Washington, D.C. partner Judith Alison Lee is the author of “The digitising of central bank currencies among the major economies — the current landscape,” [PDF] published in the September 2021 issue of Financier Worldwide.

The torrid pace of new securities class action filings over the last several years slowed a bit in the first half of 2021, a period in which there have been many notable developments in securities law. This mid-year update briefs you on major developments in federal and state securities law through June 2021:

In Goldman Sachs, the Supreme Court found that lower courts should hear evidence regarding the impact of alleged misstatements on the price of securities to rebut any presumption of classwide reliance at the class-certification stage, and that defendants bear the burden of persuasion on this issue.
Just before its summer recess, the Supreme Court granted certiorari in Pivotal Software, teeing up a decision on whether the PSLRA’s discovery-stay provision applies to state court actions, which may impact forum selection in private securities actions.
We explore various developments in Delaware courts, including the relative decline of appraisal litigation, and the Court of Chancery’s (1) decision to enjoin a poison pill, (2) rejection of a claim that the COVID-19 pandemic constituted a material adverse effect, (3) approach in a potential bellwether SPAC case, and (4) analysis of post-close employment opportunities with respect to Revlon fiduciary duties.
We continue to survey securities-related lawsuits arising in connection with the coronavirus pandemic, including securities class actions, stockholder derivative actions, and SEC enforcement actions.
We examine developments under Lorenzo regarding disseminator liability and under Omnicare regarding liability for opinion statements.
Finally, we explain important developments in the federal courts, including (1) the widening circuit split regarding the jurisdictional reach of the Exchange Act based on recent decisions in the First and Second Circuits, (2) the Eighth Circuit’s holding that class action allegations, including those under Section 10(b), can be struck from pleadings, (3) Congress’s codification of the SEC’s disgorgement authority in the National Defense Authorization Act, (4) a federal district court’s holding that a forum selection clause superseded anti-waiver provisions in the Exchange Act, and (5) the Ninth Circuit’s broad interpretation of the PSLRA’s safe harbor for forward-looking statements.

I. Filing and Settlement Trends

According to Cornerstone Research, both the number of new filings and the average approved settlement amount in securities class actions decreased relative to the same period last year and historically. However, the number of approved settlements is the highest it has been since the second half of 2017, indicating that 2021 may be on track to set a record in terms of the number of approved securities class action settlements even if the total dollar amount falls short of last year.

The decline in total filings is driven by a sharp decline in new mergers and acquisitions filings, which are at the lowest level since the second half of 2014. Despite the decline in filings, 2021 has nonetheless already set a record for new SPAC-related filings by doubling both the 2020 and 2019 full-year totals in this category.

A. Filing Trends

Figure 1 below reflects filing rates for the first half of 2021 (all charts courtesy of Cornerstone Research). The first half of the year saw 112 new class action securities filings, a nearly 40% decrease from the same period last year and a 25% decrease from the second half of 2020. The decrease is largely driven by a drop in new M&A filings, from 64 and 35 in the two halves of 2020, respectively, to 12 in the first half of 2021. This represents a 66% decline in M&A filings from the second half of 2020, and 83% decline against the biannual average for M&A filings dating back through 2016.

Figure 1:

Semiannual Number of Class Action Filings (CAF Index^®)
January 2012 – June 2021

B. Industry and Other Trends in Cases Filed

Keeping with recent trends, new filings against consumer non-cyclical firms continued to make up the majority of new federal, non-M&A filings in the first half of 2021, as shown in Figure 2 below. New filings against communications and technology sector firms remained fairly steady, and an increase in filings against firms in the consumer cyclical and energy sectors partially offset the decline in filings against firms in the basic materials, industrial and financial sectors.

Figure 2:

Core Federal Filings by Industry
January 1997 – June 2021

As noted at the start and illustrated in Figure 3 below, the number of SPAC-related filings in the first half of 2021 exceeds those filed in both 2019 and 2020 combined. The increase is driven by filings in the consumer cyclical industry, and specifically, firms in the Auto manufacturers and Auto Parts & Equipment industries. In addition to notable activity in the SPAC space, cybersecurity-, cryptocurrency- and cannabis-related filings are all on pace to meet or exceed the 2020 totals, and 2021’s increased activity in ransomware attacks has already resulted in an uptick in cybersecurity filings in the second half of 2021. On the other hand, the majority of the new filings related to COVID-19 occurred earlier in the year, indicating that, as mentioned below, it is still too early to tell what the full year brings in terms of filings related to COVID-19.

Figure 3:

Summary of Trend Case Filings
January 2017 – June 2021

C. Settlement Trends

As shown in Figure 4, the total settlement dollars, adjusted for inflation, is down 72.7% against the same period last year despite a 35% increase in the number of settlements approved. Two settlements in the first half of 2021 exceeded $100 million, as compared to six such settlements last year and four in 2019, and the median value of approved settlements through the first half of the year is $7.9 million, reflecting an 18% decline against the same period last year. The difference between the magnitude of the decline in settlement amounts is likely driven by an outlier settlement in first half of last year.

Figure 4:

Total Settlement Dollars (in billions)
January 2016 – June 2021

II. What to Watch for in the Supreme Court

A. Supreme Court Issues Narrow Decision in Price-Impact Case

As we previewed in our 2020 Year-End Securities Litigation Update, in Goldman Sachs Group Inc. v. Arkansas Teacher Retirement System, 141 S. Ct. 1951 (2021), the Supreme Court this Term considered questions regarding price-impact analysis at the class-certification stage in securities class actions. Recall that in Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014) (“Halliburton II”), the Supreme Court preserved the “fraud-on-the-market” theory that enables courts to presume classwide reliance in Rule 10b-5 cases, but also permitted defendants to rebut that presumption with evidence that the alleged misrepresentation did not affect the issuer’s stock price.

Goldman Sachs presented the Court with the opportunity to decide how courts can address cases in which plaintiffs plead fraud through the “inflation maintenance” price impact theory, which claims that misstatements caused a preexisting inflated price to be maintained instead of causing the artificial inflation in the first instance. In granting certiorari, the Supreme Court accepted two questions for review: (1) “[w]hether a defendant in a securities class action may rebut the presumption of classwide reliance recognized in Basic Inc. v. Levinson, 485 U.S. 224 (1988), by pointing to the generic nature of the alleged misstatements in showing that the statements had no impact on the price of the security, even though that evidence is also relevant to the substantive element of materiality,” and (2) “[w]hether a defendant seeking to rebut the Basic presumption has only a burden of production or also the ultimate burden of persuasion.” Petition for a Writ of Certiorari at I, Goldman Sachs, 141 S. Ct. 1951 (No. 20-222).

In its June 21, 2021 decision, the Court declined to take a position on the “validity or . . . contours” of the inflation-maintenance theory in general, which it has never directly approved. Goldman Sachs, 141 S. Ct. at 1959 n.1. On the first question, the Court unanimously agreed with the parties that lower courts should hear evidence—including expert evidence—and rely on common sense to make determinations at the class-certification stage as to whether the alleged misrepresentations were so generic that they did not distort the price of securities. Id. at 1960. This analysis is permitted at the class-certification stage even though such evidence may also be relevant to the question of materiality, which is reserved for the merits stage. Id. at 1955 (citing Amgen Inc. v. Connecticut Ret. Plans and Tr. Funds, 568 U.S. 455, 462 (2013)). Importantly, the Court noted that in the context of an inflation-maintenance theory, the mismatch between generic misrepresentations and later, specific corrective disclosures will be a key consideration in the price-impact analysis. Goldman Sachs, 141 S. Ct. at 1961. “Under those circumstances, it is less likely that the specific disclosure actually corrected the generic misrepresentation, which means that there is less reason to infer front-end price inflation—that is, price impact—from the back-end price drop.” Id. The Court, with only Justice Sotomayor dissenting, then remanded the case for further consideration of the generic nature of the statements at issue here, explicitly directing the Second Circuit to “take into account all record evidence relevant to price impact, regardless whether that evidence overlaps with materiality or any other merits issue.” Id. (emphasis in original).

As to the second question, the Court held by a 6–3 majority that defendants at the class-certification stage bear the burden of persuasion on the issue of price impact in order to rebut the presumption of reliance—that is, to convince the court, by a preponderance of the evidence, that the challenged statements did not affect the price of securities. The Court determined that this rule had already been established by its previous decisions in Basic and Halliburton II: Basic recognized that defendants could rebut the presumption of classwide reliance by making “[a]ny showing that severs the link between the alleged misrepresentation and . . . the price,” and in Halliburton II, the Court again referenced defendants’ ability to rebut the Basic presumption with a “showing.” Id. at 1962 (internal citations omitted). The majority rejected an argument by the defendants, taken up by Justice Gorsuch (joined by Justices Thomas and Alito), that these references to a “showing” by the defense imposed only a burden of production. Id. at 1962; see also id. at 1965–70 (Gorsuch, J., concurring in part and dissenting in part). That reading would have allowed defendants to rebut the presumption of reliance “by introducing any competent evidence of a lack of price impact”—and would have imposed on plaintiffs the requirement to “directly prov[e] price impact in almost every case,” a requirement that had been rejected in Halliburton II. Id. at 1962–63 (emphasis in original). However, the Court noted that imposing the burden of persuasion on defendants would be unlikely to alter the outcome in most cases, as the “burden of persuasion will have bite only when the court finds the evidence is in equipoise—a situation that should rarely arise.” Id. at 1963.

B. Supreme Court to Decide whether the PSLRA’s Discovery Stay Applies in State Court

On July 2, 2021, just before its summer recess, the Court granted certiorari in Pivotal Software, Inc. v. Tran, No. 20-1541, which raises the question of whether the Private Securities Litigation Reform Act’s (“PSLRA”) discovery-stay provision applies to state court actions in which a private party raises a Securities Act claim. The PSLRA provides that the stay applies “[i]n any private action arising under” the Securities Act before a court has addressed a motion to dismiss, 15 U.S.C. § 77z-1-(b)(1), but state courts are sharply divided over whether the stay applies to suits in state court, rather than only to those in federal court. In opposition, respondent plaintiffs argued that not only is the issue moot (because they have agreed to adhere to the stay provision and the state court will have issued a decision on the motion to dismiss before the Supreme Court can issue an opinion), but also that no court of appeals has ever decided the issue. Brief in Opposition at 7–16, Pivotal Software, Inc. v. Tran, No. 20-1541. Petitioners countered that the issue will only ever arise in state courts and that state trial courts are divided, with at least a dozen decisions refusing to apply the stay and seven applying it, with many more decisions unreported. Moreover, the issue evades appellate review because it is time-sensitive and unlikely to affect a final judgment, rendering any error harmless. Reply Brief for Petitioners at 1–12, Pivotal Software, Inc. v. Tran, No. 20-1541.

Given the costs of discovery in securities actions, Pivotal could have a lasting impact on both the choice of forum in which securities actions are brought and on how discovery progresses in the early stages of a case.

C. The Court Addresses Constitutional Challenges to Administrative Adjudicators

Recall that in Lucia v. SEC, 138 S. Ct. 2044 (2018), the Court held that the SEC’s administrative law judges (“ALJs”) were “Officers of the United States” who must be appointed by the President, a court of law, or the SEC itself. Building on Lucia, the Supreme Court issued two decisions this Term that raised further questions on the constitutionality of administrative officers’ appointments.

Following Lucia, the petitioners in Carr v. Saul and Davis v. Saul sought judicial review of administrative decisions of the Social Security Administration (“SSA”), challenging in the district courts for the first time the constitutionality of SSA ALJ appointments. Carr v. Saul, 141 S. Ct. 1352, 1356–57 (2021). The district courts split on the question of whether petitioners had been required to raise their constitutional challenges during their administrative hearings in the first instance, but both the Eighth and Tenth Circuits agreed that the challenges had been forfeited. Id. at 1357. In its April 22, 2021 decision in these consolidated cases, the Supreme Court unanimously reversed, holding that the petitioners were not required to raise the appointments issue in SSA administrative proceedings, though the Justices were split in their reasoning. Id. at 1356.

The majority opinion held that the benefits claimants were not required to administratively exhaust the appointment issue, in the absence of any statutory or regulatory requirement, for three primary reasons. First, the Court had previously held that the SSA’s Appeals Council conducts proceedings that are more “inquisitorial” than “adversarial,” and that in the absence of “adversarial development of issues by the parties” before the agency tribunal, there was no basis for requiring a petitioner to raise all claims before the agency in order to preserve the issues for judicial review. Id. at 1358–59 (citing Sims v. Apfel, 530 U.S. 103, 112 (2000)). The Court applied the Sims rationale to SSA ALJs who, like the Appeals Council, conduct “informal, nonadversarial proceedings,” even though SSA ALJ proceedings may be considered “relatively more adversarial.” Id. at 1359–60. Second, as the Court has “often observed,” agency decision-makers “are generally ill suited to address structural constitutional challenges, which usually fall outside the adjudicators’ areas of technical expertise.” Id. at 1360. And third, the Court recognized that requiring issue exhaustion here would be futile as the agency adjudicators “are powerless to grant the relief requested.” Id. at 1361. The Court’s consolidated decision in Carr and Davis was dependent on features specific to the SSA’s review, so the question of whether issue exhaustion is required may be answered differently if it arises in future cases, either in the context of an agency with more adversarial administrative review procedures or if the constitutional challenge at issue is “[outside] the context of [the] Appointments Clause.” Id. at 1360 n.5.

In United States v. Arthrex, Inc., 141 S. Ct. 1970 (2021), the Court took up the question of whether administrative patent judges (“APJs”) in the Patent and Trademark Office (“PTO”) are “principal” or “inferior” officers under the Appointments Clause. (Readers should note that Gibson Dunn represented the private parties arguing alongside the government that APJs are inferior officers permissibly appointed by the Secretary of Commerce.) By a 5–4 vote, the majority held that the “unreviewable authority” of APJs to resolve inter partes review proceedings was incompatible with their appointment to an inferior office because “[o]nly an officer properly appointed to a principal office may issue a final decision binding the Executive Branch.” Id. at 1985.

In fashioning a remedy supported by seven Justices, the Court opted for a “tailored approach,” rather than striking down the entire inter partes review regime as unconstitutional. Id. at 1987. Specifically, the Court severed a provision of the statutory scheme that prevented the PTO Director from reviewing APJ decisions. Id. According to the Chief Justice, this remedy would align the Patent Trial and Appeal Board adjudication scheme with others in the Executive Branch and within the PTO itself. Id. In finding that the Constitutional violation is the restraint on the Director’s review authority rather than the APJs’ appointment by the Secretary, the Court found that the proper remedy was remand to the Director rather than to a new panel of APJs for rehearing. Id. at 1987–88.

The majority opinion drew opinions concurring and dissenting in part by Justice Gorsuch (objecting to the Court’s severability analysis) and Justice Breyer (joined by Justices Sotomayor and Kagan, agreeing with Justice Thomas’s analysis on the merits, but supporting the Court’s remedy), as well as a full dissent by Justice Thomas, who criticized the Court’s failure to take a clear position on whether APJs are inferior officers and whether their appointment complies with the Constitution. Id. at 1988–2011. He also disagreed with the Court’s modification of the statutory scheme because, in his view, APJs “are both formally and functionally inferior to the Director and to the Secretary,” and those officers already had sufficient control over APJs. Id. at 2011 (Thomas, J., dissenting).

III. Delaware Developments

**A. Court of Chancery Invalidates Poison Pill under Second Unocal Prong**

In February, the Court of Chancery in Williams Companies Stockholder Litigation, 2021 WL 754593 (Del. Ch. Feb. 26, 2021), enjoined a stockholder rights plan, also known as a “poison pill.” In March 2020, The Williams Companies, Inc. (“Williams”), a natural gas infrastructure company, adopted a stockholder rights plan after the company’s stock price declined substantially due to fallout from the COVID‑19 pandemic, which decreased demand and lowered prices in the global natural gas markets. Id. at *1. Williams adopted the plan in response to multiple perceived threats, including stockholder activism generally, concerns that activist investors may pursue disruptive, short-term agendas, and the potential for rapid and undetected accumulation of Williams stock (a “lightning strike”) by an opportunistic outside investor. Id. at *2.

The court employed the two-part Unocal standard of review to analyze whether (1) the Williams Board had a reasonable basis to implement a poison pill to respond to a legitimate threat, and (2) the reasonableness of the actual terms of the poison pill in relation to the threat posed. Id. at *22 (citing Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985)). Assuming for the sake of analysis that the “lightning strike” concern constituted a legitimate corporate objective, the court held that the plan’s terms were unreasonable. Id. at *33–34. The plan included a triggering ownership threshold of just 5%, compared to a typical market range of 10% to 15%. Id. at *35–36. It also contained an expansive definition of “beneficial ownership” that covered even synthetic interests, an expansive definition of “acting in concert” that covered any parallel conduct by multiple parties, and a relatively narrow definition of the term “passive investor,” which limited the number of investors exempt from the plan’s provisions. Id. at *35. The court concluded that the combined impact of these terms went well beyond that of comparable rights plans and could impermissibly stifle legitimate stockholder activity. Id. at *35–40. Notably, the court looked beyond the stated rationales listed in board resolutions, board minutes, and company disclosures, and instead sought to determine the actual intent of the directors based on testimony and other evidence. Id. The ruling offers an important reminder that rights plans have limits and that the Court of Chancery will not hesitate to assess a board’s subjective basis for implementing a rights plan and its specific terms.

B. Court of Chancery Rejects Claim that Pandemic Constituted a Materially Adverse Effect

In April, the Court of Chancery in Snow Phipps Group, LLC v. KCake Acquisition, Inc., 2021 WL 1714202 (Del Ch. Apr. 30, 2021), rejected a claim that the COVID‑19 pandemic constituted a material adverse effect (“MAE”) under the agreement at issue. There, a private equity firm buyer signed a $550 million agreement with Snow Phillips to purchase DecoPac, a company that supplies cake decorations and equipment to grocery stores. Id. at *1, *9–10. The deal coincided with the early months of the COVID-19 pandemic, which caused a significant decline in DecoPac’s sales. Id. at *1–2. The buyer subsequently attempted to terminate the agreement when it was unable to secure financing based on the target’s revised sales projections. Id. at *24–25.

In the ensuing litigation, the buyer alleged that DecoPac breached a representation that no change or development had, or “would reasonably be expected to have,” an MAE on DecoPac’s finances. Id. at *10. The court rejected this argument, observing—consistent with Delaware precedent—that the existence of an MAE must be judged in terms of DecoPac’s long-term financial prospects (measured in “years rather than months”). Id. at *30. Further, the court noted that the reduction in sales fell within a carve-out from the MAE representation, namely, effects arising from changes in laws or governmental orders. Id. at *35. The decision is notable not just for reaffirming the difficulty of invoking MAE clauses, but also for its broad discussion of how MAE clause carve-outs might negate the occurrence of an existing MAE.

C. Bellwether SPAC Litigation Remains in Initial Stages

In June, the defendants in In re MultiPlan Corp. Stockholders Litigation, Cons. C.A. No. 2021-0300-LWW, filed their motion to dismiss a closely watched consolidated class action filed by the stockholders of MultiPlan, a provider of cost management technology services to insurance agencies. MultiPlan was partially acquired in October 2020 via a reverse merger with a Special Purpose Acquisition Company (“SPAC”), Churchill Capital Corp. III. Most notably, the complaint contends that SPAC structures create inherent conflicts, alleging that MultiPlan’s business prospects have weakened and its stock price has decreased approximately 30% since the acquisition, but the personal investments of individuals managing the SPAC entity have increased materially. The plaintiff stockholders accuse the SPAC, its sponsor, and other directors of issuing misleading and deficient disclosures and of grossly mispricing the transaction.

Although some commentators have characterized the case as a bellwether and the claims asserted as novel, the defendants’ motion to dismiss tracks familiar arguments for attacking complaints concerning merger transactions at the pleading stage. For example, the defendants characterize the claims as derivative and urge dismissal for failure to make a demand. The defendants alternatively assert that, if the claims are direct, they are subject to the business judgment rule and warrant dismissal. More notably, the defendants contend that claims regarding plaintiffs’ redemption rights cannot proceed as fiduciary duty claims because they arise solely from contract. A decision on the pending MultiPlan motion to dismiss may have significant implications for the very active SPAC market, as the Court of Chancery weighs in on the efficacy of these entities and any implications their structure may have for deal disclosures.

D. Court of Chancery Determines CEO Breached Fiduciary Duty and Financial Advisor Aided and Abetted That Breach in Course of Executing a Merger

In Firefighters’ Pension System of the City of Kansas City, Missouri Trust v. Presidio, Inc., 2021 WL 298141 (Del. Ch. Jan. 29, 2021), the Court of Chancery denied motions to dismiss by Presidio’s CEO for allegedly breaching his fiduciary duty and Presidio’s financial advisor for allegedly aiding and abetting that breach, but dismissed claims against the controlling stockholder and other board members. The class action suit challenged a merger of Presidio, a controlled company, with an unaffiliated third party. The court held that a number of actions the CEO allegedly took, if credited, would yield an unreasonable sales process under Revlon. Id. at 267–68. For example, the court credited allegations that the CEO inappropriately steered the bidding process in favor of a private equity buyer that was more eager to retain existing management and simultaneously downplayed to the board of directors the interests of a strategic bidder. Although the strategic bidder allegedly had the capability to pay a higher price as a result of the synergies, it was more likely to replace the CEO. Id. at 267. The court also credited allegations that Presidio’s financial advisor had tipped the potential private equity buyer to confidential information that enabled it to structure its proposed terms into the ultimately bid-winning offer. Id. Presidio has the potential to serve as informative precedent for transactions entailing potential post-close employment opportunities for executives who guide the company’s sale process.

E. Appraisal Litigation Continues Its Steady Decline

The frequency of appraisal litigation continues to decline, with just four appraisal actions filed in the Delaware Court of Chancery in the first half of 2021, compared to the 13 actions filed in the first half of 2020. Going forward, we expect to see appraisal actions concentrated to a subset of deals involving alleged conflicts, process issues, or a limited market check.

Recent appraisal actions that have proceeded continue to reinforce the rulings in DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017) and Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., 177 A.3d 1 (Del. 2017): objective market evidence—including deal price (potentially less synergies) and unaffected market price—generally provides the best indication of a company’s fair value. In In re Appraisal of Regal Entertainment Group, 2021 WL 1916364 (Del. Ch. May 13, 2021), for example, the Court of Chancery awarded a relatively modest 2.6% increase over the original merger price. The court held that the best evidence of the target’s fair value was the deal price, adjusted for post-signing value increases. Id. at *58. The court rejected arguments that Regal’s stock price was the best indicator of fair value, finding that “the sale process that led to the Merger Agreement was sufficiently reliable to make it probable that the deal price establishes a ceiling for the determination of fair value.” Id. at *34.

In the absence of reliable market-based indicators, the Court of Chancery has demonstrated a willingness to fall back on potentially more subjective valuation techniques, including discounted cash flow and comparable company analyses. In January 2021, the Delaware Supreme Court affirmed a Court of Chancery decision awarding a 12% premium on the merger price based solely on a discounted cash flow (“DCF”) valuation. SourceHOV Holdings, Inc. v. Manichaean Capital, LLC, 246 A.3d 139 (Del. 2021). The Court of Chancery’s exclusive use of the petitioner’s DCF valuation was premised on the Respondent’s failure to prove a fair value for the transaction, with the court noting it was “struck by the fact that [Respondent] disagreed with its own valuation expert, relied on witnesses whose credibility was impeached and employed a novel approach to calculate SourceHOV’s equity beta that is not supported by the record evidence. In a word, Respondent’s proffer of fair value is incredible.” Manichaean Capital, LLC v. SourceHOV Holdings, Inc., 2020 WL 496606, at *2 (Del. Ch. Jan. 30, 2020).

IV. Further Development of Disseminator Liability Theory Upheld in Lorenzo

As we initially discussed in our 2019 Mid-Year Securities Litigation Update, in March 2019, the Supreme Court held in Lorenzo v. SEC, 139 S. Ct. 1094 (2019), that those who disseminate false or misleading information to the investing public with the intent to defraud can be liable under Section 17(a)(1) of the Securities Act and Exchange Act, Rules 10b-5(a) and 10b-5(c), even if the disseminator did not “make” the statement within the meaning of Rule 10b-5(b). In practice, Lorenzo creates the possibility that secondary actors—such as financial advisors and lawyers—could face liability under Rules 10b-5(a) and 10b-5(c) (known as the “scheme liability provisions”) simply for disseminating the alleged misstatement of another, if a plaintiff can show that the secondary actor knew the alleged misstatement contained false or misleading information.

In 2021, courts have continued to grapple with Lorenzo’s application, particularly “whether Lorenzo’s language can be read to stretch scheme liability to cases in which plaintiffs are specifically alleging that the defendant did ‘make’ misleading statements (or omissions) as prohibited in Rule 10b5-(b),” or if “Lorenzo merely extends scheme liability to those who ‘disseminate false or misleading statements’ but that it does not hold that ‘misstatements [or omissions] alone are sufficient to trigger scheme liability’” absent additional conduct. Puddu v. 6D Global Techs., Inc., 2021 WL 1198566, at *10 (S.D.N.Y. Mar. 30, 2021) (quoting SEC v. Rio Tinto PLC, 2021 WL 818745, at *2 (S.D.N.Y. Mar. 3, 2021)) (summarizing the divergent views of various district courts).

In June, the Ninth Circuit, in In re Alphabet, Inc. Securities Litigation, 1 F.4th 687 (9th Cir. 2021) (“Alphabet”), signaled its support for the view that disseminator liability does not require “conduct other than misstatements.” Alphabet involved allegations that executives at Google and its holding company, Alphabet, were aware of security vulnerabilities on the Google+ social network. Id. at 693–97. Plaintiffs brought a claim against Alphabet under Rule 10b-5(b), in addition to scheme liability claims under Rule 10b-5(a) and (c), alleging a scheme to defraud shareholders by withholding material and damaging information about the security vulnerabilities from Alphabet’s quarterly filings. See id. at 698. The district court granted Alphabet’s motion to dismiss in full, finding that plaintiffs had failed to adequately allege a misrepresentation or omission of a material fact and failed to adequately allege scienter for the purposes of their Rule 10b-5 claims. Id.

On appeal, the Ninth Circuit reversed in part, holding that that the trial court erred by dismissing the claims under Rule 10b-5(a) and (c) because defendants had not specifically moved to dismiss those claims but instead moved to dismiss only on the basis of Rule 10b-5(b) and Rule 10b-5 generally. Id. at 709. Notably, the panel also disagreed with Alphabet’s “argument that Rule 10b-5(a) and (c) claims cannot overlap with Rule 10b-5(b) statement liability claims” because such an argument “is foreclosed by Lorenzo, which rejected the petitioner’s argument that Rule 10b-5(a) and (c) ‘concern “scheme liability claims” and are violated only when conduct other than misstatements is involved.’” Id. (quoting Lorenzo, 139 S. Ct. at 1101–02).

At the same time, district courts within the Second Circuit are considering the breadth of Lorenzo. See In re Teva Sec. Litig., 2021 WL 1197805, at *5 (D. Conn. Mar. 30, 2021) (summarizing the divergent views). As the Teva court explained, “[s]ome district courts in this circuit apparently agree with the” view that Lorenzo “abrogated the rule that ‘scheme liability depends on conduct that is distinct from an alleged misstatement,’” “[b]ut other district courts cabin Lorenzo and read it more restrictively” to only hold that “‘those who disseminate false or misleading statements to potential investors with the intent to defraud can be liable under [Rule 10b-5(a) and (c)], not that misstatements alone are sufficient to trigger scheme liability.’” Id. (quoting Rio Tinto PLC, 2021 WL 818745, at *2–3).

The Second Circuit itself has not yet squarely addressed the scope of Lorenzo. However, earlier this year, the district court in SEC v. Rio Tinto PLC, 2021 WL 1893165 (S.D.N.Y. May 11, 2021), certified an interlocutory appeal to the Second Circuit, following its dismissal of scheme liability claims where the SEC failed to “allege that Defendants disseminated [the] false information, only that they failed to prevent misleading statements from being disseminated by others.” At the time of this update, the Second Circuit had not ruled on whether it will hear the appeal. Gibson Dunn represents Rio Tinto in this and other litigation.

As these developments suggest, the application of the Lorenzo disseminator liability theory continues to evolve among and within the circuits. We will continue to monitor closely the changing applications of Lorenzo and provide a further update in our 2021 Year-End Securities Litigation Update.

Although the stock market has largely stabilized since COVID-19 first impacted the United States in 2020, courts are still feeling the effects of the economic disruption and attendant securities litigation arising out of the pandemic. While the first series of COVID-19 securities lawsuits focused on select industries, such as travel and healthcare, plaintiffs eventually set their sights on other industries. We surveyed a select number of these cases in our 2020 Year-End Securities Litigation Update.

Since then, there have been several dismissals of COVID-19-related securities cases, including dismissals of some of the earliest cases brought in March 2020 concerning the travel industry. Nevertheless, lawsuits for misstatements regarding safety and risk disclosures are still being brought, and now that the “Delta” variant has spread throughout the United States, such lawsuits may continue for the foreseeable future.

Although it is too soon to tell whether the midpoint of COVID-19 securities litigation has passed, we will continue to monitor developments in this area. Additional resources regarding the legal impact of COVID-19 can be found in the Gibson Dunn Coronavirus (COVID-19) Resource Center.

A. Securities Class Actions

1. False Claims Concerning Commitment to Safety

Douglas v. Norwegian Cruise Lines, No. 20-cv-21107, 2021 WL 1378296 (S.D. Fla. Apr. 12, 2021): As we discussed in our 2020 Mid-Year Securities Litigation Update, the COVID-19 pandemic birthed an entire category of class action lawsuits concerning service companies’ commitments to safety, including a proposed class action lawsuit against Norwegian Cruise Lines. In April 2021, Judge Robert Scola, Jr. dismissed the lawsuit, which had originally alleged that Norwegian violated securities laws by minimizing the impact of the COVID-19 outbreak on its operations and failing to disclose allegedly deceptive sales practices that downplayed COVID-19. Id. at *2–3. Judge Scola, Jr. concluded that “[a]ll the challenged statements constitute corporate puffery” such that no reasonable investor would have relied on them. Id. at *4.

In re Carnival Corp. Securities Litigation, No. 20-cv-22202, 2021 WL 2583113 (S.D. Fla. May 28, 2021): Similarly, in May 2021, a year after plaintiffs filed the complaint, Judge K. Michael Moore dismissed a putative class action against Carnival that alleged that Carnival misrepresented the effectiveness of its health and safety protocols during the COVID-19 outbreak. Id. at *1–3. The court held that the plaintiffs-investors had failed to show that Carnival’s “statements affirming compliance with then-existing regulatory requirements [were] materially false or misleading” because the plaintiffs’ argument relied on the inference that “passengers would ultimately fall ill aboard Carnival’s ships—just as people did in other venues across the globe.” Id. at *15. Accordingly, the court found the inference was “too tenuous to meet the heightened pleading standard applicable in the securities fraud context.” Id.

2. Failure to Disclose Specific Risks

Plymouth Cnty. Retirement Assoc. v. Array Techs., Inc., No. 21-cv-04390 (S.D.N.Y. May 14, 2021): Plaintiffs allege that Array, a solar panel manufacturer, along with several of its directors and underwriters, failed to disclose that “unprecedented” increases in steel and shipping costs negatively impacted the company’s quarterly results until the company’s CFO revealed the results in a conference call. Dkt. No. 1 at ¶¶ 10–42, 113–15. Upon the release of this news, Array’s stock price fell by $11.49 to close at $13.46. Id. at ¶ 118. Array had previously issued warnings on the “global shipping constraints due to COVID-19” but allegedly failed to disclose the impact of dramatically increasing supply prices and increasing freight costs. Id. at ¶¶ 103, 112. This case was later consolidated with Keippel v. Array Technologies, Inc., 21-cv-5658 (S.D.N.Y. June 30, 2021). Dkt. No. 61 at 1. The case remains pending.

Denny v. Canaan Inc., No. 21-cv-03299 (S.D.N.Y. Apr. 15, 2021): A shareholder of Canaan, a company that manufactures and sells Bitcoin mining machines, alleged that the company misleadingly issued positive statements about strong demand for bitcoin mining machines without disclosing how “ongoing supply chain disruptions” and the introduction of its latest machines had “cannibalized sales of [its] older product offerings,” which caused sales to decline. Dkt No. 1 at ¶ 4. Purportedly, Canaan did not reveal these issues until a conference call to discuss fourth quarter earnings, after which Canaan’s American Depository Receipts, which are a type of securities, declined by nearly 30%. Id. at ¶¶ 27–28.

3. Alleged Insider Trading and “Pump and Dump” Schemes

Tang v. Eastman Kodak Co., No. 20-cv-10462 (D.N.J. Aug. 13, 2020): In our 2020 Year-End Securities Litigation Update, we previously discussed this putative class action, in which stockholders contended Eastman Kodak violated securities law by failing to disclose that its officers were granted stock options prior to the company’s public announcement that it had received a loan to produce drugs for the treatment of COVID-19. Dkt. No. 1 at 2. On May 28, the New Jersey federal judge transferred the case to the Western District of New York, where the alleged misconduct occurred. Dkt. No. 62 at 1. In parallel, New York Attorney General Leticia James commenced an action under Section 34 of General Business Law to seek evidence of insider trading from Kodak. NYSCEF No. 451652/2021, Dkt. No. 1 at 1. On June 15, the court ordered Kodak’s executives to publicly testify. Dkt. No. 9 at 2.

B. Stockholder Derivative Actions

1. Disclosure Liability

Berndt v. Kelly, No. 21-cv-50422 (W.D. Wash. June 4, 2021): In this derivative suit, plaintiff alleges that CytoDyn Inc., which is developing a drug with potential benefits for HIV patients, misleadingly touted the drug as a potential COVID-19 treatment, resulting in a significant increase in the company’s stock price. Dkt. No. 1 at ¶¶ 2–4. “[W]hile the [c]ompany’s stock price was sufficiently inflated with the COVID-19 cure hype,” the complaint alleges, a close circle of long-term shareholders “dumped millions of shares.” Id. at ¶ 6. Following the alleged cash-out of company shares, the price of CytoDyn “dropped precipitously” after it was revealed that the COVID-19 treatment was not commercially viable. Id. at ¶ 8. The suit includes claims for breach of fiduciary duty, waste of corporate assets, unjust enrichment, and violations of the Exchange Act. Id. at ¶¶ 78–98.

Golubinski v. Douglas, No. 2021-0172 (Del. Ch. Apr. 20, 2021): An investor of Novavax Inc. derivatively sued the company’s directors and certain officers, claiming that they granted themselves a series of lucrative equity awards in 2020 with the knowledge that Novavax’s stock was going to increase nearly 700% based on promising COVID-19 vaccine news. Dkt. 1 at ¶¶ 5–13. The investor alleges that “management exploited its relationships with regulators and influential players in the vaccine community to both secure funding and position itself to receive even more funding for COVID-19 research prior to granting spring-loaded awards to [c]ompany insiders.” Id. at ¶ 15. The stock granted to executives in April and June 2020 allegedly rose in value within a few months, after the news became public that the company would be getting billions in funding through Operation Warp Speed, the U.S. government’s COVID-19 vaccine initiative. Id. at ¶¶ 9–13. The derivative suit seeks, among other things, to have the stock awards rescinded. Id. at ¶ 16.

2. Oversight Liability

Bhandari v. Carty, No. 2021-0090 (Del. Ch. Feb. 5, 2021): Two stockholders of YRC Worldwide, Inc. sued the company’s directors, claiming that they oversaw a fraudulent scheme to overcharge customers for freight cargo, and then sought a $700 million government bailout purportedly justified by fraudulent concerns relating to COVID-19. Dkt. 1 at ¶¶ 3–15. The bailout, which plaintiffs allege “made the company one of the largest recipients of taxpayer money meant to support businesses and workers struggling amid the coronavirus,” has now “come under scrutiny from” Congress, which is investigating whether it “was really worthy of a rescue,” according to the complaint. Id. at ¶ 15. Plaintiffs allege that the board “could and should have quickly and responsibly taken action to correct management’s wrongdoing,” but failed to do so. Id. at ¶ 5.

3. Insider Trading

Lincolnshire Police Pension Fund v. Kramer, No. 21-cv-01595 (D. Md. June 29, 2021): Plaintiff sued directors of Emergent BioSolutions Inc. derivatively for claims that the board members allegedly sold a combined $20 million of personally held Emergent shares “on the basis of the nonpublic information about the problems at the Bayview Facility,” where the company was working on a COVID-19 vaccine for Johnson and Johnson. Dkt. 1 at ¶¶ 9, 15–26, 89, 101. The fund claims that the directors allegedly “used their knowledge of Emergent’s material, nonpublic information to sell their personal holdings while the Company’s stock was artificially inflated.” Id. at ¶ 89. Specifically, the allegations are that the directors were supposedly aware of Bayview’s history of internal control failures and inability to handle the “massive and critical work required to manufacture [the COVID-19] vaccines.” Id. at ¶ 3.

In Delaware, another Emergent stockholder brought a Section 220 action against Emergent to enforce his statutory right to inspect the company’s books and records. See Elton v. Emergent BioSolutions, Inc., No. 2021-0426 (Del. Ch. May 21, 2021). There, too, the stockholder alleged that there was a “credible basis to infer the Company’s fiduciaries sold Company stock while in possession of material, non-public information” relating to Emergent’s alleged “regulatory, compliance, and manufacturing failures.” Dkt. 1 at ¶ 3.

C. SEC Cases

SEC v. Arrayit Corp., No. 21-cv-01053 (N.D. Cal. Feb. 11, 2021): As we discussed in our 2020 Year-End Securities Litigation Update, the SEC charged Mark Schena, the President of Arrayit Corporation, a healthcare technology company, for “making false and misleading statements about the status of Arrayit’s delinquent financial reports.” SEC v. Schena, No. 20-cv-06717 (N.D. Cal. Sept. 25, 2020), Dkt. No. 1 at ¶ 1. That case was stayed, pending the resolution of a criminal case against Mr. Schena. Dkt. 23. Since then, the SEC has brought a separate case against Arrayit itself, as well as Mark Schena’s wife, who served as Arrayit’s CEO, CFO, and chairman for over a decade. No. 5:21-cv-01053, Dkt. No. 1 at ¶¶ 1, 11. The new claims brought under Sections 10(b) and 13(a) mirror those in the prior action against Mr. Schena, namely that the defendants allegedly misrepresented the company’s capability to develop COVID-19 tests. Id. at ¶ 1. The parties settled on a neither-admit-nor-deny basis, with Ms. Schena also agreeing to a $50,000 penalty. Dkt. No. 11 at 1–3; Dkt No. 12 at 2.

SEC v. Parallax Health Sciences, Inc., No. 21-cv-05812 (S.D.N.Y. July 7, 2021): This enforcement action, brought under Section 17(a)(1)(3) of the Securities Act and Section 10(b) of the Exchange Act, resulted from a series of seven press releases issued by Parallax, a healthcare company, about its ability to capitalize on the COVID-19 pandemic. Dkt. No. 1 at ¶¶ 1, 4. The SEC’s complaint alleges that Parallax falsely claimed that its COVID-19 screening test would be “available soon” despite the company’s insolvency and the company’s own internal projections showing that, even if it had the funds, other factors prevented the company from acquiring the needed equipment. Id. at ¶¶ 1–2. Parallax, its CEO, and CTO settled with the SEC on a neither-admit-nor-deny basis, and agreed to penalties of $100,000, $45,000, and $40,000, respectively. Dkt. No. 4 at 1, 4.

SEC v. Wellness Matrix Grp., Inc., No. 21-cv-1031 (C.D. Cal. June 11, 2021): The SEC charged Wellness Matrix, a wellness company, and its controlling shareholder for allegedly misleading investors about the availability and approval status of its at-home COVID-19 testing kits and disinfectants in violation of Section 10(b) and Rule 10b-5. Dkt. No. 1 at ¶¶ 6–7, 9. The SEC alleges that the company’s claims were false and, to the contrary, defendants knew its distributor was unable to fulfill the order and the products were neither FDA- nor EPA-approved. Id. at ¶¶ 44–48. The SEC had suspended trading in Wellness Matrix’s securities approximately two months before bringing the action. Id. at ¶ 68.

VI. Falsity of Opinions – Omnicare Update

As we discussed in our prior securities litigation updates, lower courts continue to examine the standard for imposing liability based on a false opinion as set forth by the Supreme Court in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 575 U.S. 175 (2015). In Omnicare, the Supreme Court held that “a sincere statement of pure opinion is not an ‘untrue statement of material fact,’ regardless whether an investor can ultimately prove the belief wrong,” but that an opinion statement can form the basis for liability in three different situations: (1) the speaker did not actually hold the belief professed; (2) the opinion contained embedded statements of untrue facts; or (3) the speaker omitted information whose omission made the statement misleading to a reasonable investor. Id. at 184–89.

In 2021, federal courts have continued to grapple with whether Omnicare—which was decided in the context of a Section 11 claim—applies to claims brought under the Exchange Act. In April, the Ninth Circuit extended the Omnicare standard to claims brought under Exchange Act Section 14(a) and Rule 14a-9. Golub v. Gigamon Inc., 994 F.3d 1102, 1107 (9th Cir. 2021). The court reasoned that such claims contain a “virtually identical limitation on liability” to claims under Section 11 and Rule 10b-5, to which the Ninth Circuit held Omnicare applies. Id.; see also City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Align Tech., Inc., 856 F.3d 605 (9th Cir. 2017).

Two additional cases addressing Omnicare’s application to the Exchange Act came down in the District of New Jersey, with one of them ultimately deciding to apply the Omnicare standard for falsity to claims brought under Section 10(b) and Rule 10b-5. Ortiz v. Canopy Growth Corp., No. 2:19-cv-20543, 2021 WL 1967714 (D.N.J. May 17, 2021). Recognizing the majority view outside the Third Circuit that Omnicare applies to such claims, the court in Ortiz “s[aw] no reason to apply a different rule.” Id. at *33. However, after finding that the alleged statements were actionable under Omnicare, the court still dismissed the complaint for failure to plead scienter. Id. at *44. While plaintiffs adequately pled that defendants did not believe certain statements when they were made and misleadingly omitted certain material facts, plaintiffs could not overcome the PLSRA’s high bar for scienter. Id. at *38–39. The court found that plaintiffs failed to plead facts to support a “strong inference” of scienter because, based on several factors, another more “innocent explanation” was plausible. Id. at *42–43. In another case, a District of New Jersey court found evaluation of Omnicare unnecessary for the same reason: Plaintiffs did not plead facts to “support a ‘strong inference’ of scienter.” In re Amarin Corp. PLC Sec. Litig., No. 3:19-cv-06601, 2021 WL 1171669 at *19 (D.N.J. Mar. 29, 2021). These cases suggest Omnicare may rarely be outcome-determinative for Section 10(b) and Rule 10b-5 claims because opinions that may be actionable under Omnicare may often lack an “intent to deceive, manipulate, or defraud,” as required to demonstrate scienter. See Ortiz, 2021 WL 1967714, at *10.

Omnicare has remained a significant pleading barrier in the first half of 2021. In Salim v. Mobile Telesystems PJSC, No. 19-cv-1589, 2021 WL 796088 (E.D.N.Y. Mar. 1, 2021), the Eastern District of New York held that a statement about potential liability resulting from investigations into alleged FCPA violations “would have necessarily been a statement of opinion until the company could give a reasonable estimate of its potential losses.” Because plaintiff failed to allege sufficient facts to show that defendant did not actually believe what it stated, the court granted defendants’ motion to dismiss. Id. at *8–9. Similarly, in City of Miami Fire Fighters’ and Police Officers’ Retirement Trust v. CVS Health Corp., the District of Rhode Island held that reported results of goodwill assessments conducted under Generally Accepted Accounting Principles are opinion statements that must be assessed under Omnicare because “[e]stimates of goodwill depend on management’s determination of the fair value of the assets acquired and liabilities assumed, which are not matters of objective fact.” No. 19-437-MSM-PAS, 2021 WL 515121, at *9 (D.R.I. Feb. 11, 2021). In granting defendants’ motion to dismiss, the court found allegations “amount[ing] to a retrospective disagreement with [defendant’s] judgment” inadequate “without sufficient facts to undermine the assumptions [defendant] used when it made its goodwill assessments.” Id. at *10.

Other recent district court decisions illustrate the narrow situations in which plaintiffs have overcome Omnicare’s high bar. For instance, in Howard v. Arconic Inc., defendants argued that aluminum manufacturer Arconic’s statement that it “believes it has adopted appropriate risk management and compliance programs to address and reduce” certain risks was a non-actionable opinion under Omnicare. No. 2:17-cv-1057, 2021 WL 2561895, at *7 (W.D. Pa. June 23, 2021). The court disagreed, holding that the statement “conveyed to investors that there was a reasonable basis for [defendants’] belief about the adequacy of the compliance/risk management programs,” but facts regarding Arconic’s practice of selling hazardous products “call[ed] into question the reasonableness of that belief.” Id.

Finally, in SEC v. Bluepoint Investment Counsel, LLC, the SEC claimed that the investment-advisor defendants had defrauded investors by reporting misleading and unreasonable valuations of fund assets in order to charge excessive management and other fees. No. 19-cv-809, 2021 WL 719647, at *1 (W.D. Wis. Feb. 24, 2021). The court held that the statements were actionable, consistent with Omnicare, because “the SEC has alleged specific facts which, taken as true, involve valuations containing embedded statements of fact that were untrue.” Id. at *17. Specifically, defendants had stated that the valuations would be “based on underlying market driven events,” but the SEC alleged that the appraisal process was far less thorough. Id. This method, the court reasoned, “reflects the kind of ‘baseless, off-the-cuff judgment[]’ that an investor reasonably would not expect in the context of a third-party appraisal that is then relied upon in an investor fund’s financial statements.” Id.

As shareholder litigation arising from the economic impact of COVID-19 continues, including a handful of cases targeting vaccine development and efficacy, Omnicare will likely play a significant role. See Complaint for Violations of the Federal Securities Law, In re AstraZeneca PLC Sec. Litig., No. 1:21-cv-00722 (S.D.N.Y. Jan. 26, 2021) (containing various allegations based on statements or omissions relating to clinical trials for the COVID-19 vaccine). Disclosures and accounting estimates impacted by the rapidly evolving circumstances presented by the pandemic, and other statements and estimates involving interpretation of complex scientific data, are at the heart of Omnicare analysis. We will continue to monitor developments in these and similar cases.

VII. Halliburton II Market Efficiency and “Price Impact” Cases

As previewed in our last two updates, and discussed above in our Supreme Court roundup, the Supreme Court issued its decision in Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System on June 21. 141 S. Ct. 1951 (2021) (“Goldman Sachs”). Practitioners now have confirmation from the Supreme Court that courts must consider the generic nature of allegedly fraudulent statements at the class certification stage when necessary to determine whether the statements impacted the issuer’s stock price, even though that analysis will often overlap with the merits issue of materiality. See id. at 1960–61. The Court also resolved the question of which party bears what burden when defendants offer evidence of a lack of price impact to rebut the presumption of reliance, placing the burdens of both production and persuasion on defendants. See id. at 1962–63.

Recall that in Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014) (“Halliburton II”), the Supreme Court preserved the “fraud-on-the-market” presumption of class-wide reliance in Rule 10b-5 cases, but also permitted defendants to rebut this presumption at the class certification stage with evidence that the alleged misrepresentation did not impact the issuer’s stock price. Since that decision, as we have detailed in these updates, lower courts have struggled with several recurring questions, including: (1) how to reconcile Halliburton II with Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804 (2011) (“Halliburton I”) and Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 568 U.S. 455 (2013), in which the Court held that loss causation and materiality, respectively, were not class certification issues, but instead should be addressed at the merits stage; (2) who bears what burden when defendants present evidence of a lack of price impact; and (3) what evidence is sufficient to rebut the presumption. The Court has now resolved the first two questions in Goldman Sachs.

In its most recent decision, the Second Circuit held that the generic nature of Goldman Sachs’s allegedly fraudulent statements was irrelevant at the class-certification stage and instead should be litigated at trial, and that defendants bore both the burden of production and persuasion in rebutting the presumption of reliance. Ark. Tchr. Ret. Sys. v. Goldman Sachs Grp., Inc., 955 F.3d 254, 265–74 (2d Cir. 2020). As detailed above, the Supreme Court disagreed with the first holding but agreed with the second. Because it was unclear whether the Second Circuit properly considered Goldman Sachs’s price impact evidence, the Court remanded for further consideration. Goldman Sachs, 141 S. Ct. at 1961. The Court also confirmed that the Second Circuit allocated the parties’ burdens correctly, because the defendant “bear[s] the burden of persuasion to prove a lack of price impact by a preponderance of the evidence,” including at the class-certification stage. Id. at 1958. The Court clarified that its opinions had already placed that burden on defendants—although “the allocation of burden is unlikely to make much difference on the ground,” and will “have bite only when the court finds the evidence in equipoise.” Id. at 1963.

Most importantly, an eight-justice majority made clear that even when the question of price impact overlaps with merits questions, all relevant evidence on price impact must be considered at the class certification stage. Goldman Sachs, 141 S. Ct. at 1960–61 (citing Halliburton II, Comcast Corp. v. Behrend, 569 U.S. 27 (2013), and Wal-Mart Stores, Inc. v. Dukes, 564 U.S. 338 (2011)). This is the case even though “materiality and price impact are overlapping concepts” and “evidence relevant to one will almost always be relevant to the other.” Id. at 1961 n.2. In other words, the Supreme Court has now confirmed that Halliburton I, Amgen, and Halliburton II are consistent because plaintiffs do not need to prove materiality and loss causation to invoke the presumption of reliance, but defendants can use price impact evidence—including evidence of immateriality or a lack of loss causation—to defeat the presumption of reliance at the class certification stage.

Despite its relevance to the case, the Court declined to offer a view on the validity of the inflation-maintenance theory, under which plaintiffs frequently argue that price movements associated with negative news can be attributed to earlier, challenged statements. See id. at 1959 n.1. However, the Court underscored that the connection between a statement and a corrective disclosure is particularly important in inflation-maintenance cases. Id. at 1961. As the Court noted, the inference that a subsequent price drop proves there was previous inflation “starts to break down when there is a mismatch between the contents of the misrepresentation and the corrective disclosure,” which can occur “when the earlier misrepresentation is generic . . . and the later corrective disclosure is specific.” Id.

The Second Circuit has now remanded to the district court to examine all relevant evidence of price impact in the first instance. Arkansas Tchr. Ret. Sys. v. Goldman Sachs Grp., Inc., No. 18-3667, 2021 WL 3776297, at *1 (2d Cir. Aug. 26, 2021). We will continue to monitor this and related cases.

VIII. Other Notable Developments

A. Morrison Domestic Transaction Test

The circuit split concerning the application of the domestic transaction test from Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), has widened in the first half of this year. In Morrison, the Supreme Court held that the Exchange Act only applied to “transactions in securities listed on domestic exchanges, and domestic transactions in other securities.” Id. at 267. This holding was premised on “the focus of the Exchange Act,” which is “not upon the place where the deception originated, but upon purchases and sales of securities in the United States.” Id. at 266. Thereafter, courts have held that a security that is not traded on a domestic exchange satisfies the second prong of Morrison, “if irrevocable liability is incurred or title passes within the United States.” Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 67 (2d Cir. 2012).

This January, in Cavello Bay Reinsurance Ltd. v. Shubin Stein, 986 F.3d 161 (2d Cir. 2021), the Second Circuit reaffirmed its prior holding in Parkcentral Global Hub Ltd. v. Porsche Automobile Holdings SE, 763 F.3d 198 (2d Cir. 2014), that the traditional “irrevocable liability” test is necessary, but not sufficient to bring a claim under the Exchange Act. Instead, a plaintiff must additionally show that the transaction was not “‘so predominantly foreign’ as to be impermissibly extraterritorial.” Cavello Bay, 986 F.3d at 165 (citing Parkcentral, 763 F.3d at 216). The Second Circuit considered that this test “uses Morrison’s focus on the transaction rather than surrounding circumstances, and flexibly considers whether a claim—in view of the security and the transaction as structured—is still predominantly foreign.” Id. at 166–67. Under this framework, the court affirmed the dismissal of an action based on “a private offering between a Bermudan investor . . . and a Bermudan issuer” because it was predominantly foreign, even though the fact that the contract was countersigned in the United States may have been sufficient to incur irrevocable liability in the United States. Id. at 167–68.

On the other hand, in its first application of Morrison, the First Circuit, “[l]ike the Ninth Circuit . . . reject[ed] Parkcentral as inconsistent with Morrison.” Sec. & Exch. Comm’n v. Morrone, 997 F.3d 52, 60 (1st Cir. 2021). Because “Morrison says that § 10(b)’s focus is on transactions,” the court found that “[t]he existence of a domestic transaction suffices to apply the federal securities laws under Morrison” and “[n]o further inquiry is required.” Id.

B. Eighth Circuit Strikes Class Allegations under Rule 12(f)

In Donelson v. Ameriprise Financial Services, Inc., 999 F.3d 1080 (8th Cir. 2021), the Eighth Circuit struck class allegations pursuant to Rule 12(f) of the Federal Rules of Civil Procedure, which permits a court to strike from a pleading “any insufficient defense or any redundant, immaterial, impertinent, or scandalous matter.” Id. at 1091 (quoting Fed. R. Civ. P. 12(f)). The court “agree[d] with the Sixth Circuit that a district court may grant a motion to strike class-action allegations prior to the filing of a motion for class-action certification” when certification is a “clear impossibility,” noting that other federal courts have reached the conclusion that this was not permissible. Id. at 1092.

Donelson concerned an investor’s claims, including under Section 10(b) of the Securities Exchange Act, against a broker and investment advisor for mishandling and making misrepresentations about his investment account. Id. at 1086. The plaintiff sought to bring claims on behalf of a class of individuals who had allegedly suffered similar harms. While the agreement governing the plaintiff’s account contained a mandatory arbitration clause, there was an exception for “putative or certified class actions.” Id. The court found that the class allegations should be stricken because they were not “cohesive” and would require “a significant number of individualized factual and legal determinations to be made,” including specifically whether the defendants made misrepresentations to each investor, whether those misrepresentations were material, whether the investor relied upon them, and whether the investor suffered economic harm. Id. at 1092–93. Furthermore, the court found that the circumstances warranted striking the class allegations because delaying the inevitable decision would “needlessly force the parties to remain in court when they previously agreed to arbitrate.” Id. at 1092.

C. Congress Codifies SEC Disgorgement Remedy

On January 1, 2021, Congress codified the SEC’s right to disgorgement remedies as part of the National Defense Authorization Act (“NDAA”). While the SEC has often sought—and courts have often granted—disgorgement remedies, the new law codifies this right and also adds guidance as to the parameters. Section 6501 of the NDAA amends the Exchange Act to allow any United States District Court to “require disgorgement…of any unjust enrichment by the person who received such unjust enrichment as a result of [violations under the securities laws].” Previously, disgorgement was awarded pursuant to the court’s equitable power, rather than statutorily mandated in cases of unjust enrichment.

Significantly, the amendment also provides for a 10-year statute of limitations that applies to “[any actions for disgorgement arising out] of the securities laws for which scienter must be established.” 15 U.S.C. § 78u(d)(8)(A)(ii). The law further provides for a 10-year statute of limitations for “any equitable remedy, including for an injunction or for a bar, suspension, or cease and desist order” irrespective of whether the underlying securities law violation carries a scienter requirement. 15 U.S.C. § 78u(d)(8)(B). The law expands disgorgement to “any equitable remedy” and ensures that a court awards disgorgement in these cases. Moreover, for the purposes of calculating any limitations period under this paragraph, “any time in which the person . . . is outside of the United States shall not count towards the accrual of that period.” 15 U.S.C. § 78u(d)(8)(C).

D. Delaware Exclusive Forum Bylaws Applicable to Section 14

A recent federal decision in the Northern District of California precluded plaintiffs from bringing Section 14(a) claims in the face of an exclusive forum selection clause in a company’s bylaws. Lee v. Fisher, 2021 WL 1659842 (N.D. Cal. Apr. 27, 2021). In Lee, plaintiffs brought derivative claims on behalf of The Gap, Inc. for violation of Section 14(a) of the Securities Exchange Act as a result of allegedly misleading statements about the Gap’s commitment to diversity. Id. at *1. The defendants moved to dismiss the claims on forum non conveniens grounds based on the forum selection clause in Gap’s bylaws, which provided that any action had to be brought in Delaware Chancery Court. Id. at *2. In granting the motion and dismissing the claims, the court noted a strong policy in favor of enforcing forum selection clauses where practicable. Id. at *3. In response to the plaintiff’s objection that Section 14(a) claims must be asserted in federal court because of its exclusive jurisdiction and that the anti-waiver provisions in the Securities Act preclude waiving the jurisdictional requirement, the court noted Ninth Circuit precedent has held that the policy of enforcing forum selection clauses supersedes anti-waiver provisions like those in the Exchange Act. Id. In addition, enforcement of the exclusive forum selection clause would not leave the plaintiff without a remedy because the plaintiff could file separate state law derivative claims in Delaware, even if such action could not include a federal securities law claim. The plaintiffs have filed a notice of appeal in the Ninth Circuit.

E. Ninth Circuit Upholds Broad Protection for Forward-Looking Statements

In Wochos v. Tesla, Inc., 985 F.3d 1180 (9th Cir. 2021), the Ninth Circuit upheld a broad interpretation of the safe harbor protections afforded by the PSLRA. The PSLRA’s safe harbor for forward-looking statements protects against liability that is premised upon statements made about a company’s plans, objectives, and projections of future performance, along with the assumptions underlying such statements. In Wochos, the Ninth Circuit held that this protection applies even when the statements touch on the current state of affairs.

The plaintiffs in Wochos alleged that statements by Tesla officers that the company was “on track” to meet certain production goals was misleading because the company was facing manufacturing problems that made these production goals difficult to attain. Id. at 1185–86. Plaintiffs claimed that the statements were not protected under the PSLRA’s safe harbor provisions because these “predictive statements contain[ed] embedded assertions concerning present facts that are actionable.” Id. at 1191 (emphasis in original). The court disagreed, finding that the definition of forward-looking statements “expressly includes ‘statement[s] of the plans and objectives of management for future operations,’” and “‘statement[s] of the assumptions underlying or relating to’ those plans and objectives.” Id. (emphases in original). Even though Tesla’s statements touched on the current state of the business, the court found that they were forward-looking because “any announced ‘objective’ for ‘future operations’ necessarily reflects an implicit assertion that the goal is achievable based on current circumstances.” Id. at 1192 (emphasis in original). The court reasoned that the safe harbor would be rendered moot if it “could be defeated simply by showing that a statement has the sort of features that are inherent in any forward-looking statement.” Id. (emphasis in original).

The following Gibson Dunn attorneys assisted in preparing this client update: Jeff Bell, Shireen Barday, Monica Loseman, Brian Lutz, Mark Perry, Avi Weitzman, Lissa Percopo, Michael Celio, Alisha Siqueira, Rachel Jackson, Andrew Bernstein, Megan Murphy, Jonathan D. Fortney, Sam Berman, Fernando Berdion-Del Valle, Andrew V. Kuntz, Colleen Devine, Aaron Chou, Luke Dougherty, Lindsey Young, Katy Baker, Jonathan Haderlein, Marc Aaron Takagaki, and Jeffrey Myers.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following members of the Securities Litigation practice group:

Monica K. Loseman – Co-Chair, Denver (+1 303-298-5784, mloseman@gibsondunn.com)
Brian M. Lutz – Co-Chair, San Francisco/New York (+1 415-393-8379/+1 212-351-3881, blutz@gibsondunn.com)
Craig Varnen – Co-Chair, Los Angeles (+1 213-229-7922, cvarnen@gibsondunn.com)
Shireen A. Barday – New York (+1 212-351-2621, sbarday@gibsondunn.com)
Jefferson Bell – New York (+1 212-351-2395, jbell@gibsondunn.com)
Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com)
Michael D. Celio – Palo Alto (+1 650-849-5326, mcelio@gibsondunn.com)
Paul J. Collins – Palo Alto (+1 650-849-5309, pcollins@gibsondunn.com)
Jennifer L. Conn – New York (+1 212-351-4086, jconn@gibsondunn.com)
Thad A. Davis – San Francisco (+1 415-393-8251, tadavis@gibsondunn.com)
Ethan Dettmer – San Francisco (+1 415-393-8292, edettmer@gibsondunn.com)
Mark A. Kirsch – New York (+1 212-351-2662, mkirsch@gibsondunn.com)
Jason J. Mendro – Washington, D.C. (+1 202-887-3726, jmendro@gibsondunn.com)
Alex Mircheff – Los Angeles (+1 213-229-7307, amircheff@gibsondunn.com)
Robert F. Serio – New York (+1 212-351-3917, rserio@gibsondunn.com)
Robert C. Walters – Dallas (+1 214-698-3114, rwalters@gibsondunn.com)
Avi Weitzman – New York (+1 212-351-2465, aweitzman@gibsondunn.com)

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Los Angeles of counsel Nathaniel L. Bach and associate Marissa M. Mulligan are the authors of “Ninth Circuit Unanimously Affirms First Amendment Protection for Rachel Maddow’s ‘Paid Russian Propaganda’ Commentary,” [PDF] published by MLRC MediaLawLetter in August 2021.

The UK’s Competition Appeal Tribunal (the CAT) has certified the first application for a collective proceedings order (CPO) on an opt-out basis in Walter Hugh Merricks CBE v Mastercard Incorporated & Ors.

In the UK, a CPO is pre-requisite for opt-out collective actions seeking damages for breaches of competition law. Opt-out means that an action can be pursued on behalf of a class of unnamed claimants who are deemed included in the action unless they have specifically opted out. Opt-out ‘US style’ class actions have the potential to be far more complex, expensive and burdensome than traditional named party litigation.

Opt-out class actions were introduced for the first time in the UK in 2015 (see our previous alert here). Almost six years on, last week’s judgment by the CAT is therefore an important procedural step towards the first opt-out class action damages award in the UK.

As had been expected, following the Supreme Court’s judgment in December 2020 (see our previous alert here) Mastercard did not resist certification outright. As a result, the CAT’s most recent judgment provides little further clarity on how the test set out in the Supreme Court’s judgment will be applied to future applications for a CPO. However, the CAT’s recent judgment did address certain interesting questions concerning suitability to act as a class representative, whether deceased persons could be included in the proposed class and the suitability of claims for compound interest. These are discussed in more detail below.

Background

In 2017, the CAT had originally refused to grant Mr. Merricks a CPO. However, in December 2020, in Merricks v Mastercard, the UK’s Supreme Court dismissed Mastercard’s appeal against the Court of Appeal’s judgment regarding the correct certification test and remitted the case back to the CAT for reconsideration. The judgment of the Supreme Court was of seminal importance because it provided much needed clarification as to the correct approach for the CAT to take when considering whether claims are suitable for collective proceedings (see our previous alert here).

Following the Supreme Court’s clarification, Mastercard no longer challenged eligibility for collective proceedings in the remitted proceedings before the CAT. However, the CAT was still required to consider: (i) the authorisation of Mr. Merricks as the class representative in light of developments since the CAT’s original judgment in 2017; (ii) whether Mr. Merricks was entitled to include deceased persons in the proposed class; and (iii) whether Mr. Merricks’ claim for compound interest was suitable to be brought in collective proceedings.

Although the CAT reaffirmed that Mr. Merricks was suitable to act as a class representative, it held that deceased persons could not be included in the proposed class and that the claim for compound interest was not suitable to brought in collective proceedings. Whilst this will significantly reduce the damages Mastercard will be required to pay should Mr. Merricks ultimately succeed at the substantive trial, the CAT’s judgment has still paved the way for what could be the largest award of damages in English legal history.

CAT Judgment (Walter Hugh Merricks CBE v MasterCard Incorporated & Ors [2021] CAT 28)

(i) Authorisation of the Class Representative

In relation to the suitability of Mr. Merricks to act as the class representative, two issues arose. The first related to written submissions filed by a proposed class member contending that it was not just and reasonable for Mr. Merricks to act as class representative as a result of Mr. Merricks’ handling of a historic complaint related to a property transaction involving the proposed class member. However, the CAT did not consider that this gave rise to any issue in terms of Mr. Merricks’ suitability to act as class representative.

The second related to the terms of a new litigation funding agreement (LFA) put in place by Mr. Merricks in order to document the replacement of the original funder following the CAT’s 2017 judgment. Here, the CAT made it clear that, even if no objections were raised about the terms of a LFA by a proposed defendant (i.e., Mastercard) “the Tribunal has responsibility to protect the interests of the members of the proposed class, and their interests are of course not necessarily aligned with the interests of Mastercard”.

The CAT therefore independently scrutinised the new LFA with particular focus on the provisions permitting the funder to terminate the new LFA where it ceases to be satisfied about the merits of the claims or believes that the proceedings are no longer commercially viable. The CAT was concerned that this gave the funder too broad a discretion to terminate and, during the course of the remitted hearing, it was agreed that the termination provisions would be amended to include a requirement that the funder’s views had to be based on independent legal and expert advice.

Mastercard’s only objection to the terms of the new LFA was that it had no rights to enforce the new LFA and, as such, Mastercard sought an undertaking from the funder to the CAT that it would discharge any adverse costs award that might be made against Mr. Merricks. The CAT agreed that such an undertaking should be given and directed the parties to agree the wording.

(ii) The Deceased Persons Issue

On remittal, Mr. Merricks wanted to include deceased persons within the proposed class definition and sought to amend the definition to include “persons who have since died”.

Whilst the CAT accepted that a class definition could include the representatives of the estates of deceased persons, section 47B of the Competition Act 1998 did not permit claims to be brought by deceased persons in their own right (as Mr. Merricks’ proposed amendment was seeking to do). In any event, the Tribunal held that Mr. Merricks’ application to amend the proposed class definition was not permissible as the limitation period had already expired.

(iii) The Compound Interest Issue

A claim for compound interest had been included in the Claim Form from the outset. It was alleged by Mr. Merricks that all class members will either have incurred borrowings or financing costs to fund the overcharge they suffered or have lost interest that they would otherwise have earned through deposit or investment of the overcharge, or some combination of the two.

The CAT held that the Canadian jurisprudence in relation to certification had been explicitly recognised by the Supreme Court in the context of the UK regime. As such, a “plausible or credible” methodology for calculating loss had to be put forward at the certification stage in order for a claim to be suitable for collective proceedings. In the case of Mr. Merricks’ claim for compound interest, the CAT held that no credible or plausible methodology had been put forward by Mr. Merricks to arrive at any estimate of the extent of the overcharge that would have been saved or used to reduce borrowings rather than spent, which is the essential basis for a claim to compound interest.

Comment

The CAT’s judgment in Merricks is significant because it is the first class action to be certified on an opt-out basis since the current regime was introduced in 2015.

The CAT’s approach to Mr. Merricks’ claim for compound interest and the requirement for a “plausible or credible” methodology is of particular interest in circumstances where the Supreme Court made it clear that there is only a very limited role for the application of a merits test at the certification stage.

The UK was comparatively slow to introduce a regime for opt-out proceedings in relation to competition law infringements and, since its introduction in 2015, the regime itself has taken some time to find its feet. But momentum has been building and there are now a large number of high value opt-out CPO applications awaiting determination by the CAT covering both follow-on claims and standalone claims. In the next few months, a number of judgments are expected in relation to applications that had been stayed pending the Supreme Court’s judgment in Merricks. These will not only provide greater clarity on the application of the Supreme Court’s judgment but also answer questions that, to date, have not been considered by the CAT. These include, for example, how a carriage dispute between two competing proposed class representatives should be resolved. There will also be significant attention paid to the procedures adopted by the CAT as Mr. Merricks’ claim progresses now that it moves beyond the certification stage.

It is increasingly clear that companies operating in the UK are now at greater risk of facing ‘US style’ class actions for breaches of competition law. In addition, for non-competition claims that fall outside the regime introduced in 2015, parallel developments in the courts raise the possibility of complex group actions. For example, in relation to alleged breaches of data protection laws, the highly anticipated Supreme Court judgment in Lloyd v Google LLC (expected in Autumn) will provide guidance on the potential for representative actions to proceed in England and Wales.

Gibson Dunn is currently instructed on a number of the largest CPO applications currently being heard by the CAT and is deeply familiar with navigating this developing regime.

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, any member of the firm’s Antitrust and Competition practice group, or the following authors in London and Brussels:

Ali Nikpay (+44 (0) 20 7071 4273, anikpay@gibsondunn.com)
Doug Watson (+44 (0) 20 7071 4217, dwatson@gibsondunn.com)
Mairi McMartin (+32 2 554 72 29, MMcMartin@gibsondunn.com)
Dan Warner (+44 (0) 20 7071 4213, dwarner@gibsondunn.com)

UK Competition Litigation Group:
Philip Rocher (+44 (0) 20 7071 4202, procher@gibsondunn.com)
Allan Neil (+44 (0) 20 7071 4296, aneil@gibsondunn.com)
Patrick Doris (+44 (0) 20 7071 4276, pdoris@gibsondunn.com)
Susy Bullock (+44 (0) 20 7071 4283, sbullock@gibsondunn.com)
Deirdre Taylor (+44 (0) 20 7071 4274, dtaylor2@gibsondunn.com)
Gail Elman (+44 (0) 20 7071 4293, gelman@gibsondunn.com)
Camilla Hopkins (+44 (0) 20 7071 4076, chopkins@gibsondunn.com)
Kirsty Everley (+44 (0) 20 7071 4043, keverley@gibsondunn.com)

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On August 19, 2021, the New York Stock Exchange (“NYSE”) proposed an amendment to Section 314.00 of the NYSE Listed Company Manual (the “NYSE Manual”), the NYSE’s related party transaction approval rule. The proposal follows the NYSE’s recent amendments to Section 314.00, approved by the Securities and Exchange Commission (the “SEC”) on April 2, 2021, which had amended the rules to, among other things, require “reasonable prior review and oversight” of related party transactions and had defined related party transactions (for companies other than foreign private issuers) to be those subject to Item 404 of the SEC’s Regulation S-K, but “without applying the transaction threshold of that provision.” For foreign private issuers, the previous amendments had defined related party transactions to be those subject to disclosure under Form 20-F, but “without regard to the materiality threshold of that provision.” As a result of those amendments, NYSE-listed companies were faced with the prospect of potentially presenting immaterial transactions, or transactions in which related parties’ interests were immaterial, before their independent directors for approval.

In its latest proposal, the NYSE noted that the prior amendment had been intended to “provide greater clarity as to the types of transactions that were specifically subject to review and approval under the rule” but that “[i]n the period since the adoption of that amendment, it has become clear to the Exchange that the amended rule’s exclusion of the applicable transaction value and materiality thresholds is inconsistent with the historical practice of many listed companies, and has had unintended consequences.” As such, the NYSE’s latest amendments to Section 314.00 “provide that the review and approval requirement of that rule will be applicable only to transactions that are required to be disclosed after taking into account the transaction value and materiality thresholds set forth in Item 404 of Regulation S-K or Item 7.B of Form 20-F, respectively, as applicable.” Notably, Item 404 of Regulation S-K only requires disclosure of transactions where the amount involved is greater than $120,000 and in which the related person “had or will have a direct or indirect material interest” in the transaction. The notes to Item 404 also contain various other exclusions.

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The following Gibson Dunn attorneys assisted in preparing this update: Elizabeth Ising, Ronald Mueller, Cassandra Tillinghast, and Lori Zyskowski.

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On August 16, 2021, the U.S. Securities and Exchange Commission announced a settled enforcement action against Pearson plc, a U.K. educational publisher, for inadequate disclosure of a cyber intrusion. According to the settlement, following a cyberattack, which the SEC deemed to be material, Pearson failed to revise its periodic cybersecurity risk disclosure to reflect that it had experienced a material data breach. In addition, in a subsequent media statement, Pearson misstated the significance of the breach by minimizing its scope and overstating the strength of the company’s security measures. The settlement, in which Pearson agreed to pay a $1 million penalty, is the latest indication of the SEC’s continuing focus on cyber disclosures as an enforcement priority and an important signal to public companies that, particularly in the face of an environment of increasing cyberattacks, accurate public disclosure about cyber events and data privacy is critical. The SEC action also underscores the importance, as part of an overall cyber-incident response, of carefully making materiality judgments.

According to the SEC Order,[1] Pearson learned in March 2019 that a sophisticated attacker took advantage of a vulnerability in software that Pearson provided to 13,000 school, district, and university accounts to access and download user names and passwords that were protected with an outdated algorithm as well as more than 11 million rows of student data that included names, dates of birth, and email addresses. The software manufacturer had publicized the existence of the vulnerability in September 2018 and made a patch available at that time; however, Pearson did not install the patch until after learning about the breach in March 2019. Also, at that time, Pearson conducted an internal investigation and began notifying impacted customers in July 2019.

According to the SEC Order, Pearson determined that it was not necessary to issue a public disclosure of the incident. The company’s next report on Form 6-K contained the same data security risk disclosure that it had used in previous reports, stating that there was a “[r]isk” that “a data privacy incident or other failure to comply with data privacy regulations and standards and/or a weakness in information security, including a failure to prevent or detect a malicious attack on our systems, could result in a major data privacy or confidentiality breach causing damage to the customer experience and our reputational damage, a breach of regulations and financial loss” (emphasis added). Consistent with its past position that companies should not discuss risks as hypothetical if they have already materialized or are materializing,[2] the SEC viewed this statement as implying that no “major data privacy or confidentiality breach” had occurred, and determined it was therefore misleading.

A few days after it filed this Form 6-K, a journalist asked Pearson about the data breach. In response, Pearson provided a statement, which it later posted on its website, that the SEC also described as misleading. According to the SEC Order, the statement had been prepared months earlier and failed to disclose that the attacker had extracted data, not just accessed it; understated what types of data were taken; suggested that it was uncertain whether data had been taken, whereas Pearson by that time allegedly knew exactly what data had been extracted; did not state how many rows of data were involved; and stated that Pearson had “strict data protections” and had patched the vulnerability, even though Pearson had waited months to install the patch and had relied upon outdated software to encrypt passwords.

As a result of the foregoing statements, the SEC Order states that Pearson violated Sections 17(a)(2) and (a)(3) of the Securities Act, provisions which prohibit misleading statements or omissions in the context of a securities offering,[3] as well Section 13(a) of the Exchange Act. The SEC Order also finds that the conduct demonstrated that Pearson failed to maintain adequate disclosure controls and procedures in violation of Exchange Act Rule 13a-15(a).

The Pearson settlement reflects a number of instructive points. First, this settlement demonstrates the importance of carefully assessing the materiality of a cyberattack. Here, the SEC determined that the data breach was material based on, among other things, the company’s business and its user base, the nature and volume of the data exfiltrated, and the importance of data security to the company’s reputation, as reflected in the company’s existing risk disclosures. However, the order does not assert that there was any adverse impact on Pearson’s business as a result of the incident. In fact, Pearson’s subsequent filings on Form 20-F expressly stated that prior attacks “have not resulted in any material damage” to the business. Consulting with counsel in making materiality assessments can help mitigate the risk of the government second-guessing materiality judgments in hindsight. Second, this is the third recent enforcement case that the SEC has brought based on disclosures contained in reports that are “furnished,” not “filed” with the SEC and in media statements.[4] Third, this is the second enforcement case in which the SEC has found that a company’s disclosures regarding a cybersecurity incident reflected inadequate disclosure controls and procedures.[5] Collectively, these cases reiterate that the SEC is intensely focused on cybersecurity disclosure issues, that public companies should be mindful of SEC disclosure considerations when responding to or publicly commenting on a cybersecurity issue, and that companies should ensure that their disclosure controls and procedures appropriately support their cybersecurity response plans.

The Pearson settlement is the latest — and likely not the last — SEC cyber disclosure enforcement action. The SEC Enforcement Division has also taken an expansive look into cyber disclosures with a sweep related to how companies responded to the widely reported SolarWinds breach, where foreign hackers believed to be tied to Russia used SolarWinds’ software to breach numerous companies and government agencies.[6] The agency asked companies it believed were impacted to voluntarily furnish information about the attack, and offered immunity, under certain conditions, for potential disclosure failings.[7]

In addition, although SEC interpretive guidance on cybersecurity disclosures was issued in 2018,[8] additional disclosure rulemaking appears likely. According to the Unified Agenda of Regulatory and Deregulatory Actions (“Reg Flex Agenda”) made available in June 2021, the first reflecting Chair Gary Gensler’s agenda,[9] the SEC is considering whether to propose new rules to enhance issuer disclosure on “cybersecurity risk governance.”[10]

The possible new proposed rulemaking project and the increasing enforcement efforts are a clear signal of the SEC’s continuing focus on accurate cybersecurity disclosures and robust disclosure controls and procedures around cybersecurity. The recent increase in cyberattacks contributes to the focus, as does the apparent perception of a risk that companies may under-report data security incidents. The Pearson enforcement action makes plain that a company’s disclosure about the possible risk of a data breach will likely be insufficient — and even be viewed as misleading — if the company has in fact suffered a cyber breach that the SEC deems to be material. Moreover, the SEC’s actions reinforce the importance of having strong disclosure controls and procedures so that full information about data breaches and vulnerabilities are communicated to those making decisions about disclosures.

____________________

[1] In re Pearson plc, Release No. 33-10963 (Aug. 16, 2021), https://www.sec.gov/litigation/admin/2021/33-10963.pdf.

[2] See Gibson, Dunn & Crutcher, “Considerations For Preparing Your 2019 Form 10-K” (Jan. 13, 2020), https://www.gibsondunn.com/considerations-for-preparing-your-2019-form-10-k; Gibson, Dunn & Crutcher, “Considerations For Preparing Your 2020 Form 10-K” (Feb. 3, 2021), https://www.gibsondunn.com/considerations-for-preparing-your-2020-form-10-k.

[3] These violations, which the SEC Order notes do not require a showing of intent, appear to be premised on the fact that Pearson had employee benefit plan equity offerings on-going that were registered on a Form S-8.

[4] See also In re First American Financial Corp., Release No. 34-92176 (June 14, 2021), https://www.sec.gov/litigation/admin/2021/34-92176.pdf; The Cheesecake Factory Incorporated, Release No. 34-90565 (Dec. 4, 2020), https://www.sec.gov/litigation/admin/2020/34-90565.pdf (disclosure involved two “furnished” Form 8-Ks).

[5] In re First American Financial Corp., Release No. 34-92176 (June 14, 2021), https://www.sec.gov/litigation/admin/2021/34-92176.pdf. In the First American Financial Corp. case, the SEC Order alleged that company executives did not have full information about a cybersecurity vulnerability when the company issued a statement to a reporter and furnished a voluntary Form 8-K addressing the situation. Id.

[6] Katanga Johnson, “U.S. SEC probing SolarWinds clients over cyber breach disclosures -sources,” Reuters (June 22, 2021), https://www.reuters.com/technology/us-sec-official-says-agency-has-begun-probe-cyber-breach-by-solarwinds-2021-06-21.

[7] In the Matter of Certain Cybersecurity-Related Events (HO-14225) FAQs, U.S. Sec. & Exch. Comm’n, https://www.sec.gov/enforce/certain-cybersecurity-related-events-faqs (last modified June 25, 2021).

[8] Commission Statement and Guidance on Public Company Cybersecurity Disclosures, 83 Fed. Reg. 8166 (Feb. 26, 2018), https://www.govinfo.gov/content/pkg/FR-2018-02-26/pdf/2018-03858.pdf.

[9] Press Release, U.S. Sec. & Exch. Comm’n, SEC Announces Annual Regulatory Agenda (June 11, 2021), https://www.sec.gov/news/press-release/2021-99.

[10] See Gibson, Dunn & Crutcher, “Back to the Future: SEC Chair Announces Spring 2021 Reg Flex Agenda” (June 21, 2021), https://www.gibsondunn.com/back-to-the-future-sec-chair-announces-spring-2021-reg-flex-agenda.

This alert was prepared by Alexander H. Southwell, Mark K. Schonfeld, Lori Zyskowski, Thomas J. Kim, Ron Mueller, Eric M. Hornbeck, and Terry Wong.

Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Privacy, Cybersecurity and Data Innovation, Securities Regulation and Corporate Governance, and Securities Enforcement practice groups, or the following authors:

Alexander H. Southwell – New York (+1 212-351-3981, asouthwell@gibsondunn.com)
Mark K. Schonfeld – New York (+1 212-351-2433, mschonfeld@gibsondunn.com)
Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Eric M. Hornbeck – New York (+1 212-351-5279, ehornbeck@gibsondunn.com)

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 of key class action developments during the second quarter of 2021. Part I covers TransUnion v. Ramirez, 141 S. Ct. 2190 (2021), an important decision from the Supreme Court about Article III standing and its application to damages class actions. Significantly, the Supreme Court for the first time held that all class members seeking to recover damages must have Article III standing. Part II reports on developments in a closely watched Ninth Circuit appeal that also concerns the application of Article III standing in putative class actions.

I. The Supreme Court Issues Important Ruling on the Application of Article III Standing to Damages Class Actions in TransUnion v. Ramirez

In the years since Spokeo, Inc. v. Robins, 578 U. S. 330 (2016), the courts of appeals have wrestled with applying Article III standing principles to putative class actions. On June 25, 2021, the Supreme Court revisited the issue of Article III standing for the first time since Spokeo. In TransUnion LLC v. Ramirez, 141 S. Ct. 2190 (2021), the Court reversed a judgment on the claims of more than 6,000 class members whose internal credit reports contained inaccuracies that were never published to any third parties. In so holding, the Court clarified an issue left ambiguous in Spokeo: whether the violation of a federal statute, standing alone, confers Article III standing. The Court held that it does not. If a plaintiff does not suffer a real harm and the risk of future harm never materializes, there is no concrete injury and thus no standing to assert a damages claim. And importantly, the Court held that “every class member”—not just the named plaintiff—is required to meet this standard in order to recover individual damages.

As covered in a previous update, Ramirez concerned a jury verdict awarding $60 million in damages to a class of over 8,000 consumers. The plaintiff alleged that TransUnion violated the Fair Credit Reporting Act (“FCRA”) by inaccurately labelling him and his fellow class members as potential terrorists, drug traffickers, and other threats to national security on their consumer credit reports. The Ninth Circuit noted that “each member of a class certified under Rule 23 must satisfy the bare minimum of Article III standing at the final judgment stage of a class action in order to recover monetary damages in federal court,” but it found that each of the 8,185 class members had done so. 951 F.3d 1008, 1023 (9th Cir. 2020). Even though 75% of the class never had an inaccurate credit report disseminated to any third party, the Ninth Circuit ruled that each class member had standing because they were subjected to a real risk of harm to their privacy, reputational, and informational interests protected by the FCRA. Id. at 1027.

The Supreme Court, in a 5-4 decision, reversed. The core of the Court’s ruling was premised on the straightforward Article III principle: “No concrete harm, no standing.” 141 S. Ct. at 2200. The Court explained that under Spokeo, each class member must have suffered a “concrete” harm bearing a “close relationship” to traditional harms—like physical injury, monetary injury, or intangible injuries like damage to reputation—to have standing. Id. And even though “Congress may create causes of action for plaintiffs to sue defendants who violate . . . legal prohibitions or obligations,” “an injury in law is not an injury in fact.” Id. at 2205. Thus, only those class members whose inaccurate credit reports were actually provided to third parties had Article III standing to pursue the FCRA claim. Id. at 2209–10. By contrast, the remaining 75% of class members, “whose credit reports were not provided to third-party businesses,” did not have Article III standing because the “mere existence of inaccurate information” does not constitute a “concrete injury.” Id. at 2209. The Court left it to the Ninth Circuit to “consider in the first instance whether class certification is appropriate in light of [the] conclusion about standing.” Id. at 2214.

Although the Court’s decision clarifies the Article III standard, and confirms that all class members seeking damages must satisfy it, the decision still left unresolved the question “whether every class member must demonstrate standing before a court certifies a class,” id. at 2208 n.4 (emphasis added), and whether the lead plaintiff’s claims were typical of those of the class, id. at 2216 n.1. As a practical matter, it makes little sense for either party to defer this question until after class certification, because time and resources spent litigating a faulty class action benefits no one. At minimum, the issue of how Article III standing can be proven in a class trial should be part of the Rule 23 calculus. But we expect that in the coming months, the lower courts will grapple with these important issues as they seek to apply TransUnion.

II. The Ninth Circuit Grants Rehearing En Banc in Olean v. Bumble Bee Foods

As we discussed in our First-Quarter 2021 Update, the Ninth Circuit issued an important decision in April 2021 in Olean Wholesale Grocery Cooperative, Inc. v. Bumble Bee Foods LLC, 993 F.3d 774 (9th Cir. 2021), concerning the standards for establishing predominance in putative class actions under Rule 23(b)(3). In a 2-1 decision, the court held that even though plaintiffs may establish predominance using statistical evidence, district courts must still scrutinize the reliability of that evidence before certifying a class. Id. at 791. Additionally, the court stated that the inclusion of uninjured individuals in a class “must be de minimis,” and suggested “that 5% to 6% constitutes the outer limits of a de minimis number.” Id. at 792-93. Consistent with the Supreme Court’s subsequent holding in TransUnion, the court also acknowledged that the presence of uninjured class members presented “serious standing implications under Article III,” but did not reach the issue because class certification failed under Rule 23(b)(3). Id. at 792 n.7.

On August 3, 2021, the Ninth Circuit vacated this split-panel decision and agreed to rehear the matter en banc. 5 F.4th 950 (9th Cir. 2021). Although the court’s order did not specify the issues the court will consider, it will likely provide guidance on the interplay between Article III and Rule 23 in the wake of the Supreme Court’s decision in TransUnion, and potentially address whether Rule 23(b)(3) requires a district court to find that no more than a “de minimis” number of class members are uninjured before certifying a class.

The following Gibson Dunn lawyers contributed to this client update: Christopher Chorba, Kahn Scolnick, Bradley Hamburger, Lauren Blas, Jennafer Tryck, Wesley Sze, and Lauren Fischer.

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

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Climate change matters and related calls for regulation are in headlines daily. On August 9, 2021, the UN’s Intergovernmental Panel on Climate Change (IPCC) published the first major international assessment of climate-change research since 2013. The IPCC report will inform negotiations at the 2021 UN Climate Change Conference, also known as COP26, beginning on October 31, 2021 in Glasgow.

Chair Gary Gensler of the Securities and Exchange Commission (SEC) has made climate change headlines of his own in recent weeks. On July 16, 2021, Chair Gensler appointed Mika Morse to the newly created role of Climate Counsel on his policy staff, further demonstrating the importance of climate policy to the SEC’s agenda. In addition, the Reg Flex Agenda includes “Climate Change Disclosure” – whether to “propose rule amendments to enhance registrant disclosures regarding issuers’ climate-related risks and opportunities.” (See our client alert on the Reg Flex Agenda here.) Chair Gensler has also been very active on Twitter. On July 28, 2021, he posted a video on his Twitter feed addressing the question: “What does the SEC have to do with climate?”

In prepared remarks at the Principles for Responsible Investment “Climate and Global Financial Markets” webinar later that same day, Chair Gensler shared that he has “asked SEC staff to develop a mandatory climate risk disclosure rule proposal for the Commission’s consideration by the end of the year,” and offered detailed insights into potential elements of that rulemaking. Chair Gensler’s remarks began, like many conversations this summer, with a reference to the Olympics. Drawing a connection between the games and public company disclosure, he contended having clear rules to judge performance is critical in both forums. Taking the analogy further, Chair Gensler observed the events competed in at the Olympics, as well as who can compete in them, have evolved substantially since the first modern games in 1896. Likewise, he suggested, the categories of information investors require to make an informed investment decision also evolve over time and that the framework for public company disclosure must take appropriate steps to modernize.

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The following Gibson Dunn attorneys assisted in preparing this update: Hillary Holmes, Elizabeth Ising, Lori Zyskowski, and Patrick Cowherd.

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Washington, D.C. partner Adam M. Smith is the author of “The Humanitarian and Policy Challenges of U.S. Sanctions on the Taliban,” [PDF] published by Just Security on August 23, 2021.

On August 18, 2021, EPA released a final rule revoking tolerances for chlorpyrifos residues on food.[1] EPA took this action to “stop the use of the pesticide chlorpyrifos on all food to better protect human health, particularly that of children and farmworkers.”[2] The agency will also issue a Notice of Intent to Cancel under the Federal Insecticide, Fungicide, and Rodenticide Act to cancel registered food uses of the chemical associated with the revoked tolerances.

Chlorpyrifos is an “insecticide, acaricide and miticide used primarily to control foliage and soil-borne pests,” in a large variety of agricultural crops, including soybeans, fruit and nut trees, and other row crops.[3] EPA sets “tolerances,” which represent “the maximum amount of a pesticide allowed to remain in or on a food.”[4] Under the Federal Food, Drug, and Cosmetic Act (FFDCA), EPA “shall modify or revoke a tolerance if the Administrator determines it is not safe.”[5]

Yesterday’s revocation follows a recent order from the U.S. Court of Appeals for the Ninth Circuit instructing EPA to issue a final rule in response to a 2007 petition filed by the Pesticide Action Network North America and Natural Resources Defense Council requesting that EPA revoke all chlorpyrifos tolerances on the grounds that they were unsafe.[6] EPA previously responded to and denied the original petition and subsequent objections to its denial. A coalition of farmworker, environmental, health, and other interest groups then challenged the denials in court.[7] In April 2021, a split panel of the Ninth Circuit ruled that EPA’s failure either to make the requisite safety findings under the FFDCA or issue a final rule revoking chlorpyrifos tolerances was “in derogation of the statutory mandate to ban pesticides that have not been proven safe,” and ordered the agency to grant the 2007 petition, issue a final rule either revoking the tolerances or modifying them with a supporting safety determination, and cancel or modify the associated food-use registrations of chlorpyrifos.[8]

In response, EPA has granted the 2007 petition and issued a final rule that revokes all chlorpyrifos tolerances listed in 40 CFR 180.342.[9] In issuing this rule, EPA noted that, based on currently available information, it “cannot make a safety finding to support leaving the current tolerances” in place.[10] The final rule becomes effective 60 days after publication in the Federal Register, and the revocation of tolerances becomes effective six months thereafter.

EPA indicated it followed the Ninth Circuit’s instruction by issuing the rule under section 408(d)(4)(A)(i) of the FFDCA, which allows issuance of a final rule “without further notice and without further period for public comment.”[11] EPA indicated its intent to review comments on the previously issued proposed interim decision, draft revised human health risk assessment, and draft ecological risk assessment for chlorpyrifos.[12] The Agency also intends to review registrations for the remaining non-food uses of the chemical.[13]

Prior to EPA’s action, certain states including Hawaii, New York, and Oregon had restricted the sale or use of the pesticide.[14] California prohibited the sale, possession, and use of chlorpyrifos for nearly all uses by the end of 2020.[15]

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[1] U.S. EPA, Pre-Publication Notice of Final Rule re Chlorpyrifos (Aug. 18, 2021), https://www.epa.gov/system/files/documents/2021-08/pre-pub-5993-04-ocspp-fr_2021-08-18.pdf.

[2] U.S. EPA, News Releases from Headquarters, EPA Takes Action to Address Risk from Chlorpyrifos and Protect Children’s Health (Aug. 18, 2021), https://www.epa.gov/newsreleases/epa-takes-action-address-risk-chlorpyrifos-and-protect-childrens-health.

[3] https://www.epa.gov/ingredients-used-pesticide-products/chlorpyrifos.

[4] U.S. EPA, Regulation of Pesticide Residues on Food, https://www.epa.gov/pesticide-tolerances.

[5] See 21 U.S.C. § 346a(b)(2)(a)(i) (EPA “may establish or leave in effect a tolerance for a pesticide chemical residue in or on a food only if the Administrator determines that the tolerances is safe.”).

[6] Pre-Publication Notice of Final Rule re Chlorpyrifos at 6–7; League of United Latin Am. Citizens v. Regan, 996 F.3d 673 (9th Cir. 2021).

[7] Pre-Publication Notice of Final Rule re Chlorpyrifos at 7.

[8] League of United Latin Am. Citizens, 996 F.3d at 667, 703–04.

[9] Pre-Publication Notice of Final Rule re Chlorpyrifos at 8.

[10] Id.

[11] League of United Latin Am. Citizens, 996 F.3d at 702; 21 U.S.C. § 346a(d)(4)(A)(1).

[12] U.S. EPA, EPA Takes Action to Address Risk from Chlorpyrifos and Protect Children’s Health.

[13] Id.

[14] See Haw. S.B.3095 (Relating to Environmental Protection) (2018); N.Y. Dep’t of Environ. Conservation, Chlorpyrifos Pesticide Registration Cancellations and Adopted Regulation, https://www.dec.ny.gov/chemical/122311.html; O.A.R. 603-057-0545 (Permanent Chlorpyrifos Rule) (Dec. 15, 2020), available here.

[15] Cal. Dep’t of Pesticide Regulation, Chlorpyrifos Cancelation https://www.cdpr.ca.gov/docs/chlorpyrifos/index.htm.

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 authors:

Abbey Hudson – Los Angeles (+1 213-229-7954, ahudson@gibsondunn.com)
David Fotouhi – Washington, D.C. (+1 202-955-8502, dfotouhi@gibsondunn.com)
Joseph D. Edmonds – Orange County (+1 949-451-4053, jedmonds@gibsondunn.com)
Jessica M. Pearigen – Orange County (+1 949-451-3819, jpearigen@gibsondunn.com)

Please also feel free to contact the following practice group leaders:

Environmental Litigation and Mass Tort Group:
Stacie B. Fletcher – Washington, D.C. (+1 202-887-3627, sfletcher@gibsondunn.com)
Daniel W. Nelson – Washington, D.C. (+1 202-887-3687, dnelson@gibsondunn.com)

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 overview of shareholder proposals submitted to public companies during the 2021 proxy season, including statistics and notable decisions from the staff (the “Staff”) of the Securities and Exchange Commission (the “SEC”) on no-action requests.

I. Top Shareholder Proposal Takeaways from the 2021 Proxy Season

As discussed in further detail below, based on the results of the 2021 proxy season, there are several key takeaways to consider for the coming year:

Shareholder proposal submissions rose significantly. After trending downwards since 2016, the number of proposals submitted increased significantly by 11% from 2020 to 802.
The number of social and environmental proposals also significantly increased, collectively overtaking governance proposals as the most common. Social and environmental proposals increased notably, up 37% and 13%, respectively, from 2020. In contrast, governance proposals remained steady in 2021 compared to 2020 and represented 36% of proposals submitted in 2021. Executive compensation proposal submissions also declined in 2021, down 13% from the number of such proposals submitted in 2020. The five most popular proposal topics in 2021, representing 46% of all shareholder proposal submissions, were (i) anti-discrimination and diversity, (ii) climate change, (iii) written consent, (iv) independent chair, and (v) special meetings.
Overall no-action request success rates held steady, but the number of Staff response letters declined significantly. The number of no-action requests submitted to the Staff during the 2021 proxy season increased significantly, up 18% from 2020 and 19% from 2019. The overall success rate for no-action requests held steady at 71%, driven primarily by procedural, ordinary business, and substantial implementation arguments. However, the ongoing shift in the Staff’s practice away from providing written response letters to companies, preferring instead to note the Staff’s response to no-action requests in a brief chart format, resulted in significantly fewer written explanations, with the Staff providing response letters only 5% of the time, compared to 18% in 2020.
Company success rates using a board analysis during this proxy season rose modestly, while inclusion of a board analysis generally remained infrequent. Fewer companies included a board analysis during this proxy season (down from 19 and 25 in 2020 and 2019, respectively, to 16 in 2021), representing only 18% of all ordinary business and economic relevance arguments in 2021. However, those that included a board analysis had greater success in 2021 compared to 2020, with the Staff concurring with the exclusion of five proposals this year where the company provided a board analysis, compared to four proposals in 2020 and just one proposal in 2019.
Withdrawals increased significantly. The overall percentage of proposals withdrawn increased significantly to the highest level in recent years. Over 29% of shareholder proposals were withdrawn this season, compared to less than 15% in 2020. This increase is largely attributable to the withdrawal rates of both social and environmental proposals, which rose markedly in 2021 compared to 2020 (increasing to 46% and 62%, respectively).
Overall voting support increased, including average support for social and environmental proposals. Average support for all shareholder proposals voted on was 36.2% in 2021, up from the 31.3% average in 2020 and 32.8% average in 2019. In 2021, environmental proposals overtook governance proposals to receive the highest average support at 42.3%, up from 29.2% in 2020. Support for social (non-environmental) proposals also increased significantly to 30.6%, up from 21.5% in 2020—driven primarily by a greater number of diversity-related proposals voted on with increased average levels of support. Governance proposals received 40.2% support in 2021, up from 35.3% in 2020. This year also saw a double-digit increase in the number of shareholder proposals that received majority support (74 in total, up from 50 in 2020), with an increasing number of such proposals focused on issues other than traditional governance topics.
Fewer proponents submitted proposals despite the increase in the number of proposals. The number of shareholders submitting proposals declined this year, with approximately 276 proponents submitting proposals (compared to more than 300 in both 2020 and 2019). Approximately 41% of proposals were submitted by individuals and 21% were submitted by the most active socially responsible investor proponents. As in prior years, John Chevedden and his associates were the most frequent proponents (filing 31% of all proposals in 2021 and accounting for 75% of proposals submitted by individuals). This year also saw the continued downward trend in five or more co-filers submitting proposals—down to 35 in 2021, from 54 in 2020 and 58 in 2019.
Proponents continued to use exempt solicitations. Exempt solicitation filings continued to proliferate, with the number of filings reaching a record high again this year and increasing 30% over the last three years.
Amended Rule 14a-8 in Effect. With the amendments to Rule 14a-8 now in effect for meetings held after January 1, 2022, companies should revise their procedural reviews and update their deficiency notices accordingly. However, it remains to be seen whether the new rules will lead to a decrease in proponent eligibility or result in an increase in proposals eligible for procedural or substantive exclusion, based on the new ownership and resubmission thresholds. The SEC’s recently announced Reg Flex Agenda indicates that the SEC intends to revisit Rule 14a-8 as a new rulemaking item in the near term, putting into question the future of the September 2020 amendments.

Read More

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

Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Michael Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com)
Lori Zyskowski – New York, NY (+1 212-351-2309, lzyskowski@gibsondunn.com)
Aaron Briggs – San Francisco, CA (+1 415-393-8297, abriggs@gibsondunn.com)
Courtney Haseley – Washington, D.C. (+1 202-955-8213, chaseley@gibsondunn.com)
Julia Lapitskaya – New York, NY (+1 212-351-2354, jlapitskaya@gibsondunn.com)
Cassandra Tillinghast – Washington, D.C. (+1 202-887-3524, ctillinghast@gibsondunn.com)
Geoffrey E. Walter – Washington, D.C. (+1 202-887-3749, gwalter@gibsondunn.com)
David Korvin – Washington, D.C. (+1 202-887-3679, dkorvin@gibsondunn.com)

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Los Angeles partners Nicola T. Hanna and James L. Zelenay Jr. and associate Sean S. Twomey are the authors of “Surge in False Claims Act enforcement continues,” [PDF] published by the Daily Journal on August 13, 2021.

Decided August 12, 2021

Chrysafis v. Marks, No. 21A8

On Thursday, August 12, 2021, the Supreme Court granted Gibson Dunn’s request for an extraordinary writ of injunction pending appeal and held that New York State’s eviction moratorium law (“CEEFPA”)—which bars landlords from commencing or continuing eviction proceedings against any tenants who self-certify that they are suffering a COVID-related “hardship,” with no opportunity for property owners to challenge those hardship claims—is inconsistent with fundamental due process principles.

Background:
CEEFPA was enacted in December 2020 and extended in May 2021. The law prohibits New York property owners from filing eviction petitions, continuing pending eviction cases, or enforcing existing eviction warrants, even in cases initiated prior to the COVID 19 pandemic, if their tenants submit a “hardship declaration.” It also requires landlords to distribute these hardship declarations, along with government-drafted notices and government-curated lists of legal service providers, to their tenants.

On May 6, 2021, Pantelis Chrysafis, Betty S. Cohen, Brandie LaCasse, Mudan Shi, Feng Zhou, and the Rent Stabilization Association of NYC, Inc. (“Plaintiffs”), represented by Gibson Dunn partners Randy M. Mastro and Akiva Shapiro, filed suit in the U.S. District Court for the Eastern District of New York. Plaintiffs alleged that CEEFPA—which shuts them out of the housing courts without a hearing and compels them to convey government messages against their own wishes and interests—violates the Due Process Clause and the First Amendment.

Despite finding, after an evidentiary hearing, that Plaintiffs had adequately alleged irreparable harm, the district court declined to enter a preliminary injunction and dismissed the case on the merits. Among other things, the district court determined that CEEFPA did not implicate property owners’ procedural due process rights; that it only compelled commercial speech and was thus subject only to rational basis review; and that the government’s interest in combatting the pandemic outweighed the irreparable harm that Plaintiffs had demonstrated. A Second Circuit panel denied Plaintiffs’ motion for an emergency injunction pending appeal.

Issues:
1. Whether Plaintiffs’ constitutional challenge to CEEFPA was likely to succeed.

2. If so, whether the eviction moratorium should be enjoined on an emergency basis pending appeal.

Court’s Holding:
Yes and yes.

“[The moratorium] violates the Court’s longstanding teaching that ordinarily ‘no man can be a judge in his own case’ consistent with the Due Process Clause.”

Per Curiam Opinion of the Court

What It Means:

CEEFPA’s prohibitions on initiating eviction proceedings, prosecuting existing eviction cases, and enforcing existing eviction warrants—along with its requirement that landlords distribute hardship declarations to tenants—cannot be enforced during the pendency of appellate proceedings in the Second Circuit and, potentially, before the Supreme Court. Six Justices agreed that the challenged “scheme”—under which, “[i]f a tenant self-certifies financial hardship,” the moratorium “generally precludes a landlord from contesting that certification and denies the landlord a hearing”—“violates the Court’s longstanding teaching that ordinarily ‘no man can be a judge in his own case’ consistent with the Due Process Clause.” Slip. op. 1 (citation omitted). While the analogy to other state and federal COVID-19 eviction moratoria is not exact, the decision suggests that government actors cannot close the courthouse doors for any extended period of time to landlords seeking to protect their property rights by prosecuting eviction actions.
The majority effectively rejected the dissenting Justices’ arguments that emergency relief was unwarranted because, inter alia, CEEFPA is set to expire in a number of weeks and courts should defer to a state government’s pandemic-based defenses or justifications. See Slip. op. 3-4 (Breyer, J., dissenting). Moreover, even those dissenting Justices acknowledged “the hardship to New York landlords” that the eviction moratorium has caused, and they signaled that they might be inclined to grant a renewed application for emergency relief if the State were to extend the moratorium beyond its current expiration date of August 31. Slip. op. 4-5 (Breyer, J., dissenting).

The Court’s opinion is available here.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court. Please feel free to contact Randy M. Mastro (+1 212.351.3825, rmastro@gibsondunn.com), Akiva Shapiro (+1 212.351.3830, ashapiro@gibsondunn.com), or the following practice leaders:

Appellate and Constitutional Law Practice

Allyson N. Ho
+1 214.698.3233
aho@gibsondunn.com

Mark A. Perry
+1 202.887.3667
mperry@gibsondunn.com

On August 6, 2021, a divided Securities and Exchange Commission (the “SEC”) voted to approve new listing rules submitted by The Nasdaq Stock Market LLC (“Nasdaq”) to advance board diversity through a “comply or disclose” framework and enhance transparency of board diversity statistics (the “Final Rules”). The Final Rules continue the use of listing standards by Nasdaq and other securities exchanges to improve corporate governance at listed companies (e.g., requiring independent board committees) and reflect similar movement in the market (e.g., Goldman Sachs’s requirement to have at least two diverse directors, including one woman, on boards of companies it helps take public after July 1, 2021).

Overview

There are three key components of the Final Rules. Under the Final Rules, certain Nasdaq-listed companies are required to:

annually disclose aggregated statistical information about the board’s voluntary self-identified gender and racial characteristics and LGBTQ+ status in substantially the format set forth in new Nasdaq Rule 5606 (the “Board Diversity Matrix”)[1] for the current year and (after the first year of disclosure) the prior year (the “Board Diversity Disclosure Rule”); and
either include on their board of directors, or publicly disclose why their board does not include, a certain number (as discussed below) of “Diverse”[2] directors (the “Board Diversity Objective Rule”).

As discussed below, the compliance period for the Board Diversity Disclosure Rule begins in 2022, while the Final Rules take a tiered approach for the compliance period for the Board Diversity Objective Rule, which begins in 2023. These compliance periods are subject to certain phase-in-periods for companies newly listing on Nasdaq.

Third, the Final Rules provide for Nasdaq to offer certain listed companies access to a complimentary board recruiting service to help advance diversity on company boards (the “Board Recruiting Service Rule”). Companies that do not have a specified number of Diverse directors will have the opportunity to access “a network of board-ready diverse candidates” in order to help them meet the Board Diversity Objective Rule.[3]

Background and SEC Approval

Nasdaq first proposed these rules on December 1, 2020 (the “Proposed Rules”) as discussed in detail in our December client alert. On February 26, 2021, following the receipt of over 200 comment letters from Nasdaq-listed issuers, institutional investors, state and federal legislators, advocacy organizations and other parties, Nasdaq filed an amendment to the Proposed Rules, as well as a response letter to the SEC addressing the comments it received. While Nasdaq indicated that almost 85% of substantive comment letters supported the Proposed Rules, Nasdaq responded to concerns raised by commenters by: amending the Proposed Rules to provide more flexibility for boards with five or fewer directors; extending the compliance periods for newly listing Nasdaq companies; aligning the disclosure requirements with companies’ annual shareholder meetings; and adding a grace period for covered companies that fall out of compliance with applicable board diversity objectives. In its response letter, Nasdaq emphasized that the rules are not intended to impose a quota or numeric mandate on listed companies, as companies will have the choice to either meet the board diversity objectives or explain both their different approach and why it is appropriate for the company. Nasdaq also responded to commenter concerns that the Board Recruiting Service Rule could create a conflict of interest by emphasizing that companies are not required to use the complimentary recruiting service and, accordingly, Nasdaq will not penalize companies that do not utilize the service.

The SEC approved the Board Diversity Disclosure Rule and Board Objective Rule by a 3-2 party-line vote and approved the Board Recruiting Service Rule by a 4-1 vote, with only Commissioner Peirce voting against its approval.[4] The majority characterized the Final Rules as “improv[ing] the quality of information available to investors for making investment and voting decisions by providing consistent and comparable diversity metrics.”[5] As Chairman Gary Gensler explained, the Final Rules “reflect calls from investors for greater transparency about the people who lead public companies,” and will “allow investors to gain a better understanding of Nasdaq-listed companies’ approach to board diversity, while ensuring that those companies have the flexibility to make decisions that best serve their shareholders.”[6]

By contrast, Commissioners Peirce and Roisman expressed concern about the SEC’s approval of the Board Diversity Disclosure Rule and Board Diversity Objective Rule. Commissioner Roisman expressed concern that the SEC failed to “meet[] the legal standards that [it is] required to apply in evaluating rules proposed by self-regulatory organizations” and that approval of the Final Rules could result in the SEC “tak[ing] future action in which the agency must consider disclosure of the racial, ethnic, gender, or LGBTQ+ status of individual directors.”[7] Commissioner Peirce separately criticized the empirical evidence cited by Nasdaq in support of the proposed rule changes. She also argued that the Final Rules are outside of the scope of the SEC’s authority under the Securities Exchange Act of 1934, as amended, and “encourage discrimination and effectively compel speech by both individuals and issuers in a way that offends protected Constitutional interests.”[8]

Nasdaq’s Board Diversity Disclosure Rule

Under the Board Diversity Disclosure Rule, Nasdaq-listed companies, other than “Exempt Entities,”[9] are required to annually report aggregated statistical information about the Board’s self-identified gender and racial characteristics and self-identification as LGBTQ+ using the Board Diversity Matrix or in a substantially similar format. For the first year companies are required to provide only current year data, and in subsequent years companies must disclose data on both the current and prior year.

This statistical information must be provided in a searchable format (1) in the company’s proxy statement or information statement for its annual meeting of shareholders (“Proxy Materials”), (2) in an Annual Report on Form 10-K or Form 20-F (“Annual Report”), or (3) on the company’s website. If provided on its website, the company must also submit the disclosure to the Nasdaq Listing Center no later than 15 calendar days after the company’s annual shareholders meeting.

In addition to formatting and other non-substantive changes, the Final Rules reflect several changes to the matrix and related instructions initially included with the Proposed Rules.[10] The amended instructions also clarify that companies may include supplemental data in addition to the statistical information required in the Board Diversity Matrix. However, companies may not substantially alter the matrix. Nasdaq provides on its website examples of the Board Diversity Matrix and the alternative disclosure matrix for Foreign Issuers as well as examples of acceptable and unacceptable matrices.

Nasdaq’s Board Diversity Objective Rule

The Final Rules require most Nasdaq-listed companies, other than Exempt Entities and companies with boards consisting of five or fewer members (“Smaller Boards”), to:

have at least two self-identified “Diverse”[11] members of its board of directors; or
explain why the company does not have the minimum number of directors on its board who self-identify as “Diverse.”

Of the two self-identified Diverse directors, at least one director must self-identify as Female and at least one director must self-identify as an Underrepresented Minority and/or LGBTQ+.

In response to commenter concerns, the Board Diversity Objective Rule provides additional flexibility for listed companies with Smaller Boards. Specifically, Smaller Boards are required only to have at least one self-identified Diverse director. In addition, companies with Smaller Boards in place prior to becoming subject to the Board Diversity Objective Rule are permitted to add a sixth director who is Diverse in order to meet the one Diverse director requirement for Smaller Boards. However, if the company later increases its board to more than six members, it will become subject to the two Diverse director requirement.

Where a listed company determines instead to explain why it does not meet the applicable diversity objectives, Nasdaq emphasized that it will not evaluate the substance or merits of that explanation. However, companies must detail the reasons why they do not have the applicable number of Diverse directors instead of merely stating that they do not comply with the Board Diversity Objective Rule.

Compliance Periods

Under the Final Rules, the compliance periods for both the Board Diversity Disclosure Rule and the Board Diversity Objective Rule were extended.

Listed companies (other than newly listing companies) now must comply with the Board Diversity Disclosure Rule by the later of (1) August 6, 2022, or (2) the date the company files its Proxy Materials (or, if the company does not file Proxy Materials, the date it files its Annual Report) for the company’s annual shareholders meeting held during the 2022 calendar year.
Listed companies (other than newly listing companies) now must comply with the Board Diversity Objective Rule as follows:
- At Least One Diverse Director by 2023: A company listed on the Nasdaq Global Select Market, Nasdaq Global Market or Nasdaq Capital Market must have, or explain why it does not have, one Diverse director by the later of (1) August 6, 2023, or (2) the date the company files its Proxy Materials (or, if the company does not file Proxy Materials, the date it files its Annual Report) for the company’s annual shareholders meeting held during the 2023 calendar year.
- At Least Two Diverse Directors:
  - A company listed on the Nasdaq Global Select Market or Nasdaq Global Market with more than five directors must have, or explain why it does not have, at least two Diverse directors by the later of (1) August 6, 2025, or (2) the date the Company files its Proxy Materials (or, if the company does not file Proxy Materials, the date it files its Annual Report) for the company’s annual shareholders meeting held during the 2025 calendar year.
  - A company listed on the Nasdaq Capital Market with more than five directors must have, or explain why it does not have, at least two Diverse directors by the later of (1) August 6, 2026, or (2) the date the Company files its Proxy Materials (or, if the company does not file Proxy Materials, the date it files its Annual Report) for the company’s annual shareholders meeting held during the 2026 calendar year.

Phase-in Periods for Newly Listing Companies

Under the Final Rules, a company newly listing on Nasdaq will be subject to certain phase-in-periods for compliance with the Board Diversity Disclosure Rule and Board Diversity Objective Rule, as long as the company was not previously subject to a substantially similar requirement of another national securities exchange.

A company newly listing on Nasdaq must comply with the requirements of the Board Diversity Disclosure Rule within one year of its listing date.

For the Board Diversity Objective Rule, Nasdaq extended the phase-in period in response to comments. The Final Rules take a tiered approach based on the Nasdaq market on which the company is newly listing and the size of the company’s board:

A company newly listing on the Nasdaq Global Select Market or the Nasdaq Global Market must have or explain why it does not have:
- at least one Diverse director by the later of (a) one year from the listing date, or (b) the date the company files its Proxy Materials (or, if the company does not file Proxy Materials, its Annual Report) for the company’s first annual shareholders meeting after its listing; and
- at least two Diverse directors by the later of (a) two years from the listing date, or (b) the date the company files its Proxy Materials (or, if the company does not file Proxy Materials, its Annual Report) for the company’s second annual shareholders meeting after its listing.
A company newly listing on the Nasdaq Capital Market must have, or explain why it does not have, at least two Diverse directors by the later of (1) two years from the listing date, or (2) the date the company files its Proxy Materials (or, if the company does not file Proxy Materials, its Annual Report) for the company’s second annual shareholders meeting after its listing.
A company newly listing on the Nasdaq Global Select Market, Nasdaq Global Market or Nasdaq Capital Market with a Smaller Board must have, or explain why it does not have, at least one Diverse director by the later of (1) two years from the listing date, or (2) the date the company files its Proxy Materials (or, if the company does not file Proxy Materials, its Annual Report) for the company’s second annual shareholders meeting after its listing.

In addition, companies that cease to be a Foreign Issuer, a Smaller Reporting Company or an Exempt Entity will be permitted to satisfy the applicable requirements of the Board Diversity Objective Rule by the later of (1) one year from the date the company’s status changes, or (2) the date the company files its Proxy Materials (or, if the company does not file Proxy Materials, its Annual Report) during the calendar year following the date the company’s status changes.

Grace Period for Board Diversity Objective Rule

The Final Rules also provide a grace period for listed companies that fall out of compliance with the Board Diversity Objective Rule because of a board vacancy. In such a circumstance, a non-compliant company will have until the later of (1) one year from the date of the vacancy, or (2) the date the company files its Proxy Materials (or, if the company does not file Proxy Materials, its Annual Report) for its annual shareholder meeting in the calendar year after the year in which the vacancy occurs, to comply with the Board Diversity Objective Rule. During this period, the company is not required to explain why it is not compliant with the Board Diversity Objective Rule, and it may publicly disclose that it is relying on the board vacancy grace period.

Cure Period

If a listed company fails to comply with the Board Diversity Objective Rule, Nasdaq’s Listing Qualifications Department will notify the company that it has until the later of the company’s next annual shareholders meeting, or 180 days from the event that caused the deficiency, to cure the deficiency.

If a listed company fails to comply with the Board Diversity Disclosure Rule, it will have 45 days after notification of non-compliance by Nasdaq’s Listing Qualifications Department to submit a plan to regain compliance. Based on that plan, Nasdaq could provide the company with up to 180 days to regain compliance.

Practical Considerations

While Nasdaq-listed companies have some time to bring their boards into compliance with the Board Diversity Objective Rule, director recruitment is a time-consuming task that requires careful decision making. Accordingly, Nasdaq-listed companies and pre-IPO companies considering listing on Nasdaq should review the current composition of their boards in order to assess whether to make any changes in light of the Final Rules. Although both Nasdaq and the SEC have emphasized that the Final Rules do not impose a mandate on listed companies to have a certain number of Diverse directors, companies will need to carefully consider the disclosure requirements and potential investor reaction should they elect not to have the minimum number of Diverse directors required under the Board Diversity Objective Rule.

In addition, Nasdaq-listed companies should consider adding questions to their D&O questionnaires to elicit responses regarding the self-identified diversity characteristics required to be disclosed in the Board Diversity Matrix (as well as by other diversity requirements such as California’s two board diversity laws, which impose diversity quotas for women and underrepresented minorities for publicly held companies with principal executive offices in California). As noted above, the Final Rules indicate that companies may also include supplemental data on their directors’ diversity characteristics. Accordingly, companies should consider whether their D&O questionnaires should include questions about other diversity characteristics, such as a director’s military service, disability status, language and/or culture.

We note that the Final Rules may face legal challenges from activists and other interest groups that have characterized the rules’ requirements as inconsistent with the Constitution’s equal protection principles and the Civil Rights Act of 1964. State laws that mandate board representation for women and other communities are already being challenged in court. For example, in June the U.S. Court of Appeals for the Ninth Circuit revived a legal challenge to California’s board gender diversity law. In its reversal of the District Court’s dismissal for lack of standing, the Ninth Circuit held that the plaintiff “plausibly alleged that [California’s board diversity law] requires or encourages him to discriminate based on sex” and therefore has standing to challenge the law.[12] And in July the Alliance for Fair Board Recruitment, a Texas-based nonprofit that submitted comments opposing approval of the Final Rules, filed suit against the state of California over both of its board diversity laws. The organization argues that the quotas require California corporations to impermissibly discriminate based on sex and race in selecting their board members.

It also remains to be seen whether the New York Stock Exchange will follow Nasdaq’s lead and adopt its own board diversity rules. Nonetheless, the SEC’s approval of Nasdaq’s Final Rules is in keeping with increased market focus on board diversification. And, in light of statements made by the majority in its approval of the Final Rules, the SEC appears poised to take future action to support board diversity initiatives.[13]

Exhibit A

Board Disclosure Format

Board Diversity Matrix (As of [DATE])
Total Number of Directors	#
	Female	Male	Non-Binary	Did Not Disclose Gender
Part I: Gender Identity
Directors	#	#	#	#
Part II: Demographic Background
African American or Black	#	#	#	#
Alaskan Native or Native American	#	#	#	#
Asian	#	#	#	#
Hispanic or Latinx	#	#	#	#
Native Hawaiian or Pacific Islander	#	#	#	#
White	#	#	#	#
Two or More Races or Ethnicities	#	#	#	#
LGBTQ+	#
Did Not Disclose Demographic Background	#

Board Diversity Matrix (As of [DATE]) To be completed by Foreign Issuers (with principal executive offices outside of the U.S.) and Foreign Private Issuers
Country of Principal Executive Offices:	[Insert Country Name]
Foreign Private Issuer	Yes/No
Disclosure Prohibited Under Home Country Law	Yes/No
Total Number of Directors	#
	Female	Male	Non-Binary	Did Not Disclose Gender
Part I: Gender Identity
Directors	#	#	#	#
Part II: Demographic Background
Underrepresented Individual in Home Country Jurisdiction	#
LGBTQ+	#
Did Not Disclose Demographic Background	#

———

[1] The Board Diversity Matrix included in the Final Rules is reproduced as Exhibit A below and is also available at the Nasdaq Listing Center.

[2] Under the Final Rules, “Diverse” director means (1) a director who self-identifies her gender as female, without regard to the individual’s designated sex at birth (“Female”), (2) a director who self-identifies as one more or of: Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, or two or more races or ethnicities (“Underrepresented Minority”), and (3) lesbian, gay, bisexual, transgender or a member of the queer community (“LGBTQ+”).

[3] Nasdaq has provided a short primer on the Final Rules, which includes additional compliance information and related resources for listed companies.

[4] Although she voted against it, Commissioner Peirce indicated she did not object to the approval of the Board Recruiting Service Rule. See Commissioner Hester M. Peirce, “Statement on the Commission’s Order Approving Proposed Rule Changes, as Modified by Amendments No. 1, to Adopt Listing Rules Related to Board Diversity submitted by the Nasdaq Stock Market LLC” (Aug. 6, 2021) at note 3, available here.

[5] Commissioner Allison Herren Lee and Commissioner Caroline A. Crenshaw, “Statement on Nasdaq’s Diversity Proposal – A Positive First Step for Investors” (Aug. 6, 2021), available here.

[6] Chairman Gary Gensler, “Statement on the Commission’s Approval of Nasdaq’s Proposal for Disclosure about Board Diversity and Proposal for Board Recruiting Service” (Aug. 6, 2021), available here.

[7] Commissioner Elad L. Roisman, “Statement on the Commission’s Order Approving Exchange Rules Relating to Board Diversity” (Aug. 6, 2021), available here.

[8] Commissioner Hester M. Peirce, “Statement on the Commission’s Order Approving Proposed Rule Changes, as Modified by Amendments No. 1, to Adopt Listing Rules Related to Board Diversity submitted by the Nasdaq Stock Market LLC” (Aug. 6, 2021), available here.

[9] Under the Final Rules, “Exempt Entities” means: (1) acquisition companies; (2) asset-backed issuers and other passive issuers (as set forth in Rule 5615(a)(1)); (3) cooperatives (as set forth in Rule 5615(a)(2)); (4) limited partnerships (as set forth in Rule 5615(a)(4)); (5) management investment companies (as set forth in Rule 5615(a)(5)); (6) issuers of non-voting preferred securities, debt securities, and derivative securities (as set forth in Rule 5615(a)(6)) that do not have equity securities listed on the Exchange; and (7) issuers of securities listed under the Rule 5700 series.

[10] The Board Diversity Matrix and related instructions were revised to refer to “Native American” instead of “American Indian” and include a definition of the term “Non-Binary.” For Foreign Issuers, the alternative disclosure matrix was amended to permit Foreign Issuers to note whether disclosure of the data required by the Board Diversity Disclosure Rule is prohibited under the company’s home country law.

[11] For Foreign Issuers the definition of “underrepresented individual” within the definition of “Diverse” was amended in the Final Rules to be based on identity in the country of the Foreign Issuer’s principal executive offices, as opposed to the Foreign Issuer’s home country jurisdiction.

[12] See Meland v. Weber, No. 20-15762 (9th Cir. 2021), available here.

[13] Notably, Commissioners Lee and Crenshaw emphasized their support for additional action to enhance both diversity and transparency and expressed the hope that the Final Rules are “a starting point for initiatives related to diversity, not the finish line.” Commissioner Allison Herren Lee and Commissioner Caroline A. Crenshaw, “Statement on Nasdaq’s Diversity Proposal – A Positive First Step for Investors” (Aug. 6, 2021), available here.

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

Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Brian J. Lane – Washington, D.C. (+1 202-887-3646, blane@gibsondunn.com)
James J. Moloney – Orange County, CA (+ 949-451-4343, jmoloney@gibsondunn.com)
Ronald O. Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Michael Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com)
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Geoffrey E. Walter – Washington, D.C. (+1 202-887-3749, gwalter@gibsondunn.com)

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

After a busy start to the year, regulatory and policy developments related to Artificial Intelligence and Automated Systems (“AI”) have continued apace in the second quarter of 2021. Unlike the comprehensive regulatory framework proposed by the European Union (“EU”) in April 2021,[1] more specific regulatory guidelines in the U.S. are still being proposed on an agency-by-agency basis. President Biden has so far sought to amplify the emerging U.S. AI strategy by continuing to grow the national research and monitoring infrastructure kick-started by the 2019 Trump Executive Order[2] and remain focused on innovation and competition with China in transformative innovations like AI, superconductors, and robotics. Most recently, the U.S. Innovation and Competition Act of 2021—sweeping, bipartisan R&D and science-policy legislation—moved rapidly through the Senate.

While there has been no major shift away from the previous “hands off” regulatory approach at the federal level, we are closely monitoring efforts by the federal government and enforcers such as the FTC to make fairness and transparency central tenets of U.S. AI policy. Overarching restrictions or bans on specific AI use cases have not yet been passed at the federal level, but we anticipate (at the very least) further guidance that insists upon greater transparency and explainability to address concerns about algorithmic discrimination and bias, and, in the near term, increased regulation and enforcement of narrow AI applications such as facial recognition technology.

Our 2Q21 Artificial Intelligence and Automated Systems Legal Update focuses on these key regulatory efforts, and also examines other policy developments within the U.S. and EU that may be of interest to domestic and international companies alike.[3]

________________________

I. U.S. NATIONAL POLICY & REGULATORY DEVELOPMENTS

A. U.S. National AI Strategy

Senate Passes Bipartisan U.S. Innovation and Competition Act (S. 1260) to Bolster Tech Competitiveness with China

U.S. Launches National AI Research Resource Task Force and National Artificial Intelligence Advisory Committee

Understanding “Trustworthy” AI: NIST Proposes Model to Measure and Enhance User Trust in AI Systems

GAO Publishes Report “Artificial Intelligence: An Accountability Framework for Federal Agencies and Other Entities”

B. National Security

Artificial Intelligence Capabilities and Transparency (“AICT”) Act

C. Algorithmic Accountability and Consumer Protection

Federal Lawmakers Reintroduce the Facial Recognition and Biometric Technology Moratorium Act

Algorithmic Justice and Online Platform Transparency Act of 2021 (S. 1896)

House Approves Bill to Study Cryptocurrency and Consumer Protection (H.R. 3723)

Data Protection Act of 2021 (S. 2134)

D. Autonomous Vehicles (“AVs”)

II. EU POLICY & REGULATORY DEVELOPMENTS

A. EDPB & EDPS Call for Ban on Use of AI for Facial Recognition in Publicly Accessible Spaces

________________________

I. U.S. NATIONAL POLICY & REGULATORY DEVELOPMENTS

A. U.S. National AI Strategy

1. Senate Passes Bipartisan U.S. Innovation and Competition Act (S. 1260) to Bolster Tech Competitiveness with China

On June 8, 2021, the U.S. Senate voted 68-32 to approve the U.S. Innovation and Competition Act (S. 1260), intended to grow the boost the country’s ability to compete with Chinese technology by investing more than $200 billion into U.S. scientific and technological innovation over the next five years, listing artificial intelligence, machine learning, and autonomy as “key technology focus areas.”[4] $80 billion is earmarked for research into AI, robotics, and biotechnology. Among various other programs and activities, the bill establishes a Directorate for Technology and Innovation in the National Science Foundation (“NSF”) and bolsters scientific research, development pipelines, creates grants, and aims to foster agreements between private companies and research universities to encourage technological breakthroughs.

The Act also includes provisions labelled as the “Advancing American AI Act,”[5] intended to “encourage agency artificial intelligence-related programs and initiatives that enhance the competitiveness of the United States” while ensuring AI deployment “align[s] with the values of the United States, including the protection of privacy, civil rights, and civil liberties.”[6] The AI-specific provisions mandate that the Director of the Office for Management and Budget (“OMB”) shall develop principles and policies for the use of AI in government, taking into consideration the NSCAI report, the December 3, 2020 Executive Order “Promoting the Use of Trustworthy Artificial Intelligence in the Federal Government,” and the input of various interagency councils and experts.[7]

2. U.S. Launches National AI Research Resource Task Force and National Artificial Intelligence Advisory Committee

On January 1, 2021, President Trump signed the National Defense Authorization Act (“NDAA”) for Fiscal Year 2021 into law, which included the National AI Initiative Act of 2020 (the “Act”). The Act established the National AI Initiative, creating a coordinated program across the federal government to accelerate AI research and application to support economic prosperity, national security, and advance AI leadership in the U.S.[8] In addition to creating the Initiative, the Act also established the National AI Research Resource Task Force (the “Task Force”), convening a group of technical experts across academia, government and industry to assess and provide recommendations on the feasibility and advisability of establishing a National AI Research Resource (“NAIRR”).

On June 10, 2021, the White House Office of Science and Technology Policy (“OSTP”) and the NSF formed the Task Force pursuant to the requirements in the NDAA.[9] The Task Force will develop a coordinated roadmap and implementation plan for establishing and sustaining a NAIRR, a national research cloud to provide researchers with access to computational resources, high-quality data sets, educational tools and user support to facilitate opportunities for AI research and development. The roadmap and plan will also include a model for governance and oversight, technical capabilities and an assessment of privacy and civil liberties, among other contents. Finally, the Task Force will submit two reports to Congress to present its findings, conclusions and recommendations—an interim report in May 2022 and a final report in November 2022. The Task Force includes 10 AI experts from the public sector, private sector, and academia, including DefinedCrowd CEO Daniela Braga, Google Cloud AI chief Andrew Moore, and Stanford University’s Fei-Fei Li. Lynne Parker, assistant director of AI for the OSTP, will co-chair the effort, along with Erwin Gianchandani, senior adviser at the NSF. A request for information (“RFI”) will be posted in the Federal Register to gather public input on the development and implementation of the NAIRR.

The Biden administration also announced the establishment of the National AI Advisory Committee, which is tasked with providing recommendations on various topics related to AI, including the current state of U.S. economic competitiveness and leadership, research and development, and commercial application. [10] Additionally, the Advisory Committee will assess the management, coordination and activities of the National AI Initiative, and societal, ethical, legal, safety and security matters, among other considerations. An RFI will be posted in the Federal Register to call for nominations of qualified experts to help develop recommendations on these issues, including perspectives from labor, education, research, startup businesses and more.

3. Understanding “Trustworthy” AI: NIST Proposes Model to Measure and Enhance User Trust in AI Systems

In June 2021 the National Institute of Standards and Technology (“NIST”), tasked by the Trump administration to develop standards and measures for AI, released its report of how to identify and manage biases in AI technology.[11] NIST is accepting comments on the document until September 10, 2021 (extended from the original deadline of August 5, 2021), and the authors will use the public’s responses to help shape the agenda of several collaborative virtual events NIST will hold in coming months.

4. GAO Publishes Report “Artificial Intelligence: An Accountability Framework for Federal Agencies and Other Entities”

In June 2021, the U.S. Government Accountability Office (“GAO”) published a report identifying key practices to help ensure accountability and responsible AI use by federal agencies and other entities involved in the design, development, deployment, and continuous monitoring of AI systems. In its executive summary, the agency notes that these practices are necessary as a result of the particular challenges faced by government agencies seeking to regulate AI, such as the need for expertise, limited access to key information due to commercial procurement of AI systems, as well as a limited understanding of how an AI system makes decisions.[12]

The report identifies four key focus areas: (1) organization and algorithmic governance; (2) system performance; (3) documenting and analyzing the data used to develop and operate an AI system; and (4) continuous monitoring and assessment of the system to ensure reliability and relevance over time.[13]

The key monitoring practices identified by the GAO are particularly relevant to organizations and companies seeking to implement governance and compliance programs for AI-based systems and develop metrics for assessing the performance of the system. The GAO report notes that monitoring is a critical tool for several reasons: first, it is necessary to continually analyze the performance of an AI model and document findings to determine whether the results are as expected, and second, monitoring is key where a system is either being scaled or expanded, or where applicable laws, programmatic objectives, and the operational environment change over time.[14]

B. National Security

1. Artificial Intelligence Capabilities and Transparency (“AICT”) Act

On May 19, 2021, Senators Rob Portman (R-OH) and Martin Heinrich (D-NM), introduced the bipartisan Artificial Intelligence Capabilities and Transparency (“AICT”) Act.[15] AICT would provide increased transparency for the government’s AI systems, and is based primarily on recommendations promulgated by the National Security Commission on AI (“NSCAI”) in April 2021.[16] It would establish a Chief Digital Recruiting Officer within the Department of Defense, the Department of Energy, and the Intelligence Community to identify digital talent needs and recruit personnel, and recommends that the NSF should establish focus areas in AI safety and AI ethics as a part of establishing new, federally funded National Artificial Intelligence Institutes.

The AICT bill was accompanied by the Artificial Intelligence for the Military (AIM) Act.[17] The AICT Act would establish a pilot AI development and prototyping fund within the Department of Defense aimed at developing AI-enabled technologies for the military’s operational needs, and would develop a resourcing plan for the DOD to enable development, testing, fielding, and updating of AI-powered applications.[18]

C. Algorithmic Accountability and Consumer Protection

As we have noted previously, companies using algorithms, automated processes, and/or AI-enabled applications are now squarely on the radar of both federal and state regulators and lawmakers focused on addressing algorithmic accountability and transparency from a consumer protection perspective.[19] The past quarter again saw a wave of proposed privacy-related federal and state regulation and lawsuits indicative of the trend for stricter regulation and enforcement with respect to the use of AI applications that impact consumer rights and the privacy implications of AI. As a result, companies developing and using AI are certain to be focused on these issues in the coming months, and will be tackling how to balance these requirements with further development of their technologies. We recommend that companies developing or deploying automated decision-making adopt an “ethics by design” approach and review and strengthen internal governance, diligence and compliance policies.

1. Federal Lawmakers Reintroduce the Facial Recognition and Biometric Technology Moratorium Act

On June 15, 2021, Senators Edward Markey (D-Mass.), Jeff Merkley (D-Ore), Bernie Sanders (II-Vt.), Elizabeth Warren (D-Mass.), and Ron Wyden (D-Ore.), and Representatives Pramila Jayapal (D-Wash.), Ayanna Pressley, (D-Mass.), and Rashida Tlaib, (D-Mich.), reintroduced the Facial Recognition and Biometric Technology Moratorium Act, which would prohibit agencies from using facial recognition technology and other biometric tech—including voice recognition, gate recognition, and recognition of other immutable physical characteristics—by federal entities, and block federal funds for biometric surveillance systems.[20] As we previously reported, a similar bill was introduced in both houses in the previous Congress but did not progress ut of committee.[21]

The legislation, which is endorsed by the ACLU and numerous other civil rights organizations, also provides a private right of action for individuals whose biometric data is used in violation of the Act (enforced by state Attorneys General), and seeks to limit local entities’ use of biometric technologies by tying receipt of federal grant funding to localized bans on biometric technology. Any biometric data collected in violation of the bill’s provisions would also be banned from use in judicial proceedings.

2. Algorithmic Justice and Online Platform Transparency Act of 2021 (S. 1896)

On May 27, 2021, Senator Edward J. Markey (D-Mass.) and Congresswoman Doris Matsui (CA-06) introduced the Algorithmic Justice and Online Platform Transparency Act of 2021 to prohibit harmful algorithms, increase transparency into websites’ content amplification and moderation practices, and commission a cross-government investigation into discriminatory algorithmic processes across the national economy.[22] The Act would prohibit algorithmic processes on online platforms that discriminate on the basis of race, age, gender, ability and other protected characteristics. In addition, it would establish a safety and effectiveness standard for algorithms and require online platforms to describe algorithmic processes in plain language to users and maintain detailed records of these processes for review by the FTC.

3. House Approves Bill to Study Cryptocurrency and Consumer Protection (H.R. 3723)

On June 22, 2021, the House voted 325-103 to approve the Consumer Safety Technology Act, or AI for Consumer Product Safety Act (H.R. 3723), which requires the Consumer Product Safety Commission to create a pilot program that uses AI to explore consumer safety questions such as injury trends, product hazards, recalled products or products that should not be imported into the U.S.[23] This is the second time the Consumer Safety Technology Act has passed the House. Last year, after clearing the House, the bill did not progress in the Senate after being referred to the Committee on Commerce, Science and Transportation.[24]

4. Data Protection Act of 2021 (S. 2134)

In June 2021, Senator Kirsten Gillibrand (D-NY) introduced the Data Protection Act of 2021, which would create an independent federal agency to protect consumer data and privacy.[25] The main focus of the agency would be to protect individuals’ privacy related to the collection, use, and processing of personal data.[26] The bill defines “automated decisions system” as “a computational process, including one derived from machine learning, statistics, or other data processing or artificial intelligence techniques, that makes a decision, or facilitates human decision making.”[27] Moreover, using “automated decision system processing” is a “high-risk data practice” requiring an impact evaluation after deployment and a risk assessment on the system’s development and design, including a detailed description of the practice including design, methodology, training data, and purpose, as well as any disparate impacts and privacy harms.[28]

D. Autonomous Vehicles (“AVs”)

The second quarter of 2021 saw new legislative proposals relating to the safe deployment of autonomous vehicles (“AVs”). As we previously reported, federal regulation of CAVs has so far faltered in Congress, leaving the U.S. without a federal regulatory framework while the development of autonomous vehicle technology advances. In June 2021, Representative Bob Latta (R-OH-5) again re-introduced the Safely Ensuring Lives Future Deployment and Research Act (“SELF DRIVE Act”) (H.R. 3711), which would create a federal framework to assist agencies and industries to deploy AVs around the country and establish a Highly Automated Vehicle Advisory Council within the National Highway Traffic Safety Administration (“NHTSA”). Representative Latta had previously introduced the bill in September 23, 2020 and in previous sessions.[29]

Also in June 2021, the Department of Transportation (“DOT”) released its “Spring Regulatory Agenda,” and proposed that the NHTSA establish rigorous testing standards for AVs as well as a national incident database to document crashes involving AVs.[30] The DOT indicated that there will be opportunities for public comments on the proposals, and we stand ready to assist companies who wish to participate with submitting such comments.

Further, NHTSA issued a Standing General Order on June 29, 2021 requiring manufacturers and operators of vehicles equipped with certain automated driving systems (“ADS”)[31] to report certain crashes to NHTSA to enable the agency to exercise oversight of potential safety defects in AVs operating on publicly accessible roads.[32]

Finally, NHTSA extended the period for public comments in response to its Advance Notice of Proposed Rulemaking (“ANPRM”), “Framework for Automated Driving System Safety,” until April 9, 2021.[33] The ANPRM acknowledged that the NHTSA’s previous AV-related regulatory notices “have focused more on the design of the vehicles that may be equipped with an ADS—not necessarily on the performance of the ADS itself.”[34] To that end, the NHTSA sought input on how to approach a performance evaluation of ADS through a safety framework, and specifically whether any test procedure for any Federal Motor Vehicle Safety Standard (“FMVSS”) should be replaced, repealed, or modified, for reasons other than for considerations relevant only to ADS. NHTSA noted that “[a]lthough the establishment of an FMVSS for ADS may be premature, it is appropriate to begin to consider how NHTSA may properly use its regulatory authority to encourage a focus on safety as ADS technology continues to develop,” emphasizing that its approach will focus on flexible “performance-oriented approaches and metrics” over rule-specific design characteristics or other technical requirements.[35]

II. EU POLICY & REGULATORY DEVELOPMENTS

On April 21, 2021, the European Commission (“EC”) presented its much-anticipated comprehensive draft of an AI Regulation (also referred to as the “Artificial Intelligence Act”).[36] It remains uncertain when and in which form the Artificial Intelligence Act will come into force, but recent developments underscore that the EC has set the tone for upcoming policy debates with this ambitious new proposal. We stand ready to assist clients with navigating the potential issues raised by the proposed EU regulations as we continue to closely monitor developments in that regard.

A. EDPB & EDPS Call for Ban on Use of AI for Facial Recognition in Publicly Accessible Spaces

On June 21, 2021, the European Data Protection Board (“EDPB”) and European Data Protection Supervisor (“EDPS”) published a joint Opinion calling for a general ban on “any use of AI for automated recognition of human features in publicly accessible spaces, such as recognition of faces, gait, fingerprints, DNA, voice, keystrokes and other biometric or behavioral signals, in any context.”[37]

In their Opinion, the EDPB and the EDPS welcomed the risk-based approach underpinning the EC’s proposed AI Regulation and emphasized that it has important data protection implications. The Opinion also notes the role of the EDPS—designated by the EC’s AI Regulation as the competent authority and the market surveillance authority for the supervision of the EU institutions—should be further clarified.[38] Notably, the Opinion also recommended “a ban on AI systems using biometrics to categorize individuals into clusters based on ethnicity, gender, political or sexual orientation, or other grounds on which discrimination is prohibited under Article 21 of the Charter of Fundamental Rights.”

Further, the EDPB and the EDPS noted that they “consider that the use of AI to infer emotions of a natural person is highly undesirable and should be prohibited, except for very specified cases, such as some health purposes, where the patient emotion recognition is important, and that the use of AI for any type of social scoring should be prohibited.”

________________________

[1] For more information on the EU’s proposed regulations, please see our Artificial Intelligence and Automated Systems Legal Update (1Q21).

[2] For more details, please see our previous alerts: Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems; and President Trump Issues Executive Order on “Maintaining American Leadership in Artificial Intelligence.”

[3] Note also, for example, the Government of Canada’s “Consultation on a Modern Copyright Framework for Artificial Intelligence and the Internet of Things.” The consultation seeks public comment on the interplay between copyright, AI, and the “Internet of Things.” With respect to AI, the consultation paper covers three potential areas of reform: (1) text and data mining (TDM), also known as “Big Data”; (2) authorship and ownership of works generated by AI; and (3) copyright infringement and liability regarding AI. With respect to IoT, the paper outlines twin concerns of repair and interoperability of IoT devices. The comment period is open until September 17, 2021. There have also been several recent policy developments in the UK, including the Government’s “Ethics, Transparency and Accountability Framework for Automated Decision-Making” (available here), and the UK Information Commissioner’s Opinion and accompanying blog post on “The Use of Live Facial Recognition Technology in Public Places.”

[4] S. 1260, 117th Cong. (2021).

[5] Id., §§4201-4207.

[6] Id., §4202.

[7] Id., §4204. For more details on the NSCAI report and 2020 Executive Order, please see our Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems.

[9] The White House, Press Release, The Biden Administration Launches the National Artificial Intelligence Research Resource Task Force (June 10, 2021), available at https://www.whitehouse.gov/ostp/news-updates/2021/06/10/the-biden-administration-launches-the-national-artificial-intelligence-research-resource-task-force/.

[10] Id.

[11] Draft NIST Special Publication 1270, A Proposal for Identifying and Managing Bias in Artificial Intelligence (June 2021), available at https://nvlpubs.nist.gov/nistpubs/SpecialPublications/NIST.SP.1270-draft.pdf?_sm_au_=iHVbf0FFbP1SMrKRFcVTvKQkcK8MG.

[12] U.S. Government Accountability Office, Artificial Intelligence: An Accountability Framework for Federal Agencies and Other Entities, Highlights of GAO-21-519SP, available at https://www.gao.gov/assets/gao-21-519sp-highlights.pdf.

[13] Id.

[14] U.S. Government Accountability Office, Artificial Intelligence: An Accountability Framework for Federal Agencies and Other Entities, Full Report GAO-21-519SP, available at https://www.gao.gov/assets/gao-21-519sp.pdf.

[15] S. 1705, 117th Cong. (2021); see also Press Release, Senator Martin Heinrich, ‘Heinrich, Portman Announce Bipartisan Artificial Intelligence Bills To Boost AI-Ready National Security Personnel, Increase Governmental Transparency’ (May 12, 2021), available at https://www.heinrich.senate.gov/press-releases/heinrich-portman-announce-bipartisan-artificial-intelligence-bills-to-boost-ai-ready-national-security-personnel-increase-governmental-transparency.

[16] For more information, please see our Artificial Intelligence and Automated Systems Legal Update (1Q21).

[17] S. 1776, 117th Cong. (2021).

[18] S. 1705, 117th Cong. (2021).

[19] See our Artificial Intelligence and Automated Systems Legal Update (1Q21).

[20] S. _, 117th Cong. (2021); see also Press Release, Senators Markey, Merkley Lead Colleagues on Legislation to Ban Government Use of Facial Recognition, Other Biometric Technology (June 15, 2021), available at https://www.markey.senate.gov/news/press-releases/senators-markey-merkley-lead-colleagues-on-legislation-to-ban-government-use-of-facial-recognition-other-biometric-technology.

[21] For more details, please see our previous alerts: Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems.

[22] S. 1896, 117th Cong. (2021); see also Press Release, Senator Markey, Rep. Matsui Introduce Legislation to Combat Harmful Algorithms and Create New Online Transparency Regime (May 27, 2021), available at https://www.markey.senate.gov/news/press-releases/senator-markey-rep-matsui-introduce-legislation-to-combat-harmful-algorithms-and-create-new-online-transparency-regime.

[23] H.R. 3723, 117th Cong. (2021).

[24] Elise Hansen, House Clears Bill To Study Crypto And Consumer Protection, Law360 (June 23, 2021), available at https://www.law360.com/articles/1396110/house-clears-bill-to-study-crypto-and-consumer-protection.

[25] S. 2134, 117th Cong. (2021); see also Press Release, Office of U.S. Senator Kirsten Gillibrand, Press Release, Gillibrand Introduces New And Improved Consumer Watchdog Agency To Give Americans Control Over Their Data (June 17, 2021), available at https://www.gillibrand.senate.gov/news/press/release/gillibrand-introduces-new-and-improved-consumer-watchdog-agency-to-give-americans-control-over-their-data.

[26] Under the proposed legislation, “personal data” is defined as “electronic data that, alone or in combination with other data—(A) identifies, relates to, describes, is capable of being associated with, or could reasonably be linked, directly or indirectly, with a particular individual, household, or device; or (B) could be used to determine that an individual or household is part of a protected class.” Data Protection Act of 2021, S. 2134, 117th Cong. § 2(16) (2021).

[27] Id., § 2(3) (2021).

[28] Id., § 2(11)-(13) (2021).

[29] As we addressed in previous legal updates, 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. For more details, see our Fourth Quarter and 2020 Annual Review of Artificial Intelligence and Automated Systems.

[30] U.S. Department of Transportation, Press Release, U.S. Department of Transportation Releases Spring Regulatory Agenda (June 11, 2021), available at https://www.transportation.gov/briefing-room/us-department-transportation-releases-spring-regulatory-agenda.

[31] For a full description of the Society of Automotive Engineers (“SAE”) levels of driving automation, see SAE J3016 Taxonomy and Definitions for Terms Related to Driving Automation Systems for On-Road Motor Vehicles (April 2021), available at https://www.nhtsa.gov/technology-innovation/automated-vehicles-safety#topic-road-self-driving.

[32] See NHTSA, Standing General Order on Crash Reporting for Levels of Driving Automation 2-5, available at https://www.nhtsa.gov/laws-regulations/standing-general-order-crash-reporting-levels-driving-automation-2-5.

[33] 49 CFR 571, available at https://www.nhtsa.gov/sites/nhtsa.gov/files/documents/ads_safety_principles_anprm_website_version.pdf

[34] Id., at 6.

[35] Id., at 7-8.

[36] For a fulsome analysis of the draft AI Regulation, please see our Artificial Intelligence and Automated Systems Legal Update (1Q21).

[37] Joint Opinion 5/2021 on the proposal for a Regulation of the European Parliament and of the Council laying down harmonised rules on artificial intelligence, available at https://edpb.europa.eu/system/files/2021-06/edpb-edps_joint_opinion_ai_regulation_en.pdf.

[38] EDPS, Press Release, EDPB & EDPS Call For Ban on Use of AI For Automated Recognition of Human Features in Publicly Accessible Spaces, and Some Other Uses of AI That Can Lead to Unfair Discrimination (June 21, 2021), available at https://edps.europa.eu/press-publications/press-news/press-releases/2021/edpb-edps-call-ban-use-ai-automated-recognition_en?_sm_au_=iHVWn7njFDrbjJK3FcVTvKQkcK8MG.

The following Gibson Dunn lawyers prepared this client update: H. Mark Lyon, Frances Waldmann, Samantha Abrams-Widdicombe, Tony Bedel, Emily Lamm, Prachi Mistry, and Derik Rao.

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)

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On August 5, 2021, U.S. Senate Finance Committee Chairman Ron Wyden (D-Oregon) and U.S. Senate Finance Committee member Sheldon Whitehouse (D-Rhode Island) introduced legislation entitled the “Ending the Carried Interest Loophole Act.”[1] According to a summary released by the Finance Committee, the legislation is intended to close “the entire carried interest loophole.” While this legislation is very similar to a previous proposal introduced by Chairman Wyden[2], this legislation appears to have a greater likelihood of passage given the Democratic party’s control of both chambers of Congress and the election of President Biden. The legislation may have an even greater chance of passage if it secures the support of moderate Democratic Senators who will be key to its passage through reconciliation, which is a technical procedure that would permit Democrats to pass the bill through a majority vote in the Senate.

The “Ending the Carried Interest Loophole Act” would require partners who hold carried interests in exchange for providing services to investment partnerships to recognize a specified amount of deemed compensation income each year regardless of whether the investment partnership recognizes income or gain and regardless of whether and when the service providers receive distributions in respect of their carried interests. This deemed compensation income would be subject to income tax at ordinary income rates and self-employment taxes.

This legislation goes well beyond many previously proposed bills that attempted to recharacterize certain future income from investment partnerships as ordinary income instead of capital gain. In addition, it would replace section 1061 of the Internal Revenue Code of 1986, as amended (the “Code”), which was enacted as part of the 2017 tax act,[3] and lengthened the required holding period from one year to three years for service providers to recognize long-term capital gain in respect of carried interests.

Current Treatment of “Carried Interest” Allocations

Under current law, a partnership generally can issue a partnership “profits interest” to a service provider without current tax. The service provider holds the interest as a capital asset, with both the timing of recognition and character of the partner’s share of profits from the partnership determined by reference to the timing of recognition and character of profits made by the partnership. Thus, if the partnership recognizes capital gain, the service provider’s allocable share of the gain generally would be capital gain and recognized in the same year as the partnership’s recognition of the capital gain. These partnership “profits interests” are referred to as “carried interests” in the private equity context, “incentive allocations” in the hedge fund context, or “promotes” in the real estate context. As noted above, Code section 1061 generally treats gain recognized with respect to certain partnership interests held for less than three years as short-term capital gain.

“Ending the Carried Interest Loophole Act”

The legislation introduced by Chairman Wyden and Senator Whitehouse generally would require a taxpayer who receives or acquires a partnership interest in connection with the performance of services in a trade or business that involves raising or returning capital and investing in or developing securities, commodities, real estate and certain other assets to recognize annually, on a current basis – (1) a “deemed compensation amount” as ordinary income and (2) an equivalent amount as a long-term capital loss.

The “deemed compensation amount” generally would equal the product of (a) an interest charge, referred to as the “specified rate,”[4] (b) the service provider’s maximum share of partnership profits, and (c) the partnership’s invested capital as of certain measurement dates.[5] Conceptually, the partnership is viewed as investing a portion of its capital on behalf of the service provider via an interest free loan to the service provider. The service provider is deemed to recognize ordinary self-employment income in an amount equal to the foregone interest, calculated at the “specified rate.” Although not clear, the “specified rate” appears designed to approximate the economics of the typical preferred return rate often paid to limited partners on their contributed capital before the service provider receives any distributions from the partnership.

The offsetting long-term capital loss appears to be a proxy for tax basis that is designed to avoid a “double-counting” of income when the service provider ultimately receives allocations of income from the partnership attributable to the sale or disposition of partnership assets (or income or gain attributable to the sale or disposition of the partnership interest itself).[6] The long-term capital loss generally would only be usable in the tax year of deemed recognition if the individual taxpayer recognizes other capital gain that is available to be offset (otherwise, the long-term capital loss would be available to be carried forward to subsequent tax years).

For example, if a service provider is entitled to receive up to 20 percent of an investment fund’s profits, the investment fund receives $1 billion in capital contributions, and the “specified return” for the tax year is 12 percent, the service provider’s “deemed compensation amount” for that tax year would be $24,000,000, and the service provider would recognize an offsetting long-term capital loss of $24,000,000. Assuming relevant income thresholds are already met and that the service provider has sufficient long-term capital gain in the year of inclusion against which the long-term capital loss may be offset, based on maximum individual rates under current law, the service provider would expect to incur an incremental U.S. federal income tax rate of 17% on the “deemed compensation amount” (that is, 37 percent ordinary income tax rate less the 20 percent long-term capital gain tax rate).[7] Any long-term capital gain recognized by the service provider in excess of the “deemed compensation amount” that is attributable to the sale or disposition of partnership assets (or income or gain attributable to the sale or disposition of the partnership interest itself) would be taxed at 20 percent (or 23.8 percent if the net investment income tax is applicable).

To prevent a work-around, the legislation also would apply to any service provider who has received a loan from the partnership, from any other partner of the partnership, or from any person related to the partnership or another partner, unless the loan is fully recourse or fully secured and requires payments of interest at a stated rate not less than the “specified return.”

Other Proposed Changes and Contrast with Recent Biden Proposal

Besides the current inclusion of “deemed compensation amounts” at ordinary income rates, the legislation would alter existing law in several ways. As background, current Code section 1061 generally requires a partnership to hold capital assets for three years in order for the related capital gain to be taxed at preferential long-term capital gain rates. Earlier this year, the Administration released its fiscal year 2022 Budget, including a Greenbook with detailed proposals for changes to the federal tax law.[8] Among other things, the Greenbook proposal would eliminate the ability for partners whose taxable income (from all sources) exceed $400,000 to recognize long-term capital gain with respect to these partnership “profits interests,” but partners whose taxable income do not exceed $400,000 would continue to be subject to Code section 1061.

Under the bill, Code section 1061 would be repealed. In other words, ordinary income treatment would apply regardless of holding period and regardless of the service provider’s level of taxable income. Second, like the Greenbook proposal, under this legislation – (1) the recharacterized amount would be treated as ordinary income rather than short-term capital gain (there is currently no rate differential, but there could be sourcing and other differences), and (2) the “deemed compensation amount” would be subject to self-employment tax.

In addition, this bill also would provide for a deemed election under Code section 83(b) in the event of a transfer of a partnership interest in connection with the performance of services, unless the taxpayer makes a timely election to not have the deemed election apply. Unless a service provider elects out of the deemed election, the service provider would be required to recognize taxable income at the time of the transfer of a partnership interest in connection with the performance of services in an amount equal to the partnership interest’s fair market value. Importantly, fair market value for this purpose would equal the distributions that the service provider would receive in the event of a hypothetical liquidation of the partnership’s assets for cash (after satisfying applicable liabilities) at the time of transfer. This valuation methodology is broadly consistent with current law.

____________________________

[1] Ending the Carried Interest Loophole Act, S. 2617, 117th Cong. (2021).

[2] Ending the Carried Interest Loophole Act, S. 1639, 116th Cong. (2019).

[3] The 2017 tax act, commonly known as the Tax Cuts and Jobs Act, is formally titled “An act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” Pub. L. No. 115-97, 131 Stat. 2045.

[4] The “specified rate” for a calendar year means the par yield for “5-year High Quality Market corporate bonds” for the first month of the calendar year (currently 1.21%), plus 9 percentage points.

[5] According to a summary prepared by the Senate Finance Committee, the legislation is not intended to treat an applicable percentage as higher in a given taxable year due to the application of a “catch-up” provision in the partnership agreement. In addition, a partner’s “invested capital” is intended to equal the partner’s book capital account maintained under the regulations under Code section 704(b) with certain modifications, including that invested capital is to be calculated without regard to untaxed gain and loss resulting from the revaluation of partnership property.

[6] Even though the long-term capital loss may be used to offset other capital gain income of the service provider, the legislation would still fulfill its intended purpose of ensuring that the “deemed compensation amount” is subject to tax at ordinary income rates.

[7] For simplicity, we have omitted self-employment tax from the computation of the “deemed compensation amount” and omitted net investment income tax from the offsetting capital loss benefit on the assumption that these will generally offset.

[8] The proposed changes are described here: https://www.gibsondunn.com/biden-administration-releases-fiscal-year-2022-budget-with-greenbook-and-descriptions-of-proposed-changes-to-federal-tax-law/.

Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Tax practice group, or the following authors:

Evan M. Gusler – New York (+1 212-351-2445, egusler@gibsondunn.com)
Jennifer L. Sabin – New York (+1 212-351-5208, jsabin@gibsondunn.com)
Michael J. Desmond – Los Angeles/Washington, D.C. (+1 213-229-7531, mdesmond@gibsondunn.com)
Pamela Lawrence Endreny – New York (+1 212-351-2474, pendreny@gibsondunn.com)
Eric B. Sloan – Co-Chair, New York (+1 212-351-2340, esloan@gibsondunn.com)
Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224 /+1 212-351-2344), jtrinklein@gibsondunn.com)
Daniel A. Zygielbaum – Washington, D.C. (+1 202-887-3768, dzygielbaum@gibsondunn.com)

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

On July 28, 2021, the proxy advisory firm Institutional Shareholder Services (“ISS”) opened its Annual Benchmark Policy Survey (available here), covering a broad range of topics relating to non-financial environmental, social and governance (“ESG”) performance metrics, racial equity, special purpose acquisition corporations (“SPACs”) and more. In addition, noting that climate change “has emerged as one of the highest priority ESG issues” and that “many investors now identify it as a top area of focus for their stewardship activities,” this year ISS also launched a separate Climate Policy Survey (available here) focused exclusively on climate-related governance issues.

The Annual Benchmark Policy Survey includes questions regarding the following topics for companies in the U.S. and will inform changes to ISS’s benchmark policy for 2022:

Non-financial ESG performance metrics. Citing an “upward trend” of inclusion of non-financial ESG-related metrics in executive compensation programs, a practice ISS notes “appears to have been fortified by the recent pandemic and social unrest,” the survey asks whether incorporating such metrics into executive compensation programs is an appropriate way to incentivize executives. The survey then asks which compensation components (long-term incentives, short-term incentives, both, or other) are most appropriate for inclusion of non-financial ESG-related performance metrics.
Racial equity audits. Noting increased shareholder engagement on diversity and racial equity issues in the wake of social unrest following the death of George Floyd and others, the survey asks whether and when companies would benefit from independent racial equity audits (under any set of circumstances, only depending on certain company-specific factors, or not at all). The survey then asks respondents who indicated that a company would benefit depending on company-specific factors which factors would be relevant, including, for example, whether the company has been involved in significant racial and/or ethnic diversity–related controversies or does not provide detailed workforce diversity statistics, such as EEO-1 type data.
Virtual-only shareholder meetings. This year’s survey seeks information on the types of practices that should be considered problematic in a virtual-only meeting setting. This question follows a “vast majority” of investor respondents indicating last year that they prefer a hybrid meeting approach absent COVID-19-related health and social restrictions. Among the potentially problematic practices ISS identifies in the survey are: the inability to ask live questions at the meeting; muting of participants during the meeting; the inability of shareholders to change votes at the meeting; advance registration requirements or other unreasonable barriers to registration; preventing shareholder proponents from presenting and explaining a shareholder proposal considered at the meeting; and management unreasonably “curating” questions to avoid addressing difficult topics. The survey also asks what would be an appropriate way for shareholders to voice concerns regarding any such problematic practices, including casting votes “against” the chair of the board or all directors or engaging with the company and/or communicating concerns.
CEO pay quantum and mid-cycle changes to long-term incentive programs. For companies in the U.S. and Canada, ISS’s quantitative pay-for-performance screen currently includes a measure that evaluates one-year CEO pay quantum as a multiple of the median of CEO peers. The survey asks whether this screen should include a longer-term perspective (e.g., three years). The survey also seeks respondents’ views on mid-cycle changes to long-term incentive programs for companies incurring long-term negative impacts from the pandemic. ISS noted that such changes were generally viewed by ISS and investors as problematic given the view that long-term incentives should not be adjusted based on short-term market disruptions (i.e., less than one year), but it acknowledged that some industries continue to experience significant negative impacts from the pandemic.
Companies with pre-2015 poor governance provisions – multi-class stock, classified board, supermajority vote requirements. ISS’s policy since 2015 has been to recommend votes “against” directors of newly public companies with certain poor governance provisions, including multiple classes of stock with unequal voting rights and without a reasonable sunset, classified board structure, and supermajority vote requirements for amendments to governing documents. Companies that were publicly traded before the 2015 policy change, however, were grandfathered and so are not subject to this policy. The survey asks whether ISS should consider issuing negative voting recommendations on directors at companies maintaining these provisions regardless of when the company went public, and if so, which provisions ISS should revisit and no longer grandfather.
Recurring adverse director vote recommendations – supermajority vote requirements. For newly public companies, ISS currently recommends votes on a case-by-case basis on director nominees where certain adverse governance provisions – including supermajority voting requirements to amend governing documents – are maintained in the years subsequent to the first shareholder meeting. The survey asks whether, if a company has sought shareholder approval to eliminate supermajority vote requirements, but the company’s proposal does not receive the requisite level of shareholder support, ISS should continue making recurring adverse director vote recommendations for maintaining the supermajority vote requirements, or whether a single or multiple attempts by the company to remove the supermajority requirement would be sufficient (and if multiple attempts are sufficient, how many).
SPAC deal votes. ISS currently evaluates SPAC transactions on a case-by-case basis, with a main driver being the market price relative to redemption value. ISS notes that the redemption feature of SPACs may be used so long as the SPAC transaction is approved; however, if the transaction is not approved, the public warrants issued in connection with the SPAC will not be exercisable and will be worthless unless sold prior to the termination date. Acknowledging that investors may redeem shares (or sell them on the open market) if they do not like the transaction prospects, and noting that these mechanics may result in little reason for an investor not to support a SPAC transaction, the survey asks whether it makes sense for investors to generally vote in favor of SPAC transactions, irrespective of the merits of the target company combination or any governance concerns. The survey also asks what issues, “dealbreakers,” or areas of concern might be reasons for an investor to vote against a SPAC transaction.
Proposals with conditional poor governance provisions. ISS notes that one way companies impose poor governance or structural features on shareholders is by bundling or conditioning the closing of a transaction on the passing of other voting items. This practice is particularly common in the SPAC setting where shareholders are asked to approve a new governing charter (which may include features such as classified board, unequal voting structures, etc.) as a condition to consummation of the transaction. In light of these practices, the survey asks about the best course of action for a shareholder who supports an underlying transaction where closing the transaction is conditioned on approval of other ballot items containing poor governance.

The Climate Policy Survey includes questions regarding the following topics and will inform changes to both ISS’s benchmark policy as well as its specialty climate policy for 2022:

Defining climate-related “material governance failures.” The survey seeks input on what climate-related actions (or lack thereof) demonstrate such poor climate change risk management as to constitute a “material governance failure.” Specifically, the survey asks what actions at a minimum should be expected of a company whose operations, products or services strongly contribute to climate change. Among the “minimum actions” identified by ISS are: providing clear and appropriately detailed disclosure of climate change emissions governance, strategy, risk mitigation efforts, and metrics and targets, such as that set forth by the Task Force on Climate-Related Financial Disclosure (“TCFD”); declaring a long-term ambition to be in line with Paris Agreement goals for its operations and supply chain emissions (Scopes 1, 2 & 3 targets); setting and disclosing absolute medium-term (through 2035) greenhouse gas (“GHG”) emissions reductions targets in line with Paris Agreement goals; and reporting that demonstrates that the company’s corporate and trade association lobbying activities align with (or do not contradict) Paris Agreement goals. The survey also asks whether similar minimum expectations are reasonable for companies that are viewed as not contributing as strongly to climate change.
Say on Climate. In 2021, some companies put forward their climate transition plans for a shareholder advisory vote (referred to as “Say on Climate”) or committed to doing so in the future. The survey asks whether any of the “minimum actions” (referred to above) could be “dealbreakers” for shareholder support for approval of a management-proposed Say on Climate vote. The survey then asks whether voting on a Say on Climate proposal is the appropriate place to express investor sentiment about the adequacy of a company’s climate risk mitigation, or whether votes cast “against” directors would be appropriate in lieu of, or in addition to, Say on Climate votes. Finally, the survey asks when a shareholder proposal requesting a regular Say on Climate vote would warrant support: never (because the company should decide); never (because shareholders should instead vote against directors); case-specific (only if there are gaps in the current climate risk mitigation plan or reporting); or always (even if the board is managing risk effectively, the vote is a way to test efficacy of the company’s approach and promote positive dialogue between the company and its shareholders).
High-impact companies. Noting that Climate Action 100+ has identified 167 companies that it views as disproportionately responsible for GHG emissions, the survey asks whether under ISS’s specialty climate policy these companies (or a similar list of such companies) should be subject to a more stringent evaluation of indicators compared to other companies that are viewed as having less of an impact on climate change.
Net Zero initiatives. Citing increased investor interest in companies setting a goal of net zero emissions by 2050 consistent with a 1.5°C scenario (“Net Zero”), the survey asks whether the specialty climate policy should assess a company’s alignment with Net Zero goals. The survey also asks respondents to rank the importance of a number of elements in indicating a company’s alignment with Net Zero goals, including: announcement of a long-term ambition of Net Zero GHG emissions by 2050; long-term targets for reducing its GHG emissions by 2050 on a clearly defined scope of emissions; medium-term targets for reducing its GHG emissions by between 2026 and 2035 on a clearly defined scope of emissions; short-term targets for reducing its emissions up to 2025 on a clearly defined scope of emissions; a disclosed strategy and capital expenditure program in line with GHG reduction targets in line with Paris Agreement goals; commitment and disclosure showing its corporate and trade association lobbying activities align with Paris Agreement goals; clear board oversight of climate change; disclosure showing the company considers impacts from transitioning to a lower-carbon business model on its workers and communities; and a commitment to clear and appropriately detailed disclosure of its climate change emissions governance, strategy, risk mitigation efforts, and metrics and targets, such as that set forth by the TCFD framework.

While the two surveys cover a broad range of topics, they do not necessarily address every change that ISS will make in its 2022 proxy voting policies. That said, the surveys are an indication of changes ISS is considering and provide an opportunity for interested parties to express their views. Public companies and others are urged to submit their responses, as ISS considers feedback from the surveys in developing its policies.

Both surveys will close on Friday, August 20, at 5:00 p.m. ET. ISS will also solicit more input in the fall through regionally based, topic-specific roundtable discussions. Finally, as in prior years, ISS will open a public comment period on the major final proposed policy changes before releasing its final 2022 policy updates later in the year. Additional information on ISS’s policy development process is available at the ISS policy gateway (available here).

The following Gibson Dunn lawyers assisted in the preparation of this client update: Elizabeth Ising, Lori Zyskowski, and Cassandra Tillinghast.

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

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
Thomas J. Kim – Washington, D.C. (+1 202-887-3550, tkim@gibsondunn.com)
Ron Mueller – Washington, D.C. (+1 202-955-8671, rmueller@gibsondunn.com)
Michael Titera – Orange County, CA (+1 949-451-4365, mtitera@gibsondunn.com)
Lori Zyskowski – New York, NY (+1 212-351-2309, lzyskowski@gibsondunn.com)
Aaron Briggs – San Francisco, CA (+1 415-393-8297, abriggs@gibsondunn.com)
Courtney Haseley – Washington, D.C. (+1 202-955-8213, chaseley@gibsondunn.com)
Julia Lapitskaya – New York, NY (+1 212-351-2354, jlapitskaya@gibsondunn.com)
Cassandra Tillinghast – Washington, D.C. (+1 202-887-3524, ctillinghast@gibsondunn.com)

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

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

Gibson, Dunn & Crutcher LLP is pleased to announce that the firm has launched a Global Financial Regulatory Practice, which provides comprehensive advice to financial institutions on all aspects of regulatory compliance, enforcement and transactions.

The launch of this practice draws together our market-leading regulatory lawyers across the world’s leading financial centers, and will be led by three of the firm’s most experienced leaders in this field:

William Hallatt joined Gibson Dunn’s Hong Kong office in May 2021 from Herbert Smith Freehills along with an experienced financial services regulatory team comprised of associates Emily Rumble, Becky Chung and Arnold Pun. Michelle Kirschner joined Gibson Dunn’s London office in October 2019 while Jeffrey Steiner was promoted to partner in the firm’s Washington, DC office in January of the same year. Our broader practice group includes attorneys across the globe who have significant in-house experience within financial institutions or have worked in senior positions within the world’s most prominent regulatory and policy agencies.

The practice’s core services include:

advising on complex conduct and governance issues, including the implementation of senior management accountability regimes and advising senior management and boards of directors on culture and conduct risk;
handling regulatory issues which arise in merger and acquisition transactions, including on a cross-border basis;
representing end users that are impacted by financial regulation;
preparing applications for licenses and registrations, and engagement with regulators to seek relief, exemptions and interpretations in connection with regulatory compliance matters;
advising on financial policy matters, including helping to shape the policies that impact our clients;
advising fintech and cryptocurrency businesses on the operation of their businesses inside and outside of the regulatory perimeter;
defending clients in relation to their most significant regulatory investigations and enforcement matters on high profile issues such as market misconduct, governance failings, anti-money laundering and counter-terrorist financing compliance, cybersecurity breaches, and systems and controls failures; and
conducting internal reviews and investigations, including at the request of regulators or in parallel with their inquiries.

We are trusted advisers to our clients, providing strategic advice in relation to regulatory change and the implementation of new requirements across the jurisdictions in which we operate. We regularly represent our clients before regulators on a formal and informal basis on a range of matters. We also work closely with regulators and leading industry associations and have led industry responses to high profile proposed reforms in a range of jurisdictions.

Stay Tuned!
The practice’s co-chairs will be accompanied by other senior members of the practice to provide a comprehensive overview of recent financial regulatory trends globally in a webinar coming this Fall.

London partner Sandy Bhogal and associate Bridget English are the authors of “United Kingdom,” [PDF] published in Global Legal Insights – Corporate Tax 2021, Ninth Edition in August 2021.

In March of 2020, as the COVID-19 pandemic and the consequent government shutdown orders forced business closures and event cancellations across the United States, we provided a four-step checklist and flowchart on evaluating contracts’ force majeure provisions in order to aid contracting parties in understanding their options. Force majeure (or “act of god”) provisions are the most common terms in commercial contracts that address parties’ obligations when they become unable to comply with contract terms. These provisions generally set forth limited circumstances under which a party may suspend performance, fail to perform or, in some cases, terminate the contract, without liability due to the occurrence of an unforeseen event.[1]

In the months since March 2020, as commercial disputes over these clauses have wended their way through the courts, some patterns have emerged regarding litigants’ and courts’ treatment of force majeure clauses in light of the pandemic. The courts’ discussions of these clauses in decisions over the past sixteen months provide supplemental guidance regarding the four steps of analysis of the application of force majeure clauses.

STEP 1: Does COVID-19 trigger the force majeure clause? The first step is to review the triggering events enumerated in the force majeure clause.

First, as we explained back in March 2020, force majeure clauses pre-COVID tended to be interpreted narrowly and therefore COVID-19 might not be a covered event under the general rubric of “acts of God” absent reference in the relevant clause to a specific triggering event.[2] Among those triggering events can be events relating to diseases, including “epidemic,” “pandemic,” or “public health crisis.” At the onset of the 2020 crisis, there was general consensus that COVID-19 would be covered under any of these categories, and that has not changed. Likewise, other clauses referring to government actions also seemed likely to be triggered by the restrictive executive orders regulating the size of gatherings or shuttering certain businesses, and our guidance has not altered on this point. “Catch all” language invoking other events or causes “outside the reasonable control of a party” seemed likely to broaden the interpretation of such clauses to reach COVID-19 and its derivative impacts, except in the case where such language is qualified by an exclusion of events of general applicability.

The great majority of the early published decisions on force majeure continue to adhere to the principles in our early guidance; however, litigants in cases to date appear to have primarily engaged the courts to resolve disputes over the effect of triggering their force majeure provisions and therefore have not engaged in litigation over whether COVID-19 triggered the relevant force majeure clause in the first place.

For example, in Future St. Ltd. v. Big Belly Solar, LLC, 2020 WL 4431764 (D. Mass. July 31, 2020), the issue confronting the court was whether the difficulties in making certain minimum purchases and payments under the parties’ contract was caused by COVID-19 or not; there did not appear to be a dispute that the relevant force majeure provision would have been triggered if COVID-19 had indeed been the precipitating cause. The court in that case held, consistent with the prior case law, that the plaintiff failed to establish causation but assumed without discussion that “the pandemic and effects of same” were a valid triggering event under the relevant force majeure clause, which excused failure to perform “occasioned solely by fire, labor disturbance, acts of civil or military authorities, acts of God, or any similar cause beyond such party’s control.” Id. at *6.

Similarly, in Palm Springs Mile Assocs., Ltd. v. Kirkland’s Stores, Inc., 2020 WL 5411353 (S.D. Fla. Sept. 9, 2020), the parties raised the issue of whether the defendant (who was seeking to excuse its failure to pay rent) had adequately demonstrated that county regulations restricting non-essential business operations “directly affect[ed] [its] ability to pay rent.” Id. (emphasis added).[3] The court concluded he had not. And in something of a “split the baby” decision, In re Hitz Rest. Grp., 616 B.R. 374 (Bankr. N.D. Ill. 2020), held that the triggering of a force majeure clause only “partially excuse[d]” a restaurant tenant’s obligation to pay rent after Illinois’ executive order suspending in-person dining services went into effect. Examining the factual record, the Hitz court held that the restaurant could have used approximately 25% of its space to conduct activities that were still permitted following the executive order, including food pick-up and delivery services. Accordingly, the court held that the tenant was still on the hook for 25% of the rent. See, id. at 377 (finding force majeure clause to have been “unambiguously triggered” by an executive order).

Thus, because litigants generally have not disputed that COVID-19 falls within one or more of the enumerated events in the clauses to have been considered by courts thus far, most courts have not had occasion to opine on whether COVID-19 would trigger a clause that listed only “acts of god” without specific triggering events such as pandemic. The one outlier appears to be a single case from a New York federal court, which concluded that COVID-19 qualifies as a “national disaster” based on a number of factors, including Black’s Law Dictionary’s definition of “natural” and “disaster”; the Oxford English Dictionary’s definition of “natural disaster”; and the fact that “the Second Circuit has identified ‘disease’ as an example of a natural disaster.” See JN Contemporary Art LLC v. Phillips Auctioneers LLC, 2020 WL 7405262, at *7 and n.7 (S.D.N.Y. Dec. 16, 2020) (“It cannot be seriously disputed that the COVID-19 pandemic is a natural disaster.”). Interestingly, the generic “acts of God” category in a force majeure clause has been interpreted to include “national disasters” even as it has been interpreted to exclude public health events like pandemics. What the Southern District of New York decision does not clarify is whether the Court now views COVID-19 as covered by a generic “acts of God” provision even if that provision does not specifically enumerate “national disasters.” It also remains to be seen whether other courts will follow in the footsteps of the federal court’s expansion of jurisprudence or whether other courts will continue to adhere to the notion that force majeure provisions should be interpreted narrowly.

STEP 2: What is the standard of performance? The second step is to review what specifically the force majeure clause excuses.

As described above, a number of early cases have tackled the causation component of force majeure, concluding that, consistent with prior cases, a litigant must establish a direct relationship between the alleged triggering event and the performance he or she alleges should be excused. A review of COVID-19 force majeure cases also reveals that courts have taken a narrow approach when analyzing the related question of whether the remedy sought by the litigant invoking force majeure is available under the express language of the contract. For example, in MS Bank S.A. Banco de Cambio v. CBW Bank, 2020 WL 5653264 (D. Kan. Sept. 23, 2020), the plaintiff sought to delay the defendant’s termination of a service agreement based on force majeure, but the court analyzed the agreement and held that “nothing in the Services Agreement” allowed the plaintiff “to forestall termination based on force majeure.”

Similarly, in NetOne, Inc. v. Panache Destination Mgmt., Inc., 2020 WL 6325704, (D. Haw. Oct. 28, 2020), the plaintiff argued that the defendant had breached its agreement by refusing to refund a deposit after the plaintiff terminated its event contract based on the agreement’s force majeure provision. The court held for the defendant, finding no language in the contract that obligated the defendant to refund deposits based on a triggering of the force majeure clause. In contrast, the force majeure clause in the contract at issue in Sanders v. Edison Ballroom LLC, No. 654992/2020, 2021 WL 1089938, at *1 (N.Y. Sup. Ct. Mar. 22, 2021), expressly stated that defendant would “refund all payments made by” the plaintiff in the event that the clause was triggered. The court in Sanders therefore awarded summary judgment to the plaintiff, requiring defendant to refund the full deposit previously paid by plaintiff on an event space due to the fact that the act of a “governmental authority” had made it “illegal or impossible” for the defendant to hold the event, thus triggering the force majeure clause. Id. at *3.

Ultimately, as we cautioned in March 2020, it is vital to understand not just whether or when your force majeure clause has been triggered, but what happens next. Often, such a clause provides an excuse for delaying performance, but only if that failure is directly caused by the force majeure event, as in many of the cases discussed herein. Other contracts provide that that performance may be delayed in light of a force majeure event, but only so long as the force majeure event continues.

It is worth noting that all of the foregoing cases were analyzing contracts entered into before COVID-19 came to dominate all of our lives. It will be interesting to see how courts analyze force majeure clauses in contracts executed after March 2020 and whether that context will make a difference in terms of how narrowly courts read such provisions.

Does the force majeure clause broadly cover events caused by conditions beyond the reasonable control of the performing party without enumerating specific events?	No ☐	Yes ☐	If yes, proceed to Step 2. Inquiry should also be made into what additional elements a party may need to demonstrate based on the applicable law. Some courts may require a party invoking a force majeure provision to demonstrate that the triggering event was beyond its control and without its fault or negligence and that it made efforts to perform its contractual duties despite the occurrence of the event.
Does the force majeure clause specifically reference an “epidemic,” “pandemic,” “disease outbreak,” or “public health crisis”?	No ☐	Yes ☐	If yes, proceed to Step 2. Inquiry should also be made into what additional elements a party may need to demonstrate based on the applicable law. Some courts may require a party invoking a force majeure provision to demonstrate that the triggering event was beyond its control and without its fault or negligence and that it made efforts to perform its contractual duties despite the occurrence of the event.
Does the force majeure clause refer specifically to “acts of civil or military authority,” “acts, regulations, or laws of any government,” or “government order or regulation”?	No ☐	Yes ☐	If yes, proceed to Step 2. Inquiry should also be made into what additional elements a party may need to demonstrate based on the applicable law. Some courts may require a party invoking a force majeure provision to demonstrate that the triggering event was beyond its control and without its fault or negligence and that it made efforts to perform its contractual duties despite the occurrence of the event.
Does the force majeure clause cover only “acts of God”?	No ☐	Yes ☐	If yes, proceed to Step 2. While some courts have interpreted the phrase “act of God” in a force majeure clause in a limited manner, encompassing only natural disasters like floods, earthquakes, volcanic eruptions, tornadoes, hurricanes, and blizzards, one court to consider the question head-on has found that COVID-19 clearly constitutes a “natural disaster,” suggesting that COVID-19 may trigger provisions covering only “acts of God.”
Does the force majeure clause have a catchall provision that covers “any other cause whatsoever beyond the control of the respective party” and contains an enumeration of specific events that otherwise do not cover the current situation?	No ☐	Yes ☐	If yes, the force majeure clause may not have been triggered because courts generally interpret force majeure clauses narrowly and may not construe a general catch-all provision to cover externalities that are unlike those specifically enumerated in the balance of the clause. But depending on the jurisdiction, courts may look at whether the event was actually beyond the parties’ reasonable control and unforeseeable and the common law doctrine of impossibility or commercial impracticability may still apply, depending on the jurisdiction.

Step 2a. What is the standard of performance?

Does the force majeure clause require performance of obligations to be “impossible” (often, as a result of something outside the reasonable control of a party) before contractual obligations are excused?	No ☐	Yes ☐		If yes, the force majeure clause may have been triggered if the current government regulations specifically prohibit the fulfillment of contractual obligations. Proceed to Step 2b.
Does the force majeure clause require only that performance would be “inadvisable” or “commercially impractical”?	No ☐	Yes ☐		If yes, the force majeure clause may have been triggered due to the extreme disruptions caused by COVID-19. Proceed to Step 2b.

Step 2b. What remedy is available when the force majeure clause is triggered?

Does the contract clearly provide that the remedy sought is available upon the triggering of the force majeure clause?

No ☐

Yes ☐

If yes, then proceed to Step 3.

For example, a party seeking to terminate an agreement, to obtain a refund of a deposit, or to obtain some other remedy will need to demonstrate that such remedy is expressly contemplated by the contract upon the occurrence of a force majeure event.

Step 3. When must notice be given?

Does the contract require notice?

No ☐

Yes ☐

If yes, proceed to Step 4.

Timely notice must be provided in accordance with the notice provision, or termination may not be available even though a triggering event has occurred. Some notice provisions required notice in advance of performance due. Others required notice within a certain number of days of the triggering event. Still others require notice within a specified number of days from the date that a party first asserts the impact of force majeure, without regard to when the triggering event occurred.

Step 4. Are there requirements for the form of notice?

Does the contract contain specific provisions for the method of notice?	No ☐	Yes ☐	If yes, notice provisions may specify the form of the notice, to whom it must be sent, and the manner in which it must be sent. Specific notice language may also be required.
Does the contract require specific language to give notice of a force majeure event?	Yes ☐	No ☐	If yes, determine whether required wording is present in any notice. Some contracts may even have form of notices attached as exhibits to the contract.
Does the contract specify a specific method for delivery of such notice?	No ☐	Yes ☐	If yes, notice may be required by email, priority mail, or through use of a particular form addressed to specific people.

________________________

[1] The COVID-19 pandemic ultimately thrust these clauses to the mainstream, with prominent media outlets covering the effect of force majeure clauses on sports league cancellations and broadcast contracts. See, e.g., https://www.espn.com/nba/story/_/id/29050090/under-plan-nba-players-receive-25-less-paychecks-starting-15; https://nypost.com/2020/04/28/dish-demands-disney-pay-for-espn-refund-over-no-live-sports/

[2] See, e.g., Kel Kim Corp. v. Cent. Mkts., Inc., 70 N.Y.2d 900, 902-03 (1987) (“[O]nly if the force majeure clause specifically includes the event that actually prevents a party’s performance will that party be excused.”).

[3] The force majeure clause at issue in Palm Springs excused delays that were “due to” the force majeure event.

Gibson Dunn’s lawyers are available to assist in addressing 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 firm’s Coronavirus (COVID-19) Team or Litigation, Real Estate, or Transactional groups, or the authors:

Shireen A. Barday – New York (+1 212-351-2621, sbarday@gibsondunn.com)
Nathan C. Strauss – New York (+1 212-351-5315, nstrauss@gibsondunn.com)

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.


William R. Hallatt Partner, Hong Kong	Michelle M. Kirschner Partner, London	Jeffrey L. Steiner Partner, Washington, D.C.

I. Filing and Settlement Trends

A. Filing Trends

B. Industry and Other Trends in Cases Filed

C. Settlement Trends

II. What to Watch for in the Supreme Court

A. Supreme Court Issues Narrow Decision in Price-Impact Case

B. Supreme Court to Decide whether the PSLRA’s Discovery Stay Applies in State Court

C. The Court Addresses Constitutional Challenges to Administrative Adjudicators

III. Delaware Developments

A. Court of Chancery Invalidates Poison Pill under Second Unocal Prong

B. Court of Chancery Rejects Claim that Pandemic Constituted a Materially Adverse Effect

C. Bellwether SPAC Litigation Remains in Initial Stages

D. Court of Chancery Determines CEO Breached Fiduciary Duty and Financial Advisor Aided and Abetted That Breach in Course of Executing a Merger

E. Appraisal Litigation Continues Its Steady Decline

IV. Further Development of Disseminator Liability Theory Upheld in Lorenzo

V. Survey of Coronavirus-Related Securities Litigation

A. Securities Class Actions

1. False Claims Concerning Commitment to Safety

2. Failure to Disclose Specific Risks

3. Alleged Insider Trading and “Pump and Dump” Schemes

B. Stockholder Derivative Actions

1. Disclosure Liability

2. Oversight Liability

3. Insider Trading

C. SEC Cases

VI. Falsity of Opinions – Omnicare Update

VII. Halliburton II Market Efficiency and “Price Impact” Cases

VIII. Other Notable Developments

A. Morrison Domestic Transaction Test

B. Eighth Circuit Strikes Class Allegations under Rule 12(f)

C. Congress Codifies SEC Disgorgement Remedy

D. Delaware Exclusive Forum Bylaws Applicable to Section 14

E. Ninth Circuit Upholds Broad Protection for Forward-Looking Statements

Table of Contents

I. U.S. NATIONAL POLICY & REGULATORY DEVELOPMENTS

A. U.S. National AI Strategy

1. Senate Passes Bipartisan U.S. Innovation and Competition Act (S. 1260) to Bolster Tech Competitiveness with China

2. U.S. Launches National AI Research Resource Task Force and National Artificial Intelligence Advisory Committee

3. Understanding “Trustworthy” AI: NIST Proposes Model to Measure and Enhance User Trust in AI Systems

4. GAO Publishes Report “Artificial Intelligence: An Accountability Framework for Federal Agencies and Other Entities”

B. National Security

1. Artificial Intelligence Capabilities and Transparency (“AICT”) Act

C. Algorithmic Accountability and Consumer Protection

1. Federal Lawmakers Reintroduce the Facial Recognition and Biometric Technology Moratorium Act

2. Algorithmic Justice and Online Platform Transparency Act of 2021 (S. 1896)

3. House Approves Bill to Study Cryptocurrency and Consumer Protection (H.R. 3723)

4. Data Protection Act of 2021 (S. 2134)

D. Autonomous Vehicles (“AVs”)

II. EU POLICY & REGULATORY DEVELOPMENTS

A. EDPB & EDPS Call for Ban on Use of AI for Facial Recognition in Publicly Accessible Spaces

**A. Court of Chancery Invalidates Poison Pill under Second Unocal Prong**