the AIF/portfolio.
BREXIT: IMPACT IN THE UK
The UK left the EU in January 2020 and the agreed transition period will expire on 31 December 2020. As the disclosure obligations under the SFDR and the Taxonomy Regulation will not apply until after the end of the transition period, they do not form part of the so-called “retained EU law” in the UK from 1 January 2021. In relation to the Taxonomy Regulation, for example, the UK government has stated that it will retain the taxonomy framework, including the high level environmental objectives, however the Regulation’s disclosure requirements will not form part of this (given that they are set to apply as from a date post-transition period). As the delegated legislation containing the technical standards has not, so far, been published by the European Commission, the government has not yet been in a position to comment as to the extent of the UK’s alignment with the EU on this after the transition period[11].
Also, with regard to the SFDR, the Financial Services (Miscellaneous Amendments) (EU Exit) Regulations 2020 provide that the SFDR will continue to apply in part in the UK when the Brexit transition period ends, with key omissions relating, for example, to the upcoming technical standards and financial product-specific disclosure requirements.
ANNEX
| Environmental objective | “Substantial contribution” | “Significant harm”[12] |
|
Climate change mitigation |
The process of holding the increase in the global average temperature to below 2°C and pursuing efforts to limit it to 1.5°C above pre-industrial levels, as set out in the Paris Agreement. The economic activity will substantially contribute to the stabilisation of greenhouse gas concentrations in the atmosphere, including through process or product innovation by, for example:
|
Significant greenhouse gas emissions. |
|
Climate change adaptation |
The process of adjustment to actual and expected climate change and its impacts. Broadly, this includes substantially reducing the risk of the adverse impact, or substantially reducing the adverse impact, of the current and expected future climate on (i) other people, nature or assets; or (ii) the economic activity itself, in each case without increasing the risk of an adverse impact on other people, nature and assets. |
An increased adverse impact of the current and expected climate on people, nature and assets. |
|
Sustainable use and protection of water and marine resources |
The activity substantially contributes to achieving the good status of water bodies or marine resources, or to preventing their deterioration, through certain means, including, for example, through improving water management and efficiency. |
Detriment to the good status, or where relevant the good ecological potential, of water bodies, including surface waters and groundwaters, or to the good environmental status of marine waters. |
|
Transition to a circular economy |
Maintaining the value of products, materials and other resources in the economy for as long as possible, enhancing their efficient use in production and consumption. The activity substantially contributes to the circular economy by (among other things):
|
|
|
Pollution prevention and control |
The economic activity will substantially contribute to the protection and restoration of biodiversity and ecosystems by, for example, sustainable agricultural practices, sustainable forest management and nature and biodiversity conservation. |
Detriment to a significant extent to the good condition and resilience of ecosystems or where that activity is detrimental to the conservation status of habitats and species, including those of community interest. |
|
Protection and restoration of biodiversity and ecosystems |
The economic activity will substantially contribute to the protection and restoration of biodiversity and ecosystems by, for example, sustainable agricultural practices, sustainable forest management and nature and biodiversity conservation. |
Detriment to a significant extent to the good condition and resilience of ecosystems or where that activity is detrimental to the conservation status of habitats and species, including those of community interest. |
____________________________
[1] Communication from the Commission to the European Parliament, the European Council, the Council, the European Central Bank, the European Economic and Social Committee and the Committee of the Regions – Action Plan: Financing Sustainable Growth, 8 March 2018
[2] Regulation (EU) 2020/852 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector
[3] Regulation (EU) 2019/2088 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088
[4] Markets in Financial Instruments Directive (Directive 2014/65/EU)
[5] Alternative Investment Fund Managers Directive (Directive 2011/61/EU)
[7] Note that large financial market participants (broadly, those with an average number of 500 employees during the financial year) will not have the option. From 30 June 2021 they must consider adverse impacts of their investment decisions on sustainability factors.
[8] “Good governance practices” is not defined in the SFDR. It is clear from the text that the European legislators intended it to be interpreted widely. Examples of good governance practices include: sound management structures, employee relations, remuneration of staff and tax compliance.
[9] OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organisation on Fundamental Principles and Rights at Work and the International Bill of Human Rights.
[10] These technical screening criteria will be established by the European Commission in accordance with the provisions of the Taxonomy Regulation.
[11] Letter from John Glen, Economic Secretary to the Treasury, to Sir William Cash, Chair of the European Scrutiny Committee: 9355/18: Proposal for a Regulation of the European Parliament and of the Council on the establishment of a framework to facilitate sustainable investment (28 May 2020)
[12] Further details regarding “no significant harm” to be set out in the technical screening criteria.
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 in the firm’s Financial Institutions practice group, or the following authors in London:
Michelle M. Kirschner (+44 (0)20 7071 4212, mkirschner@gibsondunn.com)
Chris Hickey (+44 (0)20 7071 4265, chickey@gibsondunn.com)
Martin Coombes (+44 (0)20 7071 4258, mcoombes@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On October 23, 2020, the UK Serious Fraud Office published a new chapter from its internal Operational Handbook, which it describes as “comprehensive guidance on how we approach Deferred Prosecution Agreements (DPAs), and how we engage with companies where a DPA is a prospective outcome.”
At the time of its publication, the Director of the SFO, Lisa Osofsky, remarked, “Publishing this guidance will provide further transparency on what we expect from companies looking to co-operate with us.” Director Osofsky’s full remarks are here: https://www.sfo.gov.uk/2020/10/23/serious-fraud-office-releases-guidance-on-deferred-prosecution-agreements/.
The 2020 DPA Guidance (“the Guidance”) is here: https://www.sfo.gov.uk/publications/guidance-policy-and-protocols/sfo-operational-handbook/deferred-prosecution-agreements/.
In Director Osofsky’s remarks, it is worth observing that she states “DPAs require the company to admit to the misconduct, pay a financial penalty and agree to adhere to conditions set out by the prosecutor to ensure future co-operation and compliance.”
In fact, the underlying statute that created DPAs is clear that a party need not admit guilt[1] and the new Guidance, when addressing the content of the Statement of Facts, also makes plain it is not necessary.[2] There has therefore been no change in the law or the SFO’s requirements with respect to completing a DPA.
The Guidance contains very little new content compared with what is already set out in the DPA Code of Practice (published in January 2014),[3] which is referenced almost 100 times in the Guidance. It should not be forgotten that the DPA Code of Practice remains in force and is the lead document for consideration, with its publication and consideration required by law and it having been laid before Parliament.[4]
So what is new?
- The Guidance contains a section on “Parallel Investigations” with other agencies that counsels the prosecutor to ensure that they coordinate early with other agencies and de-conflict. The purpose of the Guidance is to facilitate smooth and expeditious investigations that do not prejudice one another. Whilst this detail is not in the DPA Code of Practice, it is covered extensively in other prosecution guidance.[5]
- There is a section in the Guidance on the naming of individuals in the Statement of Facts that accompanies the DPA and contains a description of the conduct. The Guidance counsels the prosecutor to consider redaction or anonymization. In practice, this has been the case for the majority of Statements of Fact agreed to date; alternatively, publication has been delayed until the conclusion of the trial of individuals to avoid prejudice to their trials.
- Under “Corporate compliance programmes,” the prosecutor is counselled when requiring remediation terms to consider whether it is necessary and proportionate to require the company to adopt the use of data analytics to test compliance controls and behaviour.
- The section on “Monitors” is interesting for what it does not say, rather than what it does say. It does not repeat the guidance provided in the DPA Code of Practice that “An important consideration for entering into a DPA is whether [the Company] already has a genuinely proactive and effective corporate compliance programme. The use of monitors should therefore be approached with care.” The language in the DPA Code of Practice signals a presumption that those offered a DPA are unlikely to be required to have a monitor in place. Rarely will a term requiring a monitor be consistent with the DPA Code of Practice and therefore meet the statutory requirement for terms to be “fair, reasonable and proportionate.”[6]
- On “Sale or merger” the Guidance suggests that DPAs should include a term that requires the consent of the SFO to such a sale or merger. This is new but so far has not featured as a term in any of the DPAs agreed to date.[7] Prior DPAs make it a requirement to make it a term of a subsequent sale or merger that the acquirer be bound by the terms of the DPA.
- The section on “Compensation” provides more detail than the DPA Code of Practice. However, it does no more than rehearse the well-established criminal law principles that determine when compensation should be sought and awarded, and which have been applied by the Court in prior DPAs.
- Under a heading enticingly titled “Calculating the profits to be disgorged,” the Guidance disappoints in saying only that “Calculating the profits achieved on account of the relevant conduct may not be a straightforward exercise; and it may be helpful to obtain accountancy expertise.”
- The last four DPA’s have imposed an obligation to self-report serious new misconduct that becomes known during the term of the DPA. In a section of the Guidance headed “Compliance with terms,” it states that “If any suspected wrongdoing relating to the Company is self-reported, or is otherwise discovered, during the term of the DPA, the prosecutor should consider what if any impact such conduct has on the Company’s obligations under the DPA, the SFO’s investigation of the Company [sic].” If a company self-reports pursuant to a term in a DPA, it will not be in breach. But if it were discovered that the company failed to self-report, that may, subject to the rules of evidence, be treated by the SFO as a breach. Further, the self-reporting or discovery of new serious misconduct has the potential for the SFO to seek a variation of the terms of the DPA in order to amend or supplement its terms.[8]
The commission of a further serious offence, let alone the suspicion of one during the term of a DPA, would not amount to a breach of a DPA without an express term to that affect. To date, no DPA has contained such a term. In most instances, it would be impractical given the length of time it typically takes to investigate and prosecute new cases. By the time the SFO established that an offence had been committed, the DPA will likely have expired. Any breach proceedings in respect of the DPA must commence during the term of the DPA.[9] A term that would make it possible to breach a DPA in the event of an unproven suspicion would arguably not be fair, reasonable and proportionate.
Self-Reporting
Self-reporting features in a non-exhaustive list of public interest factors in the DPA Code of Practice that point in favour of a DPA instead of prosecution. Each of the specified public interest factors along with others that might be case-specific are to be balanced by the prosecutor in exercising their discretion whether to conclude a case by way of a DPA.[10] It has always been the case that self-reporting is not essential, albeit a factor that will carry considerable weight. This was affirmed in the January 2020 Airbus DPA where the court said “…there is no necessary bright line between self-reporting and co-operation.” If it were unclear, the Guidance now makes this plain at footnote 15, which provides, “[t]he failure of a Company to self-report is not a bar to DPA negotiations per se but must be considered as a factor when assessing whether a DPA is in the public interest.” [11]
The Guidance also makes clear that a self-report does not have to be immediate by stating, “Voluntary self-reporting suspected wrongdoing within a reasonable time of those suspicions coming to light is an important aspect of co-operation.” This mirrors the language in the DPA Code of Practice, so it also does not mark a change in policy.[12]
Conclusion
The Guidance does not materially assist companies to understand what the SFO expects in terms of co-operation beyond what was previously published. Those aspects of the Guidance that are not already in the DPA Code of Practice are found in alternative guidance or in prior DPAs, are matters of procedure addressed specifically to prosecutors or are light on detail.
Consistent with Director Osofsky’s commendation of the SFO’s most recent DPA for having “real teeth,”[13] the Guidance suggests that the SFO is considering seeking increasingly onerous terms in DPAs. The challenge for the SFO will be that, should it continue down such a track, the incentives that a DPA is designed to offer will be diminished, ultimately disincentivizing the co-operation they are designed to encourage.
______________________
[1] Crime and Courts Act 2013, Schedule 17, paragraph 5(1). See also DPA Code of practice, paragraph 6.3 which confirms guilt need not be admitted but the contents and meaning of key documents referred to in the Statement of Facts will require admission.
[2] “There is no requirement for formal admissions of guilt in respect of the offences charged on the indictment.” Guidance, section “Statement of Facts”
[3] https://www.cps.gov.uk/sites/default/files/documents/publications/dpa_cop.pdf.
[4] Crime and Courts Act 2013, Schedule 17, paragraph 6.
[5] Such as the Director of Public Prosecutions’ “Guidance on the handling of cases where the jurisdiction to prosecute is shared with prosecuting authorities overseas,” (https://www.cps.gov.uk/publication/directors-guidance-handling-cases-where-jurisdiction-prosecute-shared-prosecuting ), “Annex A – Eurojust Guidelines For Deciding ‘Which Jurisdiction Should Prosecute?’”
(https://www.eurojust.europa.eu/sites/default/files/Publications/Reports/2016_Jurisdiction-Guidelines_EN.pdf)
and the “Agreement for Handling Criminal Cases with Concurrent Jurisdiction between the United Kingdom and the United States of America.”
(https://www.cps.gov.uk/sites/default/files/documents/legal_guidance/Agreement-handling-criminal-cases-concurrent-jurisdiction-UK-USA.pdf).
[6] Crime and Courts Act 2013, Schedule 17, paragraphs 7(1)(b) and 8(1)(b).
[7] At the time of writing there remains an unpublished DPA in respect of Airline Services Limited.
[8] See also Crime and Courts Act 2013, Schedule 17, paragraph 10.
[9] Crime and Courts Act 2013, Schedule 17, paragraph 9(1).
[10] DPA Code of Practice, paragraphs 2.6 and 2.8.
[11] See also SFO v Airbus SE, January 31, 2020 at paragraph 68.
[12] DPA Code of Practice, paragraph 2.8.2 i.
[13] Future Challenges in Economic Crime: A View from the SFO, Royal United Services Institute, October 8, 2020, (https://www.sfo.gov.uk/2020/10/09/future-challenges-in-economic-crime-a-view-from-the-sfo/).
This client alert was prepared by Sacha Harber-Kelly and Steve Melrose.
Mr. Harber-Kelly is a former prosecutor at the SFO and was appointed to lead the SFO’s engagement in the cross-governmental working group which devised the DPA legislative framework, and subsequently appointed to draft the DPA Code of Practice, which sets out how prosecutors will operate the DPA regime.
Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments. If you would like to discuss this alert in detail, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following members of the firm’s UK disputes practice.
Philip Rocher (+44 (0)20 7071 4202, procher@gibsondunn.com)
Patrick Doris (+44 (0)20 7071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly (+44 (0)20 7071 4205, sharber-kelly@gibsondunn.com)
Charles Falconer (+44 (0)20 7071 4270, cfalconer@gibsondunn.com)
Allan Neil (+44 (0)20 7071 4296, aneil@gibsondunn.com)
Steve Melrose (+44 (0)20 7071 4219, smelrose@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Since the last presidential election, there have been several regulatory developments that go to the heart of the U.S. dual banking system – the quintessentially American system under which banking entities may choose either a state or federal charter. These developments have occurred at the Office of the Comptroller of the Currency (OCC), the regulator of national banks. Perceived as increasing both the number of federally regulated entities and the scope of preemption of state consumer law, these developments have been challenged by state regulators in New York, California and Illinois, and others, in lawsuits that are now pending. Potential issues for the upcoming election, therefore, may be the extent of state-federal regulatory balance and the degree of judicial control over federal regulatory actions. On the latter point, litigation over these developments will play out with a changed Supreme Court and one at which certain Justices have begun to question the traditional deference paid to regulators’ interpretations of the statutes they administer. This Alert discusses the relevant issues at stake.
I. Fintech/Payments Charters
At the end of the Obama Administration, then-Comptroller Thomas Curry stated that the OCC had the authority under the National Bank Act to grant special purpose national bank charters to fintech companies “engaged in the business of banking,” including to companies that did not take deposits. After his departure, the OCC slowly fleshed out a framework for evaluating such charters. Late this August, Acting Comptroller Brian Brooks seemed to accelerate this process by stating that the OCC was prepared to begin accepting charter applications for national banks engaged only in payments activities.The OCC’s actions were challenged by state financial regulators. Most significantly, the New York Department of Financial Services (NYDFS) sued the OCC regarding the special purpose national bank charter. Last fall, NYDFS won an initial victory in the United States District Court for the Southern District of New York, where Judge Victor Marrero held that the suit was ripe for adjudication and that the OCC had no authority to issue charters for non-deposit taking banks other than those that Congress had specifically authorized, such as national trust banks.[1]
The OCC appealed this case to the U.S. Court of Appeals for the Second Circuit (Second Circuit), where briefs have been filed, including on the issue of whether, absent congressional authorization of exceptions, a federal charter to engage in the “business of banking” in the National Bank Act always requires deposit taking.
II. The OCC’s “Valid When Made” and “True Lender” Regulations
The OCC’s second action was to promulgate, in June 2020, a final regulation that would overturn the decision of the Second Circuit in the Madden v. Midland Funding, LLC case.[2] In Madden, the Second Circuit held that a borrower could assert a usury defense against a nonbank company that had purchased a loan originally made by a national bank, even though the loan when originally made was not usurious because of the National Bank Act’s interest-rate exportation provision, 12 U.S.C. § 85 (Section 85), which allows a national bank to charge nationally the interest rate permitted under the laws of the state in which the bank is located.[3]
The OCC’s regulation (Valid When Made Regulation) overrides the Madden holding and gives nonbank purchasers of loans from national banks and federal thrifts, including fintech lending companies that have national bank lending partners, the same usury protection as is available to national banks under Section 85.[4]
In late July, the States of California, Illinois and New York sued the OCC in the United States District Court for the Northern District of California, seeking declaratory and injunctive relief. The States argued that the Valid When Made Regulation was invalid as arbitrary and capricious and contrary to law, and that only Congress had the authority to overrule the Madden decision.[5]
Finally, just yesterday, the OCC finalized a second regulation relevant to this area. This regulation (True Lender Regulation) clarifies when a national bank or federal thrift is the “lender” for purposes of Section 85 and other statutes. It states that a national bank or federal thrift is the true lender if, as of the date of origination, it (1) is named as the lender in the loan agreement or (2) funds the loan.[6] The rule also specifies that if, as of the date of origination, one bank is named as the lender in the loan agreement for a loan and another bank funds that loan, the bank that is named as the lender in the loan agreement makes the loan.[7] State regulators may be expected to claim that, taken together, the True Lender Regulation and Valid When Made Regulation will facilitate so-called “rent a bank” schemes by nonbank lenders to avoid state usury and other consumer protection requirements.
III. Dual Banking System Effects
The special purpose national bank charter and Valid When Made and True Lender Regulations clearly implicate the dual banking system and particularly as applied to fintech companies. For example, to the extent that payments companies currently engage in money transmission, they must become licensed in every state having jurisdiction. A single federal non-depository bank charter for such entities is appealing from an efficiency standpoint and would likely attract many applicants. Similarly, some fintech lending companies partner with bank lenders, with the fintech acquiring the loan from the bank after it is made and then seeking to benefit from federal preemption. Certain states have alleged that this practice creates loopholes in their licensing and consumer protection schemes. It is therefore not surprising that states and regulators in jurisdictions with active consumer regulation have chosen to go to court to challenge the OCC’s actions.
IV. Preemption and Judicial Deference: The Watters and Cuomo Cases and Beyond
It has been some time since significant decisions were handed down in cases involving the OCC and the National Bank Act – one has to look at Waters v. Wachovia Bank, N.A. in 2007 and Cuomo v. The Clearing House Association L.L.C. in 2009, both in the United States Supreme Court. Both cases were closely decided; Waters was 5-3 and Cuomo was 5-4. Waters held that national bank operating subsidiaries – subsidiaries that engaged in activities permissible for national banks – were not subject to state registration and examination requirements, but only the “visitorial powers” of the OCC.[8] Cuomo held that it was not a reasonable interpretation of the “visitorial powers” provision of the National Bank Act to preempt state enforcement of – as opposed to supervision with respect to – state consumer law against national banks.[9] Waters thus upheld the OCC’s position with respect to one aspect of the preemptive effect of the National Bank Act’s visitorial powers clause, while Cuomo rejected one. Interestingly, although the cases were closely decided, the split of the Justices was unusual: Justice Scalia and Chief Justice Roberts joined Justice Stevens’ dissent in Waters that favored the state regulators, and Justice Scalia wrote the opinion in Cuomo, which was joined by the Court’s more liberal Justices, holding that the OCC could not preempt state enforcement.[10]
Since the two cases were decided, the composition of the Supreme Court has changed substantially, and in particular, Justices Gorsuch, Kavanaugh, and Barrett have replaced Justices Scalia, Kennedy, and Ginsburg. The changed composition has resulted in speculation that the classic Chevron doctrine of deference to administrative agency interpretations of ambiguous statutes may, in an appropriate case, be refined. Justice Ginsburg wrote a classic example of Chevron deference in her opinion upholding the OCC in the famous VALIC bank annuities case. Justice Gorsuch, like Justice Thomas, has publicly criticized Chevron.
It is of course speculative whether any of the current actions against the OCC will reach the Supreme Court or how the Court might rule in them. It is certainly possible, however, that despite some commentators’ wishes, the ultimate resolution to the issues raised by the fintech/payments charter and Valid When Made/True Lender regulations will depend not on policy judgments, but rather such traditional approaches to statutory construction as textual analysis of the National Bank Act and applying canons of construction, and without exhibiting Merovingian supineness to the OCC’s interpretation.
V. The National Trust Bank Charter
With regulation unsettled, one of the special purpose national bank entities that bears a close look by companies seeking to innovate banking is the national trust bank charter. As even the District Court in Lacewell v. OCC conceded, Congress has specifically authorized the OCC to grant federal charters to non-depository institutions engaged in fiduciary activities.[11] Under the OCC’s regulations, these activities include acting as trustee, executor, administrator, registrar of stocks and bonds, transfer agent, guardian, assignee, receiver, or custodian under a uniform gifts to minors act; investment adviser, if the bank receives a fee for its investment advice; any capacity in which the bank possesses investment discretion on behalf of another; or any other similar capacity that the OCC authorizes.[12]
More importantly, although a national trust bank does not accept deposits, it may engage in other activities that are authorized as part of the “business of banking” under 12 U.S.C. 24(SEVENTH) and are related to its business plan.[13] Such activities would include foreign currency activities (including virtual currency activities) and payments. A national trust bank is required to have bona fide fiduciary activities as part of its business plan, but it is not prevented from exercising other related incidental banking powers.[14]
There are other advantages to the national trust bank charter. A national trust bank benefits in the same manner as a national bank from federal preemption. A national trust bank is permitted to become a member of the Federal Reserve System. Controlling shareholders of national trust banks are not regulated as bank holding companies.
Conclusion
The Comptroller of the Currency may be removed by a President only “upon reasons to be communicated by [the President] to the Senate.”[15] A change in Administrations could well mean a change in Comptrollers. Whether the “special purpose” non-depository charter continues to be embraced by the OCC under a Democratic President is an open question (but only an open one, as it was President Obama’s Comptroller, Thomas Curry, who first proposed the national fintech charter). Even so, it is reasonable to expect the state litigation over special purpose charters to continue for some time. National trust bank charters do have explicit authorization by Congress; such entities, assuming that the bank has a bona fide fiduciary business, can engage in incidental banking activities like currency activities and payments that are related to the business plan and therefore may offer an alternative route forward to some firms until the larger questions affecting the U.S. dual banking system are resolved.
_____________________
[1] Lacewell v. OCC, Case 1:18-cv-08377-VM (S.D.N.Y. Oct. 21, 2019).
[2] Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015).
[4] OCC, Final Rule: Permissible Interest on Loans That Are Sold, Assigned, or Otherwise Transferred, 85 Fed. Reg. 33530 (June 2, 2020).
[5] People of the State of California, People of the State of Illinois, People of the State of New York v. The Office of the Comptroller of the Currency, Case No. 20-cv-5200 (N.D. Cal. 2020).
[6] OCC, Final Rule: National Banks and Federal Savings Associations as Lenders, available at https://www.occ.gov/news-issuances/federal-register/2020/nr-occ-2020-139a.pdf.
[10] See id.; Waters, 550 U.S. 1, 22 (2007) (Stevens, J.).
[13] See, e.g., OCC Conditional Approval 877 (December 13, 1999) (“The OCC has not limited the operations of trust banks to the exercise of fiduciary powers, but has permitted a range of incidental and nonfiduciary activities. The OCC, when it chartered Trust Co., did not restrict or address its insurance agency activities. Hence, Trust Co.’s charter is sufficiently broad to encompass its proposed insurance and annuity sale[s].”).
The following Gibson Dunn lawyers assisted in preparing this client update: Arthur S. Long and Samantha J. Ostrom.
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 in the firm’s Financial Institutions practice group, or the following:
Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)
Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com)
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com)
Mylan L. Denerstein – New York (+1 212-351- 3850, mdenerstein@gibsondunn.com)
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com)
James O. Springer – New York (+1 202-887-3516, jspringer@gibsondunn.com)
Samantha J. Ostrom – Washington, D.C. (+1 202-955-8249, sostrom@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On Monday, October 5, 2020 the U.S. Department of Commerce’s Bureau of Industry and Security (“BIS”) published long-awaited controls on six categories of “emerging technologies.”[1] These new controls come nearly two years after BIS first solicited public comments on the types of items that should be covered and the types of controls that should be implemented to fulfill the requirements of the Export Control Reform Act (“ECRA”). This announcement suggests that this long delay may have been due in part to BIS’s successful efforts to ensure that these controls were adopted by multilateral export control organizations of which the U.S. and many of its allies are members.
These new multilateral controls will have significant implications for companies operating in certain high technology sectors, such as biotechnology, artificial intelligence, and advanced materials. Companies will now almost always require authorization from BIS in order to provide certain items to most jurisdictions outside the United States or even to share important technical knowledge about those items with foreign national employees (under BIS’s “deemed exports” controls). Companies operating in these sectors—particularly those that participate directly or indirectly in semiconductor manufacturing or production—should also be prepared for additional controls to be implemented in the near term. Finally, foreign investors in U.S. businesses will want to be mindful of the ways in which these new controls will affect the ability of the Committee on Foreign Investment in the United States (“CFIUS”) to review, block, or impose mitigation measures upon their investments in U.S. businesses that deal in these newly controlled technologies.
Key Takeaways
- BIS recently began announcing controls on emerging and foundational technologies, and companies operating in certain high technology sectors—particularly those that participate directly or indirectly in semiconductor manufacturing or production—should be prepared for additional controls in the near term.
- Thus far BIS has prioritized multilateral implementation over speed of imposition. Congressional pressure may speed imposition somewhat, but we still expect BIS to work with international partners given the benefits of multilateral adoption and ECRA requirements.
- BIS determinations regarding what constitutes emerging and foundational technologies impact both the scope of CFIUS mandatory jurisdiction and criteria for its application. Any technologies BIS controls as emerging or foundational will be considered “critical technologies.” Certain non-passive foreign investment in U.S. companies dealing with critical technologies must receive CFIUS review and approval.
Background
On August 13, 2018, President Trump signed the John S. McCain National Defense Authorization Act for Fiscal Year 2019 (“FY 2019 NDAA”), an omnibus bill to authorize defense spending that like many other annual NDAA bills also includes amendments unrelated to defense spending. In 2018 those amendments included significant updates to both CFIUS and the U.S. export controls regime.[2] In addition to placing the U.S. export controls regime on firmer statutory footing for the first time in decades, ECRA significantly expanded the President’s authority to regulate and enforce export controls by requiring the Secretary of Commerce to establish controls on the export, re-export, or in-country transfer of “emerging or foundational technologies.”[3]
ECRA was passed alongside the Foreign Investment Risk Review Modernization Act (“FIRRMA”), which reformed the CFIUS review process for inbound foreign investment in an effort to enhance the tools used to address the threats posed by foreign investment in U.S. critical technology companies, among other risks.[4] As FIRRMA was negotiated, a proposed mechanism to regulate outbound investments—such as joint ventures or licensing agreements—through the CFIUS process was ultimately replaced by ECRA, which instead granted BIS the authority to identify and regulate the transfer of these emerging and foundational technologies via U.S. export controls.[5]
ECRA did not offer a precise definition of the “emerging technologies” to be controlled by BIS. Instead, it included criteria for BIS to consider when determining what technologies will fall within this area of BIS control. It was initially thought that these controls might focus strictly on “technology,” which under the EAR does not include end-items, commodities, or software. Instead, “technology” refers to the information, in tangible or intangible form, necessary for the development, production, or use of such goods or software.[6] Technology may include written or oral communications, blueprints, schematics, photographs, formulae, models, or information gained through mere visual inspection.[7] However, as discussed further below, BIS opted for a broader reading of this term to reach goods, software, and technical know-how.
On November 19, 2018, BIS published a request for the public’s assistance in identifying “emerging technologies” essential for U.S. national security that should be subject to new export restrictions.[8] For a longer discussion of the advance notice of proposed rulemaking (“ANPRM”), see our previous alert, New Export Controls on Emerging Technologies – 30-Day Public Comment Period Begins. The ANPRM broadly described emerging technologies as “those technologies essential to the national security of the United States that are not already subject to export controls under the Export Administration Regulations (“EAR”) or the International Traffic in Arms Regulations (“ITAR”).”[9] The ANPRM suggested that technologies would be considered “essential to the national security of the United States” if they “have potential conventional weapons, intelligence collection, weapons of mass destruction, or terrorist applications or could provide the United States with a qualitative military or intelligence advantage.”[10]
In narrowing down which of these technologies would be subject to new export controls, BIS also considered the development of emerging technologies abroad, the effect of unilateral export restrictions on U.S. technological development, and the ability of export controls to limit the spread of these emerging technologies in foreign countries. In making this assessment and further narrowing the category of affected technologies, BIS was also to consider information from a variety of interagency sources, as well as public information drawn from comments submitted in response to the ANPRM.
While the ANPRM did not provide concrete examples of “emerging technologies,” BIS did provide a list of technologies currently subject to limited controls that could be considered “emerging” and subject to new, broader controls. These include the following: (1) biotechnology; (2) artificial intelligence and machine learning; (3) position, navigation, and timing (“PNT”) technology; (4) microprocessor technology; (5) advanced computing technology; (6) data analytics technology; (7) quantum information and sensing technology; (8) logistics technology; (9) additive manufacturing; (10) robotics; (11) brain-computer interfaces; (12) hypersonics; (13) advanced materials; and (14) advanced surveillance technologies.
As the regulated community waited to see what technologies would be considered “emerging” and what types of controls would be imposed, there was also some uncertainty regarding the way in which these new controls would be implemented. ECRA required BIS to coordinate with U.S. allies and international export control regimes to encourage widespread adoption of similar controls on the items it determined were “emerging technologies.” Ensuring such international coordination would protect against the development of a fragmented regulatory environment that could promote the offshoring of “emerging technology” development and production from the U.S. to other jurisdictions by companies seeking to avoid U.S. export controls. Unilateral U.S. controls might also encourage and enable non-U.S. companies to rush in and backfill the effective void created once U.S. companies could no longer freely export their technology to jurisdictions where they might otherwise compete.[11] In several similar areas, the United States had recently adopted a “control-now-cooperate-later” approach, taking unilateral action to amend its trade controls, foreign direct investment, and procurement regulations in ways that might encourage other countries to take similar steps but not waiting for other countries to agree the controls are necessary. However, in this case BIS officials gave early indications that they planned to present the new controls for adoption by multilateral export control bodies before implementing the controls in the United States.
Emerging Technologies
Consistent with the approach to multilateralize such controls as a first step, and with one notable exception discussed below, the initial round of “emerging technology”—adopted earlier this year—were implemented following their adoption by the Australia Group, a multilateral forum that maintains export controls on a list of chemicals, biological agents, and related equipment and technology. On June 17, 2020, BIS designated the first emerging technologies, adding certain chemical weapons precursors and biological equipment to the Commerce Control List (“CCL”) for increased export controls.[12] In its announcement of the new controls, BIS indicated that the agency had not only completed the ECRA-described interagency process to determine that the newly controlled items were “emerging technologies” but had also secured multilateral adoption of these controls at the Australia Group’s Intersessional Implementation Meeting in February 2020.
The newly controlled items include the following:
- Twenty-four precursor chemicals, including chemical mixtures where at least one of the controlled chemicals constitutes 30 percent or more of the mixture;
- Single-use cultivation chambers with rigid walls and related technology; and
- Middle East respiratory syndrome-related coronavirus (MERS-related coronavirus) due to its homology with severe acute respiratory syndrome-related coronavirus (SARS-related coronavirus) and its potential use in biological weapons activities.
These items, which were not previously subject to licensing requirements for export to most jurisdictions, now require authorization for export to most destinations. However, licenses are still not required for exports of the precursor chemicals or cultivation chambers to Australia Group member states.[13]
In addition, the final rule announced on October 5 added six new previously unregulated emerging technologies to the CCL for increased export controls. This second round of emerging technology controls focused primarily on items used in semiconductor manufacturing and development, along with surveillance equipment and certain spacecraft. Like the initial round of “emerging technologies,” these items were added to the CCL to implement changes agreed to by a multilateral organization that oversees international development of controls on dual-use items. Specifically, these new controls implemented a decision taken by the governments participating in the Wassenaar Arrangement at the group’s December 2019 Plenary meeting.[14] BIS, together with its interagency partners, had also concluded that these six technologies are recently developed or developing technologies that are essential to U.S. national security and therefore warranted treatment as “emerging technologies.”
The six categories of controlled items include the following:
1. Hybrid additive manufacturing (“AM”)/computer numerically controlled (“CNC”) tools;
The first control on additive manufacturing and computer numerically controlled tools was added as Note 4 to ECCN 2B001 in response to machine tool manufacturers adding multiple capabilities to their machines. Items captured under this control will now require an export license to most countries for national security (“NS”) reasons but will also be eligible for the Strategic Trade Authorization (“STA”) license exception,[15] as well as any other applicable transaction-based exceptions.
2. Certain computational lithography software designed for the fabrication of extreme ultraviolet masks (“EUV”);
The second modification updates ECCN 3D003 to control electronic design automation (“EDA”) or computational lithography software developed for extreme ultraviolet masks. Software captured under this control will require an export license to most countries for NS and anti-terrorism (“AT”) reasons but will also be eligible for the Technology and Software Under Restriction (“TSR”) license exception,[16] STA, and other transaction-based license exceptions.
3. Technology for finishing wafers for 5nm production;
The third addition creates ECCN 3E004 to control technology for the production of substrates for high-end integrated circuits. Technology captured under this control will require an export license to certain countries for NS reasons and AT reason but will be eligible for TSR, STA, and other transaction-based license exceptions.
4. Forensics tools that circumvent authentication or authorization controls on a computer or communications device and extract raw data;
The fourth control adds ECCN paragraph 5A004.b to control digital forensics and investigative tools that circumvent authentication or authorization mechanisms and extract raw data from a computer or communications device. This control was added because BIS determined that items previously used primarily for law enforcement tools were increasingly being used by militaries to extract time-critical information from devices found on the battlefield. This control does not capture items that extract unprotected data, or items that extract simple user data. Tools captured under this control will require an export license to most countries for NS and AT reasons, and an encryption item license requirement applies. These tools will be eligible for Limited Value Shipment (“LVS”)[17] and Encryption Commodities, Software, and Technology (“ENC”)[18] license exceptions.
5. Software for monitoring and analysis of communications and metadata acquired from a telecommunications service provider via a handover interface; and
The fifth control adds ECCN paragraph 5D001.e to control software specially designed or modified for use by law enforcement to analyze the content of communications acquired from a handover interface—a tool allowing law enforcement to request and receive intercepted communications from communications service providers. According to BIS, such software can be used by international actors in ways that are contrary to U.S. national security. BIS has clarified that this new control does not apply to network management tools or banking software. Software captured under this control will require an export license to most countries for NS and AT reasons, and is eligible for TSR for Country Group A:5 countries and STA license exceptions.
6. Sub-orbital aircraft.
The sixth control adds “sub-orbital craft” to paragraph 9A004.h. This does not include “spacecraft,” which is limited to satellites and space probes. Items captured under this control will require an export license for NS, AT, and regional stability (“RS”), and anti-terrorism reasons, and will be eligible for STA and may be eligible for LVS at $1,500.
The Notable Exception – 0Y521 Controls on Geospatial Imagery Artificial Intelligence
What BIS has chosen not to target multilaterally is just as interesting as what it has.
With one notable exception, BIS has previously avoided imposing emerging technology controls on artificial intelligence (“AI”) broadly, suggesting that BIS took seriously arguments from many sectors that broad controls on U.S. AI technology might be too late or unworkable for several reasons.
However, almost as soon as BIS learned of a specific emerging AI technology with significant national security implications, BIS took unilateral action using another export control authority to control its export from the United States. On January 3, 2020, BIS announced that it would be imposing new export controls on certain types of artificial intelligence software specially designed to automate the analysis of geospatial imagery in response to emergent national security concerns related to the newly covered software. Covered software includes products that employ artificial intelligence to analyze satellite imagery and identify user-selected objects. As a result of the new controls, a license from BIS is now required to export the geospatial imagery software to all countries, except Canada, or to transfer the software to foreign nationals. The only exception to this license requirement is for software transferred by or to a department or agency of the U.S. Government.
BIS deployed a rarely used tool for temporarily controlling the export of emerging technologies—the 0Y521 Export Controls Classification Number (“ECCN”). This special ECCN category allows BIS to impose export restrictions on previously uncontrolled items that have “significant military or intelligence advantage” or when there are “foreign policy reasons” supporting restrictions on its export. Although these controls would only last one year, items subjected to these controls can be moved to a more permanent ECCN before the expiration of the classification.
BIS’ use of the 0Y521 control for this technology demonstrates that BIS can and will impose unilateral controls when the export of emerging technologies from the United States poses an imminent threat to U.S. national security or foreign policy interests.
Looking Ahead, BIS Controls on Foundational Technologies
On August 27, 2020, BIS published an ANPRM seeking public comment on criteria for identifying these “foundational technologies.”[19] The comment period will close on October 26, 2020. Like emerging technologies, ECRA also did not offer a precise definition of the “foundational technologies” to be controlled by BIS. Unlike emerging technologies, however, those determined to be “foundational” may already be restricted with an ECCN on the CCL.
In contrast to the ANPRM for emerging technologies, the foundational technologies ANPRM did not provide a list or categories of specific items that BIS is considering for export controls. However, like it has for emerging technology controls, BIS has clarified that the term foundational technologies includes not only “technology” but also “commodities” and “software,” as those terms are defined in the EAR. While the ANPRM did not provide a list of specific items or categories of items on which it requested comment, it did provide examples of types of technologies that would be subject to additional controls as foundational technologies, including:
- Semiconductor manufacturing equipment and associated software, tools, lasers, sensors and underwater systems that can be tied to indigenous military innovation efforts in China, Russia, or Venezuela;
- Items designated as EAR99 or controlled only for AT reasons that are utilized or required for innovation in developing weapons, enabling foreign intelligence collection activities, or have weapons of mass destruction applications; and
- Technologies that have been the subject of illicit procurement attempts which may demonstrate some level of dependency on U.S. technologies to further foreign military or intelligence capabilities in countries of concern or development of weapons of mass destruction.
In response to criticism levied in public comments on the ANPRM for emerging technologies, BIS introduced a way in this ANPRM to allow private sector companies and other organizations to submit private information that can be redacted in published versions of their comments. We think that this will invite additional comments from companies who would like to better inform BIS rulemaking but also not risk the loss of business competitive information.
CFIUS Consequences
Importantly, any technologies that BIS has controlled or will control as emerging or foundational through these rulemaking processes will be also considered “critical technologies” with respect to a CFIUS national security review, including the determination of whether a mandatory CFIUS filing requirement applies.[20] FIRRMA now requires that certain non-passive foreign investment in U.S. companies dealing with critical technologies receive CFIUS review and approval. Under CFIUS’s new regulations implemented this year, CFIUS must receive advance notice of certain types of non-passive foreign investment in U.S. companies that design, test, manufacture, fabricate, or develop critical technologies—including emerging and foundational technologies identified by BIS—if a license would be required to export those technologies to the foreign investor or certain of its parent entities. In this regard, BIS’s final determination regarding what constitutes emerging and foundational technologies impacts not only the scope of CFIUS’s new mandatory jurisdiction but also the criteria for its application.
Displeased with the pace with which BIS is implementing the new emerging and foundational technology controls, some in Congress are pushing to grant CFIUS even more jurisdiction over these items. In September, the House of Representatives Republican-led China Task Force published a report arguing that the absence of a complete control list is impeding both the implementation of the ECRA and the operation of CFIUS’s expanded jurisdiction.[21] Additionally, on August 6, 2020, Senators Tillis (R-NC), Rubio (R-FL), and Cornyn (R-TX, who previously sponsored FIRRMA) introduced legislation to expand CFIUS’s jurisdiction to review foreign investments in emerging and foundational technology in the United States[22] Rather than waiting for BIS rulemaking to complete its identification of emerging and foundational technologies, this bill would allow the CFIUS chair and one other member of CFIUS to designate technologies as emerging or foundational. This bill does not yet have bipartisan support, nor has a companion bill been introduced in the House of Representatives. While this bill may never become law, it is illustrative of the feeling among some Congressional Republicans that BIS is taking too long to identify foundational and emerging technologies and could result in more designations of “emerging technologies” and a faster timeline for the implementation of the “foundational technology” controls.
Conclusion
The first two rounds of “emerging technology” controls described here are not likely to be the last. Consistent with BIS’s own suggestions and with the increased Congressional pressure it is receiving, we expect that BIS will continue to intermittently release lists of new emerging technologies for addition to the CCL.
However, the first rounds of controls do offer some indication of how future controls are likely to be implemented. BIS has made clear that it is not only targeting “technology,” as defined in the EAR, but is more broadly looking to control goods and software as well. Rather than creating entirely new categories of controls for these items, BIS has also shown a preference for amending existing controls to add newly covered items. Additionally, in both rounds, BIS has prioritized multilateral implementation over speed of imposition. Congressional pressure could threaten this method, but given the significant benefits of multilateral adoption (especially in the wake of China’s own newly-adopted export control law) and the requirements of ECRA, we would still expect BIS to work with its international partners to help standardize implementation of the new controls on both emerging and foundational technologies. Finally, the new emerging technology controls and the foundational technology ANPRM suggest that BIS is particularly focused on semiconductor manufacturing equipment and associated software tools. This is consistent with other recent BIS actions aimed primarily at limiting China’s access to the cutting-edge tools and technology required to produce these critical computing components.
________________________
[1] Implementation of Certain New Controls on Emerging Technologies Agreed at Wassenaar Arrangement 2019 Plenary, https://www.federalregister.gov/documents/2020/10/05/2020-18334/implementation-of-certain-new-controls-on-emerging-technologies-agreed-at-wassenaar-arrangement-2019.
[2] Export Control Reform Act of 2018, Pub. L. No. 115-232, §§ 1751-1781 (2018).
[4] Foreign Investment Risk Review Modernization Act of 2018, Pub. L. No. 115-232, §§ 1701-28 (2018).
[5] Export Control Reform Act of 2018, Pub. L. No. 115-232, §§ 1758 (2018).
[8] Review of Controls for Certain Emerging Technologies, 83 Fed. Reg. 58,201 (advance notice of proposed rulemaking Nov. 19, 2018), https://www.gpo.gov/fdsys/pkg/FR-2018-11-19/pdf/2018-25221.pdf.
[9] Emerging Technologies ANPRM, supra note 1 at 58,201.
[11] These are general observations that one can make regarding the imposition of new unilateral export controls, but not all kinds of emerging technologies are likely to be impacted such controls in the same way. Depending on a range of background conditions, such as the nature of collaboration and economies of innovation in different areas of emerging technologies, the impact of export controls on their continuing development will differ. For an in-depth discussion of these factors and a comparison of how they will impact two areas of emerging technology – hypersonics and artificial intelligence – see our recently published article in the NATO Legal Gazette. C. Timura, J.A. Lee, R. Pratt and S. Toussaint, U.S. Export Controls: The Future of Disruptive Technologies, NATO LEGAL GAZETTE, 41: 96-124 (Oct. 2020).
[12] Implementation of the February 2020 Australia Group Intersessional Decisions: Addition of Certain Rigid-Walled, Single-Use Cultivation Chambers and Precursor Chemicals to the Commerce Control List, https://www.govinfo.gov/content/pkg/FR-2020-06-17/pdf/2020-11625.pdf.
[13] The Australia Group member states are: Argentina, Australia, Austria, Belgium, Bulgaria, Canada, Croatia, Cyprus, Czech Republic, Denmark, Estonia, European Union, Finland, France, Germany, Greece, Hungary, Iceland, India, Ireland, Italy, Japan, Korea, Latvia, Lithuania, Luxembourg, Malta, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, Switzerland, Turkey, Ukraine, United Kingdom, and United States. See Australia Group Participants, The Australia Group, https://www.dfat.gov.au/publications/minisite/theaustraliagroupnet/site/en/participants.html.
[14] The participating states of the Wassenaar Arrangement are: Argentina, Australia, Austria, Belgium, Bulgaria, Canada, Croatia, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, India, Ireland, Italy, Japan, Latvia, Lithuania, Luxembourg, Malta, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Republic of Korea, Romania, Russian Federation, Slovakia, Slovenia, South Africa, Spain, Sweden, Switzerland, Turkey, Ukraine, United Kingdom, and United States. See About Us, The Wassenaar Arrangement, https://www.wassenaar.org/about-us/.
[15] License Exception STA permits exports, reexports, and in-country transfers without a license that would otherwise be required for specified items on the CCL to destinations posing a low risk of unauthorized or impermissible uses.
[16] License Exception TSR permits exports and reexports of technology and software where the CCL indicates a license requirement to the ultimate destination for NS reasons only, TSR is noted in the CCL, and the software or technology is destined to Country Group B.
[17] License Exception LVS permits exports and reexports in a single shipment of eligible commodities where LVS is noted on the CCL, the net value of the commodities does not exceed the amount specified in the LVS paragraph for the entry on the CCL, and the commodities are destined to Country Group B.
[18] License Exception ENC permits export, reexport, and in-country transfer of systems, equipment, commodities, and components classified under ECCN 5A002, 5B002, equivalent or related software and technology classified under 5D002 or 5E002, and “cryptanalytic items” and digital forensics items classified under ECCN 5A004, 5D002, or 5E002.
[19] Identification and Review of Controls for Certain Foundational Technologies, 85 Fed. Reg. 52,934 (advance notice of proposed rulemaking Aug. 27, 2020), https://www.federalregister.gov/documents/2020/08/27/2020-18910/identification-and-review-of-controls-for-certain-foundational-technologies [hereinafter, “Foundational Technologies ANPRM”].
[20] Foreign Investment Risk Review Modernization Act of 2018, Pub. L. No. 115-232, § 1703 (2018).
[21] China Task Force Report, https://medium.com/@ChinaTaskForce/china-task-force-report-1dbc47d05f8f.
[22] Tillis, Cornyn & Rubio Introduce Legislation to Protect Our Most Valuable Technology from China, https://www.tillis.senate.gov/2020/8/tillis-cornyn-rubio-introduce-legislation-to-protect-our-most-valuable-technology-from-china.
The following Gibson Dunn lawyers assisted in preparing this client update: Judith Alison Lee, Adam Smith, Chris Timura, Stephanie Connor, R.L. Pratt and Allison Lewis.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above 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 International Trade practice group:
United States:
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Jose W. Fernandez – New York (+1 212-351-2376, jfernandez@gibsondunn.com)
Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, sconnor@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Ben K. Belair – Washington, D.C. (+1 202-887-3743, bbelair@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
Laura R. Cole – Washington, D.C. (+1 202-887-3787, lcole@gibsondunn.com)
Jesse Melman – New York (+1 212-351-2683, jmelman@gibsondunn.com)
R.L. Pratt – Washington, D.C. (+1 202-887-3785, rpratt@gibsondunn.com)
Samantha Sewall – Washington, D.C. (+1 202-887-3509, ssewall@gibsondunn.com)
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)
Asia and Europe:
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Beijing – (+86 10 6502 8534, qyue@gibsondunn.com)
Joerg Bartz – Singapore – (+65 6507 3635, jbartz@gibsondunn.com)
Peter Alexiadis – Brussels (+32 2 554 72 00, palexiadis@gibsondunn.com)
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Nicolas Autet – Paris (+33 1 56 43 13 00, nautet@gibsondunn.com)
Susy Bullock – London (+44 (0)20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris – London (+44 (0)207 071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly – London (+44 20 7071 4205, sharber-kelly@gibsondunn.com)
Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com)
Steve Melrose – London (+44 (0)20 7071 4219, smelrose@gibsondunn.com)
Matt Aleksic – London (+44 (0)20 7071 4042, maleksic@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com)
Richard W. Roeder – Munich (+49 89 189 33-160, rroeder@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
Today, a majority of the Senate Judiciary Committee voted to approve Judge Amy Coney Barrett to fill the seat on the Supreme Court of the United States vacated by the passing of Justice Ruth Bader Ginsburg. If confirmed by the full Senate, Judge Barrett would become the third female Justice to serve on the current Supreme Court, and the fifth female Justice in history.
To assess Judge Barrett’s likely impact on the Supreme Court, our Appellate and Constitutional Law Practice Group has analyzed a sample of her written opinions in her three years as a Judge on the United States Court of Appeals for the Seventh Circuit. As of the date she was nominated for the Supreme Court (September 29, 2020), Judge Barret had written 92 judicial opinions, including 81 majority opinions, 4 concurrences, and 7 dissents. In her responses to the Senate Judiciary Committee’s questionnaire, Judge Barrett identified ten of these, as well as a per curiam decision, as her “most significant” opinions.[*]
Below, we briefly summarize a number of Judge Barrett’s opinions, and a couple of her law review articles, that may provide insights to her approach to several key areas of law, including (1) administrative law, (2) arbitration, (3) class actions and collective actions, (4) constitutional and statutory interpretation, (5) due process, (6) First Amendment, (7) Fourth Amendment, (8) immigration, (9) intellectual property, (10) labor and employment, (11) personal jurisdiction, (12) Second Amendment, (13) standing, (14) stare decisis, and (15) subject-matter jurisdiction.
(1) Administrative Law
- Meza Morales v. Barr, 963 F.3d 629 (7th Cir. 2020). Writing for a unanimous panel, Judge Barrett held that immigration judges have the authority to administratively close cases—a procedural device that temporarily takes a removal case off of an immigration judge’s calendar, preventing the case from moving forward. In doing so, she embraced the Supreme Court’s admonition that courts should not “leap too quickly to the conclusion that a rule is ambiguous.” Applying the “traditional tools of construction,” Judge Barrett rejected the Attorney General’s interpretation of the “thorny but not ambiguous” immigration regulation.
- Williams v. Wexford Health Sources, Inc., 957 F.3d 828 (7th Cir. 2020). In a concurring opinion, Judge Barrett argued that an inmate had failed to exhaust his administrative remedies before filing a civil rights action under 42 U.S.C. § 1983, as required by the Prison Litigation Reform Act. Because the inmate could have filed a “standard grievance” after the prison had determined that his “emergency grievance” did not warrant fast-track treatment, there were still additional remedies available to him.
(2) Arbitration
- Wallace v. GrubHub, 970 F.3d 798 (7th Cir. 2020).* In a unanimous opinion written by Judge Barrett, a Seventh Circuit panel adopted a narrow view of the Section 1 exemption to the Federal Arbitration Act for transportation workers engaged in interstate commerce, holding that certain food delivery drivers were required to arbitrate their claims. The drivers argued that they engaged in interstate commerce by carrying goods that had moved across state lines. But the panel rejected that argument because “to fall within the exemption,” a class of workers “must be connected not simply to the goods, but to the act of moving those goods across state or national borders.” The panel observed that the drivers’ interpretation would sweep in numerous categories of workers whose occupations have nothing to do with interstate transport—a reading inconsistent with the “stringent” requirement that the class of workers “‘actually’” is engaged in interstate commerce.
(3) Class Actions and Collective Actions
- Herrington v. Waterstone Mortg. Corp., 907 F.3d 502 (7th Cir. 2018). Writing for a unanimous panel, Judge Barrett held that the availability of class or collective arbitration is a threshold question of arbitrability that the court must decide unless the parties have clearly and unmistakably delegated the question to an arbitrator. Although the Supreme Court held that waivers of class arbitration for employment claims are enforceable in Epic Systems Corp. v. Lewis, 138 S. Ct. 1612 (2018), it did not determine who should interpret an arbitration agreement to decide whether it waived or authorized that procedure. Following the reasoning of “every federal court of appeals to reach the question,” Judge Barrett held that the availability of class or collective arbitration was so “fundamental” an issue as to belong in the category of “gateway” questions presumptively reserved to the court to decide.
- Weil v. Metal Techs., Inc., 925 F.3d 352 (7th Cir. 2019). In a unanimous opinion by Judge Barrett, the panel affirmed the decertification of class and collective actions under the Fair Labor Standards Act (FLSA) and Indiana wage laws. After the district court’s initial certification order, the plaintiffs failed to provide classwide evidence that the employees in the class “were actually working without compensation.” The plaintiffs therefore lacked “both a theory of liability and proof of any injury” to support certification. Judge Barrett emphasized the Seventh Circuit’s “repeated assertions that district courts have wide discretion in managing class and collective actions” under Rule 23 and the Fair Labor Standards Act, including revisiting prior certification rulings.
(4) Constitutional and Statutory Interpretation
- In her nomination speech, Judge Barrett stated that the textualist judicial philosophy of Justice Scalia—for whom she clerked—is “mine too.” She echoed this sentiment at her confirmation hearings, emphasizing that a judge tasked with interpretation must set aside her policy views and apply the law as written. On the Seventh Circuit, Judge Barrett has shown a willingness to engage in “intense grammatical parsing” when necessary to determine textual meaning. Gadelhak v. AT&T Servs., Inc., 950 F.3d 458, 460 (7th Cir. 2020). She also has indicated discomfort with arguments from extratextual considerations, such as legislative history or congressional inaction. Cook Cty., Illinois v. Wolf, 962 F.3d 208, 250 (7th Cir. 2020) (Barrett, J., dissenting).
(5) Due Process
- A.F. Moore & Assocs., Inc. v. Pappas, 948 F.3d 889 (7th Cir. 2020).* Writing for a unanimous panel, Judge Barrett held that the Tax Injunction Act, which generally strips federal courts of jurisdiction over challenges to state and local taxes, did not prohibit taxpayers from bringing equal protection and due process claims in federal court. This is because, as Judge Barrett explained, Illinois state courts do not offer an adequate forum for taxpayers’ constitutional claims, since Illinois tax-objection procedures do not allow taxpayers to challenge anything other than the correctness of the assessor’s valuation. Because these procedures provide “no remedy at all” for the taxpayers’ claims, the Tax Injunction Act did not apply.
- Cleven v. Soglin, 903 F.3d 614 (7th Cir. 2018). Judge Barrett, writing for a unanimous panel, rejected a city employee’s procedural due process challenge against the city based on an alleged deprivation of his retirement funds. Assuming without deciding that the temporary loss of these funds qualified as a lost property right, Judge Barrett reasoned that the plaintiff still could not show inadequate process, because the state offered a procedure—a writ of mandamus—to challenge any violation of state law. Since the writ provided a meaningful post-deprivation remedy for redressing property deprivation, the panel concluded that petitioner’s due process rights had been satisfied.
- Doe v. Purdue Univ., 928 F.3d 652 (7th Cir. 2019).* Writing for a unanimous panel, Judge Barrett held that a student, John Doe, adequately alleged that a university violated due process by using constitutionally flawed procedures to find him guilty of sexual violence. Judge Barrett first analyzed whether John had lost a liberty or property interest when he was found guilty and punished. While agreeing with the university that John could establish no property interest in continuing his education, Judge Barrett concluded that he was deprived of a protected liberty interest: By finding John guilty of sexual violence—causing his expulsion from the Navy ROTC program—and telling the Navy about this finding, the university denied John “his freedom to pursue naval service, his occupation of choice.” Judge Barrett next evaluated the procedures the university used to determine John’s guilt, finding them far short of what was required under the Due Process Clause. Because John alleged that the university withheld evidence on which it relied, failed to investigate evidence that would support John’s case, and conducted a deficient hearing, Judge Barrett held that he had pleaded facts sufficient to state a claim under the Fourteenth Amendment.
- Green v. Howser, 942 F.3d 772 (7th Cir. 2019). In an opinion by Judge Barrett, a unanimous panel held that sufficient evidence existed to support a jury verdict in favor of a mother who had sued her parents under 42 U.S.C. § 1983 for conspiring with state law enforcement officials to violate her due process right to make decisions regarding the care, custody, and control of her child. Finding “plenty of evidence” from which a jury could conclude that the mother’s parents conspired with law enforcement officials to forcibly gain custody of her child, Judge Barrett rejected the argument that no reasonable jury could find a violation of the mother’s due process rights.
(6) First Amendment
- Grussgott v. Milwaukee Jewish Day Sch., Inc., 882 F.3d 655 (7th Cir. 2018) (per curiam).* Judge Barrett joined a panel concluding that a teacher at a Jewish school was a “minister” under the Supreme Court’s decision in Hosanna-Tabor Evangelical Lutheran Church & School v. E.E.O.C., 565 U.S. 171 (2012), and thus the teacher’s Americans with Disabilities Act claim was barred by the First Amendment’s ministerial exception to employment-discrimination laws. The ministerial exception “allow[s] religious employers the freedom to hire and fire those with the ability to shape the practice of their faith.” To determine whether an employee was a “minister” covered by the exception, the Supreme Court in Hosanna-Tabor looked to the employee’s title, the substance reflected in that title, the employee’s use of that title, and “the important religious functions she performed for the Church.” Hosanna-Tabor, 565 U.S. at 192. The panel in Grussgott emphasized that the Supreme Court had “expressly declined” to adopt a “rigid formula” for the ministerial-exception test. In Grussgott, the teacher’s title and use of that title “cut[] against applying the ministerial exception” while the substance reflected in her title and her performing important religious functions—such as her “integral role in teaching her students about Judaism”—supported applying the ministerial exception. Explaining that “it would be overly formalistic to call th[e] case a draw simply because two ‘factors’ point[ed] each way” while cautioning that “all facts must be taken into account and weighed on a case-by-case basis,” the panel concluded that the “duties and functions” of the teacher’s position were enough to apply the ministerial exception. The Supreme Court’s later decision in Our Lady of Guadalupe School v. Morrissey-Berru, 140 S. Ct. 2049 (2020), was consistent with this non-formulaic approach to the ministerial exception.
(7) Fourth Amendment
- Rainsberger v. Bennett, 913 F.3d 640 (7th Cir. 2019).* In a unanimous opinion by Judge Barrett, a panel denied qualified immunity to a police detective who allegedly lied in a probable-cause affidavit that led prosecutors to charge the plaintiff with murdering his mother. The affidavit stated, for example, that the plaintiff placed a call from his mother’s home an hour before he claimed to have found her dead, but the call actually occurred a few minutes after he said he arrived. The detective argued that the alleged misrepresentations were immaterial because probable cause existed even without them, but the panel determined that the remaining evidence did not support a finding of probable cause. And because it is clearly established that it violates the Fourth Amendment to use deliberately falsified allegations to demonstrate probable cause, the panel concluded, the detective was not entitled to qualified immunity.
- Torry v. City of Chicago, 932 F.3d 579 (7th Cir. 2019). Writing for a unanimous panel, Judge Barrett rejected the plaintiffs’ argument that proving reasonable suspicion for a Terry stop required police officers to have some independent memory of what they knew at the time. Rather, as Judge Barrett explained, “the Fourth Amendment does not govern how an officer proves that he had reasonable suspicion for a Terry stop; he can rely on evidence other than his memory to establish what he knew when the stop occurred.” Judge Barrett also affirmed the lower court’s finding that the officers were entitled to qualified immunity. Because the Terry stop did not violate clearly established law, qualified immunity applied regardless of whether the stop violated the Fourth Amendment, which the panel concluded they “need not consider.”
- United States v. Kienast, 907 F.3d 522 (7th Cir. 2018). Judge Barrett, writing for a unanimous panel, held that the district courts did not err by declining to suppress the evidence obtained by searches that the defendants alleged were unlawful, because the good-faith exception to the exclusionary rule applied. Reasoning that suppression of evidence “is not a personal constitutional right” but rather “a judge-made rule meant to deter future Fourth Amendment violations,” Judge Barrett concluded that suppression was not justified because it would have no deterrent effect on FBI agents’ reliance on a warrant that the magistrate judge allegedly had no authority to issue. Judge Barrett also rejected the defendants’ argument that FBI agents acted in bad faith, concluding instead that “[t]he record establishes that the FBI acted reasonably” in preparing the affidavits and executing the warrants. Because the good-faith exception applied, the panel declined to consider whether the searches violated the Fourth Amendment.
- United States v. Vaccaro, 915 F.3d 431 (7th Cir. 2019). In an opinion by Judge Barrett, a unanimous panel held that a Terry pat-down frisk and the search of the defendant’s car were lawful. Judge Barrett first rejected the defendant’s argument that the Terry frisk was unreasonable. Because the record admitted of more than one permissible reading of the evidence, the district court did not clearly err in finding that the defendant “made furtive movements before leaving the car,” which aroused reasonable suspicion to justify a pat-down search. Judge Barrett next evaluated whether the sweep of the defendant’s car was lawful. While admitting that the sweep was “a closer call,” Judge Barrett concluded that it, too, was permissible because the officers reasonably suspected that the defendant was dangerous and could gain “immediate control” of weapons in his car, notwithstanding that he was handcuffed in the back of a squad car. On this last point, Judge Barrett explained that because the defendant’s detention was a Terry stop, and did not amount to an arrest, he “admitt[ed] that he would have been allowed to return to his car, … [where] he could have gained ‘immediate control of weapons.’”
(8) Immigration
- Cook Cty., Illinois v. Wolf, 962 F.3d 208 (7th Cir. 2020).* Judge Barrett, dissenting from the panel opinion, contended that the definition of “public charge” adopted by the Department of Homeland Security was a reasonable interpretation of the statutory language, which provides that a noncitizen may be denied admission or adjustment of status if he or she “is likely at any time to become a public charge.” The government defined “public charge” as any noncitizen who receives certain cash or noncash government benefits for more than 12 months in the aggregate in a 36-month period. The majority, over Judge Barrett’s dissent, concluded that the term “public charge” necessarily required a higher degree of government dependence. Judge Barrett, in contrast, would have held that under Chevron step two, the government’s broad definition was reasonable. Judge Barrett engaged in a detailed discussion of statutory framework and, citing Justice Scalia, expressed skepticism of plaintiffs’ legislative-inaction arguments. “At bottom,” she explained, “the plaintiffs’ objections reflect disagreement with [a] policy choice and … [l]itigation is not the vehicle for resolving policy disputes.” Judge Barrett declined to address plaintiffs’ other challenges because the district court did not reach them and the plaintiffs barely briefed them.
- Yafai v. Pompeo, 912 F.3d 1018 (7th Cir. 2019).* Judge Barrett, over a dissent, affirmed the district court’s dismissal under the doctrine of consular nonreviewability of a Yemeni husband and wife’s claims that a consular officer improperly denied the wife’s application for an immigrant visa. Observing that Congress has delegated the power to determine who may enter the country to the Executive Branch and that courts generally have no authority to second-guess the Executive’s decisions, Judge Barrett concluded that the consular officer provided a facially legitimate and bona fide reason for denying the wife’s application. The officer cited a valid statutory basis and provided the factual predicate for his decision and, Judge Barrett stressed, under Kleindienst v. Mandel, 408 U.S. 753 (1972), the court cannot “look behind the exercise of that discretion.” Judge Barrett also concluded that the “bad faith” exception to Mandel did not apply because plaintiffs failed to make “an affirmative showing” that the officer denied the wife’s visa in bad faith. The dissent maintained that the majority’s “view of the doctrine sweeps more broadly than required by the Supreme Court and [the Seventh Circuit’s] own precedent.”
- Alvarenga-Flores v. Sessions, 901 F.3d 922 (7th Cir. 2018). Judge Barrett, over a dissent, held that substantial evidence supported the immigration judge’s adverse credibility finding. Judge Barrett noted that the court “afford[s] significant deference to an agency’s adverse credibility determination,” and may reverse such determinations only “if the facts compel an opposite conclusion.”
(9) Intellectual Property
- J.S.T. Corp. v. Foxconn Interconnect Tech. Ltd., 965 F.3d 571 (7th Cir. 2020). In a unanimous opinion by Judge Barrett, the panel affirmed the dismissal for lack of personal jurisdiction of a suit for misappropriation of trade secrets. In so ruling, Judge Barrett analyzed the distinctions between different forms of intellectual property law. She distinguished trade secret law, which focuses on the defendants’ alleged acts, from both “trademark law, in which consumer confusion can be at the heart of the underlying claim,” and “patent law, in which the sale of a patented invention to a consumer can be an act of infringement, even if the seller is unaware of the patent.” Because the defendants’ alleged acts of trade secret misappropriation were all completed outside of the forum state, Judge Barrett concluded that the court lacked personal jurisdiction over those claims on these facts. This decision is also an example of Judge Barrett’s jurisprudence on personal jurisdiction.
- PMT Mach. Sales, Inc. v. Yama Seiki USA, Inc., 941 F.3d 325 (7th Cir. 2019). In a unanimous opinion by Judge Barrett, the panel affirmed the entry of summary judgment against a plaintiff suing under Wisconsin’s Fair Dealership Law. That state law provides contractual protections to “dealerships,” which it defines to include agreements granting persons the right to “use a trade name [or] trademark.” Judge Barrett reasoned that the mere inclusion of another party’s logos on the plaintiff’s website did not qualify as “use” of those trademarks sufficient to establish it as a “dealership” entitled to protection under the Wisconsin law.
(10) Labor and Employment
- Smith v. Rosebud Farm, Inc., 898 F.3d 747 (7th Cir. 2018). Writing for a unanimous court, Judge Barrett held that the district court properly denied an employer’s post-trial motion for judgment as a matter of law on a male employee’s Title VII sex discrimination claim. Judge Barrett reasoned that the evidence supported the jury’s finding that the employee’s coworkers harassed the plaintiff because he was male, rather than engaging in across-the-board and nondiscriminatory “sexual horseplay,” because the shop was a mixed-sex workplace and only men were groped and taunted.
- EEOC v. Costco Wholesale Corp., 903 F.3d 618 (7th Cir. 2018).* Writing for a unanimous court, Judge Barrett held that the district court properly denied Costco’s post-trial motion for judgment as a matter of law on a Title VII hostile work environment claim, because sufficient evidence supported the jury’s finding that a customer’s year-long stalking of a Costco employee was severe or pervasive enough to render the work environment hostile. Judge Barrett explained that harassment does not need to be “overtly sexual to be actionable under Title VII,” but instead “can take other forms, such as demeaning, ostracizing, or even terrorizing the victim because of her sex.” Judge Barrett also held that the district court was correct that the employee could not recover backpay for the period of time after Costco fired her, because the employee did not return to work after a year-long medical leave and thus was not constructively discharged. But Judge Barrett held that the employee may be entitled to backpay for some or all of her time on unpaid medical leave that she took after being traumatized by the customer’s stalking. Judge Barrett remanded for the district court to consider the unpaid-leave issue in the first instance.
- Fessenden v. Reliance Std. Life Ins. Co., 927 F.3d 998 (7th Cir. 2019). Writing for a unanimous panel, Judge Barrett held that a court owes no deference to a benefits plan administrator that, in issuing a benefits decision, misses a deadline imposed by regulations governing the Employee Retirement Income Security Act (ERISA). Although a court may apply an “arbitrary and capricious” standard of review to a plan administrator’s decision that “substantially complies” with other procedural requirements, a “deadline is a bright line,” and a court must apply a de novo standard of review if a plan administrator misses a regulatory deadline. Judge Barrett reasoned that adopting a “substantial compliance” exception under the common law would contravene the regulations’ plain text, which provide that “in no event shall” an extension of time exceed the allotted period. Judge Barrett also explained that a substantial compliance exception would be incompatible with the doctrine itself because a party seeking benefits has exhausted remedies when the regulatory deadlines for a benefits determination lapse, and thus can file suit—and yet, in that circumstance, the district court would have no administrative decision to review. In reaching this conclusion, Judge Barrett expressly disagreed with several other circuits that have applied the substantial compliance exception to missed ERISA deadlines.
(11) Personal Jurisdiction
- Lexington Ins. Co. v. Hotai Ins. Co., 938 F.3d 874 (7th Cir. 2019). Judge Barrett held for a unanimous panel that a district court in Wisconsin lacked personal jurisdiction over two Taiwanese insurance companies that had contracted with the suppliers of the plaintiff bike retailer to provide worldwide insurance coverage for both the suppliers and the bike distributor. Judge Barrett stated that the plaintiff had “failed to demonstrate that either [of the insurance companies] made any purposeful contact with Wisconsin before, during, or after the formation of the insurance contracts.” The fact that the insurance companies had agreed to indemnify the bike distributor, who did business out of Wisconsin, was insufficient, because “it is a defendant’s contacts with the forum state, not with the plaintiff, that count.” Judge Barrett further rejected that any “collateral financial benefits” of the insurance companies’ arrangement gave rise to personal jurisdiction.
(12) Second Amendment
- Kanter v. Barr, 919 F.3d 437 (7th Cir. 2019).* Judge Barrett dissented from a panel decision holding that felon dispossession statutes prohibiting firearm possession by persons convicted of felonies did not violate the Second Amendment. The panel majority applied intermediate scrutiny and concluded that the statutes were substantially related to the important government interest of “keeping firearms away from persons, such as those convicted of serious crimes, who might be expected to misuse them.” In her dissent, Judge Barrett adopted an originalist framework for analyzing the Second Amendment in which “all people have the right to keep and bear arms” unless “history and tradition” support a legislature’s “power to strip certain groups of that right.” Applying that framework, Judge Barrett explained that historically, legislatures have had the power to prohibit dangerous people from possessing guns, but not the power to strip felons—both violent and nonviolent—of their right to bear arms simply because of their status as felons. After noting the government’s “undeniably compelling interest in protecting the public from gun violence,” Judge Barrett concluded the dispossession statutes were “unconstitutional as applied to” the plaintiff, who did not belong to “a dangerous category” of felons—he was convicted of mail fraud—and did not have any “individual markers of risk,” such as a history showing a proclivity for violence.
(13) Standing
- Casillas v. Madison Ave. Assocs., Inc., 926 F.3d 329 (7th Cir. 2019).* Judge Barrett held for a unanimous panel that the plaintiff lacked standing under Article III to sue a debt collector for failure to include all statutorily required information in a debt-collection letter. The omitted information related to the requirement that any objection to the asserted debt be made in writing, but Judge Barrett observed that the plaintiff “did not allege that [the debt collector’s] actions harmed or posed any real risk of harm to her interests under the [Fair Debt Collection Practices] Act.” The plaintiff, Judge Barrett noted, “did not allege that she tried to dispute or verify her debt orally and therefore lost or risked losing the statutory protections,” nor did she “allege that she ever even considered contacting [the debt collector].” Judge Barrett also rejected the plaintiff’s alternative argument that she had suffered an “informational injury,” explaining that “the bare harm of receiving inaccurate or incomplete information” is not a cognizable harm for Article III standing purposes.
- Protect Our Parks Inc. v. Chicago Park Dist., 971 F.3d 722 (7th Cir. 2020). Writing for a unanimous panel, Judge Barrett held that plaintiffs challenging Chicago’s plan to transfer control of public land to the Barack Obama Foundation to construct a presidential memorial center lacked standing to pursue their state-law claims. The plaintiffs claimed that Chicago breached Illinois’ public trust doctrine by transferring control of public lands for private use. Judge Barrett held that the plaintiffs lacked standing to pursue the state-law claims, explaining that the fact that Illinois state courts have heard similar cases does not control the standing inquiry in federal court, and that a desire that the government follow the law is not sufficient. Judge Barrett also affirmed the district court’s dismissal of the federal takings claims on the ground that the plaintiffs lacked a cognizable property interest in the public land.
- Carello v. Aurora Policemen Credit Union, 930 F.3d 830 (7th Cir. 2019). Judge Barrett held for a unanimous panel that a plaintiff lacked standing to sue a credit union under the Americans with Disabilities Act for failing to offer a website that could be read aloud by a screen reader, because the plaintiff was legally ineligible to become a member in the credit union. Judge Barrett explained that “[b]ecause Illinois has erected a neutral legal barrier to [the plaintiff’s] use of the Credit Union’s service, the Credit Union’s failure to accommodate the visually impaired in the provision of its services cannot affect him personally.” Judge Barrett further rejected the plaintiff’s theory that he had suffered an “informational injury,” because the case was “about accessibility accommodations, not disclosure.”
- Gadelhak v. AT&T Servs., Inc., 950 F.3d 458 (7th Cir. 2020), cert. filed, No. 20‑209 (U.S. Aug. 21, 2020). Before addressing the merits of this case arising under the Telephone Consumer Protection Act (TCPA), Judge Barrett first considered whether the plaintiff had standing, even though no party had raised the issue. She concluded for the unanimous panel that a plaintiff who receives unwanted marketing text messages has suffered a sufficiently “concrete” injury for Article III purposes, because “[t]he common law has long recognized actions at law against defendants who invaded the private solitude of another by committing the tort of ‘intrusion upon seclusion.’” Moreover, in enacting the TCPA, “Congress decided that automated telemarketing can pose this same type of harm to privacy interests.” Judge Barrett therefore broke with the Eleventh Circuit, instead siding with the Second and Ninth Circuits holding that the receipt of “unwanted text messages can constitute a concrete injury-in-fact for Article III purposes.”
(14) Stare Decisis
- Stare Decisis and Due Process, 74 U. Colo. L. Rev. 1011 (2003). As a professor, Judge Barrett has questioned whether an inflexible view of stare decisis—which “effectively forecloses a litigant from meaningfully urging error-correction” in future cases—“unconstitutionally deprives a litigant of the right to a hearing on the merits of her claims.” “Generally speaking,” then-Professor Barrett wrote, “if a litigant demonstrates that a prior decision clearly misinterprets the statutory or constitutional provision it purports to interpret, the court should overrule the precedent.”
- Statutory Stare Decisis in the Courts of Appeals, 73 Geo. Wash. L. Rev. 317 (2005). The Supreme Court has long afforded “special force” to stare decisis in the realm of statutory interpretation. As a professor, however, Judge Barrett has questioned whether the courts of appeals should apply the same “super-strong stare decisis” to their own statutory interpretations. “It is one thing,” for example, “to claim that congressional silence signals approval of a decision from the Supreme Court; it is another thing to claim that congressional silence signals approval of a decision from any of the courts of appeals.” Then-Professor Barrett wrote that it is “hard to see why the precedential effect of statutory interpretations in the courts of appeals should be anything more than the simple presumption against overruling that all opinions enjoy.”
(15) Subject-Matter Jurisdiction
- Groves v. United States, 941 F.3d 315 (7th Cir. 2019). In an opinion authored by Judge Barrett, a unanimous panel overruled Seventh Circuit precedent that permitted district courts to recertify their decisions for interlocutory appeal after the expiration of the 10‑day filing window in order to give the appealing party more time to file a petition to appeal with the court of appeals. Judge Barrett explained that the Supreme Court’s more recent decisions had made clear that courts lack discretion to either directly or indirectly extend jurisdictional deadlines, such as the 10-day deadline for filing a petition for interlocutory review. Judge Barrett also rejected the appealing party’s argument that the 10-day limitation was not jurisdictional, holding that the statute setting the deadline “speak[s] to the power of the court rather than to the rights or obligations of the parties.”
- Webb v. FINRA, 889 F.3d 853 (7th Cir. 2018). Judge Barrett held, over a partial dissent, that the federal courts lacked diversity jurisdiction because the amount in controversy did not exceed the statutory threshold of $75,000. The plaintiffs sued the Financial Industry Regulatory Authority, Inc. (FINRA), arguing that FINRA had breached its contract to arbitrate the plaintiffs’ underlying dispute with their former employer, and seeking to obtain their fees for attempting to arbitrate the dispute and for the litigation. Although no party raised a jurisdictional challenge, the court sua sponte ordered supplemental briefing on jurisdiction. Judge Barrett held that the law recognized no right to recover expenses and fees the plaintiffs incurred in either arbitration or in litigation, and that the amount in controversy therefore did not exceed $75,000. Judge Barrett also rejected the alternative theory, offered by FINRA, that the claims arose under federal securities law, explaining that the case presented no questions requiring interpretation of a federal law.
- Wisconsin Cent. Ltd. v. TiEnergy LLC, 894 F.3d 851 (7th Cir. 2018), cert. denied, 139 S. Ct. 918 (2019). Judge Barrett held for a unanimous panel that the court of appeals and district court below had jurisdiction over this dispute involving fees owed for the delayed return of rail cars. The panel had sua sponte raised two issues of jurisdiction and solicited supplemental briefing. On the first, Judge Barrett held that the absence of a separate document setting forth the final judgment with respect to a third-party claim did not divest the appellate court of jurisdiction, because the district court “clearly signaled in its opinion that it was finished with the case.” On the second, Judge Barrett concluded that the district court had federal question jurisdiction over the case, because the plaintiff had brought suit pursuant to a federal law assigning liability for the payment of transportation rates, including fees for the delayed return of rail cars.
____________________
[*] Decisions denoted with an asterisk (*) are decisions that Judge Barrett identified as her “most significant” decisions.
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 Gibson Dunn lawyer with whom you usually work, any member of the firm’s Appellate and Constitutional Law practice group, or the following:
Allyson N. Ho – Dallas (+1 214.698.3233, aho@gibsondunn.com)
Mark A. Perry – Washington, D.C. (+1 202.887.3667, mperry@gibsondunn.com)
Lucas C. Townsend – Washington, D.C. (+1 202.887.3731, ltownsend@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
The United Nations Convention on International Settlement Agreements Resulting from Mediation (the “Singapore Convention” or the “Convention”) came into force on 12 September 2020.[1] The Singapore Convention is a significant step for international commercial dispute resolution, enabling enforcement of mediated settlement agreements among its signatories. For international businesses this means that they are presented with another viable and effective alternative to litigation and arbitration in resolving their cross-border disputes, especially during the global COVID-19 pandemic.[2]
Key Features of the Convention
By facilitating a negotiated settlement between parties, mediation can usually provide them with a faster, more cost-effective and commercial method of resolving disputes than resorting to litigation and arbitration. With the aid of neutral and qualified professionals, mediated settlements focus parties onto what really matters to them, ironing out their differences swiftly in confidentiality while preserving businesses’ reputation and their long term relationship. However, until the Singapore Convention, no harmonised enforcement mechanism existed for these negotiated settlements. Hence, the only remedy for a party who was faced with an opponent refusing to honour the terms of such negotiated settlement, was to bring an action for breach of contract and then seek to have the subsequent judgment enforced, potentially in multiple jurisdictions. This was an expensive and inefficient deterrent for parties to even consider mediation for the resolution of their disputes, so they instead turned to arbitration or litigation from the outset.
Now, the Singapore Convention has the potential to greatly increase the appeal of mediation as a mechanism of resolving commercial disputes with a cross-border dimension. The Convention provides parties who have agreed a mediated settlement with a uniform and efficient mechanism to enforce the terms of that agreement in other jurisdictions, in the way that the New York Convention on the Recognition and Enforcement of Arbitral Awards (the “New York Convention”) does for international arbitral awards.
Where a State has ratified the Convention, the Convention commands that a relevant court (or other competent authority) in that State enforces an international mediated settlement agreement in accordance with the Convention and its own rules of procedure, without the parties needing to initiate new proceedings for its recognition and enforcement. Provided the settlement agreement falls within the scope of the Convention, the negotiated settlement can also be invoked as a defence by the parties, preventing further litigation or arbitration of a matter already settled by the agreement.
Conditions for Enforcement
The Convention applies to international mediated settlement agreements concluded in writing and which resolve a commercial dispute. A settlement agreement will be classified as “international” under the Convention if the parties have their place of business in different States or the parties’ place of business is different from the State in which a substantial part of the obligations under the settlement agreement is performed or with which the subject matter of the settlement agreement is most closely related. The Convention excludes from its scope agreements arising from transactions engaged in by one of the parties (a consumer) for personal, family or household purposes, or whose subject matter concerns family, inheritance or employment law. The Convention also does not apply to settlement agreements that have been concluded during court proceedings (and which are therefore already enforceable as a judgment) and to settlement agreements that are enforceable as an arbitral award. In addition, signatory States have the option to make reservations to the application of the Convention, excluding settlements involving them or their government agencies; or agreeing to apply the Convention only to the extent that disputing parties have agreed to its application. So far, Belarus and Iran have made reservations to that effect.
A party seeking to enforce a settlement agreement under the Convention will have to show that it resulted from mediation. The Convention sets out a number of ways parties can do this, including provision of a settlement agreement signed by the mediator herself/himself or confirmation that a mediation was carried out; or an attestation by the institution that administered the mediation. When none of these are available, the Convention also allows proof by any other evidence acceptable to the relevant competent authority enforcing the agreement.
Similar to the New York Convention, there are limited grounds for refusal to enforce a mediated settlement agreement under the Singapore Convention. These include cases where:
- a party is under some kind of incapacity when entering the settlement agreement;
- the settlement agreement is null and void, inoperative or incapable of being performed under the law to which the parties have validly subjected it;
- the settlement agreement is not binding, or final according to its terms; or has been subsequently modified;
- the obligations in a settlement agreement have been performed, or are not clear or comprehensible; or granting relief would be otherwise contrary to its terms;
- there was a serious breach by the mediator of the applicable standards without which a party would not have entered into the settlement agreement; and
- there was a failure by the mediator to disclose to the parties circumstances that raise justifiable doubts as to the mediator’s impartiality or independence and such failure to disclose had a material impact or undue influence on a party without which failure that party would not have entered into the settlement agreement.
Likewise, if granting relief would be contrary to public policy in the enforcing State or the subject matter of the dispute is not capable of settlement by mediation under the laws of the enforcing State, then enforcement can be refused by the competent authority of such State as it is the case under the New York Convention.
Interestingly, the Singapore Convention does not have a reciprocity requirement like the New York Convention, meaning that a mediation performed anywhere in the world could potentially be recognised and enforced in a ratifying State.
Acceptance of the Convention
On the first day the Singapore Convention opened for signature (7 August 2019), 46 States including the U.S., Singapore, and China signed the Convention. This rose to 53 by January 2020. At the time of writing (October 2020), six of these signatories have ratified the Convention (Singapore, Qatar and Fiji for whom the Convention came into force on 12 September 2020, followed by Saudi Arabia in November 2020, Belarus in January 2021 and Ecuador in March 2021).[3] None of the EU Member States or the EU itself have signed the Convention yet.[4] Similarly, according to a policy statement from the UK Government in June 2020 and the following Parliamentary discussions in September 2020, no formal decision has yet been taken on whether the UK should join the Convention.[5]
Like the New York Convention, the Singapore Convention requires implementation into domestic legislation. Thus, the corresponding UNCITRAL Model Law on International Commercial Mediation and International Settlement Agreements Resulting from Mediation adopted by the United Nations General Assembly in 2018 (amending the UNCITRAL Model Law on International Commercial Conciliation, 2002)[6] will also assist signatory countries by providing the legal framework and procedures for implementing the Convention.
Why Is the Singapore Convention More Important Now?
As with everything in the current challenging climate, the impact of the COVID-19 pandemic on the civil justice systems and formal dispute resolution methods has been palpable. Since the early months of 2020, businesses have been forced to search for alternative means of resolving their mounting disputes, allowing them to fast-track resolution before things escalate into intractable ends.
As such, the Convention’s entry into force is more than timely. If the current uptake by signatories and the historic experience with the New York Convention in terms of promoting arbitration globally are anything to go by, things are looking very positive for the future of mediation and the Singapore Convention. It is without a doubt that the Convention is a momentous step in growing and developing mediation globally and providing a viable alternative to the current dispute resolution gridlock.
That is probably why international institutions for mediation have been quick to see the opportunities lying ahead. For example, in May 2020, the Singapore International Mediation Centre launched the SIMC COVID-19 Protocol with the aim of providing “a swift and inexpensive route to resolve commercial disputes during the COVID-19 period” by introducing expedited online mediation procedures.[7] Likewise, the London Court of International Arbitration has updated its Mediation Rules for the first time in eight years, effective from 1 October 2020.[8]
Unsurprisingly, Singapore is playing a pioneering role in Asia for the promotion of the Convention and mediation, to further solidify Singapore’s place as an international dispute resolution hub. Its proactivity has a high chance of paying off to cement that position in the long run, especially because mediation is viewed as a means of dispute resolution consistent with Asian business culture, as it encourages parties to work towards an acceptable and face-saving outcome, preserving the commercial relationships. Indeed, various Asian jurisdictions have already enacted mediation legislation in recent years, including Singapore, Hong Kong, Malaysia and China. Thus, the Convention is one more step in the right direction for Singapore, perhaps giving it the slight edge over its biggest rival in the region—Hong Kong—as an alternative dispute resolution centre.
___________________
[1] Available at: https://uncitral.un.org/en/texts/mediation/conventions/international_settlement_agreements.
[2] See our previous alert on the Convention here: https://www.gibsondunn.com/singapore-convention-on-mediation-and-the-path-ahead/.
[3] See here for a full list of signatories.
[4] However, please note that the Member States have the benefit of the Mediation Directive No.2008/52/EC which allows the enforcement of cross-border mediated settlement agreements through the national courts of EU Member States.
[6] Available at: https://uncitral.un.org/en/texts/mediation/modellaw/commercial_conciliation.
[7] Available at: http://simc.com.sg/simc-covid-19-protocol/.
[8] See https://www.lcia.org/lcia-rules-update-2020.aspx.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s International Arbitration and Transnational Litigation practice groups, or the following:
Cyrus Benson – London (+44 (0) 20 7071 4239, cbenson@gibsondunn.com)
Penny Madden Q.C. – London (+44 (0) 20 7071 4226, pmadden@gibsondunn.com)
Jeffrey Sullivan – London (+44 (0) 20 7071 4231, jeffrey.sullivan@gibsondunn.com)
Rahim Moloo – New York (+1 212-351-2413, rmoloo@gibsondunn.com)
Ceyda Knoebel – London (+44 (0)20 7071 4243, cknoebel@gibsondunn.com)
Brad Roach – Singapore (+65 6507 3685, broach@gibsondunn.com)
Robson Lee – Singapore (+65 6507-3684, rlee@gibsondunn.com)
Brian Gilchrist – Hong Kong (+852 2214 3820, bgilchrist@gibsondunn.com)
Elaine Chen – Hong Kong (+852 2214 3821, echen@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On 29 September 2020, the European Commission (“Commission”) issued its first report on concomitant minority shareholdings by institutional investors in companies active in the same market (“Common Shareholdings”)(“Report”).[1] The findings of the 320 page Report were drawn upon lessons learned from five sectors which are considered by the Commission to be relatively concentrated, namely: Oil & Gas, Electricity, Mobile Telecoms, Trading Platforms, and Beverages.
The Report was triggered by the identification of an increasing number of Common Shareholdings in recent years. For instance, in 2014, 60% of U.S. public firms had a shareholder that held at least 5% both in the firm itself and in a competitor.[2] In Europe, Common Shareholdings with at least 5% participation concerned 67% of listed companies in 2016.[3]
Traditionally, Common Shareholdings have not been an antitrust issue as institutional investors usually held small minority stakes, falling far below the level necessary to give them the ability to exercise control, and implemented passive investment strategies. However, in recent years, Common Shareholdings have attracted the attention of antitrust enforcement agencies in Europe and the U.S.[4], given that fund managers have accumulated more substantial shareholdings, together with the related voting rights, in a large number of firms that are often direct competitors.
A number of economists have also raised concerns about this perceived concentration of power, the influence that could be exerted over the management of the companies affected, and the potential incentives to collude amongst the investors.
Overview of the competition assessments made thus far
To date, empirical research on the competitive effects of Common Shareholdings has been focused on the U.S. Specifically, two major studies of the retail banking and airline sectors have concluded that Common Shareholdings in those sectors were associated with higher prices (for banking deposit services and airline tickets respectively) and accordingly may have had a detrimental effect on competition.[5] Following the publication of those studies, the U.S. Federal Trade Commission held a hearing on Common Shareholdings in December 2018.[6]
In the EU, the Commission has examined the potential effects of Common Shareholdings in two recent merger cases: Dow/DuPont[7] and Bayer/Monsanto.[8] As a result of high levels of Common Shareholdings, the Commission concluded that the usual market share indicators (including the HHI Index) were likely to underestimate the level of market concentration, which would lead it to “underestimate the expected non-coordinated effects of the Transaction”.[9] The Commission’s analysis noted in particular that Common Shareholdings may reduce the likelihood of companies to invest in R&D efforts where this would harm the interests of competing firms held in the same institutional investor portfolio.[10] In addition, the Commission observed that passive investors “exert influence on individual firms with an industry-wide perspective”, and also that dispersed ownership exaggerates that influence.[11]
In 2018, Commission Vice-President Margrethe Vestager indicated that the Commission would be looking “carefully” at the prevalence of Common Shareholdings in the EU.[12] Consistent with this approach, the German Monopolies Commission also concluded in a lengthy report that institutional investors may have the means to influence certain of their portfolio companies’ decisions and recommended that the issue receive more attention at EU level.[13] In early 2019, the European Parliament’s Economic and Monetary Affairs Committee agreed to commission research to examine the prevalence of Common Shareholdings in the EU.
The Report’s findings
The Report sets out evidence on the presence and extent of Common Shareholdings across the EU and its possible anticompetitive effects, without putting forward any concrete policy proposals. Its main findings are as follows:
- More than two-thirds of all listed firms active in the EU (67%) are cross-held by Common Shareholdings of at least 5% in each company.
- Portfolios of Common Shareholdings continue to be especially large – in some cases including between 30% to 40% of active companies – in the electricity, financial instruments, telecommunications, and beverage sectors.
- Despite the wide presence of Common Shareholdings, a causal link with competitive outcomes is still challenging, not least because of the definition of the relevant market, the measurement of the Common Shareholding itself, the choice of an appropriate competition indicator (market dominance, concentration levels), or data availability at firm or product level.
- The Report introduces a detailed study of the beverages sector, concluding that a 2009 merger between two institutional investors may have had an effect on the margins of the beverage firms in their portfolios.
- Nonetheless, the Report stresses that more detailed analysis is needed in specific cases regarding the precise causal link between a given Common Shareholding and any actual impact on competition.
Takeaway
As was clear from the Commission’s Dow/DuPont and Bayer/Monsanto merger Decisions, Common Shareholdings are likely to become a more established element in the Commission’s scrutiny of mergers, particularly in concentrated markets.
Following the publication of the Report, in cases where it believes that market shares and other traditional analytical tools underestimate the effect of a concentration the Commission may be inclined to argue that a material impact on competition is more likely where a Common Shareholding is present. This could result in even more complex merger review procedures, potentially including a review of investment histories and strategies.
The Report shows, however, that there are no hard and fast theories of harm of Common Shareholdings. We are currently none the wiser as to whether the Commission will seek to build such an analysis into its existing “coordinated effects”[14] theories or as part of a broader analysis in so-called “gap” cases.[15] It is, therefore, unlikely that the Commission will rely solely on Common Shareholdings to veto a merger. Nonetheless, it is likely that the Commission will view Common Shareholding as an “element of context” capable of magnifying anticompetitive concerns raised by other elements of the investigation.
__________________________
[1] Full report available here. The Report was undertaken by the Finance & Economy Unit of the Commission’s Joint Research Centre at the request of the Commission’s Directorate-General for Competition, as part of a project reviewing “Possible anti-competitive effects of common ownership”.
[2] See OECD, ‘Common Ownership by Institutional Investors and its Impact on Competition’, Background Note by the Secretariat, 5-6 December 2017, p. 13, available at: https://one.oecd.org/document/DAF/COMP(2017)10/en/pdf.
[3] Common Shareholding Report, op. cit., at p. 2.
[4] OECD Background Note, op. cit., at p. 13.
[5] Jose Azar, Sahil Raina and Martin C Schmalz, ‘Ultimate Ownership and Bank Competition’, May 2019; Jose Azar, Martin C Schmalz and Isabel Tecu, ‘Anticompetitive Effects of Common Ownership’, Journal of Finance 28(4), 2018.
[6] FTC Hearing #8: Competition and Consumer Protection in the 21st Century, 6 December 2018, transcript available here.
[7] Case M.7932 Dow/DuPont.
[8] Case M.8084 Bayer/Monsanto.
[9] Case M.7932 Dow/DuPont, Annex 5, paras. 4 and 81; Case M.8084 Bayer/Monsanto, para. 229.
[10] Case M.7932 Dow/DuPont, Annex 5
[11] Case M.7932 Dow/DuPont, Annex 5, para. 7.
[12] Full speech accessible at: https://wayback.archive-it.org/12090/20191129215248/https://ec.europa.eu/commission/commissioners/2014-2019/vestager/announcements/competition-changing-times-0_en; see also https://globalcompetitionreview.com/dg-comp-looking-common-ownership-says-vestager.
[13] Full report available here.
[14] Coordinated effects occur where as a result of the merger, the merging parties and their competitors will successfully be able to coordinate their behaviour in an anti-competitive way, for example by tacit or explicit collusion.
[15] Mergers in oligopolistic markets which the Commission believes would significantly lessen competition without creating or strengthening a dominant position in the marketplace.
Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. For additional information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the Antitrust and Competition practice group or the following authors in Brussels:
Jens-Olrik Murach (+32 2 554 7240, jmurach@gibsondunn.com)
David Wood (+32 2 554 7210, dwood@gibsondunn.com)
Peter Alexiadis (+32 2 554 7200, palexiadis@gibsondunn.com)
Antitrust and Competition Group in Europe:
Brussels
Peter Alexiadis (+32 2 554 7200, palexiadis@gibsondunn.com)
Attila Borsos (+32 2 554 72 11, aborsos@gibsondunn.com)
Jens-Olrik Murach (+32 2 554 7240, jmurach@gibsondunn.com)
Christian Riis-Madsen (+32 2 554 72 05, criis@gibsondunn.com)
Lena Sandberg (+32 2 554 72 60, lsandberg@gibsondunn.com)
David Wood (+32 2 554 7210, dwood@gibsondunn.com)
Munich
Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com)
Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com)
London
Patrick Doris (+44 20 7071 4276, pdoris@gibsondunn.com)
Charles Falconer (+44 20 7071 4270, cfalconer@gibsondunn.com)
Ali Nikpay (+44 20 7071 4273, anikpay@gibsondunn.com)
Philip Rocher (+44 20 7071 4202, procher@gibsondunn.com)
Deirdre Taylor (+44 20 7071 4274, dtaylor2@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On October 14, 2020, the California Air Resources Board (CARB) issued a letter to light-, medium-, and heavy-duty vehicle and engine manufacturers encouraging industry to report any hardware or software changes made to their vehicles or engines if such changes (i) affect emissions and (ii) were not previously or properly disclosed to CARB. The letter indicates that the agency is in the process of selecting new targets for investigation and is implementing new enhanced testing to identify potential violations. In connection with this forthcoming enforcement initiative, CARB urges industry to proactively and voluntarily disclose any violations under California mobile source regulations before the end of this year. Companies that do so could secure a reduction in penalties ranging from 25% to 75%, depending on the relevant facts and circumstances of the case.
Background. California law, like the federal Clean Air Act, requires manufacturers to disclose all auxiliary emission control devices (“AECDs”) at the time a particular vehicle or engine is submitted for certification. California and federal law also prohibit the installation of any AECD that reduces the effectiveness of the emission control system under conditions which may reasonably be expected to be encountered in normal vehicle operation and use, unless certain exceptions apply. Such functions are referred to as defeat devices. These requirements, or other reporting requirements, apply to a number of mobile source categories including light-duty vehicles, heavy-duty on-road engines and vehicles, highway motorcycles, off-road compression ignition engines, off-road small and large spark-ignition engines, off-highway recreational vehicles, spark-ignition marine engines, and evaporative systems for off-road small and large equipment and marine watercraft.
CARB’s October 14 letter builds upon, and incorporates by reference, a September 25, 2015 letter sent by CARB to light-, medium-, and heavy-duty vehicle and engine manufactures in the wake of the Volkswagen diesel emissions scandal related to its installation of defeat devices in its 2.0L and 3.0L diesel vehicles and reporting issues related thereto. That letter reiterated manufacturers’ obligations to disclose all AECDs at the time of certification, and informed industry of CARB’s intent to begin implementing a robust testing program in support of CARB’s enforcement efforts designed to screen for undisclosed AECDs and defeat devices.
CARB’s letter explains that through this expanded testing program, since 2015, it has achieved multiple settlements with vehicle and engine manufacturers. It further notes that certain manufacturers have “stepped forward” to disclose potential violations, and it encourages others to make voluntary disclosures of any potential violations with respect to the applicable regulatory requirements.
Finally, the letter states that CARB currently is identifying new targets for investigation and plans to open a new, state-of-the-art testing laboratory in 2021, which will better enable it to identify violations related to vehicles and engines sold in California.
Potential Violations Highlighted in the Letter. The letter lists the specific violation types CARB is presently investigating and for which it encourages manufacturers to make proactive reports:
- Undisclosed AECDs
- Defeat Devices
- Unreported Running Changes and Field Fixes
- Failure to Report or Address Warranty Claims
- Manufacturer In-Use Compliance Testing and Manufacturer’s Self-Testing
- Failure to Report Corrective Actions that Should be Under a CARB Approved Recall
- Submission of False Data or Non-Compliance with Regulatory Test Requirements
- Failure to Meet OBD Requirements
- Failure to Disclose Adjustable Parameters that May Affect Emissions
CARB’s Request for Self-Disclosure. The letter concludes by urging manufacturers to voluntarily disclose any potential violations in the above-listed categories by the end of 2020, and reiterates CARB’s authority to enforce California’s emissions laws against noncompliant manufacturers, including through the assessment of maximum penalties of $37,500 per mobile source or engine, per identified violation. CARB states that voluntary disclosure “will trigger a reduction in penalties,” whereas failure to make a voluntary disclosure could result in future enforcement actions or influence ongoing investigations by CARB.
CARB’s letter states that this initiative reflects California’s ongoing efforts to meet existing and future air quality targets and to protect affected communities in the state from the effects of exposure to air pollution.
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 Environmental Litigation and Mass Tort practice group, or the following practice leaders and authors in Washington, D.C.:
Stacie B. Fletcher – Co-Chair (+1 202-887-3627, sfletcher@gibsondunn.com)
Raymond B. Ludwiszewski (+1 202-955-8665, rludwiszewski@gibsondunn.com)
Daniel W. Nelson – Co-Chair (+1 202-887-3687, dnelson@gibsondunn.com)
Rachel Levick Corley (+1 202-887-3574, rcorley@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
On September 25, 2020, California Governor Gavin Newsom signed into law the California Consumer Financial Protection Law (CCFPL), which was passed by the state legislature on August 31, 2020.[1] Under the CCFPL, California’s Department of Business Oversight (DBO) has been renamed the Department of Financial Protection and Innovation (DFPI). Modeled after the Consumer Financial Protection Bureau (CFPB) provisions in the Dodd-Frank Act, the CCFPL aims to strengthen consumer protections by expanding the regulatory authority of the DFPI and promoting access to responsible and affordable credit. The substantive provisions of the CCFPL go into effect on January 1, 2021.
The effects of the CCFPL will be felt most immediately by certain nonbank financial companies – for example, payday lenders and student loan servicers – as well as affiliated “service providers” to financial companies, because of statutory exclusions for regulated banks and many other current DBO nonbank licensees. This said, the CCFPL also gives the DFPI the authority to define other financial services whose providers would thereby become subject to its jurisdiction, and it includes new provisions relating to unfair, deceptive and abusive acts and practices enforcement authority (UDAAP) over statutorily covered persons and service providers. The DFPI will also have the authority to bring civil actions under the Dodd-Frank Act’s consumer protection provisions against all state-licensed banks and nonbank financial companies. As a result, financial institutions doing business in California are now facing a potentially powerful and reinvigorated regulatory authority.
I. Jurisdiction
The CCFPL grants authority to the DFPI to regulate the offering and provision of consumer financial products or services under California’s consumer financial laws, to exercise nonexclusive oversight and enforcement authority under California’s consumer financial laws, and, to the extent permissible under federal consumer financial laws, nonexclusive oversight and enforcement under federal consumer financial laws as well.[2]
The CCFPL’s definition of “consumer financial products and services” closely parallels the broad definition in Title X of the Dodd-Frank Act and its implementing regulations;[3] these include any financial product or service that is delivered, offered, or provided for use by consumers primarily for personal, family, or household purposes.[4] The definition also includes brokering the offer or sale of a franchise in California on behalf of another.[5] Similar to the authority granted to the CFPB under the Dodd-Frank Act, the DFPI will have authority to issue regulations defining any other financial product or service when the financial product or service (i) is entered into or conducted as a subterfuge or with a purpose to evade consumer financial law or (ii) will likely have a material impact on consumers, in each case, subject to certain exceptions.[6]
As a general matter, the CCFPL applies to “covered persons.” Subject to the important exclusions discussed immediately below, this includes (1) any person that engages in offering or providing a consumer financial product or service to a resident of California, (2) any affiliate of a covered person that acts as a service provider, and (3) any service provider to the extent that person offers or provides its own consumer financial product or service.[7] A “service provider” is any person that provides a material service to a covered person in connection with the covered person’s offering or provision of a consumer financial product or service.[8]
Reflecting a legislative compromise, the CCFPL does not apply to the following entities that were previously subject to licensing and DBO regulation: banks, bank holding companies, trust companies, savings and loan associations, savings and loan holding companies, credit unions, industrial loan corporations, insurers, certain electronic financial data transmitters, escrow agents, finance lenders and brokers, mortgage loan originators, broker-dealers, investment advisers, residential mortgage lenders, mortgage servicers, and money transmitters.[9] Payday lenders and student loan servicers, however, are not excluded. Also excluded are licensees of other state agencies and their employees where the licensee or employee is acting under the authority of the other state agency’s license (for example, real estate brokers).[10]
II. UDAAP
Like Title X of Dodd-Frank, the CCFPL contains expanded UDAAP (unfair, deceptive or abusive acts and practices) authority over “covered persons” and “service providers.” The CCFPL permits the DFPI to take action against a covered person or service provider that engages, has engaged, or proposes to engage in UDAAPs with respect to consumer financial products or services.[11] In addition to enforcement authority, the CCFPL authorizes the DFPI to prescribe rules applicable to any covered person or service provider regarding UDAAP, subject to the following limitations.[12] The DFPI must interpret “unfair” and “deceptive” in a manner consistent with California’s broad Unfair Competition Law and case law thereunder.[13] In this area, the definition of “unfair” remains unsettled.[14] Courts typically use one of two tests to determine “unfairness”: (1) an “examination of [the practice’s] impact on its alleged victim, balanced against the reasons, justifications and motives of the alleged wrongdoer”[15] or (2) the Federal Trade Commission’s definition of “unfair” conduct.[16] As for the term “abusive,” the CCFPL requires that it must be interpreted consistently with Title X of the Dodd-Frank Act, and any inconsistency must be resolved in favor of greater protections to the consumer and more expansive coverage.[17]
In addition to UDAAP authority, the DFPI is authorized to bring civil actions or other appropriate proceedings to enforce the consumer protection provisions of Title X of the Dodd-Frank Act and the CFPB’s regulations thereunder, with respect to any entity licensed, registered or subject to DFPI oversight.[18]
III. Other Enforcement Powers
In addition to its UDAAP authority, the DFPI may enforce consumer financial laws with respect to covered persons, service providers, and – broadening its authority substantially – persons who knowingly or recklessly provide substantial assistance to a covered person or service provider in violating consumer financial law.[19] This authority applies only to acts or practices engaged in on or after the January 1, 2021.[20]
The DFPI also has the power to bring administrative and civil actions, issue subpoenas, hold hearings, issue publications, and conduct investigations.[21] It may issue orders directing a person to desist and refrain from engaging in an activity, act, practice or course of business; such injunctive orders become effective and final if a respondent does not request a hearing within 30 days.[22] After notice and an opportunity for a hearing, the DFPI can suspend or revoke the license or registration of a covered person or service provider.[23] The DFPI can also apply to the appropriate superior court for an order compelling the cited licensee or person to comply with its orders.[24]
No civil action can be brought by the DFPI more than four years after the date of discovery of the violation to which an action relates.[25] What constitutes the “date of discovery” is undefined in the CCFPL and similarly undefined in Title X of the Dodd-Frank Act. The United States District Court for the Northern District of California, however, has held that the CFPB’s limitations period begins running when the CFPB “actually” discovers facts constituting a violation or when a “reasonably diligent plaintiff would have” discovered those facts.[26] If, however, an action arises solely under a California or federal consumer financial law, the limitations period under such consumer financial law will apply.[27]
With respect to UDAAP violations, the DFPI will have at its disposal the same wide-ranging remedial tools as the CFPB, including rescission or reformation of contracts, refund of moneys or return of real property, restitution, disgorgement or compensation for unjust enrichment, payment of damages, public notification regarding the violation, and limits on the activities or functions of the violator.[28] Like Title X of the Dodd-Frank Act, the CCFPL does not authorize exemplary or punitive damages,[29] but does empower the DFPI to impose considerable penalties for violations.[30]
|
CCFPL Penalties | ||||
|
May not exceed the greater of | ||||
| Violation | $5,000 for each day the violation continues | $2,500 for each act or omission in violation | ||
| Reckless Violation | $25,000 for each day the violation continues | $10,000 for each act or omission in violation | ||
|
May not exceed the lesser of | ||||
| Knowing Violation | $1,000,000 for each day the violation continues | $25,000 for each act or omission in violation | 1% of the violator’s total assets | |
IV. Consumer Complaints
The CCFPL authorizes the DFPI to promulgate regulations to round out its investigatory authority. Like the CFPB, the DFPI may promulgate rules and procedures governing informational requests from covered persons concerning consumer complaints or inquiries.[31] The DFPI is required to finalize its complaint response procedures before it may commence an enforcement action against a covered person or service provider for a violation of these provisions.[32] The DFPI may, however, make the information requests themselves beginning on January 1, 2021. Notably, these provisions do not apply to consumer complaints regarding credit reporting agencies.
V. Registration
Covered persons engaged in the business of offering or providing a consumer financial product or service may become subject to new registration requirements and attendant fees, as the latter will help support the DFPI’s operating budget.[33] The authority to promulgate rules related to the registration and reporting of covered persons will expand the reach of the DFPI to oversee entities that are not currently subject to licensure or registration. In order to deter regulation by enforcement, the CCFPL requires the DFPI to promulgate registration rules no later than three years following the initiation of its second action to enforce a violation of the CCFPL by persons providing the same or substantially similar consumer financial product or service.[34]
VI. Covered Person Reporting
Like the CFPB, the DFPI can require a covered person to generate, provide, or retain records for the purposes of facilitating oversight and assessing and detecting risks to consumers.[35] In conducting any monitoring, regulatory or assessment activity, the DFPI can also gather information regarding the organization, business conduct, markets, and activities of any covered persons or service providers.[36]
VII. DFPI Reporting
The DFPI must prepare and publish an online annual report detailing actions taken during the prior year.[37] The report must include information on actions with respect to rulemaking, enforcement, oversight, consumer complaints and resolutions, education, research, and the activities of the Financial Technology Innovation Office.[38] The report may also include recommendations, including those intended to result in improved oversight, greater transparency, or increased availability of beneficial financial products and services in the marketplace.[39]
VIII. Conclusion
Notwithstanding its exclusions for many entities previously subject to DBO oversight, the CCFPL creates a more powerful state financial services regulator with new registration authority, expanded enforcement authority, and UDAAP authority. If it makes full use of the CCFPL’s powers, the DFPI will become a significant consumer regulator. Firms that offer consumer financial products and services in California will therefore need to pay close attention to the DFPI in 2021 as it begins to implement its new statutory authority.
______________________
[1] California Assembly Bill 1864 (passed August 31, 2020), available here.
[3] See 12 C.F.R. § 1091.101 (definition of “consumer financial product or service”) and 12 U.S.C. § 5481(15) (definition of “financial product or service”).
[4] New Cal. Fin. Code § 90005(c).
[5] Id. § 90005(e). For a complete list of “financial products or services,” see id. § 90005(k).
[6] Compare New Cal. Fin. Code § 90005(k)(12) with 12 U.S.C. § 5481(15)(A)(xi).
[7] New Cal. Fin. Code § 90005(f).
[11] Id. §§ 90012(a); 90009(c); 12 U.S.C. § 5531(a), (b).
[12] New Cal. Fin. Code § 90009(c). The statute further authorizes the DFPI to define UDAAP in connection with the offering or provision of commercial financing or other financial products and services to small business recipients, nonprofits, and family farms. Id. § 90009(c)(3).
[14] See, e.g., Mui Ho v. Toyota Motor Corp., 931 F. Supp. 2d 987, 1000 n.5 (N.D. Cal. 2013) (“California courts and the legislature have not specified which of several possible ‘unfairness’ standards is the proper one.”); Ferrington v. McAfee, Inc., No. 10-CV-01455-LHK, 2010 WL 3910169, at *11 (N.D. Cal. Oct. 5, 2010) (“California law is currently unsettled with regard to the correct standard to apply to consumer suits alleging claims under the unfair prong of the UCL.”).
[15] Motors, Inc. v. Times Mirror Co., 102 Cal. App. 3d 735, 740 (1980).
[16] The Federal Trade Commission Act provides that an act or practice is unfair when (1) it causes or is likely to cause substantial injury to consumers, (2) the injury is not reasonably avoidable by consumers and (3) the injury is not outweighed by countervailing benefits to consumers or to competition. 15 U.S.C. § 45(n). The CFPB uses the same standard for unfairness. 12 U.S.C. § 5531(c).
[17] New Cal. Fin. Code § 90009(c)(3).
[26] See Consumer Financial Protection Bureau v. Nationwide Biweekly Administration, Inc., et. al., No. 15-cv-02106-RS (N.D. Cal. Sep. 8, 2017)
[27] New Cal. Fin. Code § 90014.
[29] Compare New Cal. Fin. Code § 90013(d) with 12 U.S.C. § 5565(a)(3).
[30] New Cal. Fin. Code § 90013(d).
[31] Id. § 90008. Notably, these provisions do not apply to consumer complaints regarding consumer reporting agencies. Id.
[35] Id. § 90009(b); 12 U.S.C. § 5514(b)(7)(B).
[36] New Cal. Fin. Code § 90010(f).
The following Gibson Dunn lawyers assisted in preparing this client update: Arthur S. Long, Benjamin B. Wagner, James O. Springer and Samantha J. Ostrom.
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 in the firm’s Financial Institutions practice group, or the following:
Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)
Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com)
Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com)
Mylan L. Denerstein – New York (+1 212-351- 3850, mdenerstein@gibsondunn.com)
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com)
Benjamin B. Wagner – Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com)
James O. Springer – New York (+1 202-887-3516, jspringer@gibsondunn.com)
Samantha J. Ostrom – Washington, D.C. (+1 202-955-8249, sostrom@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
This Client Alert provides an update on shareholder activism activity involving NYSE- and Nasdaq-listed companies with equity market capitalizations in excess of $1 billion and below $100 billion (as of the close of trading on June 30, 2020) during the first half of 2020. As the markets weathered the dislocation caused by the novel coronavirus (COVID-19) pandemic, shareholder activist activity decreased dramatically. Relative to the first half of 2019, the number of public activist actions declined from 51 to 28, the number of activist investors taking actions declined from 33 to 10 and the number of companies targeted by such actions declined from 46 to 22.
By the Numbers – H1 2020 Public Activism Trends
Additional statistical analyses may be found in the complete Activism Update linked below.
The decline in shareholder activism activity brought concentration among those investors engaged in activist activity during the first half of 2020. For example, during the first half of 2020, NorthStar Asset Management launched six campaigns and Starboard Value LP launched four campaigns. Three activists represented half of the total public activist actions that began during the first half of 2020.
In addition, as compared to the first half of 2019, activists turned their focus away from agitating for particular transactions as the animating rationale for the campaigns they launched. While changes in board composition remained the leading rationale for campaigns initiated in the first half of 2019 and the first half of 2020, M&A (which includes advocacy for or against spin-offs, acquisitions and sales) and acquisitions of control, which served as the rationale for 24% and 8%, respectively, of activist campaigns in the first half of 2019, declined to 9% and 0%, respectively, in the first half of 2020. By contrast, advocacy for changes in governance, which emerged in 6% of campaigns in the first half of 2019, became the principal rationale for 28% of campaigns in the first half of 2020. Business strategy also remained a high-priority area of focus for shareholder activists, representing the rationale for 22% of campaigns begun in the first half of 2019 and 24% of campaigns begun in the first half of 2020. The rate at which activists engaged in proxy solicitation remained consistent at 24% in the first half of 2019 and 21% in the first half of 2020. (Note that the percentages for campaign rationales described in this paragraph sum to over 100%, as certain activist campaigns had multiple rationales.)
Publicly filed settlement agreements declined alongside the decrease in shareholder activism activity. Nine settlement agreements were filed during the first half of 2020, as compared to 17 such agreements during the first half of 2019. Nonetheless, the settlement agreements into which activists and companies entered contained many of the same features noted in prior reviews, including voting agreements and standstill periods as well as non-disparagement covenants and minimum and/or maximum share ownership covenants. Expense reimbursement provisions appeared in two thirds of the settlement agreements reviewed, which represented an increase relative to historical trends. We delve further into the data and the details in the latter half of this Client Alert.
We hope you find Gibson Dunn’s 2020 Mid-Year Activism Update informative. If you have any questions, please do not hesitate to reach out to a member of your Gibson Dunn team.
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this publication. For further information, please contact the Gibson Dunn lawyer with whom you usually work, or any of the following authors in the firm’s New York office:
Barbara L. Becker (+1 212.351.4062, bbecker@gibsondunn.com)
Dennis J. Friedman (+1 212.351.3900, dfriedman@gibsondunn.com)
Richard J. Birns (+1 212.351.4032, rbirns@gibsondunn.com)
Eduardo Gallardo (+1 212.351.3847, egallardo@gibsondunn.com)
Saee Muzumdar (+1 212.351.3966, smuzumdar@gibsondunn.com)
Daniel S. Alterbaum (+1 212.351.4084, dalterbaum@gibsondunn.com)
Jessica L. Bondy (+1 212.351.3802, jbondy@gibsondunn.com)
Please also feel free to contact any of the following practice group leaders and members:
Mergers and Acquisitions Group:
Jeffrey A. Chapman – Dallas (+1 214.698.3120, jchapman@gibsondunn.com)
Stephen I. Glover – Washington, D.C. (+1 202.955.8593, siglover@gibsondunn.com)
Jonathan K. Layne – Los Angeles (+1 310.552.8641, jlayne@gibsondunn.com)
Securities Regulation and Corporate Governance Group:
Brian J. Lane – Washington, D.C. (+1 202.887.3646, blane@gibsondunn.com)
Ronald O. Mueller – Washington, D.C. (+1 202.955.8671, rmueller@gibsondunn.com)
James J. Moloney – Orange County, CA (+1 949.451.4343, jmoloney@gibsondunn.com)
Elizabeth Ising – Washington, D.C. (+1 202.955.8287, eising@gibsondunn.com)
Lori Zyskowski – New York (+1 212.351.2309, lzyskowski@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
California’s housing shortage continues as the state grapples with the COVID-19 pandemic. In an effort to mitigate delays in housing production throughout the state, California Governor Gavin Newsom recently signed into law Assembly Bill 1561 (“AB 1561”), which extends the validity of certain categories of residential development entitlements. Devised as a remedy for impediments to housing development as a result of interruptions in planning, financing, and construction due to the pandemic, AB 1561 helps cities and counties that would otherwise need to devote significant resources to addressing individual permit extensions on a case-by-case basis.
AB 1561 adds a new section to the state’s Government Code, Section 65914.5, that extends the effectiveness of “housing entitlements” that were (a) issued and in effect prior to March 4, 2020 and (b) set to expire prior to December 31, 2021. All such qualifying housing entitlements will now remain valid for an additional period of eighteen (18) months.
Section 65914.5 broadly defines a “housing entitlement” to include any of the following:
- A legislative, adjudicative, administrative, or any other kind of approval, permit, or other entitlement necessary for, or pertaining to, a housing development project issued by a state agency;
- An approval, permit, or other entitlement issued by a local agency for a housing development project that is subject to the Permit Streamlining Act (Cal. Gov. Code § 65920 et seq);
- A ministerial approval, permit, or entitlement by a local agency required as a prerequisite to the issuance of a building permit for a housing development project;
- Any requirement to submit an application for a building permit within a specified time period after the effective date of a housing entitlement described in numbers 1 and 2 above; and
- A vested right associated with an approval, permit, or other entitlement described in numbers 1 through 4 above.
Notably, specifically excluded from the definition of a “housing entitlement” are: (a) development agreements authorized pursuant to California Government Code Section 65864; (b) approved or conditionally approved tentative maps which were previously extended for at least eighteen (18) months on or after March 4, 2020 pursuant to Government Code Section 66452.6; (c) preliminary applications under SB 330 (the Housing Crisis Act of 2019); and (d) applications for development approved under SB 35 (Cal. Gov. Code § 65913.4).
Further, housing entitlements which were previously granted an extension by any state or local agency on or after March 4, 2020, but before the effective date of AB 1561 (i.e. September 28, 2020), will not be further extended for an additional 18-month period so long as the initial extension period was for no less than eighteen (18) months.
The definition of a “housing development project” is broad and includes any of the following: (x) approved or conditionally approved tentative maps, vesting tentative maps, or tentative parcel maps for Subdivision Map Act compliance (Cal. Gov. Code § 66410 et seq); (y) residential developments; and (z) mixed-use developments in which at least two-thirds (2/3rds) of the square footage of the development is designated for residential use. For purposes of calculating the square footage devoted to residential use within a mixed-use development, the calculation must include any additional density, floor area, and units, and any other concession, incentive, or waiver of development standards obtained under California’s Density Bonus Law (Cal. Gov. Code § 65915); however, the square footage need not include any underground space such as a basement or underground parking garage.
AB 1561 makes clear that while the extension provision of Section 65914.5 applies to all cities, including charter cities, local governments are not precluded from further granting extensions to existing entitlements.
Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. For additional information, please contact any member of Gibson Dunn’s Real Estate or Land Use Group, or the following authors:
Doug Champion – Los Angeles (+1 213-229-7128, dchampion@gibsondunn.com)
Amy Forbes – Los Angeles (+1 213-229-7151, aforbes@gibsondunn.com)
Ben Saltsman – Los Angeles (+1 213-229-7480, bsaltsman@gibsondunn.com)
Matthew Saria – Los Angeles (+1 213-229-7988, msaria@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
While the COVID-19 pandemic has disrupted the practice of law in 2020, courts have continued to churn out important rulings impacting the media and entertainment industries. Here, Gibson Dunn’s Media, Entertainment and Technology Practice Group highlights some of those key cases and trends: from politically charged First Amendment cases to copyright battles over rock anthems, fictional pirates, and real-life music piracy.
I. Recent Litigation Highlights
A. First Amendment Litigation
1. President Trump’s Failed Efforts to Block Publication of Critical Books.
This presidential election year saw two efforts by the federal government and President Trump to enjoin the publication of forthcoming books critical of the current president. Both efforts to obtain a prior restraint order failed and the books were released, though one of the cases is far from over.
On June 20, 2020, the District Court for the District of Columbia rejected the U.S. government’s motion for a preliminary injunction and temporary restraining order to block former National Security Advisor John Bolton from publishing his memoir, The Room Where it Happened.[1] The United States filed its lawsuit on June 16, 2020, alleging that Bolton’s book contains sensitive information that could compromise national security, that its publication breached non-disclosure agreements that bound Bolton, and that Bolton abandoned the prepublication review process.[2] In addition to an injunction, the government seeks as a remedy a constructive trust over Bolton’s proceeds from the book. PEN American Center, Inc., Association of American Publishers, Inc., Dow Jones & Company, Inc., The New York Times Company, Reporters Committee or Freedom of the Press, The Washington Post, the ACLU and others filed amicus briefs opposing the government’s effort to enjoin publication, arguing, among other things, that the First Amendment prohibits prior restraints for any duration of time.[3] Rejecting the government’s motion, the district court held that, while the government is likely to succeed on the merits of its complaint, it did not establish that it would suffer irreparable injury absent an injunction.[4] Judge Lamberth had harsh words for Bolton, stating that—while not controlling as to that present motion—Bolton “has exposed his country to harm and himself to civil (and potentially criminal) liability.”[5] On July 30, 2020, the government filed a motion for summary judgment against Bolton.[6] On September 15, 2020, it was reported that the Justice Department had opened a criminal investigation into Bolton’s alleged disclosure of classified information in connection with his book.[7] On October 1, 2020, the district court denied Bolton’s motion to dismiss the government’s civil case against him.[8] [Disclosure: Gibson Dunn represented amicus PEN American Center, Inc. in opposing the government’s effort to enjoin publication.]
On July 13, 2020, the New York Supreme Court rejected a similar attempt by President Trump’s brother, Robert S. Trump—brought shortly before his death—to enjoin publication of their niece Mary Trump’s book, Too Much and Never Enough.[9] Robert Trump filed his motion for temporary restraining order and preliminary injunction against Mary Trump and her publisher, Simon and Schuster, on June 26, 2020, alleging that publication of Ms. Trump’s book would breach a confidentiality clause in a nearly 20-year-old settlement agreement among the Trump family regarding the president’s parents’ estates.[10] Ms. Trump argued, among other things, that a prior restraint is not a constitutionally permissible method of enforcing a settlement agreement’s confidentiality provision and that the contract Robert Trump invoked was not enforceable under the circumstances.[11] The Court agreed, finding that “in the vernacular of First year law students, ‘Con. Law trumps Contracts.’”[12] Ms. Trump’s book was released and became a best-seller. [Disclosure: Gibson Dunn represents Mary Trump in this lawsuit.]
2. Defamation Litigation
a. A Barrage of Defamation Claims, Settlements, Trials, and Dismissals.
The past year has been particularly active in the defamation arena. While media defendants have won some high-profile victories over slander and libel claims, such claims remain a threat, and plaintiffs continue to file lawsuits with headline-grabbing damages requests. Sarah Palin’s libel case against The New York Times Company—over a 2017 editorial that she alleges falsely tied her to a mass shooting—will proceed to trial in February 2021 after the judge denied dueling summary judgment motions and found that the case should be decided by a jury.[13] And this year, Nicholas Sandmann settled suits brought against The Washington Post and CNN over coverage of his viral-video encounter with a Native American activist at the 2019 March for Life rally in Washington D.C.[14] Sandmann still has pending suits against NBC, ABC News, CBS News, The New York Times, Gannett, and Rolling Stone.[15]
On the other hand, in December 2019, a Los Angeles jury determined that Elon Musk did not defame Vernon Unsworth when he called him a “pedo guy” during a name-calling spat on Twitter.[16] Moreover, over the past year, Congressman Devin Nunes has seen many of his defamation suits against media companies rebuffed, with courts recently dismissing his lawsuit against Esquire and journalist Ryan Lizza, and dismissing another suit against the political research firm Fusion GPS, though Nunes continues to pursue both actions.[17] Nunes also continues to try to sue Twitter and certain of its users for defamation, including a Republican political strategist and anonymous parody accounts belonging to a fake cow (Devin Nunes’ cow @DevinCow) and to Nunes’ “mother” (Devin Nunes’ Alt-Mom @NunesAlt), even after Twitter was dismissed from the case.[18] Nunes has also filed suits against McClatchy, The Washington Post, and CNN.[19] [Disclosure: Gibson Dunn represents The McClatchy Company in the suit filed by Nunes.]
b. Rachel Maddow Wins Dismissal of One America News Network Owner’s Defamation Claim.
On May 22, 2020, Judge Cynthia A. Bashant of the Southern District of California granted Rachel Maddow, MSNBC, NBCUniversal, and Comcast’s anti-SLAPP special motion to strike in response to a complaint filed by Herring Networks, Inc., owner of the conservative news outlet One America News (“OAN”).[20] Herring Networks filed its lawsuit in September 2019 over comments Ms. Maddow made during a broadcast of The Rachel Maddow Show. During that show, she commented on a Daily Beast article that reported how OAN employed an on-air reporter who also worked for Sputnik, a pro-Kremlin news organization funded by the Russian government. While reporting on the article, Ms. Maddow exclaimed, “the most obsequiously pro-Trump right wing news outlet in America really literally is paid Russian propaganda. Their on air U.S. politics reporter is paid by the Russian government to produce propaganda for that government.”[21] Herring Networks argued Ms. Maddow’s statement that the network “really literally is paid Russian propaganda” was false and defamatory.[22]
Ms. Maddow and the other defendants challenged Herring Networks’ suit via a motion to strike under California’s anti-SLAPP law, arguing that Ms. Maddow’s statement was fully protected opinion under the First Amendment and, in any event, was substantially true.[23] The court granted the defendants’ motion, explaining Ms. Maddow clearly outlined the basis for her opinions during the segment and “inserted her own colorful commentary” regarding the facts.[24] As such, the court found the statement was protected opinion as a matter of law and disagreed with Herring Networks’ argument that Ms. Maddow’s statement raised a factual issue for a jury. The court dismissed Herring Networks’ complaint with prejudice, and ordered the defendants to file a motion to recover their fees (as required by California’s anti-SLAPP law).[25] Herring Networks has filed a notice of appeal with the Ninth Circuit. [Disclosure: Gibson Dunn represents Ms. Maddow, MSNBC, NBCUniversal, and Comcast in this action.]
c. “Wolf of Wall Street” Libel Claim Fails.
In June 2020, the Second Circuit rejected a libel lawsuit filed against Paramount Pictures over the film “The Wolf of Wall Street,” in which Wall Street brokerage-firm attorney Andrew Greene alleged he was defamed by a fictional character in the film who Greene claimed resembled him.[26] Greene, an ex-employee of the financial firm portrayed in the film, alleged that the film featured a character that is “recognizable as him” and “depicted as engaging in behavior that defames his character.”[27] The District Court for the Eastern District of New York granted the defendants’ motion for summary judgment, holding that Greene failed to raise a genuine issue of material fact as to whether Paramount Pictures acted with knowledge or reckless disregard in making defamatory statements “of and concerning” Greene.[28]
The Second Circuit affirmed, holding that Greene’s claims failed as a matter of law because a reasonable jury would not find that Paramount Pictures acted with actual malice.[29] First, the Second Circuit found that Paramount Pictures “took appropriate steps to ensure that no one would be defamed by the Film.”[30] Those steps included reading the book and news articles on which the film was based and assigning characters fictitious names with no “specific real life analogue.”[31] Second, the circuit court found that “no reasonable viewer” of “The Wolf of Wall Street” would believe that Paramount Pictures intended the character in the film as a depiction of Greene, as Paramount Pictures knew the film character was a fictitious, composite character.[32] Also, Greene worked as head of the corporate finance department at the financial firm portrayed in the film, while the character at issue worked as a broker on the trading floor.[33] Finally, the film included a disclaimer that characters in the film were fictionalized.[34]
3. Right of Publicity
a. New York Considers New Right of Publicity Law.
In July 2020, both houses of the New York Legislature unanimously passed a much-anticipated proposed right of publicity bill, which awaits signature by Governor Andrew Cuomo.[35] The bill, Senate Bill S5959D/Assembly Bill No. A05605B, would replace New York Civil Rights Law § 50 and changes the right of publicity landscape in the state.[36] Significantly, the bill makes a person’s right of publicity an independent property right that is freely transferable and creates postmortem rights for forty years after the death of an individual.[37] It further “protects a deceased performer’s digital replica in expressive works to protect against persons or corporations from misappropriating a professional performance.”[38]
Given the rise of pornographic deepfakes—“hyper-realistic manipulation of digital imagery that can alter images so effectively it’s largely impossible to tell real from fake”[39]—SAG-AFTRA called the bill’s passage “a remarkable step in the ongoing effort to protect our members, and all performers, from the exploitation of our images and voices – the very assets we use to make a living.”[40] But others, including the Motion Picture Association of America (“MPAA”) and the New York State Broadcasters Association, Inc., have voiced concerns about the bill’s implications, arguing it chills speech and presents First Amendment concerns.[41] Specifically, the MPAA argues that the bill’s language is vague and overbroad and interferes with the ability of filmmakers to tell stories inspired by real people and events.[42]
B. Profit Participation & Royalties
1. AMC Prevails in First The Walking Dead Profits Trial in California.
On July 22, 2020, following a bench trial, Judge Daniel Buckley of the Superior Court for the County of Los Angeles issued a sweeping ruling in favor of AMC in a profit participation action regarding the hit AMC series The Walking Dead.[43] This California lawsuit, governed by New York contract law, was brought by various show participants, including Robert Kirkman, David Alpert, and Gale Anne Hurd. The case also involved issues pertaining to spin-offs Fear the Walking Dead and Talking Dead. The profit participants alleged that AMC failed to properly account to them under their agreements, and Judge Buckley ordered the eight-day trial to resolve key, gateway issues of contractual interpretation.
Those issues included (1) whether AMC’s standard modified adjusted gross receipts definition (“MAGR Definition”) governed the calculation, reporting, and payment of MAGR to the plaintiffs; and (2) whether the affiliate transaction provision in certain plaintiffs’ agreements applied to AMC Network’s exhibition of The Walking Dead.[44]
Judge Buckley found that AMC’s standard MAGR Definition governed the calculation, reporting, and payment of MAGR to the plaintiffs, even where the MAGR exhibit was supplied after the plaintiffs signed their agreements. The court looked at the plain text of the parties’ agreements, which stated that “MAGR shall be defined, computed, accounted for and paid in accordance” with AMC’s MAGR Definition, and explained that “New York courts routinely uphold the right of one party to a contract to fix a material price term in the future.”[45] The court also noted that the plaintiffs bargained for and received particular MAGR protections in the agreements themselves.[46] Though the court found looking to extrinsic evidence was unnecessary, it explained how years of post-performance conduct only confirmed AMC’s position that its MAGR Definition controlled, with certain plaintiffs waiting four years to object to the MAGR Definition after they received it, all the while accepting payments from AMC under that definition.[47]
One of the plaintiffs’ key arguments was that the license fee imputed for AMC Network’s exhibition of The Walking Dead, which appeared in the MAGR Definition, was too low and not in compliance with the affiliate transaction provisions in their agreements. Those provisions required “‘AMC’s transactions with Affiliated Companies [to] be on monetary terms comparable with the terms on which AMC enters into similar transactions with unrelated third party distributors for comparable programs after arms’ length negotiation.”[48] The court held AMC Network’s exhibition of The Walking Dead was governed by the imputed license fee in the MAGR Definition, and that the affiliate transaction provisions only applied to transactions where the participant “has no seat at the table to negotiate. . . .”[49] The court found the provision did not apply to the kind of internal rights transfers the plaintiffs challenged.
Similar lawsuits over The Walking Dead were filed by CAA and Frank Darabont in New York.[50] The consolidated jury trial in these lawsuits is scheduled to begin in April 2021. [Disclosure: Gibson Dunn represents AMC in these actions.]
C. #MeToo Litigation
1. Ninth Circuit Revives Ashley Judd’s Harassment Claim against Harvey Weinstein.
On July 29, 2020, the Ninth Circuit ruled that the actor Ashley Judd could proceed with her sexual harassment claim against Harvey Weinstein. Ms. Judd filed her action alleging defamation, sexual harassment, intentional interference with prospective economic advantage, and unfair competition on April 30, 2018. Ms. Judd’s claims stemmed from events occurring in and around 1997, at which time Ms. Judd alleges Mr. Weinstein invited her, a Hollywood newcomer, to a “general” industry meeting at the Peninsula Hotel in Beverly Hills, where she was to seek advice and guidance. When Ms. Judd arrived, she was directed to Mr. Weinstein’s private hotel room, where Mr. Weinstein appeared in a bathrobe, asked to give Ms. Judd a massage, and asked her to watch him shower.
Judge Phillip Gutierrez of the Central District of California granted Mr. Weinstein’s motion to dismiss Ms. Judd’s sexual harassment claim, brought pursuant to California Civil Code section 51.9, finding Ms. Judd and Mr. Weinstein’s relationship did not fall within the definition of a “business, service, or professional relationship” under the statute. The court nonetheless explained that “an appellate decision on these important issues could provide needed guidance to lower courts applying § 51.9.” Ms. Judd appealed the dismissal of her sexual harassment claim to the Ninth Circuit.
Reversing the district court, the Ninth Circuit explained that “[Ms. Judd’s and Mr. Weinstein’s] relationship consisted of an inherent power imbalance wherein Weinstein was uniquely situated to exercise coercion or leverage over Judd by virtue of his professional position and influence as a top producer in Hollywood.”[51] The court held that section 51.9 does, in fact, cover such business or professional relationships where there is an inherent power imbalance.[52] [Disclosure: Gibson Dunn represents Ashley Judd in this action.]
D. Music Industry Litigation
1. Led Zeppelin Prevails in En Banc “Stairway” Ruling.
On March 9, 2020, the Ninth Circuit, sitting en banc, reinstated a Los Angeles jury’s 2016 verdict clearing Led Zeppelin of infringing the band Spirit’s song “Taurus.”[53] Michael Skidmore, the trustee of for the estate of Spirit’s founding member Randy Wolfe (pka Randy California), had alleged that the opening riff of “Stairway to Heaven” is substantially similar to “Taurus,” and infringed Wolfe’s copyright in the composition. In 2016, the jury found no substantial similarity between “Taurus” and the rock anthem under the extrinsic test for unlawful appropriation. But in September 2018, a Ninth Circuit three-judge panel vacated the verdict and remanded the case for a new trial.[54] The three-judge panel found that lack of an instruction explaining copyrights that cover the selection and arrangement of music, combined with an allegedly faulty instruction on the requisite element of originality prejudicially “undermined the heart of plaintiff’s argument.”[55]
The March 2020 en banc ruling overturned the panel in a detailed opinion, agreeing with U.S. District Judge R. Gary Klausner that the 1909 Copyright Act, not the 1976 Copyright Act, governed, and that only the bare-bones “deposit copy” of “Taurus” was properly introduced for comparison to “Stairway to Heaven.”[56] The en banc panel held that “[b]ecause the 1909 Copyright Act did not offer protection for sound recordings, [Spirit]’s one-page deposit copy defined the scope of the copyright at issue.”[57] Thus, it was not error for the district court to deny the plaintiff’s request to play for the jury sound recordings of “Taurus.”[58]
The en banc panel also rejected the “inverse ratio rule” previously adopted by the Ninth Circuit, under which it had “permitted a lower standard of proof of substantial similarity where there is a high degree of access.”[59] To preserve the inverse ratio rule, Judge McKeown wrote for the en banc panel, would “unfairly advantage[] those whose work is most accessible by lowering the standard of proof for similarity,” thereby benefitting “those with highly popular works.”[60] The “Stairway” case had been closely watched by the music industry and attracted numerous amicus at the court of appeals, including the U.S. Department of Justice supporting Led Zeppelin’s position on appeal. On October 5, 2020, the U.S. Supreme Court denied Skidmore’s petition for writ of certiorari.[61]
2. Labels’ and Publishers’ Billion-Dollar Verdict Against Cox Upheld.
On June 2, 2020, U.S. District Judge Liam O’Grady of the Eastern District of Virginia largely upheld a $1B verdict against Cox Communications won by over 50 records labels and music publishers, including Sony Music Entertainment, Universal Music Group, and Warner Bros. Records.[62]
Judge O’Grady rejected Cox’s contention that the evidence at trial was insufficient, concluding that there was “overwhelming” and “strong” evidence that Cox’s users illegally reproduced the sound recordings and distributed them over Cox’s network.[63] Further, there was “ample” evidence for the jury to conclude that Cox gained some direct benefit from the infringement and find Cox liable for vicarious copyright infringement.[64] Judge O’Grady emphasized evidence showing that “Cox looked at customers’ monthly payments when considering whether to terminate them for infringement.”[65]
Judge O’Grady also rejected Cox’s argument that the award was “grossly excessive.”[66] He noted that the per-work damages of $99,830.29 were more than $50,000 below the statutory maximum under the Copyright Act,[67] but ordered additional briefing on the issue of the calculation of the number of infringed works.[68]
3. Music Publishers and Peloton Reach Settlement in Copyright Suit After Dismissal of Cycling Company’s Counterclaims.
In March 2019, more than a dozen music publishers filed suit in New York federal court alleging popular fitness tech company Peloton failed to license songs for its online classes, thereby violating the publishers’ copyrights.[69] The publishers claimed over $150 million in damages for unlicensed uses of more than 1000 songs, with each use of an allegedly unlicensed song constituting a separate infringement because audiovisual “sync” licenses are issued on a per-video basis.[70] The publishers also alleged Peloton’s conduct was “deliberate and willful” because the company had obtained the necessary “sync” licenses from other music copyright owners.[71]
In response, Peloton counterclaimed against the publishers, alleging that any failure to obtain licenses was due to the National Music Publishers’ Association’s (“NMPA”) creation of a price fixing “cartel.”[72] Peloton alleged the NMPA both engaged in “horizontal collusion” to inflate prices in its own negotiations with the company and tortiously interfered with Peloton’s ability to negotiate with individual publishers.[73] On January 29, 2020, U.S. District Judge Denise Cote dismissed Peloton’s counterclaims without leave to amend, finding that Pelton failed define a “relevant market,” a necessary element to Peloton’s antitrust claim under Section 1 of the Sherman Act.[74] A month later, the case settled.
4. Second Circuit Upholds Copyright Win for Drake.
On February 3, 2020, the Second Circuit affirmed the Southern District of New York’s ruling that Drake did not violate copyright law by incorporating a 35-second clip of the song “Jimmy Smith Rap” into his song “Pound Cake” without a license.[75] The lawsuit began in April 2014, when the estate of Jimmy Smith sued Drake and Drake’s record labels and publishers for copyright infringement. The defendants moved for summary judgment, arguing that Drake’s use of the song was protected by the fair use doctrine.[76]
The District Court granted the defendants’ motion for summary judgment in May 2017.[77] In its 2020 ruling, the Second Circuit affirmed, finding Drake’s use of the song was protected by the fair use doctrine, as the use was “transformative.”[78] The Court stated that “‘Pound Cake’ criticizes the jazz-elitism that the ‘Jimmy Smith Rap’ espouses. By doing so, it uses the copyrighted work for a purpose, or imbues it with a character, different from that for which it was created.”[79] In addition, the Court found “no evidence that ‘Pound cake’ usurps demand for ‘Jimmy Smith Rap.’”[80] [Disclosure: Gibson Dunn represented one of the defendants in the action.]
E. Copyright Litigation
1. Ninth Circuit Revives Screenwriter’s Pirates of the Caribbean Copyright-Infringement Suit.
On July 22, 2020, the Ninth Circuit revived a screenwriter’s copyright-infringement suit against The Walt Disney Company alleging that the film Pirates of the Caribbean: Curse of the Black Pearl is substantially similar to plaintiff’s screenplay.[81] The district court had granted Disney’s Rule 12(b)(6) motion to dismiss on the grounds that the two works were not substantially similar as a matter of law.[82] In reversing, the Ninth Circuit acknowledged “striking differences between the two works,” but nonetheless found “the selection and arrangement of the similarities between them [to be] more than de minimis” and sufficient to warrant denial of Disney’s motion.[83]
The district court had noted the similarities between the works but concluded that many of the shared elements were “unprotected generic, pirate-movie tropes.”[84] The Ninth Circuit disagreed, explaining “it is difficult to know whether such elements are indeed unprotectible material” at the pleading stage, and further noting that additional evidence—including expert testimony—“would help inform the question of substantial similarity.”[85] According to the court, such additional evidence would be “particularly useful” given that “the blockbuster Pirates of the Caribbean film franchise may itself have shaped what are now considered pirate-movie tropes.”[86] Ultimately, because “[t]he district court erred by failing to compare the original selection and arrangement of the unprotectible elements between the two works,” the Ninth Circuit reversed the dismissal and remanded for further proceedings.[87] And on August 31, 2020, the Ninth Circuit denied Disney’s petition for panel rehearing and for rehearing en banc. Some commentators and practitioners have noted that the ruling appears to represent the latest in a shift away from the Ninth Circuit’s prior precedents that had generally leaned toward upholding dismissals of substantial similarity suits, representing a cautionary ruling for industry defendants.[88]
2. Copyright Act Preempts Lyrics Site Genius’s Claims Against Google.
On August 10, 2020, District Judge Margo Brodie dismissed Genius Media Group Inc.’s suit against Google. Genius Media had alleged in December 2019 that Google “misappropriated lyric transcriptions from its website.”[89] According to its complaint, Genius Media earns revenue by, among other things, licensing its database of high-quality lyrics to companies and generating ad revenue via traffic to its website.[90] In its complaint, Genius Media alleged that when users search for song lyrics, Google’s “Information Box”—which appears above the search results—displays complete song lyrics obtained from Genius Media’s website and thus reduces traffic to that site.[91] Genius Media sued Google for breach of contract, indemnification, unfair competition under New York and California law, and unjust enrichment.[92]
Judge Brodie determined, however, that Genius Media’s state law claims were preempted by the Copyright Act.[93] As an initial matter, Judge Brodie found that the transcribed song lyrics were among the works protected by the Copyright Act, and because the subject of Plaintiff’s claims was the transcribed lyrics, the subject-matter prong of the Copyright Act’s preemption test was met.[94] Judge Brodie additionally determined that Genius Media’s contract claims were “nothing more than claims seeking to enforce the copyright owner’s exclusive rights to protection from unauthorized reproduction of the lyrics and are therefore preempted”; however, Genius Media licensed, but did not own, the relevant copyrights.[95] The court found that Genius Media’s transcriptions are, in essence, derivative works, and held that “the case law is clear that only the original copyright owner has exclusive rights to authorize derivative works.”[96] Accordingly, the Court dismissed Genius Media’s complaint for failure to state a claim.[97]
______________________
[1] United States v. Bolton, No. 20-cv-1580, Order Denying Plaintiff’s Motion for Temporary Restraining Order and Preliminary Injunction (D. D.C. June 20, 2020).
[3] See, e.g., United States v. Bolton, No. 20-cv-1580, Brief of PEN American Center, Inc. as Amicus Curiae in Support of Defendant (D. D.C. June 19, 2020).
[4] United States v. Bolton, No. 20-cv-1580, Order Denying Plaintiff’s Motion for Temporary Restraining Order and Preliminary Injunction, *8 (D. D.C. June 20, 2020).
[6] United States v. Bolton, No. 20-cv-1580, Plaintiff’s Motion for Summary Judgment (D. D.C. July 30, 2020).
[7] Katie Benner, “Justice Dept. Opens Criminal Inquiry Into John Bolton’s Book,” N.Y. Times (Sept. 15, 2020), https://www.nytimes.com/2020/09/15/us/politics/john-bolton-book-criminal-investigation.html.
[8] Charlie Savage, “Government Lawsuit Over John Bolton’s Memoir May Proceed, Judge Rules,” N.Y. Times (Oct. 5, 2020), https://www.nytimes.com/2020/10/01/us/politics/john-bolton-book-proceeds-lawsuit.html.
[9] Trump v. Trump, No. 22020-51585, 2020 WL 4212159 (N.Y. Sup. Ct. July 13, 2020).
[10] Trump v. Trump, No. 22020-51585, Motion for Temporary Restraining Order and Preliminary Injunction (N.Y. Sup. Ct. June 26, 2020).
[11] Trump, 2020 WL 4212159, *14.
[13] Palin v. The New York Times Co., No. 17-cv-4853, Opinion and Order on Motions for Summary Judgment (S.D.N.Y Aug. 28, 2020).
[14] Ted Johnson, “Nick Sandmann, Student at Center of Viral Video, Settles Defamation Lawsuit Against Washington Post,” The Washington Post (July 24, 2020), https://deadline.com/2020/07/nick-sandmann-washington-post-defamation-1202994384/.
[15] Cameron Knight, “Sandmann files 5 more defamation lawsuits against media outlets,” Cincinnati Enquirer (Mar. 3, 2020), https://www.cincinnati.com/story/news/2020/03/03/sandmann-files-5-more-defamation-lawsuits-against-media-outlets/4938142002/.
[16] Lauren Berg, “Jury Says Elon Musk Didn’t Defame with ‘Pedo Guy’ Tweet,” Law360 (Dec. 6, 2019), https://www.law360.com/articles/1226249/jury-says-elon-musk-didn-t-defame-with-pedo-guy-tweet.
[17] Kate Irby, “Judge tells Devin Nunes for 3rd time he can’t sue Twitter over anonymous tweets,” The Fresno Bee (Aug. 14, 2020), https://www.fresnobee.com/news/california/article244958665.html.
[20] Herring Networks, Inc. v. Maddow, No. 19-cv-1713, Order Granting Defendants’ Special Motion to Strike (S.D. Cal. May 22, 2020).
[21] Id. at *3 (internal quotations omitted).
[26] Greene v. Paramount Pictures Corp., 813 F. App’x 728 (2d Cir. 2020).
[27] Id. at 730.
[28] Greene v. Paramount Pictures Corp., 340 F. Supp. 3d 161, 172 (E.D.N.Y. 2018).
[29] Greene, 813 F. App’x at 732.
[30] Id. at 731.
[31] Id.
[32] Id.
[33] Id.
[34] Id. at
[35] Senate Bill S5959D, 2019-2020 Legislative Session of The New York State Senate (last accessed Aug. 26, 2020), https://www.nysenate.gov/legislation/bills/2019/s5959.
[36] Jennifer E. Rothman, New York Reintroduces Right of Publicity Bill with Dueling Versions, Rothman’s Roadmap to the Right of Publicity (May 22, 2019), https://www.rightofpublicityroadmap.com/news-commentary/new-york-reintroduces-right-publicity-bill-dueling-versions.
[37] Senate Bill S5959D, Summary Memo, supra note 35.
[39] Eriq Gardner, Deepfakes Pose Increasing Legal and Ethical Issues for Hollywood, The Hollywood Reporter (July 12, 2019), https://www.hollywoodreporter.com/thr-esq/deepfakes-pose-increasing-legal-ethical-issues-hollywood-1222978.
[40] David Robb, SAG-AFTRA Expects NY Gov. Andrew Cuomo To Sign Law Banning “Deepfake” Porn Face-Swapping, Deadline (July 28, 2020), https://deadline.com/2020/07/deepfakes-sag-aftra-expects-andrew-cuomo-to-sign-law-banning-face-swapping-porn-1202997577/.
[41] Ben Sheffner, New York vs. biopics? The state Legislature is poised to crack down on fact-inspired works of art, New York Daily News (June 18, 2019), https://www.nydailynews.com/opinion/ny-oped-stop-this-threat-to-free-speech-20190618-evesugulizgspk4reelegxiazu-story.html.
[43] Kirkman v. AMC Film Holdings, LLC, No. BC672124, 2020 WL 4364279 (Cal. Super. Ct. July 22, 2020).
[50] Darabont v. AMC Network Entertainment LLC, No. 654328/2013 (N.Y. Sup. Ct.); Darabont v. AMC Network Entertainment LLC, No. 650251/2018 (N.Y. Sup. Ct.).
[51] Judd v. Weinstein, 967 F.3d 952, 959 (9th Cir. 2020).
[53] Skidmore v. Led Zeppelin, 952 F.3d 1051 (9th Cir. 2020) (“Skidmore II”).
[54] Skidmore v. Led Zeppelin, 905 F.3d 1116 (9th Cir. 2018) (“Skidmore I”).
[56] Skidmore II, 952 F.3d at 1079.
[61] Bill Donahue, “Supreme Court Won’t Hear Led Zeppelin Copyright Fight,” Law360 (Oct. 5, 2020), https://www.law360.com/california/articles/1308109/supreme-court-won-t-hear-led-zeppelin-copyright-fight.
[62] Sony Music Entm’t v. Cox Commc’ns, Inc., No. 1:18-CV-950-LO-JFA (E.D. Va. June 2, 2020).
[69] Complaint, Downtown Music Publishing LLC, et al v. Peloton Interactive, Inc., No. 1:19-cv-02426 (S.D.N.Y. Mar. 19, 2019).
[72] Answer to Complaint and Counterclaims Against National Music Publishers’ Association, Inc. and Plaintiff Publishers, Downtown Music Publishing LLC, et al v. Peloton Interactive, Inc., No. 1:19-cv-02426-DLC, at 35–37 (S.D.N.Y. Apr. 30, 2019).
[74] Opinion & Order, Downtown Music Publishing LLC, et al v. Peloton Interactive, Inc., No. 1:19-cv-02426 (S.D.N.Y. Jan. 29, 2020).
[75] Smith v. Graham, No. 19-28, 799 F. App’x 36 (2d Cir. Feb. 3, 2020).
[76] Smith v. Cash Money Records, Inc., 253 F. Supp. 3d 737 (S.D.N.Y. 2017).
[78] Smith v. Graham, No. 19-28, 799 F. App’x. 36, 78 (2d Cir. Feb. 3, 2020).
[81] Alfred v. Walt Disney Co., — F. App’x —, 2020 WL 4207584 (9th Cir. July 22, 2020).
[88] See Bill Donahue, “9th Circ. Making It Harder for Studios To Beat Copyright Suits,” Law360 (July 29, 2020), https://www.law360.com/articles/1296112/9th-circ-making-it-harder-for-studios-to-beat-copyright-suits.
[89] Genius Media Grp. Inc. v. Google LLC, Case No. 1:19-cv-07279-MKB-VMS, Dkt. No. 22 at 1 (E.D.N.Y. Aug. 10, 2020).
[95] Id. at 16; see also id. at 23, 29 (similarly finding the unjust enrichment and state-law unfair-competition claims preempted by the Copyright Act).
[97] Id. at 36 (also denying Genius Media’s motion to remand to state court).
The following Gibson Dunn lawyers assisted in the preparation of this client update: Theodore Boutrous, Scott Edelman, Howard Hogan, Nathaniel Bach, Jonathan Soleimani, Dillon Westfall, Marissa Moshell, Kaylie Springer, Daniel Rubin, Sarah Scharf, and Abi Averill.
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 the following leaders and members of the firm’s Media, Entertainment & Technology Practice Group:
Theodore J. Boutrous, Jr. – Co-Chair, Litigation Practice, Los Angeles (+1 213-229-7000, tboutrous@gibsondunn.com)
Scott A. Edelman – Co-Chair, Media, Entertainment & Technology Practice, Los Angeles (+1 310-557-8061, sedelman@gibsondunn.com)
Kevin Masuda – Co-Chair, Media, Entertainment & Technology Practice, Los Angeles (+1 213-229-7872, kmasuda@gibsondunn.com)
Orin Snyder – Co-Chair, Media, Entertainment & Technology Practice, New York (+1 212-351-2400, osnyder@gibsondunn.com)
Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
Ari Lanin – Los Angeles (+1 310-552-8581, alanin@gibsondunn.com)
Benyamin S. Ross – Los Angeles (+1 213-229-7048, bross@gibsondunn.com)
Helgi C. Walker – Washington, D.C. (+1 202-887-3599, hwalker@gibsondunn.com)
Nathaniel L. Bach – Los Angeles (+1 213-229-7241,nbach@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.
The Hong Kong Court of Appeal (Court of Appeal) recently reaffirmed[1], in the context of an application for an examination order of individuals (Respondents) residing in Hong Kong to obtain information which may enable partial satisfaction of a judgment debt under a judgment in proceedings in a foreign court to which neither the Respondents nor the companies of which they are officers were parties, that pre-trial discovery against non-party witness is not permitted, save within the limited scope of Norwich Pharmacal discovery.
1. Background Leading to the Application in Hong Kong
The applicants for the Hong Kong examination order (Applicants) obtained a judgment for US$100,738,980 (Judgment Debt) in the United States District Court, Western District of Washington at Seattle (Federal Court) against a number of judgment debtors.
The Applicants’ case was that based on the unaudited balance sheet of one of the judgment debtors (Judgment Debtor), there were receivables owed by some third parties to the Judgment Debtor, being US$18.9 million by an exempted limited partnership registered in Cayman Islands, and US$4 million by a company incorporated in the British Virgin Islands (respectively, the Two Sums and the Third Parties).
The Applicants were appointed by the King County Superior Court, State of Washington (State Court) as collecting agent to collect the receivables of the Judgment Debtor, including the Two Sums. Such receivables were to be applied to satisfy the Judgment Debt. The State Court subsequently clarified that it did not have jurisdiction over the Third Parties (as they had no place of business in the State of Washington) and it did not adjudicate on the issue of whether the Two Sums were owed by them to the Judgment Debtor, and held that the collection orders only placed the Applicants in the shoes of the Judgment Debtor for collection purposes and such orders could be made even though the State Court had no jurisdiction over the Third Parties.
Of importance to note is that the collection orders were not garnishee orders, and there is no evidence to suggest that the Federal Court and the State Court had the requisite personal jurisdiction over the Third Parties for garnishee proceedings. Further, the relevant transaction agreements between the Judgment Debtor and the Third Parties respectively had an exclusive jurisdiction clause, which provided that the agreements were governed by the laws in Hong Kong and subject to resolution solely in the Hong Kong Courts.
The Two Sums were disputed by the Third Parties, and their case was that it was the Judgment Debtor which owed them monies instead.
The Respondents, being the subjects of the examination order, are officers of the Third Parties, who reside in Hong Kong.
2. Procedural History in the Hong Kong Courts
The Federal Court issued two Letters of Request for an examination of the Respondents, the purpose of which was to allow the Applicants to obtain information regarding the Two Sums that may enable them to collect the monies owed to the Judgment Debtor which could be utilised to satisfy the Judgment Debt.
An ex parte application by way of an Originating Summons supported by the two Letters of Request to examine the Respondents were made by the Applicants and Master Lai of the Court of First Instance (CFI) granted an examination order (Examination Order).
The Respondents applied to set aside the Examination Order and/or to strike out the Applicants’ ex parte Originating Summons. Both applications were allowed by Recorder Yvonne Cheng SC (Judge) of the CFI.
The Applicants appealed against the decision of the Judge, which decision was upheld by the Court of Appeal.
3. Requirements under the Evidence Ordinance (Cap. 8) (Ordinance) in the Context of Evidence for Civil Proceedings in Other Jurisdictions
Whilst both sections 75(b) and 76(3) of the Ordinance are relevant in the circumstances[2], the Court of Appeal upheld the Judge’s decision based on section 76(3) alone. The analysis under paragraph 3.2 below on section 75(b) is included for completeness.
3.1 Section 76(3) – Pre-Trial Discovery Against Non-Party Witness Prohibited
Section 76 provides for the power of the Court of First Instance to give effect to an application for assistance in obtaining evidence for civil proceedings in foreign courts. Section 76(3) states that:
An order under this section shall not require any particular steps to be taken unless they are steps which can be required to be taken by way of obtaining evidence for the purposes of civil proceedings in the court making the order (whether or not proceedings of the same description as those to which the application for the order relates)…” (emphasis added)
The Judge held that the proposed examination was for pre-trial discovery against non-party witnesses, which is not permitted under Hong Kong law and prohibited by section 76(3), since the allegations of fact relied upon by the Applicants (in short, the Third Parties owed monies to the Judgment Debtor) were not live issues before and to be resolved by the Federal Court where the main action was concluded, and enforcement proceedings (i.e. garnishee proceedings) in which such allegations could be raised had not been instituted. As to the Applicants’ alternative case that after the examination of the Respondents they would “plot a course for collection depending on the evidence so obtained”, the judge held that the proposed examination was a fishing exercise.
The Court of Appeal agreed with the Judge’s decision, and made, inter alia, the following remarks:
- Hong Kong has adopted the common law position that there is no pre-trial discovery against non-party witnesses other than those falling within the limited scope of Norwich Pharmacal discovery (i.e. discovery against third parties who got innocently mixed up in the wrongdoings of others);
- whether the assistance request falls foul of section 76(3) on account of fishing must be a matter for the judge in Hong Kong by reference to Hong Kong laws rather than US laws under which the permissible scope of discovery is wider. Whilst examination which is investigatory in nature (in contrast to eliciting admissible evidence) is allowed under US laws, it is not permitted under Hong Kong laws; and
- obtaining information from a non-party witness by way of post-judgment discovery in aid of execution, whilst permissible under US laws, is not a permissible procedure in Hong Kong, noting that if a judgment creditor has sufficient ground to support the application for a garnishee order in respect of a debt due to a judgment debtor, the judgment creditor has to commence garnishee proceedings first before he can obtain directions for determination of the liability of the garnishee (including directions for discovery as necessary)[3].
3.2 Section 75(b) – Obtaining Evidence for the Purposes of Civil Proceedings
Section 75 provides for the requirements to be fulfilled in an application for assistance. Section 75(b) provides that:
“Where an application is made to the Court of First Instance for an order for evidence to be obtained in Hong Kong and the court is satisfied that the evidence to which the application relates is to be obtained for the purposes of civil proceedings which either have been instituted before the requesting court or whose institution before that court is contemplated, the Court of First Instance shall have the powers conferred on it by this part.” (emphasis added)
The central issue under this section is therefore whether evidence is to be obtained for the purposes of civil proceedings, instituted or contemplated, before the requesting court.
The Judge, without the benefit of expert evidence on US law from the Applicants which was set out in an affirmation[4], ruled that the requirement was not satisfied because the evidence was not obtained for the purposes of civil proceedings which either have been instituted before the Federal Court or whose institution was contemplated.
The Judge rejected that the very application for discovery leading to the Federal Court’s request for evidence could constitute civil proceedings within the meaning of section 75(b) as a matter of construction, since it would render the section redundant. Further, since there was no evidence that the Applicants could establish the Federal Court’s jurisdiction over the Third Parties, it could not be said that proceedings against the Third Parties in the said court for enforcement of the judgment were contemplated.
The Court of Appeal, however, left the issue open, since it disagreed with the Judge on the admissibility of the Applicants’ expert evidence on US law.[5]
Notwithstanding such disagreement and that it was prepared to assume that under US law, the obtaining of information to facilitate the “plotting of the next course of action” would be regarded as obtaining evidence for use in the Federal Court proceedings, the Court of Appeal took the view that it also had to be established that the relevant proceedings were proceedings in a civil or commercial manner in the requested jurisdiction, i.e. Hong Kong court, in addition to the requesting jurisdiction.
In this regard, the Court of Appeal considered that the mere facilitation of the Applicants to act as collection agent did not qualify as civil proceedings in Hong Kong. Whilst discovery procedure is a form of civil proceedings in Hong Kong, such discovery would not be permitted against non-party witnesses, other than the limited form of Norwich Pharmacal discovery.
4. Conclusion
It is clear from the decisions of the Judge and the Court of Appeal that to obtain an order for assistance in obtaining evidence for civil proceedings in a foreign court, such obtaining of evidence must be permissible under the laws of Hong Kong. It is not sufficient that it is only permissible under the laws of the requesting jurisdiction (which may be implied by the Letter of Request issued by the foreign court). On this note, pre-action discovery against non-party witness is not permitted in Hong Kong save for Norwich Pharmacal discovery.
_______________________
[1] Re a civil matter now pending in United States District Court for the Western District of Washington at Seattle under No 2:13-CV-1034 MJP ([2020] HKCA 766). The presiding judges were Hon Lam VP, Chu JA and G Lam J. A copy of the judgement of the Court of Appeal is available here. The judgment of the Court of First Instance ([2019] HKCFI 1738) is available here.
[2] The Respondents also argued that (1) there were material non-disclosures on the Applicants’ part when they took out the ex parte application for the Examination Order and (2) the Examination Order contravened section 6 of the Protection of Trading Interests Ordinance (Cap. 471). However, these were not the focus of the Judge or the Court of Appeal and accordingly, are not the focus of this alert.
[3] The Applicants did not commence garnishee proceedings against the Third Parties since the Federal Court did not appear to have personal jurisdiction over the Third Parties and they were also unable to say that the Two Sums were actually due from these entities to the Judgment Debtor. Further, the Applicants also faced the difficulty of the exclusive choice of forum clauses in the agreements governing the transactions between the Judgment Debtor and the Third Parties. However, these issues were not put before the Federal Court in the application for the Letters of Request and accordingly, the Federal Court had no opportunity to address it. The Court of Appeal remarked that if the Applicants wished to rely on the use of evidence of the Respondents in garnishee proceedings against the Third Parties, they should have at least alluded to such basis in their motion for application for the Letters of Request.
[4] The Judge ruled that such evidence was not admissible on the basis that there was no expert declaration in accordance with Order 38 Rule 37C of the Rules of the High Court (RHC). The expert for the Applicants, being the general counsel of the Applicants (who was heavily engaged in the present dispute), felt that he was unable to give an expert declaration.
[5] The Court of Appeal was inclined to take the view that the prohibition against admissibility for lack of expert declaration under Order 38 Rule 37C of the RHC does not apply automatically to expert evidence set out in affidavits or affirmations adduced under Order 38 Rule 2(3) (as opposed to expert reports filed for trial pursuant to directions given under Order 38 Rule 6 regarding proceedings commenced by, inter alia, Originating Summons), being an exception under Order 38 Rule 36(2) .
Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, or the authors and the following lawyers in the Litigation Practice Group of the firm in Hong Kong:
Brian Gilchrist (+852 2214 3820, bgilchrist@gibsondunn.com)
Elaine Chen (+852 2214 3821, echen@gibsondunn.com)
Emily Chan (+852 2214 3825, echan@gibsondunn.com)
© 2020 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.