Last week, the Small Business Administration (the “SBA”) issued two interim final rules incorporating changes to the Paycheck Protection Program (the “PPP”) prescribed by the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act, Pub. L. 116-260 (the “Economic Aid Act”). The Act extended the authority to make PPP loans to first and second-time PPP borrowers through March 31, 2021, and changed certain PPP requirements, including establishing additional eligibility criteria for applicants seeking a second PPP loan. One of the interim final rules governs new PPP loans made under the Economic Aid Act and pending loan forgiveness applications for existing PPP loans (the “First IFR”). The other interim final rule governs second draw PPP loans (the “Second IFR”). This alert will focus on some of the key provisions of these interim final rules.[1]

First IFR  

The First IFR consolidates the interim final rules and significant guidance previously issued by the SBA regarding the PPP originally established under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) to provide a single regulation governing borrower and lender eligibility, loan application requirements and loan origination requirements, as well as general rules regarding PPP loan increases and forgiveness. The First IFR expressly states that it is not intended to substantively change any existing PPP rules that were not amended by the Economic Aid Act, and that the SBA plans to issue a consolidated rule governing PPP loan forgiveness and the loan review process.

Notable amendments to the rules governing the PPP implementing the changes required by the Economic Aid Act include the following:

• Certain new types of organizations that meet the PPP eligibility requirements are eligible to receive new PPP loans including:
  • Certain nonprofit business associations (other than professional sports leagues and organizations formed to promote or participate in a political campaign) that do not employ more than 300 employees;[2]
  • Certain news organizations that employ no more than 500 employees (or, if applicable, the employee size standard established by the SBA for the entity’s industry) per location;[3]
  • Destination marketing organizations[4] that meet the requirements described in this alert for section 501(c)(6) organizations;[5] and
  • Housing cooperatives that employ no more than 300 employees.
• Certain business concerns that may have been eligible for PPP Loans under prior rules are ineligible to receive new PPP loans. These business concerns include:
  • Public companies (i.e., companies whose securities are listed on a national securities exchange); and
  • Recipients of grants under the Shuttered Venue Operator Grant program established by the Economic Aid Act.
• All new PPP borrowers may use 2019 or 2020 for purposes of calculating their maximum loan amount.
• A PPP borrower’s forgiveness amount will not be reduced by the amount of an Economic Injury Disaster Loan (“EIDL”) advance received by the borrower. Similarly, when calculating the maximum amount of a new PPP loan that will be used to refinance an EIDL made between January 31, 2020 and April 3, 2020, borrowers should not include the amount of an EIDL advance as this advance does not need to be repaid.
• PPP loan proceeds (including PPP loans made prior to December 27, 2020, as long as the SBA has not already remitted a loan forgiveness payment to the lender with respect to the loan) may be used to pay for goods that are essential to the borrower’s operations, investments in facility modifications, personal protective equipment required for the borrower to operate safely and business software and cloud computing services that help facilitate the borrower’s business operations.
• Recipients of new PPP loans may select a covered period between eight and 24 weeks.
• The SBA will forgive a PPP loan of $150,000 or less if the borrower signs and submits a one-page certification that, among other things, requires the borrower to describe the number of employees it was able to retain because of the PPP loan. The SBA has not published the certification to date.

Second IFR 

The Economic Aid Act gives PPP loan recipients the opportunity to receive, for the first time, a second PPP loan. However, the eligibility requirements are narrower than those for initial PPP loans as we first described in our recent client alert, Coronavirus Relief Package Passed by Congress Would Revive Paycheck Protection Program and Provide Additional Relief to Eligible Businesses. Each potentially eligible borrower must be an eligible recipient of an initial PPP loan and: (1) together with its affiliates, employ 300 or fewer employees (compared to the 500 employee standard for initial PPP loans); however, hotels and restaurants with a NAICS code beginning with 72 and certain news organizations are exempt from the affiliation rules and may employ 300 or fewer employees per physical location; (2) have used, or will use, the first PPP loan funds on eligible expenses before the second PPP loan is disbursed; and (3) demonstrate at least a 25% reduction in revenue in at least one quarter of 2020 relative to 2019. Borrowers whose initial PPP loans are under review will not receive a second loan until their eligibility for the first loan is confirmed.

Second draw PPP loans are eligible for loan forgiveness under the same terms as initial PPP loans, including the changes to the forgiveness rules set forth in the First IFR. Most borrowers’ maximum second draw loan amount is capped at 2.5 times monthly payroll costs up to $2 million, although eligible hotels and restaurants may receive a second draw loan of up to 3.5 times monthly payroll costs up to $2 million.

The Second IFR provides important clarifications for second draw PPP loan requirements under the Economic Aid Act:

• First, the 25% revenue reduction may be measured by comparing quarterly revenues (as established in the Economic Aid Act) or annual revenues. The Second IFR makes clear that eligible borrowers may use annual tax returns, in addition to quarterly statements, to demonstrate that they experienced at least a 25% reduction in revenue in 2020 as compared to 2019 to meet the revenue reduction criteria under the Economic Aid Act. An entity that was not in business during 2019, but was in operation on February 15, 2020, may satisfy the revenue reduction requirement for a second draw PPP loan if it had revenue during the second, third, or fourth quarter of 2020 that demonstrates at least a 25 percent reduction from the revenue of the entity during the first quarter of 2020.
• Second, borrowers may calculate payroll costs based on calendar year 2020 rather than, as provided in the Economic Aid Act, the 12-month period before the second loan is made. Noting that all second draw PPP loans will be made in 2021, the Second IFR states that this adjustment is not expected to make a significant difference in payroll costs while simplifying the payroll cost calculation and easing a borrower’s administrative burden. Adjusted calculation methodologies apply to seasonal businesses.
• Third, borrowers must determine whether their revenue was reduced in 2020 as compared to 2019 by comparing their “gross receipts” for the relevant periods. “Receipts” for this purpose is defined consistent with “receipts” as defined in SBA’s size regulations (§ 121.104) to include “all revenue in whatever form received or accrued (in accordance with the entity’s accounting method) from whatever source, including from the sales of products or services, interest, dividends, rents, royalties, fees, or commissions, reduced by returns and allowances.” Amounts forgiven in connection with initial PPP loans are not included in this definition.[6]
• Fourth, businesses that are part of a single corporate group may not collectively receive more than $4 million in second draw PPP loans in the aggregate. Given the maximum loan amount of $2 million, this cap is proportionately the same as the $20 million aggregate limit for first draw PPP loans to businesses that are part of a single corporate group. A borrower that has temporarily closed or temporarily suspended its business remains eligible for a second draw PPP loan, while a borrower that has permanently closed its operations is not.
• Finally, potential borrowers seeking more than $150,000 in a second draw PPP loan must submit documentation—such as annual tax forms or quarterly financial statements—at the time of their application to support the 25% reduction in revenue relative to 2019. Borrowers that receive less than $150,000 must submit such documentation prior to applying for loan forgiveness. If a borrower does not apply for loan forgiveness, this documentation is required upon request by the SBA.

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   [1]   For additional details about the PPP please refer to Gibson Dunn’s Frequently Asked Questions to Assist Small Businesses and NonProfits in Navigating the COVID-19 Pandemic and prior Client Alerts about the Program: Federal Reserve Modifies Main Street Lending Programs to Expand Eligibility and Attractiveness; President Signs Paycheck Protection Program Flexibility Act; Small Business Administration and Department of Treasury Publish Paycheck Protection Program Loan Application Form and Instructions to Help Businesses Keep Workforce Employed; Small Business Administration Issues Interim Final Rule and Final Application Form for Paycheck Protection Program; Small Business Administration Issues Interim Final Rule on Affiliation, Summary of Affiliation Tests, Lender Application Form and Agreement and FAQs for Paycheck Protection Program; Analysis of Small Business Administration Memorandum on Affiliation Rules and FAQs on Paycheck Protection Program; Small Business Administration Publishes Additional Interim Final Rules and New Guidance Related to PPP Loan Eligibility and Accessibility; Small Business Administration Publishes Loan Forgiveness Application; and Coronavirus Relief Package Passed by Congress Would Revive Paycheck Protection Program and Provide Additional Relief to Eligible Businesses.

   [2]   To be eligible, the business association must qualify for federal income tax-exempt status under section 501(c)(6) of the Internal Revenue Code and (1) it must not receive more than 15 percent of its receipts from lobbying activities; (2) its lobbying activities must not comprise more than 15 percent of its total activities; and (3) the cost of its lobbying activities must not exceed $1,000,000 during its most recent tax year ended prior to February 15, 2020.

   [3]   To be eligible, the news organization must be majority owned or controlled by a NAICS code 511110 business (newspaper publishers) or 5151 business (radio networks, radio stations, television broadcasting), or a nonprofit public broadcasting entity with a trade or business under NAICS code 511110 or 5151, and must certify in good faith that proceeds of the loan will be used to support expenses at the component of the organization that produces or distributes locally focused or emergency information.

   [4]   The Economic Aid Act defines a “destination marketing organization” as (a) engaged in marketing and promoting communities and facilities to businesses and leisure travelers through a range of activities, including assisting with the location of meeting and convention sites; providing travel information on area attractions, lodging accommodations and restaurants; providing maps; and organizing group tours of local historical, recreational and cultural attractions; or (b) engaged in, and deriving the majority of its operating budget from revenue attributable to, providing live events.

   [5]   In addition, to be eligible, the destination marketing organization must either be exempt from federal income taxation under section 501(a) of the Internal Revenue Code or be a quasi-governmental entity or political subdivision of a State or local government or their instrumentalities.

   [6]   The Second IFR also states that “receipts generally are considered “total income” (or in the case of a sole proprietorship, independent contractor, or self-employed individual “gross income”) plus “cost of goods sold,” and exclude net capital gains or losses as these terms are defined and reported on IRS tax return forms.”

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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, or the following authors:

Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com)
Roscoe Jones, Jr. – Washington, D.C. (+1 202-887-3530, rjones@gibsondunn.com)
Alisa Babitz – Washington, D.C. (+1 202-887-3720, ababitz@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP

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

In an unprecedented year for UK regulated firms and the Financial Conduct Authority (“FCA”), the regulatory agenda has at times seemed dominated by the global pandemic. However, regulated firms should be mindful of the regulatory direction of travel. This client alert assesses the regulatory landscape, now and in the coming years, through the prism of three areas of increasing regulatory focus: governance, culture and individual accountability; conduct and enforcement; and operational and financial resilience. This client alert provides practical guidance to firms to ensure continuing compliance with regulatory expectations in each of these three areas. The regulatory landscape has also been impacted as a result of the ending of the Brexit transition period on 31 December 2020. The FCA’s actions over last year will be shown to be indicators of the type of regulator that the FCA may seek to be post-Brexit.

The Gibson Dunn UK Financial Services Regulation team looks forward to discussing the matters outlined in this alert in further detail. For more analysis, please join us for our upcoming complimentary webinar presentation on 27 January 2021: UK Financial services regulatory update: what happened in 2020 and what to expect in 2021 and beyond (to register, click here).

Executive Summary

Governance, culture and individual accountability It is important that firms have strong governance frameworks that allow their culture and values to drive decision-making across the business. A key barometer that a firm is meeting the FCA’s expectations is the effective  implementation of the Senior Managers and Certification Regime (“SMCR”). In 2021 and beyond, we anticipate an increase in enforcement action from the FCA in this area, as we move away from the implementation phase of the SMCR for solo-regulated firms. Conduct and enforcement Working from home poses particular challenges for firms when monitoring the conduct of staff. However, the FCA expects firms to have appropriate systems and controls in place to manage the enhanced conduct risks that arise in the context of the pandemic and it is likely that there will be a regulatory review of how firms treated clients at the time. The regulatory direction of travel has been to push firms to think more broadly in terms of what types of misconduct they need to tackle with an increased focus on non-financial misconduct and how this reflects the culture of the firm. Operational and financial resilience These have been a particular area of FCA focus for some time. The pandemic is indicative of the type of scenario that firms must be prepared for, however, it is only one of many scenarios which the FCA would expect firms to factor into risk assessments and business continuity plans. We anticipate that the FCA will conduct a detailed retrospective review of firms’ operational and financial resilience throughout 2021. Post-Brexit UK regulatory outlook Prior to the conclusion of the EU-UK free trade agreement (discussed further below), the government produced a number of documents that indicate what a post-Brexit UK regulatory framework may look like. The UK approach is intended to “to ensure that [the UK] regulatory regime has the agility and flexibility needed to respond quickly and effectively to emerging challenges and to help UK firms seize new business opportunities in a rapidly changing global economy.” The UK Government’s willingness to diverge from the EU in certain regulatory matters raises important questions regarding the likelihood of any future EU equivalence decisions.

The year in review

2020 was an unprecedented year for both UK regulated firms and the FCA. Both had to adjust to a “new normal”, which in most cases included initiating working from home contingency planning. The regulatory agenda for the year was in many ways dominated by the global pandemic. This is illustrated by the FCA’s annual Business Plan[1], which was heavily influenced by tackling the impact of COVID-19. In response to the pandemic, the FCA delayed certain regulatory initiatives and indicated regulatory forbearance in a number of areas, while maintaining the emphasis on the importance of treating customers fairly[2].

However, the FCA continued to advance certain areas of regulatory focus. It is, therefore, possible to identify key themes that the FCA focused on during 2020 and is likely to pursue in the coming months and years. In particular, this client alert will focus on three important areas of regulatory interest: (1) governance, culture and individual accountability; (2) conduct and enforcement; and (3) operational and financial resilience. These key areas can be assessed in terms of the FCA’s developments during 2020 but also what regulated firms need to be aware of in terms of each of these areas going forward.

(1)  Governance, culture and individual accountability

“The specifics of your culture, like your strategy, remain up to you as leaders. But there is a growing consensus that healthy cultures are purposeful, diverse and inclusive.”[3]

Governance, culture and individual accountability are inextricably linked. As the quote above from the FCA suggests, the FCA will not dictate what a firm’s governance model or culture should be. Both are firm-specific, however, firms should be wary of the FCA’s expectations.

The FCA’s Approach to Supervision document[4] notes that the key cultural drivers in firms are: purpose; leadership; approach to rewarding and managing people; and governance. Last year the FCA reiterated the importance of these factors in its annual Business Plan and in a discussion paper on driving purposeful cultures.[5]

The importance of good governance, in particular, forms a common thread through the FCA’s supervisory correspondence to key industry sectors. For example, the FCA has emphasised that it is “important that firms have strong governance frameworks that allow their culture and values to drive decision-making across the business, including its approach to dealing with all kinds of misconduct. It is also critical that firms are headed by effective boards, with a suitable mix of skills and experience, to conduct appropriate oversight of the firms’ risks, strategy, policies and controls”.[6]

A key barometer that a firm is meeting the FCA’s expectations is the effectiveness of its implementation of the  Senior Managers and Certification Regime (“SMCR”). The introduction of the SMCR was driven by a perceived lack of individual accountability and governance failings post-financial crisis. For the majority of solo-regulated firms, the SMCR has now applied for over a year, whilst a similar regime for banks and insurers has applied since 2016. The implementation of the SMCR is an iterative process. What constituted adequate implementation for 9 December 2019 will not necessarily be sufficient now. Firms should be considering how their implementation can be tested and enhanced.

Key practical steps for firms Take stock of the firm’s current governance arrangements to identify any areas in which there is a need for improvement. For example: are there clear accountabilities for those activities which affect outcomes, with appropriate delegation and escalation? is a robust risk framework in place under which accountable individuals identify, monitor and mitigate key risks of harm? is there strong and independent Board oversight and challenge? From a “firm culture” perspective, whilst the focus is now also on the “tone from above” (such as immediate line managers), it is clear that “tone from the top” still remains crucial. Firms should think about what their CEOs, business line heads and other senior individuals say – and what they do not say – in this context. Further, are messages from the top, including corporate purpose and values, translated in a meaningful way to the specific roles and responsibilities, targets and objectives at the individual and unit level across the firm? One year on from the coming into force of the SMCR for solo-regulated firms, review the firm’s implementation of the regime to identify any weaknesses and take any required remedial action.

(2)  Conduct and enforcement

“We will remain vigilant to potential misconduct. There may be some who see these times as an opportunity for poor behaviour – including market abuse, capitalising on investors’ concerns or reneging on commitments to consumers…Where we find poor practice, we will clamp down with all relevant force.”[7]

A key indicator of a firm’s culture is its practical response to compliance issues and, in particular, instances of potential misconduct. Market abuse (including the handling of confidential information)[8] and personal account dealing[9] remain perennial areas of regulatory focus. Working from home poses particular challenges for firms when monitoring the conduct of staff. However, the FCA expects firms to have appropriate systems and controls in place to manage the enhanced conduct risks that arise in the context of the pandemic.[10]

The pandemic undoubtedly had an impact on enforcement action, for example, instances of regulatory forbearance and the FCA holding back on searches / warrants.  The FCA issued the lowest number of fines since its establishment in 2013:

However, the FCA took a number of high-profile enforcement actions against firms. For example, in 2020, the FCA continued to take action against firms for market misconduct[11], failures to show forbearance and due consideration to customers in financial difficulty[12] and took the first UK enforcement action under the Short Selling Regulation.[13]

The regulatory direction of travel has been towards an increased focus on non-financial misconduct and how this is tackled by firms. A increasing challenge for regulated firms is how to address non-financial misconduct and, in particular, non-financial misconduct that takes place outside of the workplace.[14] In response to the Me Too movement in 2018, firms introduced corrective responses to this important issue. However, in 2021 the FCA would expect a thorough and well-thought out response. Diversity and inclusion are now rightly integral to the FCA’s assessment of a firm’s culture.

Key practical steps for firms As required under the SMCR, check that the firm has a robust process to ensure that senior managers and certification staff are “fit and proper”, both on joining and on an ongoing basis. Review the firm’s processes for the handling and escalation of misconduct. For example, review the firm’s whistleblowing procedures and make sure that staff are appropriately trained and have an understanding of their obligations to inform the firm of relevant matters.[15] Consider whether the firm’s remuneration structure incentivises appropriate or inappropriate behaviour.

(3)  Operational and financial resilience

“We expect all firms to have contingency plans to deal with major events and that these plans have been properly tested.” “…financial pressures could give rise to harm to customers if firms cut corners on governance or their systems and controls – for example, increasing the likelihood of financial crime, poor record keeping, market abuse and unsuitable advice and investment decisions.”[16]

It will come as no surprise that the FCA focused on regulated firms’ operational and financial resilience during 2020. For example, the FCA issued statements to firms outlining its expectations on financial crime systems and controls and information security during the pandemic.[17] In addition, in June and August 2020, the FCA issued a COVID-19 impact survey to help gain a more accurate view of firms’ financial resilience. This mandatory survey was repeated in November 2020 to understand the change in firms’ financial positions with time.[18]

However, the regulatory focus on operational and financial resilience goes beyond the pandemic. In December 2019 the FCA, alongside the Prudential Regulation Authority and the Bank of England, published a joint consultation paper on operational resilience.[19] The pandemic is indicative of the type of scenario that firms must be prepared for, but it is one of many scenarios for which the FCA would expect firms to factor into risk assessments and business continuity plans.

Similarly, the FCA’s focus on financial resources is wider than in the context of the pandemic. The FCA has indicated that it will implement its own version of the Investment Firms Regulation and that the new regime will come into force on 1 January 2022. The FCA has also published final guidance on a framework to help financial services firms ensure they have adequate financial resources and to take effective steps to minimise harm.[20] In particular, the FCA notes that the guidance does not place specific additional requirements on firms because of COVID-19, but the crisis underlines the need for all firms to have adequate resources in place and to assess how those needs may change in the future.

Key practical steps for firms Review the firm’s business continuity plan and risk assessment to ensure that they are comprehensive and stand up to scrutiny. For example, make sure any risks associated with “working from home” are incorporated and mitigated as far as possible. Re-visit the firm’s assessment of its adequacy of financial resources, in light of the FCA’s published guidance, referred to above.

Forward looking regulatory priorities

Looking to the future, it is very likely indeed that the FCA’s priorities will, at least in part, mirror those areas of focus in 2020 (being: (1) governance, culture and individual accountability; (2) conduct and enforcement; and (3) operational and financial resilience).

(1) Governance, culture and individual accountability

Whilst the FCA has been relatively quiet from an enforcement perspective to date, firms should not be drawn into a false sense of security. This is particularly the case given that the extension of the regime brought within scope a significant number of firms (approximately 47,000). Additionally, a number of these firms are also more likely to be viewed as “low hanging fruit” by the FCA – some firms will perhaps have less sophisticated governance procedures in place (meaning potentially more breaches) and it will be much easier for the FCA to identify the decision-making processes of these solo-regulated firms when it is investigating breaches.

As at 17 August 2020, there were 25 open FCA investigations relating to senior managers. Of these, the majority related to retail misconduct, wholesale misconduct and senior manager conduct rule breaches.

It appears that resolution of these matters has been delayed by the pandemic but we expect to see some of these senior manager outcomes in 2021. We also anticipate an increase in new enforcement action from the FCA in this area, as we move away from the implementation phase of the SMCR for solo-regulated firms.

(2) Conduct and enforcement

As noted above, there is evidence to suggest that the pandemic has had some impact on enforcement action, for example, instances of regulatory forbearance and the FCA holding back on searches / warrants. However, it is likely that there will be a regulatory review of how firms treated clients during pandemic. As the FCA’s pronouncements since March 2020 have indicated, regulatory forbearance in certain areas does not replace regulated firm obligations under the regulatory system and, in particular, to treat customers fairly. It is highly likely that the FCA will conduct a retrospective review of firms’ conduct.|

This will likely include a review of firms’ financial crime controls during the pandemic.  In Guidance it issued in May, the FCA acknowledges operational issues faced by firms but was clear that firms should not adjust their risk appetites in the face of new risks.[21]  There will undoubtedly be a focus on fraud and other crimes committed during the pandemic, and firms will face scrutiny if there were red flags that were missed or not escalated.  Firms may wish to, therefore, take the opportunity now to review the efficacy of the controls they have in place, as a general “health check”.

As at 17 August 2020, there were 571 open FCA investigations, with a significant focus on consumers, with retail misconduct accounting for 192 of these investigations. Other common areas responsible for investigations included: unauthorised business (103); insider dealing (60); financial crime (57); financial promotions (49) and wholesale conduct (33). We would, therefore, expect a number of these investigations to crystallise into final notices producing a series of messages around expected standards throughout the course of 2021.

Another potential area of regulatory focus in the conduct space is the transition from LIBOR. The FCA has already indicated that a member of senior management should be responsible for LIBOR transition, where applicable to the business.[22] Firms need to consider whether any LIBOR-related risks are best addressed within existing conduct risk frameworks or need a separate, dedicated program. Amongst other things, firms should keep appropriate records of management meetings or committees that demonstrate they have acted with due skill, care and diligence in their overall approach to LIBOR transition and when making decisions impacting customers.

(3) Operational and financial resilience

As noted above, whilst the pandemic firmly brought the operational and financial resilience of firms into the FCA’s cross-hairs, this was a particular area of interest of the regulator pre-COVID-19. As stated by the FCA’s Executive Director of Supervision: Investment, Wholesale and Specialist in December 2019, the “[FCA’s] intention is to bring about change in how the industry thinks about operational resilience – a shift in mindset as it were – informed and driven by the public interest”.[23]

The industry disruption caused by the pandemic, however, provides the FCA with an invaluable opportunity in a “real life” context, as opposed to simulated scenario, to kick the tyres of firms’ policies and procedures in order to determine how they coped with the operational and financial stresses brought about during the unprecedented circumstances of 2020. Whereas in 2020, the focus of the regulator was much more reactive, in terms of (for example) issuing statements outlining its expectations on financial crime systems and controls, we anticipate that 2021 will be much more centred around retrospective reviews of firms – for example, through looking at their business continuity plans, amongst other things.

Post-Brexit UK regulatory framework

The route map

A long awaited free trade agreement between the UK and EU was agreed on 24 December 2020, governing their relationship post-Brexit transition period. The financial services industry is addressed in the agreement, albeit to a much lighter extent than for goods and other services. The contents of the provisions on financial services are unlikely to come as a great surprise to the industry – amongst other things, the agreement does not provide for passporting rights nor address equivalence decisions. It is worth noting, however, that a joint declaration  draft states that the parties will, by March 2021, agree a memorandum of understanding establishing the framework for structured regulatory co-operation on financial services. The aim of this is to provide for transparency and appropriate dialogue in the process of adoption, suspension and withdrawal of equivalence decisions.

In the months leading up to the eventual conclusion of the free trade agreement, the UK government produced a number of documents that indicate what a post-Brexit UK regulatory framework may look like. The Financial Services Bill[24] states that the UK Government has a number of objectives including: (1) enhancing the UK’s world-leading prudential standards and promoting financial stability; (2) promoting openness between the UK and overseas markets; and (3) maintaining the effectiveness of the financial services regulatory framework and sound capital markets. The UK Government has also published the Phase II consultation of its Financial Services Future Regulatory Framework Review.[25] The UK Government’s approach is intended to “to ensure that [the UK] regulatory regime has the agility and flexibility needed to respond quickly and effectively to emerging challenges and to help UK firms seize new business opportunities in a rapidly changing global economy.”

In its response to the global pandemic, the FCA’s actions are also indicative of the type of regulator it may be post-Brexit. Through its exercise of regulatory forbearance, for example, the FCA has proven itself to be more nimble and pragmatic.

Regulatory divergence

The UK approach in an environmental, social and governance (“ESG”) setting is another sign as to what the industry might expect in a post-Brexit world. Rather than onshore the EU Sustainable Finance Disclosure Regulation, the UK has announced that it will introduce disclosure rules aligning with the recommendations of the Task Force on Climate-related Financial Disclosures (“TCFD”).[26] This will make the UK the first country in the world to make TCFD-aligned disclosures mandatory. It was also announced that the UK will implement a green taxonomy – a common framework for determining which activities can be defined as environmentally sustainable. This will take the scientific metrics in the EU taxonomy as its foundation and a UK Green Technical Advisory Group will be established to review these metrics to ensure they are appropriate for the UK market.

Whilst this by no means signals a radical departure from the EU in terms of regulatory approach – indeed, the UK Government has flagged the need in the ESG sphere for, where possible, consistency between UK and EU requirements – the UK Government’s willingness to diverge from the EU in certain regulatory matters raises important questions regarding the likelihood of any future EU equivalence decisions.

The global stage

Perhaps in common with the UK’s desire to remain a key player on the global stage post-Brexit, despite not forming a part of the more influential EU, the FCA is also keen not to become isolated from other regulators across the world and to keep working closely on matters spanning different jurisdictions. By way of an example, the TFS-ICAP final notice[27] (under which the FCA fined TFS-ICAP Ltd, an FX options broker, £3.44 million for communicating misleading information to clients), indicated that the FCA continues to work in tandem with overseas regulators (in this instance, the Commodity Futures Trading Commission in the United States).

Conclusion

Firms may be lured into a false sense of security that they can in some way “take the foot off the gas” from a regulatory perspective after having made it through a tumultuous 2020. However, this could not be further from the truth. Whilst 2020 was an unprecedented year, the FCA by no means gave firms carte blanche when it came to regulatory compliance, particularly in instances where there is a risk of customer detriment. It is in 2021 that we expect to see action from the FCA towards those firms who did not meet its expectations. This will be the case not just for firms but also, as we move away from the implementation phase of the SMCR for solo-regulated firms, individuals as well.

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Gibson Dunn’s UK Financial Services Regulation team looks forward to discussing the matters outlined in this alert in further detail in a client webinar in the near future, details of which will be provided shortly. Please feel free to contact the Gibson Dunn lawyer with whom you usually work, or any of the following authors:

Michelle M. Kirschner (+44 (0) 20 7071 4212, mkirschner@gibsondunn.com)
Matthew Nunan (+44 (0) 20 7071 4201, mnunan@gibsondunn.com)
Steve Melrose (+44 (0) 20 7071 4219, smelrose@gibsondunn.com)
Martin Coombes (+44 (0) 20 7071 4258, mcoombes@gibsondunn.com)
Chris Hickey (+44 (0) 20 7071 4265, chickey@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP

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

On January 11, 2021, the Supreme Court in a summary disposition vacated the U.S. Court of Appeals for the Second Circuit’s major insider trading decision in United States v. Blaszczak, 947 F.3d 19 (2d Cir. 2019), remanding the case to the Second Circuit for further consideration in light of the Supreme Court’s recent decision in Kelly v. United States, 140 S.Ct. 1565 (2020). See Blaszczak v. United States, 2021 WL 78043 (Jan. 11, 2021); Olan v. United States, 2021 WL 78042 (Jan. 11, 2021). The Supreme Court’s decision raises important questions regarding whether, and to what extent, the Second Circuit will retreat from the significant expansion of insider trading liability it enunciated in Blaszczak barely more than one year ago.

United States v. Blaszczak

As we described in greater detail in a prior client alert, in Blaszczak, the U.S. Department of Justice (“DOJ”) alleged that, between 2009 and 2014, certain Centers for Medicare & Medicaid Services (“CMS”) employees disclosed confidential information relating to planned changes to medical treatment reimbursement rates to David Blaszczak, a former CMS employee who became a “political intelligence” consultant for hedge funds. Blaszczak allegedly provided this “predecisional” confidential information to employees of the hedge fund Deerfield Management Company, L.P., which then shorted stocks of healthcare companies that would be hurt by the planned reimbursement rate changes.

The DOJ indicted Blaszczak, one CMS employee, and two Deerfield employees for the alleged insider trading scheme. After an April 2018 trial, the jury returned a split verdict, acquitting all the defendants on certain counts, but finding the defendants guilty on other counts, including conversion, wire fraud, and (except for the CMS employee) Title 18 securities fraud. The defendants appealed.

In December 2019, the Second Circuit upheld the convictions and, in doing so, heightened the risk of investigation and prosecution in certain types of insider trading cases in two significant respects. First, in traditional civil and criminal insider trading cases against both tippers and tippees for Title 15 securities fraud under the Securities Exchange Act, the government must prove, among other things, that the tipper breached a duty in exchange for a direct or indirect personal benefit, and that the downstream tippee knew that the tipper had done so. The Second Circuit held that, by contrast, there is no “personal benefit” requirement in criminal insider trading cases charging Title 18 offenses like wire fraud and the criminal securities fraud provisions added in 2002 in the Sarbanes-Oxley Act.

Second, the court held that the “predecisional” confidential information relating to planned medical treatment reimbursement rate changes constituted government “property” necessary to bring insider trader cases under an embezzlement or misappropriation theory. In so holding, the Second Circuit found that this confidential government information was more akin to The Wall Street Journal’s confidential business information that the Supreme Court held constituted property for insider trading purposes in Carpenter v. United States, 484 U.S. 19 (1987), than to the fraudulently-obtained Louisiana state video poker licenses that the Supreme Court found did not constitute property in Cleveland v. United States, 531 U.S. 12 (2000), because “the State’s core concern” in granting video poker licenses was “regulatory.”

The Second Circuit’s decision thus expanded potential criminal insider trading liability in cases where there was limited-to-no evidence of a personal benefit to the tipper or that the downstream tippee knew of such a benefit, as well as in cases involving disclosure of nonpublic government information.

Kelly v. United States

In May 2020, five months after the Second Circuit’s decision in Blaszczak, the Supreme Court in Kelly addressed the scope of government “property” under federal fraud statutes. Specifically, the Supreme Court reviewed the criminal convictions of two “Bridgegate” defendants on federal-program and wire fraud charges arising out of their alleged involvement in a scheme to limit the number of lanes in Fort Lee, New Jersey accessing the George Washington Bridge as political retribution against the city’s mayor. To convict under both fraud provisions, the government was required to show “that an object of their fraud was money or property.”

The Supreme Court reversed the convictions, holding that “[t]he realignment of the toll lanes was an exercise of regulatory power—something this Court has already held fails to meet the statutes’ property requirement. And the [traffic engineers and toll collectors’] labor was just the incidental cost of that regulation, rather than itself an object of the officials’ scheme.” In reaching this conclusion, the Supreme Court relied heavily on Cleveland, noting that the defendants “exercised the regulatory rights of ‘allocation, exclusion, and control,’” and “under Cleveland, that run-of-the-mine exercise of regulatory power cannot count as the taking of property.”

Blaszczak Appeal to Supreme Court

In September 2020, three of the Blaszczak defendants petitioned the Supreme Court for a writ of certiorari, arguing that the Second Circuit had improperly expanded criminal insider trading liability by holding that there was no “personal benefit” requirement in Title 18 insider trading cases and that, contrary to the Supreme Court’s rulings in Cleveland and Kelly, predecisional confidential information constituted government property. See Petition for a Writ of Certiorari, Blaszczak v. United States (Sept. 4, 2020) (No. 20-5649); Petition for a Writ of Certiorari, Olan v. United States, 2020 WL 5439755 (Sept. 4, 2020).

Rather than address the propriety of the Second Circuit’s decision head-on, the government in its response brief instead argued that “the appropriate course is to grant the petitions for writs of certiorari, vacate the decision below, and remand the case for further consideration in light of Kelly.” Mem. for the United States, Blaszczak v. United States (Nov. 24 2020) (Nos. 20-306 & 20-5649).

On reply, the petitioners argued that the Supreme Court should squarely rule on their petition, rather than vacate and remand, noting that the Second Circuit may only “reverse[] itself on the ‘property’ issue,” without needing to again address its prior holding that there was no personal benefit requirement in Title 18 insider trading cases. Reply Brief for Petitioners, Olan v. United States, 2020 WL 7345516 (Dec. 8, 2020). As a result, “unless the [Second Circuit’s] existing erasure of the personal-benefit requirement…is repudiated, prosecutors in the Second Circuit will continue to feel free to charge insider-trading crimes even where there is no proof of personal benefit. And district courts in the Circuit (where most insider-trading prosecutions are brought) would likely follow the Second Circuit’s lead even if it were not technically binding….”

Despite the concerns that petitioners raised, on January 11, 2021, the Supreme Court agreed to the course that the government proposed, granting certiorari and directing that “[t]he judgment is vacated, and the case is remanded to the…Second Circuit for further consideration in light of Kelly….” Blaszczak v. United States, 2021 WL 78043 (Jan. 11, 2021); Olan v. United States, 2021 WL 78042 (Jan. 11, 2021).

Implications of Supreme Court’s Blaszczak Decision

It is unclear at this juncture what effect, if any, the Supreme Court’s decisions in Kelly and Blaszczak will have on the Second Circuit’s expansion of insider trading liability. In an expansive reading, for example, the Second Circuit could distinguish the “exercise of regulatory power” in Kelly from the “predecisional” government information in Blaszczak and continue to analogize confidential government information to the confidential business information that the Supreme Court ruled in Carpenter constitutes property for insider trading purposes. In a narrower reading, the Second Circuit could find that the principle of Kelly should apply to predecisional government information and thus that it does not constitute property under Title 18 securities fraud.

If the Second Circuit concludes that, after Kelly, confidential government information does not constitute property, the Court could reverse the convictions on this ground while leaving unaddressed its prior holding that there is no personal benefit requirement in Title 18 insider trader cases. As the petitioners warned the Supreme Court, prosecutors in this scenario would likely treat this silence as a green light to continue to charge insider-trading crimes where there is little to no evidence of a personal benefit to the tipper, or tippee knowledge of that benefit. Of course, under such circumstances, prosecutors would not have the benefit of Blaszczak to rely on, and thus there could be litigation risk to the government depending on the facts of the particular case.

Clouding the picture even further is that the Second Circuit ruling in Blaszczak was a 2-1 decision. And one of the two judges who joined in the majority ruling has since retired. As a result, the outcome of Blaszczak could be impacted significantly by the views of the third judge assigned to the panel. Should that new judge join with the original dissenting judge, the Blaszczak holding will change substantially. In addition, regardless of how the Second Circuit rules on remand, the losing side may seek the Supreme Court’s review of that decision. Blaszczak will therefore continue to be an important case to monitor in the ongoing court battles to define the scope of insider trading liability.

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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. For additional information, please feel free to contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Securities Enforcement or White Collar Defense and Investigations practice groups, or the following authors:

Reed Brodsky – New York (+1 212-351-5334, rbrodsky@gibsondunn.com)
Barry R. Goldsmith – New York (+1 212-351-2440, bgoldsmith@gibsondunn.com)
M. Jonathan Seibald – New York (+1 212-351-3916, mseibald@gibsondunn.com)

Please also feel free to contact any of the following practice leaders:

Securities Enforcement Group:
Barry R. Goldsmith – New York (+1 212-351-2440, bgoldsmith@gibsondunn.com)
Richard W. Grime – Washington, D.C. (+1 202-955-8219, rgrime@gibsondunn.com)
Mark K. Schonfeld – New York (+1 212-351-2433, mschonfeld@gibsondunn.com)

White Collar Defense and Investigations Group:
Joel M. Cohen – New York (+1 212-351-2664, jcohen@gibsondunn.com)
Nicola T. Hanna – Los Angeles (+1 213-229-7269, nhanna@gibsondunn.com)
Charles J. Stevens – San Francisco (+1 415-393-8391, cstevens@gibsondunn.com)
F. Joseph Warin – Washington, D.C. (+1 202-887-3609, fwarin@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP

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

On January 9, 2021, the Ministry of Commerce of the People’s Republic of China (the “MOFCOM”) issued the MOFCOM Order No. 1 of 2021 on Rules on Counteracting Unjustified Extraterritorial Application of Foreign Legislation and Other Measures (the “Chinese Blocking Statute”). The Chinese Blocking Statute establishes the first sanctions blocking regime in China to counteract the impact of foreign sanctions on Chinese persons.[1] While the law is effective immediately, as noted below, it currently only establishes a legal framework. The law will become enforceable once the Chinese government denotes the specific extraterritorial measures—likely sanctions and export controls the United States is increasingly levying against Chinese companies—to which it then will apply.

The European Union has a comparable set of rules – known as the “EU Blocking Statute” – which seeks to restrict the impact on EU parties of unilateral, extraterritorial U.S. sanctions.[2] The new Chinese rules appear to borrow much from the European model.

There are several core components to the new Chinese rule:

Reporting Obligation: The Chinese Blocking Statute creates a reporting obligation for Chinese persons and entities impacted by extraterritorial foreign regulations. Under the new rules, when “a [Chinese] citizen, legal person or other organization … is prohibited or restricted by foreign legislation and other measures from engaging in normal economic, trade and related activities with a third State (or region) or its citizens, legal persons or other organizations,” the Chinese person or entity is required to report such matters to China’s State Council within 30 days.[3] Critically, this reporting obligation is applicable to Chinese subsidiaries of multinational companies.

A comparable reporting requirement, including the 30-day reporting obligation, is also found in the EU Blocking Statute.[4]

Implicated Foreign Laws: Unlike the EU Blocking Statute, the specific laws and measures covered by the Chinese Blocking Statute have yet to be identified. Specifically, the Chinese Blocking Statute establishes a mechanism for the government to designate specific foreign laws as “unjustified extraterritorial applications,” and subsequently issue prohibitions against compliance with these foreign laws. Under the Chinese Blocking Statute, a “working mechanism” led by the State Council is responsible for assessing and determining whether the foreign sanctions laws constitute “unjustified extra-territorial application of foreign legislation and other measures.” The law sets out an open-ended and largely undefined list of factors for the State Council to consider, including whether the law represent “a violation of principals of international relations,” impacts China’s “national sovereignty, security and development interests,” or effects the “legitimate rights and interests” of Chinese persons and entities, as well as “other factors that shall be taken into account.”[5] If the working mechanism confirms the existence of an “unjustified extraterritorial application” of a foreign law, it will direct the State Council to issue an order prohibiting parties in China from complying with the law.[6]

The EU Blocking Statute, in comparison, applies only to a specific set of laws specified in its Annex[7]–which presently consists principally of certain U.S. sanctions on Cuba and Iran. While the Chinese model may appear to provide individuals and entities with time to adjust and comply as the Chinese government will only list laws and measures in the future, the Chinese rules might eventually target substantially more foreign laws and measures.

Exemption Process: A Chinese person or entity will be able to apply for an exemption from compliance with the prohibition by submitting a written application to the State Council. Such request will need to provide the reasons for and the scope of the requested exemption. The State Council will then decide whether to approve such application within 30 days or less.[8] The format for applying for an exemption is not yet clear.

The EU Blocking Statute has a similar exemption mechanism. However, the EU Blocking Statute provides for approval “(…) without delay”[9]—which in practice can mean significantly more than 30 days.

Private Right of Action: Like the EU Blocking Statute, the Chinese rule creates a private right of action for Chinese persons or entities to seek civil remedies in Chinese courts from anyone who complies with prohibited extraterritorial measures, unless the State Council has granted an exemption to the prohibition order.[10] Under the EU Blocking Statute, EU entities are also entitled to sue for damages, including legal costs, arising from the application of the extraterritorial measures (enforcement of which claims may extend to seizure and sale of assets).[11]

A Chinese person or entity who suffers “significant losses” due to a counterparty’s compliance with a prohibited law may also obtain “necessary support” from the Chinese government[12].

Consequences of Non-Compliance: A Chinese person or entity who fails to comply with the reporting obligation or the prohibition order may be subject to government warnings, orders to rectify, or fines.[13] Under the EU Blocking Statute, individual member states exercise enforcement authority. In several such states, entities have been threatened with fines, and have even been subject to mandated specific performance of contractual obligations which may expose them to risk of liability under U.S. sanctions.

While the Chinese regulations remain nascent and the initial list of extra-territorial measures that the Blocking Statute will cover has yet to be published, the law marks a material escalation in the longstanding Chinese rhetoric threatening counter-measures against the United States (principally) by establishing a meaningful Chinese legal regime that will challenge foreign companies with operations in China. If the European model for the Blocking Statute continues to be Beijing’s inspiration, we will likely see both administrative actions to enforce the measures as well as private sector suits to compel companies to comply with contractual agreements, even if doing so is in violation of their own domestic laws.

U.S. authorities recognize the challenge posed by the EU Blocking Statute, and the recent increasingly robust public and private sector enforcement of it. However, the U.S. Government has not formally adjusted U.S. sanctions programs to account for the legal conflict faced by U.S. and European companies eager to remain on the right side of both U.S. and European regulations. The question for the United States with respect to this new Chinese law will be how to balance the progressively aggressive suite of U.S. sanctions and export control measures levied against China—which the U.S. Government is unlikely to pare back—against the growing regulatory risk for global firms in China that could be caught between inconsistent compliance obligations.

As has long been the case, international companies will continue to be on the front lines of Beijing-Washington tensions and they will need to remain flexible in order to respond to a fluid regulatory environment and maintain access to the world’s two largest economies.

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   [1]   MOFCOM Order No.1 of 2021 on Rules on Counteracting Unjustified Extra-Territorial Application of Foreign Legislation and Other Measures (January 9, 2021) (“Chinese Blocking Statute”), http://www.mofcom.gov.cn/article/b/c/202101/20210103029710.shtml (Chinese), http://english.mofcom.gov.cn/article/policyrelease/questions/202101/20210103029708.shtml (English)

   [2]   https://www.gibsondunn.com/new-iran-e-o-and-new-eu-blocking-statute-navigating-the-divide-for-international-business/

   [3]   Chinese Blocking Statute (Article 5)

   [4]   Article 2 of Council Regulation (EC) No 2271/96 of 22 November 1996 protecting against the effects of the extra-territorial application of legislation adopted by a third country, and actions based thereon or resulting therefrom.

   [5]   Chinese Blocking Statute (Articles 4 & 6)

   [6]   Id. (Article 7)

   [7]   Id. (Article 5); Annex of Council Regulation (EC) No 2271/96 of 22 November 1996 protecting against the effects of the extra-territorial application of legislation adopted by a third country, and actions based thereon or resulting therefrom. Under Article 11a, the European Commission has power to adopt legislation adding further foreign extraterritorial laws to the Annex to the EU Blocking Statute.

   [8]   Chinese Blocking Statute (Article 8)

   [9]   Article 5 of Commission Implementing Regulation (EU) 2018/1101 of 3 August 2018 laying down the criteria for the application of the second paragraph of Article 5 of Council Regulation (EC) No 2271/96 protecting against the effects of the extra-territorial application of legislation adopted by a third country, and actions based thereon or resulting therefrom.

[10]   Chinese Blocking Statute (Article 9)

[11]   Article 6 of Council Regulation (EC) No 2271/96 of 22 November 1996 protecting against the effects of the extra-territorial application of legislation adopted by a third country, and actions based thereon or resulting therefrom.

[12]   Chinese Blocking Statute (Article 11)

[13]   Chinese Blocking Statute (Article 13)

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The following Gibson Dunn lawyers assisted in preparing this client update: Kelly Austin, Judith Alison Lee, Adam M. Smith, Patrick Doris, Ronald Kirk, Ning Ning, Chris Timura, Stephanie Connor, and Richard Roeder.

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

United States:
Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com)
Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, rkirk@gibsondunn.com)
Jose W. Fernandez – New York (+1 212-351-2376, jfernandez@gibsondunn.com)
Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com)
Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com)
Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, sconnor@gibsondunn.com)
Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com)
Ben K. Belair – Washington, D.C. (+1 202-887-3743, bbelair@gibsondunn.com)
Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com)
Laura R. Cole – Washington, D.C. (+1 202-887-3787, lcole@gibsondunn.com)
Jesse Melman – New York (+1 212-351-2683, jmelman@gibsondunn.com)
R.L. Pratt – Washington, D.C. (+1 202-887-3785, rpratt@gibsondunn.com)
Samantha Sewall – Washington, D.C. (+1 202-887-3509, ssewall@gibsondunn.com)
Audi K. Syarief – Washington, D.C. (+1 202-955-8266, asyarief@gibsondunn.com)
Scott R. Toussaint – Washington, D.C. (+1 202-887-3588, stoussaint@gibsondunn.com)
Shuo (Josh) Zhang – Washington, D.C. (+1 202-955-8270, szhang@gibsondunn.com)

Asia and Europe:
Kelly Austin – Hong Kong (+852 2214 3788, kaustin@gibsondunn.com)
Fang Xue – Beijing (+86 10 6502 8687, fxue@gibsondunn.com)
Qi Yue – Beijing – (+86 10 6502 8534, qyue@gibsondunn.com)
Joerg Bartz – Singapore – (+65 6507 3635, jbartz@gibsondunn.com)
Peter Alexiadis – Brussels (+32 2 554 72 00, palexiadis@gibsondunn.com)
Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com)
Nicolas Autet – Paris (+33 1 56 43 13 00, nautet@gibsondunn.com)
Susy Bullock – London (+44 (0)20 7071 4283, sbullock@gibsondunn.com)
Patrick Doris – London (+44 (0)207 071 4276, pdoris@gibsondunn.com)
Sacha Harber-Kelly – London (+44 20 7071 4205, sharber-kelly@gibsondunn.com)
Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com)
Steve Melrose – London (+44 (0)20 7071 4219, smelrose@gibsondunn.com)
Matt Aleksic – London (+44 (0)20 7071 4042, maleksic@gibsondunn.com)
Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com)
Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com)
Richard W. Roeder – Munich (+49 89 189 33-160, rroeder@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP

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

The Trump administration recently finalized a rule that clarifies that the incidental killing of migratory birds is not punishable under the Migratory Bird Treaty Act (the “MBTA”).

Part of a multinational effort to protect migratory birds, the MBTA was enacted in 1918 as a response to concern over poaching and over-hunting.

The Act criminalizes the hunting, taking, capturing or killing of birds – “by any means or in any manner” – and does not expressly exempt activities whose underlying purpose is one other than inflicting such harm. The possibility of MBTA liability has therefore long lurked in the shadows of petroleum refineries, wind projects, electric transmission lines, and other energy and infrastructure projects whose normal business operations may result in inadvertent impacts to birds. Indeed, the federal government has, albeit infrequently, wielded the MBTA to hold parties accountable for accidental bird kills in the past, including several prosecutions of oil and gas industry actors during the Obama Administration. More often, regulators use the threat of MBTA liability to encourage energy projects and other operators to voluntarily adopt bird impact mitigation best practices.

The U.S. Department of the Interior (“DOI”) claims that its new regulation reaffirms the original meaning and intent of the MBTA and that it is consistent with the interpretation of “several” federal courts (more on that in a moment).[1] While the rule intends to provide legal certainty to landowners and business interests, it is likely to meet immediate resistance on multiple fronts.

Environmentalists and their political allies have been quick to voice their opposition to a regulatory move that DOI has conceded will likely result “in increased bird mortality.”[2] A senior official in the Biden transition team has already indicated that the new administration will work to roll back the regulation,[3] with reversal options including new rulemaking(s) or Congress’s use of the Congressional Review Act (the “CRA”) to rescind the rule. The CRA allows Congress, with Presidential approval, to rescind a rulemaking by simple majority within 60 legislative days of the rule’s finalization. Democrats’ recent clinching of Senate control increases the odds that the CRA option will be exercised.

In the meantime, environmentalists are likely to take their case to court, undeterred by the likely obstacle of agency deference, which would preserve DOI’s interpretation of the MBTA so long as a court deems the interpretation reasonable. Such deference was not on the table when a federal judge recently rejected an earlier DOI legal opinion from December 2017 that informally adopted the MBTA interpretation now codified via formal rulemaking. The U.S. District Court for the Southern District of New York concluded that the MBTA is broad enough to criminalize incidental bird impacts, and rejected the December 2017 legal opinion under the Administrative Procedure Act as contrary to law. The court recognized that the Court of Appeals for the Fifth Circuit had previously limited the MBTA’s prohibition to deliberate acts done directly and intentionally to migratory birds, but sided with prior opinions from the Second and Tenth Circuits that held that incidental impacts are also criminal.[4]

A circuit split will once again be the status quo if DOI’s rule is administratively, legislatively, or judicially undone, unless and until the Biden Administration goes a step further and promulgates a formal rule interpreting the MBTA as prohibiting the incidental take of migratory birds.

Assuming the new DOI rule is ultimately overturned, exactly how the Biden Administration will approach MBTA enforcement is uncertain. Environmentalists will bring pressure to take an aggressive approach to wildlife protection, but it is reasonable to expect that the President-elect’s friendly outlook toward the renewable energy sector, which potentially faces the most significant impact from a stringent application of the law, will result in continued leniency for wind energy operators and supporting facilities that implement bird protection best practices. Whether the Biden Administration would be inclined to extend such goodwill more broadly is less clear.

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  [1]   U.S. Fish and Wildlife Service Finalizes Regulation Clarifying the Migratory Bird Treaty Act Implementation, U.S. Fish & Wildlife Service (January 5, 2021), https://www.fws.gov/news/ShowNews.cfm?ref=us-fish-and-wildlife-service-finalizes-regulation–clarifying-the-&_ID=36829.

  [2]   Page 8 of Final Environmental Impact Statement, Regulations Governing Take of Migratory Birds, prepared by Fish & Wildlife Service, U.S. Department of Interior (November 2020).

  [3]   Lisa Friedman, Trump Administration, in Parting Gift to Industry, Reverse Bird Protections, New York Times (January 5, 2021), https://www.nytimes.com/2021/01/05/climate/trump-migratory-bird-protections.html.

  [4]   Nat. Res. Def. Council, Inc. v. U.S. Dep’t of the Interior, No. 18-CV-4596 (VEC), 2020 WL 4605235, at 7 (S.D.N.Y. Aug. 11, 2020). The Court also posited that the Eighth and Ninth Circuits, in separate decisions regarding MBTA liability, have both left the door open to finding that the MTBA creates criminal liability for incidental bird kills.

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

Michael K. Murphy – Washington, D.C. (+1 202-955-8238, mmurphy@gibsondunn.com)
Kyle Neema Guest – Washington, D.C. (+1 202-887-3673, kguest@gibsondunn.com)

Please also feel free to contact the leaders of the Environmental Litigation and Mass Tort practice:

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)

© 2021 Gibson, Dunn & Crutcher LLP

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

Recovering from a relatively slow start to the year, due in no small part to the global pandemic, the U.S. Foreign Corrupt Practices Act (“FCPA”) Units of the U.S. Department of Justice (“DOJ”) and Securities and Exchange Commission (“SEC”) closed the year with a bang. With 32 combined FCPA enforcement actions, 51 total cases including ancillary enforcement, and a record-setting $2.78 billion in corporate fines and penalties (plus billions more collected by foreign regulators), 2020 marks another robust year in the annals of FCPA enforcement.

This client update provides an overview of the FCPA and other domestic and international anti-corruption enforcement, litigation, and policy developments from 2020, as well as the trends we see from this activity. We at Gibson Dunn are privileged to help our clients navigate these challenges daily and are honored again to have been ranked Number 1 in the Global Investigations Review “GIR 30” ranking of the world’s top investigations practices, the fourth time we have been so honored in the last five years. For more analysis on the year in anti-corruption enforcement, compliance, and corporate governance developments, please view or join us for our complimentary webcast presentations:

• 11th Annual Webcast: FCPA Trends in the Emerging Markets of Asia, Russia, Latin America, India and Africa on January 12 (view materials; recording available soon);
• FCPA 2020 Year-End Update on January 26 (to register, Click Here); and
• 17th Annual Webcast: Challenges in Compliance and Corporate Governance (date to be announced).

FCPA OVERVIEW

The FCPA’s anti-bribery provisions make it illegal to corruptly offer or provide money or anything else of value to officials of foreign governments, foreign political parties, or public international organizations with the intent to obtain or retain business.  These provisions apply to “issuers,” “domestic concerns,” and those acting on behalf of issuers and domestic concerns, as well as to “any person” who acts while in the territory of the United States.  The term “issuer” covers any business entity that is registered under 15 U.S.C. § 78l or that is required to file reports under 15 U.S.C. § 78o(d).  In this context, foreign issuers whose American Depository Receipts (“ADRs”) or American Depository Shares (“ADSs”) are listed on a U.S. exchange are “issuers” for purposes of the FCPA.  The term “domestic concern” is even broader and includes any U.S. citizen, national, or resident, as well as any business entity that is organized under the laws of a U.S. state or that has its principal place of business in the United States.

In addition to the anti-bribery provisions, the FCPA also has “accounting provisions” that apply to issuers and those acting on their behalf.  First, there is the books-and-records provision, which requires issuers to make and keep accurate books, records, and accounts that, in reasonable detail, accurately and fairly reflect the issuer’s transactions and disposition of assets.  Second, the FCPA’s internal controls provision requires that issuers devise and maintain reasonable internal accounting controls aimed at preventing and detecting FCPA violations.  Prosecutors and regulators frequently invoke these latter two sections when they cannot establish the elements for an anti-bribery prosecution or as a mechanism for compromise in settlement negotiations.  Because there is no requirement that a false record or deficient control be linked to an improper payment, even a payment that does not constitute a violation of the anti-bribery provisions can lead to prosecution under the accounting provisions if inaccurately recorded or attributable to an internal controls deficiency.

Foreign corruption also may implicate other U.S. criminal laws. Increasingly, prosecutors from the FCPA Unit of DOJ have been charging non-FCPA crimes such as money laundering, mail and wire fraud, Travel Act violations, tax violations, and even false statements, in addition to or instead of FCPA charges. Perhaps most prevalent among these “FCPA-related” charges is money laundering—a generic shorthand term for several statutory provisions that together criminalize the concealment or transfer of proceeds from certain “specified unlawful activities,” including corruption under the FCPA or laws of foreign nations, through the U.S. banking system. DOJ now frequently deploys the money laundering statutes to charge “foreign officials”—most often, employees of state-owned enterprises, but occasionally political or ministry figures—who are not themselves subject to the FCPA. It is thus increasingly commonplace for DOJ to charge the alleged provider of a corrupt payment under the FCPA and the alleged recipient with money laundering violations. DOJ has even used these foreign officials to cooperate in ongoing investigations.

FCPA AND FCPA-RELATED ENFORCEMENT STATISTICS

The below table and graph detail the number of FCPA enforcement actions initiated by DOJ and the SEC, the statute’s dual enforcers, during each of the past 10 years.

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC 23 25 11 12 19 8 17 9 10 10 21 32 29 10 22 17 35 19 21 11

The regularity of non-FCPA charges brought by DOJ FCPA Unit prosecutors was noted by the OECD Working Group on Bribery, which published a thorough Phase 4 report on the United States in November 2020. It praised the United States for “further increas[ing] its strong enforcement of the [FCPA] [and] maintaining its prominent role in the fight against transnational corruption,” noting in particular that “U.S. enforcement authorities have made broad use of other statutes and offences to prosecute payments to foreign government officials and intermediaries either in addition to or instead of FCPA charges.” With 19 such actions in 2020 (vs. 21 FCPA cases), thus continues what has matured into a multi-year trend of substantial extra-FCPA enforcement by DOJ.

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC DOJ SEC 24 25 12 12 21 8 23 9 12 10 27 32 36 10 48 17 54 19 40 11

2020 FCPA + FCPA-RELATED ENFORCEMENT TRENDS

In each of our year-end FCPA updates, we seek not merely to report on each of the year’s FCPA enforcement actions, but more so to distill the thematic trends that we see stemming from these individual events. For 2020, we have identified five key enforcement trends that we believe stand out from the rest:

1. Yet another high-water mark for corporate FCPA financial penalties;
2. The CFTC dives into FCPA waters;
3. The cautionary tale of Beam Suntory;
4. No FCPA-related monitorships in 2020; and
5. Spotlight on Latin America.

Yet Another High-Water Mark for Corporate FCPA Financial Penalties

For all of the fears expressed by some with respect to our 45th President—Donald J. Trump has been recorded as openly hostile to the FCPA—one that did not come to pass was diminishment of enforcement of the FCPA. Put simply, the modern era of FCPA enforcement largely has been indifferent to shifting political winds.

As just one measure of this phenomenon, one year ago we reported in these pages that corporate fines in FCPA cases had topped $2.5 billion for the first time in the history of the statute. In large part, this was because the record for highest single corporate FCPA resolution was set twice over in 2019—first, with the $850 million resolution with Mobile TeleSystems PJSC in March 2019, only to be outdone months later with the $1 billion resolution with Telefonaktiebolaget LM Ericsson in December 2019 (both covered in our 2019 Year-End FCPA Update). In 2020, the aggregate and individual records fell yet again.

Our readership is familiar with the long-running corruption investigation related to Malaysian sovereign wealth fund 1Malaysia Development Berhad (“1MDB”). From a massive civil forfeiture action seeking to recover allegedly misappropriated funds, to criminal FCPA actions against Malaysian businessperson Low Taek Jho (“Jho Low”) and former bankers Tim Leissner and Roger Ng Chong Hwa, even to charges under the Foreign Agents Registration Act (“FARA”) against individuals allegedly trying to lobby the Trump Administration on Jho Low’s behalf, the 1MDB scandal has resulted in significant enforcement activity and scrutiny over the last several years. Collectively, the former bankers and Jho Low allegedly participated in the diversion of more than $2.7 billion from 1MDB, between 2009 and 2014 and in connection with three separate bond offerings, for the illicit purposes of making payments to officials of state-owned investment funds of Malaysia and the UAE and embezzlement for their own personal benefit. Now added to the 1MDB enforcement list is the largest monetary corporate FCPA resolution ever. On October 22, 2020, global financial institution The Goldman Sachs Group Inc. reached a multi-billion dollar coordinated resolution in connection with the same core allegations with the SEC, DOJ, other U.S. authorities, as well as authorities in Singapore, the United Kingdom, and Hong Kong.

On the U.S. enforcement front, Goldman Sachs resolved the criminal case by entering into a three-year deferred prosecution agreement with DOJ alleging conspiracy to violate the FCPA’s anti-bribery provisions, while its Malaysian subsidiary pleaded guilty to one count of conspiracy to violate the anti-bribery provisions. The criminal penalty was calculated at $2.315 billion, but after a variety of offsets for payments to other regulators—domestic and foreign—Goldman Sachs agreed to pay $1.263 billion to DOJ. To resolve the civil case with the SEC, the bank consented to the entry of a cease-and-desist order charging anti-bribery, books-and-records, and internal controls violations, and agreed to pay a $400 million civil penalty, bringing the total FCPA financial resolution to $1,663,088,000. The SEC also ordered disgorgement of $606 million, but fully credited the amount against payments Goldman Sachs made under an earlier settlement in Malaysia pursuant to which the bank agreed to a $2.5 billion payment, as well as a guarantee of the return of $1.4 billion of 1MDB assets seized by authorities around the world.

Goldman Sachs also reached parallel resolutions with the Federal Reserve ($154 million), New York State Department of Financial Services ($150 million), UK Financial Conduct Authority ($63 million) and Prudential Regulation Authority ($63 million), Singaporean authorities ($122 million), and Hong Kong Securities and Futures Commission ($350 million). All told, total payments under the various resolutions exceed $5 billion.

In addition to Goldman Sachs and the Airbus and Novartis FCPA resolutions covered in our 2020 Mid-Year FCPA Update, two other 2020 corporate FCPA enforcement actions that topped the $100 million mark in combined penalties and disgorgement include:

• Herbalife Nutrition Ltd. – On August 28, 2020, DOJ and the SEC announced a combined $123 million FCPA resolution with U.S.-based global nutrition company Herbalife. According to the charging documents, over several years employees of Herbalife subsidiaries in China allegedly provided improper benefits, including cash, gifts, travel, and hospitality, to influence government officials in a variety of regulatory matters. To resolve the SEC investigation, Herbalife consented to the entry of an administrative cease-and-desist order charging FCPA accounting violations and agreed to pay more than $67 million in disgorgement and prejudgment interest. Herbalife also entered into a deferred prosecution agreement with DOJ and agreed to pay $55 million in criminal penalties to resolve a charge of conspiracy to violate the books-and-records provision of the FCPA. Herbalife received full credit for its cooperation and remediation, including steps to enhance its anti-corruption compliance program and accounting controls and take disciplinary actions against employees involved in the conduct. Herbalife will self-report on the status of its compliance program for a three-year period. Gibson Dunn represented Herbalife in connection with the joint resolutions.
• J&F Investimentos S.A. – On October 14, 2020, the SEC and DOJ announced a combined $155 million FCPA resolution with private Brazilian-based holding company J&F Investimentos S.A. and its affiliated global meat and protein producer and ADS-issuer JBS, S.A. J&F pleaded guilty to a single charge of conspiracy to violate the FCPA’s anti-bribery provisions based on allegations that over many years, millions in payments were made to high-level Brazilian officials, including high-ranking executives at state-owned banks and a state-controlled pension fund, to obtain hundreds of millions of dollars of financing and approval for a corporate merger. The SEC brought FCPA accounting charges against JBS and two of its executives: brothers Joesley and Wesley Batista. To resolve the criminal case, J&F agreed to a total fine of $256,497,026, but will pay only $128,248,513 (50%) of that to DOJ, with an offsetting credit applied against agreements in Brazil pursuant to which J&F agreed to pay approximately $3.2 billion. To resolve the SEC’s civil allegations, JBS agreed to pay $26.8 million in disgorgement and the Batistas agreed to pay civil penalties of $550,000 each. J&F and JBS will report on compliance and remedial measures for a three-year term.

Together with the other enforcement activity from 2020, corporate fines in FCPA cases reached a new height of $2.78 billion. A chart tracking the total value of corporate FCPA monetary resolutions by year, since the advent of blockbuster fines brought in with the 2008 Siemens resolution, follows:

Our Corporate FCPA Top 10 list currently reads as follows:

No.	Company*	Total Resolution	DOJ Component	SEC Component	Date
1	Goldman Sachs**	$1,663,088,000	$1,263,088,000	$400,000,000	10/22/2020
2	Ericsson	$1,060,570,432	$520,650,432	$539,920,000	12/06/2019
3	Mobile TeleSystems	$850,000,000	$750,000,000	$100,000,000	03/06/2019
4	Siemens AG***	$800,000,000	$450,000,000	$350,000,000	12/15/2008
5	Alstom S.A.	$772,290,000	$772,290,000	—	12/22/2014
6	KBR/Halliburton	$579,000,000	$402,000,000	$177,000,000	02/11/2009
7	Teva	$519,000,000	$283,000,000	$236,000,000	12/22/2016
8	Telia****	$483,103,972	$274,603,972	$208,500,000	09/21/2017
9	Och-Ziff	$412,000,000	$213,000,000	$199,000,000	09/29/2016
10	BAE Systems*****	$400,000,000	$400,000,000	—	02/04/2010

*  Our figures do not include the 2018 FCPA case against Petróleo Brasileiro S.A. – Petrobras (“Petrobras”), even though some sources have reported the resolution as high as $1.78 billion, because the first-of-its kind resolution negotiated by Gibson Dunn offset the vast majority of payments against a shareholders’ class action lawsuit and foreign regulatory proceeding, leaving only $170.6 million fairly attributable to the DOJ / SEC FCPA resolution.

**  Goldman Sachs’s U.S. FCPA resolutions were coordinated with numerous authorities in the United States, United Kingdom, Singapore, Hong Kong, and Malaysia, with total payments under the various resolutions exceeding $5 billion.

***  Siemens’s U.S. FCPA resolutions were coordinated with a €395 million ($569 million) anti-corruption settlement with the Munich Public Prosecutor.

****  Telia’s U.S. FCPA resolutions were coordinated with resolutions in the Netherlands and Sweden for a combined total of $965.6 million.

*****  BAE pleaded guilty to non-FCPA conspiracy charges of making false statements and filing false export licenses, but the alleged false statements concerned the existence of the company’s FCPA compliance program, and the publicly reported conduct concerned alleged corrupt payments to foreign officials.

The CFTC Dives into FCPA Waters

Our readers well know that as the prominence of international anti-corruption enforcement has grown, so too has the number of enforcers from around the world taking an active participation interest. Meetings with regulators are now coordinated across global time zones rather than a question of meeting at the Bond Building or at the SEC. But even as the waters of international anti-corruption enforcement were already crowded, a new entrant just caught its first big wave: the U.S. Commodity Futures Trading Commission (“CFTC”).

As covered in our 2019 Year-End FCPA Update, on March 6, 2019 the CFTC published an advisory on self-reporting and cooperation for “violations involving foreign corrupt practices,” and the same day the Enforcement Division Director delivered remarks announcing the CFTC’s intent to bring enforcement actions stemming from foreign bribery. Almost overnight, multiple companies then announced investigations by the CFTC with a potential foreign bribery nexus. And it did not take long for the first to reach a resolution.

On December 3, 2020, DOJ and the CFTC announced their first coordinated foreign corruption resolution, with Vitol Inc., the U.S. affiliate of one of the world’s largest energy trading firms. DOJ charged an alleged conspiracy to violate the FCPA’s anti-bribery provisions through payments to government officials in Brazil, Ecuador, and Mexico over a period of several years. To resolve the criminal case, Vitol entered into a deferred prosecution agreement and agreed to a $135 million fine, but will pay only $90 million of that to DOJ, with an offsetting credit applied to $45 million paid as part of a leniency agreement with Brazil’s Federal Public Ministry (“MPF”).

But perhaps most notable about the resolution is that, in a first-of-its-kind action, Vitol also consented to a cease-and-desist order by the CFTC for “manipulative and deceptive conduct” under the Commodity Exchange Act (“CEA”). According to the CFTC, Vitol paid the alleged bribes to state oil companies in Brazil, Ecuador, and Mexico in order to obtain preferential treatment, access to trades with the oil companies, and confidential information, including (in Brazil) specific prices at which Vitol understood it would win a particular bid or tender. The CFTC order, which also alleges that Vitol attempted to manipulate two oil benchmarks through separate trading activity, requires Vitol to pay more than $95 million in civil monetary penalties and disgorgement. However, so as not to impose duplicative penalties, the CFTC order provides a $67 million offsetting credit for the FCPA criminal fine, leaving Vitol to pay approximately $28.8 million.

Two former oil traders also were charged with FCPA and FCPA-related charges for their roles in the alleged criminal conspiracy. Javier Aguilar—a Mexican citizen, U.S. resident, and former Vitol oil trader—was charged in an indictment unsealed on September 22 with FCPA and money laundering conspiracy counts. Aguilar allegedly paid $870,000 to officials of Ecuador’s state-owned oil company, Petroecuador, in exchange for a contract to purchase $300 million in fuel oil. Aguilar pleaded not guilty in October 2020 and awaits trial in the Eastern District of New York. And on November 30, DOJ unsealed the February 2019 guilty plea of Rodrigo Garcia Berkowitz, a former oil trader of Petróleo Brasileiro S.A. (“Petrobras”), to money laundering conspiracy. Garcia Berkowitz allegedly accepted money from commodity trading companies, including Vitol, in exchange for directing Petrobras business to the companies, and also helped the companies determine the highest price they could charge to Petrobras and still win the bids. Berkowitz awaits sentencing.

The Cautionary Tale of Beam Suntory

In our 2018 Mid-Year FCPA Update, we reported on what appeared to be a rather modest FCPA resolution between the SEC and Chicago-based spirits producer Beam Suntory, Inc. The allegations were that senior executives at Beam’s Indian subsidiary directed efforts by third parties to make improper payments to increase sales, process license and label registrations, obtain better positioning on store shelves, and facilitate distribution. The SEC cited Beam’s voluntary disclosure—reportedly spawned by a series of proactive investigations initiated in the wake of competitor Diageo plc’s 2011 FCPA enforcement action in India—and reached what seemed like a favorable result for Beam, including a relatively modest combined penalty and disgorgement figure of just over $8 million. But there was mention of an ongoing DOJ investigation, with which Beam continued to cooperate. That investigation came to a less favorable end in 2020.

On October 27, 2020, DOJ announced its own, separate resolution with Beam arising from what appears to be substantially the same course of conduct in India with the lead corrupt payment allegation being a 1 million rupee (~ $18,000) payment to a senior government official in exchange for a license. The result was a deferred prosecution agreement on FCPA anti-bribery, internal controls, and books-and-records charges with a criminal fine of $19,572,885, none of which was credited against the prior SEC resolution.

Unlike the SEC, DOJ did not give Beam voluntary disclosure credit because it contended that the disclosure occurred only after a former employee sent a whistleblower complaint that copied U.S. and Indian authorities. DOJ further did not provide Beam with full cooperation credit, citing “positions taken by the Company that were not consistent with full cooperation, as well as significant delays caused by the Company in reaching a timely resolution and its refusal to accept responsibility for several years.” Finally, in support of a criminal internal controls charge (knowing and willful failure to implement and maintain internal controls), DOJ cited at length what it perceived to be an inadequate investigative response by certain in-house counsel to numerous red flags from audit reports and outside counsel opinions regarding the risks that third parties were paying bribes on Beam’s behalf. In one cited email, an in-house counsel allegedly wrote: “Beam Legal believes it is critical to approach a compliance review with the understanding that a U.S. regulatory regime should not be imposed on our Indian business and that acknowledges India customs and ways of doing business.” DOJ’s citation to and reliance on internal audit reports as evidence of internal controls breakdowns is troubling. Internal audit is, by definition, one of the lines of defense in a corporate control environment. Using it as a sword against a corporation is unfortunate and will lead to process changes within a corporation.

Had DOJ credited Beam’s voluntary disclosure and cooperation under the FCPA Corporate Enforcement Policy, and credited the penalty previously imposed by the SEC under the “Anti-Piling On” Policy, Beam’s criminal fine could have been less than $9 million rather than the more than $19.5 million fine imposed.

If one thing is clear it is that the public record does not disclose the full background and there surely is another side to the story. Nonetheless, Beam stands as a cautionary tale worthy of further study on subjects ranging from investigative response to red flags, to the challenges of educating business personnel on the need to conduct business in a compliant manner even in challenging markets, to the risks of unilaterally settling with one regulator while another investigation continues.

No FCPA Compliance Monitorships in 2020

Post-resolution oversight mechanisms long have been a mainstay of corporate FCPA enforcement. Early in the modern era of FCPA enforcement, it was commonplace for DOJ and/or the SEC to impose external compliance monitors in corporate FCPA resolutions. In more recent years, we observed a trend of the government employing a more diverse mix of post-resolution mechanisms, including requiring corporate self-assessments, which a company conducts itself and submits the findings of to the government (as covered in our 2009 and 2012 Year-End FCPA Updates), to using a “hybrid” approach whereby a company retains a monitor for part of the post-resolution period followed by a self-assessment period (as discussed in our 2014 Year-End FCPA Update).

Even as the frequency and mix of the different types of obligations have changed over time, it is rare to see a year go by without a single corporate monitor being imposed. In 2020, however, despite an overall record year in corporate FCPA fines and several large individual corporate resolutions, not a single FCPA-related monitorships was imposed. What may be the driving force for this shift is adherence to DOJ’s 2018 guidance concerning compliance monitors, covered in our 2018 Year-End FCPA Update. The “Benczkowski Memorandum” signaled that “the imposition of a monitor will not be necessary in many corporate criminal resolutions.” Among the considerations that should be taken into account in deciding whether to require a monitor are the company’s remediation efforts as well as the potential cost of a monitor and its impact on the company’s operations.

As can be seen from the following chart, which tallies the frequency of external monitors in corporate FCPA enforcement actions over the last five years, monitors are becoming relatively rarer oversight mechanisms in these cases.

Spotlight on Latin America

A headline from nearly 15 years ago, in our 2007 Year-End FCPA Update, read “China, China, China” to highlight the dramatic uptick in FCPA enforcement actions spawning from one of the world’s leading and most challenging economies. Then, five years ago, in our 2016 Year-End FCPA Update, we commented that it was “Still China, China, China . . . But Don’t Forget About Latin America,” to highlight that while China still remained the most prevalent situs of FCPA enforcement activity, Latin America was emerging as the new risk capital of anti-corruption compliance. That trend has continued, with more than 60% of the 51 FCPA and FCPA-related enforcement actions brought or announced in 2020 involving allegations of misconduct in Central or South America. Highlights not covered elsewhere include:

• Sargeant Marine, Inc. (“SMI”), a Florida-based asphalt company, on September 21, 2020 pleaded guilty to FCPA conspiracy related to its alleged conduct in several South American countries, including most prominently Brazil. DOJ alleged that SMI offered and paid bribes to officials in Brazil, Venezuela, and Ecuador in order to secure business contracts to provide asphalt to state-owned oil companies Petrobras, Petróleos de Venezuela, S.A. (“PDVSA”), and EP Petroecuador. The criminal penalty, reflecting a 25% discount off the bottom of the Sentencing Guidelines range for SMI’s cooperation and remediation, was $90 million, but DOJ reduced the penalty to $16.6 million by applying its “Inability to Pay” Policy. Relatedly, seven individuals have been charged in connection with the investigation of corrupt practices in the Latin American asphalt procurement market, including SMI part-owner and senior executive Daniel Sargeant; SMI traders Jose Tomas Meneses and Roberto Finocchi, SMI consultants Luiz Eduardo Andrade and David Diaz, and former PDVSA officials Hector Nuñez Troyano and Daniel Comoretto.
• On December 16, DOJ announced a superseding indictment bringing money laundering and money laundering conspiracy charges against two new defendants allegedly involved in corruption relating to Venezuela’s state-run currency exchanges: former National Treasurer of Venezuela Claudia Patricia Diaz Guillen and her husband, Adrian Jose Velasquez Figueroa. As covered in our 2018 Year-End FCPA Update, Diaz Guillen’s predecessor, former National Treasurer of Venezuela Alejandro Andrade Cedeno, pleaded guilty to money laundering after allegedly accepting bribes from Globovision news network mogul Raul Gorrin Belisario, who was indicted in August 2018, in exchange for conducting foreign exchange transactions on Gorrin’s behalf at artificially high government rates. According to the superseding indictment, when Diaz Guillen succeeded Andrade Cedeno as National Treasurer, she also succeeded him as Gorrin Belisario’s access point to Venezuela’s government currency exchanges, and she and her husband began accepting bribes from Gorrin to continue the scheme.
• On November 24, Venezuelan businessperson Natalino D’Amato became the latest defendant to face charges stemming from DOJ’s investigation of Venezuelan “pay for play” corruption. From 2015 to 2017, D’Amato allegedly bribed officials of multiple PDVSA subsidiaries to secure inflated supply contracts for D’Amato’s businesses. The PDVSA subsidiaries allegedly transferred over $160 million into Florida-based accounts controlled by D’Amato, and D’Amato allegedly paid out over $4 million of those funds in bribes to PDVSA officials. D’Amato now faces 11 counts of money laundering, money laundering conspiracy, and engaging in transactions involving criminally derived property.
• On August 6, DOJ unsealed an indictment against Jose Luis De Jongh Atencio, a new defendant in a separate branch of the Venezuela “pay for play” scheme detailed in our 2020 Mid-Year FCPA Update. Juan Manuel Gonzalez Testino and Tulio Anibal Farias-Perez pleaded guilty in May 2019 and February 2020, respectively, to FCPA charges for bribing officials of PDVSA subsidiary Citgo Petroleum Corporation in exchange for Citgo supply contracts. De Jongh, a former Citgo procurement officer and manager, allegedly was a recipient of those bribes. According to the indictment, De Jongh accepted Super Bowl, World Series, and concert tickets, in addition to approximately $2.5 million in payments used to purchase property in Texas. De Jongh was charged with money laundering and conspiracy to commit money laundering.
• Alexion Pharmaceuticals, Inc., a Boston-headquartered pharmaceutical company, settled an SEC-only cease-and-desist proceeding on July 2, 2020 arising from alleged violations of the FCPA’s accounting provisions primarily associated with the alleged bribery of Turkish and Russian officials to influence regulatory treatment and prescriptions for the company’s primary drug. The SEC also alleged that employees of Alexion’s subsidiaries in Brazil and Colombia created or directed third parties to create inaccurate records concerning payments that were used to cover employee personal expenses, though no bribery was alleged in these areas. Without admitting or denying the SEC’s findings, Alexion agreed to $17.98 million in disgorgement and prejudgment interest, as well as a $3.5 million penalty. Alexion earlier reported that DOJ had closed its five-year inquiry into the same conduct without any enforcement action.
• World Acceptance Corporation (“WAC”), a South Carolina-based consumer loan company, on August 6, 2020 agreed to resolve FCPA charges with the SEC arising from alleged misconduct in Mexico between 2010 and 2017. According to the settled cease-and-desist order, employees of WAC’s former Mexican subsidiary paid more than $4 million to Mexican government officials and union officials to secure the ability to make loans to government employees and then ensure those loans were repaid. To resolve these charges, and without admitting or denying the findings, WAC consented to the entry of an administrative order finding violations of the FCPA’s anti-bribery, books-and-records, and internal controls provisions and paid $19.7 million in disgorgement and prejudgment interest, as well as a $2 million civil penalty. Although the SEC order does not mention a voluntary self-disclosure, DOJ did recognize WAC’s voluntary disclosure, cooperation, and remediation in issuing a public declination pursuant to the FCPA Corporate Enforcement Policy.

Rounding Out the 2020 FCPA and FCPA-Related Enforcement Docket

Additional 2020 FCPA and FCPA-related enforcement actions not covered elsewhere in this update or our 2020 Mid-Year FCPA Update include:

           Deck Won Kang

On December 17, 2020, New Jersey resident and contractor to Korea’s Defense Acquisition Program Administration (“DAPA”) Deck Won Kang pleaded guilty to one count of violating the FCPA’s anti-bribery provisions. According to the charging document, DAPA solicited bids in connection with contracts to upgrade the Korean Navy’s fleet, and Kang paid $100,000 to a DAPA procurement official to obtain non-public information to help Kang’s companies secure and retain the contracts. Kang also has been sued in New Jersey state court by DAPA. The civil proceedings are ongoing, and Kang is scheduled to be sentenced on the FCPA charge in April 2021 in the District of New Jersey.

           Jeremy Schulman

In a matter that appears to have arisen out of an FCPA investigation, DOJ’s FCPA Unit announced on December 3, 2020 the indictment of Maryland attorney Jeremy Schulman on charges stemming from an alleged six-year conspiracy to misappropriate Somali sovereign assets held in accounts with U.S. financial institutions that had been frozen since the beginning of Somalia’s 1991 civil war. According to the charging documents, Schulman and his co-conspirators allegedly forged paperwork purporting to show that Schulman acted on the authority of the Central Bank of Somalia in repatriating these assets, which materials Schulman then presented to banks with requests to recover the frozen funds. Schulman and his co-conspirators learned the locations of the frozen assets from a former Governor of Somalia’s Central Bank, who was appointed as an advisor to the Transitional Government of Somalia’s President after the alleged conspiracy began; however, neither Schulman nor the former Governor were authorized to recover the funds. Schulman allegedly obtained control of approximately $12.5 million of the frozen Somali funds using his forged documents; his law firm retained approximately $3.3 million and the rest was remitted to the Somali government. Schulman now faces 11 counts of bank, mail, and wire fraud and money laundering, as well as associated conspiracy counts.

           Foreign Adoption Corruption

We reported in our 2019 Year-End FCPA Update on FCPA charges against Ohio-based adoption agent Robin Longoria, alleging that she and other U.S. adoption agents bribed Ugandan probation officers to recommend that certain children be placed into orphanages, then bribed Ugandan judges and court personnel to grant guardianship of these children to the adoption agency’s clients. On August 17, 2020, DOJ announced the indictment of three alleged co-conspirators, U.S. citizens Debra Parris and Margaret Cole, and Ugandan citizen Dorah Mirembe. The charges, which include FCPA bribery, visa fraud, mail fraud, money laundering, and false statements, relate to alleged corrupt payments to process international adoptions without following the correct procedures in Uganda (Parris and Mirembe) and Poland (Parris and Cole). Although Mirembe is a Ugandan citizen, for purposes of applying the FCPA she is alleged to be an “agent” of a “domestic concern”—the Ohio-based adoption agency to which she provided services. Parris and Cole have pleaded not guilty, while Mirembe has yet to be arraigned. Longoria is scheduled to be sentenced in January 2021.

Although this could be dismissed as a confined fact pattern, this is not the first time the FCPA Unit has brought charges related to corruption in international adoptions. In February 2014, DOJ announced charges against four former employees of an adoption agency (Alisa Bivens, James Harding, Mary Mooney, and Haile Ayalneh Mekonnen) for, among other things, allegedly conspiring to pay bribes to Ethiopian officials to facilitate adoptions. In August 2017, Mooney, Harding, and Bivens were sentenced—Mooney to 18 months, 3 years of supervised release, and $223,946 in restitution; Harding to 12 months, 3 years supervised release, and $301,224 in restitution; and Bivens to one year probation and $31,800 in restitution. Although they were not charged with FCPA violations (possibly because the foreign “officials” at issue included a teacher at a government school and a head of a regional ministry for women’s and children’s affairs), the DOJ FCPA Unit was involved in the prosecution.

2020 YEAR-END FCPA-RELATED ENFORCEMENT LITIGATION

Following the initiation of an FCPA or FCPA-related action, the lifecycle of criminal and civil enforcement proceedings can take years to wind through the courts. A selection of prior-year matters that saw enforcement litigation developments during 2020 follows.

Second Circuit Affirms Chi Ping Patrick Ho’s FCPA and Money Laundering Convictions

We reported in our 2018 Year-End FCPA Update on the trial conviction of Hong Kong businessman Chi Ping Patrick Ho arising from his alleged participation in two separate corruption schemes in Chad and Uganda. On December 29, 2020, the U.S. Court of Appeals for the Second Circuit affirmed all of the convictions in an important precedential opinion authored by the Honorable Richard J. Sullivan.

With respect to the FCPA charges, the Second Circuit rejected Ho’s argument that the evidence was insufficient to establish that he was acting on behalf of a “domestic concern” under § 78dd-2, where he had been an officer of a Virginia-based NGO but claimed the beneficiary of the scheme was a foreign business subject to § 78dd-3. The Court held § 78dd-2 does not require that a U.S. entity be the beneficiary of corruption, but rather only that the defendant act on behalf of a domestic concern to procure corrupt business “for . . . any person,” which may include a foreign entity. The Court further held that it is permissible for the Government to charge a defendant both with acting on behalf of a domestic concern under § 78dd-2 and with being “any person other than . . . a domestic concern” under § 78dd-3, as the two provisions are not mutually exclusive and the same person could fit both definitions where, as here, multiple courses of conduct are charged.

As or perhaps even more important, with respect to the money laundering charges, the Court held that a wire transfer from Hong Kong to Uganda, which passed through a correspondent U.S.-dollar bank account in New York, was sufficient on the facts to constitute a monetary transaction “to” or “from” the United States (rather than “through” the United States as Ho argued). Since the vast majority of the world’s U.S.-dollar transactions pass through correspondent banking accounts in New York, this is an expansive decision that could give DOJ global reach over U.S.-dollar denominated corruption anywhere, even with only the most fleeting of connections to the United States. With precedent (including Second Circuit precedent) pointing in the other direction, this is a hotly contested aspect of the money laundering statutes and ripe for further review. Less controversially, the Court also held that an FCPA violation under § 78dd-3 may serve as a “specified unlawful activity” pursuant to the money laundering statutes.

           José Carlos Grubisich Motion to Dismiss Denied

In our 2019 Year-End FCPA Update, we covered the arrest of Jose Carlos Grubisich, former CEO and board member of Brazilian petrochemical company and U.S. ADS-issuer Braskem S.A., on FCPA and related charges as he arrived at JFK Airport for vacation (unaware of a sealed indictment). After four months of preventive detention, and after bail was initially denied, Grubisich was released to home detention with the onset of the COVID-19 pandemic—though only after he posted a $30 million bond with $10 million cash bail. Grubisich thereafter filed a motion to dismiss the charges on, among other things, statute-of-limitations grounds because he left his role as CEO in 2008. Judge Raymond J. Dearie of the U.S. District Court for the Eastern District of New York denied the motion in a Memorandum and Order dated October 12, 2020, concluding that although the motion “raise[d] issues that may warrant critical attention after an evidentiary record has been established,” the arguments were fact-based and improper to resolve in a motion to dismiss.  

           PDVSA-Related Guilty Pleas

In our 2020 Mid-Year FCPA Update, we reported that Lennys Rangel, the procurement head of a PDVSA majority-owned joint venture, and Edoardo Orsoni, the former general counsel of PDVSA, had been charged with conspiracy to commit money laundering in connection with the alleged receipt of more than a million dollars each in cash and property in exchange for favorable treatment in PDVSA bidding processes. On August 11 and August 25, 2020, respectively, Rangel and Orsoni pleaded guilty. Both await 2021 sentencing dates.

           Mark T. Lambert Sentenced

In our 2019 Year-End FCPA Update, we covered the trial conviction of Mark T. Lambert, former president of Transport Logistics International Inc. (“TLI”), on FCPA and wire fraud counts associated with an alleged scheme to pay more than $1.5 million in bribes to an affiliate of Russia’s State Atomic Energy Corporation. On October 28, 2020, DOJ announced that Lambert had been sentenced to 48 months in prison and a $20,000 fine (which matched the four-year term to which the government official bribe recipient, Vadim Mikerin, was sentenced in 2015). Lambert has noticed an appeal to the Fourth Circuit, while his former co-president at TLI, Daren Condrey, is scheduled for sentencing in 2021, nearly six years after his 2015 guilty plea.

Corpoelec Defendants Receive 40% Reductions in Prison Sentences for Substantial Cooperation in the Prosecution of Others

As outlined in our 2019 Year-End FCPA Update, on June 24, 2019, Jesus Ramon Veroes and Luis Alberto Chacin Haddad each pleaded guilty to FCPA conspiracy charges arising from an alleged scheme to pay bribes to senior officials at Venezuela’s state-owned electric company, Corporación Eléctrica Nacional, S.A. (“Corpoelec”), in exchange for the award of contracts worth $60 million. Shortly thereafter, the Honorable Cecilia Altonaga of the U.S. District Court for the Southern District of Florida sentenced each defendant to 51 months of imprisonment. But on October 13, 2020, Judge Altonaga approved prosecutors’ request to reduce by nearly two years Chacin’s and Veroes’ respective sentences, finding that the two had provided prosecutors detailed information about the bribery and money laundering scheme at issue, which resulted in the indictment of Luis Alfredo Motta Dominguez and Eustiquio Jose Lugo Gomez, respectively the President and Procurement Director of Corpoelec.

            Probationary Sentence in Petrobras Corruption Case

As reported in our 2019 Year-End FCPA Update, Brazilian citizen Zwi Skornicki pleaded guilty in early 2019 to a single count of FCPA bribery conspiracy in connection with a scheme to pay $55 million to officials of Petrobras and the Brazilian Workers’ Party. On August 4, 2020, the Honorable Kiyo Matsumoto of the U.S. District Court for the Eastern District of New York sentenced Skornicki, 70, to 18 months of probation, which the Court allowed Skornicki to serve remotely from Brazil. In addition, Skornicki will have to pay a $50,000 fine. In issuing the sentence, Judge Matsumoto noted that he had considered a six-month prison sentence Skornicki had served in Brazil, and the $25 million fine he had already paid in Brazil. Judge Matsumoto also acknowledged Skornicki’s age and the increased risk of travel in light of the ongoing COVID-19 pandemic in allowing Skornicki to complete his probation remotely.

            Alstom Defendants Sentenced to Time Served

In our 2019 Year-End FCPA Update, we described that, following the trial conviction of former Alstom executive Lawrence Hoskins, DOJ unsealed charges against former Alstom Indonesia Country President Edward Thiessen and Regional Sales Manager Larry Puckett. Both Thiessen and Puckett had entered into plea agreements years prior, but their agreements remained non-public until their cooperation completed with testimony at Hoskins’s trial. On July 20, 2020, the Honorable Janet Bond Arterton of the U.S. District Court for the District of Connecticut sentenced Thiessen to time served and a $15,000 fine, noting in part that Thiessen had cooperated extensively with U.S. prosecutors, including by providing trial testimony against Hoskins. Earlier in the year, Judge Arterton similarly sentenced Puckett to time served. Finally, another former Alstom executive, David Rothschild, who had pleaded guilty in November 2012, was similarly sentenced to time served on July 27, 2020.

2020 YEAR-END FCPA-RELATED POLICY DEVELOPMENTS

            Two SEC Commissioners Rebuff Extensive Use of Internal Controls Provision

We observe often that the SEC employs aggressive theories of liability by utilizing the FCPA’s accounting provisions (most recently in our 2019 Year-End FCPA Update). Although not in a foreign corruption case, the FCPA defense bar took note when, in November 2020, SEC Commissioners Hester M. Peirce and Elad L. Roisman issued a statement disapproving of the SEC’s settled action with Andeavor LLC. The SEC Staff alleged that Andeavor had violated the FCPA’s internal controls provision—though the case involved alleged insider trading, not foreign bribery. Insider trading cases typically are brought under Exchange Act Section 10(b) and Rule 10b-5 thereunder, which “would have required finding that Andeavor acted with scienter despite the steps it took to confirm that it did not possess material nonpublic information.” Sounding in many of the themes presented by expansive civil FCPA internal controls cases, the Staff alleged that Andeavor used an “abbreviated and informal process” leading to an internal controls failure.

Commissioners Peirce and Roisman highlighted that the FCPA “requires not ‘internal controls’ but ‘internal accounting controls.’” And they noted that although Andeavor was “unprecedented” in applying the internal controls provision to insider trading compliance, the SEC has resolved other recent matters based on theories of deficient internal controls that “go well beyond the realm of ‘accounting controls.’” Although this viewpoint was not sufficient to carry a majority, and the settlement was approved, the articulate dissent of Commissioners Peirce and Roisman provides a roadmap for advocates and is worthy of continued monitoring.

            SEC Approves Amendments to Whistleblower Program Rules

On September 23, 2020, the SEC approved a set of amendments to the rules governing its whistleblower program, which, according to the SEC, are meant to “provide greater clarity to whistleblowers and increase the program’s efficiency and transparency.” Significant changes to the rules include:

1. Revising the definition of “whistleblower” to cover only those individuals who report information in writing to the SEC, consistent with the U.S. Supreme Court’s 2018 decision in Digital Realty Trust v. Somers;
2. Procedural changes designed to facilitate more efficient resolution of frivolous claims and to allow the SEC to bar individuals who have filed false or frivolous claims from participating in the program;
3. Clarifying that deferred prosecution agreements, non-prosecution agreements, and SEC settlements not resolved through administrative or judicial proceedings are among the resolutions eligible for whistleblower awards;
4. Providing interpretive guidance explaining the “independent analysis” expected of whistleblowers in order to be eligible for awards; and
5. Amendments to the award determination process, which allow the SEC to revise small awards upward and further clarify the scope of the SEC’s discretion in determining awards.
6. These rules became effective 30 days later, on October 23, 2020. For additional details regarding these revisions, please see our separate Client Alert, “SEC Amends Whistleblower Rules.”

            DOJ Issues First FCPA Opinion Procedure Release in Six Years (20-01)

By statute, DOJ must provide a written opinion at the request of an issuer or domestic concern stating whether DOJ would prosecute the requestor under the anti-bribery provisions for prospective (not hypothetical) conduct it is considering. Published on DOJ’s FCPA website, these releases once provided valuable insights into how DOJ interprets the FCPA, although only parties who join in the requests may rely upon them authoritatively. But although such releases were once a staple of these semi-annual updates, they have fallen out of use in recent years (until 2020, the last one had issued in 2014).

On August 14, 2020, DOJ released its first FCPA opinion procedure release in nearly six years (and its 62nd overall). The requestor was a U.S.-based multinational investment advisor. In 2017, the requester sought to acquire assets from a foreign subsidiary—identified as “Country A Office”—of a foreign bank that was majority owned by a foreign government. To facilitate the transaction, the requester engaged a different foreign subsidiary—identified as “Country B Office”—of the aforementioned bank and a local investment firm. Upon completion of the transaction, Country B Office requested a fee of $237,500, which equaled 0.5% of the face value of the purchased assets, for services rendered in connection with the transaction.

DOJ’s opinion concluded that, as the facts were presented by the requester and assuming that the Country B Office is an instrumentality of a foreign government, it would not bring an enforcement action based on payment of the fee. DOJ found persuasive that the fee would be paid to a government entity and not an individual. DOJ’s conclusion also was aided in part by a certification by Country B Office’s chief compliance officer that the fee would be used for general corporate purposes and not be diverted to any individual government officials or other entities. Finally, DOJ’s conclusion rested in part on the same chief compliance officer’s certification that Country B Office provided legitimate services and that the fee was commercially reasonable.

DOJ’s conclusion breaks no new ground and is consistent with prior opinion releases that did not apply the FCPA to payments to government entities. That DOJ relied in part on the compliance officer’s certification that such a diversion did not occur further supports the importance of documenting sound compliance efforts to address corruption-related risks.

2020 YEAR-END KLEPTOCRACY FORFEITURE ACTIONS

The second half of 2020 saw continued activity in the Kleptocracy Asset Recovery Initiative spearheaded by DOJ’s Money Laundering and Asset Recovery Section (“MLARS”) Unit, which uses civil forfeiture actions to freeze, recover, and, in some cases, repatriate the proceeds of foreign corruption.

On July 15, 2020, DOJ filed a civil complaint in the U.S. District Court for the District of Maryland seeking the forfeiture of a Potomac mansion owned by former Gambian President Yahya Jammeh. The complaint alleges the property was purchased with $3.5 million obtained through the embezzlement of public funds and solicitation of bribes while Jammeh was in power from 1994 to 2017.

On August 6, 2020, DOJ filed two civil forfeiture complaints in the U.S. District Court for the Southern District of Florida seeking to seize commercial property linked to Ukrainian oligarchs Igor Kolomoisky and Gennadiy Boholiubov. On December 30, 2020, DOJ filed a third complaint in the Southern District of Florida, seeking to seize additional property linked to the pair. The complaints allege that Kolomoisky and Boholiubov used front companies to buy office buildings in Louisville, Dallas, and Cleveland—with a combined value of more than $60 million—with funds allegedly embezzled from Ukrainian lender PrivatBank. The complaints further allege that businesspeople Uriel Laber and Mordechai Korf helped the oligarchs acquire the properties.

Finally, with further 1MDB-related developments, on September 16, 2020 DOJ announced that it is seeking an additional $300 million linked to funds allegedly misappropriated from 1MDB. The assets include funds held in escrow in the United Kingdom linked to money misappropriated from 1MDB through a joint venture with PetroSaudi, as well as four dozen promotional movie posters allegedly purchased by Malaysian film producer Riza Aziz with money traceable to funds misappropriated from 1MDB. The complaint followed a recent settlement between DOJ and Aziz over another $60 million in assets linked to 1MDB, announced on September 2, 2020. To date, the United States has sought forfeiture of more than $2.1 billion in assets associated with 1MDB, and has recovered almost $1.1 billion of that amount.

2020 YEAR-END PRIVATE CIVIL LITIGATION

As we have been reporting for many years, although the FCPA does not provide for a private right of action, civil litigants continue to pursue a variety of causes of action in connection with FCPA-related conduct, with varying degrees of success.  A selection of matters with developments during the second half of 2020 follows.

            Select Shareholder Lawsuits

• Glencore PLC – On July 31, 2020, the Honorable Susan D. Wigenton of the U.S. District Court for the District of New Jersey dismissed a complaint filed against Glencore and certain executives alleging that the defendants made false and/or misleading statements and failed to disclose facts relating to alleged bribery schemes in the Democratic Republic of Congo, Venezuela, and Nigeria. The Court dismissed the suit on forum non conveniens grounds, concluding that the plaintiff’s choice of forum was accorded less deference because Glencore did not have offices or subsidiaries in the forum and the alleged conduct giving rise to the plaintiff’s claims allegedly occurred in foreign nations. An amended complaint was not filed after the ruling and the case has been closed.
• Tenaris S.A. – On October 9, 2020, the Honorable Raymond J. Dearie of the U.S. District Court for the Eastern District of New York granted in part and denied in part Tenaris’s motion to dismiss a putative securities fraud class action, in which shareholders alleged that the company’s public filings and employee codes of conduct were materially misleading in light of bribery allegations that became public in 2018. In connection with what became known as the “Notebooks” case, Tenaris’s CEO was charged in 2018 by an Argentine court with bribery in connection with alleged bribes paid to Argentinian government officials in return for their lobbying of the Venezuelan government to prevent the nationalization of the asset of Tenaris’s Venezuelan subsidiary. Although the court dismissed some claims relating to statements contained in the company’s code of ethics, Judge Dearie held that the plaintiffs’ assertions with regard to statements in the code of conduct, as well as references to the code in the company’s filings, were actionable. Tenaris filed its answer to plaintiffs’ amended complaint on December 1, 2020.
• Ternium S.A. – In another U.S. civil lawsuit arising from the Argentinian “Notebooks” scandal, on September 14, 2020, the Honorable Pamela K. Chen of the U.S. District Court for the Eastern District of New York dismissed a shareholder suit against Ternium, a Luxembourg steel product manufacturer, as well as individual officers and a director. In ruling on Ternium’s motion to dismiss, the court agreed with the defendants’ position that their statements regarding the relevant transaction did not create a duty to disclose the alleged bribery, explaining that the statements “‘accurately report[ed] income derived from illegal sources’ . . . without ‘attribut[ing] [the transaction’s] success to a particular cause’ . . . thereby relieving Ternium of any obligation to disclose the bribery scheme.” Judge Chen subsequently dismissed the case with prejudice on November 17, 2020, after plaintiffs failed to file an amended complaint.
• Sociedad Química y Minera de Chile SA (“SQM”) – On November 11, 2020, Chilean mining company SQM announced its agreement to pay $62.5 million to resolve a class action lawsuit brought by investors in March 2017, following SQM’s $30 million settlement with DOJ and the SEC to resolve related foreign bribery charges covered in our 2017 Mid-Year FCPA Update. The investors sued the company for not disclosing the alleged bribery scheme in its securities filings, against which SQM had argued that revelations of the alleged fraud did not cause statistically significant negative reactions in its stock price. The parties briefed summary judgment earlier this year, but settled before a decision was reached by the court. On December 18, 2020, the court held a hearing and preliminarily approved the settlement agreement but set a schedule for briefing in support of the settlement and a settlement conference for 2021.

            Select Civil Fraud / RICO Actions

• Harvest Natural Resources, Inc. – As reported most recently in our 2020 Mid-Year FCPA Update, in February 2018 now-defunct Houston energy company Harvest Natural Resources filed suit in the U.S. District Court for the Southern District of Texas alleging RICO and antitrust violations against various individuals and entities affiliated with the Venezuelan government and PDVSA. In late 2018, Harvest voluntarily dismissed the case as to all defendants except Rafael Darío Ramírez Carreño, Venezuela’s former Minister of Energy and former President of PDVSA. Chief Judge Lee H. Rosenthal then granted a default $1.4 billion judgment in the action against Ramírez after he failed to appear. Upon Ramírez’s later appearance and motion to vacate the default judgment, Judge Rosenthal reopened the case and vacated the default judgment but denied his motion to dismiss. On August 26, 2020, Harvest filed a notice voluntarily dismissing Ramírez from the case, which Judge Rosenthal granted, thereby dismissing Ramírez and concluding all pending litigation.

            Select Employment Lawsuits

• Landec Corp. – On September 2, 2020, Ardeshir Haerizadeh, a former Landec subsidiary executive, sued the company in California state court alleging that Landec unfairly terminated and attempted to make him a scapegoat in connection with an internal investigation into potential bribery in Mexico. In January 2020, Landec disclosed in a securities filing that it had identified potential FCPA violations by recently acquired company Yucatan Foods, a Los Angeles-based guacamole maker founded by Haerizadeh. Landec said in the filing that the potential misconduct began before the acquisition, which was completed in late 2018 for approximately $80 million, and that the company had made a disclosure to DOJ and the SEC. Since the initial complaint filing, Landec has filed an answer and cross-complaint, to which Haerizadeh has not yet responded.

            Select Arbitration-Related Litigation

• Petrobras – On July 16, 2020, the U.S. Court of Appeals for the Fifth Circuit upheld an international arbitration award requiring Petrobras to pay more than $700 million to offshore drilling company Vantage Drilling International for terminating a contract allegedly procured through bribery. The underlying allegations and associated FCPA resolutions—which arose out of Brazil’s Operation Car Wash—were covered in our 2018 Year-End FCPA Update. In July 2018, an internal arbitration tribunal issued the award in favor of Vantage, finding that Petrobras breached the parties’ contract. Petrobras later filed a motion to vacate the arbitration award in the U.S. District Court for the Southern District of Texas, arguing that the award violated U.S. public policy. The Fifth Circuit affirmed the district court’s confirmation of the award, agreeing with the arbitration tribunal’s findings that Petrobras had knowingly ratified the contract with Vantage after Petrobras became aware of the bribery allegations.

            Select Anti-Terrorism Act Suits

• Certain Pharmaceutical and Medical Device Companies – On July 17, 2020, the Honorable Richard J. Leon of the U.S. District Court for the District of Columbia dismissed a lawsuit brought by U.S. service members and their families in late 2017, alleging that a number of pharmaceutical and medical device companies violated the Anti-Terrorism Act (“ATA”) and state laws. According to the suit, the defendants purportedly bribed officials at the Iraqi Ministry of Health, which was controlled by the terrorist group Jaysh al-Mahdi (“JAM”), and JAM used these funds and medical goods to perpetuate attacks against the plaintiffs. Judge Leon ruled that the Court lacked personal jurisdiction over the foreign defendants, because all of the alleged conduct occurred outside of the United States, and further held that the plaintiffs did not adequately plead a violation under the ATA with respect to any defendants because: (1) plaintiffs did not “establish the substantial connection between defendants and JAM necessary for proximate causation”; (2) defendants could not have aided and abetted a foreign terrorist organization because JAM is not designated as such; and (3) plaintiffs did not show that the defendants provided substantial assistance to the attacks. On August 14, 2020, the plaintiffs filed a notice of appeal to the U.S. Court of Appeals for the D.C. Circuit.
• Certain Defense Contractors and Telecommunications Companies – On December 27, 2019, U.S. citizens who were killed or wounded in Taliban terrorist attacks while serving in Afghanistan, and their family members, brought a suit in the U.S. District Court for the District of Columbia against American and foreign defense contractors, and international telecommunications companies, under the ATA. The lawsuit accuses the companies of providing material support to and aiding and abetting terrorist attacks against Coalition forces by paying “protection money” to the Taliban. According to the complaint, at least one defendant used funds from the World Bank’s International Finance Corporation to make the payments, and also allegedly “went beyond financing,” engaging in “active coordination” by deactivating its cellular network at night at the request of the Taliban, thereby hindering Coalition intelligence-gathering efforts. The defendants filed motions to dismiss in late April 2020, which were rendered moot by an amended complaint filed on June 5, 2020, that included additional U.S. company defendants. On September 10, 2020, the contractors filed separate motions to dismiss the amended complaint, arguing that the plaintiffs failed to state a claim and/or on jurisdictional grounds. The Court has yet to rule as of the date of this publication.

2020 YEAR-END INTERNATIONAL ANTI-CORRUPTION DEVELOPMENTS

Multilateral Development Banks

            MDBs signal long-term shift to prevention, not just investigative work

Officials from various MDBs’ anti-corruption teams have made public statements recently in which they have signaled that their respective institutions are shifting away from the traditional investigate-after-the-fact model of compliance to a more proactive and preventive approach focusing on due diligence and ongoing monitoring of bank-financed projects. For example, the Head of the African Development Bank’s (“AfDB”) integrity and anticorruption unit, Alan Bacarese, recently highlighted the AfDB’s emphasis of “proactive integrity reviews” in major AfDB-financed projects. As part of this initiative, the AfDB took the extraordinary step of embedding an anti-corruption official in the project from the outset, with the stated purpose of avoiding any procurement problems before they evolve into sanctionable misconduct. Bacarese explained: “We’re not in the business of investigating and debarring – although that is part of our mandate. We are as interested, if not more interested, in working with companies and working with our colleagues within the bank to bring good business ethics into development finance.”

Other MDBs have echoed this approach. For her part, the chief compliance officer of the European Bank for Reconstruction and Development, Lisa Rosen, recently remarked that she believes that it was incorrect to think the key tool in the fight against corruption in MDB-financed projects is “the investigation and debarment function of MDBs.” She suggested, instead, that prevention is more effective. Laura Profeta, the Inter-American Development Bank’s anti-corruption chief similarly remarked in the context of the COVID-19 pandemic that her team had developed “a very intense focus on the prevention side of our work.”

World Bank Announces Prospective Shift in Process for Evaluating Corporate Compliance Programs

The World Bank’s Integrity Vice Presidency (“INT”) recently announced that, for a period of several months, it been developing what it described as a “major initiative” to improve its processes for evaluating a company’s compliance efforts. The apparent aim of the program is to ensure that companies receive “the kind of mitigation credit they deserve if they have a compliance program.” As part of this effort, the office of the Integrity Compliance Officer (“ICO”) will work collaboratively with INT before a sanction is imposed as part of a settlement agreement to determine the breadth, scope, and effectiveness of a company’s compliance program, which could in turn result in a reduction in the proposed debarment period and/or post-debarment obligations. The proposed initiative will represent a shift in the current paradigm, in which the ICO typically becomes involved in a matter after settlement to work with debarred companies to improve their compliance programs.

Europe and the Former CIS

            United Kingdom

SFO 2020 Deferred Prosecution Agreement Guidance

On October 23, 2020, the UK Serious Fraud Office (“SFO”) published guidance on its approach to deferred prosecution agreements (“DPAs”) and how it engages with companies when a DPA is possible. As discussed in our separate Client Alert, “The UK Serious Fraud Office 2020 Deferred Prosecution Agreement Guidance: Something Old and Something New,” the underlying statute creating DPAs is clear that a party need not admit guilt, and this new guidance also makes plain that this is unnecessary. The DPA Code of Practice remains in force as the lead document for consideration in connection with DPAs. Aspects of the new guidance not already in the DPA Code of Practice can be found in other guidance or in judgments given by the court in prior DPAs. As such, the guidance does not provide significant new insights but is instead a consolidation of other source material.

Former Unaoil executive sentenced for paying bribes to win $1.7 billion worth of contracts

As covered in our 2019 Year-End and 2020 Mid-Year FCPA Updates, Monaco-based oil services company Unaoil has been at the center of a developing cluster of anti-corruption enforcement that has grown to include enforcement activity on both sides of the Atlantic.

On October 8, 2020, Basil Al Jarah, Unaoil’s former Iraqi partner, was sentenced to 40 months’ imprisonment. Al Jarah pleaded guilty in July 2019 to five offenses of conspiracy to give corrupt payments in excess of $17 million to public officials at the South Oil Company and Iraqi Ministry of Oil. Co-conspirators Stephen Whiteley and Ziad Akle were found guilty in July 2020 of one and two counts, respectively, of conspiring to give corrupt payments. Akle was sentenced to five years’ imprisonment and Whiteley to three years’ imprisonment. Another individual, Paul Bond, faces retrial in January 2021.

            Russia

On December 8, 2020, the Prosecutor General’s Office of the Russian Federation reported that in 2020 the overall damage from corruption offenses claimed in initiated criminal cases in the country exceeded 45 billion rubles (~$612 million), down from 55.5 billion rubles (~$850 million) reported for 2019.  As of October 2020, Russian prosecutors had filed 6.6 billion rubles (~$102 million) worth of civil damage recovery claims linked to corruption offenses.  The Prosecutor General’s Office reported a total recovery of more than 2.3 billion rubles (~$35.7 million) in corruption-related damages through criminal and civil proceedings.

Russian authorities also reported a number of high-profile corruption cases initiated against officials at the governor and deputy governor levels, many of them involving fraud and embezzlement related to contracts with entities affiliated with government officials.  Against this backdrop of reported steady progress of anti-corruption enforcement, Russian authorities have faced significant criticism in connection with the suspected poisoning of Alexei Navalny, a high-profile anti-corruption activist and opposition leader.  On August 20, 2020, Navalny fell violently ill during a flight from Siberia to Moscow and was rushed for treatment to a hospital in Germany.

As we reported in our 2020 Mid-Year FCPA Update, numerous arrests were made in connection with a scheme involving senior Deposit Insurance Agency (“DIA”) officials allegedly taking kickbacks from contractors tasked with bank restructurings.  In the second half of 2020, more information has come to light regarding the scheme.  With the Russian Central Bank invoking a zero-tolerance policy for corrupt banks, many banks have seen their licenses revoked.  Under Russian law, the DIA would then take control and contract with companies to handle all aspects of the bankruptcy.  But to be hired, contractors allegedly had to pay a substantial bribe—and after the banks’ assets were up for auction, they were sold at well below fair market value.  DIA officials allegedly accumulated billions of rubles.  Since these findings came to light, the DIA has been forbidden from handling new bailouts, and the Federal Antimonopoly Service has pushed for the passage of a law requiring increased transparency in DIA operations.

            Ukraine

President Volodymyr Zelensky’s anti-corruption efforts were dealt a major blow recently when the Constitutional Court of Ukraine (“CCU”) struck down a key anti-corruption initiative signed into law by President Zelensky a year ago. In a ruling made public on October 28, 2020, the CCU held, among other things, that Ukraine’s National Agency on Corruption Prevention may not seek criminal lability for government officials, including judges, for failing accurately to report all of their assets and explain their sources. This is not the first time the CCU has struck down such a law—the version signed into law by President Zelensky was passed in response to the CCU striking down an earlier iteration. The revised version of the law was declared unconstitutional partly because it gave anti-corruption officials authority over judges, which the CCU found to interfere with the judiciary’s independence. As a result of the CCU’s ruling in October, more than 100 corruption investigations had to be closed. The Ukrainian parliament, however, quickly responded on December 4, 2020, by passing another version of the law, which attempts to address some of the CCU’s concerns by decreasing penalties and increasing thresholds for criminal liability.

            Uzbekistan

On September 11, 2020, Switzerland and Uzbekistan announced the signing of an agreement for the return of funds seized in connection with a money laundering investigation against Gulnara Karimova, the daughter of former President Islam Karimov, who has been imprisoned since 2017. The framework agreement provides for the return to Uzbekistan of $131 million, which were confiscated from Swiss bank accounts held by Karimova, conditional on ensuring transparency and appropriate monitoring of the funds’ use. The details of the restitution are set to be agreed upon under a second agreement, but the framework agreement makes clear that the restituted funds “shall be used for the benefit of the people of Uzbekistan.” The $131 million comprises part of the approximately $880 million that Swiss authorities froze in 2012 in connection with criminal proceedings against Karimova. The framework agreement also will apply to the restitution of any of the remaining frozen funds.

The Americas

            Argentina

In the second half of 2020, proceedings continued in connection with the “Notebooks” scandal reported in our prior updates, related to former President Cristina Fernández de Kirchner and her administration. In November 2020, a federal judge acquitted Fernández in one corruption trial after determining that the notebooks—belonging to the chauffeur of a high-ranking official in Fernández’s administration and allegedly describing various bribes the chauffeur delivered to Fernández and others—were inadmissible. Appeals are ongoing. The acquittal came shortly after Fernández’s former top aide, a key witness and the uncle of one of the prosecutors involved, was found murdered.

Another longstanding investigation with Argentinian touchpoints saw developments in the second half of the year. In connection with investigations of corruption involving international soccer federation officials, in October 2020 the Swiss Office of the Attorney General announced the seizure of $40 million from Argentinians Nicolás Leoz and Eduardo Deluca, respectively the former president and secretary general of the South American Football Confederation (“CONMEBOL”), who were accused of exploiting their positions to unlawfully enrich themselves. The case against Leoz ended with his death in August 2019; Deluca was convicted of aggravated criminal mismanagement in 2019. Swiss authorities concluded that the funds were unlawfully acquired and should be returned to CONMEBOL.

            Brazil

In Brazil, the years-long Operation Car Wash continued as Brazilian prosecutors extended existing investigations, launched new phases, and brought additional suits.

In November 2020, federal prosecutors filed suit against oil trading company Trafigura and several individuals related to alleged bribes paid to Petrobras executives in return for favorable treatment on 31 deals dating to 2012 and 2013. The Federal Public Ministry (“MPF”) is seeking to recover a minimum of R$403 million, and has sought to freeze up to R$1 billion of the named parties’ assets. Several of the people named in the complaint previously were named in other bribery actions or signed leniency agreements with the government.

On December 3, 2020, the Operation Car Wash task force announced that Vitol Inc. had entered into a leniency agreement with the MPF, agreeing to pay approximately $45 million to Petrobras as damages in connection with alleged bribes in exchange for favorable treatment and bidding advantages. The agreement, which needs to be approved by the MPF’s Chamber to Combat Corruption, also will require Vitol to adopt certain transparency measures and to report on compliance-, corruption-, and money laundering-related risks. This resolution was coordinated with Vitol’s U.S. resolutions with DOJ and the CFTC noted above.

In August 2020, Brazilian enforcement authorities announced a “technical cooperation agreement” that articulates principles and procedures for joint action against corruption and aims to promote more effective cooperation among Brazil’s public agencies executing leniency agreements, which have been a significant tool in recent corruption investigations. Brazil’s Comptroller-General’s Office, Attorney General’s Office, Ministry of Justice and Public Security, and Federal Court of Accounts executed the agreement. The agreement provides, among other things, that Brazil’s Comptroller-General’s Office and federal Attorney General’s Office will negotiate leniency agreements under Brazil’s Anti-Corruption Law, and that they must share information after the agreements’ execution. The MPF has not executed the agreement, and the MPF’s 5th Chamber issued a Technical Note advising against execution on the grounds that the agreement unconstitutionally limits the role of the MPF in negotiating and executing leniency agreements, among other critiques.

            Colombia

Colombia continued to deal with the impact of investigations related to Brazilian construction company Odebrecht S.A. In October 2020, Colombia’s highest administrative court upheld a Bogotá Chamber of Commerce award nullifying an Odebrecht consortium’s contract for a billion-dollar highway construction—a project that also led to ICC claims and an investment treaty dispute—because of corruption. Relatedly, the Odebrecht-related indictment of Juan Carlos Granados Becerra, former governor of Boyacá and recently elected magistrate judge on the National Commission for Judicial Discipline, has been indefinitely postponed. Just days before the hearing, Granados revoked the power of the attorney representing him, forcing a delay due to his lack of representation.

On the legislative front, Colombia’s Congress introduced Bill 341/20 on October 27, 2020, seeking to create more stringent corporate transparency requirements and tackle corruption by creating a beneficial ownership registry. The bill intends to bring Colombia in line with international recommendations, which recognize that transparency regarding “beneficial owners” (i.e., natural persons with more than 5% ownership of a company) is important to efforts to counter corruption, money laundering, and terrorism financing. If passed, the bill will standardize and streamline reporting across government agencies in the country.

            Ecuador

In September 2020, a three-judge panel of Ecuador’s National Court of Justice ratified former President Rafael Correa’s eight-year prison sentence for breaking campaign finance laws. As reported in our 2020 Mid-Year FCPA Update, Correa was found guilty of bribery and corruption and sentenced in absentia in April 2020. The sentence also required $14.7 million of reparations to the state and stripped Correa’s citizenship rights. The decision effectively blocks Correa’s efforts to participate in Ecuador’s 2021 election as a vice presidential candidate.

            El Salvador

In November 2020, the El Salvadoran Attorney General executed more than 20 raids on government offices in response to alleged improper spending of emergency pandemic funds by the administration of President Nayib Bukele, including allegedly overpaying relatives for medical equipment and, in some instances, improperly making payments to companies not specializing in medical equipment.

            Guatemala

As discussed in our 2019 Year-End FCPA Update, Guatemala’s commitment to anti-corruption efforts has been uncertain, with the country’s major anti-corruption organization, the International Commission Against Impunity (known by its Spanish acronym “CICIG”), being disbanded in late 2019. In October 2020, Guatemala’s Attorney General approved nine administrative complaints against Guatemala’s remaining anti-corruption organization, the Special Prosecutor’s Office Against Impunity (known by its Spanish acronym “FECI”). FECI has suggested that the complaints, some of which were filed by its investigative targets, are politically motivated. This development follows the Guatemalan Attorney General’s previous decision to remove FECI from investigations into allegations of financial mismanagement at the country’s social security administration and into a high-profile narcotics trafficking operation.

            Haiti

Haiti’s Superior Court of Auditors and Administrative Disputes, which functions as a government accountability office, published a report in August 2020 finding that more than $2 billion in petrodollars from Venezuela’s PetroCaribe petroleum-import finance program were embezzled over eight years. The program, created at former President Hugo Chavez’s behest, allows Latin American and Caribbean countries to obtain Venezuelan loans through a system of preferential oil delivery. The report found that most of the millions Haiti received in response to the devastating 2010 earthquake was wasted, embezzled, and poorly managed as it went to hundreds of projects that did little to improve the lives of Haitians. Despite the report, recommendations from the High Court of Auditors, and popular protests, Haiti has not yet pursued prosecution of former ministers and high-ranking officials involved in the PetroCaribe scandal.

            Honduras

In early 2020, Honduras allowed the mandate for its anti-corruption body, the Mission to Support the Fight against Corruption and Impunity in Honduras (known by its Spanish acronym “MACCIH”) to expire. The decision reportedly was backed by supporters of President Juan Orlando Hernández Alvarado. President Hernandez’s term in office has been marred by allegations of corruption; he allegedly received bribes and improperly protected his brother, Juan Antonio “Tony” Hernandez, from extradition after he was found guilty of narcotics-related charges in a U.S. court.

            Panama

Panama recently enacted a number of initiatives to strengthen its anti-corruption efforts. In August 2020, following high-profile corruption-related arrests related to former Panamanian President Ricardo Martinelli, Panamanian and U.S. officials announced an agreement to create a joint anti-money laundering task force. The countries agreed that the U.S. Federal Bureau of Investigation would provide training to Panamanian prosecutors, law enforcement, and other regulatory officials to target money laundering networks and strengthen Panama’s capacity to investigate, disrupt, and prosecute corruption and related issues. In November 2020, Panama also launched the “Observatorio Ciudadano de la Corrupcion” (“OCC”), a public-private partnership within the framework of Panama’s National Action Plan for Open Government. The OCC writes reports and releases statistics monitoring the judiciary’s performance, and seeks to prevent corruption by promoting transparency and efficiency. These analyses and reports are made available to the public on the OCC’s website.

            Peru

In recent years, former President Martin Alberto Vizcarra Cornejo emerged as Peru’s most vocal proponent of measures to end decades of entrenched corruption in Peruvian politics, often sparring with the country’s more conservative legislature. In July 2020, Vizcarra introduced constitutional amendments that, among other things, would ban persons convicted of serious crimes from seeking office, criminalize illegal funding for political parties, require open internal party elections, and pave the way toward removing immunity for members of congress. Some measures passed, and Congress voted the following month to create a temporary commission to investigate corruption in Peru’s construction sector, which already has resulted in charges against four former presidents who allegedly accepted $20 million in bribes in connection with the Odebrecht scandal. National anger erupted, however, after the revelation that Congress inserted an exception in an immunity-related bill for actions involving the performance of congressional duties.

Amid these moves, tension between the President and Congress grew. When allegations emerged that Vizcarra had taken bribes from a construction company during his time as a governor, Peru’s legislature voted to impeach and remove him, citing the corruption allegations as one justification for the move. Following the vote, thousands of supporters protested in the streets of Lima. Vizcarra denied the accusations and, to date, has not been charged. The new President, Manuel Merino, was forced to resign a mere six days into his term due to national anger over the death of two young protesters at the hands of police. This incident paved the way for the country’s current President, Francisco Sagasti, to assume office on November 17, 2020. Given this significant unrest—including a week when Peru was led by three different presidents—additional anti-corruption reforms likely will be stalled for the foreseeable future.

Asia

            China

In December 2020, the National People’s Congress promulgated amendments to the Criminal Law of the People’s Republic of China. The amendments revised the maximum criminal penalties for private individuals convicted of commercial bribery, embezzlement, and graft of corporate assets and funds, placing them on par with fines and potential prison sentences for government officials found guilty of similar misconduct. In addition to increasing potential penalties, the amendments set out similar sentencing guidelines for embezzlement and graft of corporate assets and funds.

Over the last year, President Xi Jinping’s ongoing anti-corruption campaign focused on senior domestic security personnel and members of the judiciary, resulting in investigations into the Shanghai chief of police and at least 21 other high-level police and judicial officials. The chief of police of the Chongqing municipality also is under investigation for “seriously violating disciplinary rules and the law,” a phrase the Chinese Communist Party often uses to describe graft and corruption. We also continue to see investigations, arrests, and convictions of government officials and state-owned enterprise executives in the energy, finance, and manufacturing sectors. In October, for example, enforcement authorities announced a corruption probe into Liu Baohua, the deputy director of China’s National Energy Administration. In November, China’s anti-graft watchdog announced an investigation into Shen Diancheng, a former executive at China National Petroleum Corporation. Also in December, authorities announced two high-profile corruption investigations involving government officials in the financial sector in China’s Chongqing municipality: Jiang Bin, a former official of the Export-Import Bank of China who was dismissed from his post in 2019, is under investigation for allegedly accepting bribe payments in exchange for authorizing illegal loans. Mao Bihua, the former party secretary and director of the Chongqing division of the China Securities Regulatory Commission, is also under investigation.

            India

The Government of India recently released a report detailing statistics for enforcement actions brought under the Prevention of Corruption Act, 1988 (“PCA”) in 2019, the first full year following landmark PCA amendments passed in 2018. These statistics show a continued downward trend in the number of corruption cases registered against public officials under the PCA. Registered corruption investigations have dropped from 632 (involving 1,142 officials) in 2017, to 460 cases (involving 867 officials) in 2018, to 396 cases (involving 607 officials) in 2019. Some commentators have noted that the dip in cases may be related to Section 17A of the PCA, one of the 2018 amendments, which bars investigations by anti-corruption enforcement agencies into a public official without the prior sanction of the state or central government.

The local enforcement numbers, however, do not necessarily reflect the situation on the ground, as evidenced by continued corruption scandals and public perception that graft remains endemic. Indian authorities recently charged the former CEO of ICICI Bank, Chanda Kochhar, and her husband with providing favorable bank loans to private companies, which in turn invested funds in businesses held by the couple. Further, the results of Transparency International’s latest Global Corruption Barometer survey show that 89% of Indians polled believe that corruption is a “big problem” in the country, and 39% reported paying bribes to access public services within the last 12 months, the largest percentage among all Asian jurisdictions polled.

On the regulatory side, the Securities and Exchange Board of India (“SEBI”) passed rules that may impact listed companies seeking to conduct internal investigations. In September 2020, SEBI determined that companies listed on Indian stock exchanges must disclose information regarding the initiation of any forensic audit—irrespective of materiality. While the rules, applicability, and reporting mechanisms await further clarification, under the decision, listed companies must disclose the following: (1) that it has initiated a forensic audit; (2) the name of entity initiating the forensic audit and reasons for initiating the audit; and (3) the final forensic audit report (other than for forensic audits initiated by regulatory or enforcement agencies), along with any comments from company management.

            South Korea

This past year, President Moon Jae-In, who was swept into power on the heels of a corruption scandal that resulted in the impeachment of his predecessor, found himself mired in corruption allegations involving his own justice ministers and his newly appointed prosecutor general. In 2019, President Moon appointed Yoon Seok-Youl as the country’s top prosecutor, charging him with rooting out public corruption that has plagued Korean government agencies for decades. Shortly thereafter, Yoon launched an investigation into Cho Kuk, President Moon’s justice minister, on allegations of falsifying investment documents and other financial irregularities. The investigation resulted in Cho’s resignation, and eventual criminal indictments including bribery, document falsification, and manipulation of evidence.

In November, Choo Mi-Ae, then-justice minister and Cho’s successor, suspended Yoon, alleging a number ethical and criminal violations, including breaching prosecutorial neutrality and illegal surveillance operations. The Justice Ministry’s Inspection Committee, however, found the allegations to be baseless and reinstated Yoon. Choo nevertheless continued to call for Yoon to be sanctioned, a move criticized by the public, which overwhelmingly backed Yoon and viewed Choo as attempting to obstruct Yoon’s efforts to root out corruption within the Justice Ministry. On December 30, 2020, President Moon accepted Choo’s resignation, and appointed Park Beom-Kye, a member of the National Assembly from President Moon’s Democratic Party, as Korea’s new justice minister. The scandal caused President Moon’s approval rating to plummet to the lowest levels of his presidency.

            Japan

Japanese authorities have arrested House of Representatives member Tsukasa Akimoto on several occasions in connection with allegations that he accepted bribes from 500.com Ltd., a Chinese online gaming company. Prosecutors suspect Akimoto of receiving the payments in connection with 500.com Ltd.’s bid to obtain a license to build an integrated resort in Japan.

A former Liberal Democratic Party Justice Minister, Katsuyuki Kawai, and his wife, Anri Kawai, were indicted on charges that they paid cash to Hiroshima legislators to secure Ms. Kawai’s seat on the House of Councilors. Prosecutors allege that Ms. Kawai paid approximately $16,000 to five local assembly members in advance of her July 2019 victory in the Upper House election. Her husband is accused of providing approximately $280,000 to 100 individuals. Both await trial.

            Indonesia

Corruption at the highest levels of government took center stage in Indonesia in 2020. In December, Indonesia’s Social Affairs Minister, Juliari Batubara, surrendered to authorities after the country’s anti-corruption agency, Komisi Pemberantasan Korupsi (“KPK”), accused him and two other officials of accepting kickbacks from private contractors hired to supply aid packages to those affected by the COVID-19 pandemic. The accusations against Batubara followed the arrest of Edhy Prabowo, the Minister of Maritime Affairs and Fisheries, whom the KPK accused of receiving kickbacks from private companies in exchange for lobster larvae export permits. In June, Imam Nahrawi, a former Sports Minister, was sentenced to seven years in prison after being found guilty of accepting bribes worth more than $800,000 in exchange for approving grants given by the Indonesian Sports Council. The KPK announced that 109 total people were arrested in relation to anti-corruption investigations during 2020.

In May, an Indonesian court convicted Emirsyah Satar, former CEO of Garuda Indonesia, Indonesia’s state-owned airline, of corruption and money laundering after finding that, between 2005 and 2014, Satar received bribes from Airbus and Rolls-Royce in exchange for procurement contracts for aircraft and aircraft parts. Satar was sentenced to eight years in prison and ordered to pay a fine of $1.4 million.

            Malaysia

As reported in our 2020 Mid-Year FCPA Update, Malaysian authorities charged former Prime Minister Najib Razak with 42 counts of corruption, abuse of power, and money laundering in five criminal cases linked to the 1MDB scandal. In the verdict of the first trial, delivered in July 2020 and involving seven of the charges, the court found Najib guilty on all counts, namely criminal breach of trust, money laundering and abuse of power. The court sentenced Najib to 12 years imprisonment. In separate proceedings, Malaysian authorities accused Najib’s wife, Datin Seri Rosmah Mansor, of accepting bribes in exchange for government contracts. The prosecution’s case concluded in December 2020, and the defense is scheduled for early January 2021.

Malaysian authorities also charged former Finance Minister Lim Guan Eng with both seeking and receiving a bribe in connection with the appointment of a contractor to manage an infrastructure project in Penang. According to the Malaysian Anti-Corruption Commission, Lim, who served as finance minister between 2008 and 2018, allegedly received bribes of more than $1 million in exchange for contracts connected to the Penang underseas tunnel project.

On the legislative front, new amendments to the Malaysian Anti-Corruption Commission Act 2009, effective June 1, 2020, made corporations and their management potentially liable for the corrupt acts of their employees. Under the new Section 17A, a “commercial organization” is deemed to have committed an offense if a person associated with the organization “corruptly gives, agrees to give, promises or offers” any gratification to any person to obtain or retain business for the organization. Under the law, businesses may be fined no less than 10 times the amount of the gratification or MYR 1 million (~$247,000), whichever is higher, as well as prison terms of up to 20 years for those involved. Section 17A also provides a defense for corporations where they can prove they had “adequate procedures” in place to prevent employees from undertaking such misconduct. Along with the amendment, the Government of Malaysia published a series of guidance documents, including case studies, to assist companies in implementing compliance programs designed to prevent bribery. The guidance lists, among other things, management commitment to compliance, regular risk assessments, and training as examples of adequate procedures. The new law also holds directors, controllers, officers, and partners strictly liable for the offenses of their companies unless they can show the offense was committed without their consent and connivance, and that they exercised “due diligence” to prevent the commission of the offense.

Australia, the Middle East, and Africa

            Australia

In November 2020, Australian police made an arrest in connection with the years-long probe into bribery related to Monaco-based oil services company Unaoil, which, as noted above has been at the center of a developing body of anti-corruption enforcement around the world. Former Leighton Offshore executive Russell Waugh was arrested on charges related to allegations that he conspired to pay bribes to Iraqi officials and falsified corporate books. Charges against additional former executives reportedly are expected, with former Unaoil CEO Cyrus Allen Ahsani and COO Saman Ahsani cooperating with the Australian government following their March 2019 FCPA guilty pleas.

            Israel

Prosecutors faced a setback in their long pursuit of corruption charges against Israeli Prime Minister Benjamin Netanyahu. As covered most recently in our 2019 Year-End FCPA Update, the Israeli Attorney General announced indictments in February 2019 stemming from three separate allegations of wrongdoing (referred to as Case 1000, Case 2000, and Case 4000).

In a partial victory for Netanyahu, the judge recently ordered prosecutors to amend their indictment in Case 4000, indicating that he agreed with the defense’s argument that the indictment improperly grouped Netanyahu’s alleged misconduct with that of his wife and son. At the same time, however, the Court rejected Netanyahu’s claim that he was immune from the charges. Netanyahu cheered the ruling in Case 4000 and continues to claim that the charges against him amount to nothing more than a political witch hunt. This month, prosecutors filed a revised indictment listing more than 300 incidents in which members of the Netanyahu family or their intermediaries allegedly sought more positive media coverage, including 150 in which the Prime Minister himself was involved. Netanyahu’s trial is expected to resume next month, shortly before Israel’s March 2021 national elections.

            Mozambique

Manuel Chang, the ex-Finance Minister of Mozambique charged by DOJ along with others in March 2019 with an assortment of wire fraud, securities fraud, and money laundering conspiracy charges, and arrested in South Africa (as covered in our 2019 Year-End FCPA Update), continues to be subject to competing extradition requests from the United States and Mozambique. Chang has been held in South Africa for the last two years. The United States requested Chang’s extradition in 2019. An extradition request by Mozambique followed, but with no underlying charges in the country to support it. In November 2020, Chang was charged in Mozambique for his involvement in the same $2 billion dollar debt scandal. Chang now awaits the decision of South African Justice Minister Ronald Lamola on extradition.

CONCLUSION

As is our semiannual tradition, in the following weeks Gibson Dunn will be publishing a series of enforcement updates for the benefit of our clients and friends as follows:

• Tuesday, January 12: 2020 Year-End Update on California Labor and Employment;
• Wednesday, January 13: 2020 Year-End Update on Corporate NPAs and DPAs;
• Thursday, January 14: 2020 Year-End UK Financial Services Regulation Update;
• Friday, January 15: 2020 Year-End German Law Update;
• Tuesday, January 19: 2020 Year-End Securities Enforcement Update;
• Wednesday, January 20: 2020 Year-End UK Labor & Employment Update;
• Thursday, January 21: 2020 Year-End False Claims Act Update;
• Friday, January 22: 2020 Year-End Class Actions Update;
• Wednesday, January 27: 2020 Year-End Privacy & Cybersecurity Update (United States);
• Thursday, January 28: 2020 Year-End Privacy & Cybersecurity Update (International);
• Friday, January 29: 2020 Year-End AI & Related Technologies Update;
• Thursday, February 4: 2020 Year-End Sanctions Update;
• Monday, February 8: 2020 Year-End Shareholder Activism Update; and
• Tuesday, February 9: 2020 Year-End Securities Litigation Update.

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The following Gibson Dunn lawyers assisted in preparing this client update:  F. Joseph Warin, John Chesley, Christopher Sullivan, Richard Grime, Patrick Stokes, Reuben Aguirre, Brian Anderson, Chaplin Carmichael, Claire Chapla, Josiah Clarke, Austin Duenas, Tessa Gellerson, Julie Hamilton, Patricia Herold, Jabari Julien, Amanda Kenner, Derek Kraft, Nicole Lee, Allison Lewis, Warren Loegering, Jenny Lotova, Andrei Malikov, Megan Meagher, Jesse Melman, Katie Mills, Alayna Monroe, Caroline Monroy, Erin Morgan, Alexander Moss, Jaclyn Neely, Ning Ning, Joshua Robbins, Jeff Rosenberg, Liesel Schapira, Jason Smith, Pedro Soto, Laura Sturges, Karthik Ashwin Thiagarajan, Oleh Vretsona, Oliver Welch, Dillon Westfall, and Caroline Ziser Smith.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues.  We have more than 110 attorneys with FCPA experience, including a number of former federal prosecutors and SEC officials, spread throughout the firm’s domestic and international offices.  Please contact the Gibson Dunn attorney with whom you work, or any of the following:

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This past year saw the enactment of a variety of new employment laws in California, including new disclosure requirements for employers and changes to the independent contractor landscape. In addition, the COVID-19 pandemic has touched nearly every sector of society, in nearly every corner of the world, and employment law in California is certainly no exception. The pandemic has ushered in a new legal landscape marked by heightened requirements for employers stretching from 2020 into 2023.

Below, we outline four new laws that require attention from California employers in the new year: (1) the new requirements for California employers in reporting wage and hour data; (2) the continuing evolution of the worker classification standard and the recent passage of Proposition 22; (3) the new COVID-19 notice requirements that will require employers to notify employees of possible exposure; and (4) the new Workers’ Compensation Disputable Presumption under SB 1159. We also highlight California’s current plan for rolling out the recently approved COVID-19 vaccines, a strategy that will no doubt develop more in the next few months as essential workers become eligible to receive the vaccine.

____________________

Table of Contents

I.        California Employers Required to File Equal Pay Report to California DFEH (SB 973)

II.       Amendment to ABC Test Under Assembly Bill 2257 and Proposition 22

III.     COVID-19 Notice Requirements Under Assembly Bill 685

IV.      Workers’ Compensation Disputable Presumption Under Senate Bill 1159

V.        COVID-19 Vaccine – Who Will Get It and When?

____________________

I.  California Employers Required to File Equal Pay Report to California DFEH (SB 973)

On September 30, 2020, California Governor Gavin Newsom signed Senate Bill 973 (“SB 973”) into law, which requires employers to submit pay and hours data for various categories of employees to California’s Department of Fair Employment and Housing (“DFEH”). The stated goals of SB 973 are to decrease gender and racial pay disparities in California and fill the gap of the currently suspended federal effort to collect data for these purposes.

A.  Background on SB 973 – From President Obama to Governor Newsom

Since the 1960s, employers with 100 or more employees have been required to report certain demographic data to the Equal Employment Opportunity Commission (“EEOC”). The Obama Administration expanded the reporting requirements in 2016, adding hours and pay data to the report, which would be broken down by job category, race, ethnicity and gender. The EEOC collected this data until September 2019, when it announced that it would no longer collect the information. SB 973 was enacted in an effort to continue the Obama Administration’s equal pay policies by imposing largely the same requirements that existed under those policies.

B.  When Does the Law Take Effect?

The law took effect on January 1, 2021, and the first report is due on March 31, 2021, with subsequent reports due each year thereafter. Employers should begin compiling the relevant data as soon as possible to ensure compliance. The DFEH has stated that it intends to issue standard forms that employers will be able to use to prepare the reports.

C.  Who Does the Law Apply To?

The law applies to private employers with 100 or more employees, or employers who are required to file a federal Employer Information Report EEO-1 form. According to current DFEH guidelines, employees both inside and outside of California are counted when determining whether an employer has 100 or more employees. Temporary workers will also count toward the determination of whether an employer meets 100 employees, if the employer is required to include the temporary workers in an EEO-1 report, and if the employer is required to withhold federal social security taxes from their wages.

D.  What Information Does the Report Require?

Employers will need to create a “snapshot,” counting all employees (part and full-time) in a given category during a single pay period of the employer’s choice between October 1 and December 31 of the prior calendar year (the “Reporting Year”). To prepare the report, employers should first count and record the number of employees by race, ethnicity, and gender organized by job categories (which are the same categories used by the federal government in the EEO-1 report).[1]

Second, employers will need to further break down the data by separating employees in each category by pay band.[2] To determine what pay band an employee falls into, the employer should look at the employee’s W-2 earnings for the entire Reporting Year, regardless of whether that employee worked for the full calendar year.

Third, using the same general format, the employer must include the total number of hours worked by each employee counted in each pay band during the Reporting Year.

The employer will be permitted, but not required, to provide clarifying remarks. The report must be in searchable and sortable format. If the employer has multiple establishments, it will need to submit a separate report for each establishment, as well as a consolidated report. Each report should include the employer’s North American Industry Classification System (NAICS) code.

If an employer fails to submit a report, the DFEH may seek an order requiring the employer to comply with the requirements and will be entitled to recover the costs associated with seeking the order for compliance.

E.  What Does the Law Mean For Employers, Besides Additional Reporting?

While the intent is for the DFEH to use the reported data to “more efficiently identify wage patterns and allow for targeted enforcement of equal pay or discrimination laws,” in reality, these goals are more likely to be impeded than helped by the data collected. This is because W-2 data is not a precise—or even remotely reliable—measure of wages paid.

For instance, W-2 compensation reflects an employee’s reported income for a calendar year, which is not necessarily tied to the number of hours worked or the employee’s earnings in that year. Identically compensated employees may have a wide variance in W-2 data in any given year for reasons other than differences in wage rates. For example, if an employee’s compensation package includes equity grants, such compensation will not be reflected on a W-2 until the stock option is exercised or the rights vest, which may be years later (and potentially after unforeseen or unpredictable events that may significantly increase or decrease the value of the equity). Other non-wage compensation, such as reimbursement of relocation expenses or payment of recruitment bonuses, will also be reflected in the W-2, but do not have any meaningful tie to compensation level.

W-2 data also does not report hours worked, or account for employees who worked only part of the year (for example, employees who took a leave of absence, or were hired or quit in the middle of the year). SB 973 tries to account for these potential gaps by requiring employers to report the hours worked by the employee. But many employers do not track hours of exempt employees, and will be forced to either leave that portion blank or estimate hours, which may skew the analysis.

Additionally, the pay data report asks employers to categorize employees based on the federal EEO-1 job categories. But those categories do not account for different skills required between jobs in the same category for which the market dictates different compensation. The job categories also do not account for differences in an employee’s education, training or experience within the same job category, all variables that greatly affect compensation and which the law acknowledges should be considered in evaluating wage rates under the Equal Pay Act.[3]

As a result of these many deficiencies of the reported W-2 data, many employers who are actively and conscientiously working to ensure equitable compensation may nevertheless face allegations of pay discrimination. To reduce this risk, employers should consider providing clarifying remarks, as is permitted by the statute, but should work closely with experienced counsel to determine how much and what kind of clarifying data they should provide.

II.  Amendment to ABC Test Under Assembly Bill 2257 and Proposition 22

In 2018, the California Supreme Court in the Dynamex case articulated a new test for classification of independent contractors, which the legislature codified in Assembly Bill 5 (“AB 5”) a year later—albeit with numerous exemptions of varying complexity. The Legislature this year passed Assembly Bill 2257 (“AB 2257”), which provides still more exemptions than already existed under AB 5, and revises many of the exemptions that AB 5 had put in place the previous year. And just recently, California voters passed Proposition 22, which further narrowed the reach of AB 5. Thus, while 2020 has brought some clarity concerning classification of independent contractors, many questions remain that will need to be addressed in 2021 and thereafter.

A.  History of the Worker Classification Test and the Adoption of the ABC Test

In 2018, the California Supreme Court imported a new legal standard for determining worker classification for purposes of California wage orders: the “ABC test.” In contrast to the flexible, multi-factor analysis that had been in place for nearly three decades, the Court in Dynamex Operations West, Inc. v. Superior Court, 4 Cal. 5th 903 (2018), held that companies seeking to classify workers as independent contractors must prove three elements:

1. The worker remains free from the hiring entity’s control and direction in connection with the performance of the work, both under the contract and in fact;
2. The worker performs work that is outside the usual course of the hiring entity’s business; and
3. The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity.

On September 18, 2019, Governor Newsom signed AB 5 into law, declaring it “landmark legislation” for “workers and our economy.” AB 5 not only codified the ABC test, but also clarified that this test applies broadly to claims arising under the Labor Code and Unemployment Insurance Code, and not just the narrower wage orders to which Dynamex is limited. But AB 5 also exempted many industries from its otherwise broad reach and permitted those industries to continue using the more employer-friendly test in S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal. 3d 341 (1989)—the standard before Dynamex.[4] Notably, truck drivers, journalists, and on-demand app-based workers, such as ride-share workers, were not expressly exempted.

B.  AB 2257—Providing More Exemptions to AB 5

On September 4, 2020, AB 2257 was signed into law. Among other things, AB 2257 widened the business-to-business and referral agency exemptions, and introduced 109 additional categories of workers exempted from AB 5. The business-to-business exemption involves business entities such as corporations and partnerships contracting with other businesses to provide services, while the referral agency exemption applies to business entities that perform services through a referral agency. These business entities prefer to be labeled as an independent contractor, and not employee, of the referral agencies. Yet, even though these exemptions were broadened, once again, gig economy workers were not among the many expressly exempted industries.

C.  Prop 22—Creating a Safe Harbor for App-Based Workers and Companies

In November, California voters passed the Protect App-Based Drivers and Services Act (Prop 22) to ameliorate the threat of AB 5 for on-demand, app-based rideshare and delivery companies in California. Prop 22 ensures AB 5 cannot be applied to “app-based workers,” enabling “network compan[ies]” to continue classifying app-based workers as independent contractors.

Companies can classify workers as independent contractors and take advantage of Prop 22’s safe harbor as long as they qualify as a Delivery Network Company or Transportation Network Company and meet the requirements of Prop 22’s four-element independent contractor standard:

1. The network company does not unilaterally prescribe specific dates, times of day, or minimum number of hours during which the app-based driver must be logged into the network company’s online enabled platform;
2. The network company does not require the app-based driver to accept any specific rideshare service or delivery service request as a condition of maintaining access to the network company’s online-enabled application or platform;
3. The network company does not restrict the app-based driver from performing rideshare services or delivery services through other network companies except during engaged time; and
4. The network company does not restrict the app-based driver from working in any other lawful occupation or business.

Prop 22 also requires network companies to provide workers with certain levels of compensation and specific benefits to ensure the “economic security” of app-based rideshare and delivery drivers. These benefits include hourly compensation of at least 120% of the local minimum wage plus $0.30 per mile; a healthcare subsidy consistent with contributions required under the Affordable Care Act for certain qualifying workers; occupational accident insurance; and protection against discrimination and sexual harassment.

D.  What Questions Remain Regarding Worker Classification After AB 2257 and Prop 22?

While AB 2257 and Prop 22 have provided more clarity regarding the classification of independent contractors in California, many questions remain. Thus, over the next year, we expect to see courts addressing the reaches of both the ABC Test and Prop 22. For example, we expect decisions regarding:  

• Retroactive Application of Dynamex’s ABC Test: On November 3, 2020, the California Supreme Court heard oral arguments in Vazquez v. Jan-Pro Franchising International, Inc., No. S258191 (filed Sept. 26, 2019), where it is poised to determine whether Dynamex applies retroactively.
• Federal Preemption of the ABC Test Under the FAAAA: Parties have challenged the ABC Test, both under Dynamex and AB 5, as preempted by federal law. In particular, trucking groups and companies have challenged AB 5 as preempted by the FAAAA, which regulates motor carriers. See California Trucking Association, et al. v. Xavier Becerra, et al., 433 F. Supp. 3d 1154 (S.D. Cal. 2020) (issuing preliminary injunction of AB 5 as applied to motor carriers in California because of FAAAA preemption); see also People v. Superior Court of Los Angeles County (Cal Cartage Transportation Express, LLC), 57 Cal.App.5th 619 (Cal. Ct. App. 2020), petition for review pending (finding that the ABC test is not preempted by the FAAAA).
• Reach of Prop 22: Parties have already begun filing cases concerning whether Prop 22 can apply retroactively and whether it is a partial repeal of AB 5, among other questions.

The focus on worker classification issues is not likely to fade in 2021. Companies with independent contractor workforces should review their practices and contracts to make sure that they can comply with the applicable legal standard, and should stay apprised of the many developments we expect to see in this area over the coming year.

III.  COVID-19 Notice Requirements Under Assembly Bill 685

On September 17, 2020, Assembly Bill 685 (“AB 685”) was signed into law by Governor Newsom in order to strengthen access to information regarding the spread of COVID-19. AB 685 imposes two new notice requirements on employers regarding COVID-19, effective January 1, 2021. First, employers are required to notify certain employees and representatives concerning a possible exposure to COVID-19. Second, should the number of cases reach an “outbreak” as defined by the State Department of Public Health, the employer must notify the local public health agency.

A.  Notice of Potential Exposure

When an employer is aware of potential exposure to COVID-19 at a worksite, the employer must provide written notice of the potential exposure to all employees who were on the same worksite as the qualifying individual who caused the potential exposure, as well as notice to all employers of subcontracted employees, and to any exclusive representatives (e.g. union representatives) of potentially exposed employees.

1.  What counts as a potential exposure?

If an employee, or an employee of a subcontractor, has been on the premises at the same worksite as a qualifying individual within the infectious period of COVID-19, that is a potential exposure. A qualifying individual is a person who has: (1) a laboratory-confirmed positive case; (2) a diagnosis from a licensed health care provider; (3) received an isolation order from a public health official; or (4) died due to COVID-19. If the individual developed symptoms, the infectious period begins 2 days before the symptoms were first developed, and ends when 10 days have passed since the symptoms first appeared, 24 hours have passed with no fever, and other symptoms have improved. If the individual never developed symptoms, the infectious period begins 2 days before the specimen that tested positive was collected, and ends 10 days after the specimen was collected.[5]

2.  What kind of notice must be provided?

The required notice must be written, and given in a manner normally used by the employer to communicate employment-related information. This could include personal service, email, or text message if it can reasonably be anticipated to be received by the employee within one business day. The notice must be in both English and the language understood by the majority of the employees.

Each notice must include the following information:

• That the employee may have been exposed to COVID-19;
• Information regarding COVID-19 related benefits and employee protections, including protections from discrimination and retaliation for disclosing a positive diagnosis; and
• Information on the disinfection and safety plan that the employer will implement and complete per CDC guidelines.

The notice must not include the name, or any other identifying information, of the qualifying individual.

3.  Are there any penalties for failing to provide notice?

The statute provides that the Division of Occupational Safety and Health (“Cal OSHA”) may issue a citation and civil penalties to employers who fail to provide the required notice of potential exposure, or if the notice does not include information regarding the employer’s disinfection and safety plan.

B.  Notice in Case of an “Outbreak”

AB 685 also requires non-healthcare employers to notify the local public health agency in the jurisdiction of the affected worksite within 48 hours in the case of a COVID-19 outbreak.

1.  What counts as an “outbreak”?

According to the current guidelines from the California Department of Health, a “COVID-19 outbreak in a non-healthcare workplace is defined as at least three COVID-19 cases among workers at the same worksite within a 14-day period.”[6] Whether a COVID-19 case exists is determined consistent with the criteria for a qualifying individual outlined above.

2.  What information must be given to the local public health agency?

The employer must provide the names, total number, occupation and worksite of the employees who are qualifying individuals. In addition, the employer must report the business address of the worksite and the North American Industry Classification System (NAICS) industry code.[7] The employer must continue to notify the agency of any subsequent cases, and the employer must provide the agency with any additional information it might request as part of the investigation.

C.  Takeaways

In order to meet the notice requirements in the time constraints under AB 685, employers should take immediate steps to:

1. Implement a policy requiring employees working on-site to report COVID-19 positive tests and a process to then track those reports in a manner that will meet the standards required by AB 685 while also preserving employee privacy. This process should seek to incentivize employees to report results swiftly to the employer. The tracking method used should have the capacity to quickly determine what the infectious period is for each case.
2. Draft a notice template that can be filled out and sent quickly that includes all of the required information.
3. Implement a strategy for rapidly providing notice to employees (and subcontractors and union representatives) in case of exposure that meets the requirements of AB 685. This will require the capability to determine quickly which employees were on-site with the qualifying individual during the infectious period in order to generate the contact list for the notice that must be received within one business day.
4. Implement a process to streamline communications with the local public health agency. This may include steps such as designating a point person ahead of time who will manage communications and send required notices to the agency, determining the appropriate contacts at the local health agency, and preparing templates in advance that can be quickly generated.

IV.  Workers’ Compensation Disputable Presumption Under Senate Bill 1159

Governor Newsom also signed Senate Bill 1159 into law on September 17, 2020. The bill creates a disputable (rebuttable) presumption that an illness or death resulting from COVID-19 is an injury that arises out of and in the course of employment, and is thus compensable under California’s workers’ compensation laws. The presumption only applies to certain claims from July 6, 2020 through January 1, 2023.

A.  What Conditions Create a Presumption?

For most employers, the presumption only applies if the employer maintains 5 or more employees, and an employee tests positive for COVID-19 within 14 days after reporting to their specific place of employment during an “outbreak.” A “specific place of employment” means the location where an employee performs work, but does not include the employee’s home or residence, unless the employee provides home health care services to another individual at the employee’s home or residence.

An “outbreak” exists for the purpose of the presumption if one of the following occurs:

1. For employers with 100 employees or fewer at a specific place of employment, if 4 employees test positive for COVID-19 within 14 calendar days;
2. For employers with more than 100 employees at a specific place of employment, if 4% of the number of employees who reported to the specific place of employment test positive for COVID-19 within 14 calendar days; or
3. A specific place of employment is ordered to close by a local public health department, the State Department of Public Health, the Division of Occupational Safety and Health, or a school superintendent due to a risk of infection with COVID-19.

B.  How Can Employers Rebut the Presumption?

Employers can rebut the presumption that the injury or death arose out of employment by submitting evidence which tends to dispute the claims. For example, the employer can offer evidence of the measures it established to reduce potential transmission of COVID-19, or of the employee’s nonoccupational risks of COVID-19 infection.

C.  Are There Any Other Changes to the Workers’ Compensation Process?

Under SB 1159, the claims administrator only has 45 days to deny a claim based on COVID-19 once filed, as opposed to the typical 90 day period. If the claim is not denied, the illness is presumed compensable, and only evidence discovered subsequent to the 45-day period may be used to rebut this presumption. Thus, it is vital that employers work quickly to gather the necessary information as soon as a claim is filed.

D.  Additional Requirement: Report to Claims Administrator

The bill also requires an employer that knows or reasonably should know that an employee has tested positive for COVID-19 to submit a report containing the below information to its workers’ compensation claims administrator within three business days:

• Notice that an employee has tested positive (the employee should not be identified unless the employee asserts the infection is work-related or has already filed a claim);
• The date the employee tested positive;
• The address of the employee’s specific place of employment during the 14-day period before the date the employee tested positive; and
• The highest number of employees who reported to work at the specific place of employment of the employee who tested positive in the 45-day period preceding the last day that the employee worked.

Reporting this information to a claims administrator provides the claims administrator with information to determine whether an outbreak has occurred. If an employer intentionally submits false or misleading information or fails to submit information when reporting, the Labor Commissioner can impose a civil penalty of up to $10,000.

E.  First Responders and Healthcare Workers

The bill instituted a similar set of provisions for certain first responders such as firefighters, some peace officers, paramedics and EMTs, and healthcare workers, but with a few key distinctions. Crucially, no outbreak at the workplace is required to give rise to the presumption that a positive COVID-19 test arose from the first responder or healthcare worker’s employment, and the presumption is not limited to employers of a certain size. Moreover, healthcare employers may not rebut the presumption through evidence of preventative measures or the employee’s nonoccupational risks, but may rebut the presumption “by other evidence.” Finally, the claim administrator must deny the claim within 30 days of its being filed to avoid a presumption that the injury is compensable, instead of the 45-day period outlined above.

F.  Claims that Arose Before July 6, 2020.

For COVID-19 related claims between March 19, 2020 and July 5, 2020, there is still a disputable presumption that an injury from COVID-19 is presumed to have arisen out of and in the course of employment. An employee must, within 14 days of being present at the place of employment, either test positive for COVID-19 or be diagnosed by a licensed medical doctor, with the diagnosis confirmed by a test within 30 days. The presumption is disputable and may be controverted by other evidence. Employers are not required by the law to report employees who tested positive in this time frame to claim administrators.

G.  Takeaways

To best meet the requirements of SB 1159, several critical steps should be taken:

1. Review records for confirmed COVID-19 illnesses or deaths from July 6, 2020, through the present. Implement a process to reliably and quickly record and report employee COVID-19 illnesses to your workers’ compensation claims administrator within three business days.
2. Determine if any “outbreaks” have occurred since July 6, 2020. If there has been no outbreak, there is no presumption (except in the limited cases noted above). Create a method to automatically flag when an outbreak has occurred or might be imminent.
3. Implement a strategy to dispute the presumption that an infection occurred in the workplace when appropriate. This should include preparing information regarding safety measures taken by the company to prevent transmission of COVID-19. Additionally, the company should employ an appropriate investigation strategy to determine if an employee was subject to any nonoccupational risks of exposure to COVID-19.

V.  COVID-19 Vaccine – Who Will Get It and When?

Finally, perhaps the most pressing question for employers and employees alike is when to expect the vaccines to rollout in California, and what this process will look like. The U.S. Food and Drug Administration has issued Emergency Use Authorization for two COVID-19 vaccines, with the possibility that more vaccines will be authorized in early 2021. California, with guidance from the CDC, has outlined a scalable, three-phased approach, starting with healthcare workers, and ending with the general population.[8]

A.  Phase 1-A: Healthcare Residents and Workers

Due to the currently limited availability of the vaccine, Phase 1-A includes three different tiers in order to provide gradual distribution. The first tier of potential vaccine recipients includes residents of skilled nursing facilities, assisted living facilities, and other similar long-term care settings for medically vulnerable or older populations. Also in the first tier are healthcare workers who come into direct contact with COVID-19 patients, and generally those medical professionals who are most at risk in terms of exposure, which include workers at correctional and psychiatric hospitals, nursing homes, acute care centers, and dialysis centers, as well as paramedics and emergency medical technicians.

The second tier within Phase 1-A includes those healthcare workers who work in intermediate care facilities, primary care clinics, urgent care clinics, rural health centers, correctional facility clinics, as well as home health care workers and public health field staff.

The third tier of healthcare workers includes workers in dental offices, specialty clinics, laboratories, and pharmacy staff not included in higher tiers.

B.  Phase 1-B: Frontline Essential Workers & Adults Age 65 and Older

Phase 1-B is slated to take place once the healthcare workers in Phase 1-A are mostly vaccinated. According to the CDC, this group should include “workers in essential and critical industries” such as teachers, child care workers, and first responders, among others.[9]

Similar to Phase 1-A, the Advisory Committee on Immunization Practices (“ACIP”) has proposed taking a tiered approach within Phase 1-B.[10] This proposal recommends that adults 75 and older as well as non-healthcare “frontline essential workers,” such as first responders, teachers, grocery store workers, food and agriculture workers, and manufacturing employees, among others, should take priority in Phase 1-B. This would then push the remaining essential non-frontline workers, such as those who work in construction, transportation, food services, IT, finance, the legal industry, and the media industry, among others, to Phase 1-C, along with adults age 65 or older (but under age 75) and adults with high-risk medical conditions. “Frontline essential workers,” for purposes of this proposal, has only been defined as including workers “in sectors essential to the functioning of society and are at substantially higher risk of exposure to SARS-CoV-2.”[11] So far, California seems to largely mirror the ACIP’s approach (which is accepted by the CDC), as California’s Community Vaccine Advisory Committee has agreed that non-healthcare frontline workers should be prioritized in Phase 1-B. Moreover, California’s approach separates Phase 1-B into two tiers: the first tier includes workers in education, childcare, emergency services, and food and agriculture industries and individuals age 75 and older, while the second tier within Phase 1-B includes workers in transportation and logistics, the industrial, commercial, and residential facilities and services industry, and critical manufacturing, along with individuals 65 to 74 years of age.[12]

C.  Phase 1-C: Non-Frontline Essential Workers, Adults Age 50 and Older, & High Risk Adults

This group includes adults 50 to 64 years of age, individuals with preexisting conditions that put them at high risk of getting severely ill from COVID-19, and the non-frontline essential workers excluded from Phase 1-B in industries such as water and wastewater, defense, energy, chemical and hazardous materials, financial services, communications and IT, government operations and community-based essential functions.[13]

D.  Remaining Phases

Phases 2 and 3 would include the general public and nonessential workers, although these categories are not fully fleshed out yet, and depend on a substantial increase in vaccine supply.

Overall, it is important to keep in mind that this is an evolving situation. On the state-wide level, there is no definitive guidance as to what exactly separates these frontline essential workers in the first tier of Phase 1-B from the other essential workers in California for purposes of the vaccine rollout. Moreover, the California Department of Public Health has not yet determined the details for allocation in Phase 1-B, as it has not yet released the allocation guidelines that tend to provide clarity to this rapidly changing process. Even if this tiered approach for Phase 1-B is carried out, essential workers will all be covered under Phase 1, whether in groups 1-A, 1-B, or 1-C, thus putting them ahead of the general population and nonessential workers in terms of eventually receiving the vaccine.[14]

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[1]  The job categories required by the statute are:

1. Executive or senior level officials and managers.
2. First or mid-level officials and managers.
3. Professionals.
4. Technicians.
5. Sales workers.
6. Administrative support workers.
7. Craft workers.
8. Operatives.
9. Laborers and helpers.
10. Service workers.

[2]  The pay bands are those used by the United States Bureau of Labor Statistics in the Occupational Employment Statistics survey, and include the following categories:   (1) $19,239 and under; (2) $19,240 – $24,439; (3) $24,440 – $30,679; (4) $30,680 – $38,999; (5) $39,000 – $49,919; (6) $49,920 – $62,919; (7) $62,920 – $80,079; (8) $80,080 – $101,919; (9) $101,920 – $128,959; (10) $128,960 – $163,799; (11) $163,800 – $207,999; and (12) $208,000 and over.

[3]  California Equal Pay Act, California Labor Code § 1197.5 (a): “An employer shall not pay any of its employees at wage rates less than the rates paid to employees of the opposite sex for substantially similar work, when viewed as a composite of skill, effort, and responsibility, and performed under similar working conditions, except where the employer demonstrates: … (D) A bona fide factor other than sex, such as education, training, or experience.”

[4]  Some of the industry workers specifically exempted by AB 5 include physicians and other medical industry professionals, lawyers, accountants, engineers, architects, securities brokers, real estate agents, as well as certain professional service providers meeting six requirements (including workers in areas such as human resources and marketing, among others), and business-to-business contracting relationships that also satisfy certain conditions.

[5]  Employer Guidance on AB 685: Definitions, Cal. Dep’t of Public Health (last updated Oct. 16, 2020), https://www.cdph.ca.gov/Programs/CID/DCDC/Pages/COVID-19/Employer-Guidance-on-AB-685-Definitions.aspx.

[6]  Employer Guidance on AB 685: Definitions, Cal. Dep’t of Public Health (last updated Oct. 16, 2020), available at https://www.cdph.ca.gov/Programs/CID/DCDC/Pages/COVID-19/Employer-Guidance-on-AB-685-Definitions.aspx.

[7]  Companies can find their codes here: https://www.naics.com/search/.

[8]  State of California COVID-19 Vaccination Plan: Interim Draft, Cal. Dep’t of Pub. Health (Oct. 16, 2020), https://www.cdph.ca.gov/Programs/CID/DCDC/CDPH%20Document%20Library/COVID-19/COVID-19-Vaccination-Plan-California-Interim-Draft_V1.0.pdf.

[9]  How CDC is Making COVID-19 Vaccine Recommendations, Ctrs. for Disease Control and Prevention (last updated Dec. 23, 2020), https://www.cdc.gov/coronavirus/2019-ncov/vaccines/recommendations-process.html; see also Advisory Memorandum On Ensuring Essential Critical Infrastructure Workers’ Ability to Work During the COVID-19 Response, Cybersecurity & Infrastructure Sec. Agency (December 16, 2020), here.

[10]  The Advisory Committee on Immunization Practices’ Updated Interim Recommendation for Allocation of COVID-19 Vaccine – United States, December 2020, Ctrs. for Disease Control and Prevention (last updated December 22, 2020), https://www.cdc.gov/mmwr/volumes/69/wr/mm695152e2.htm.

[11]  ACIP COVID-19 Vaccines Work Group: Phased Allocation of COVID-19 Vaccines, Advisory Comm. on Immunization Practices (Dec. 20, 2020), https://www.cdc.gov/vaccines/acip/meetings/downloads/slides-2020-12/slides-12-20/02-COVID-Dooling.pdf.

[12]  Vaccines, Cal. ALL State Gov’t Website (Jan. 8, 2021), https://covid19.ca.gov/vaccines/#Vaccine-allocation-and-administration.

[13]  Id.

[14]  See Employer Playbook for the COVID “Vaccine Wars,” Gibson, Dunn & Crutcher LLP, https://www.gibsondunn.com/wp-content/uploads/2020/12/an-employer-playbook-for-the-covid-vaccine-wars.pdf.

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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, any member of the firm’s Labor and Employment practice group, or the authors:

Michele L. Maryott – Orange County (+1 949-451-3945, mmaryott@gibsondunn.com)
Jesse A. Cripps – Los Angeles (+1 213-229-7792, jcripps@gibsondunn.com)
Katherine V.A. Smith – Los Angeles (+1 213-229-7107, ksmith@gibsondunn.com)
Daniel Weiss – Los Angeles (+1 213-229-7388, dweiss@gibsondunn.com)
Megan Cooney – Orange County (+1 949-451-4087, mcooney@gibsondunn.com)
Kat Ryzewska – Los Angeles (+1 310-557-8193, kryzewska@gibsondunn.com)

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

Catherine A. Conway – Los Angeles (+1 213-229-7822, cconway@gibsondunn.com)
Jason C. Schwartz – Washington, D.C. (+1 202-955-8242, jschwartz@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP

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

Social unrest, political upheaval, and economic instability and retrenchment defined the first year of the new decade, all against the backdrop of the COVID-19 pandemic. In emerging markets, these issues impacted efforts to reign in endemic corruption, as illustrated by headline-grabbing scandals, legislative changes, and enforcement actions. In China, for example, Chinese regulators began training their sights on corruption in key sectors, such as the pharmaceutical industry. In India, COVID-19 and the impact of recent legislative changes may be causing a reduction in local enforcement actions, even as massive corruption scandals continue and Indian citizens increasingly report that bribery and corruption are part of daily life. In Russia, the latest statistics show that law enforcement continues to focus on corruption as the country grapples with far-reaching amendments to the Constitution, severe economic losses and the spread of COVID-19. In Africa, high-profile cases involving corruption in both the public and private sector will keep regulatory focus on the continent for the foreseeable future. And in Latin America, after years of substantial anti-corruption activism resulting in sweeping legal reforms in many key markets, anti-corruption initiatives have largely stalled in the last year.

Join our team of experienced international anti-corruption attorneys to learn more about how to do business in Russia, Latin America, China, India and Africa without running afoul of anti-corruption laws, including the Foreign Corrupt Practices Act (“FCPA”).

Topics to be Discussed:

• An overview of FCPA enforcement statistics and trends for 2020;
• The corruption landscape in key emerging markets, including recent headlines and scandals;
• Lessons learned from local anti-corruption enforcement in Latin America, China, India, Africa and Russia;
• Key anti-corruption legislative changes in Latin America, China, India, Africa, and Russia;
• The effect of COVID-19 on corruption and anti-corruption efforts; and
• Mitigation strategies for businesses operating in high-risk markets.

View Slides (PDF)

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PANELISTS:

F. Joseph Warin is Co-Chair of Gibson Dunn’s global White Collar Defense and Investigations Practice Group, and he is chair of the Washington, D.C. office’s 200-person Litigation Department. Mr. Warin is ranked annually in the top-tier by Chambers USA, Chambers Global, and Chambers Latin America for his FCPA, fraud and corporate investigations experience. Mr. Warin has handled cases and investigations in more than 40 states and dozens of countries involving federal regulatory inquiries, criminal investigations and cross-border inquiries by international enforcers, including UK’s SFO and FCA, and government regulators in Germany, Switzerland, Hong Kong, and the Middle East. He has served as a compliance monitor or counsel to the compliance monitor in three separate FCPA monitorships, pursuant to settlements with the SEC and DOJ.

Kelly Austin is Partner-in-Charge of Gibson Dunn’s Hong Kong office and a member of the firm’s Executive Committee. Ms. Austin is ranked top-tier in the category “Corporate Investigations/Anti-Corruption: China” year after year by Chambers Asia Pacific and Chambers Global. Ms. Austin’s practice focuses on government investigations, regulatory compliance and international disputes. She has extensive expertise in government and corporate internal investigations, including those involving the FCPA and other anti-corruption laws, and anti-money laundering, securities, and trade control laws.

Joel Cohen is Co-Chair of Gibson Dunn’s global White Collar Defense and Investigations Practice Group. Mr. Cohen is highly-rated in Chambers and ranked a “Super Lawyer” in Criminal Litigationby Global Investigations Review. He has been lead or co-lead counsel in 24 civil and criminal trials in federal and state courts, and he is equally comfortable in leading confidential investigations, managing crises or advocating in court proceedings. Mr. Cohen’s experience includes all aspects of FCPA/anticorruption issues, in addition to financial institution litigation and other international disputes and discovery.

Benno Schwarz is a partner in the Munich office, where his practice focuses on white collar defense and compliance investigations. Mr. Schwarz is ranked as a leading lawyer for Germany in White Collar Investigations/Compliance by Chambers Europe 2020 and commenters have noted his “special expertise on compliance matters related to the USA and Russia”. For more than 25 years, Mr. Schwarz has advised companies on sensitive cases and investigations in the context of all compliance issues with international aspects, such as the implementation of German or international laws to prevent and avoid corruption, money laundering or avoiding economic sanctions in the corporate context. Especially noteworthy is Mr. Schwarz’ experience advising companies in connection with FCPA and NYDFS monitorships or similar monitor functions under U.S. legal regimes.

Patrick Stokes is a litigation partner in the Washington, D.C. office, where his practice focuses on internal corporate investigations and enforcement actions regarding corruption, securities fraud, and financial institutions fraud. Mr. Stokes is ranked nationally and globally by Chambers USA and Chambers Global as a leading attorney in FCPA. Prior to joining the firm, Mr. Stokes headed the DOJ’s FCPA Unit, managing the FCPA enforcement program and all criminal FCPA matters throughout the United States covering every significant business sector. Previously, he served as Co-Chief of the DOJ’s Securities and Financial Fraud Unit.

Oliver Welch is a partner in the Hong Kong office, where he represents clients throughout the Asia Pacific region in connection with government enforcement actions and corporate internal investigations, including those involving anti-corruption, anti-money laundering, and trade control laws. Mr. Welch also regularly guides companies on creating, implementing and maintaining effective compliance programs.

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MCLE CREDIT INFORMATION:

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 2.0 credit hours, of which 2.0 credit hours may be applied toward the areas of professional practice requirement.

This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact CLE@gibsondunn.com to request the MCLE form.

Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 2.0 hours.

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

We are pleased to present a comparative guide to restructuring procedures in the UK, US, DIFC, ADGM and UAE.

The easy-to-use comparative guide is organised by key aspects of the restructuring processes and compares and contrasts the selected restructuring regimes in each jurisdiction so that the reader can easily identify the differences.

The comparative guide will be particularly relevant for clients operating in the UAE who may be considering restructuring options in the current market conditions.

Comparative Guide to Restructuring Procedures in the UK, US, DIFC, ADGM and UAE

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For further information, please contact the Gibson Dunn lawyer with whom you usually work, or the following authors, with any questions, thoughts or comments arising from this update.

Aly Kassam – Dubai (+971 (0) 4 318 4641, akassam@gibsondunn.com)
Scott J. Greenberg – New York (+1 212-351-5298, sgreenberg@gibsondunn.com)
David M. Feldman – New York (+1 212-351-2366, dfeldman@gibsondunn.com)
Ben Myers – London (+44 (0) 20 7071 4277, bmyers@gibsondunn.com)
Galadia Constantinou – Dubai (+971 (0) 4 318 4663, gconstantinou@gibsondunn.com)
Ashtyn Hemendinger – New York (+1 212-351-2349, ahemendinger@gibsondunn.com)

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Gibson Dunn’s Middle East practice focuses on regional and global multijurisdictional transactions and disputes whilst also acting on matters relating to financial and investment regulation. Our lawyers, a number of whom have spent many years in the region, have the experience and expertise to handle the most complex and innovative deals and disputes across different sectors, disciplines and jurisdictions throughout the Middle East and Africa.

Our corporate team is a market leader in MENA mergers and acquisitions as well as private equity transactions, having been instructed on many of the region’s highest-profile buy-side and sell-side transactions for corporates, sovereigns and the most active regional private equity funds. In addition, we have a vibrant finance practice, representing both lenders and borrowers, covering the full range of financial products including acquisition finance, structured finance, asset-based finance and Islamic finance. We have the region’s leading fund formation practice, successfully raising capital for our clients in a difficult fundraising environment.

Our international Business Restructuring and Reorganization Practice is a leader in U.S., European, Middle East and cross-border insolvencies and workouts. Our lawyers advise companies in financial distress, their creditors and investors, and parties interested in acquiring assets from companies in distress. We also guide hedge funds, private equity firms and financial institutions investing in distressed debt and/or equity through the restructuring and bankruptcy process. The group has been widely recognized by top industry publications, including Chambers and The Guide to the World’s Leading Insolvency Lawyers. Our lawyers are committed to understanding the businesses of their clients and crafting solutions, including complex out-of-court workouts and in-court restructurings. We also advise on innovative DIP and exit financing agreements to both debtors and DIP providers.

We are pleased to present Gibson Dunn’s eighth “Federal Circuit Year In Review,” providing a statistical overview and substantive summaries of the 130 precedential patent opinions issued by the Federal Circuit between August 1, 2019 and July 31, 2020. This term was marked by significant panel decisions with regard to the constitutionality of the PTAB and its jurisdiction and procedures (Arthrex, Inc. v. Smith & Nephew, Inc., 941 F.3d 1320 (Fed. Cir. 2019), Samsung Electronics America, Inc. v. Prisua Engineering Corp., 948 F.3d 1342 (Fed. Cir. 2020), and Nike, Inc. v. Adidas AG, 955 F.3d 45 (Fed. Cir. 2020)), subject matter eligibility (American Axle & Manufacturing, Inc. v. Neapco Holdings LLC, 967 F.3d 1285 (Fed. Cir. 2020) and Illumina, Inc. v. Ariosa Diagnostics, Inc.,952 F.3d 1367 (Fed. Cir. 2020)), and venue (In re Google LLC). The issues most frequently addressed in precedential decisions by the Court were: obviousness (43 opinions); infringement (24 opinions); claim construction (22 opinions); PTO procedures (21 opinions); and Jurisdiction, Venue, and Standing (19 opinions).

Use the Federal Circuit Year In Review to find out:

• The easy-to-use Table of Contents is organized by substantive issue, so that the reader can easily identify all of the relevant cases bearing on the issue of choice.
• Which issues may have a better chance (or risk) on appeal based on the Federal Circuit’s history of affirming or reversing on those issues in the past.
• The average length of time from issuance of a final decision in the district court and docketing at the Federal Circuit to issuance of a Federal Circuit opinion on appeal.
• What the success rate has been at the Federal Circuit if you are a patentee or the opponent based on the issue being appealed.
• The Federal Circuit’s history of affirming or reversing cases from a specific district court.
• How likely a particular panel may be to render a unanimous opinion or a fractured decision with a majority, concurrence, or dissent.
• The Federal Circuit’s affirmance/reversal rate in cases from the district court, ITC, and the PTO.

The Year In Review provides statistical analyses of how the Federal Circuit has been deciding precedential patent cases, such as affirmance and reversal rates (overall, by issue, and by District Court), average time from lower tribunal decision to key milestones (oral argument, decision), win rate for patentee versus opponent (overall, by issue, and by District Court), decision rate by Judge (number of unanimous, majority, plurality, concurring, or dissenting opinions), and other helpful metrics. The Year In Review is an ideal resource for participants in intellectual property litigation seeking an objective report on the Court’s decisions.

Gibson Dunn is nationally recognized for its premier practices in both Intellectual Property and Appellate litigation. Our lawyers work seamlessly together on all aspects of patent litigation, including appeals to the Federal Circuit from both district courts and the agencies.

Please click here to view the FEDERAL CIRCUIT YEAR IN REVIEW

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Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Federal Circuit. Please contact the Gibson Dunn lawyer with whom you usually work or the authors of this alert:

Mark A. Perry – Washington, D.C. (+1 202-887-3667, mperry@gibsondunn.com)
Omar F. Amin – Washington, D.C. (+1 202-887-3710, oamin@gibsondunn.com)
Nathan R. Curtis – Dallas (+1 214-698-3423, ncurtis@gibsondunn.com)

Please also feel free to contact any of the following practice group co-chairs or any member of the firm’s Appellate and Constitutional Law or Intellectual Property practice groups:

Appellate and Constitutional Law Group:
Allyson N. Ho – Dallas (+1 214-698-3233, aho@gibsondunn.com)
Mark A. Perry – Washington, D.C. (+1 202-887-3667, mperry@gibsondunn.com)

Intellectual Property Group:
Wayne Barsky – Los Angeles (+1 310-552-8500, wbarsky@gibsondunn.com)
Josh Krevitt – New York (+1 212-351-4000, jkrevitt@gibsondunn.com)
Mark Reiter – Dallas (+1 214-698-3100, mreiter@gibsondunn.com)

© 2020 Gibson, Dunn & Crutcher LLP

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

Direct listings have emerged as one of the new innovative pathways to the U.S. public capital markets, thought to be ideal for entrepreneurial companies with a well-recognized brand name or easily understood business model. We have also found them attractive to companies that are already listed on a foreign exchange and are seeking a dual listing in the United States. Because direct listings have been limited to secondary offerings by existing shareholders, they have not been an attractive option for companies seeking to raise new capital in connection with going public. That has changed now that the NYSE will permit primary offerings in connection with direct listings – or “Primary Direct Floor Listings” (see “Gibson Dunn Guide to Direct Listings” below).

Primary offerings through direct listings pose new challenges and questions, but nonetheless have the potential to expand access to the U.S. public markets. This new option to raise capital in connection with a listing is expected to increase the number of companies that find direct listings attractive, although we do not expect direct listings to serve as a replacement for underwritten IPOs generally.[1] Many of the open questions we discussed when the NYSE’s Selling Shareholder Direct Floor Listing rules were amended in 2018 (link here) are raised again with the new rules on Primary Direct Floor Listings (see “Open Questions” below).

History

It has taken more than a year for the NYSE’s rule changes to become effective. As we previously discussed (link here), in December 2019, the NYSE submitted its first rule proposal to the SEC that would permit a privately held company to conduct a direct listing in connection with a primary offering, but this proposal was quickly rejected by the SEC. As we further detailed (link here), the NYSE subsequently revised and resubmitted the proposal, which was approved by the SEC on August 26, 2020 following a public comment period. However, only five days later, the SEC stayed its approval order after a notice from the Council of Institutional Investors (CII) that it intended to file a petition for the SEC to review the SEC’s approval. CII objected to the proposals to allow Primary Direct Floor Listings arguing that such an offering would harm investors by limiting investors’ legal recourse for material misstatements in offering documents. In particular, CII raised concerns regarding the ability of investors to “trace” the purchase of their shares to the applicable offering document. Another criticism of the NYSE’s proposal is that the rule changes could not guarantee sufficient liquidity for a trading market in the applicable securities to develop following the direct listing.

Final Approval

On December 22, 2020, the SEC issued its final approval of the NYSE’s proposed rules. The SEC states that, following a de novo review and further public comment period, it has found that the NYSE’s proposal was consistent with the Exchange Act and the rules and regulations issued thereunder and, furthermore, that the proposed rules would “foster[] competition by providing an alternate method for companies of sufficient size [to] decide they would rather not conduct a firm commitment underwritten offering.” The SEC order discussed several procedural safeguards included by the NYSE in its proposed rules that were intended to “clarify the role of the issuer and financial advisor in a direct listing” and “explain how compliance with various rules and regulations” would be addressed. These changes include the introduction of an “Issuer Direct Offering Order type,” the clarification of how market value would be determined in connection with primary direct listings and the agreement to retain FINRA to monitor compliance with Regulation M and other anti-manipulation provisions of federal securities laws.

Notably, the SEC’s order rejects the notion that offerings not involving a traditional underwriter would “‘rip off’ investors, reduce transparency, or involve reduced offering requirements or accounting methods,” finding that the relevant “traceability issues are not exclusive to nor necessarily inherent in” Primary Direct Floor Listings. In approving the NYSE’s proposal and reaching its conclusion that the NYSE’s proposal provided a “reasonable level of assurance” that the applicable market value threshold supports a public listing and the maintenance of fair and orderly markets, the SEC specifically noted that the applicable thresholds for the equity market value under the revised rules were at least two and a half times greater than the market value standard that exists for a traditional IPO ($40 million). The SEC order also positively discussed steps taken by the NYSE to ensure compliance by participants in the direct listing process with Regulation M and other provisions of the federal securities laws.

“This is a game changer for our capital markets, leveling the playing field for everyday investors and providing companies with another path to go public at a moment when they are seeking just this type of innovation,” NYSE President Stacey Cunningham said in a statement. In a separate statement, Commissioner Elad L. Roisman stated, “Primary direct listings represent an alternative way for companies to fairly and efficiently offer shares to the public in a manner that preserves important investor protections” and have “the additional benefit of increasing opportunities for investors to purchase shares at the initial offering price, rather than having to wait to buy in the aftermarket.”

The two Commissioners who dissented (Allison Herren Lee and Caroline A. Crenshaw) and certain investor protection groups have issued statements expressing concern that the absence of a traditional underwriter removes a key gatekeeper present in traditional IPOs that helps prevent inaccurate or misleading disclosures.

New Requirements for Primary Direct Floor Listings

Under the NYSE’s rules, a privately held company seeking to conduct a primary offering in connection with a direct listing will qualify for such a primary offering if (a) it meets the already existing requirements for a direct listing (e.g., 400 round lot holders, 1.1 million publicly held shares outstanding and minimum price per share of at least $4.00 at the time of initial listing); and (b) (i) the company issues and sells common equity with at least $100 million in market value in the opening auction on the first day of listing, or (ii) the market value of common equity sold in the opening auction by such company and the market value of publicly held shares (i.e., excluding shares held by officers, directors and 10% owners) immediately prior to listing, together, exceed $250 million. In each case, such market value will be calculated using a price per share equal to the lowest price of the price range established by the issuer in its registration statement for the primary offering (the price range is defined as the “Primary Direct Floor Listing Auction Price Range”).

The NYSE will also create a new order type to be used by the issuer in a Primary Direct Floor Listing and rules regarding how that new order type would participate in a Direct Listing Auction. Specifically, the NYSE will introduce an Issuer Direct Offering Order (“IDO Order”), which would be a Limit Order to sell that is to be traded only in a Direct Listing Auction for a Primary Direct Floor Listing. The IDO Order would have the following requirements: (1) only one IDO Order may be entered on behalf of the issuer and only by one member organization; (2) the limit price of the IDO Order must be equal to the lowest price of the Primary Direct Floor Listing Auction Price Range; (3) the IDO Order must be for the quantity of shares offered by the issuer, as disclosed in the prospectus in the effective registration statement; (4) the IDO Order may not be cancelled or modified; and (5) the IDO Order must be executed in full in the Direct Listing Auction. Consistent with current rules, a Designated Market Maker (“DMM”) would effectuate a Direct Listing Auction manually, and the DMM would be responsible for determining the Auction Price. Under the new rules, the DMM would not conduct a Direct Listing Auction for a Primary Direct Floor Listing if (1) the Auction Price would be below the lowest price or above the highest price of the Primary Direct Floor Listing Auction Price Range; or (2) there is insufficient buy interest to satisfy both the IDO Order and all better-priced sell orders in full. If there is insufficient buy interest and the DMM cannot price the Auction and satisfy the IDO Order as required, the Direct Auction would not proceed and such security would not begin trading.

While not a change, the NYSE emphasized in its proposal that any services provided by a financial advisor to the issuer of a security listing in connection with a Selling Shareholder Direct Floor Listing or a Primary Direct Floor Listing (the “financial advisor”) and the DMM assigned to that security must provide such services in a manner that is consistent with all federal securities laws, including Regulation M and other anti-manipulation requirements.

Nasdaq Is Next

The Nasdaq Stock Market also has pending before the SEC a proposed rule change to allow primary offering in connection with direct listings in the context of Nasdaq’s own distinct market model, some of which require fewer record holders than the NYSE for direct listings. Additionally, on December 22, Nasdaq submitted a separate proposed rule change on this issue for which Nasdaq seeks immediate effectiveness without a prior public comment period. On December 23, the Staff of the Division of Trading and Markets of the SEC issued a public statement that “the Staff intends to work to expeditiously complete, as promptly as possible accommodating public comment, a review of these proposals, and as with all self-regulatory organizations’ proposed rule changes, will evaluate, among other things, whether they are consistent with the requirements of the Exchange Act and Commission rules.”

Gibson Dunn Guide to Direct Listings

Any company considering a direct listing is encouraged to carefully consider the risks and benefits in consultation with counsel and financial advisors. Members of the Gibson Dunn Capital Markets team are available to discuss strategy and considerations as the rules and practice concerning direct listings evolve. Gibson Dunn will also continue to update its Current Guide To Direct Listings (available here) from time to time to further describe the applicable rules and provide commentary as practices evolve.

Open Questions

It remains to be seen how the NYSE’s revised rules and forthcoming rules from NYSE and Nasdaq will play out in practice. Some of the relevant open questions include:

• Will the loss of a traditional firm-commitment underwriter create additional risks for investors? The NYSE’s revised rules permit companies to raise new capital without using a firm-commitment underwriter. The two Commissioners who dissented (Allison Herren Lee and Caroline A. Crenshaw) and certain investor protection groups have expressed concern that the absence of a traditional underwriter removes a key gatekeeper present in traditional IPOs that helps prevent inaccurate or misleading disclosures. In its order approving the NYSE’s revised rules on Primary Direct Floor Listings, the SEC suggests that, depending on the facts and circumstances, a company’s financial advisers could be subject to Securities Act liability, or at least lawsuits alleging underwriter liability, in connection with direct listings. The two dissenting Commissioners, however, suggest that guidance as to what may trigger status as a statutory underwriter should have been considered and concurrently provided.
• Will a Primary Direct Floor Listing create new risks for the listing company? Under current rules and precedent, in a Primary Direct Floor Listing the listing company may have more rather than less liability in a direct listing than a traditional IPO. In a traditional IPO, because of customary lockup arrangements, investors can generally guarantee the traceability of their shares to the registration statement because only shares issued under the registration statement are trading in the market until the lockup period expires. Under current case law, which is being appealed, the tracing requirement has been seemingly abandoned, meaning all the shares in the market can potentially make claims under Section 11.
• How will legal, diligence and auditing practices develop around direct listings? Because the listing must be accompanied by an effective registration statement under the Securities Act, the liability provisions of Section 11 and 12 of the Securities Act will be applicable to sales made under the registration statement. We note that in many of the direct listings to date, the companies have engaged financial advisors to assist with the positioning of the equity story of the company and advise on preparation of the registration statement, in a process very similar to the process of preparing a registration statement for a traditional IPO. Because a company will be subject to the same standard for liability under the federal securities laws with respect to material misstatements and omissions in a registration statement for a direct listing to the same extent as for a registration statement for an IPO, a company’s incentives to conduct diligence to support the statements in its registration statement do not differ between the two types of transactions. Similarly, financial statement requirements, and the requirements as to independent auditor opinions and consents, do not differ between registration statements for direct listings and IPOs. Furthermore, follow-on offerings by the company that involve firm-commitment underwriting or at-the-market programs will require the traditional diligence practices. To date, there have been no lawsuits alleging that financial advisers in a direct listing could be subject to Securities Act liability in connection with direct listings.
• What impact will the expanded availability of direct listings have on IPO activity? One could argue that the greatest attraction of a direct listing is that it can nearly match private markets in being faster and less costly than an IPO. In some cases, it could provide similar liquidity as a traditional IPO, although trading price certainty and trading volume could be lower following a direct listing than following an IPO. Direct listings have been available on the NYSE and Nasdaq for a decade but have not been utilized regularly by large private companies in lieu of a traditional IPO. In any event, the requirement for 400 round lot holders will continue to be a hurdle for many private companies looking to list directly.
• How will the initial reference price and/or price range in the prospectus be determined? There is no reference price from another market for the DMM to apply and no negotiation between the issuer and the underwriter as in an IPO. The NYSE seems to bridge this gap with the requirement for the DMM to consult with an independent financial adviser to determine the initial reference price in a Selling Shareholder Direct Listing and, in a Primary Direct Floor Listing, to determine the price range to be set forth in the applicable prospectus. Eventually, a standardized set of practices around the financial adviser’s work and presentation of the price to the issuer and the Exchange should develop.
• Without the firm-commitment IPO process, in which the offering is oversold and heavily marketed, how will direct listed shares trade in the aftermarket? Without an underwritten offering, the issuer will not engage in price finding and book building activities. In a direct listing, the issuer will also take on much of the role of investor outreach that is borne by underwriters in a traditional IPO. Although direct listing marketing efforts may include one or more investor days and a roadshow-like presentation, sell-side analysts will presumably not be involved, building models and educating investors. It may be more difficult for the issuer to tell its forward-looking story and build value into the trading price of the stock without research coverage prior to or after the listing. For this reason, the most successful direct listings to date have been well-known companies with widely recognized brands that have successfully engaged with a broad set of new investors. We expect that companies engaging in direct listings will continue to develop more robust internal investor/shareholder relations functions than may be needed for a company conducting a traditional IPO.
• Will large private placements (often called “private IPOs”) have a new advantage? The expanded option to direct list, whether in a secondary or primary format, through an independent valuation alone may mean investors in a private company can have access to public markets faster than through an IPO process. When private companies market private equity capital raises, including private IPOs, they might use the direct listing option as a marketing tool to attract investors to the private placement.
• Are there any companies that are well-positioned for a Primary Direct Floor Listing? The NYSE’s revised rules may prompt well-positioned companies to consider a capital raise where the private or IPO markets are otherwise unattractive. Furthermore, until Nasdaq’s rules are approved, how will the NYSE’s rules affect the decision of where to list?

Read More

Thank you to associate Evan Shepherd* for his valuable assistance with this article and the Current Guide to Direct Listings.

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[1] The SEC Final Release states in footnote 114: “While the Commission acknowledges the possibility that some companies may pursue a Primary Direct Floor Listing instead of a traditional IPO, these two listing methods may not be substitutable in a wide variety of instances. For example, some issuers may require the assistance of underwriters to develop a broad investor base sufficient to support a liquid trading market; others may believe a traditional firm commitment IPO is preferable given the benefits to brand recognition that can result from roadshows and other marketing efforts that often accompany such offerings. Thus, we do not anticipate that all companies that are eligible to go public through a Primary Direct Floor Listing will choose to do so; the method chosen will depend on each issuer’s unique characteristics.”

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Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Capital Markets or Securities Regulation and Corporate Governance practice groups, or the authors:

J. Alan Bannister – New York (+1 212-351-2310, abannister@gibsondunn.com)
Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com)
Boris Dolgonos – New York (+1 212-351-4046, bdolgonos@gibsondunn.com)
Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com)
James J. Moloney – Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com)
Evan Shepherd* – Houston (+1 346-718-6603, eshepherd@gibsondunn.com)

Please also feel free to contact any of the following practice leaders:

Capital Markets Group:
Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com)
Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com)
Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com)
Peter W. Wardle – Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com)

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
James J. Moloney – Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com)
Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com)

*Mr. Shepherd is admitted only in New York and is practicing under the supervision of Principals of the Firm.

© 2021 Gibson, Dunn & Crutcher LLP

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

Over the course of December 2019, Gibson Dunn published its “Current Guide to Direct Listings” and “An Interim Update on Direct Listing Rules” discussing, among other things, the direct listing as an evolving pathway to the public capital markets and the U.S. Securities and Exchange Commission’s (SEC) rejection of a proposal by the New York Stock Exchange (NYSE) to permit a privately held company to conduct a direct listing in connection with a primary offering, respectively.

The NYSE continued to revise its proposal in consultation with the SEC and, on August 26, 2020, the SEC approved an amendment to the NYSE’s proposal that will permit primary offerings in connection with direct listings. The August 26 order, which would have become effective 30 days after being published in the Federal Register, was stayed by the SEC on September 1, 2020 in response to a notice from the Council of Institutional Investors (CII) that it intended to file a petition for the SEC to review the SEC’s approval. On December 22, 2020, the SEC issued its final approval of the NYSE’s proposed rules. Consequently, Gibson Dunn has updated and republished its Current Guide to Direct Listings to reflect today’s landscape, including an overview of certain issues to monitor as direct listing practice evolves included as Appendix I hereto.

Direct Listings: An evolving pathway to the public capital markets.  

Direct listings have increasingly been gaining attention as a means for a private company to go public. A direct listing refers to the listing of a privately held company’s stock for trading on a national stock exchange (either the NYSE or Nasdaq) without conducting an underwritten offering, spin-off or transfer quotation from another regulated stock exchange. Under historical stock exchange rules, direct listings involve the registration of a secondary offering of a company’s shares on a registration statement on Form S-1 or other applicable registration form publicly filed with, and declared effective by, the Securities and Exchange Commission, or the SEC, at least 15 days in advance of launch—referred to as a Selling Shareholder Direct Listing.[1] Existing shareholders, such as employees and early stage investors, whose shares are registered for resale or that may be resold under Rule 144 under the Securities Act, are able to sell their shares on the applicable exchange, but are not obligated to do so, providing flexibility and value to such shareholders by creating a public market and liquidity for the company’s stock. Historically, companies were not permitted to raise fresh capital as part of the direct listing process. On December 22, 2020, however, the SEC issued its final approval of rules proposed by the NYSE that permit a primary offering along with, or in lieu of, a direct secondary listing—referred to as a Primary Direct Floor Listing.[2] Upon listing of the company’s stock, the company becomes subject to the reporting and governance requirements applicable to publicly traded companies, including periodic reporting requirements under the Securities Exchange Act of 1934, as amended (the Exchange Act), and governance requirements of the applicable exchange.

Companies may pursue a direct listing to provide liquidity and a broader trading market for their shareholders; however, the listing company can also benefit even if not raising capital in a Primary Direct Floor Listing. A direct listing, whether a Primary Direct Floor Listing or a Selling Shareholder Direct Listing, will provide a company with many of the benefits of a traditional IPO, including access to the public markets for capital raising and the ability to use publicly traded equity as an acquisition currency.

Advantages of a direct listing as compared to an IPO.

Immediate Benefits to Existing Shareholders.

In both a Selling Shareholder Direct Listing and Primary Direct Floor Listing, all selling shareholders whose shares are registered on the applicable registration statement or whose shares are eligible for resale under Rule 144 will have the opportunity to participate in the first day of trading of the company’s stock. Shareholders who choose to sell are able to do so at market trading prices, rather than only at the initial price to the public set in an IPO. The ability to sell at market prices on the first day of a listing can be a significant benefit to existing shareholders who elect to sell. However, this benefit assumes there is sufficient market demand for the shares offered for resale.

Potentially Wider Initial Market Participation.

The traditional IPO process includes a focused set of participants, and institutional buyers tend to feature prominently in the initial allocation of shares to be sold by the underwriting syndicate. Direct listings offer access to a wider group of investors, as any investor may place orders through its broker.  In a Selling Shareholder Direct Listing, any prospective purchasers of shares are able to place orders with their broker-dealer of choice, at whatever price they believe is appropriate, and such orders become part of the initial-reference, price-setting process. The price-setting mechanisms applicable to Primary Direct Floor Listings differ in material respects from the practice that has developed with respect to Selling Shareholder Direct Listings. In a Primary Direct Floor Listing, prospective purchasers of shares are able to place orders with their broker-dealer of choice at whatever price they believe is appropriate, but will have priority for purchases at the minimum offering price specified in the related prospectus.

Flexibility in Marketing.

IPO marketing has become more flexible since the introduction of rules providing for “testing-the-waters” communications by Emerging Growth Companies and, starting December 3, 2019, all companies.[3] However, a direct listing allows a company to avoid the rigidity of the traditional roadshow conducted for a specified period of time following the publicly announced launch of an IPO and allows it to tailor marketing activities to the specific considerations underlying the direct listing. For instance, the traditional roadshow has been replaced in some direct listings by an investor day whereby the company invites investors to learn about the company one-to-many, such as via a webcast, which can be considered more democratic as all investors have access to the same educational materials at once. Marketing efforts may include one or more of these investor days and a roadshow-like presentation, conducted at times deemed most advantageous (although the applicable registration statement must still be publicly filed for at least 15 days in advance of any such marketing efforts). Although the approximate timing of the direct listing can be inferred from the status of the publicly filed registration statement, the company may have more flexibility as to the day its shares commence trading on the applicable stock exchange.

Brand Visibility.

As direct listings are still a relatively novel concept in U.S. capital markets, any direct listing with moderate success, in particular a direct listing involving a primary capital raise, will likely draw broad interest from market participants and relevant media. This effect is multiplied when the listing company has a well-recognized brand name.

No Underwriting Fees.

A direct listing can save money by allowing companies to avoid underwriting discounts and commissions on the shares sold in the IPO. In direct listings to date, the companies have engaged financial advisers to assist with the positioning of the company and the preparation of the registration statement. Such financial advisors have been paid significant fees, though substantially less than traditional IPO underwriting discounts and commissions. This may marginally decrease a company’s cost of capital, although the company will still incur significant fees to market makers or specialists, independent valuation agents, auditors and legal counsel.

More Flexible Lockup Agreements.

In most direct listings to date, existing management and significant shareholders are not typically subject to the restrictions imposed by 180-day lockup agreements standard in IPOs. Notwithstanding, as practice evolves, practice may vary from transaction to transaction. For example, Spotify’s largest non-management shareholder was subject to a lockup and Palantir’s directors and executive officers were subject to a lockup period. We expect that lockup arrangements in direct listings will continue to be more tailored to the particular company’s circumstances than in traditional IPOs.

Certain issues to consider before choosing a direct listing.

Establishing a Price Range or Initial Reference Price.

No marketing efforts are permissible without a compliant preliminary prospectus on file with the SEC, and such prospectus must include an estimated price range. In a traditional IPO and Primary Direct Floor Listing, the cover page of the preliminary prospectus contains a price range of the anticipated initial sale price of the shares. In a Selling Shareholder Direct Listing, the current market practice is to describe how the initial reference price is derived (e.g., by buy-and-sell orders collected by the applicable exchange from various broker-dealers). These buy-and-sell orders have in the past been largely determined with reference to high and low sales prices per share in recent private transactions of the subject company. In cases where a company does not have such transactions to reference, additional information will be necessary to educate and assist investors and help establish an initial bid price. In addition, the listing company in a direct listing may elect to increase the period between the effectiveness of its registration statement and its first day of trading, thereby allowing time for additional buy-and-sell orders to be placed. In either case, the financial advisor to the company will play an important role in establishing a price range or initial reference price, as applicable.

Financial Advisors and Their Independence.

In a Selling Shareholder Direct Listing, the rules of both the NYSE and Nasdaq require that the listing company appoint a financial advisor to provide an independent valuation of the listing company’s “publicly held” shares and, in practice, assist the applicable exchange’s market maker or specialists, as applicable, in setting a price range or initial reference price, as applicable. In past direct listings, in particular those involving the NYSE, the financial advisor that served this role was not the financial advisor the listing company engaged to advise generally, including to assist the company define objectives for the listing, position the equity story of the company, advise on the registration statement, assist in preparing presentations and other public communications and help establish a firm price range in a Primary Direct Floor Listing. As reviewed in detail below, the financial advisor that values the “publicly held” shares and assists the applicable exchange’s market maker or specialists, as applicable, must be independent, which under the relevant rules disqualifies any broker-dealer that has provided investment banking services to the listing company within the 12 months preceding the date of the valuation.

Shares to be Registered.

In a direct listing, in addition to new shares being issued in connection with a Primary Direct Floor Listing, a company generally registers for resale all of its outstanding common equity which cannot then be sold pursuant to an applicable exemption from registration (such as Rule 144), including those subject to registration rights obligations. The company may also register shares held by affiliates and non-affiliates who have held the shares for less than one year or otherwise did not meet the requirements for transactions without restriction under Rule 144.[4] Companies may also register shares held by employees to address any regulatory concerns that resales of shares by employees occurring around the time of the direct listing may not have been entitled to an exemption from registration under the Securities Act. All shares subject to registration may be freely resold pursuant to the registration statement only as long as the registration statement remains effective and current. The company will typically bear the related costs.

Direct Listing-Specific Risks.

Traditional IPOs offer certain advantages that are not currently present in direct listings. Going public without the structure of an IPO process is not without risk, such as the need to obtain research coverage in the absence of an underwriting syndicate that has research analysts or the need to educate investors on the company’s business model. Any company considering a direct listing should contemplate whether its investor relations apparatus is capable of playing an outsized role in coordinating marketing efforts and outreach to potential investors, both in connection with the listing and after the transaction. Notably, in a Selling Shareholder Direct Listing, the listing company’s management plays no role in setting the initial reference price, and certain market-making activities conducted by the underwriting syndicate may be unavailable. In a Primary Direct Floor Listing, the listing company’s management may play an outsized role in determining an initial price range. Either scenario may present unacceptable risk for companies that may otherwise be poised to undertake a direct listing.

The NYSE and Nasdaq rules applicable to a direct listing.

Background.

The direct listing rules of both the NYSE[5] and Nasdaq Global Select Market[6] are substantially similar and are structured as an exception to each exchange’s requirement concerning the aggregate market value of the company to be listed. Prior to the direct listing rules, companies that did not previously have their common equity registered under the Exchange Act were required to show an aggregate market value of “publicly held” shares in excess of $100 million ($110 million for Nasdaq Global Select Market, under certain circumstances), such market value being established by both an independent third-party valuation and recent trading prices in a trading market for unregistered securities (commonly referred to as the Private Placement Market).

“Publicly held” shares include those held by persons other than directors, officers and presumed affiliates (shareholders holding in excess of 10%). The Private Placement Market includes trading platforms operated by any national securities exchange or registered broker-dealers. Generally, in a direct listing, the relevant company either (i) does not have its shares traded on a Private Placement Market prior its listing or (ii) underlying trading in the Private Placement Market is not sufficient to provide a reasonable basis for reaching conclusions about a company’s trading price.

Direct Listings on Secondary Markets.

Nasdaq rules permit direct listings onto the Nasdaq Global Market and Nasdaq Capital Market, the second- and third-tier Nasdaq markets, respectively.[7] If the company to be listed on a secondary market does not have recent sustained trading activity in a Private Placement Market, and thereby must rely on an independent third-party valuation consistent with the rules described above, such calculation must reflect a (i) tentative initial bid price, (ii) market value of listed securities and (iii) market value of publicly held shares that each exceed 200 percent of the otherwise applicable requirements.

Requirements for a Direct Listing.

The direct listing rules discussed above were intended to provide relief for privately held “unicorns,” or companies that are otherwise sufficiently capitalized and which do not need to raise money. Each exchange’s listing standards applicable to direct listings by U.S. companies are summarized, by relevant exchange, in the table that follows:

Overview of Listing Standards Applicable to Direct Listings

	NYSE (Selling Shareholder Direct Listing)	NYSE (Primary Direct Floor Listing)	Nasdaq Global Select Market	Nasdaq Global Market	Nasdaq Capital Market
Market Value of Publicly Held Shares (i.e., held by persons other than directors, officers and presumed affiliates)	The listing company must have a recent valuation from an independent third party indicating at least $250 million in aggregate market value of publicly held shares. (Rule 102.01A(E))[8]	The listing company (i) must sell at least $100 million of shares in the opening auction or (ii) show that the aggregate market value of shares sold in the opening auction, together with publicly held shares, exceeds $250 million, in each case with market value calculated using the lowest price per share set forth in the related prospectus.	The listing company must have a recent valuation from an independent third party indicating at least $250 million in aggregate market value of publicly held shares. (Rule IM-5315-1(b))9	The listing company must have a recent valuation[9] from an independent third party indicating in excess of $16 million to $40 million in aggregate market value of publicly held shares, depending on the financial standard met below. (Rule 5405)	The listing company must have a recent valuation10 from an independent third party indicating in excess of $10 million to $30 million in aggregate market value of publicly held shares, depending on the financial standard met below. (Rule 5505)
Financial Standards	The listing company is required to meet one of the following applicable financial standards: (i)       Each of (a) aggregate adjusted pre-tax income for the last three fiscal years in excess of $10 million, (b) with at least $2 million in each of the two most recent fiscal years and (c) positive income in each of the last three fiscal years (the “NYSE Earnings Test”). (ii)     Global market capitalization of $200 million (the “Global Market Capitalization Test”).	Same as the NYSE (Selling Shareholder)	The listing company is required to meet one of the following applicable financial standards: (i)       Each of (a) aggregate adjusted pre-tax income for the last three fiscal years in excess of $11 million, (b) with at least $2.2 million in each of the two most recent fiscal years and (c) positive income in each of the last three fiscal years (the “Nasdaq Earnings Standard”). (ii)     Each of (a) average market capitalization in excess of $550 million over the prior 12 months, (b) $110 million in revenue for the previous fiscal year and (c) aggregate cash flows for the last three fiscal years in excess of $27.5 million and positive cash flows for each of the last three fiscal years (the “Capitalization with Cash Flow Standard”). (iii)   Each of (a) average market capitalization in excess of $850 million over the prior 12 months and (b) $90 million in revenue for the previous fiscal year (the “Capitalization with Revenue Standard”). (iv)    Each of (a) market capitalization in excess of $160 million, (b) total assets in excess of $80 million, and (c) stockholders’ equity in excess of $55 million (the “Assets with Equity Standard”).	The listing company is required to meet one of the following applicable financial standards: (i)       Each of (a) aggregate adjusted pre-tax income in excess of $1 million in the latest fiscal year or in two of the last three fiscal years and (b) Stockholders’ equity in excess of $15 million. (ii)     Each of (a) Stockholders’ equity in excess of $30 million and (b) two years of operating history. (iii)   Market value of listed securities in excess of $150 million. (iv)    Total assets and total revenue in excess of $75 million in the latest fiscal year or in two of the last three fiscal years.	The listing company is required to meet one of the following applicable financial standards: (i)       Each of (a) Stockholders’ equity in excess of $15 million and (b) two years of operating history. (ii)     Each of (a) Stockholders’ equity in excess of $4 million and (b) market value of listed securities in excess of $100 million. (iii)   Total assets and total revenue in excess of $75 million in the latest fiscal year or in two of the last three fiscal years.
Distribution Standards	The listing company must meet all of the following distribution standards: (i)       400 round lot shareholders; (ii)     1.1 million publicly held shares; and (iii)   Minimum initial reference price of $4.00.	Same as the NYSE (Selling Shareholder)	The listing company must meet all of the following liquidity requirements: (i)       450 round lot shareholders or 2,200 total shareholders; (ii)     1.25 million publicly held shares; and (iii)   Minimum initial reference price of $4.00.	The listing company must meet all of the following distribution standards: (i)       400 round lot shareholders; (ii)     1.1 million publicly held shares; and (iii)   Minimum initial reference price of $8.00.	The listing company must meet all of the following liquidity requirements: (i)       300 round lot shareholders; (ii)     1 million publicly held shares; and (iii)   Minimum initial reference price of $8.00 OR closing price of $6.00.[10]
Engagement of Financial Advisor	Any valuation used in connection with a direct listing must be provided by an entity that has significant experience and demonstrable competence in the provision of such valuations. (Rule 102.01A(E)) A valuation agent will not be deemed to be independent if (Rule 102.01A(E)): (i)       At the time it provides such valuation, the valuation agent or any affiliated person or persons beneficially own in the aggregate, as of the date of the valuation, more than 5% of the class of securities to be listed, including any right to receive any such securities exercisable within 60 days. (ii)     The valuation agent or any affiliated entity has provided any investment banking services to the listing applicant within the 12 months preceding the date of the valuation. For purposes of this provision, “investment banking services” include, without limitation, acting as an underwriter in an offering for the issuer; acting as a financial adviser in a merger or acquisition; providing venture capital, equity lines of credit, PIPEs (private investment, public equity transactions), or similar investments; serving as placement agent for the issuer; or acting as a member of a selling group in a securities underwriting. (iii)   The valuation agent or any affiliated entity has been engaged to provide investment banking services to the listing applicant in connection with the proposed listing or any related financings or other related transactions.	Not required in connection with a Primary Direct Floor Listings as the related prospectus is required to include a price range within which the company anticipates selling the shares it is offering.	Any valuation used in connection with a direct listing must be provided by an entity that has significant experience and demonstrable competence in the provision of such valuations. (Rule IM-5315-1(e)) A valuation agent shall not be considered independent if (Rule IM-5315-1(f)): (i)       At the time it provides such valuation, the valuation agent or any affiliated person or persons beneficially own in the aggregate, as of the date of the valuation, more than 5% of the class of securities to be listed, including any right to receive any such securities exercisable within 60 days. (ii)     The valuation agent or any affiliated entity has provided any investment banking services to the listing applicant within the 12 months preceding the date of the valuation. For purposes of this provision, “investment banking services” include, without limitation, acting as an underwriter in an offering for the issuer; acting as a financial adviser in a merger or acquisition; providing venture capital, equity lines of credit, PIPEs (private investment, public equity transactions), or similar investments; serving as placement agent for the issuer; or acting as a member of a selling group in a securities underwriting. (iii)   The valuation agent or any affiliated entity has been engaged to provide investment banking services to the listing applicant in connection with the proposed listing or any related financings or other related transactions.	Same as the Nasdaq Global Select Market	Same as the Nasdaq Global Select Market

Upon satisfaction of the above requirements of the applicable exchange, the exchange will generally file a certification with the SEC, confirming that its requirements have been met by the listing company. After such filing, the company’s registration statement may be declared effective by the SEC (assuming the SEC review has run its course). In practice, the SEC has reviewed registration statements that contemplate a direct listing in substantially the same manner it reviews traditional IPO registration statements, with some additional focus on process as direct listing practice and the related rules evolve. After the registration statement is declared effective by the SEC, the company becomes subject to the governance requirements of the applicable exchange (subject to compliance periods) and the reporting requirements under the Exchange Act. The company may then establish the day its equity will commence trading in consultation with the applicable exchange, which could be the same day as the SEC declares the registration statement effective, assuming, in the case of a Selling Shareholder Direct Listing, the exchange’s market maker or specialists, as applicable, and the financial advisor appointed by the company are able to determine an initial reference price.

NYSE’s recent rule changes: Primary capital raise via direct listing

Allowing companies to conduct their initial public offering outside of the traditional IPO format (i.e., an underwritten firm commitment) could potentially revolutionize the way in which companies go public. Historically, companies were not permitted to raise fresh capital as part of the direct listing process. On June 22, 2020, the NYSE filed a revised proposal with the SEC that would allow companies to publicly raise capital through a direct listing, which was approved by the SEC staff on August 26, 2020. The NYSE’s proposal, which would have become effective 30 days after being published in the Federal Register, was stayed by the SEC on September 1, 2020, after the Council of Institutional Investors (CII) made public its intention to file a petition for the SEC’s Commissioners to review the August 26 order approving the NYSE’s proposal. The grounds for CII’s Petition for Review of an Order are discussed below. On December 22, 2020, the SEC issued its final approval of the NYSE’s proposed rules. The NYSE’s rules, which we expect will become effective 30 days after being published in the Federal Register, will allow a company to sell shares on its own behalf, without underwriters, in addition to or in place of a secondary offering by shareholders.

Under the NYSE’s rules, companies hoping to conduct a primary offering while listing pursuant to the NYSE’s proposed rules will be required to either:

• sell at least $100 million in the opening auction on the first day of listing, thereby ensuring that there will be at least $100 million in public float after the first trade; or
• the aggregate market value of publicly held shares immediately prior to listing together with the market value of shares sold by the company in the opening auction totals at least $250 million, with such market value calculated using a price per share equal to the lowest price of the price range established in the related prospectus.

The NYSE previously proposed a “Distribution Standard Compliance Period” whereby, in a Primary Direct Floor Listing, the requirements to have 400 round lot shareholders and 1.1 million publicly held shares would be operative after a 90-day grace period. Under the proposal approved by the SEC, companies conducting a Primary Direct Floor Listing must meet these and all other initial listing requirements at the time of initial listing.

To facilitate Primary Direct Floor Listings, the NYSE’s proposal includes a new order type that would permit a Primary Direct Floor Listing to settle only if (i) the auction price would be within the price range specified by the company in its effective registration statement and (ii) all shares to be offered by the company can be sold within the specified price range, together with other technical revisions to the order process to enable and ensure compliance with the foregoing. Notably, the NYSE will create a new order type to be used by the issuer in a Primary Direct Floor Listing, referred to as an Issuer Direct Offering Order (“IDO Order”), which would be a limit order to sell that is to be traded only in a Primary Direct Floor Listing. The IDO Order would have the following requirements: (1) only one IDO Order may be entered on behalf of the issuer and only by one member organization; (2) the limit price of the IDO Order must be equal to the lowest price set forth in the applicable prospectus; (3) the IDO Order must be for the quantity of shares offered by the issuer, as disclosed in the prospectus in the effective registration statement; (4) the IDO Order may not be cancelled or modified; and (5) the IDO Order must be executed in full in the direct listing auction. The NYSE’s proposal also includes additional revisions to related definitions that are “intended to clarify the application of the existing rule and . . . not substantively change it.”

Nasdaq.

The Nasdaq Stock Market also has pending before the SEC a proposed rule change to allow primary-offering, direct listings in the context of Nasdaq’s own distinct market model, some of which require fewer record holders than the NYSE for direct listings. Additionally, on December 22, Nasdaq submitted a separate proposed rule change on this issue for which Nasdaq seeks immediate effectiveness without a prior public comment period. On December 23, the Staff of the Division of Trading and Markets of the SEC issued a public statement that “the Staff intends to work to expeditiously complete, as promptly as possible accommodating public comment, a review of these proposals, and as with all self-regulatory organizations’ proposed rule changes, will evaluate, among other things, whether they are consistent with the requirements of the Exchange Act and Commission rules.”

CII’s Objection & SEC Response

On August 31, 2020, the Council of Institutional Investors (CII) notified the SEC of its intention to file a petition for the SEC’s Commissioners to review the August 26 order approving the NYSE’s proposed rule change.[11] On September 8, 2020, CII filed its petition for review with the SEC, setting forth its principal criticism that liberalization of direct listing regulations in the face of current limitations on investors’ legal recourse for material misstatements and omissions is not consistent with Section 6(b)(5) of the Exchange Act,[12] which requires exchange rules be “designed . . . to protect investors and the public interest.” CII previously raised concerns that the NYSE proposal would not guarantee sufficient liquidity for a trading market in the securities to develop after the listing, but did not raise this concern in its petition for review.

Section 11 & Traceability Concerns.

Section 11 of the Securities Act of 1933 (Section 11) provides legal action against a wide range of corporate actors in connection with material misstatements or omissions contained in a registration statement, where a person acquires securities traceable to that registration statement in reliance on such misstatements or omissions. Under the precedent established in Barnes v. Osovsky,[13] a person bringing such a claim for material misstatements or omissions contained in a registration statement under Section 11 must generally show that either the securities they held were purchased at the time of their initial offering or that they were issued under the deficient registration statement and purchased at a later time in the secondary market, which is referred to in concept as traceability. As discussed above, in a direct listing, a company generally registers for resale all of its outstanding common equity that cannot then be sold pursuant to an applicable exemption from registration. Generally, holders of shares that are eligible for resale pursuant to an applicable exemption from registration may, simultaneous with shares sold under an effective registration statement, sell unregistered shares in transactions under Rule 144 or otherwise not subject to, or exempt from, registration under the Securities Act. As a result, shares available in the market upon a direct listing include both shares sold under the registration statement and shares sold pursuant to an exemption from registration (and therefore not under the registration statement). At a high level, shares sold pursuant to a registration statement may be subject to claims under Section 11 as well as under Rule 10b-5 under the Exchange Act (the general anti-fraud provisions of the Exchange Act), while shares sold otherwise than under a registration statement may be subject to claims only under Rule 10b-5.  Due to differences in the standards of the two rules, and defenses available to the company or other defendants, it may generally be more difficult for a holder to make successful claims with respect to shares not sold pursuant to a registration statement.

As highlighted by CII in its petition, investor concerns about the traceability of shares sold in a direct listing were highlighted in a recent case of first impression concerning direct listings.[14] In that case, the listing company argued that a Section 11 claim could not be brought as the complaining investors could not distinguish between the shares sold under the registration statement and unregistered shares sold by an insider and were consequently unable to establish traceability. Although the district court in that case denied the motion to dismiss, appeal of the issue before the U.S. Court of Appeals for the Ninth Circuit is pending. The ultimate decision in the Ninth Circuit, which includes Silicon Valley, could play an outsized role in future cases.

In earlier commentary, the SEC noted that although the NYSE’s proposal did present a “recurring” Section 11 concern, as the issue was not “exclusive” to Primary Direct Floor Listings, approval of the NYSE’s proposal did not pose a “heighted risk to investors” (emphasis added). CII’s petition also raises certain proposals that it argues would alleviate investors’ burden in proving traceability, such as the introduction of blockchain-traceable shares, and should be addressed in advance of liberalizing direct listing rules to accommodate Primary Direct Floor Listings.

Final Approval.

On December 22, 2020, the SEC issued its final approval of the NYSE’s proposed rules, finding the NYSE’s proposal is consistent with the Exchange Act and the rules and regulations issued thereunder and, furthermore, that the proposed rules would “foster[] competition by providing an alternate method for companies of sufficient size [to] decide they would rather not conduct a firm commitment underwritten offering.” The SEC’s December 22 order discussed several procedural safeguards included by the NYSE in its proposed rules that were intended to “clarify the role of the issuer and financial advisor in a direct listing” and “explain how compliance with various rules and regulations” would be addressed. These changes include the introduction of an “IDO Order type,” the clarification of how market value would be determined in connection with primary direct listings and the agreement to retain FINRA to monitor compliance with Regulation M and other anti-manipulation provisions of federal securities laws.

Notably, the SEC’s December 22 order rejects the notion that offerings not involving a traditional underwriter would “‘rip off’ investors, reduce transparency, or involve reduced offering requirements or accounting methods,” finding that the relevant “traceability issues are not exclusive to nor necessarily inherent in” Primary Direct Floor Listings. In approving the NYSE’s proposal and reaching its conclusion that the NYSE’s proposal provided a “reasonable level of assurance” that the applicable market value threshold supports a public listing and the maintenance of fair and orderly markets, the SEC specifically noted that the applicable thresholds for the equity market value under the revised rules were at least two and a half times greater than the market value standard that exists for a traditional IPO ($40 million). The SEC order also positively discusses steps taken by the NYSE to ensure compliance by participants in the direct listing process with Regulation M and other provisions of the federal securities laws.

The two Commissioners who dissented (Allison Herren Lee and Caroline A. Crenshaw) and certain investor protection groups have issued statements expressing concern that, because of the absence of traditional underwriters, the primary direct listing process will lack a key gatekeeper present in traditional IPOs that helps prevent poorly run or fraudulent companies from going public. In its order approving the NYSE’s revised rules on Primary Direct Floor Listings, the SEC suggests that, depending on the facts and circumstances, a company’s independent financial adviser could be subject to Securities Act liability, or at least lawsuits alleging underwriter liability, in connection with direct listings. The two dissenting Commissioners, however, suggest that guidance as to what may trigger status as a statutory underwriter should have been considered and concurrently provided.

Conclusion

In any event, direct listings are a sign of the times. As U.S. companies raise increasingly large amounts of capital in the private markets, the public capital markets are responding to the need to provide a wider variety of means for a private company to enter the public capital markets and provide liquidity to existing shareholders. Although direct listings will undoubtedly provide new opportunities for entrepreneurial companies with a well-recognized brand name or easily understood business model, we do not expect direct listings to replace IPOs any time soon. Direct listing practice is evolving and involves new risks and speedbumps. There are a number of novel issues and open questions raised by the evolving direct listing landscape, some of which are highlighted in Appendix I hereto (Open Questions for Direct Listings). Regulatory divergence between the price-setting mechanisms applicable to Primary Direct Floor Listings and Selling Shareholder Direct Listings may spur further rulemaking to conform to  applicable standards. Gibson Dunn will also continue to update this Current Guide to Direct Listings from time to time to further describe the applicable rules and provide commentary as practices evolve. Any company considering an entry to the public capital markets through a direct listing is encouraged to carefully consider the risks and benefits in consultation with counsel and financial advisors. Members of the Gibson Dunn Capital Markets team are available to discuss strategy, options and considerations as the rules and practice concerning direct listings evolve.

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[1]       Many foreign private issuers have listed their shares, in the form of American Depositary Shares (evidenced by American Depositary Receipts), on U.S. exchanges without a simultaneous U.S. capital raising, seeking such listing in connection with the company’s filing of a registration statement on Form 20-F under the Securities Exchange Act of 1934, as amended, and the depositary bank’s filing of a registration statement on Form F-6 under the Securities Act of 1933, as amended (a so-called “Level II ADR facility”). Such Level II ADR facilities are outside the scope of this article and should be separately considered with the advice of counsel.

[2]       The NYSE’s most recent proposal, submitted on June 22, 2020, is available at the following link: https://www.sec.gov/comments/sr-nyse-2019-67/srnyse201967-7332320-218590.pdf. The NYSE’s prior proposal, submitted on December 12, 2019, is available at the following link: https://www.nyse.com/publicdocs/nyse/markets/nyse /rule-filings/filings/2019/SR-NYSE-2019-67%2c%20Re-file.pdf. The NYSE’s initial proposal, submitted on November 26, 2019, which was withdrawn, is available at the following link: https://www.nyse.com/publicdocs/nyse/markets/nyse/rule-filings/filings/2019/SR-NYSE-2019-67.pdf.

[3]       The SEC’s revision to Rule 163B under the Securities Act of 1933, as amended, which permits “testing-the-waters” communications by all issuers, was adopted on September 25, 2019. The adopting release is available at the following link: https://www.sec.gov/rules/final/2019/33-10699.pdf.

[4]       The SEC has published a helpful guide concerning Rule 144 transactions that is available at the following link: https://www.sec.gov/reportspubs/investor-publications/investorpubsrule144htm.html. Such a transaction is outside the scope of this article and should be separately considered with the advice of counsel

[5]       Certain NYSE rules are reviewed herein. The NYSE Listed Company Manual, which contains all of the listing standards and other rules applicable to a company listed on the NYSE, is available at the following link: https://nyse.wolterskluwer.cloud/listed-company-manual.

[6]       Certain Nasdaq rules are reviewed herein. The Nasdaq Equity Rules, which contain all of the listing standards and other rules applicable to a company listed on Nasdaq, are available at the following link: http://nasdaq.cchwallstreet.com/.

[7]       On August 15, 2019, Nasdaq submitted to the SEC proposed rule changes related to direct listings on the Nasdaq Global Market and Nasdaq Capital Market, the second- and third-tier Nasdaq markets, respectively. The Nasdaq proposal, submitted on August 15, 2019, is available at the following link: https://www.sec.gov/rules/sro/nasdaq/2019/34-86792.pdf. Nasdaq’s amendment to its proposal, submitted on November 26, 2019, is available at the following link:  https://www.sec.gov/comments/sr-nasdaq-2019-059/srnasdaq2019059-6482012-199454.pdf. The SEC’s adopting release approving the Nasdaq proposal is available at the following link: https://www.sec.gov/rules/sro/nasdaq/2019/34-87648.pdf.

[8]       There must be an independent valuation where a company goes public without an underwriting syndicate that would otherwise represent to the applicable exchange that such exchange’s distribution requirements will be met by the contemplated offering. If consistent and reliable private-market trading quotes are available, both the independent valuation and valuation based on private-market trading quotes must show a market value of “publicly held” shares in excess of $100 million ($110 million for Nasdaq Global Select Market, under certain circumstances).

[9]       In lieu of a valuation for listings on the Nasdaq Global Market and Nasdaq Capital Market, the exchange may accept “other compelling evidence” that the (i) tentative initial bid price, (ii) market value of listed securities and (iii) market value of publicly held shares each exceed 250 percent of the otherwise applicable requirements. Under the rules, as amended, such compelling evidence is currently limited to cash tender offers by the company or an unaffiliated third party that meet certain other requirements.

[10]     To qualify under the closing price alternative, the listing company must have: (i) average annual revenues of $6 million for three years, or (ii) net tangible assets of $5 million, or (iii) net tangible assets of $2 million and a three-year operating history, in addition to satisfying the other financial and liquidity requirements listed above. If listing on the Nasdaq Capital Markets under the NCM Listed Securities Standard in reliance on the closing price alternative, such closing price must be in excess of $4.00.

[11]     The Council of Institutional Investors’ August 31 notice to the SEC is available at the following link: https://www.cii.org/ files/issues_and_advocacy/correspondence/2020/August%2031%202020%20%20letter%20to%20SEC-AB.pdf. The SEC’s letter to the NYSE notifying the exchange of the stay of the SEC staff’s August 26 order is available at the following link: https://www.sec.gov/rules/sro/nyse/2020/34-89684-carey-letter.pdf.

[12]     The Council of Institutional Investors’ Petition for Review of an Order is available at the following link: https://www.sec.gov/rules/sro/nyse/2020/34-89684-petition.pdf.

[13]        373 F.2d 269 (2d Cir. 1967).

[14]     See generally Pirani v. Slack Technologies, Inc., 445 F.3d 367 (N.D. Cal. 2020).

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APPENDIX I

Open Questions for Direct Listings (as of January 8, 2021)

Some of the relevant open questions include:

• Will the loss of a traditional firm-commitment underwriter create additional risks for investors? The NYSE’s revised rules permit companies to raise new capital without using a firm-commitment underwriter. The two Commissioners who dissented (Allison Herren Lee and Caroline A. Crenshaw) and certain investor protection groups have expressed concern that the absence of a traditional underwriter removes a key gatekeeper present in traditional IPOs that helps prevent inaccurate or misleading disclosures. In its order approving the NYSE’s revised rules on Primary Direct Floor Listings, the SEC suggests that, depending on the facts and circumstances, a company’s financial advisers could be subject to Securities Act liability, or at least lawsuits alleging underwriter liability, in connection with direct listings. The two dissenting Commissioners, however, suggest that guidance as to what may trigger status as a statutory underwriter should have been considered and concurrently provided.
• Will a Primary Direct Floor Listing create new risks for the listing company? Under current rules and precedent, in a Primary Direct Floor Listing the listing company may have more rather than less liability in a direct listing than a traditional IPO. In a traditional IPO, because of customary lockup arrangements, investors can generally guarantee the traceability of their shares to the registration statement because only shares issued under the registration statement are trading in the market until the lockup period expires. Under current case law, which is being appealed, the tracing requirement has been seemingly abandoned, meaning all the shares in the market can potentially make claims under Section 11.
• How will legal, diligence and auditing practices develop around direct listings? Because the listing must be accompanied by an effective registration statement under the Securities Act, the liability provisions of Section 11 and 12 of the Securities Act will be applicable to sales made under the registration statement. We note that in many of the direct listings to date, the companies have engaged financial advisors to assist with the positioning of the equity story of the company and advise on preparation of the registration statement, in a process very similar to the process of preparing a registration statement for a traditional IPO. Because a company will be subject to the same standard for liability under the federal securities laws with respect to material misstatements and omissions in a registration statement for a direct listing to the same extent as for a registration statement for an IPO, a company’s incentives to conduct diligence to support the statements in its registration statement do not differ between the two types of transactions. Similarly, financial statement requirements, and the requirements as to independent auditor opinions and consents, do not differ between registration statements for direct listings and IPOs. Furthermore, follow-on offerings by the company that involve firm-commitment underwriting or at-the-market programs will require the traditional diligence practices. To date, there have been no lawsuits alleging that financial advisers in a direct listing could be subject to Securities Act liability in connection with direct listings.
• What impact will the expanded availability of direct listings have on IPO activity? One could argue that the greatest attraction of a direct listing is that it can nearly match private markets in being faster and less costly than an IPO. In some cases, it could provide similar liquidity as a traditional IPO, although trading price certainty and trading volume could be lower following a direct listing than following an IPO. Direct listings have been available on the NYSE and Nasdaq for a decade but have not been utilized regularly by large private companies in lieu of a traditional IPO. In any event, the requirement for 400 round lot holders will continue to be a hurdle for many private companies looking to list directly.
• How will the initial reference price and/or price range in the prospectus be determined? There is no reference price from another market for the DMM to apply and no negotiation between the issuer and the underwriter as in an IPO. The NYSE seems to bridge this gap with the requirement for the DMM to consult with an independent financial adviser to determine the initial reference price in a Selling Shareholder Direct Listing and, in a Primary Direct Floor Listing, to determine the price range to be set forth in the applicable prospectus. Eventually, a standardized set of practices around the financial adviser’s work and presentation of the price to the issuer and the Exchange should develop.
• Without the firm-commitment IPO process, in which the offering is oversold and heavily marketed, how will direct listed shares trade in the aftermarket? Without an underwritten offering, the issuer will not engage in price finding and book building activities. In a direct listing, the issuer will also take on much of the role of investor outreach that is borne by underwriters in a traditional IPO. Although direct listing marketing efforts may include one or more investor days and a roadshow-like presentation, sell-side analysts will presumably not be involved, building models and educating investors. It may be more difficult for the issuer to tell its forward-looking story and build value into the trading price of the stock without research coverage prior to or after the listing. For this reason, the most successful direct listings to date have been well-known companies with widely recognized brands that have successfully engaged with a broad set of new investors. We expect that companies engaging in direct listings will continue to develop more robust internal investor/shareholder relations functions than may be needed for a company conducting a traditional IPO.
• Will large private placements (often called “private IPOs”) have a new advantage? The expanded option to direct list, whether in a secondary or primary format, through an independent valuation alone may mean investors in a private company can have access to public markets faster than through an IPO process. When private companies market private equity capital raises, including private IPOs, they might use the direct listing option as a marketing tool to attract investors to the private placement.
• Are there any companies that are well-positioned for a Primary Direct Floor Listing? The NYSE’s revised rules may prompt well-positioned companies to consider a capital raise where the private or IPO markets are otherwise unattractive. Furthermore, until Nasdaq’s rules are approved, how will the NYSE’s rules affect the decision of where to list?

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Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Capital Markets or Securities Regulation and Corporate Governance practice groups, or the authors:

Alan Bannister– New York (+1 212-351-2310, abannister@gibsondunn.com)
Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com)
Boris Dolgonos – New York (+1 212-351-4046, bdolgonos@gibsondunn.com)
Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com)
James J. Moloney – Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com)
Evan Shepherd* – Houston (+1 346-718-6603, eshepherd@gibsondunn.com)

Please also feel free to contact any of the following practice leaders:

Capital Markets Group:
Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com)
Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com)
Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com)
Peter W. Wardle – Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com)

Securities Regulation and Corporate Governance Group:
Elizabeth Ising – Washington, D.C. (+1 202-955-8287, eising@gibsondunn.com)
James J. Moloney – Orange County, CA (+1 949-451-4343, jmoloney@gibsondunn.com)
Lori Zyskowski – New York (+1 212-351-2309, lzyskowski@gibsondunn.com)

*Mr. Shepherd is admitted only in New York and is practicing under the supervision of Principals of the Firm.

© 2021 Gibson, Dunn & Crutcher LLP

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

This Alert reports on recent intellectual property law developments relating to the COVID-19 pandemic, and provides updates on various developments we covered in previous alerts. First, we briefly review the intellectual property-related provisions of the COVID-19 relief and government funding bill that the President signed into law at the end of December. Second, we discuss ongoing efforts around the world to facilitate the donation of intellectual property rights, including through the Open COVID Pledge, and a proposal pending before the World Trade Organization (“WTO”). Finally, we include updated figures regarding the frequency of patent litigation in 2020, and note manufacturer 3M’s success in using trademark law to combat price gouging of its personal protective equipment.

(1) New Intellectual Property Laws in the COVID-19 Relief and Government Funding Bill

The COVID-19 relief and government funding bill that became law on December 27, 2020 incorporates three sections focused on intellectual property-related measures: the Copyright Alternative in Small-Claims Enforcement Act (“CASE Act”), which amends certain provisions of the Copyright Act, 17 U.S.C. § 101 et seq; amendments to the Federal Criminal Code that make it a felony to engage in unauthorized streaming of copyrighted content (commonly referred to as the Protecting Lawful Streaming Act); and the Trademark Modernization Act, which includes revisions to the Lanham Act, 15 U.S.C. § 1051 et seq. We summarize these developments below; more detailed discussions can be found in Gibson Dunn’s prior alerts about the intellectual property Acts in the bill, available here and here.

The CASE Act (Consolidated Appropriations Act of 2021, Division Q, Title II, Subtitle A) establishes a new Copyright Claims Board (“Board”) within the United States Copyright Office to serve as an alternative forum to federal courts for parties to resolve small copyright infringement claims, with streamlined procedures, and limited remedies amounting to no more than $30,000 in total damages in a single proceeding for registered works, and $15,000 of the same for unregistered works.[1] Decisions of the Board will not be precedential, and the Act provides for limited appellate review. This new procedure has the potential to provide individual rights holders (such as composers and graphic artists), an alternative mechanism that should be more efficient and affordable than federal court litigation for resolving small claims. Whether copyright owners will use this alternative forum remains to be seen.

An additional measure, widely referred to as “The Protecting Lawful Streaming Act” (Consolidated Appropriations Act of 2021, Division Q, Title II, Subtitle A), adds a new Section 2319C to the federal criminal code that makes it a criminal offense for a person “to willfully, and for purposes of commercial advantage or private financial gain” digitally transmit material without authorization of the copyright owner, or the law. The provision will allow the Department of Justice to bring felony charges against digital transmission services that are “primarily designed” for the purpose of streaming copyrighted materials without authorization. The maximum penalty for violation is imprisonment for up to ten years.[2] Before this provision, criminal copyright infringement based on unauthorized streaming could be charged only as a misdemeanor.

The Trademark Modernization Act of 2020 (Consolidated Appropriations Act of 2021, Division Q, Title II, Subtitle B) revises various provisions of the Lanham Act, 15 U.S.C. §§ 1501 et seq., in response to a recent rise in fraudulent trademark applications. Specifically, the Act enhances trademark examination proceedings by formalizing the process third-parties may use to submit evidence to the USPTO, and by providing the Office with greater authority and flexibility to set deadlines for trademark applicants to respond to actions taken by examiners.[3] The Act also clarifies the standard for finding the irreparable harm necessary for injunctions in trademark cases, bringing uniformity in response to inconsistencies that have emerged across federal courts after the Supreme Court’s decision in eBay Inc. v. MercExchange, LLC, 547 U.S. 388 (2006).[4]

(2) Ongoing Efforts to Facilitate the Donation of Intellectual Property Rights During the COVID-19 Pandemic

WTO Proposal to Suspend IP Rights Under the TRIPS Agreement. The TRIPS council met again on December 10, 2020, to discuss a proposal, originally submitted in October by South Africa and India, seeking the temporary waiver of various provisions in Section II of the TRIPS Agreement that grant Member countries intellectual property rights, and impose obligations to enforce them. The proposal, if passed, would effectively waive all copyright, trademark, industrial design, and patent rights provided under the TRIPS Agreement, insofar as such rights relate to the prevention, containment, or treatment of COVID-19; the effective waiver would apply until vaccination is widespread and “the majority of the world’s population has developed immunity” to the virus.[5] The TRIPS Agreement already includes provisions that require compulsory licensing of intellectual property rights during health emergencies to assist low-income countries that do not have the capacity to make pharmaceutical products. Proponents of the proposed waiver contend that these provisions are cumbersome and do not facilitate the necessary access to other personal protective equipment and vaccines.[6]

The TRIPS proposal has gained support from more than 99 countries, but major players, including the United States, the United Kingdom, Japan, Canada, and the European Union oppose it. The United Kingdom explained that its opposition to the proposal arises in part from a lack of “clear ways in which IP has acted as a barrier to accessing vaccines, treatments, or technologies” in the response to COVID-19.[7] The WTO has postponed further discussion of the proposal.

Open COVID Pledge. Organizations continue to sign onto the Open COVID Pledge, through which signatories grant a non-exclusive, royalty-free, worldwide license to use their patents and copyrights “for the sole purpose of ending” the COVID-19 pandemic. The pledge now includes patents related to wearable technology to perform contact tracing and proximity alerts, face covering and face shield designs, and computer software relating to diagnosing the virus. A Japanese-led Open COVID Pledge Coalition was founded last spring. That coalition, which includes several major Japanese companies, has also continued to grow, with voluntary pledges now having contributed approximately 1 million patents.

COVID-19 Technology Access Framework. The COVID-19 Technology Access Framework, which was established in April, creates a mechanism for universities to grant “non-exclusive royalty free licenses . . . for the purpose of making and distributing products to prevent, diagnose and treat COVID-19 infection during the pandemic and for a short period thereafter.” Since our prior reporting on the framework (see here), 21 more universities have now signed on.

Medicines Patent Pooling. As we previously reported, the UN-backed nonprofit Medicines Patent Pool (“MPP”) has been compiling patent information relating to products that are being used in clinical trials to treat COVID-19. The MPP also negotiates licenses with patent holders to facilitate widespread access to treatments. Twenty-one generic pharmaceutical manufacturers have now signed a pledge to work with the MPP to (among other things) negotiate licenses for patented COVID-19 therapeutics, and to accelerate development and delivery timelines for new treatments.

(3) Patent Litigation Sees Steady Increase While 3M’s Use of Trademark Law to Combat Price Gouging Proves Successful

Patent Lawsuits. Nearly 4,000 patent cases were filed in federal district courts in 2020, an increase of approximately 400 cases over 2019.[8] The Patent Trial and Appeal Board has seen a small increase in filings, with approximately 1500 petitions for inter partes, covered business method, and post-grant review, filed in 2020—an increase of approximately 200 proceedings over 2019.[9] District courts across the country continue to delay jury trials, and hold hearings remotely. The Federal Circuit’s May 18, 2020 order suspending in-person oral arguments indefinitely, and opting in favor of telephonic arguments (or no argument at all, if the Court so orders) remains in effect. In the Eastern District of Texas, Judge Gilstrap announced in November that all of his jury trials would be postponed until March 2021, with other judges ordering similar delays. Many courts, however, continue to hold the majority of proceedings online and have ordered jury trials to be continued. The Western District of Texas has postponed all jury trials until after January 31 while the Southern District of New York has postponed the same until after February 12.

3M Litigation. As reported in a previous update, in the summer of 2020, manufacturer 3M brought a wave of lawsuits across the country against online vendors, asserting claims under the Lanham Act for the sale of counterfeit PPE using 3M’s trademarks, and related state law claims, in an effort to combat both the counterfeit production of PPE, as well as price gouging of the same. In some of these cases, 3M established irreparable harm under a reputational theory of injury—namely, that “[n]o amount of money could repair the damage to 3M’s brand and reputation” if it were associated with “price-gouging at the expense of healthcare workers and other first responders in the midst of the COVID-19 crisis.”[10] In analyzing these trademark infringement claims based on the sale of counterfeit PPE at inflated prices, courts have also paid particular attention to the “bad faith” prong of the trademark infringement analysis, with one, for example, noting that the defendant’s decision to stop selling automobiles in favor of selling N95 masks constituted “textbook bad faith.”[11]

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We are continuing to monitor intellectual property-related updates and trends relating to COVID-19.

____________________

   [1]   17 U.S.C. § 1504(e)(1)(A), (D).

   [2]   Id. § 2319C(c).

   [3]   15 U.S.C. § 1051(f).

   [4]   15 U.S.C. § 1116(a).

   [5]   WTO, Council for Trade-Related Aspects of Intellectual Property Rights, Waiver from Certain Provisions of the TRIPS Agreement for the Prevention, Containment and Treatment of COVID-19, p. 2, October 2, 2020, https://docs.wto.org/dol2fe/Pages/SS/directdoc.aspx?filename=q:/IP/C/W669.pdf&Open=True.

   [6]   See WTO, Members discuss intellectual property response to the COVID-19 pandemic, October 20, 2020, https://www.wto.org/english/news_e/news20_e/trip_20oct20_e.htm.

   [7]   See, e.g., UK Mission to the WTO, UN, and Other International Organizations (Geneva), “UK Statement to the TRIPS Council: Item 15 Waiver Proposal for COVID-19,” UK Government, October 16, 2020.

   [8]   These figures were obtained from Docket Navigator’s Omnibus Reporting of Patent Cases by year. A “patent case” here refers to actions “addressing the infringement, validity or enforceability of a U.S. patent flagged with Nature of Suit (“NOS”) 830 in the PACER system as well as other cases that are known to meet the above criteria.” Docket Navigator, Scope of Data Available in Docket Navigator, https://search.docketnavigator.com/help/scope.html (last visited January 6, 2021).

[9]   Docket Navigator, Omnibus Report PTAB Petitions,  https://search.docketnavigator.com/patent/binder/390087/13 (last visited January 8, 2021). This does not include proceedings conducted pursuant to 35 U.S.C. § 6(b)(1)-(3), such as appeals of adverse decisions of examiners, appeals of reexaminations, or derivation proceedings.

[10]   3M Co. v. Performance Supply, LLC, 1:20-cv-02949, Dkt. No. 23 (S.D.N.Y. May 4, 2020).

[11]   Id.

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Gibson Dunn lawyers regularly counsel clients on the issues raised by this pandemic, and we are working with many of our clients on their response to COVID-19.  For additional information, please contact any member of the firm’s Coronavirus (COVID-19) Response Team.  Please also feel free to contact the Gibson Dunn lawyer with whom you usually work, or the authors in New York:

Richard Mark (+1 212-351-3818, rmark@gibsondunn.com)
Joe Evall (+1 212-351-3902, jevall@gibsondunn.com)
Doran Satanove (+1 212-351-4098, dsatanove@gibsondunn.com)
Wendy Cai (+1 212-351-6306, wcai@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP

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

Los Angeles partner Maurice Suh, of counsel Daniel Weiss and associate Zathrina Perez are the authors of “Supreme Court needs to rethink NCAA ‘amateurism’” [PDF] published by the Daily Journal on January 5, 2021.

Washington, D.C. counsel Roscoe Jones Jr., New York partner Joel Cohen, Washington, D.C. partner Michael Bopp, New York partner Arthur Long, Washington, D.C. partner Jeffrey Steiner, Washington, D.C. associate Samantha Ostrom, Orange County associate Maggie Zhang and San Francisco associate Alexandra Farmer are the authors of “Financial Policy in the Incoming Biden Administration: What Can We Expect?” [PDF] published by Wall Street Lawyer in its December 2020 issue.

President-elect Joe Biden has signaled that robust consumer protection will be a major focus of his policy agenda. In this webcast, an experienced team of Gibson Dunn consumer protection attorneys will preview the incoming administration’s anticipated consumer protection agenda in areas including consumer fraud, privacy, and consumer financial protection. We also will discuss what, if any, impact this policy shift is likely to have on state-level enforcement. Topics to be discussed include:

• DOJ and SEC consumer fraud enforcement;
• FTC consumer protection enforcement, including privacy and cybersecurity enforcement;
• HHS privacy enforcement;
• CFPB consumer financial protection enforcement; and
• State Attorney General consumer protection enforcement in key jurisdictions, including New York and California.

View Slides (PDF)

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PANELISTS:

Joel M. Cohen is a partner in the New York office and Co-Chair of the firm’s global White Collar Defense and Investigations Practice Group. He is a trial lawyer and former federal prosecutor highly-rated in Chambers and ranked a “Super Lawyer” in Criminal Litigation by Global Investigations Review. Mr. Cohen’s practice focuses on financial institution litigation, FCPA/anticorruption issues, and other international disputes and discovery.

Alex Southwell is a partner in the New York office and Co-Chair of the firm’s Privacy, Cybersecurity and Consumer Protection Practice Group.  He is a Chambers-ranked former federal prosecutor and was named a “Cybersecurity and Data Privacy Trailblazer” by The National Law Journal.  Mr. Southwell’s practice focuses on white-collar criminal and regulatory enforcement defense, internal investigations and compliance monitoring, and he has considerable experience in information technology-related investigations, counseling, and litigation.

Ryan Bergsieker is a partner in the Denver office and a former federal cybercrimes prosecutor.  He is recognized by Chambers as one of the top white collar defense and government investigations lawyers in Colorado, and was named by BTI to its Client Service All-Stars List.  Mr. Bergsieker’s practice focuses on government investigations, complex civil litigation, and cybersecurity/ data privacy counseling.

Winston Y. Chan is a former federal prosecutor and litigation partner in the San Francisco office.  He has particular expertise representing clients in enforcement actions and investigations by California’s Attorney General and local district attorneys.  Mr. Chan is a Chambers-ranked attorney in White Collar Crime and Government Investigations, recognized by Benchmark Litigation as a “Litigation Star”, and recommended annually by Global Investigations Review.

Mylan Denerstein is a partner in the New York office and Co-Chair of the firm’s Public Policy Practice Group.  Ms. Denerstein leads complex litigation and internal investigations and represents companies facing a diverse range of legal issues, typically involving federal, state and municipal government agencies.  She is a former federal prosecutor and also served as Counsel to New York State Governor Andrew Cuomo.  She was named by Benchmark Litigation as a 2021 “Top 250 Women in Litigation” and a 2021 “Litigation Star” nationally and in New York.

Elizabeth Papez is a litigation and regulatory partner in the Washington D.C. office and a former federal prosecutor and Justice Department official.  She is repeatedly recognized as one of Benchmark USA’s Top 250 Women in Litigation nationwide.  Ms. Papez’s practice focuses on high-stakes consumer protection, securities, and antitrust matters with parallel civil regulatory and litigation exposure.  She has particular experience with the application of federal competition and consumer protection laws and multi-jurisdictional discovery and data-sharing considerations.

Ashley Rogers is a partner in the Dallas office.  She is a member of the firm’s Litigation Department and practices in the Privacy, Cybersecurity and Consumer Protection Practice Group.  Ms. Rogers’ practice focuses on a wide range of data privacy and consumer protection matters, and she has particular experience representing clients in the technology and internet industries in putative data privacy class actions and in government investigations.

Amanda Aycock is a senior associate in the New York office, and a member of the firm’s Litigation Department and Privacy, Cybersecurity and Consumer Protection Practice Group.  Her practice is cross-disciplinary and includes significant experience in consumer protection, data privacy, contract, antitrust, and criminal law.  She was named in 2020 by Legal 500 as a Rising Star” in corporate investigations and white collar criminal defense, and as a “Name to Note” for white collar matters emanating from the technology, media and entertainment industries.

Victoria Weatherford is a senior associate in the San Francisco office and member of the firm’s Litigation Department.  She has particular experience representing clients in enforcement actions and investigations by California’s Attorney General and local district and city attorneys, in California writs and appeals, and at trial.  She is recognized as one of the ABA’s “On the Rise – Top 40 Young Lawyers” in 2020.  From 2014-2018, she served as a Deputy City Attorney in the San Francisco City Attorney’s Office, where she first-chaired statewide consumer protection cases to trial under California’s Unfair Competition Law and False Advertising Law.

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MCLE CREDIT INFORMATION:

This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.5 credit hours, of which 1.5 credit hours may be applied toward the areas of professional practice requirement.

This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact CLE@gibsondunn.com to request the MCLE form.

Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.5 hours.

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

San Francisco partner Ethan Dettmer and Washington, D.C. associates Suria Bahadue and Matthew Rozen are the authors of “Invalid appointments and the restoration of DACA,” [PDF] published by the Daily Journal on January 4, 2021.

On 18 December 2020, the European Commission (the “Commission”) launched a comprehensive public consultation (the “Consultation”) on the revision of the European Union (“EU”) antitrust rules specifically applicable to distribution agreements, namely, the 2010 Vertical Block Exemption Regulation (Regulation 330/2010 or “VBER”) and the 2010 Vertical Guidelines, both of which will expire on 31 May 2022.[1]

The Commission is consulting with a view to gathering feedback on a number of policy options:[2]

• On one side, the Commission proposes to adopt an arguably more lenient approach to the application of EU competition rules to certain types of vertical arrangements, ranging from: long-term non-compete obligations, efficiency-generating resale price maintenance (“RPM”), sustainability agreements in the context of the European Green Deal,[3] active sale restrictions outside of pure exclusive distribution, and measures indirectly restricting online sales.
• On the other side, the Commission is considering adopting a stricter competition law enforcement strategy in relation to other types of vertical agreements such as: restrictions on price comparison websites and on online advertising, dual distribution and parity obligations (e.g., most favoured nation, or “MFN” clauses).

The Consultation is open until 26 March 2021, and will be followed by a report on the findings and results of the impact assessment phase. This will result in the publication of the proposed new draft VBER and accompanying Vertical Guidelines. Given the range of policy options under consideration by the Commission, this Consultation gives companies involved in both traditional and online retail business a unique opportunity to seek to influence the shape of future vertical restraint policies.

1.   Background & Historical Context

Since the 1960s, the Commission has had in place regulations and guidance exempting certain categories of distribution agreements from the application of EU competition rules prohibiting anti-competitive agreements or arrangements.[4] The current VBER entered into force on 1 June 2010.

The VBER block exempts from the application of EU competition law distribution agreements where the market shares of the supplier and reseller do not exceed 30% in the respective relevant markets. The exemption applies if the agreement does not include so-called ‘hard-core’ restrictions.[5] Where companies cannot safely determine that their distribution agreement is covered by the VBER ‘safe harbour’, the company will need to consider: (i) if the agreement contains any ‘hard-core’ or excluded restrictions, (ii) if it may have any foreseeably anti-competitive effects on competition, and (iii) if there are any efficiencies that may benefit the agreement from an individual exemption under Article 101(3) TFEU. The Vertical Guidelines provide guidance to companies to perform these individual assessments.

2.   The 2010 VBER and Vertical Guidelines and the Commission’s Approach to E-Commerce and Other Restrictions

The VBER and the Vertical Guidelines currently in force include rules and guidance that aim at fostering cross-border trade and online commerce as well as promoting competition. For example, the 2000 Vertical Guidelines allowed suppliers to require that quality standards be met in order to allow the resale of products through a distributor’s website.[6] The 2010 version of the Guidelines implicitly limited the application of such quality standards in the context of the Internet to situations involving selective distribution arrangements. And in any event, the standards had to be applied in an “overall equivalent” manner to both physical and online points of sale (i.e., stricter standards could not be applied only to online sales).[7] The 2010 Vertical Guidelines also set out a list of obligations and restrictions that suppliers were not permitted to impose on online resellers without potentially breaching EU competition law.[8]

The application of antitrust rules to e-commerce was significantly influenced by the 2011 Judgment of the Court of Justice of the EU (“CJEU”) in Pierre Fabre, which found that EU competition law prohibited manufacturers from engaging generally in online sales restrictions. In Pierre Fabre, the restriction resulted from the obligation on distributors to sell personal care products only in the presence of qualified pharmacists, de facto excluding sales through distributors’ websites.[9] The CJEU fully endorsed the view that e-commerce constituted a legitimate channel for the resale of products, and that a prohibition of e-commerce sales amounted to a hard-core restriction of competition ‘by object’. Pierre Fabre was followed by other decisions at EU and national level which confirmed the strict approach of European competition authorities and courts against measures likely to restrict e-commerce.[10]

By 2017, however, the Commission and the CJEU had started to become more nuanced in their approach to e-commerce, in particular regarding the sale of goods in online marketplaces. In the Commission’s final report in its E-Commerce Sector Enquiry, the Commission considered the perceived erosion of manufacturers’ freedom to limit online sales, and concluded that suppliers’ restrictions on distributors which made sales on online marketplaces were not per se anti-competitive.[11] Later that year, in Coty, the CJEU confirmed that manufacturers of luxury goods could seek to preserve the luxury image of those goods by preventing their sale in online marketplaces.[12]

3.   The Commission’s Review of the VBER and the Vertical Guidelines

Against the backdrop of the findings of the E-Commerce Sector Enquiry and the Coty judgment, in 2018 the Commission launched a review of the 2010 VBER and the Vertical Guidelines, which are due to be replaced by 31 May 2022.

The first part of the review process lasted through September 2020, with the Commission gathering evidence on the functioning of the current VBER and the Vertical Guidelines. Respondents indicated that both the 2010 VBER and the Vertical Guidelines had to be revised, especially in light of the profound impact of e-commerce and digitalisation, the increase in direct sales by manufacturers to customers, the wider use of retail price parity clauses, and the emergence of online platforms. Furthermore, the Commission found that there are certain practices and restrictions that have become more commonplace over the past few years, for which additional guidance is required (e.g., dual distribution, online platform bans and restrictions on the use of price comparison websites).[13]

4.   The Commission’s Ongoing Impact Assessment

On 23 October 2020, the Commission published a Roadmap[14] for an impact assessment of the initiatives tabled to address the deficiencies identified in the 2010 VBER and Vertical Guidelines, identifying the following priorities:

1)   The need to clarify, simplify and complete EU competition rules applicable to vertical agreements regarding:

• the assessment of possible efficiencies resulting from resale price maintenance (“RPM”), which is currently a hard-core restriction under the VBER.
• how to address restrictions that have become more prevalent since 2010 (e.g., restrictions on the use of price comparison websites, or online advertising restrictions).
• the treatment of new market players, such as online platforms and marketplaces, especially in areas of distribution not addressed by the current case law, such as agency agreements and dual distribution (i.e., situations in which a supplier sells its goods or services directly to end customers, thereby competing with its distributors at the retail level).
• the objectives of the European Green Deal,[15] in relation to agreements pursuing sustainability objectives.

2)   Non-compete clauses: These include obligations imposed on buyers not to manufacture, purchase, sell or resell goods or services which compete with those of the supplier, and are currently block exempted by the VBER provided that, inter alia, their duration does not exceed five years and is not automatically renewable. The Commission will consider a more lenient treatment of non-compete clauses whose duration may exceed this period due to automatic extensions, provided that they are subject to termination rights or renegotiation obligations.

3)   Dual distribution: This occurs where a supplier sells its products to consumers both directly and through independent resellers. The growth of online sales has led to a significant increase in dual distribution practices, leading the Commission to consider issues such as: (i) horizontal competition concerns arising from suppliers’ activities in the same market as resellers; (ii) the ability of dual distribution to satisfy the test for efficiencies that is used under Article 101(3) TFEU; and (iii) the comparison of the supplier’s situation with that of other wholesale distributors and resellers which are not in a position to benefit from the VBER in comparable situations.

To address the more widespread use of dual distribution, the Commission has identified the following policy options (with the possibility of Options 2 and 3 being introduced in combination):

• Option 1: baseline scenario (i.e., no policy change).
• Option 2: limiting the scope of the exemption to situations that are not likely to raise horizontal concerns by, for example, by introducing a threshold based on the parties’ market shares in the retail market, and by aligning the exemption with what is considered to be capable of being exempted in the case of agreements among competitors.[16]
• Option 3: extending the exemption to dual distribution practices by wholesalers and/or importers.
• Option 4: removing the exemption from the VBER, thereby requiring an individual assessment under Article 101(3) TFEU for all dual distribution cases.

4)   Active sales restrictions: The VBER treats as ‘hard-core’ situations where a supplier restricts the territory into which, or the customers to whom, a reseller can sell the products. Resellers should generally be allowed to approach direct individual customers (‘active sales’) and to respond to unsolicited requests from individual customers (‘passive sales’). However, the current rules permit restrictions on active sales in limited cases, notably where they are justified to protect investments made by exclusive distributors.

The rigidity of the current VBER framework regarding the treatment of active and passive sales can render it difficult for suppliers to implement distribution networks that are tailored to their specific needs. For example, the VBER and the Vertical Guidelines do not foresee the use of ‘shared exclusivities’ between two or more distributors in a particular territory (i.e., shielded from active sales by distributors established outside of their territory), or the genuine combination of exclusive and selective distribution methods for the same product lines in the same territory.[17]

The Commission has therefore identified the following policy options (with Options 2 and 3 possibly being introduced in combination):

• Option 1: baseline scenario (i.e., no policy change).
• Option 2: expanding the existing exemptions available for the prohibition of active sales in order to give suppliers more flexibility to design their distribution systems.
• Option 3: ensuring more effective protection for selective distribution systems, by allowing restrictions on sales made from outside the allocated selective distribution territory to unauthorised distributors inside that territory.

5)   Indirect measures restricting online sales: As noted above, most restrictions on distributors to sell through the Internet are considered to be ‘hard-core’ restrictions, which will generally not benefit from the automatic exemption under the VBER.[18] The current versions of the VBER and the Vertical Guidelines apply the same approach to certain indirect measures that might hinder online sales, such as charging the same distributor a higher wholesale price for products intended to be sold online than with respect to products sold off-line (‘dual pricing’), or where selective criteria are imposed for online sales that are not truly equivalent to the criteria imposed in brick-and-mortar shops (the “overall equivalence” principle).[19]

The Commission recognises that, by not allowing suppliers to charge different wholesale prices depending on the actual costs of maintaining different channels, the current rules may prevent them from incentivising associated investments, notably in physical stores.

As a result, the Commission has identified the following policy options (with Options 2 and 3 possibly being introduced in combination):

• Option 1: baseline scenario (i.e., no policy change).
• Option 2: no longer treating dual pricing strategies as a ‘hard-core’ competition restriction, with certain safeguards to be defined in accordance with principles established under case law.
• Option 3: no longer considering as a ‘hard-core’ restriction the imposition of selective criteria for online sales that are not “overall equivalent” to the criteria imposed in brick-and-mortar shops, with safeguards to be defined in accordance with principles set forth under case law.

6)   Parity obligations (so-called ‘most-favoured nation’, or “MFN”, clauses): These types of clause require a business to offer the same or better conditions to its contracting party as those it offers to any other party, or by the company itself through its direct sales channels. Parity obligations are generally block exempted under the conditions of the VBER. However, the increase in their use, notably by online platforms, has led to the identification of possible anti-competitive effects under certain scenarios (e.g., obligations that require parity with other indirect sales or marketing channels).

In order to address these scenarios, the Commission has identified the following policy options:

• Option 1: baseline scenario (i.e., no policy change).
• Option 2: removing the benefit of the VBER and including within the list of excluded restrictions (Article 5 VBER) obligations that require parity relative to specific types of sales channel – thereby requiring an individual effects-based assessment of such obligations under Article 101 TFEU. For example, the benefit of the VBER could be generally excluded for parity obligations that relate to indirect sales and marketing channels, including online platforms and other intermediaries.
• Conversely, parity obligations relating to other types of sales channel would continue to benefit from the block exemption, on the basis that they are more likely to create efficiencies that satisfy the conditions of Article 101(3) TFEU.
• Option 3: removing the benefit of the VBER ‘safe harbour’ for all types of parity obligations, by including them in the list of excluded restrictions (Article 5 VBER). This option would require companies to perform an individual effects-based assessment in all such cases.

5.   The Consultation – A Call for Action

With the release of its Consultation on 18 December 2020, the Commission is seeking to address the wide range of issues described above and to prepare for the adoption of a revised VBER and Vertical Guidelines in 2022.

While some of the issues addressed in the Consultation have long been highlighted by antitrust agencies, practitioners and industry stakeholders, a number of other issues have also raised heightened attention because of the extra impetus enjoyed by e-commerce during the last years.

The issues and potential solutions identified by the Commission in the Consultation (which is open until 26 March 2021) are important for manufacturers and resellers of all products, but especially for consumer products. Companies may therefore wish to take this opportunity to try to shape the future form of the EU competition rules which will apply to their distribution arrangements.

_____________________

[1]  The Consultation is available in the following link: https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12636-Revision-of-the-Vertical-Block-Exemption-Regulation/public-consultation.

[2]  These issues and policy options were first set out in the VBER’s inception impact assessment, published on 23 October 2020. See Ref. Ares(2020)5822391 – 23.10.2020, available at: https://ec.europa.eu/info/law/better-regulation/.

[3]  The European Green Deal is the EU plan to create a sustainable economy, and provides for an action plan to boost the efficient use of resources by moving to a clean, circular economy, and to restore biodiversity and cut pollution. See further: https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal_en.

[4]  Article 101(1) TFEU prohibits all agreements or concerted practices that have as their object or effect the restriction of competition where the effect of that restriction may affect trade between Member States.

[5]  See Article 4 of the VBER for a list of ‘hard-core’ restrictions. The VBER also identifies a limited number of restrictions which, if contained in a vertical arrangement, do not benefit from the VBER ‘safe harbour’ but which do not preclude the application of the VBER ‘safe harbour’ to the rest of the agreement (provided that the other conditions set out in the VBER are fulfilled).

[6]  See Commission notice – Guidelines on Vertical Restraints, OJ C 291, 13 October 2000, pp. 1-44, para. 51.

[7]  See Vertical Guidelines, para. 54.

[8]  See Vertical Guidelines, para. 52.

[9]  See Case C-439/09 Pierre Fabre Dermo-Cosmetique EU:C:2011:649.

[10]  For more information, see A. Font Galarza, E. Dziadykiewicz, and A. Guerrero Perez, ‘Selective Distribution and e-Commerce: Recent developments in EU and national case law’, e-Competitions Bulletin, No. 63958, 2014. See further, e.g., Case COMP/AT.40428 – Guess.

[11]  See Report from the Commission to the Council and the European Parliament, Final report on the E-commerce Sector Inquiry, COM(2017) 229 final, 10 May 2017; and the accompanying Staff Working Document, SWD(2017) 154 final, 10 May 2017, Section 4.4.8.

[12]  See Case C-230/16 Coty Germany GmbH v Parfümerie Akzente GmbH EU:C:2017:941.

[13]  See Commission Staff Working Document Evaluation of the Vertical Block Exemption Regulation, SWD(2020) 172 final, 8 September 2020.

[14]  See: https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12636-Revision-of-the-Vertical-Block-Exemption-Regulation.

[15]  The European Green Deal is the EU plan to create a sustainable economy, and provides for an action plan to boost the efficient use of resources by moving to a clean, circular economy, and to restore biodiversity and cut pollution. See further: https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal_en.

[16]  For Commission regulations that establish block exemptions applicable to horizontal agreements among competitors, see, e.g., Commission Regulation (EU) No 1217/2010 of 14 December 2010 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to certain categories of research and development agreements, OJ L 335, 18 December 2010, pp. 36-42; Commission Regulation (EU) No 1218/2010 of 14 December 2010 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to certain categories of specialisation agreements, OJ L 335, 18 December 2010, pp. 43-47; and Commission Regulation (EU) No 316/2014 of 21 March 2014 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to categories of technology transfer agreements, OJ L 93, 28 March 2014, pp. 17-23.

[17]  The Vertical Guidelines currently find that combined selective and exclusive distribution can only be block exempted if active selling in other territories is not restricted (para. 152). This dilutes significantly the impact that exclusivities are meant to have in a distribution network. The Vertical Guidelines currently only foresee the possibility of restricting active sales by selective retailers into other territories for the purpose of overcoming free-riding problems pursuant to an individual assessment (para. 63).

[18]  As indicated above, qualitative criteria that are “overall equivalent” to criteria imposed on physical stores may also be imposed on Internet stores. Suppliers may also request that distributors have one or more brick-and-mortar shops or showrooms as a condition for becoming a member of its distribution system (Vertical Guidelines, para. 54).

[19]  See Vertical Guidelines, paras. 52-56. The Commission foresees very specific exceptional scenarios where dual distribution may benefit from an individual exemption under Article 101(3) TFEU (see para. 64).

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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. For additional information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Antitrust and Competition Practice Group, or the following authors:

Kai Gesing – Munich (+49 89 189 33 180, kgesing@gibsondunn.com)
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David Wood – Brussels (+32 2 554 7210, dwood@gibsondunn.com)

Antitrust and Competition Group:

Brussels
Peter Alexiadis (+32 2 554 7200, palexiadis@gibsondunn.com)
Attila Borsos (+32 2 554 72 11, aborsos@gibsondunn.com)
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In a surprise u-turn, on 31 December 2020, the UK government took steps to narrow the scope of mandatory reporting under DAC 6. In the UK, only cross-border arrangements falling under the Category D hallmark (broadly, those that (a) have the effect of circumventing the OECD’s Common Reporting Standard or (b) obscure beneficial ownership) will be reportable. The change will apply to both historic, and future, cross-border arrangements. The amendment to the existing legislation is intended as a temporary step. In the coming year, the UK intends to introduce, and consult on, legislation to implement mandatory reporting under the OECD Mandatory Disclosure Rules (the “MDR”). These actions will significantly reduce the number of arrangements that need to be reported to HMRC. Nevertheless, reporting under DAC 6 is already required in some EU member states (such as Germany), and will be required elsewhere in Europe in the coming months. Accordingly, it needs to be considered whether arrangements that would previously have been reportable to HMRC under DAC 6 now need to be reported to other tax authorities.

EU Council Directive 2011/16 (as amended) (known as DAC 6) requires UK intermediaries (or failing which, taxpayers) to report, and HMRC to exchange, information regarding cross-border arrangements which meet one or more specified characteristics (hallmarks) and which concern at least one EU country. Regulations implementing DAC 6 reporting obligations into UK law (the “Regulations”) came into force on 1 July 2020.

At the end of the Brexit transition period at 11pm on 31 December 2020, obligations requiring the UK to implement DAC 6 fell away. During the course of last year, the UK government had indicated that DAC 6’s UK implementation would be unaffected by, and that the Regulations would remain in force following, the end of the Brexit transition period. However, under the Free Trade Agreement agreed between the UK and the EU on 24 December 2020, the UK is only required to ensure any legislation it implements at the end of the transition period relating to the exchange of information concerning potential cross-border tax planning arrangements offers the level of protection provided for by the “standards and rules which have been agreed in the OECD…”.

Accordingly, on 31 December 2020, the UK government published legislation (taking effect at the end of the transition period) to narrow the scope of the Regulations in line with the MDR. As a result, only cross-border arrangements (i.e. those concerning the UK or an EU member state) that fall within Category D of Part II of DAC 6 will fall within the scope of UK reporting obligations.[1] Broadly, an arrangement will be reportable under Category D if the arrangement either: (i) has the effect of undermining reporting obligations under agreements for the automatic exchange of information (e.g. the EU Common Reporting System, or the OECD’s Common Reporting Standards); or (ii) involves non-transparent legal or beneficial ownership chains that:

• do not carry on a substantive economic activity;
• are incorporated, managed, resident, controlled or established in any jurisdiction other than the jurisdiction of residence of one or more of the beneficial owners of the assets held by such persons, legal arrangements or structures; and
• have unidentifiable beneficial owners.

Historic arrangements

For reportable transactions after 30 June 2020, the first UK DAC 6 reporting deadline is 30 January 2021, and for transactions on or before 30 June 2020 where the first step in implementation was taken on or after 25 June 2018, it is 28 February 2021.

The effect of the amending Regulations (which has been confirmed by HMRC) is that the narrower reporting obligation will not only apply to future arrangements, but will also apply to historic arrangements for the period prior to 31 December 2020. Accordingly, only those arrangements which fall within a hallmark under Category D would need to be reported to HMRC.

Practical impact

The amendments to the Regulations have reduced the scope of disclosures to HMRC under DAC 6. Nevertheless, a full DAC 6 assessment and hallmark analysis will still be required in respect of EU jurisdictions involved in a transaction, in order to determine whether a DAC 6 filing obligation arises in those member states. Cross-border transactions that would otherwise have been reportable to HMRC may need to be reported to EU tax authorities. It is expected that the exception would be cross-border transactions that were reportable under hallmarks A, B, C and E of DAC 6 solely as a result of a UK nexus. However, it remains to be seen whether EU member states will update their domestic legislation implementing DAC 6 to require reporting of arrangements that concern only the UK and a non-EU jurisdiction. Such amendments would likely raise a number of practical issues, including, for example, questions as to who should bear the reporting obligation where intermediaries in the relevant EU jurisdiction have limited knowledge of the wider arrangements.

From a practical perspective, the UK’s divergence from the DAC 6 standard may create additional administrative burdens for those intermediaries and taxpayers with pan-European operations that had planned to coordinate and submit DAC 6 reports in the UK. As the UK’s actions were not trailed, these businesses may, at short notice, need to shift the coordination and submission of reports to an EU member state involved in the reportable arrangement. For those businesses that had already begun preparing data for submission using HMRC’s XML schema, additional administrative work may be needed to ensure this data can be submitted to other relevant EU member states’ databases. It remains to be seen whether (to lessen such burdens) HMRC may be willing to accept submissions on a voluntary basis or whether (if HMRC was so willing) this would be permissible under the laws of relevant EU member states.

Going forward

OECD Mandatory Disclosure Rules

We understand that the UK government will consult on draft legislation to implement the MDR in due course. The MDR were first published in March 2018, and form part of the OECD’s recommendations set out in the “Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures”.[2] They are designed for jurisdictions wanting to implement disclosure obligations on certain intermediaries involved in arrangements intended to circumvent disclosure obligations under the OECD’s Common Reporting Standard.[3]

It is unclear whether such legislation would, in the immediate term, substantively alter the scope of mandatory reporting obligations provided for under the Regulations (as amended). Looking forward, however, enhanced reporting is fast becoming a popular measure, internationally, for tackling tax avoidance, evasion and non-compliance. Countries outside the EU have introduced disclosure requirements that go beyond the MDR (with Mexico being the latest country to implement a disclosure regime modelled on DAC 6). Given this trend, it is expected that the OECD will further expand the scope of the MDR in the future. Accordingly, despite the reduced scope of the UK’s current reporting regime, wider mandatory disclosure obligations may well become standard practice for taxpayers party to, and intermediaries advising on, cross-border arrangements.

Exchange of tax information

Before the end of the transition period, the UK was required to exchange tax information (including information relating to tax rulings and advance transfer pricing agreements, EU Common Reporting Standards, country-by-country reporting and beneficial ownership) with EU member states under the various provisions of Directive 2011/16/EU (the “DAC”). However, it is not yet clear: (i) how reports relating to Category D cross-border arrangements will be shared between HMRC and other tax authorities under the current DAC 6 exchange framework; (ii) whether HMRC will have access to information relating to cross-border arrangements falling within hallmarks A, B, C or E; and (iii) whether HMRC will retain access to other information currently shared under the DAC, given that the UK is no longer part of the EU. The FTA, for example, is silent on such matters.[4]

Outside of the DAC, there are existing international frameworks that allow for the exchange of tax information between tax authorities. In particular, (a) the OECD provides a platform for the spontaneous exchange of tax rulings and advance transfer pricing agreements and (b) most double tax treaties between the UK and EU member states allow for the exchange of information between the treaty parties on request, in each case where the information is foreseeably relevant to the recipient tax authority. Furthermore, the OECD provides an information sharing platform for jurisdictions that have entered into bilateral agreements to exchange information, should the UK seek to enter into such agreements with EU member states. For the moment, however, it remains to be seen whether existing frameworks will provide sufficient information sharing rights for HMRC.

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   [1]   The Category D hallmarks are contained in Annex IV Part II of the EU Council Directive 2018/822 of 25 May 2018 amending Directive 2011/16/EU at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex:32018L0822

   [2]   OECD (2018), Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures, OECD, Paris. https://www.oecd.org/tax/exchange-of-tax-information/model-mandatory-disclosure-rules-for-crs-avoidance-arrangements-and-opaque-offshore-structures.htm

   [3]   The CRS was introduced in 2014 as a global reporting standard for the cross-border exchange of financial information.

   [4]   https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:22020A1231(01)&from=EN

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Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the Tax Practice Group or the authors:

Sandy Bhogal – London (+44 (0) 20 7071 4266, sbhogal@gibsondunn.com)
Benjamin Fryer – London (+44 (0) 20 7071 4232, bfryer@gibsondunn.com)
Bridget English – London (+44 (0) 20 7071 4228, benglish@gibsondunn.com)
Fareed Muhammed – London (+44 (0) 20 7071 4230, fmuhammed@gibsondunn.com)
Barbara Onuonga – London (+44 (0) 20 7071 4139,bonuonga@gibsondunn.com)
Aoibhin O’ Hare – London (+44 (0) 20 7071 4170, aohare@gibsondunn.com)
Avi Kaye – London (+44 (0) 20 7071 4210, akaye@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP

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On December 18, 2020, three federal banking regulators—the Office of the Comptroller of the Currency (“OCC”), the Board of Governors of the Federal Reserve System (“Board”), and the Federal Deposit Insurance Corporation (“FDIC”)—jointly issued a notice of proposed rulemaking that would impose rapid notification requirements on banking organizations and bank service providers following “significant” computer-security incidents.

Under the proposal, “banking organizations” include all institutions subject to a primary federal bank regulator: for the OCC, national banks, federal savings associations, and federal branches and agencies of non-U.S. banks; for the Board, all U.S. bank holding companies and savings and loan holding companies, state member banks, the U.S. operations of foreign banking organizations, and Edge and agreement corporations; and for the FDIC, all insured state nonmember banks, insured state-licensed branches of foreign banks, and state savings associations.

The proposal defines “bank service providers” by reference to the Bank Service Company Act (“BSCA”) as entities that provide BSCA-regulated services—“check and deposit sorting and posting, computation and posting of interest and other credits and charges, preparation and mailing of checks, statements, notices, and similar items, or any other clerical, bookkeeping, accounting, statistical, or similar functions performed for a depository institution,” including “data processing, back office services, and activities related to credit extensions.”[1] With the increasing significant use of third-party vendors to supply technology-related services to banks, this inclusion is important.

The proposal would require a banking organization to notify its primary federal regulator when it believes in “good faith” that it has experienced a “significant” computer-security incident—which the proposal terms a “notification incident.” Notification of regulators would be required “as soon as possible and no later than 36 hours” after the organization determines that a notification incident has occurred. The proposal defines a “computer-security incident” as “an occurrence that—(i) [r]esults in actual or potential harm to the confidentiality, integrity, or availability of an information system or the information that the system processes, stores, or transmits; or (ii) [c]onstitutes a violation or imminent threat of violation of security policies, security procedures, or acceptable use policies.” The proposal describes a “notification incident” as a computer-security incident that “could jeopardize the viability of the operations of an individual banking organization, result in customers being unable to access their deposit and other accounts, or impact the stability of the financial sector.”[2] Notification incidents can arise from both criminal and non-malicious computer-security incidents.

The proposal would require a bank service provider to notify “at least two individuals at affected banking organization customers immediately after experiencing a computer-security incident that it believes in good faith could disrupt, degrade, or impair services provided subject to the BSCA for four or more hours.” The bank service provider would not be required to determine if such an incident rises to the level of a “notification incident” for particular banking organizations; rather, the bank service provider would be required to inform affected banking organization customers, who would themselves have that responsibility.

Additionally, the proposal would require a banking organization subsidiary of another banking organization to notify both its primary federal regulator and its parent banking organization that the subsidiary had experienced a notification incident “as soon as possible.” The proposal would then require the subsidiary’s parent banking organization to make a separate assessment about whether the parent organization had also suffered a notification incident requiring it to notify its primary federal regulator as result of the incident at the subsidiary. Thus, the proposal would require both the subsidiary and parent banking organizations to separately determine whether they had each suffered a notification incident, and should both make such a determination, would require both to notify their regulators individually.

In contrast, the proposal would not require a non-bank subsidiary of a banking organization to notify its regulator following a notification incident at the non-bank subsidiary. Instead, the proposal would seemingly require the non-bank subsidiary to notify its parent banking organization. The parent banking organization would then be required to determine whether the computer-security incident at its non-bank subsidiary constituted a notification incident, and if so, to notify the parent banking organization’s primary federal regulator.

Entities that wish to comment on the proposed rule must submit their comments no later than 90 days after the proposal is published in the Federal Register.

The proposed rule is the latest attempt to impose obligations on financial institutions that have suffered a cyber incident. Regulations requiring notification following a data breach have been in place for years, but, as we have previously noted, state and federal regulators have recently begun imposing rules requiring faster and more in-depth notifications following cybersecurity incidents. For example, since 2017, the New York Department of Financial Services has required financial institutions to notify the Superintendent of Financial Services “as promptly as possible but in no event later than 72 hours” following a cybersecurity incident.[3]

These proposed and enacted regulations requiring rapid notification following cybersecurity incidents highlight the need for financial institutions to be able to respond quickly to and report accurately and effectively on cyber events. Such notification requirements will help incentivize banking organizations to assess whether they have a well-functioning incident response plan and effective lines of communication among their information security, legal, and other relevant departments already in place before a cybersecurity incident occurs. This is important for organizations to be able to quickly assess incidents—which can often be challenging to understand fully—and be positioned to notify regulators within the required time period following an incident. Among other preparation measures, cross-departmental training exercises can help improve the functionality of response processes before they are tested in an actual cybersecurity event.

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   [1]  See 12 U.S.C. §§ 1861-1867.

   [2] The proposed rule’s complete definition of “notification incident” is “a computer-security incident that a banking organization believes in good faith could materially disrupt, degrade, or impair—(i) the ability of the banking organization to carry out banking operations, activities, or processes, or deliver banking products and services to a material portion of its customer base, in the ordinary course of business; (ii) any business line of a banking organization, including associated operations, services, functions and support, and would result in a material loss of revenue, profit, or franchise value; or (iii) those operations of a banking organization, including associated services, functions and support, as applicable, the failure or discontinuance of which would pose a threat to the financial stability of the United States.”

   [3] N.Y. Comp. Codes R. & Regs. tit. 23, § 500.17 (2020).

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The following Gibson Dunn lawyers assisted in the preparation of this article: Ryan T. Bergsieker, Arthur S. Long, Alexander H. Southwell and Marie D. Zoglo.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any member of the firm’s Privacy, Cybersecurity and Consumer Protection or Financial Institutions practice groups.

Financial Institutions Group:

Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com)
Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com)
M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com)
Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)

Privacy, Cybersecurity and Consumer Protection Group:

United States
Alexander H. Southwell – Co-Chair, PCCP Practice, New York (+1 212-351-3981, asouthwell@gibsondunn.com)
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Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com)
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Benjamin B. Wagner – Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com)
Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, mwong@gibsondunn.com)

Europe
Ahmed Baladi – Co-Chair, PCCP Practice, Paris (+33 (0)1 56 43 13 00, abaladi@gibsondunn.com)
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Asia
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