On June 6, 2023, the Public Company Accounting Oversight Board (“PCAOB”) proposed new auditing standards that would substantially broaden auditors’ responsibilities for considering an audit client’s noncompliance with laws and regulations, including fraud. If adopted, the proposal is likely to entangle auditors in complicated questions of legal and regulatory compliance.

PCAOB Release No. 2023-003 (the “Proposal”) heightens auditors’ responsibilities for detecting legal and regulatory noncompliance and alerting appropriate members of management and audit committees. The PCAOB’s stated objectives for the new standard are to (1) “protect investors from the resulting harm of noncompliance with laws and regulations when the effect of such noncompliance has a material effect on the financial statements” and (2) “improve audit quality through the auditor’s identification of noncompliance with laws and regulations that could reasonably result in a material effect on the financial statements. Proposal at 4-5.

The existing auditing standard AS 2405 (“Illegal Acts by Clients”) requires auditors to perform procedures designed to provide reasonable assurance of detecting illegal acts that would have a direct and material effect on a company’s financial statements. Audit procedures are designed to identify and respond to fraud risks and communicate with management and the audit committee about such risks. Under the current regime, illegal acts further removed from the company’s financial reporting and accounting functions, such as noncompliance with regulations related to the company’s operations, are less likely to fall within the scope of the audit.

The Proposal, which would replace AS 2405, would ostensibly require auditors to proactively identify all laws and regulations applicable to the company and determine whether violations of such laws and regulations could have a direct or indirect material effect on the company’s financial statements. It further requires auditors to determine whether noncompliance “has or may have occurred.” See id. at 4. This expanded scope would require auditors to (1) identify laws and regulations applicable to the company; (2) perform additional risk assessment procedures that address noncompliance; (3) perform procedures designed to identify whether noncompliance has or may have occurred; and (4) assess the nature of any noncompliance detected by the auditor.

While the Proposal expands the auditor’s role in assessing legal and regulatory noncompliance, it provides no guidance on how auditors should determine whether a law or regulation was violated and, if violated, whether the violation could have a material impact on a company’s financial statements. This type of analysis would present a daunting task for auditors, and is likely to raise wide-ranging and complex legal and regulatory issues requiring input from numerous subject-matter experts. Indeed, the PCAOB recognizes that the Proposal will require auditors to work extensively with experts and lawyers to satisfy their new obligations, including to understand laws and regulations, evaluate whether noncompliance has or may have occurred, and assess the risk of material misstatements of the financial statements due to noncompliance. Id. at 42-43.

The only two CPAs serving on the PCAOB  strongly criticized the Proposal. One of these members, Christina Ho, warned that it would collapse the distinction between the auditor’s and management’s responsibilities, and “transform[] the auditor’s role from one of providing reasonable assurance to one of performing a management function.”

The PCAOB’s transformative proposal comes on the heels of a proposal by the Securities & Exchange Commission (“SEC”) also seeking to expand auditors’ responsibilities as they relate to companies’ disclosures regarding environmental, social, and governance (“ESG”) issues. One of those proposed rules requires public companies to disclose climate-related impacts to financial statement line items in the footnote disclosures, even where the impacts are not material to the financial statements as a whole. Auditors will have to consider those climate-related disclosures when conducting the financial statement audit, resulting in additional audit procedures. If one or both of these proposals are adopted, auditors will face increasingly onerous audit requirements and are likely to face heightened regulatory scrutiny as they adapt to markedly different standards.

Key Takeaways:

• A faculty member at a research university was convicted of making false statements to the federal government, a felony, for failing to disclose an outside engagement with a Chinese institution on his university's conflict of interest disclosure form.
• When faced with conflicts of interest disclosure obligations, university faculty with federal funding for research should disclose all engagements that may raise questions of conflict of commitment or interest.
• Developing and implementing clear and robust processes to timely disclose and manage potential conflicts of interest, and ensuring those policies are current and are understood by faculty, should continue to be a top priority for all research institutions.

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Last month, former University of Kansas Professor Feng “Franklin” Tao was sentenced to time served and two years of supervised release for making false statements in the University of Kansas's conflict of interest and commitment disclosure form. Because the University, like many research universities, uses its disclosure form to implement and manage conflict of interest policies for federal grants, Professor Tao's statements violated 18 U.S.C. § 1001, a broad statute that prohibits lying to the federal government.

The University's disclosure form required Professor Tao to disclose and secure prior approval for “any consulting or outside involvement” and to “disclose on an ad hoc basis current or prospective situations that may raise questions of conflict of commitment or interest.” Professor Tao failed to disclose his participation in the Chinese government's Changjiang Scholar program and a related eight-month period of involvement with Fuzhou University while he was on a spring “buy-out” from his teaching duties at the University of Kansas.

The Changjiang Scholar program recruits scholars to work at Chinese universities by offering them resources to perform their research. Although the details of Professor Tao's exact commitments were unclear, during the eight-month period he worked in China, he applied for research funding, recruited graduate students, and procured equipment at Fuzhou University.

Professor Tao had certified upon submitting the University of Kansas's disclosure form that the information included in it was “true, complete, and correct”; that he had read and complied with the relevant University policies; that he would secure approval before engaging in any outside consulting activities and outside employment; and that he would promptly report any changes.

During sentencing, U.S. District Judge Julie A. Robinson spoke about several notable aspects of the case that factored into her sentencing decision. Judge Robinson remarked that there was no evidence that any conflict of interest had in fact biased Professor Tao's research results or put the integrity of the research into question. She also noted that although Professor Tao did in fact understand that his disclosure obligations required him to disclose his Fuzhou affiliation, the disclosure requirements in the University of Kansas's forms and forms used by other universities may in some cases be ambiguous, citing one letter of support for Professor Tao by a writer who reported that he had been asking for clarity around the disclosure requirements at his own university “for years” and had not received it.

Judge Robinson concluded that there was “certainly at least a concern about a conflict of time,” and Professor Tao did knowingly fail to disclose – and otherwise concealed – the award and activity when it arose: “That particular institutional responsibilities form wasn't fully accurate, and that's why Dr. Tao sits here today as a convicted felon and having suffered the consequences over the last three and a half years and the consequences of that going forward.”

As counterbalancing factors, Judge Robinson noted: “This is not a case about espionage.” The judge explained that there was no evidence that Professor Tao stole anything from the University of Kansas, his grantors the National Science Foundation and U.S. Department of Energy, or the American taxpayers. There was also no evidence that Professor Tao shared information in China that taxpayers had funded for him to share exclusively with the University of Kansas and the federal government. To the contrary, Judge Robinson noted that he was conducting fundamental research that was freely shared globally and in scientific journals. There was additional testimony that the research was 20 to 50 years from being monetized or commercialized, if ever.

Even in the absence of such circumstances, however, Judge Robinson clarified that the need for academic integrity remained critically important to her sentencing decision, including ensuring that conflicts be disclosed so that people operate without bias and there are no questions as to the integrity of the data and research itself.

The case had originally been brought in connection with the U.S. Justice Department's “China Initiative,” which was formally ended in February 2022. Professor Tao was arrested in August 2019 and spent a week in jail before being released on bond to home detention. He ultimately faced a jury trial which began on March 21, 2022 and lasted almost two weeks. On April 8, 2022, Professor Tao was convicted on one count of making false statements in certified forms, along with three counts of wire fraud.

Professor Tao then renewed his motion for judgement of acquittal, and on September 20, 2022, Judge Robinson granted the motion for the wire fraud counts, but denied the judgement for an acquittal and for a new trial for the false statement charge. Judge Robinson found that although Professor Tao was deceptive in not disclosing his activities at Fuzhou University, “there was no evidence that Tao obtained money or property through the alleged scheme to defraud, as required under the wire fraud statute.” Sentencing took place on January 18, 2023, and Professor Tao appealed the final judgement on January 25, 2023.

The case sends a strong message to faculty and universities nationwide that failure to comply with the conflict of interest and conflict of commitment requirements of universities and federal grantors could put universities and their faculty at direct risk of criminal sanctions. Arguable ambiguity in the disclosure forms, a potential absence of any actual conflict (rather than merely the opportunity for one), the absence of any proof of economic espionage, and the lack of any demonstrable theft or fraudulent intent were all found to be insufficient bases to avoid a felony conviction here (subject to appellate review). Developing and implementing clear and robust processes to timely disclose and manage potential conflicts of interest, and ensuring that those policies are current and are understood by faculty, should continue to be a top priority for all research institutions.

Case cite: U.S. v. Tao, case number 2:19-cr-20052, in the U.S. District Court for the District of Kansas

Key Takeaways

• Courts are showing continued skepticism of broad use of federal fraud statutes.  Last week, two decisions repudiated creative government interpretations of wire fraud's “property” requirement.
• In United States v. Ciminelli, the Supreme Court unanimously rejected the “right to control” theory, holding that only “traditional property interests” can support a federal wire fraud conviction, and the right to accurate information to make an informed economic decision is not such an interest.
• In United States v. Abdelaziz, the First Circuit overturned convictions in the “Varsity Blues” college admissions scandal, rejecting prosecutors' argument that admissions slots per se qualified as property.

On May 11, the Supreme Court issued its decision in Ciminelli v. United States, its latest in a series of recent rulings reinforcing a narrow interpretation of wire fraud under federal law.[1]

Ciminelli presented the Court with a question regarding the scope of what constitutes “property” under the wire fraud statute.[2]  (For more information regarding the facts of the Ciminelli case, please see our supreme court preview from last August.)

For decades, the Second Circuit has followed a “right-to-control” property theory, which contemplates that “property” under federal fraud statutes includes certain “intangible” property rights, including an entity's right to control the use of its assets.  The theory is rooted in the notion that “a defining feature of most property is the right to control the asset in question.” United States v. Lebedev, 932 F.3d 40, 48 (2d Cir. 2019).  Accordingly, a showing that a defendant, through withholding or inaccurate reporting of information, deprived an entity of information necessary to make discretionary economic decisions pertaining to its assets amounts to a “cognizable harm” under the theory.  See United States v. Binday, 804 F.3d 558, 570 (2d Cir. 2015).

Last Thursday, however, the Court rejected the “right-to-control” theory altogether.  In a unanimous decision authored by Justice Thomas, the Court held that “the wire fraud statute reaches only traditional property interests,” and the “right to control” is no such interest.  While acknowledging that “the right to information necessary to make informed economic decisions” may be “useful for protecting and making use of one's property,” the Court rejected the notion that the “right to control” itself constitutes a property interest as traditionally understood.  The Court also expressed concern about the scope of what the “right-to-control” theory would criminalize, warning that acknowledging a right to accurate information would bring “almost any deceptive act” within its purview.

Coincidentally, the Supreme Court was not the only court to reject a creative “property” theory last week.  On Wednesday, the First Circuit issued its ruling in United States v. Abdelaziz, addressing appeals from the convictions of two parents in the “Varsity Blues” prosecution.  There, the “property” underlying defendants' mail and wire fraud convictions were “admissions slots.”  In a somewhat prescient 156-page opinion by Judge Lynch, the court rejected the “categorical assertion” that admissions slots qualify as property under the statutes.  The First Circuit cited the Supreme Court's historic emphasis on “traditional notions of property,” and noted that multiple circuit courts—including Sixth and Ninth Circuit opinions cited with approval in Ciminelli the next day—have rejected intangible interests in property.

The First Circuit did not go so far, however, as to hold that admissions slots can never be property.  Rather, the court explained that the government must prove (using dictionaries, treatises, and case law) that that admissions slots have “historically been treated as property” or bear the “traditional hallmarks” of property.  The court recognized that its ruling “leaves considerable uncertainty as to how district courts should apply the mail and wire fraud statutes' property requirement in cases involving admission to educational institutions,” but it explained “[t]here are sound reasons to be prudent and cautious about criminalizing conduct, even unethical conduct, in this complicated area affecting so many students and parents.”  As with Supreme Court in Ciminelli, the First Circuit expressed concern about the potential breadth of conduct the government's theory would criminalize, which in the case of admissions slots could include “embellishments in a kindergarten application.”

Both cases provide a cautionary tale for prosecutors seeking to use federal fraud statutes to fill in gaps to address novel forms of misconduct.  While the government may be able to show that conduct was improper or dishonest, that does not make it a federal crime.

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[1] In 2020, the Court rejected the notion that conduct that deprives victims of property only incidentally—rather than as its object—could constitute wire fraud under the statute.

[2] The federal wire fraud statute prohibits a person from “obtaining money or property by means of false or fraudulent pretenses.”  18 U.S.C. § 1343.

Key Takeaways:

• On June 1, 2023, in United States ex rel. Schutte v. SuperValu Inc., the U.S. Supreme Court unanimously held that defendants cannot avoid liability under the False Claims Act (FCA) by demonstrating that their conduct was consistent with an “objectively reasonable” interpretation of an ambiguous legal requirement.

• The Court's decision clarifies that FCA liability turns on the subjective standard of whether a defendant, at the time it submitted a claim, knew that claim was false.

The SuperValu case arose from separate lawsuits against two companies that operate retail drug pharmacies across the country: SuperValu Inc. and Safeway, Inc. In each case, a whistleblower – on behalf of the federal government – brought FCA claims against the company for allegedly overcharging Medicare and Medicaid in seeking reimbursement for prescription drugs. The companies were obligated, through Medicare contracts or Medicaid regulations, to disclose their “usual and customary” prices for drugs.

Each company offered a discount program through which customers could purchase drugs at reduced prices. These programs generated a substantial amount of revenue for the companies. But according to the whistleblowers, the companies did not report those discounted prices as their “usual and customary” prices; instead, they reported – and charged the government – significantly higher, non-discounted prices. The whistleblowers presented evidence that the companies knew their discounted prices were their “usual and customary prices,” yet attempted to conceal that fact from regulators and contractors. According to the whistleblowers, the companies knew, when submitting claims based on non-discounted prices, that those claims were false.

The companies won summary judgment in the district court on the basis that they did not act “knowingly.” The Seventh Circuit affirmed, concluding – under Safeco Ins. Co. of America v. Burr, 551 U.S. 47 (2007) (a case interpreting the term “willfully” under the Fair Credit Reporting Act) – that because it was objectively reasonable for the companies to interpret the ambiguous phrase “usual and customary” prices as applying to their non-discounted prices, it was irrelevant that they may have believed that their discounted prices were their “usual and customary” prices (and that their claims were therefore false).

The Supreme Court disagreed unanimously. Looking at the statutory text and common-law roots of the FCA, the Court determined that “[t]he FCA's scienter element refers to respondents' knowledge and subjective beliefs—not to what an objectively reasonable person may have known or believed.” The Court noted that there are three mental states that satisfy the knowledge requirement under the FCA: (1) actual knowledge that a claim is false, (2) deliberate ignorance of the truth or falsity of a claim, and (3) reckless disregard of the truth or falsity of a claim. The FCA, according to the Court, focuses on “what the defendant thought when submitting the false claim—not what the defendant may have thought after submitting it.”

This decision comes as no surprise, given the far-reaching implications in FCA matters had the Court imposed an objective, rather than a subjective, standard, especially in the face of allegations that the companies in SuperValu were aware that they were submitting false claims to the federal government for reimbursement. FCA cases will continue to turn on whether a claim was false and whether the company submitting it had knowledge (whether actual or constructive, as broadly interpreted under the FCA) of that falsity. SuperValu makes it clear, however, that there is no safe harbor for conduct that, while subjectively culpable, was objectively reasonable.

Key Takeaways

• Companies in France should have detailed procedures covering investigations of wrongdoing and should also clearly lay out employees' rights and obligations during such investigations.
• Investigative tools must be proportionate to the wrongdoing and should respect the privacy rights of employees.
• Companies in France should be engaged in an iterative process of updating policies regarding investigating misconduct.

On March 14, 2023, the French Anticorruption Agency (AFA) and the National Financial Prosecutor's Office (PNF) jointly issued an updated guide (“Guide”) relating to internal anti-corruption investigations.  The Guide attempts to balance diligent anticorruption efforts with the rights of employees. The updated Guide provides recommendations for all companies, regardless of size, to implement systems for internal investigations that respect individual rights. Large companies are also subject to additional obligations in this area. First, as we have written about previously, pursuant to Article 17 of the Sapin Act, companies with at least 500 employees and turnover exceeding 100 million euros are required to implement programs to prevent and detect corruption, including a whistleblowing system.  Second, the Waserman Act in March 2022 expanded the mandate for whistleblowing programs to reach all companies with at least 50 employees.

The Guide follows a draft version of guidelines that the AFA and PNF submitted for public comment and review. They received nearly 350 comments from professional federations and associations, companies, and law and consultancy firms. What does the guide recommend?

Prior to an Investigation. The Guide details several internal policies that companies should consider adopting as “good practice” before an investigation begins. The Guide recommends that companies create a written set of policies, including a description of the step-by-step process of the investigation, the events that may trigger an investigation, the composition of an investigation team, and the tools available to the company to conduct the investigation. It also recommends companies develop a “charter” for the benefit of employees to explain their rights and obligations during investigations (for example, when serving as a witness in such an investigation).

Conducting an Investigation. Once the company uncovers facts that could lead to an investigation, the Guide makes several recommendations for how to proceed. As an initial matter, the Guide stresses that the tools available to companies to investigate misconduct are more limited than those possessed by prosecuting authorities. Additionally, the Guide explicitly recognizes that an employee is required to participate in an investigation under their duty of loyalty to their employer.  An employer, for its part, must respect procedural protections for employees and must conduct an investigation that is proportionate to its legitimate investigative objective.

Whether the company will conduct an internal investigation is determined by the company's management body or “qualified persons” designated by it. The Guide recognizes that the company can create a “special or ad hoc committee” to decide how to respond to an internal alert, especially when those alerts are particularly sensitive. This committee may be comprised of key company personnel within various functions such as legal, internal audit, compliance, human resources, and/or finance. Any individual on such a committee must be independent (i.e., not involved in the alleged misconduct) and free from conflicts to ensure the objectivity of the investigation.

Employers should take note that while the General Data Protection Regulation (GDPR) does not require an employee's consent to collect and process their data for a necessary investigation, the GDPR does mandate that an employer must inform the employee of such collection and processing as soon as possible and not less than a month after obtaining such data (unless such a revelation would compromise evidence).

The Guide makes clear that a company must inform its employees of the tools it may use for an investigation. A company may not use a tool to monitor employee activity about which the employee was not informed (usually through their employment contract). The Guide details several monitoring tools that would and would not be permitted—i.e., the files saved by an employee on a computer's hard drive are presumed to be professional and open to monitoring while there is a presumption against the monitoring of “personal” files on a work computer (though labeling such documents as personal is not determinative).

The Investigation Report. The Guide strongly recommends that a company draft an internal investigation report. It suggests the report include all the investigative acts carried out, all the facts established, and a description of the facts that gave rise to the investigation. Should the internal investigation take place at the same time as a preliminary criminal investigation or judicial investigation, the company may make the report available to those respective authorities. Companies need not provide an internal investigation report to an employee subject to the investigation.

Follow-Up to the Investigation. If the internal investigation confirms facts likely to qualify as a criminal offense or breaches of the anti-corruption code of conduct, the Guide imposes a duty for the investigators to report such facts to the decision-making body within the company (which may involve legal personnel), which will determine next steps. Generally, employee misconduct should result in disciplinary sanctions according to legally sufficient processes (and may include criminal sanctions if the facts dictate a referral for prosecution). Internally, the Guide suggests several courses of action for companies upon the conclusion of its internal investigation.

• If the internal investigation was inconclusive but the company still suspects a risk of corruption, the company should consider conducting an external audit—for example, an investigation by outside counsel.
• The company should continuously review and improve the organization's anti-corruption framework to prevent recurrence.
• If the Code of Conduct does not cover the type of misconduct uncovered by the investigation, the company should update the Code to include that misconduct and redistribute the amended version to employees. The company should consider updating training materials to include the scenario highlighted by the investigation.
• The company should evaluate the need to update or strengthen the procedure for assessing the risk of corruption posed by interactions with third parties.
• The company should assess the need to update or strengthen accounting and internal control procedures if those in place failed to detect the transactions that allowed the underlying misconduct to occur and not be detected.

In the end, the guidance recommends that companies make plans for how to open and conduct investigations regarding misconduct—remaining vigilant in the face of possible misconduct by consistently reviewing and amending its policies while keeping employees apprised of such policies.

This is the second part in our 2023 series examining important trends in white collar law and investigations. Up next: health care enforcement.

The days of decreased IRS enforcement activity may be coming to a close.  Although the overall volume of civil audits and criminal investigations has declined in recent years, last year's Inflation Reduction Act, signed into law by President Biden on August 16, 2022, may reverse this trend.  The Inflation Reduction Act allocates $79.6 billion to the IRS over the next 10 years, with more than half of the money going to enforcement.  This law aims to supplement, not replace, the IRS's normal annual appropriations.  Stay tuned—only time will tell how these additional funds will impact the volume and focus of IRS's criminal financial investigations.

The IRS remains a significant player in white collar crime enforcement. IRS Criminal Investigation (“IRS-CI”) is the federal agency responsible for investigating and recommending prosecution of criminal tax violations and other related financial crimes to the Department of Justice. It is the only agency that dedicates one-hundred percent of its time to financial investigations and the only agency with authority to investigate criminal violations of the Internal Revenue Code.  According to the IRS-CI's 2022 annual report (“2022 Annual Report”),[1] this past year IRS-CI spent 71.7% of its time investigating tax-specific crimes, 15.2% of its time investigating non-tax financial crimes such as money laundering (“tax fraud in progress”), and 11.6% of its time on narcotics-related financial cases through participation in the Organized Crime Drug Enforcement Task Force.

IRS-CI Chief Jim Lee, a veteran of the organization, continues to head the division.  He touts the agency's 90% conviction rate, warning crowds around the country that “if a CI special agent has you in their crosshairs, there is a good chance you are going to jail.”  Indeed, the incarceration rate for those sentenced in 2022 is 77%, with an average of 42 months to each sentence.

IRS-CI specifically emphasized the following areas of focus in 2022:

• Cryptocurrency and Cybercrimes. IRS-CI has been investing in its cybercrime program since 2015, and that investment shows no signs of slowing.  Calling it a “strategic realignment,” IRS-CI has focused on building internal capabilities to address cybercrime in recognition of the growing role digital assets play in the global economy and the unique risks they present.  In FY 2021, the agency created the Office of Cyber and Forensic Services (“CFS”) to bring together digital asset investigation, cybercrime investigation, digital forensics, and physical forensics under one roof.  The CFS supports criminal investigations agency-wide and, specifically, the Washington, D.C. and Los Angeles-based Cyber Crimes Units, which spearhead investigations into “the highest impact cases” of potential criminal activity involving digital assets.This year, IRS-CI plans to establish the Advanced Collaboration and Data Center, previously slated for completion last year, to provide centralized access to data and resources to effectively support investigations in challenging areas such as the dark web, cryptocurrency, and social media and other open-source platforms.This past year, IRS-CI's cybercrime efforts continued to focus on cryptocurrency.  In fact, all three of the cybercrime cases highlighted in the 2022 Annual Report involve the nefarious use of cryptocurrency, including the April 2022 seizure of Hydra, a darknet marketplace that conducted transactions using cryptocurrency.  Looking ahead, IRS-CI identified decentralized finance, peer-to-peer payments, and anonymity-enhanced cryptocurrencies as “evolving” threats that the agency is working to address.

• Sanctions-Related Investigations. As we noted last year, IRS-CI has a strong international presence, with attachés of the agency in 11 countries and partnerships around the world.  In 2022, international activity took center stage, with an increase in investigations into financial crime connected with sanctions on Russia and Russian individuals.  IRS-CI participated in a multi-agency task force, Task Force KleptoCapture, which was established to located sanctioned Russians and their assets.  IRS-CI also relied on its international partnerships, including its leadership of the Joint Chiefs of Global Tax Enforcement (J5), to identify potential sanctions-evaders or sanctioned assets and to develop a global strategy to deter Russian's aggression.

Beyond these areas at the cutting edge of IRS-CI's efforts, traditional examinations and enforcement actions against high-income individuals and large companies are and will always be a focus for the IRS.  With both tax and non-tax crimes, the number of investigations initiated by IRS-CI increased slightly in 2022, but IRS-CI recommended prosecution in slightly fewer cases than the year before.  Given the time-lag in tax investigations in prosecutions, it is possible that tax enforcement is or will soon be on the rise, as IRS-CI and others have been projecting for years.

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[1] See links to recent IRS annual Data Books here, and IRS-CI Annual Reports here.

This is the third part in our 2023 series examining important trends in white collar law and investigations. Up next: congressional investigations.

Health care fraud enforcement remained a top priority at both the national and local levels in 2022 and we predict 2023 will be no different.  This post details certain categories of health care fraud that regulators and government agencies have indicated will be a focus in this coming year as well as other expected trends. The key takeaways are the following:

• Opioids: Both federal and state governments were extremely active in opioid-related enforcement actions in 2022, as they have for many years now, and the Department of Justice (“DOJ”) announced its continued commitment to focus on individual medical professionals as part of this effort.
• COVID-19: Health care fraud in connection with COVID-19 relief funding remains a focus of DOJ, which announced in September that it was creating three new Strike Force teams dedicated to these types of matters.
• Telehealth: Regulators and DOJ have demonstrated that it will continue to focus on telehealth services—a space that is still new and found to be susceptible to fraud and abuse.
• Data Analytics: Data analytics remains central to the investigation and prosecution of health care fraud and will likely only grow in its importance in the coming year.
• False Claims Act (“FCA”): The FCA is an important tool for both government enforcement and private relator actions in the health care fraud realm. The Supreme Court is set to hear important questions related to the FCA, which may transform how the FCA is used in future enforcement actions.

Opioids

Opioid enforcement actions were a core focus for both DOJ and state enforcement agencies this past year. Enforcement has not only focused on companies, but also on individuals. Earlier in 2022, DOJ announced the “2022 Opioid Enforcement Action.” This action included charges in eight federal districts against 14 individuals, 12 of whom were medical professionals, and related to unlawful distribution of prescription opioids. In announcing this action, DOJ emphasized the work it has done so far to combat the opioid crisis but made clear that “[its] work is far from done.”

Indeed, similar enforcement actions have continued across the country. In October 2022, a doctor in Maine was arrested on criminal charges for allegedly prescribing opioids without a medical purpose.  And, at the beginning of this month, nine individuals were arrested in Texas for their roles in a “pill-mill pharmacy” scheme, selling opioids on the black market. DOJ has also demonstrated its commitment to this effort by creating a New England Prescription Opioid Strike Force this past year with a focus on investigating individual medical professionals.

Accordingly, aggressive enforcement of opioid-related fraud is likely to continue in 2023.

COVID-19

Although President Biden recently announced that he would end the official national emergency declaration for COVID-19 in May 2023, which will begin the decrease of distribution of federal COVID-19 relief money, enforcement actions related to COVID-19 are not necessarily set to slow down quite yet this year. 2022 saw a number of settlements in connection with COVID-19 funding and resources. DOJ has largely focused these efforts on borrowers under the Paycheck Protection Program (“PPP”), enacted to provide loans to assist small businesses in paying day-to-day business expenses during the pandemic. In just 2022, DOJ resolved 35 FCA matters tied to allegations that borrowers improperly received these loans and it recovered over $6.8 million. DOJ also obtained its first-ever FCA settlement with a lender who improperly disbursed PPP funds. Settlements have further continued into the beginning of this year; for example, three companies recently settled FCA allegations relating to improper PPP loans, totaling over $500,000.

In September, DOJ announced three new COVID-19 Fraud Strike Force Teams “to support, enhance, and continue” DOJ’s efforts to combat COVID-related fraud demonstrating that these types of actions are likely to continue through 2023.

Telehealth

The federal government greatly expanded the types of telehealth services that federal payors could cover at the start of the COVID-19 pandemic, and these services continue to be used at high volumes.  Regulators and government enforcement agencies have accordingly scrutinized this new type of health care.

Last year, there was a nationwide DOJ “Telemedicine Enforcement Action” that alleged a healthcare fraud scheme utilizing telemedicine and involving more than $1.2 billion in losses. There were charges in 13 federal districts against 36 defendants, including a telemedicine company executive. CMS also took administrative action against 52 providers involved in similar schemes. The schemes generally involved medical professionals making referrals for allegedly medically unnecessary cardiovascular genetic testing, cancer genetic testing, and durable medical equipment. For example, one case involved a clinical laboratory charged with paying kickbacks to telemedicine companies to induce those companies’ physicians to order the clinical laboratory’s tests. Of note, in announcing this enforcement action, DOJ declared its view that “fraudulent cardiovascular genetic testing[] [is] a burgeoning scheme.” This multi-district enforcement action follows a similarly large enforcement action in 2021, where DOJ announced charges against 138 defendants across 31 federal districts in connection with fraud schemes, many of which related to telemedicine. DOJ will thus likely continue its focus on telemedicine schemes in 2023.

Recently, the U.S. Department of Health and Human Services, Office of Inspector General (“OIG”) promulgated its report “Insights of Telehealth Use and Program Integrity Risks Across Selected Health Care Programs During the Pandemic.” A portion of the report was dedicated to “program integrity risks associated with billing for telehealth services,” which it found included upcoding, duplicate billing for the same service, billing for services that were never actually provided, billing for services that were not medically necessary or that were inappropriate for telehealth, and ordering durable medical equipment, supplies, or laboratory tests. As one example, OIG found upcoding (i.e., billing for the highest, most expensive level of telehealth services even though those services were not provided) where one provider treated an individual consistently for 45-50 minute sessions but billed for 60 minutes of psychotherapy each time. Companies should be aware of these risks and update compliance programs accordingly.

Data Analytics

A constant theme across various instances of health care enforcement is DOJ’s use of data analytics. For example, in battling the opioid crisis, DOJ has created numerous strike force teams. DOJ has explained that, in addition to traditional investigative techniques, these teams “use[] advanced data analysis techniques to identify aberrant billing levels in health care fraud ‘hot spots.’” DOJ, in fact, chose to convene its most recent strike force team in New England because, as Assistant AG Polite stated, he “asked [the] Fraud Section to identify the data, study the data, and identify where [DOJ] should [based on identified risks from that data] replicate [the] strike force model . . . [and] the New England area was the clear answer.” DOJ has also created three COVID-19 Fraud Strike Force Teams, which it announced are “designed to accelerate the process of turning data analytics into criminal investigations.”

In the telehealth sphere, the OIG noted in its above-referenced report that federal programs use data analysis to oversee telehealth medicine (e.g., “data analysis identifies concerning billing patterns in claims data”). And the report urges federal programs to go further in the monitoring and oversight of telehealth services, including targeted data analysis of the risks identified in the report and mentioned above.

In general, as AG Merrick Garland recognized in a speech last year, an “important force-multiplier is data analytics” and DOJ is only continuing to strengthen its “ability to bring data-driven corporate crime cases nationwide.”  DOJ, and other agencies, are likely to continue relying more and more on data analytics to investigate and prosecute companies and individuals for health care fraud.

FCA

The FCA is consistently a powerful tool used in the fight against health care fraud. This is especially due to the ability for private individuals—relators—to bring qui tam actions under the FCA. Qui tam actions are approximately 75% of the new health care FCA matters that arose in 2022. Further, almost 95% of the value of the settlements and judgments recovered for health care FCA matters last year came from qui tam actions.

Notably, there are some thorny issues that remain as a source of contention within the FCA world that are being litigated at the Supreme Court this coming year. In one of these cases, United States, ex rel. Polansky v. Executive Health Resources, Inc., the Supreme Court will decide whether the government has authority to dismiss a FCA suit after initially declining to intervene in the action. In a second set of cases, United States ex rel. Schutte v. SuperValu Inc. and United States ex rel. Proctor v. Safeway, Inc., the Supreme Court will clarify the scienter element of the FCA. (For a more detailed discussion of the FCA and these cases, see our recent post here). Depending on how these issues resolve, FCA cases may be harder to successfully progress through the courts and the number of actions could begin to subside. Nonetheless, for now, the FCA—and qui tam matters more particularly—will continue to serve a central role in health care fraud enforcement.

This is the first in our 2023 series examining important trends in white collar law and investigations. Up next: criminal tax enforcement.

The False Claims Act (or “FCA”) continued to drive significant enforcement activity in 2022, especially, but not exclusively, in the healthcare sector.  In 2023, we expect the government and whistleblowers to continue to prosecute and likely resolve False Claims Act matters in large numbers.  In addition, we await decisions from the Supreme Court in United States, ex rel. Polansky v. Executive Health Resources, Inc. and consolidated cases, United States ex rel. Schutte v. SuperValu Inc. and United States ex rel. Proctor v. Safeway, Inc.  Together, these cases will answer critical questions about the government's ability to dismiss suit after declining to intervene and False Claims Act defendants' ability to rely on objectively reasonable interpretations of regulation as evidence of intent.

2022 by the numbers

In 2022, FCA matters continued to be a fertile ground for the government and whistleblowers, though the sheer number of FCA matters did not necessarily track the dollars recovered.  Thus, in 2022, the government and whistleblowers resolved 351 FCA matters through settlement or judgment—the second highest number of settlements and judgments in a single year.  Despite this high volume, total FCA recoveries dipped from $5.6 billion in FY 2021 to $2.2 billion in FY 2022.  More than $1.9 billion of the $2.2 billion came from resolutions of whistleblower lawsuits, resulting in $488 million in payouts to whistleblowers.

Notably, whistleblowers filed 652 new qui tam lawsuits in 2022, a steady stream of more than 12 new cases on average each week.  What this portends for 2023 awaits to be seen, but based on this data and general historical trends, the FCA will continue to be a frequently invoked enforcement tool.

Healthcare continues to be the mainstay, but not to the exclusion of other industries

Unsurprisingly, the health care industry remained the primary area of FCA enforcement in 2022, with over $1.7 billion in settlements and judgments in matters involving drug and medical device manufacturers, durable medical equipment, home health and managed care providers, hospitals, pharmacies, hospice organizations, and physicians.  Notably, several of these health care matters involved claims against individuals, consistent with the government's stated commitment to use the FCA to pursue individuals as well as corporations.

There are pockets of other budding FCA activity.  In a first under its Civil Cyber-Fraud Initiative, announced in October 2021, the government settled its first Civil Cyber-Fraud FCA matter with Comprehensive Health Service LLC (CHS) for $930,000.  The government alleged that CHS certified that it complied with the State Department and Air Force’s contract requirements and submitted claims to the State Department for the cost of a secure electronic medical record system.  The electronic medical record system was intended to store the confidential identifying information of U.S. service member, diplomats, officials, and contractors working and receiving medical care in Iraq.  However, the government alleged that CHS failed to disclose that it did not consistently store patients’ medical records on this secure system, and instead stores copies of the records on an internal, unsecured, network drive.

Cybersecurity is not the only non-health care area where the government’s FCA attention has increased.  The government continues to pay close attention to COVID-related fraud cases, including improper payments and lender disbursements under the Paycheck Protection Program by the U.S. Small Business Administration and improper vaccination of ineligible individuals under the Centers for Disease Control and Prevention’s Pharmacy Partnership for Long-Term Care Program.

In addition to the above, we note other areas of interest for the government, including allegations of fraud in customs contracts, small business contracting, and telecommunications contracts.

Up next: A big year for the False Claims Act at the Supreme Court

The year ahead promises to be a big year for the False Claims Act, both doctrinally and practically, with the Supreme Court of the United States agreeing to hear two sets of FCA cases during its 2022-2023 term.

The first, United States, ex rel. Polansky v. Executive Health Resources, Inc. (“Polansky”), concerns the government's authority to dismiss a False Claims Act suit after initially declining to intervene in the action.  Under the FCA, when a whistleblower files a lawsuit alleging violations of the Act, the government must decide within a specified period of time whether it wishes to intervene in the suit, in which case the government will take over prosecuting the action.  If the government declines to intervene, the whistleblower may conduct the action on their own and receive up to thirty percent of any recovery.  In Polansky, the government had initially declined to intervene, only to later decide, after the whistleblower's lawyers had incurred $20 million in time and costs, to seek dismissal.  The district court dismissed the action over the whistleblower's objection, and the whistleblower appealed, first to the Third Circuit, which affirmed the dismissal, and now to the Supreme Court.  The Supreme Court heard argument on December 6, 2022, and will decide whether the government can seek dismissal in such circumstances and, if so, what standard courts should apply when ruling on motions to dismiss.  Certainly for companies facing False Claims Act suits prosecuted by whistleblowers, the government's ability to seek dismissal of pending suits is an important protective mechanism.

The second set of cases, United States ex rel. Schutte v. SuperValu Inc. (“SuperValu”), and United States ex rel. Proctor v. Safeway, Inc. (“Safeway”), concern the FCA's scienter element.  FCA liability only attaches to a defendant who acts “knowingly,” which the Act defines as actual knowledge, deliberate ignorance, or reckless disregard.  The defendants in SuperValu and Safeway argued that they did not “knowingly” submit false claims because they relied on objectively reasonable interpretations of relevant regulations, regardless of whether they subjectively believed that those interpretations were correct.  The Seventh Circuit sided with the defendants, ruling that the defendants had not acted “knowingly” because their interpretations of the regulations were objectively reasonable, there was no authoritative guidance that cautioned against their interpretations, and their subjective beliefs were irrelevant for purposes of liability.  The plaintiffs petitioned the Supreme Court to hear their appeal, and the Supreme Court granted the petitions and consolidated the appeals for argument this April.

We will follow these matters closely in the year ahead and share development as they come down.

This is the fifth part in our 2023 series examining important trends in white collar law and investigations. Up next: ESG.

Takeaways:

• The SEC’s Division of Enforcement set record-highs in total money relief ordered and total civil penalties assessed in fiscal year 2022.
• The SEC will likely focus its enforcement efforts on securing the cryptocurrency industry’s compliance with the registration requirements of the Securities Act of 1933 and ensuring statements made by investment advisers and issuers concerning their ESG-compliance are both truthful and not misleading.
• Amendments to the SEC’s Whistleblower Program designed to incentivize a broader and larger range of whistleblower awards will continue to provide the Division of Enforcement with a pipeline of investigative leads.

The U.S. Securities and Exchange Commission (“SEC”) continued its aggressive pursuit of investigations and enforcement actions in fiscal year 2022, setting records for the most money recovered and the most civil penalties assessed in a fiscal year.  The SEC announced that its Division of Enforcement (“Enforcement”) brought 760 total enforcement actions in fiscal year 2022 (representing a 9% increase over fiscal year 2021), including 462 “stand alone” actions (enforcement actions excluding those brought against issuers for delinquent filings and “follow-on” administrative proceedings seeking bars against individuals), 129 actions against issuers for delinquent filings, and 169 “follow-on” administrative proceedings.  Enforcement collected a record-setting $6.439 billion (up from $3.852 billion in fiscal year 2021), including a record-high $4.194 billion in civil penalties.

These metrics reinforce expectations that the SEC would take a more forceful regulatory stance under SEC Chairman Gary Gensler’s and Enforcement Director Gurbir Grewal’s leadership.  We expect the SEC to continue to flex its regulatory muscles in fiscal year 2023, including by focusing on the priorities discussed below.

Crypto Likely to Headline Enforcement Efforts in 2023

Enforcement has advanced Chairman Gensler’s directives to pursue unregistered sales of digital assets under the Securities Act of 1933 (“Securities Act”).  Those enforcement actions included charges against the founders of Forsage, an alleged “fraudulent crypto pyramid and Ponzi scheme” responsible for raising more than $300 million; charges against Payward Ventures, Inc. and Payward Trading Ltd. for their alleged failure to register the offer and sale of their staking-as-a-service program; and charges against Genesis Global Capital, LLC and Gemini Trust Company, LLC, for their alleged unregistered offer and sale of their Gemini Earn program, which provided investors with the opportunity to tender their crypto assets in exchange for a return.  Of particular note, Director Grewal has made clear to the crypto space that Enforcement will continue to go after staking-as-a-service providers who fail to register their offerings, which generally provide investors with the ability to tender their crypto assets to a platform in exchange for a return.

The uptick and prominence of the SEC’s enforcement actions in the crypto space follow the SEC’s announcement that it was bolstering Enforcement’s Crypto Assets and Cyber Unit (formerly known as the Cyber Unit) with 20 additional positions, nearly doubling the unit’s size.  According to the SEC, those additional personnel will be responsible for protecting investors in crypto markets, and will be specifically focusing on crypto asset offerings, crypto asset exchanges, crypto asset lending and staking products, decentralized finance platforms, non-fungible tokens, and stablecoins.  Since its creation in 2017, the Cyber Unit has been responsible for commencing more than 80 enforcement actions relative to fraudulent and unregistered crypto offerings and has collected more than $2 billion in monetary relief.

With the high profile bankruptcy filings of crypto companies in recent months, and the SEC’s investment in the Crypto Assets and Cyber Unit last year, we expect the SEC’s regulatory and enforcement efforts into the crypto space to take center stage in fiscal year 2023.

Enforcement Tackles ESG Fraud

The SEC has continued its enforcement efforts into investment advisers and issuers characterizing their investment strategies and offerings as environmental, social, and governance (“ESG”)-compliant.  Last year, the SEC charged BNY Mellon Investment Adviser, Inc. for certain statements it allegedly made about its ESG considerations in connection with mutual funds.  Specifically, the SEC’s order alleged that BNY represented or implied that all investments in those mutual funds had undergone an ESG-quality review, when several investments in those funds did not have an associated ESG-quality review score at the time of the investment.  In addition, the SEC charged publicly-traded Brazilian mining company Vale S.A. for its claims about the safety of its dams prior to the January 2019 collapse of the Brumadinho dam.  The SEC alleged that Vale misled local governments, communities, and investors about the safety of the Brumadinho dam through various ESG disclosures.  With ESG considerations taking increasing importance with retail investors, we expect the SEC to continue to probe ESG-related representations to ensure that the retail public is not being misled.

Individual Accountability Remains Priority

In November, the SEC released its Strategic Plan for the next four years, which emphasizes the agency’s desire to hold individuals accountable for securities laws violations:  “The SEC will continue to pursue misconduct wherever its staff find it and will use all of the tools in its toolkit to deter those who might choose to violate the securities laws, including by holding bad actors – including responsible individuals – accountable.”  More than two-thirds of enforcement actions in fiscal year 2022 involved at least one individual respondent, a trend we expect to continue into 2023.

A number of the SEC’s enforcement actions included high-profile individual respondents.  For example, the SEC charged the Boeing Company's former CEO with making materially misleading public statements regarding the safety of Boeing’s 737 MAX airplanes for his role in editing and approving company press releases and making other public statements following two airplane crashes.  In another example, the SEC charged Eagle Bancorp, Inc.'s former CEO and Chairman of the Board with negligently making false and misleading public statements concerning certain related party loans Eagle Bancorp made to his family trusts.  The SEC’s pursuit of individuals in fiscal year 2022 extended beyond those circumstances where senior company leaders allegedly made false and misleading statements to the public, and included instances where the SEC charged senior executives at public companies for their failures to prevent misconduct at their firms, even where those executives themselves were not charged with the misconduct.  These enforcement actions signal the SEC’s intention to keep individual accountability at the heart of Enforcement’s investigations.

SEC Enhances Whistleblower Program with Two Amendments

The Whistleblower Program received 12,300 whistleblower tips in fiscal year 2022, representing the largest number of tips the Program has received in a fiscal year.  Despite these record-setting figures, the Program dramatically decreased the amount of monetary awards provided to whistleblowers from 2021. The SEC awarded approximately $229 million in 103 different awards in 2022, less than half of the total amount of money provided in 2021 ($564 million in 108 different awards). The largest awards in 2022 were a $40 million award in October and a $37 million award in January, a notable decline from the largest awards in 2021 ($110 million and $114 million awards).  Despite these drop-offs, the SEC continued to revamp the Program through multiple rule changes designed to incentivize more whistleblowers to come forward.

The SEC adopted two amendments to the Securities Exchange Act of 1934 in Rules 21F-3 and 21F-6, which became effective October 3, 2022. The amendments largely reverse controversial Trump-era policy changes to the Program that we discussed in our previous installment. The two amendments (1) provide the SEC with the ability to award whistleblowers for information resulting in enforcement actions brought by other agencies or regulators where those alternative whistleblower programs contain more limited statutory award ranges, award caps, or discretionary awards, provided that the whistleblower waives any claim to the other program’s award; and (2) affirmed the SEC’s statutory authority to consider the dollar amount of a whistleblower award to increase, but not reduce, the award.  Together, these amendments reinforce the SEC’s commitment to incentivizing whistleblowers to report wrongdoing.

In addition to these policy changes, the SEC instituted enforcement actions against individuals and entities who allegedly retaliated against and obstructed would-be whistleblowers.  For example, the SEC assessed a $97,523 penalty against the co-founder and former Chief Information Officer of NS8, Inc. for allegedly retaliating against an employee-whistleblower by removing his access to the company’s computer systems, surveilling his laptop activities, and prompting his termination.  In another case, the SEC assessed a $400,000 penalty against The Brink’s Company for allegedly requiring employees to sign restrictive confidentiality agreements that prevented employees’ communication with the SEC.  These actions suggest the importance of the Program to the SEC’s enforcement directives, and we expect the SEC to continue to rely upon the pipeline of information received by whistleblowers.

SEC’s Reliance on Data Analytics Uncovers Insider Trading

The SEC increasingly relied on data analytics to ferret out potential securities law violations in 2022.  In particular, Enforcement’s Market Abuse Unit (“MAU”), which uses data analytics to detect suspicious trading patterns, contributed to significant insider trading enforcement actions within the last year.  With assistance from the MAU, the SEC charged the former chief information security officer of Lumentum Holdings, Inc. and others in connection with an alleged insider trading ring that generated more than $5.2 million in illicit profits.  The SEC alleged that the officer purchased securities of a target after learning about Lumentum’s acquisition plans and tipped his friends about another target in advance of the information becoming public.  The SEC was able to detect suspicious trading patterns using advanced data analytics, ultimately revealing the alleged insider trading, despite the fact that the officer used his wife’s brokerage account and one of his friends siphoned the gains through a relative in India.  In another case, the SEC charged an investment banker and his friend with insider trading after the MAU identified suspicious trading activity occurring before four acquisition announcements in 2017.

We expect the SEC to continue to rely on their advanced technology developments and the MAU to uncover difficult-to-detect insider trading.  As expressed in its Strategic Plan, the SEC aims to leverage emerging technologies such as machine learning and artificial intelligence to evolve and sharpen its data analytical tools in 2023 and beyond.

Enforcement Credits Cooperation with Recalibration of Penalties

Despite the SEC’s announcement last year that it intended to take a more rigid stance on cooperation credit than it had during the Trump era, the SEC notably recalibrated penalties for companies that provided the SEC with meaningful cooperation.  For example, the SEC charged HeadSpin, Inc. with fraud for the company’s alleged inflation of certain financial metrics and fabrication of sales records, but did not impose a penalty on account of the company’s extensive remedial actions.  According to Director Grewal, the significant remedial actions taken by the company weighed against the imposition of a penalty.  In another case, the SEC charged Baxter International, Inc. with engaging in improper intra-company foreign exchange transactions.  But because of the company’s remediation actions, including self-reporting; internal investigation; adoption of a new, GAAP-complaint foreign exchange rate convention; and recoupment of bonuses paid to the CEO and CFO, the SEC limited the penalty assessed against Baxter to $18 million.

This is the fourth part in our 2023 series examining important trends in white collar law and investigations. Up next: SEC.

Key Takeaways

• With Republicans gaining control of the House, the party has plans to investigate both areas of focus from past Congresses, such as federal support for clean energy companies, and new areas, such as ESG practices.
• Certain areas of interest—especially China, large technology companies, and health care costs—will draw scrutiny from both parties and likely will continue in future Congresses.
• Some investigations that primarily focus on government actors, like scrutiny of the COVID-19 response or federal law enforcement investigations, are likely to draw in private sector entities as well.

Last year, as we laid out the landscape for congressional investigations in 2022, we noted that Democratic control of both the House and Senate enabled members of Congress to use investigations of the private sector and government entities to drive their party’s legislative agenda. In 2023, as the 118th Congress opens with a Republican-controlled House and Democratic Senate, companies can now expect potential scrutiny from Congress on even more fronts than before.

With a divided government and significant legislation having passed in 2022—such as the Inflation Reduction Act (IRA) provisions on drug pricing and climate change and the CHIPS and Science Act’s investment in the U.S. technology industrial base—Congress may find even more reason to focus on investigations rather than major legislation in 2023.

Leadership in each party has already identified numerous areas of investigative interest that may lead to requests or subpoenas for information and testimony from private sector entities, including U.S. companies’ relationship with China; the COVID-19 pandemic; turbulence in cryptocurrency markets; firms’ use of environmental, social, and governance (ESG) practices; federal support for clean energy companies; and health care and prescription drug costs.

Investigating COVID-19

In the House rules package released in early January, House Republicans established a Select Subcommittee on the Coronavirus Pandemic that will fall under the House Oversight and Government Reform Committee, following the Democratic House’s ambitious COVID-19 oversight committee in the 117th Congress. Like its predecessor, the new House committee looks likely to focus primarily on investigations of government entities, including federal funding of gain-of-function research, uses of COVID-19 relief funds by state and local governments, and governments’ pandemic response on issues like school closures.

However, the panel is also slated to investigate the development of COVID-19 vaccines and therapeutics, with Rep. James Comer (R-KY), chair of the House Oversight Committee, stating that he is planning to “talk to researchers” involved in the development of vaccines, including employees at the National Institutes of Health. Companies involved in the public-private vaccine and therapeutic development efforts, as well as companies that may have interests in oversight of federal scientific research funding, will want to stay tuned to Republicans’ COVID-19 oversight work.

Surveilling the China-U.S. Relationship

The House rules package also establishes a Select Committee on the Strategic Competition Between the United States and the Chinese Communist Party, chaired by Rep. Mike Gallagher (R-WI). Although Gallagher has primarily focused on national security issues in Congress, Republicans have indicated that they see China-related national security concerns as encompassing a wide array of economic and business relationships between U.S. firms and China. Republicans have identified a number of particular areas where they expect to use oversight to push back on what they have called China’s “coordinated whole-of-society strategy to undermine American leadership and American sovereignty”:

• Chinese foreign direct investment in the U.S., including real estate, and S. firms’ investments in China.
• American supply chains’ dependence on China, an issue that also attracted substantial interest in the previous Congress.
• Chinese companies’ treatment of U.S. intellectual property, an investigation that U.S. private-sector stakeholders such as the National Association of Manufacturers and the S. Chamber of Commerce have identified as a positive opportunity for exposing Chinese practices and challenges facing U.S. companies.
• Potential human rights abuses in China, which, under the Uyghur Forced Labor Protection Act, have now become a significant legal issue for U.S. firms.
• Chinese companies’ practices in the U.S., with TikTok’s policies around content moderation and U.S. citizens’ personal data already having received detailed scrutiny from Gallagher and others.

As the above list makes clear, U.S. firms with significant exposure to China in a variety of ways—from having manufacturing facilities or other activities located in China to joint ventures, investment agreements, and other relationships—could potentially have interests at stake in the Select Committee’s work.

A select committee like this one lasts for the duration of the rules established for the 118th Congress, but it can also be continued into a future Congress under a future rules package. The House Select Committee on the Climate Crisis, for instance, lasted through the 116th and 117th Congresses. While Republicans opted not to continue the climate committee, a committee focusing on China-related oversight may be more likely to endure in a future Congress. In other words:  Don’t just expect the growing oversight interest on China issues to float away like a weather balloon.

The Financial Industry: Examining ESG and Cracking Down on Crypto

As we noted in our review of congressional investigations last year, new trends in the financial sector are always popular targets for congressional oversight—especially when they grab headlines, as turbulence in cryptocurrency markets did throughout 2022.

Last year, we noted Congress’s interest in a range of cryptocurrency issues, with particular focus on cryptocurrency practices that may have a greater effect on the broader financial system, such as “stablecoins” that are pegged to the price of a commodity or currency. In 2023, one particular focus will be cryptocurrency exchanges, with the Senate Banking Committee having launched an investigation of FTX’s bankruptcy in December 2022. This interest is certain to continue in 2023, covering not just the practices of cryptocurrency exchanges but also their relationships with regulators. Such activity may also directly inform legislation on cryptocurrency regulation, with now-Chairman of the House Financial Services Committee Patrick McHenry (R-VA) saying that the FTX events demonstrate the need for Congress to create a clear regulatory framework for cryptocurrency.

While financial firms’ use of environmental, social, and governance (ESG) principles may not generate as many exciting headlines as the cryptocurrency industry does, Republicans made it clear in recent years that they see ESG as a ripe area for investigation. The Securities and Exchange Commission’s work on its 2022 proposed rules on climate disclosure will also be an oversight target, with a top Republican on the House Financial Services Committee promising “rigorous oversight of both regulators and private sector asset managers who have politicized capital allocation.” ESG investigations may extend not only to companies that have touted their own ESG practices, but also firms that play a role in the dissemination or rating of practices throughout industries, such as proxy firms, accounting firms, and rating agencies.

Temperature Stays Elevated for Energy and Climate

In 2022, Democrats made investigations of oil and gas firms a high priority, using their oversight powers to build a case for legislation on energy and climate. Now, with the passage of the IRA’s major new programs to support green energy investments, as well as new programs created by the Infrastructure Investment and Jobs Act of 2021, Republicans see oversight of these programs as a top priority. This will include oversight of the Department of Energy’s Loan Programs Office and Office of Clean Energy Demonstrations, with one Republican member already saying that they view the dramatic expansion of such programs to be a potential “Solyndra on steroids” (referring to the bankruptcy of a solar firm that received a loan guarantee under the 2009 economic stimulus bill).

Republicans have also shown interest in investigating the Department of Energy’s management of the Strategic Petroleum Reserve during oil price spikes in 2021 and 2022, as well as dealings with foreign oil producers over pricing, which could sweep in private sector entities involved in those efforts. Although attention to energy and gas prices has abated somewhat, Democratic leadership has indicated that oil and gas companies remain a topic of significant interest for oversight, with Sen. Ron Wyden (D-OR) recently highlighting one oil company’s stock buyback and using it to draw attention to a proposal for a windfall tax on oil and gas profits.

Keeping an Eye on Health Care Costs

With the passage of the IRA in 2022, Democrats in Congress achieved a long-desired goal of overhauling how Medicare pays for prescription drugs. However, health care costs remain an area of vigorous interest, including hospital costs and drug-pricing issues that were not directly addressed by the IRA. Sen. Bernie Sanders (I-VT) has made no secret of his desire to investigate pharmaceutical companies and their pricing practices, promising a “very aggressive” oversight strategy and framing such concerns in a recent Fox News op-ed as an area of bipartisan interest.

Pharmaceutical companies aren’t the only health care firms that will be attracting oversight in the new Congress. House Ways and Means Chairman Jason Smith (R-MO) has emphasized an interest in price transparency measures and highlighted hospitals’ level of compliance with the 2020 final rule on price transparency as a particular area for oversight.

Focusing on the Federal Government

The new Republican leadership in the House has also shown that it plans to devote significant oversight resources to investigations of the Biden Administration and federal agencies. This will include the work of the House Select Subcommittee on the Weaponization of the Federal Government’s investigations of federal law enforcement agencies, but also the Biden Administration’s COVID-19 response, implementation of the energy programs mentioned above, Biden family members’ personal business dealings, and more.

Despite their primary focus on the government, these investigations may interact with private sector firms as well. Rep. Jim Jordan (R-OH), chair of the subcommittee investigating the federal government, has indicated that he sees this effort as covering cooperation by technology firms with federal law enforcement, such as collaboration on content moderation decisions, and part of broader Republican efforts to investigate “Big Tech.”

Conclusion

Foley Hoag will continue to monitor the evolving work of congressional investigations throughout 2023, and we have outlined best practices for companies responding to such investigations. Companies concerned about potential congressional interest should bear in mind not only the above stated priorities of the 118th Congress, but also the shifting political priorities of the two parties in Congress, the Biden Administration’s actions, and media storylines that can fuel potential congressional interest in 2023 and beyond.

This is the seventh part in our 2023 series examining important trends in white collar law and investigations. Up next: crypto enforcement.

2023 promises historic change for the Office of the Massachusetts Attorney General with Andrea Campbell sworn in as the new Attorney General earlier this year. Andrea Campbell ran a campaign on the idea that the Attorney General's office is uniquely suited to help in uplifting the underrepresented and her first month in office has signaled she intends to prioritize those groups. In her inaugural address on January 18, 2023, she outlined her priorities for her first term focusing on the theme that had come to define her candidacy. Her historic inauguration speech focused on how she will hold the powerful accountable, create economic prosperity and stability for families, prioritize the mental health and well-being of young people and bring the community into that work to make the office more accessible to people across Massachusetts regardless of income, language, zip code or ability.

This post previews what we can expect in the coming year under the Office's new direction, namely a renewed focus on big topics like elder care; reproductive justice, gun safety, and access to education as well as a continued focus on the opioid crisis, labor violations, and healthcare.

The Elder Justice and Reproductive Justice Units

While campaigning, Attorney General Campbell vowed to form the Elder Justice Unit and Reproductive Justice Unit. Her vision was for these units to use the tools of the Office to protect Massachusetts elders from hardship caused by unequal access to health care, deceptive business practices, and fraud and to protect and expand the right to access safe and legal abortion and reproductive care throughout the Commonwealth.

On her first day in office, Attorney General Campbell reiterated those vows[1] and she has stayed true to her promise, already launching a reproductive-focused hotline – a free and confidential resource to connect Massachusetts-based health care providers, helpers, and patients obtaining care in Massachusetts with free legal advice and resources about abortion access and care.[2] We expect a similar focus on Elder Justice is not far behind.

Gun Safety

Gun safety has been a prominent focus in Attorney General Campbell's first month in office. In less than a month in the Office, Attorney General Campbell has filed back-to-back briefs in support of common sense gun laws in Massachusetts.[3] The first brief, filed in the First Circuit Court of Appeals, argues that Massachusetts handgun safety regulations do not violate the second amendment.[4] The second brief, filed in the District of Massachusetts opposes a request for temporary injunction for a law that would ban the sale and possession of assault weapons and large-capacity magazines.[5] The Massachusetts Attorney General also signed on to support gun laws in New York, joining a multistate coalition of 18 attorneys general in filing an amicus brief in support of New York's law prohibiting the carrying of firearms in places of worship and religious observation.[6]

Attorney General Campbell has further signaled that she will be proactive in gun safety legislation. Most recently, she signed on to support Massachusetts state legislation to strengthen laws prohibiting the purchase, possession and use of silencers by amending the definition to mirror federal law. Gun safety was a major issue in Attorney General Campbell's campaign and it is likely to remain a top priority as she begins her term in office.

Access to Education

Attorney General Campbell's campaign promised to “fight to ensure that all students have access to high-quality public education regardless of geography or income.”[7] Her first days in office show execution on that promise. Indeed, Attorney General Campbell has already taken significant steps toward ensuring access to education, marking herself a leader in this sphere by announcing earlier this month that she would co-lead a coalition in support of a federal proposal to create a more affordable repayment plan for student loan borrowers. The coalition of 24 state attorneys general has since submitted comments to the Department of Education's Income-Driven Repayment Program. That plan enables borrowers to make payments based on income and family size and offers the possibility of loan forgiveness after 20 to 25 years of qualifying payments. Supporting this plan is consistent with Attorney General's Campbell's campaign promise to combat “predatory student loan practices that lead to burdensome debt and destroyed the credit ratings of individuals and families.”[8] Attorney General Campbell's steps toward access to education are taken on the heels of action by Massachusetts leadership earlier this year to secure a victory for student loan debt relief. On January 11, then Acting Massachusetts Attorney General Dewar led a group of 22 attorneys general in filing an amicus brief in support of the Biden administration's targeted cancellation of student loan debt to address the continuing effects of COVID.

Opioid Crisis, Labor Violations, and Healthcare

Attorney General Campbell's first month in office also saw a recommitment to labor violations, healthcare fraud, and combating illegal drugs, issues that were prioritized by prior Massachusetts attorneys general and on which Campbell also ran on. For example, in the labor space, earlier this month, the Office issued eight citations against USA Management LLC, a Georgia company that operates pool repair and lifeguard services to clients in Massachusetts for labor violations.[9] The Office also joined a coalition calling for the federal government to set standards to occupational heat exposure to protect workers. [10]

With respect to healthcare fraud, the Office announced a settlement with a Taunton-based Mental Health Center, settling allegations of that the company submitted false claims to MassHealth for services provided by improperly supervised clinicians. In its press release announcing the settlement, Attorney General Campbell not only announced the resolution, but also issued a statement about the urgent need to address the mental health and behavioral health crisis facing Massachusetts.[11]

On illegal drugs, in January, the Attorney General's New England Fentanyl Strike Force recovered 522 grams of fentanyl and $20,000 in cash. The press release announcing the success of the Strike Force further reiterated the Attorney General Office's commitment to combatting the opioid crisis in the Commonwealth.[12]

Looking Forward

Looking forward, we can expect to see a continuation of the efforts we have already seen Attorney General Campbell's office prioritize, such as workers' rights, reproductive rights, elder care and mental health, gun safety and access to education. Given her now proven track record of making good on campaign promises, onlookers should be on the lookout for Attorney General Campbell's office to take action on other issues she stressed on the campaign trail such as protecting immigrant communities and the LGBTQ communities through the use of anti-discrimination and civil rights laws, prioritizing the environment and combatting climate change through actions aimed at industries which historically contributed to these problems, protecting consumers against unfair and deceptive practices in developing industries including app-based services, and promoting affordable housing by investigating “digital redlining” by technology companies that sell discriminatory products. We will be sure to keep you updated on any developments in these areas.

[1] Press Release, Office of the Attorney General, Attorney General Andrea Joy Campbell Outlines Priorities in Historic Inaugural Address, https://www.mass.gov/news/attorney-general-andrea-joy-campbell-outlines-priorities-in-historic-inaugural-address (Jan. 18, 2023).

[2] Press Release, Office of the Attorney General, AG Campbell, Abortion Advocates and Law Firms Launch ‘Abortion Legal Hotline’ Amidst Unprecedented Legal Questions Following Dobbs Decision, https://www.mass.gov‌/news/ag-campbell-abortion-advocates-and-law-firms-launch-abortion-legal-hotline-amidst-unprecedented-legal-questions-following-dobbs-decision (Jan. 30, 2023)

[3] Press Release, Office of the Attorney General, AG Campbell Files Briefs in Support of Common Sense Gun Laws, https://www.mass.gov/news/ag-campbell-files-briefs-in-support-of-common-sense-gun-laws (Feb. 3, 2023).

[4] That case is Granata v. Campbell, No. 22-1478 (1st Cir).

[5] That case is National Association for Gun Rights v. Campbell, 22-cv-11431-FDS (D. Mass).

[6] Press Release, Office of the Attorney General, AG Andrea Joy Campbell Joins Coalition in Support of New York Law Banning Guns in Places of Worship, https://www.mass.gov/news/ag-andrea-joy-campbell-joins-coalition-in-support-of-new-york-law-banning-guns-in-places-of-worship (Jan. 27, 2023).

[7] On the Issues: Equal Access to Quality Education, Andrea Campbell: Attorney General, https://www.andrea‌campbell. org/issues/education/.

[8] Id.

[9] Press Release, Office of the Attorney General, AG's Office Cites Georgia-Based Lifeguard Services Company for Labor Violations, Secures $70,000 in Restitution for Workers, https://www.mass.gov/news/ags-office-cites-georgia-based-lifeguard-services-company-for-labor-violations-secures-70000-in-restitution-for-workers (Feb. 10, 2023).

[10] Press Release, Office of the Attorney General, AG Campbell Joins Coalition Calling for Emergency Federal Heat Exposure Standard to Protect Workers, https://www.mass.gov/news/ag-campbell-joins-coalition-calling-for-emergency-federal-heat-exposure-standard-to-protect-workers (Feb. 14, 2023).

[11] Press Release, Office of the Attorney General, Former Owners of Taunton-Based Mental Health Centers To Pay $940,000 to Masshealth in Settlement, https://www.mass.gov/news/former-owners-of-taunton-based-mental-health-centers-to-pay-940000-to-masshealth-in-settlement (Feb. 13, 2023).

[12] Press Release, Office of the Attorney General, Boston Man Arrested and Charged in Fentanyl Takedown, https://www.mass.gov/news/boston-man-arrested-and-charged-in-fentanyl-takedown/ (Jan. 27, 2023).

This is the sixth part in our 2023 series examining important trends in white collar law and investigations. Up next: MA attorney general.

According to the Securities & Exchange Commission, its proposed revisions to SEC regulations regarding climate change disclosures in May 2022 were intended to provide investors with consistent and reliable information regarding how climate change could impact their investment decisions. We have written previously about how these disclosure requirements affect investment advisers and about some of the key takeaways from climate-related disclosures under the new rule.

Many stakeholders and market participants have come out strongly against certain aspects of the proposed rules. We will revisit here the key points of the SEC's proposed rules (focusing on those drawing the most criticism), summarize the pushback the proposed rules have received, and consider where the SEC may go from here.

Revisiting Key Aspects of the SEC Proposal

In 2010, the SEC first adopted guidance describing how existing rules could require companies to disclose how climate change could impact their businesses. Specifically, the guidance focused on areas where climate change could trigger disclosure—the impact of climate change regulation and legislation on business, the impact of international accords, the indirect consequences of regulation or business trends, and the physical impacts of climate change. In short, the guidance directed companies to disclose ESG-related information based on whether such information was material as described in TSC Industries v. Northway (holding that a “fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote”).

Last year, the SEC proposed new rules that would enhance climate-related disclosures for businesses. Should the new provisions go into effect, companies would be required to report climate-related risks that amount to 1% or higher of a total line item in a company's financial statements. As outlined in a press release, the provisions would also require registrants  to disclose information about direct greenhouse gas (GHG) emissions and indirect emissions from purchased electricity as well as GHG emissions from upstream and downstream activities in its value chain if material or if the registrant has set a GHG emissions target. The proposal was open for public comment for 90 days following its proposal—originally ending in June 2022 but reopened until Nov. 1, 2022 after a technical issue impacted online comment submissions. In total, the SEC received more than 14,000 comments in response to the rule.

The Opposition

Companies have called on the SEC to reconsider its approach, citing the practical difficulties that would result from the proposal. Amazon.com Inc. noted that companies would need to essentially double their accounting efforts if the SEC required them to disclose lost revenues and avoided costs because of climate-related factors. Institutional investors, such as BlackRock, have commented that the 1% rule “would result in highly inaccurate disclosures and unduly burdensome compliance costs.”

Commissioner Hester Peirce has also criticized the proposed rules as unnecessary in light of existing rules requiring companies to disclose material risks. According to Commissioner Peirce, “rather than simply ticking off a preset checklist based on regulators' prognostication of what should matter, companies have to think about what is financially material in their unique circumstances” under those rules. As Bloomberg has noted, some companies object to the GHG reporting on the basis that they need “more flexibility” to reflect climate-related risks than such rules would allow.

Commissioner Mark T. Uyeda has suggested that the SEC's usual “straightforward regulatory approach would treat ESG [a shorthand for Environmental, Social, and Governance issues] investing like any other investment strategy” and so makes ESG-specific regulations superfluous. In short, the SEC can bring enforcement actions against companies that fail to invest in a manner described to clients. Even without finalized rules, the SEC has brough ESG-related enforcement actions. For example, it charged BNY Mellon Investment Adviser, Inc. for representing that all investments in specific mutual funds had undergone ESG-quality review when several did not. The SEC also charged Vale S.A., a publicly-traded Brazilian mining company, for misleading investors and governments through its ESG disclosures regarding the safety of a dam it had constructed.

Beyond the fact that the SEC may already use its regulatory framework to pursue ESG-related fraud, Commissioner Uyeda described three problems with ESG-specific regulations. First, an objective definition of ESG is illusive and thus fails to provide standardized metrics for investors. Second, the SEC may be (undemocratically) putting a thumb on the scale in favor of certain ESG objectives. And third, asset managers may be pursuing ESG objectives without receiving such a mandate from their clients.

The Rationale

The SEC is considering “softening” rules mandating companies' disclosure of the effects of climate change on its business in face of such opposition. So why might the SEC consider changing its climate change proposal?

First, as a matter of expedience, the SEC might alter its rules to demonstrate its own flexibility and to show that it's listening, bolstering its chance of success in any court challenge once the final rules are adopted. Courts, such as the D.C. Circuit Court of Appeals in Carlson v. Postal Regulatory Com'n, have noted that reasoned decision-making includes an agency's response to public comments challenging its proposed rules. And the SEC may recognize that it could still achieve the majority of its climate change disclosure goals notwithstanding revisions around the edges of its proposal. Alex Martin, a senior policy climate analyst for Americans for Financial Reform has asserted that SEC could forego the 1% threshold rule and still achieve the majority of its disclosure goals where “other proposed changes to companies' financial statements are more important, such as a requirement that companies to disclose the assumptions they use to make forward-looking estimates regarding, for instance, the profitability of fossil-fuel assets.”

Second, the SEC must have in mind recent successful legal challenges to agency authority.  For example, in NFIB v. OSHA, the National Federation of Independent Business (NFIB) challenged OSHA's promulgated rule requiring employers with at least 100 employees to require workers to receive the COVID-19 vaccine or wear a mask and be subject to weekly testing. The Supreme Court stayed OSHA's vaccine mandate on the basis that the challengers were likely to prevail because the agency had exceeded its statutory authority. The Court noted that Congress had created OSHA to set workplace safety standards and that the rule at issue went beyond such authorization to essentially create “broad public health measures.”

West Virginia v. EPA placed another limit on agency authority. West Virginia and other states challenged the EPA's authority to broadly regulate GHG emissions via the Clean Power Plan (repealed by the Trump administration which had its replacement, the Affordable Clean Energy Rule, vacated by the D.C. Circuit). The Supreme Court held that the EPA did not have the requisite authority to regulate GHG emissions under a generation shifting approach as outlined in the Clean Power Plan. The West Virginia Court made plain that because the EPA “assert[ed] highly consequential power beyond what Congress could reasonably be understood to have granted,” the agency needs clear congressional authorization to cap carbon emissions as outlined in the Clean Power Plan.

Given the Supreme Court's willingness to circumscribe an agency's authority to regulate beyond its mandate, the SEC may take a more cautious approach to avoid serious challenges that could result in courts curtailing the agency's authority.

Final Thoughts

The fate of the SEC's proposed rules on climate change disclosures remains unclear. Given the nature and amount of pushback the SEC has received, and the current legal environment of hostility to agency action that strays beyond the bounds of clearly proscribed authority from Congress, it seems likely the SEC may soften its proposals in the near future.

On October 28, 2021, Deputy Attorney General Lisa Monaco released a memo setting out “initial revisions to corporate criminal enforcement policies.” The memo indicated that the Department of Justice would place greater emphasis on a corporation's “history of misconduct” in reaching determinations about whether to criminally charge a corporation. Noting that past misconduct is potentially indicative of the strength of internal controls to prevent criminal activity, the Monaco memo made waves for directing prosecutors to take into account “all misconduct by the corporation” as a part of a holistic assessment in charging decisions. Past misconduct is understood as prior violations of criminal laws, civil laws, or regulatory rules discovered in any prior domestic or foreign action.

The decision to take into account all prior misconduct generated waves among the white collar bar. Partially in response to feedback, Deputy Attorney General Monaco updated the memo on September 15, 2022, providing additional guidance as to how prior charges should be considered. In the memorandum further revisions to corporate criminal enforcement policies,” the Department of Justice clarified the weight that should be assigned to different instances of past misconduct. In particular, the memo sets out the following:

• Not all instances of prior misconduct are equally relevant or probative. Recent misconduct should be weighted more heavily than that long in the past; criminal misconduct should be accorded greater weight than regulatory violations. In particular, criminal conduct that occurred more than ten years before the conduct currently under investigation, and civil or regulatory resolutions that took place more than five years before the current conduct will be accorded less weight;
• The similarity of prior and current misconduct should be assessed, even where different statutes are being applied;
• Misconduct which occurs under supervision or monitorship should be understood in that context; similarly, when reaching charging decisions, the regulatory atmosphere should be taken into account, with corporations operating in a highly regulated industry being compared to their peers;
• Prior misconduct involving entities that do not share common management should receive less weight, particularly if that entity was subsequently acquired and incorporated into a corporation with a robust compliance program;
• Likewise, where separate instances of misconduct involve the same individuals or entities under shared management, DoJ suggests that this may be indicative of cultural problems which should be addressed;
• Multiple non-prosecution or deferred prosecution agreements are “generally disfavored,” especially in the event that the same personnel or leadership is involved in both;
• None of the above is intended to discourage voluntary disclosure, which will still be appropriately credited by the DoJ.

During a December 1, 2022 speech at the ACI Conference on the FCPA, Acting Principal Deputy Assistant Attorney General Nicole Argentieri elaborated on this last point relating to voluntary self-disclosures. Noting that the Department sought to balance corporate recidivism with mitigating factors, the Deputy Attorney General stated that companies with a history of misconduct who self-disclose may still avoid a guilty plea so long as other aggravating factors are not present. While those other factors, such as involvement by executive management or egregious misconduct, may result in a harsher penalty even for a company that self-discloses, the Deputy Attorney General was clear: “Recidivism is purposefully not one of these aggravating factors.” Put another way, even repeat offenders will see a benefit if they self-disclose under the new Department policy, according to DOJ.

At least two “recidivist” enforcement actions have already taken place in 2022 prior to these recently announced clarifications. In June, manufacturer Tenaris reached a settlement with the SEC to pay US$ 53 million in disgorgement and a civil penalty of US$ 25 million for violations of the FCPA by its Brazillian subsidiary. Tenaris had previously entered into a Non-Prosecution Agreement with the Department of Justice and a Deferred Prosecution Agreement with the SEC arising from separate misconduct allegations in Uzbekistan. And in September, the Austin-based technology company Oracle Corporation reached a settlement agreeing to pay US$ 7.9 million in disgorgement and a civil penalty of US$ 15 million arising out of Oracle Turkey's use of a slush fund to pay for travel and accommodation expenses of its customers. Oracle had previously been hit with an enforcement action in 2012 relating to violations of the FCPA by its employees in India. However, the relationship of these new charges to the updated guidelines remain unclear.

The Wall Street Journal has reported that Swiss-based ABB Ltd. is close to finalizing a settlement to resolve FCPA claims lodged against its South African subsidiary. While the settlement appears to still be under negotiation, the Wall Street Journal has reported that the corruption allegations concern ABB's work on the Kusile power plant, which is run by Eskom, South Africa's state-owned energy utility.

If true, this will be ABB's third FCPA enforcement action in the past twenty years. In 2004, ABB Ltd. admitted that its Jordan-based subsidiary had paid kickbacks to former Iraqi government officials, and agreed to adhere to enhanced compliance and reporting obligations, as well as pay a fine of roughly US$ 16.4 million. In 2010, ABB Ltd.'s U.S. subsidiary, ABB Inc., pleaded guilty to bribing Mexican officials and paid a fine of US$ 17.1 million.

The ABB case – assuming the press reports are true — is poised to be the first major test of DoJ's application of its new guidelines regarding charging of repeat offenders. The Wall Street Journal's reporting indicates that the terms of ABB's latest settlement include an agreement to pay fines and disgorgement amounting to around US$ 325 million, but do not include a guilty plea by the Swiss parent-entity or the imposition of a corporate monitor.

The final terms of the ABB settlement – which appear to be coming soon — will provide important information as to the application of the new DoJ guidelines and whether they really have teeth.  Stay tuned.

Key Takeaways:

• DOJ revised its Corporate Enforcement Policy (CEP) to further incentivize robust voluntary disclosures by corporations when they discover misconduct.
• Even when aggravating circumstances would otherwise warrant criminal resolution, prosecutors will now have discretion to decline to prosecute when a company provides extraordinary cooperation.
• Recognizing the unique opportunity to encourage disclosure and remediation in M&A transactions, DOJ took the opportunity to highlight particular benefits available in that context.
• Companies, in consultation with outside counsel, must be prepared to act quickly and proactively should they uncover misconduct to take maximum advantage of the CEP.

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Earlier in January 2023, the U.S. Department of Justice (DOJ) announced revisions to its Corporate Enforcement Policy (CEP) under the Foreign Corrupt Practices Act (FCPA) for the first time since 2017. In his speech announcing the revisions, Assistant Attorney General Kenneth A. Polite emphasized that the revisions “provide specific, additional incentives to companies for voluntary self-disclosures [of misconduct], as well as for cooperation and remediation…[and] that there will be very different outcomes for companies that do not self-disclose, meaningfully cooperate with [DOJ] investigations, or remediate.” This is the latest development in DOJ's decade-long effort to provide greater transparency and predictability in how it will respond to a voluntary disclosure. DOJ's revised policy remains focused on individual accountability, with AAG Polite emphasizing in his speech that the revised policy will “further [DOJ's] ability to bring individual wrongdoers—the corporate executives, employees, and agents who engage in misconduct—to justice,” including by focusing on the extent to which companies “discipline bad actors and reward the good one.” The revised policy continues to emphasize the requirement that companies identify specific individuals involved in the misconduct to receive credit for full cooperation and self-disclosure.

In this revised policy, DOJ has included a number of enhancements and clarifications of the incentives to encourage companies to disclose misconduct. In general, these revisions represent DOJ's ongoing promotion of the value of self-disclosure and remediation—that a company's voluntary and timely self-disclosure and effective remediation may carry tangible benefits. Notable revisions include the following:

Declinations in the Face of Aggravating Circumstances. Perhaps most notable is that the CEP now explicitly allows a prosecutor to determine that a declination is still appropriate, despite the presence of “aggravating circumstances,” where the company has provided “extraordinary” cooperation and remediation. Prior to the revisions, the presence of any aggravating circumstance generally was seen as disqualifying.

The CEP now makes clear that prosecutors may find a declination is appropriate in the face of aggravating circumstances if the company: self-disclosed immediately upon the company's becoming aware of the misconduct; had an effective compliance system that led to the self-disclosure; paid disgorgement, forfeiture or restitution resulting from the misconduct; and provided “extraordinary cooperation” and “extraordinary remediation.”  While these criteria set a high bar, DOJ's acknowledgement of a pathway to declination in the face of aggravating circumstances does provide an additional incentive to disclose for a company facing that difficult situation.

DOJ considers concepts of immediacy, consistency, degree, and impact when it assesses a company's level of cooperation, and has expanded its description of what it views as “full” cooperation, including its continued emphasis on the identification of individuals involved in the misconduct regardless of their position within the company. Of course, DOJ's assessment of cooperation will vary on a case-by-case basis. The revised policy makes clear that a company starts with zero credit and must affirmatively earn credit up to “full” cooperation (rather than starting with a presumption of 100% credit and “losing” credit for deficiencies in cooperation). That said, DOJ did not specify what constitutes “extraordinary” cooperation, except to say that it must “exceed” the factors set out in the policy that define “full” cooperation. As with other aspects of the CEP over the past half-dozen years, DOJ will undoubtedly use future cases to provide case-by-case guidance.

DOJ has also expanded its description of “appropriate” remediation. Factors such as the company's commitment to instilling corporate values that promote compliance; the effectiveness of the company's risk assessment and the manner in which it was utilized; the resources a company has dedicated to compliance; the quality and experience of personnel involved in compliance, the authority and independence of the compliance function, and the ongoing testing of the compliance program to ensure effectiveness figure into DOJ's remediation analysis. As with the concept of cooperation discussed above, DOJ will look for a company's remediation efforts that exceed the factors listed in order to find “extraordinary” remediation.

Polite's speech highlighted the DOJ's “undeniable message” in releasing these revisions—companies must “come forward, cooperate, and remediate.”

Additional Tangible Benefits for Self-Disclosure Where a Criminal Resolution Is Warranted. DOJ has expanded the range of benefits available to companies facing a criminal resolution in situations where they have voluntarily self-disclosed, fully cooperated, and timely and appropriately remediated. In such instances, DOJ will accord or recommend a 50% to 75% reduction of the low end of sentencing guideline fine ranges. Where a company is a “criminal recidivist,” the 50% to 75% reduction will generally not be from the low end of the range—prosecutors have discretion to determine the starting point for reductions. DOJ will generally not require a guilty plea, even for recidivist companies, unless there are “particularly egregious” or multiple aggravating circumstances. Further, DOJ will generally not require a compliance monitor if the company has demonstrated an effective compliance program.

Highlighting the Benefits of Self-Disclosure in the M&A Context. Recognizing that corporate mergers and acquisitions present a unique opportunity to incentivize voluntary disclosure and to encourage the swift implementation of a compliance program, the CEP now highlights particular benefits available to an acquiring entity. Where a company that has a robust compliance program in place undertakes an acquisition, then uncovers misconduct at the target company either during pre-acquisition due diligence or post-acquisition integration, and voluntarily discloses the misconduct and rapidly remediates and implements an effective compliance program at the target, there will be a presumption of declination, even in the face of aggravating circumstances at the target. This represents some acknowledgment of the benefits of enabling a company that has been “doing the right thing” to acquire a company that historically has not been compliant and bring it into compliance.

A company's decision regarding whether, and the extent to which, it will voluntarily self-disclose is one that should be made with care, in consultation with counsel. The bar to receive credit for such voluntary self-disclosure and cooperation is high—especially in situations where aggravating circumstances are present. As before, the revised CEP continues to give DOJ a great deal of flexibility in determining whether a company has met the requirements for full cooperation and disclosure. DOJ may make such determinations on a case-by-case basis. Further, it remains to be seen exactly what level of cooperation constitutes “extraordinary” cooperation in practice.

We help guide companies through the decision-making process when it comes to voluntary self-disclosure. Companies with questions about how to enhance their anti-corruption compliance program or address any particular compliance concerns should contact us.

This is the eighth part in our 2023 series examining important trends in white collar law and investigations. Up next: anti-corruption.

Key Takeaways:

• As we predicted in our march 2022 post, 2022 was a year of heavy cryptocurrency enforcement, with a spike in actions by the U.S. Securities and Exchange Commission (the “SEC”) and the U.S. Commodity Futures Trading Commission (the “CFTC”) against companies and individuals involved in cryptocurrency. It was also a year of major setbacks for the cryptocurrency industry, including the crash of the stablecoin TerraUSD (a cryptocurrency pegged to the value of the U.S. dollar that used an algorithm to control price fluctuation) and, shortly thereafter, the bankruptcy of the major cryptocurrency exchange FTX.
• The SEC and CFTC show no signs of slowing down their enforcement activities in 2023. But their approaches to enforcement have diverged, giving rise to what some see as a “good cop, bad cop” dichotomy: while the SEC continues to pursue perceived misconduct on a case-by-case basis against any crypto entity it believes offers a “security,” the CFTC is seeking express authority from Congress to expand its jurisdiction to fill regulatory gaps.
• The SEC's active approach to crypto enforcement on a case-by-case basis, which recently included adding securities fraud charges against a defendant indicted for insider trading, has led to continued accusations that the agency is pursuing regulation by enforcement instead of promulgating clear rules that the industry can understand and follow.
• The tumultuous crypto events of 2022, combined with the heightened agency and executive action we have seen so far in 2023, could potentially spur Congress to act by passing one of the many cryptocurrency bills that have been introduced.

The SEC and the CFTC Continue to Dominate Crypto Enforcement

The SEC and CFTC each announced a record-breaking number of crypto enforcement actions in 2022.  Jurisdiction over crypto activities, while messy, generally depends on whether the particular product or technology is a security (within the SEC's remit), a derivative or commodity (the CFTC's domain), or a currency (left to the Treasury Department).  And while both the SEC and CFTC have been ramping up their enforcement, the SEC has expressed more confidence about the current scope of its enforcement authority over crypto assets.  SEC Commissioner Gary Gensler believes most cryptocurrencies are securities that are already within the SEC's purview, and has stated that crypto legislation should focus on stablecoins and granting the CFTC additional regulatory authority over digital assets that are not securities.  CFTC Chairman Rostin Behnam agrees that the CFTC should fill the regulatory gap over non-security cryptocurrencies and that Congress should expressly grant it that authority.

The SEC

In 2022, the SEC announced 30 crypto-related enforcement actions (its highest number ever and a 50% increase from the 20 actions brought in 2021) and imposed $242 million in monetary penalties.  Further, in 2022, the SEC charged a total of 79 respondents in cryptocurrency enforcement actions, of which 56 (71%) were individuals and 23 (29%) were firms.  Gensler has repeatedly highlighted cryptocurrency as an enforcement priority, and he is now under pressure from Congress to take on crypto issues affecting investors following the bankruptcy of FTX.  So we can expect to see heightened levels of crypto enforcement from the SEC in 2023.

On February 9, 2023, the SEC pushed the crypto exchange Kraken out of the business of providing interest to U.S. retail investors who loaned it cryptocurrency (a process known as staking).  The SEC took the position that a staking product amounts to a securities offering, which should be registered with the SEC and should meet disclosure standards.  Similar services are offered to U.S. customers from exchanges including Gemini, Binance.US, and Coinbase.  But questions remain whether the SEC is more broadly targeting all staking in the United States, how crypto companies can permissibly offer staking services, and whether the SEC will offer any guidance to companies that offer these services and do not want to be the SEC's next target.

Under Gensler, the SEC has been pursuing individuals at a higher rate.  During the period of 2013-2020, on average, 20% of the agency's enforcement actions targeted individuals as opposed to entities.  That rate rose to 35% in 2021 and reached 50% in 2022.  The SEC scored a high-profile settlement in early 2023: on February 17, it announced that NBA champion and former Boston Celtics player Paul Pierce had agreed to pay more than $1.4 million for allegedly making false and misleading statements about a cryptocurrency and sharing these statements on social media without disclosing his promotion fee.

The CFTC

Like the SEC, the CFTC's crypto enforcement numbers have been on the rise.  In 2022, the CFTC announced 18 enforcement actions involving digital assets, up 73% from 11 actions in 2021 and representing more than 20% of all actions filed in 2022.  In 2023, the CFTC will likely continue targeting platforms offering cryptocurrency derivatives based on theories that those companies have engaged in unlawful commodity transactions or failed to register with the CFTC.

On February 3, 2023, Chairman Behnam praised the 69 digital enforcement actions that had been brought by the CFTC to date during a speech to the American Bar Association.  Behnam has been outspoken in his calls for greater crypto regulation, as well as his requests for congressional action to expand the CFTC's jurisdiction and increase its budget to allow it to play a larger role in crypto enforcement.  According to Benham, the CFTC wants to conduct more effective due diligence on businesses and grow its enforcement team.

Increased Action by Executive Agencies

While the SEC and the CFTC have been (and will likely remain) the two heavyweights in crypto enforcement, executive agencies have also been expanding their reach in this area.  For example, the U.S. Department of the Treasury has continued to regulate the use of cryptocurrencies in international transactions.  Recently, the Office of Foreign Asset Controls settled with crypto companies Bittrex and Kraken over alleged sanctions violations.  Even the IRS is in mix, with its Criminal Investigation division hiring hundreds of new agents to work on digital assets and cybercrime.

The U.S. Department of Justice (“DOJ”) remains committed to enforcing federal criminal laws against alleged violations related to cryptocurrency.  One highlight in 2022 was the prosecution of the first-ever cryptocurrency insider trading case.  Ishan Wahi, a former product manager at Coinbase Global, Inc. (“Coinbase”), pleaded guilty to two counts of conspiracy to commit wire fraud in connection with an alleged scheme to commit insider trading in cryptocurrency assets.  His brother Nikhil Wahi had previously pleaded guilty to one count of conspiracy to commit wire fraud and was sentenced to 10 months in prison.  While most insider trading cases are based on allegations of securities fraud, these indictments were based exclusively on wire fraud charges, which allowed DOJ to leave unaddressed the question of whether the crypto assets involved were securities.

But the SEC weighed in on that question, bringing a securities fraud action against the Wahi brothers in connection with the same conduct underlying the DOJ action.  In its complaint, the SEC characterized the nine tokens the brothers traded as investment contracts, spurring CFTC Commissioner Caroline D. Pham to criticize the SEC's actions as a “striking example of ‘regulation by enforcement.'”  While the Wahis maintain that the tokens are not securities under the law, the comment by Pham – herself a government official – highlights the view, held by some, that the SEC's tactics are overly aggressive.

In late January 2023, the White House released a statement setting forth the administration's roadmap for mitigating crypto risks, piggybacking on last year's Executive Order on Ensuring Responsible Development of Digital Assets.  The Biden administration highlighted the increase in enforcement by multiple agencies and called on Congress to take steps to expand regulators' powers, and to strengthen transparency and disclosure requirements for cryptocurrency companies.

Signs of Emerging Legislation from Congress

It is possible that, in 2023, we may finally see congressional action on crypto.  Notable legislation that has been introduced includes the bipartisan Lummis-Gillibrand Responsible Financial Innovation Act and the Digital Commodities Consumer Protection Act, both of which would give the CFTC the lead role in regulating crypto.  In the Senate, lawmakers introduced the Digital Asset Anti-Money Laundering Act, which would apply current anti-money laundering and financing terrorism prevention methods to the crypto industry, and the Stablecoin Trust Act, which would establish a federal regulatory framework for payment stablecoins.

In the House, there's the Keep Your Coins Act, legislation that would preserve an individual's right to privacy when transacting with digital assets, and the Crypto Exchange Disclosure Act, a law that would mandate disclosure requirements for crypto exchanges. Finally, the Crypto Consumer Investor Protection Act, another House bill, would prohibit crypto exchanges from using customer funds in certain ways if the customer has not consented.

Both Republicans and Democrats have expressed a desire to increase scrutiny over the industry.  If Congress remains resolved to act and the Biden administration continues to highlight the improvements needed in the crypto enforcement area, we could eventually see a more regulated and transparent industry, with increased market stability and investor protection.  Until then, crypto companies will have to look to past and current enforcement actions to see where the federal government is drawing the lines, and will need to continue exercising heightened levels of caution in this space.

Earlier this week, the Southern District of New York dismissed bribery and honest services wire fraud charges brought against New York's former lieutenant governor, Brian Benjamin, based upon the Indictment's failure to allege an explicit quid pro quo arrangement with respect to campaign contributions, instead of an agreement by implication. The decision marks the first time that a New York federal court has held that an express agreement is required before an individual can be convicted of bribery and wire fraud in a campaign contribution case, and the Government's swift appeal to the United States Court of Appeals signals that further guidance on the reach of the bribery and wire fraud statutes in this context will soon be forthcoming.

Benjamin served as lieutenant governor—the second highest-ranking position in the State of New York—from his inauguration on September 9, 2021 until April 12, 2022, the date that a five-count indictment was brought against him for bribery, honest services wire fraud, and falsification of records charges. The crux of the Indictment concerned allegations that while a state senator, Benjamin solicited and received campaign contributions for a failed Comptroller campaign from a New York real estate developer and, in exchange, secured but never sent $50,000 in state funds for that developer's non-profit organization. According to the Indictment, Benjamin received numerous contributions between October 2019 and January 2021, all coordinated by the real estate developer months after Benjamin offered to procure $50,000 in state funds for his non-profit and many of which were submitted in the names of people who had not authorized or paid for them. But when local media noticed these discrepancies and began questioning the legitimacy of donations to Benjamin's campaign, Benjamin declined to disburse the funds that had been secured for the real estate developer's non-profit organization, such that the funds were never received.

The Indictment charged that it could be inferred from the course of conduct between Benjamin and the real estate developer that the two had entered into an agreement for Benjamin to secure funds for his non-profit organization in exchange for campaign contributions in violation of the federal bribery and honest services wire fraud statutes. Benjamin moved to dismiss those charges, arguing that under Supreme Court and Second Circuit precedent, at least in campaign-contribution related cases, the existence of an explicit quid pro quo is required, instead of merely an implicit agreement like the one alleged in the Indictment.

Benjamin's argument centered on the definition of quid pro quo as established by a pair of Supreme Court cases: McCormick v. United States, 500 U.S. 257 (1991) and Evans v. United States, 504 U.S. 255 (1992). McCormick held that receipt of a campaign contribution violated federal bribery laws only if the government could prove an explicit quid pro quo, meaning “only if the payments are made in return for an explicit promise or undertaking by the official to perform or not perform an official act.” Just one year after deciding McCormick, however, the Supreme Court arguably softened that standard in Evans, holding that the object of the quid pro quo agreement need not be fulfilled for the offense to be complete, and that the “Government need only show that a public official has obtained payment to which he was not entitled, knowing that the payment was made in return for official acts.”

As Judge Oetken pointed out in his opinion on the motion to dismiss, McCormick and Evans set forth two distinct definitions what constitutes a quid pro quo. “A quid pro quo under McCormick must involve a payment made in return for an ‘explicit promise or undertaking.'”  By contrast, “[a] quid pro quo under Evans can be proven inferentially, based on the implication that an official has knowingly accepted a payment intended to compensate him for an official act.” Thus, the sufficiency of the Government's bribery and wire fraud charges against Benjamin—which alleged only that an agreement between Benjamin and the real estate could be an inferred, and not that Benjamin had made an “explicit promise” to provide funding in exchange for campaign contributions—depended upon whether McCormick's or Evans's definition of quid pro quo controlled.

Judge Oetken held that under binding Second Circuit precedent, McCormick governed bribery prosecutions involving campaign contributions, and therefore that the Indictment's failure to allege an express agreement was fatal to its bribery and wire fraud charges.  Judge Oetken acknowledged that the interplay between McCormick and Evans remained a subject of disagreement amongst courts around the country, and that it was “unclear … whether Evans is best read as limiting or overruling McCormick's ‘explicit quid pro quo' standard in the context of campaign contributions.”  But Judge Oetken did not need to wade into that question because he concluded that the Second Circuit had already decided the issue (albeit in slightly different circumstances):  binding appellate precedent established that the “implicit” Evans modified the standard for quid pro quo in non-campaign contribution cases only.  Accordingly, “[u]nless and until the Second Circuit expresses a different view,” Judge Oetken concluded that an express quid pro quo is required to establish bribery and wire fraud in campaign contribution public corruption cases, and dismissed the bribery and honest wire fraud claims of the indictment against Benjamin for failure to satisfy that indispensable element. (The remaining falsification of records charge against Benjamin survived.).

The District Court's dismissal of the bribery and wire fraud charges against Benjamin comes just one week after the United States Supreme Court held oral argument in Percoco v. United States, a case which will consider whether a former senior aide to Government Andrew Cuomo can be convicted of federal corruption laws when he was not a government official or employee.  Benjamin's case may not be far behind:  on the same day that Judge Oetken issued its decision, the United States filed their Notice of Appeal to the United States Court of Appeals for the Second Circuit, assuring that a prosecution of an individual with ties to the Office of the Governor of New York will, once again, help shape the limits of federal public corruption laws.

We will continue to monitor for any developments in this case or the law as the case progresses.

Key Takeaways:

• The U.S. Securities and Exchange Commission’s (SEC’s) Division of Enforcement (Enforcement) announced that it will nearly double the size of its Crypto Assets and Cyber Unit, making the Unit one of the largest within Enforcement.
• The decision reflects the SEC’s increasing prioritization of cryptocurrency and cybersecurity enforcement.
• Issuers of digital assets, crypto exchanges and lending platforms, and other industry participants should expect more frequent investigations and enforcement actions.
• Public companies and investment advisers should anticipate heightened Enforcement scrutiny of their cybersecurity controls and disclosures, and an increase in charged violations for alleged shortcomings in these areas.

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In a move that further executes upon the SEC’s increasingly tough rhetoric on cryptocurrency and cybersecurity, SEC Enforcement recently announced that it will nearly double the size of its newly-renamed Crypto Assets and Cyber Unit, the specialized unit that focuses on enforcement in those areas. This development is remarkable for the dramatic expansion of what was already one of Enforcement’s most high-profile units.

While cryptocurrency and cybersecurity have been stated priorities for Enforcement since the Unit’s establishment in 2017, the SEC’s decision to allocate its limited resources to increase the Unit’s headcount almost twofold signals unambiguously that Enforcement intends to ramp up the number of investigations and enforcement actions against players in the cryptocurrency space, as well as public companies and investment advisers that the SEC deems to have taken inadequate steps to prevent and disclose cybersecurity breaches. The announcement also makes clear that the SEC intends to play a leading—if not the leading—role among regulators and law enforcement agencies in these areas, including the U.S. Department of Justice, the Commodity Futures Trading Commission, and state regulators, among others.

Crypto Enforcement Front and Center

According to the SEC’s announcement, the agency will assign 20 additional positions to the Unit, which will grow to 50 dedicated positions, making it one of the largest units within Enforcement. The SEC also specified that the enlarged Unit “will leverage the agency’s expertise to ensure investors are protected in the crypto markets,” with a particular focus on investigating violations related to:

• crypto asset offerings;
• crypto asset exchanges;
• crypto asset lending and staking products;
• decentralized finance (DeFi) platforms;
• non-fungible tokens (NFTs); and
• stablecoins.

The expansion comes against the backdrop of already vigorous crypto enforcement and a series of public statements by SEC Chair Gary Gensler pointing to a need for tighter regulation of industry participants. As the SEC’s press release notes, since its creation, the Unit has brought more than 80 enforcement actions related to allegedly fraudulent and unregistered crypto asset offerings and platforms, and obtained more than $2 billion in monetary relief.

Gensler’s recent comments make clear that the SEC remains highly concerned about what it perceives as a continuing lack of protection for crypto investors. In a September 2021 interview with the Washington Post, for instance, he likened stablecoins to “poker chips at the casino” and signaled his intention to deploy the SEC’s “robust authorities” to reign in both stablecoins specifically and cryptocurrency markets more generally. Gensler reiterated that view at the Penn Law Capital Markets Association Annual Conference in April of this year, noting that stablecoins in particular “raise three important sets of policy issues” warranting further scrutiny by the SEC:  (1) “public policy considerations around financial stability and monetary policy”; (2) “issues on how they potentially can be used for illicit activity”; and (3) “issues for investor protection.”  When describing the third policy consideration, Gensler expressed concern that “the three largest stablecoins were created by trading or lending platforms themselves,” which, in his view, poses “conflicts of interest and market integrity questions that would benefit from more oversight.”

The agency’s focus on crypto can be expected to intensify even further in the wake of the May 2022 meltdown of the cryptocurrency stablecoin TerraUSD and its sister token, Luna—an event that wiped out nearly the entire $40 billion market capitalization of Luna and accelerated the loss of $500 billion of value in the cryptocurrency economy. Unsurprisingly, Gensler and his colleagues have doubled down on their aggressive rhetoric since the Luna and TerraUSD crash. Speaking at a FINRA conference in Washington, D.C. on May 16, 2022, Gensler characterized cryptocurrency as a “highly speculative asset class,” given what he perceives as its lack of transparency in the marketplace, and advocated for basic investor protections against front-running customers, manipulation, and fraud. Just a few days before those remarks, SEC Commissioner Hester Peirce (despite her vocal and repeated criticism of what she perceives as the SEC’s excessive regulation of the industry) hinted that “one place we might see some movement” with regards to tougher regulations “is around stablecoins.”

These remarks have coincided with a broader effort by the SEC to expand its enforcement activity beyond issuance of crypto assets. In February of this year, for example, Enforcement brought its first action against a crypto lending platform, obtaining $100 million in penalties against BlockFi Lending LLC for its allegedly unregistered offering and sale of retail crypto lending products. In May, the SEC brought a settled action against NVIDIA Corporation for NVIDIA’s alleged failure to disclose that cryptomining was a significant element of its material revenue growth from the sale of its graphics processing units designed and marketed for gaming, with the company agreeing to a $5.5 million penalty. More recently, the SEC has reportedly been conducting an inquiry into safeguards against insider trading at one or more major crypto exchanges.

Though a recently-introduced Senate bill would narrow the SEC’s jurisdiction over crypto, it does not appear that the measure will advance in the near future. In the meantime, with the expansion of the Crypto Asset and Cyber Unit, we expect that the agency will continue to broaden the scope of its enforcement activity.

Cybersecurity Also in Focus

The uptick in SEC enforcement in the cryptocurrency space has been accompanied by a flurry of enforcement and rulemaking activity in the cybersecurity realm, particularly as it relates to the issue of data breaches. In the latter half of 2021, the SEC charged two companies—Pearson plc and  First American Financial Corporation—respectively, for failing to make adequate disclosures regarding cybersecurity breaches and failing to maintain adequate cybersecurity disclosure controls and procedures. The SEC also obtained penalties in three coordinated actions against registered broker-dealers and investment advisers for alleged failures in their cybersecurity policies and procedures, which the SEC found to have resulted in email account takeovers that exposed the personal information of thousands of customers.

In addition, the SEC earlier this year proposed significant new rules for public companies and investment advisers with respect to cybersecurity controls and disclosures. In February, the agency proposed rules and amendments for investment advisers, registered investment companies and business development companies that would, among other things:  require advisers and funds to adopt written policies and procedures that include specific elements set forth in the proposed rule in order to address cybersecurity risks; require advisers to report significant cybersecurity incidents to the SEC on a new Form ADV-C; and enhance cybersecurity incident and risk disclosures by advisers and funds to prospective and current investors.

The SEC followed up in March with proposed rule amendments for public companies that would, among other things, require issuers to disclose information about cybersecurity incidents within four business days after a determination that the company has experienced a “material cybersecurity incident,” and require updated disclosures concerning previously disclosed cyber incidents. The proposed rules and amendments would thus provide the strengthened Crypto Assets and Cyber Unit with an even broader arsenal for pursuing issuers and advisers.

We will continue to provide updates on this rapidly evolving regulatory landscape.

Key Takeaways:

• The U.S. Securities and Exchange Commission’s (SEC’s) Climate and ESG (Environmental, Social, and Governance)Task Force has brought its first two enforcement actions for allegedly misleading ESG-related disclosures by a public company and an investment adviser, respectively.
• The actions reflect the close and continuing focus on ESG by the SEC’s Division of Enforcement (Enforcement); more such actions are virtually certain to follow.
• These cases also underscore the importance for issuers and advisers of mitigating the risk of ESG-related disclosure violations through robust internal controls and careful vetting of public statements about ESG impacts and investments.

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The formation of SEC Enforcement's Climate and ESG Task Force last year confirmed that ESG had become one of the agency’s top enforcement priorities, and signaled that an uptick in investigations and enforcement actions against public companies and investment advisers would follow. Those expectations have been borne out by the Task Force’s first two enforcement actions, against a public company and an investment adviser, respectively. Through these actions, the SEC has further made clear that it will pursue issuers and advisers that it deems to have engaged in “greenwashing” or otherwise inaccurately represented ESG-related information about their operations or investment practices.

Alleged Issuer Misrepresentation of ESG Risks

On April 28, 2022, the SEC charged Brazilian mining and metals company Vale S.A. with making allegedly misleading claims about the safety of its dams prior to the collapse of its Brumadinho dam in Minas Gerais State, Brazil in January 2019. According to the SEC’s complaint, filed in the U.S. District Court for the Eastern District of New York, the collapse killed 270 people and released 12 million cubic tons of toxic waste, causing irreversible environmental harm to the region’s Paraopeba River. Of particular significance, the action is based not on misrepresentations concerning Vale’s ESG policies or practices, but more broadly, allegedly misleading statements about its safety practices and standards that concealed environmental and social risks.

According to the complaint, the company’s Brumadinho dam failed as a result of liquefaction, a phenomenon in which waste deposits build up and saturate the dam, dramatically increasing the risk of structural failure and collapse. Vale allegedly was aware of risks to the Brumadinho dam from liquefaction from a similar dam collapse in 2015, and as early as 2003 that the Brumadinho dam was “dangerously fragile” with “significant liquefaction risk.”

The SEC further alleges that the company “knowingly or recklessly suppressed the findings of its own retained experts” and engaged in a “pattern of deceptive acts designed to skirt the applicable regulatory requirements related to dam safety.”  In particular, the complaint alleges that between 2016 and 2018, the company obtained numerous deceptive stability declarations from auditors tasked with reporting on the dam’s structural integrity that it knew did not meet international safety standards, and cut “backroom deals” and employed “blackmail” to encourage or coerce compliance with its demands for reports that reflected positively on the operational safety of the dam.

During the same period, Vale allegedly made a series of misrepresentations to investors with respect to dam safety. For example, in an October 2016 investor presentation, the company allegedly claimed, among other things, that its dams had been audited in 2016 to address the potential for liquefaction using a “rigorous” process; that the audit process was “conservative” in modeling for liquefaction; and that the presentation reflected a “rigorous review of existing engineering studies[.]” In fact, the SEC alleges, a separate liquefaction expert had told the auditor and the company that the relevant laboratory data was not sufficiently reliable to be used in the safety evaluation.

Similarly, Vale’s 2016 SEC Forms 6-K and 20-F allegedly contained materially false and misleading statements, including representations that the company had conducted “extraordinary audits” on the stability of its dams and that “no anomalies were identified,” even though the company and its auditor had learned through one audit that the Brumadinho dam was in precarious condition and company executives had decided to suspend operations due to concerns about liquefaction.

In addition, the SEC alleges that Vale executives made false statements in sustainability reports, allegedly asserting in one that after a cycle of dam auditing, “100% of the audited structures were certified to be in stable condition, physically and hydraulically,” and that Vale adhered to “good and strictest international practices” and “rigorously” and “strictly” complied with legislative requirements.

Alleged Adviser Misrepresentation of ESG Investment Practices

The Task Force followed up the Vale action with a settled administrative proceeding, filed on May 23, 2022 against BNY Mellon Investment Adviser (BNYMIA) for alleged misstatements and omissions about the use of ESG considerations in the selection of investments for certain mutual funds advised by BNYMIA. BNYMIA agreed to pay a $1.5 million penalty to resolve the action.

According to the Order, BNYMIA’s affiliated sub-adviser to the funds maintained a “Responsible Investment Team” that prepared ESG quality reviews for equities and corporate bonds. For certain mutual funds that the sub-adviser advised, the sub-adviser required the Team to perform a proprietary ESG “quality review” for all investments, which included identifying the ESG risks and opportunities presented by potential investments and assigning a numerical ESG quality review score for the investments reviewed. For other funds, including the funds at issue in this case, the sub-adviser allegedly could, and did, select investments that did not undergo the ESG review.

The SEC found that between July 2018 and September 2021, BNYMIA inaccurately represented to investors in the fund prospectuses and to the funds’ boards that the sub-adviser conducted proprietary ESG reviews as part of the investment research process for all investments. The Order also found that BNYMIA made similar representations in written responses to requests for proposals (RFPs) from other investment firms that were considering investing in the funds.

In particular, BNYMIA allegedly represented in the “Goal and Approach” section of its fund prospectuses that the sub-adviser had a “well-established approach to responsible investment” including “identifying and considering the [ESG] risks, opportunities, and issues throughout the research process via [. . .] proprietary quality reviews in an effort to ensure that any material ESG issues are considered.”  The prospectuses also allegedly stated that this approach was “[i]ntegrated into the investment process” for the funds.

The SEC found, however, that of 185 investments made by the fund at issue, 67 did not have an ESG quality review score at the time of the investment, which represented approximately 25% of the  fund’s net assets as of the time of the statements. The SEC therefore found that a “reasonable investor” reading the prospectuses could inaccurately conclude that all portfolio holdings in the fund had undergone an ESG quality review.

In addition, the SEC found that BNYMIA’s RFP responses to other firms considering the funds described the sub-adviser’s research process, including the performance of ESG quality reviews, and stated that the sub-adviser performed an ESG quality review for every security recommended by the sub-adviser’s analysts. One RFP response, for example, stated that “ESG considerations are taken into account at every stage of the investment process” and that “ahead of investing, each security being considered for investment by our global industry analysts must have an ESG quality review conducted by a member of [the Responsible Investment Team].”

Finally, the SEC found that BNYMIA lacked written policies and procedures reasonably designed to prevent inaccurate or materially incomplete statements in prospectuses, RFP responses, or to the funds’ boards about the sub-adviser’s use of ESG quality reviews. It further found that BNYMIA compliance personnel were not aware before mid-March 2020 that quality reviews were not performed for all of the funds’ investments.

The Commission charged BNYMIA with negligence-based violations of the anti-fraud provisions of the Investment Advisers Act of 1940 and failure to have in place adequate written policies and procedures as required under the Advisers Act. It also charged BNYMIA with non-scienter violations of Section 34(b) of the Investment Company Act of 1940, which prohibits untrue statements of material fact and misleading omissions in registration statements or other documents filed pursuant to the Company Act.

Implications for Issuers and Advisers

These actions are very likely only the first in a series of ESG-related disclosure cases to come. In allocating human and financial resources to the Climate and ESG Task Force last year, Enforcement sent a strong signal that it perceived widespread violations by issuers and advisers and that enforcement activity would follow. (Indeed, Enforcement reportedly has been investigating the asset-management arms of Goldman Sachs and, in parallel with the Department of Justice, Deutsche Bank, in connection with their ESG disclosures.)  Given that the Task Force has been in operation for less than 16 months, and that SEC investigations tend to last roughly two years on average, we expect to see an increasing number of investigations and enforcement actions as the Task Force continues to ramp up.

Moreover, the SEC has recently proposed significant new rules for issuers with respect to climate-related disclosures and investment advisers and investment companies governing disclosures about their ESG investment practices. If adopted, these rules would provide Enforcement with a range of additional violations with which to charge these entities.

In view of these developments, issuers and advisers should be vigilant about and expect heightened SEC scrutiny of their ESG-related disclosures. Issuers should not assume that disclosure violations need rise to the level of egregiousness of those alleged in the Vale action in order to attract Enforcement’s attention. Rather, they should anticipate that the SEC will target any public statements that it construes as concealing or downplaying environmental, social, or governance risks from their operations, and make certain that their internal controls are designed to ensure that those risks are accurately disclosed and that their controls function effectively. Advisers should likewise be attentive to their disclosure controls and confirm that information they provide to current and prospective investors about their ESG investing practices is accurate with respect to each fund to which the information refers.

We will continue to provide updates on the SEC’s evolving ESG focus.

Key Takeaways:

US Actions:

• The Bureau of Industry and Security (“BIS”) imposes new restrictions on the export of certain industrial EAR99 items to Russia
• OFAC extends expiration date for general licenses related to administrative transactions and issues general license authorizing the processing of pension payments to U.S. persons by Russian financial institutions
• OFAC adds Russian government officials, oligarchs, and mining companies to the SDN List, along with vessels and aircrafts
• BIS adds 71 Russian and Belarussian entities to the Entity List

EU and UK Actions:

• EU bans import of Russian oil and petroleum products and imposes new restrictions on the export of 80 chemicals to Russia
• Three additional Russian banks and one Belarussian bank are removed from SWIFT
• EU imposes asset-freezing sanctions on 65 individuals and 18 entities, including Russian military officials, oligarchs and their family members, and Russian defense companies and financial institutions
• UK imposes sanctions on Russian President Vladimir Putin’s close friends, family members, and associates

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I. BIS Imposes New Export Controls on Certain Industrial EAR99 Items

Currently, all items on the Export Administration Regulations’ (“EAR“) Commerce Control List (“CCL”) require a license for export, re-export or transfer to Russia and Belarus. In addition, some EAR99 items are subject to license requirements listed on Supplement 4 to Part 746 of the EAR relating to industrial items and on Supplement 5 to Part 746 of the EAR relating to luxury goods.

On May 9, 2022, BIS issued a final rule imposing license requirements for exports, re-exports, and transfers to or within Russia of additional industrial items that are classified as EAR99. Items that are classified as EAR99 generally can be exported from the U.S. without a license, with certain exceptions for exports to embargoed countries or sanctioned end-users. The new list of items includes wood products, industrial engines, boilers, motors, fans, ventilation equipment and bulldozers. Those items are listed in Supplement 4 to Part 746 of the EAR and are identified by Schedule B number, Schedule B description, Harmonized Tariff Schedule (“HTS”) code, and HTS description. Please note that for licensing purposes, only the items identified in the HTS Description column of Supplement 4 are subject to the license requirement under EAR § 746.5(a)(1)(ii). The other 3 columns—HTS Code, Schedule B and Schedule B Description—are only intended to assist exporters with their filing responsibilities with the Census Bureau.

II. Expiration of Authorizations Under Russia-Related General Licenses 9C and 13R

On May 25, 2022, certain authorizations under General License 9C for transactions ordinarily incident and necessary to dealings in debt or equity of five Russian financial institutions expired. The entities (along with any entity in which one or more of the below own, directly or indirectly, individually or in the aggregate, a 50 percent or greater interest) are as follows:

• State Corporation Bank for Development and Foreign Economic Affairs Vnesheconombank
• Public Joint Stock Company Bank Financial Corporation Otkritie
• Sovcombank Open Joint Stock Company
• Public Joint Stock Company Sberbank of Russia
• VTB Bank Public Joint Stock Company

General License 9C still applies to transactions with Joint Stock Company Alfa-Bank, a Russian bank, until June 30, 2022, and Public Joint Stock Company Alrosa, a Russian diamond company, until July 1, 2022.

Additionally, on May 25, 2022, General License 13R authorizing the wind down of certain transactions necessary to divest or transfer debt, equity, or other holdings in GAZ Group, and General License 15L authorizing the wind down of transactions involving GAZ Group, also expired.

U.S. persons relying on authorizations under general licenses should be careful to confirm whether the licenses carry an expiration date, and, if so, to make sure that all transactions made pursuant to such general license are completed prior to the expiration date.

III. OFAC Extends General License Authorizing Certain Administrative Transactions

On May 25, 2022, OFAC issued General License 13A, which extends the authorizations of General License 13 of March 2, 2022. Consistent with the prior license, General License 13A authorizes U.S. persons, or entities owned or controlled, directly or indirectly, by a U.S. person, to pay taxes, fees, or import duties to, and purchase or receive permits, licenses, registrations, or certifications from, the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation, and the Ministry of Finance of the Russian Federation, provided such transactions are ordinarily incident and necessary to the day-to-day operations in the Russian Federation of such U.S. persons or entities. The revised general license extends this authorization through 12:01 a.m. eastern daylight time on September 30, 2022 (previously, the license expired on June 24, 2022).

IV. OFAC Issues License Authorizing the Processing of Pension Payments to U.S. Persons

On June 2, 2022, OFAC issued General License 38 authorizing all transactions ordinarily incident and necessary to the processing of pension payments to U.S. persons that are prohibited by Executive Order 14024 (“EO 14024”), provided that the only involvement of blocked persons in such a transaction is the processing of funds by financial institutions blocked pursuant to EO 14024.

V. BIS Issues a Temporary Denial Order Against Rossiya Airlines

On May 20, 2022, the BIS issued a Temporary Denial Order (“TDO”) denying the export privileges of Russian airline Rossiya Airlines (“Rossiya”) due to ongoing export violations related to comprehensive export controls on Russia imposed by the Commerce Department. As a result of the TDO, Rossiya’s right to participate in transactions subject to the EAR, including exports and re-exports from the United States, is terminated. Rossiya engaged in recent conduct prohibited by the EAR by operating aircraft classified under ECCN 9A991 on flights into Russia after March 2, 2022, without the required BIS authorization. The TDO is issued for 180 days and may be renewed. BIS has previously issued TDOs for Aeroflot, Azur Air, UTair, and Aviastar.

VI. Russian Government Officials, Oligarchs, and Mining Companies Added to SDN List

On June 2, 2022, OFAC added seventeen Russian nationals to the Specially Designated Nationals and Blocked Persons List (“SDN List”) pursuant to EO 14024, including government officials, oligarchs, and close associates of Putin.

Government Officials:

• Irek Envarovich Faizullin, the Minister of Construction, Housing and Utilities of Russia, who is also a member of the board of directors of Russian Railways.
• Dimitriy Yuryevich Grigorenko, the Deputy Prime Minister and Chief of the Government Staff of Russia.
• Maxim Gennadyevich Reshetnikov, the Minister of Economic Development of the Russian Federation. Reshetnikov serves on the board of several sanctioned Russian entities, including VTB Bank, VEB. RF, and Russian Railways.
• Vitaly Gennadyevich Savelyev, the Minister of Transport of the Russian Federation and a member of the Board of Directors of Russian Railways; he also serves as the Chairman of the Board of Directors of Aeroflot.
• Mariya Vladimirovna Zakharova, the spokesperson of the Russian Ministry of Foreign Affairs.

Oligarchs and Business Executives:

• Andrei Valeryevich Gasilov, a Russian businessman operating several sanctioned entities.
• Sergey Nikolaevich Gorkov, the head of Joint Stock Company RosGeo.
• Evgeniy Borisovich Kochman, the CEO of Imperial Yachts SARL.
• Alexey Aleksandrovich Mordashov, the leader of Severgroup and one of Russia’s wealthiest billionaires, along with several of his family members.
• God Semenovich Nisanov, a Russian billionaire property developer who is the chairman of Kievskaya Square, the largest Russian commercial estate holding.
• Evgeny Grigorievich Novitsky, a Russian billionaire who has held shares in one of Russia’s largest cellphone networks.
• Sergei Pavlovich Roldugin, a close friend and part of a system that manages President Putin’s offshore wealth, as well as his wife Elena Yuryevna Mirtova.
• Yury Borisovich Slyusar, the President of United Aircraft Corporation (“UAC”), a Russian state-owned company and major supplier of aircraft to Russia’s military, and one of the leading actors in Russia’s industry and defense sector with close ties to the Russian Government.

OFAC also added sixteen entities to the SDN List pursuant to EO 14024, including entities operating in the maritime, aviation, and mining sectors, as well as entities supporting or linked to Putin. Along with several Russian entities, the designated entities include companies based in Monaco (Imperial Yachts SARL, a yacht brokerage company), Cyprus (Ironstone Marine Investments and SCF Management Services Cyprus LTD), the Cayman Islands (O’Neil Assets Corporation), and San Marino (SRL Skyline Aviation, an aviation company added to the SDN List for operating in the Crimea region of Ukraine).

The designations also include the following two Russian mining companies:

• Nord Gold PLC, a Russian gold mining company incorporated in London linked to the Mordashov Family. OFAC has also issued General License 37 authorizing transactions that are ordinarily incident and necessary to the wind down of transactions involving Nord Gold PLC or any entity in which Nord Gold owns directly or indirectly a 50 percent or greater interest through 12:01 a.m. eastern daylight time, July 1, 2022.
• Public Joint Stock Company Severstal, a Russian steel and mining company linked to the Mordashov family. OFAC has also issued General License 36 authorizing transactions that are ordinarily incident and necessary to the wind down of transactions involving Severstal or any entity in which Severstal owns directly or indirectly a 50 percent or greater interest through 12:01 a.m. eastern daylight time, August 31, 2022.

Additionally, seven vessels and three aircrafts related to the companies or persons listed above have also been added to the SDN list by OFAC.

As a result of the SDN List designations, almost all transactions by U.S. persons with the SDNs are prohibited, and all U.S. assets of the SDNs are “blocked” and must be reported to OFAC. Designated natural persons are also subject to a travel ban, and all entities owned 50 percent or more by an SDN are generally treated as if they were also on the SDN List (known as the “50 Percent Rule”) even if they are not expressly listed. In addition, any person, including a non-U.S. person, may themselves be designated as an SDN for materially assisting, sponsoring, or providing financial, material, or technological support for, or goods or services to or in support of, these SDNs.

VII. Department of Commerce Adds 71 Russian and Belarusian Entities to the Entity List

On June 2, 2022, the Department Commerce added 70 Russian entities and one Belarusian entity to the Entity List maintained by BIS. The Entity List is a list of foreign persons subject to specific license requirements for the export, reexport or transfer (in-country) of specified U.S.-origin items. Sixty-six of the 71 entities were determined to be military end users (“MEUs”) and are receiving a “footnote 3 designation.” The footnote 3 designation means these entities are subject to a license requirement for all items subject to the EAR, with a policy of denial for such license requests. No license exceptions are available for these MEUs. As a result of this action, 322 parties have now been added to the Entity List for support of Russia’s military since February 24, 2022. The Entity List designations are based on “specific and articulable facts that the entities have been involved, are involved, or pose a significant risk of being or becoming involved in activities contrary to the national security or foreign policy interests of the United States.”

VIII. EU Actions

After weeks of negotiations, on June 3, 2022, the EU has adopted a sixth package of sanctions against Russia, which includes export controls, import bans, and list-based sanctions designations.

Ban on Russian Oil

One of the most contested aspects of the sanctions package is a ban on the import or transfer of crude oil and certain petroleum products from Russia into the EU.

This oil import ban will go into effect in 6 months for crude oil and in 8 months for other refined petroleum products, with certain exemptions for EU member states that are reliant on the Druzhba pipeline (Poland, Germany, Hungary, Slovakia and the Czech Republic, although Poland and Germany have pledged to stop using the pipeline by the end of the year) and temporary exemptions for Bulgaria and Croatia. As oil delivered into the EU via pipeline is temporarily exempt from the ban, the prohibition currently only applies to oil imports by ship.

Additionally, after a 6-month wind down period, EU operators will be prohibited from insuring and financing the transport of Russian oil to third countries, including via maritime routes. This action is intended to restrict Russia’s export of its crude oil and petroleum products to the rest of the world.

“De-SWIFTING” of Additional Russian Banks

The EU removed three of the largest Russian banks (Sberbank, Credit Bank of Moscow, and Russian Agricultural Bank) and the Belarusian Bank for Development and Reconstruction from SWIFT access. SWIFT is a secure messaging system used by banks and other financial institutions to exchange information, such as details regarding money transfers. These banks join (1) Otkritie; (2) Novikombank; (3) Promsvyazbank; (4) Bank Rossiya; (5) Sovcombank; (6) VEB; and (7) VTB, which were previously removed from SWIFT by the EU on March 12, 2022.

To date, Iran is the only country that has been completely barred from SWIFT.

Focus on Russian Propaganda

The EU suspended the broadcasting activities of Russian media entities Rossiya RTR/RTR Planeta, Rossiya 24/Russia 24, and TV Centre International, which have been used by the Russian Government to distribute propaganda and spread misinformation regarding the war in Ukraine. As a result, these three entities are barred from distributing their content across the EU, including via the internet or smartphone apps.

Export Restrictions and Service Prohibition

The EU added 80 chemicals that can be used to produce chemical weapons to the list of goods and technology that may contribute to the technological enhancement of Russia’s defense and security sector, encompassing around €663 million of EU exports to Russia. These items are now prohibited from export to Russia, with exceptions for certain non-military end-users and non-military uses, such as for humanitarian and medical purposes. The EU also expanded its list of Russian entities and natural persons associated with Russia’s military-industrial complex, which are subject to an export ban.

Additionally, similar to the earlier US prohibition, the EU has also banned the direct or indirect provision of certain business services to Russia. This prohibition includes accounting, auditing, statutory audit, bookkeeping and tax consulting services, business and management consulting, and public relations services. The UK also has prohibited providing accountancy, management consultancy, and public relations services to Russia as of May 4, 2022.

Additional Sanctions List Designations

The EU has also imposed sanctions on 65 individuals and 18 entities, targeting (1) individuals and entities responsible for the atrocities committed by Russian troops in Bucha and Mariupol; (2) pro-Russia propagandists; (3) leading businesspersons and family members of listed oligarchs and Kremlin officials; and (4) Russian defense companies and financial institutions. As a result of the sanctions, natural persons and entities are subject to an asset freeze of all EU assets, and EU persons and entities cannot make funds available to these persons and entities. Additionally, sanctioned natural persons are also subject to a travel ban.

IX. UK Actions

Economic Sanctions

On May 19, 2022, the UK imposed sanctions on Aeroflot (Russia’s largest airline), Ural Airlines and Rossiya Airlines. All three airlines are subject to an asset freeze within the UK, which prevents any UK citizen, or any business in the UK, from dealing with any funds or economic resources which are owned, held or controlled by the airlines. As a result, the airlines will now be unable to sell their unused landing slots at UK airports, which prevents Russia from receiving an estimated £50 million. The UK previously banned all Russian aircraft and vessels from UK airspace and waters.

On May 13, 2022, the UK imposed further sanctions targeting Russian President Vladimir Putin’s inner circle. These persons are subject to an asset freeze and a travel ban. The individuals sanctioned include:

• Alina Kabaeva, a retired Olympic gymnast and alleged girlfriend of Putin. Kabaeva has risen to become Chair of the Board of the National Media Group, reportedly the largest private Russian media company.
• Anna Zatseplina, grandmother of Alina Kabaeva and associate of Gennady Timchenko (a longstanding Putin associate who was sanctioned by the UK on February 22, 2022).
• Lyudmila Ocheretnaya, the former First Lady of the Russian Federation and ex-wife of Putin.
• Mikhail Putin, a Russian businessman and relative of Putin who is Deputy Chairman of the Management Board of SOGAZ Insurance (“SOGAZ”) and Deputy Chairman of the Management Board of Gazprom.
• Three of Putin’s cousins (Igor Putin, Roman Putin, and Mikhail Shelomov).
• Alexander Plekhov, a close friend of Putin and owner of Vital Development Corporation, which has benefited from significant state patronage.
• Mikhail Klishin, an executive of Bank Rossiya, and a member of the Board of Directors at SOGAZ.
• Vladimir Kolbin, the son of Peter Kolbin (Putin’s childhood friend and alleged business associate) and General Director of Gelendzhik Seaport LLC.
• Yuri Shamalov, the son of Nikolai Shamalov (sanctioned by the UK in 2014), brother of Putin’s former son-in-law (sanctioned by the UK on February 24, 2022), President of Gazfond, and Member of the Board of Directors of Gazprombank.
• Viktor Khmarin, a Russian lawyer related to Putin by marriage. Khmarin has owned a number of businesses including LLC NefteProduktServis, which operated in the Russian energy sector.

New Import/Export Restrictions

On May 9, 2022, the UK announced a new package of import/export restrictions on Russia and Belarus, which encompasses over £1.7 billion goods worth of trade. The new restrictions are imposed via import tariffs and export bans, including:

• Raising tariffs by 35 percent on products such as chemicals, platinum, and palladium. Russia is one of the leading producers of platinum and palladium products.
• An export ban on £250 million worth of goods, covering key materials such as chemicals, plastics, rubber, and machinery (representing almost 10 percent of all exports to Russia in 2021). The new restrictions are designed to impact Russia’s manufacturing and heavy machinery sectors.

Foley Hoag will continue to provide updates as the situation with respect to Ukraine develops. Companies with questions about these actions or how to ensure compliance with U.S. sanctions and export control regulations should contact a member of Foley Hoag’s Trade Sanctions & Export Controls practice. For information on earlier Russia-related actions, see our prior Client Alerts issued on May 10, April 11, April 7, March 28, March 17, March 15, March 11,  March 7, March 1, February 28, and February 17.

Additional contributions to this alert were made by summer associate Chawkat Ghazal.

Key Takeaways:

• U.S. sanctions major Russian state-owned enterprises Alrosa (diamonds) and United Shipbuilding Corporation (defense sector)
• OFAC publishes new Russia-related general licenses, including a license authorizing certain transactions related to telecommunications
• “Fifth Wave” EU sanctions package restricts trade with Russia and imposes sanctions on 217 individuals and 18 entities

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I.    U.S. Actions

Following increased sanctions on Russian banks and a new Executive Order banning investment in the Russian Federation (reported by Foley Hoag here), on April 7, 2022, the U.S. sanctioned two major Russian state-owned enterprises:  Public Joint Stock Company Alrosa (“Alrosa”) and United Shipbuilding Corporation (“USC”). The U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) added Alrosa and USC to the Specially Designated Nationals and Blocked Persons List (“SDN List”) pursuant to Executive Order (“EO”) 14024. SDN List designations are the most restrictive level of economic sanctions imposed by the U.S. government.

According to OFAC’s press release announcing the designation, Alrosa is the world’s largest diamond mining company, responsible for 28 percent of global diamond mining and has 90 percent of Russia’s diamond mining capacity. While Alrosa was previously subject to Directive 3 under EO 14024, which imposed certain restrictions on transactions involving its debt and equity, the new SDN List designation is much more restrictive and applies to all transactions by U.S. persons. Additionally, Alrosa is subject to sanctions imposed by Canada, the EU, and the UK.

In an action targeting Russia’s defense establishment, the Department of State designated USC, along with 28 of its subsidiaries and eight of its board members under EO 14024. USC develops and builds the Russian Navy’s warships. These individuals and entities were then added by OFAC to the SDN List. For more information, see the Department of State Fact Sheet here. The Department of Commerce added nine USC entities to the Entity List on March 9, 2022, and USC itself has been included on the Entity List since August 6, 2014. As a result of the Entity List designations, U.S. exports of all items subject to the Export Administration Regulations (“EAR”) to USC and USC entities are prohibited absent a license. The SDN List designation goes much further by prohibiting almost all transactions by U.S. persons unless authorized by OFAC.

In addition to the prohibition on transactions with U.S. persons, all U.S. assets of SDNs are “blocked” and must be reported to OFAC. Designated natural persons are also subject to a travel ban, and all entities owned 50% or more by an SDN are generally treated as if they were also on the SDN List (known as the “50 Percent Rule”) even if they are not expressly listed. In addition, any person, including a non-U.S. person, may themselves be designated as an SDN for materially assisting, sponsoring, or providing financial, material, or technological support for, or goods or services to or in support of these SDNs.

New General Licenses and Amendments to Prior General Licenses

OFAC issued two new Russia-related general licenses and amended several existing general licenses concurrent with the SDN List designations.

• General License 9C authorizes transactions that are ordinarily incident and necessary to dealings in the debt or equity of several specifically identified sanctioned entities (currently, State Corporation Bank for Development and Foreign Economic Affairs Vnesheconombank; Public Joint Stock Company Bank Financial Corporation Otkritie; Sovcombank Open Joint Stock Company; Public Joint Stock Company Sberbank of Russia; VTB Bank Public Joint Stock Company; Joint Stock Company Alfa-Bank, and Alrosa). Transactions involving dealing in Alrosa’s debt or equity issued prior to April 7, 2022, are authorized until July 1, 2022. This replaces the prior General License 9B, which was earlier amended on April 6, 2022, to add Alfa-Bank to the list of covered entities.
• General License 10C authorizes certain transactions that are ordinarily incident and necessary to the wind down of derivative contracts with the several specifically identified sanctioned entities listed above. Transactions involving derivative contracts entered into with Alrosa prior to April 7, 2022 are authorized until July 1, 2022. This replaces the prior General License 10B, which also had been amended on April 6, 2022 to add Alfa-Bank to the list of covered entities.
• General License 21A adds Alrosa USA, Inc., the U.S. branch of Alrosa, to the winding down general license that also covers Sberbank CIB USA. All transactions ordinarily incident and necessary to the wind down of both entities are covered through 12:01 a.m. eastern daylight time on June 7, 2022.
• General License 24 authorizes all transactions ordinarily incident and necessary to the winding down of transactions involving Public Joint Stock Company Alrosa or any entity in which Alrosa owns, directly or indirectly, a 50 percent or greater interest through 12:01 a.m. eastern daylight time, May 7, 2022.
• General License 25 authorizes (a) all transactions ordinarily incident and necessary to the receipt or transmission of telecommunications involving the Russian Federation that would otherwise be prohibited by the Russian Harmful Foreign Activities Sanctions Regulations (31 CFR part 587); and (b) the export of services, software, hardware, or technology incident to the exchange of communications over the internet, such as instant messaging, videoconferencing, chat and email, social networking, sharing of photos, movies, and documents, web browsing, blogging, web hosting, and domain name registration services. This general license applies broadly to all transactions falling within its scope, rather than only authorizing transactions with specific identified entities.

II.    EU Actions

On April 8, 2022, the EU released a “fifth wave” sanctions package “in light of Russia’s continuing war of aggression against Ukraine, and the reported atrocities committed by Russian armed forces in Ukraine.”  The economic sanctions and trade restrictions include the following:

Sanctions on Oligarchs and Kremlin Officials

The EU has imposed asset freezing sanctions and a travel ban on 217 individuals, including oligarchs, high-ranking Kremlin officials, persons spreading disinformation and Russian propaganda regarding the invasion of Ukraine, and family members of sanctioned individuals. Sanctioned oligarchs include Moshe Kantor, Boris Rotenberg and Oleg Deripaska. Russian President Vladimir Putin’s daughters, Maria Vladimirovna Vorontsova and Ekaterina Vladimirovna Tikhonova, were also sanctioned in the April 8, 2022 action. Of the 217 sanctioned individuals, 179 are ministers and members of the “People’s Council” of the so-called Donetsk People’s Republic and Luhansk People’s Republic regions of Ukraine.

Asset Freeze on Four Russian Banks and Defense Entities

The EU also imposed asset freezing restrictions on 18 entities, including on four key Russian banks who have a 23% share of the Russian banking sector: Bank Otkritie, Novikombank, Sovcombank, and VTB. These banks were already removed from SWIFT, which is the messaging system used for global bank communications. Other designated entities include Russian state-owned enterprises and defense sector companies:

• JSC Arzamas Machine-Building Plant
• JSC Ruselectronics
• JSC Tactical Missiles Corporation
• JSC Kalashnikov Concern
• JSC UEC Klimov
• LLC Military Industrial Company
• PO More Shipyard
• JSC Omsk Transport Machine Factory Omsktransmash
• JSC Russian Machines
• JSC Sozvezdie Concern
• JSC Research and Industrial Concern “Machine Engineering Technologies” - JSC RIC TECMASH
• PJSC United Engine Corporation
• Yantar Shipyard
• JSC GTLK State Transport Leasing Company

A complete list of the sanctioned individuals and entities is available here.

Coal Ban

The EU has banned the purchase, import or transfer of coal and other solid fossil fuels originating in Russia or exported from Russia into the EU. Imports of coal into the EU are currently worth EUR 8 billion per year. This measure goes into effect in August 2022, after a four-month wind down period for existing contracts. The coal ban, in response to significant international pressure, marks the first substantive foray into blocking Russian energy sector imports into the EU, and may be followed by future energy-related actions should tensions continue to escalate.

Transport Restrictions

Vessels registered under the flag of Russia are prohibited from accessing all EU ports, with exemptions for the supply of agricultural and food products, humanitarian aid, and energy.

Russian and Belarusian freight road operators are prohibited from working in the EU, with the exemption of road transit of pharmaceutical, medical, agricultural and food products, including wheat, humanitarian aid, and energy.

Export/Import Restrictions

The EU imposed significant export controls that prohibit the export from the EU to Russia of jet fuel and other goods such as quantum computers and advanced semiconductors, high-end electronics, software, sensitive machinery and transportation equipment. Additionally, the EU has also prohibited the import of products including wood, cement, fertilizers, seafood and liquor from Russia into any EU member state.

Measures to Ensure Compliance with Restrictions

New economic restrictions imposed by the EU intended to close loopholes and build on existing restrictions include (1) a prohibition on the participation of Russian nationals and entities in procurement contracts in the EU; (2) restrictions on financial and non-financial support to Russian entities with over 50% public ownership or control under EU, Euratom and Member State programmes; (3) an extended prohibition on deposits to crypto-wallets, and on the sale of banknotes and transferrable securities denominated in any official currency of the EU member states to Russia and Belarus; and (4) a prohibition on “being a beneficiary, acting as a trustee or in similar capacities for Russian persons and entities, as well as a prohibition on providing certain services to trusts.”

For more information, see Council Regulation (EU) 2022/576 of April 8, 2022 amending Regulation (EU) No 833/2014 concerning restrictive measures in view of Russia’s actions destabilizing the situation in Ukraine.

Given the multiple jurisdictions imposing sanctions and export controls on Russia, it is crucial that entities operating internationally maintain a robust screening system that checks against sanctions lists for all jurisdictions applicable to their business.

Foley Hoag will continue to provide updates as the situation with respect to Ukraine develops. Companies with questions about these actions or how to ensure compliance with U.S. sanctions and export control regulations should contact a member of Foley Hoag’s Trade Sanctions & Export Controls practice. For information on earlier Russia-related actions, see our prior Client Alerts issued on April 7, March 28, March 17, March 15, March 11,  March 7, March 1, February 28, and February 17.