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New SEC Climate-Related Disclosure Rules and Caremark Implications

BY: Erin Hunter

In their 2019 report, the World Economic Forum identified varying types of environmental risk as three of the top five global risks in their Global Risk Perception Survey. These risks range from extreme weather events to loss of biodiversity and failure of climate policy. In response to increased awareness of the broad risk that climate change poses, and increased investor demand for climate information, the Securities and Exchange Commission (“SEC”) amended their disclosure rules to include climate-related information. The final rule is effective 60 days after its publication and in accordance with its phase-in period. Upon its implementation, companies must comply with increased disclosure requirements, some of which involve disclosure of material climate-related risks, board oversight of climate mitigation strategies, and climate-related target goals.

In the same year, the Delaware Supreme Court made a significant indication of their willingness to allow plausibly pled Caremark claims to survive a motion to dismiss. Caremark claims generally allege that corporate directors breached their fiduciary duty to make a good faith effort to oversee the operations and compliance of the corporation. Caremark claims are historically difficult for plaintiffs to win because of the extremely high pleading standard and necessary showing of bad faith. However, in Marchand v. Barnhill, the Court reversed the dismissal of the claim against the board of Blue Bell, alleging that the board failed to make a good faith effort to oversee a mission critical aspect of the company’s operations. In the years following Marchand, various other Caremark claims survived motions to dismiss for failure to make a good faith effort to oversee mission critical operations. However, Caremark claims continue to be challenging for plaintiffs and are generally only viable when the claim involves a failure to oversee legal or financial compliance of a company. 

Oversight of climate risk has not yet been incorporated into the Caremark framework. In fact, some scholars argue against including climate issues into Caremark duties, arguing that it would fundamentally shift corporate purpose away from profit and towards social responsibility. However, the SEC’s efforts to incorporate climate-related information into corporations’ required disclosures could open the door to new Caremark litigation in the climate risk space. SEC disclosure rules impose a legal obligation on registered companies to comply with those rules. Pursuant to their Caremark duties, directors will now be responsible to make a good faith effort towards adequate oversight of those climate-related disclosures. This addition of climate-related information into legal disclosure obligations may increase litigation risk for corporations and create an avenue for incorporation of climate policy into corporate fiduciary duties. However, any potential Caremark litigation impact from the new rules will likely be significantly delayed, as the Fifth Circuit temporarily halted implementation of the rules in response to constitutional challenges based on the scope of SEC authority to regulate climate.

Key Sources:

World Econ. F., The Global Risk Report 2019, at 6 (14th ed. 2019)

The Enhancement and Standardization of Climate-Related Disclosure for Investors, 89 Fed. Reg. 21668 (Mar. 28, 2024)

SEC, The Enhancement and Standardization of Climate-Related Disclosure: Final Rules, Fact Sheet (Mar. 28, 2024), https://www.sec.gov/files/33-11275-fact-sheet.pdf

In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996)

Marchand v. Barnhill, 212 A.3d 805 (Del. 2019)

Stephen M. Bainbridge, Extending Caremark to Climate Change Risk Management and Other ESG Issues Would Simply Compound the Original Mistake (Dec. 8, 2021), https://www.professorbainbridge.com/professorbainbridgecom/2021/12/extending-caremark-to-climate-change-risk-management-and-other-esg-issues-would-simply-compound-the-.html

Jacob H. Hupart et al., Caremark Liability Following the SEC’s New ESG Reporting Requirements, Mintz: Insight Center (Dec. 16, 2022), https://www.mintz.com/insights-center/viewpoints/2301/2022-12-21-caremark-liability-following-secs-new-esg-reporting

Hiroko Tabuchi, Court Temporarily Halts S.E.C.’s New Climate Rules, N.Y. times (Mar. 15, 2024), https://www.nytimes.com/2024/03/15/climate/sec-climate-rules-lawsuit.html#:~:text=A%20federal%20court%20on%20Friday,Approved%20by%20the%20S.E.C.

CFPB Regulations Target Big Tech

BY: Michael Sutton

In 2021, the Consumer Financial Protection Bureau (“CFPB”) began investigating Big Tech companies offering digital payment services, including Apple, Google, and Facebook. The CFPB ordered them to produce information regarding personal financial data use and access management. The CFPB’s primary concerns were behavioral targeting or sale of data to third parties, the potential for exclusion of certain merchants, and how companies are protecting customers under existing laws. All of this often results in the phenomenon known as digital resignation, which is the feeling of helplessness when “people desire to control the information digital entities have about them but feel unable to do so.”

The CFPB has since pushed to bring Big Tech companies under the “financial institution” umbrella. In a summary of an Outline of Proposals and Alternatives, the CFPB labels financial institutions and credit card issuers “covered data providers,” whose actions are subject to the authority of the Bureau. The proposal would thus require the companies to make consumer financial data “available to a consumer, upon request.” 

One option the CFPB has considered proposing is “that covered data providers would be required to make available all the information… through online financial account management portals,” which they refer to as “third party access portals.” It is not that data should not be shared, but that it should be the choice of the consumer to share data with a third party, like a competing service provider. The proposal highlights how companies are able to hold data hostage and retain customers through the manufactured inconvenience of switching providers. The proposed rule would force providers to “earn [and retain] customers through competitive prices and high-quality service,” driving home the implicit point that this is not only a consumer rights issue, but an antitrust issue.

The CFPB has made it clear that “covered data providers” under its proposal are subject to the Gramm-Leach-Bliley Act, meaning the proposed third-party access portals would be governed by the Act. It is important to see laws like this and Electronic Fund Transfer Act (“EFTA”) as backbones to reinforce new regulations as opposed to past standards which have to change with the times; the CFPB has specified that its proposed rules will not interfere with the rights guaranteed by such laws, especially the right to digital error resolution and protection from unauthorized transfers afforded by the EFTA.

The proposal does an adequate job addressing the Bureau’s concerns. One must wonder, still, whether it adequately addresses the concerns of consumers. Certainly, ownership over one’s data is important. The existence of portals would be an improvement, but it seems unlikely to combat digital resignation in the average consumer without a simultaneous concerted effort to educate those consumers as to the role they can play in controlling their data. Even with education efforts, many consumers would likely see this development as another layer of complexity contributing to further feelings of confusion and helplessness. There is not an easy solution here. The CFPB has outlined some intriguing rules with a focus on Big Tech, but if it wants to make an even more widespread impact, it should consider a greater focus on the consumers—the human beings—who are at the center of all of this.

Sources

1. C.F.P.B. Doc. No. 2023-0052, 12 CFR pt. 1001 & 1033 (2023).
2. CFPB Orders Tech Giants to Turn Over Information on their Payment System Plans, CFPB, https://www.consumerfinance.gov/about-us/newsroom/cfpb-orders-tech-giants-to-turn-over-information-on-their-payment-system-plans/, (Oct. 21, 2021).
3. CFPB Proposes New Federal Oversight of Big Tech Companies and Other Providers of Digital Wallets and Payment Apps, CFPB, https://www.consumerfinance.gov/about-us/newsroom/cfpb-proposes-new-federal-oversight-of-big-tech-companies-and-other-providers-of-digital-wallets-and-payment-apps/, (Nov. 7, 2023).
4. CFPB Report Highlights Role of Big Tech Firms in Mobile Payments, CFPB, https://www.consumerfinance.gov/about-us/newsroom/cfpb-report-highlights-role-of-big-tech-firms-in-mobile-payments/, (Sep. 7, 2023). 
5. CONSUMER FINANCIAL PROTECTION BUREAU, THE CONVERGENCE OF PAYMENTS AND COMMERCE: IMPLICATIONS FOR CONSUMERS (2022).
6. Electronic Fund Transfer Act, 15 U.S.C. § 1693 (1978).
7. Gramm-Leach-Bliley Act, 15 U.S.C. §§ 6801-6809, §§ 6821-6827 (1999).
8. High-Level Summary and Discussion Guide of Outline of Proposals and Alternatives Under Consideration for SBREFA: Required Rulemaking on Personal Financial Data Rights, (Oct. 27, 2022).
9. Nora A. Draper & Joseph Turow, The corporate cultivation of digital resignation, NEW MEDIA & SOCIETY 1 (2016).
10. Small Bus. Advisory Rev. Panel for Required Rulemaking on Personal Financial Data Rights: Outline of Proposals and Alternatives Under Consideration, (Oct. 27, 2022).

Wielding the Bankruptcy Code: When and How to Renegotiate Debt with Your Demanding Creditors

BY: Joseph Wenzel

The Bankruptcy Code provides numerous protections for debtors facing ravenous creditors who seek to take their bite of the estate. A court “stays” (or pauses) the creditor’s abilities to seek repayment or exercise their liens on the debtor. The court can “cramdown” creditors under certain conditions, forcing them to take unfavorable repayment terms. However, bankruptcy can be an extraordinary expensive process for large debtors, racking up thousands in both legal and court fees. Additionally, a commercial debtor must give up some of their rights to freely run their business.

So how can an ailing debtor get the protections of the Bankruptcy Code while avoiding the associated expenses? This is the magic of the flexible, pre-bankruptcy “Workout Agreement.” Both the debtor and creditors share the aim of avoiding bankruptcy, often creating a substantial negotiating range where parties can cooperate to restructure the debt.

Ultimately, the creditor has a huge amount of leverage in that the debtor is contractually obligated to pay their debt according to the original terms until they strike a deal. However, the debtor has a variety of incentives to improve their bargaining power. The debtor can offer to waive the automatic stay in the case of bankruptcy, enter into restrictive covenants, or negotiate alternative financing options like debt for equity or convertible notes.

If a debtor wishes to negotiate more offensively, they can threaten to file bankruptcy. This will be especially dangerous for creditors who have recently received payments from the debtor, as they will risk being unwound, or “avoided” as preferences. Thus, there may exist a specific window for debtors to renegotiate their debt after paying their creditors. Loss aversion bias could exacerbate this effect, as creditors may fear losing money they already have in their possession, especially if they’ve made purchases or subsequent loans in reliance on that money.

Alternatively, a debtor can likely immunize payments to their preferred creditors from avoidance actions. Payments can easily be structured to intentionally fit in to one of the many exceptions to preference actions. Thus, even if an independent trustee is appointed to manage the debtor’s bankruptcy, they would be unlikely to reclaim those funds that would have otherwise been apportioned to other creditors based on priority. This is an enticing tool for debtors to use to curry favor with creditors they would like to maintain a long-term relationship with. A creditor may be willing to offer to renegotiate the debt in order to secure their recent payments from potential avoidance in bankruptcy.

Sources & Further Reading:

11 USC 362

11 USC 1129(7)(A)

11 USC 549

Mark Henricks & Mitch Strohm, Chapter 11 Bankruptcy: What You Need To Know, Forbes (Feb. 18, 2022, 7:00am), https://www.forbes.com/advisor/debt-relief/chapter-11-bankruptcy/

AccountingTools, Workout Arrangemetn Definition, (Sep. 21, 2023), https://www.accountingtools.com/articles/workout-arrangement

In re Darrell Creek Assocs., L.P., 187 B.R. 908, 910 (Bankr. D.S.C. 1995)

Kathleen P. March & Janet A. Shapiro, Prebankruptcy Creditor Actions and Strategies, Cal. Prac. Guide Bankruptcy Ch. 3-A 1

David A. Skeel, Jr., The Empty Idea of “Equality of Creditors”, 166 U. Pa. L. Rev. 699 (2018)

BlackRock Cuts Support for Shareholder ESG Proposals

BY: Michael Gersho

In the past decade businesses have increasingly focused on incorporating socially and environmentally conscious factors into their decision-making processes, often under the label of ESG (environmental, social, and governance). However, the backlash against ESG has been swift, and large asset managers like Blackrock are taking note. Blackrock, along with Vanguard and State Street, the so-called “Big Three” of index fund managers, collectively vote around 25% of shares in all S&P 500 companies.

Funds have a general fiduciary duty to vote consistent with the best interest of the fund and its shareholders but have few regulations on voting beyond limited disclosure requirements. Blackrock claims to support shareholder proposals that are aligned with maximizing value to its clients, rather than achieving a specific decarbonization outcome, or other social aims. Yet as ESG principles have come under increased scrutiny in recent years, BlackRock has reduced its support for ESG related shareholder proposals (in 2023 the firm supported a mere 7% of proposals concerning climate and natural capital, down from 22% in 2022 and 47% in 2021). This raises the question of whether ESG voting decisions were influenced more by activism or desire for favorable publicity, rather than a fiduciary duty to clients. However, BlackRock insists that the decline in support for ESG proposals is not due to a change in the firm’s investing principles, but rather a decline in the quality of the proposals themselves.

BlackRock’s explanation could be supported by a 2022 SEC regulation, which made it easier for shareholders to elect board members at annual meetings. Shareholders can now vote for individual board members rather than an entire slate of directors, regardless of whether the shareholder is present at the meeting. The change effectively grants shareholders more leverage over the board, making managers more likely to consider activist shareholder proposals. Shareholder ESG proposals increased significantly after the regulation was enacted, which could lend credence to BlackRock’s proposal quality explanation.

However, ESG has been troubled in recent years, with many large companies reporting ESG backlash, largely from state and federal politicians and policymakers. Politicians have filed anti-ESG legislation, increased scrutiny of companies and investors, and even issued civil investigative demands and subpoenas to financial sector entities regarding how ESG metrics are calculated. Moreover, a flurry of litigation from state officials and private parties have challenged fiduciaries employing ESG considerations in financial decision making. These political actions and increased litigation risk may be changing BlackRock’s risk calculus in its support of ESG proposals.

Regardless of rationale, BlackRock may have a way of avoiding ESG controversy by delegating voting decisions to its investors. The firm is increasingly giving investors the opportunity to vote their own shares, an option currently available for close to half of its total index equity but quickly expanding to more funds and classes of clients. Vanguard and State Street are implementing similar voting choice programs for investors, indicating large asset managers are responding to concerns about their control and influence.

Key Sources

Fʀᴇᴅᴇʀɪᴄᴋ H. Aʟᴇxᴀɴᴅᴇʀ, Bᴇɴᴇғɪᴛ Cᴏʀᴘᴏʀᴀᴛɪᴏɴ Lᴀᴡ ᴀɴᴅ Gᴏᴠᴇʀɴᴀɴᴄᴇ: Pᴜʀsᴜɪɴɢ Pʀᴏғɪᴛ ᴡɪᴛʜ Pᴜʀᴘᴏsᴇ 44 (2017)

Lucian Bebchuck & Scott Hirst, Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy, 119 Cᴏʟᴜᴍ. L. Rᴇᴠ. 2029, 2044 (2019)

BʟᴀᴄᴋRᴏᴄᴋ Iɴᴠᴇsᴛᴍᴇɴᴛ Sᴛᴇᴡᴀʀᴅsʜɪᴘ, Bʟᴀᴄᴋʀᴏᴄᴋ 2023 Gʟᴏʙᴀʟ Vᴏᴛɪɴɢ Sᴘᴏᴛʟɪɢʜᴛ 3 (2023)

Patrick Temple-West & Brooke Masters, BlackRock’s support for climate and social resolutions falls sharply, Fɪɴᴀɴᴄɪᴀʟ Tɪᴍᴇs, (Aug. 23, 2023), https://www.ft.com/content/06fb1b85-56ba-48cd-b6f6-75f8b8eee7e1

Richard J. Grossman et al., How the New Proxy Rules Will Affect US Companies Facing Activist Campaigns, Sᴋᴀᴅᴅᴇɴ, (Winter 2023), https://www.skadden.com/insights/publications/2023/02/the-informed-board/how-the-new-proxy-rules-will-affect-us-companies (“New ‘universal’ proxy card rules may increase the number of activist campaigns if activists believe the rules give them a better chance to win seats in contested elections.”).

Paul Washington & Andrew Jones, ESG Backlash Is Real and Growing. What to Know., Bᴀʀʀᴏɴ's, (Aug. 22, 2023, 9:05 AM), https://www.barrons.com/articles/esg-backlash-is-real-and-growing-what-to-know-264ec4f6

Rick S. Horvath et al., The Developing Litigation Risks from the ESG Backlash in the United States, Hᴀʀᴠ. L. Sᴄʜ. F. ᴏɴ Cᴏʀᴘ. Gᴏᴠᴇʀɴᴀɴᴄᴇ, (July 12, 2023), https://corpgov.law.harvard.edu/2023/07/12/the-developing-litigation-risks-from-the-esg-backlash-in-the-united-states/

Empowering investors through BlackRock Voting Choice, BʟᴀᴄᴋRᴏᴄᴋ, https://www.BlackRock.com/corporate/about-us/investment-stewardship/BlackRock-voting-choice#BlackRock-voting-choice-faqs

ESG: a Risk management Tool for Investors

BY: Omar Safi

Environmental, social, and governance (“ESG”) funds have grown rapidly over the world and have become a major source of investment for investors and managed assets. ESG has become the center of attention for investment and management, as trillions of dollars have accumulated in investments for ESG related products. The prominence and rise of ESG funds have caught the attention of millions of investors around the globe. ESG creates an avenue for investors to assess a corporation’s environmental, social, and governance practices and to make investment choices that are more aligned with their investment goals by anticipating future performance of ESG factors. ESG focuses on holding corporations accountable and to protect the environment and communities these corporations work in. 

However, while there are many in favor of ESG investments, there is also opposition. ESG is a hotly debated topic in the United States and is the subject of political legislation. Anti-ESG legislation was passed in twelve states in 2023, and pro-ESG bills have been proposed in eleven states. ESG has contributed to the polarized political landscape in the United States due to certain states wanting to protect industries such as oil and gas. Additionally, some ESG regulations call for a firearms boycott, which further divides lawmakers. While this debate continues in the United States, the European Union has taken the lead in ESG regulation and has created ESG requirements. The European Union has implemented stricter disclosure requirements for ESG regulation to create transparency and awareness for investors. 

ESG can be used as a risk management tool for investors in analyzing a corporation’s carbon footprint. ESG factors can be used by investors to identify future risks with the corporations they are interested investing in, thus being used as a risk management tool for investors. Investors then can take information from the ESG scores of a corporation and use that to make an informed decision. 

Lastly, critics have questioned whether ESG can produce positive returns for investors. ESG has the ability to improve risk-adjusted returns for investors by considering the future risks and creating transparency for investors. ESG funds have proven to perform better, or just as well, as conventional funds. Investors should not be discouraged by ESG’s critics because ESG will continue to grow and be a tool for investors to use.

Key Sources:

Elizabeth Pollman, The Making and Meaning of ESG 3 (U. Penn. Inst. for L. & Econ., Working Paper No. 22-23, 2022).

Adam Gorley, What is ESG and Why It’s Important for Risk Management, Sustainalytics (Mar. 2, 2022). https://www.sustainalytics.com/esg-research/resource/corporate-esg-blog/what-is-esg-why-important-risk-management.

Leah Malone & Emily Holland, ESG in Mid-2023: Making Sense of the Moment, Harv. L. Sch. F. on Corp. Governance (Aug. 31, 2023) https://corpgov.law.harvard.edu/2023/08/31/esg-in-mid-2023-making-sense-of-the-moment/.

Samuel Brown, Scott Kimpel, Alexandra Hamilton, Julia Casciotti, Emerging Esg Frameworks Global Implications and Local Impacts, Nat. Resources & Env't at 19 (2023).

E. Napeoletano, Environmental, Social and Governance: What is ESG Investing?, Forbes, (Dec. 4, 2023, 9:30 AM), https://www.forbes.com/advisor/investing/esg-investing/.

Karin Rives, States’ anti-ESG push leaves patchwork of policies, unclear mandates, S&P Global Market Intelligence, (Aug. 22, 2023), https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/states-anti-esg-push-leaves-patchwork-of-policies-unclear-mandates-77133331.

Joan Michelson, Wave of ‘Anti-ESG’ Investing Legislation, New Study Found, Forbes,  (Aug. 29, 2023, 7:45 AM), https://www.forbes.com/sites/joanmichelson2/2023/08/29/wave-of-anti-esg-investing-legislation-new-study-found/?sh=51e03e757286.

Fannie, Freddie, FHFA, Treasury: Litigating The Net Worth Sweep

BY: Marcus Mello

Since 2013, an onslaught of litigation stemming from the federal government’s regulatory response to the 2008 housing collapse has played out in federal district and claims courts. Plaintiff-shareholders of Fannie Mae and Freddie Mac have taken the Federal Housing Finance Agency (“FHFA,” the conservator of Fannie and Freddie) and the U.S. Treasury to task on statutory claims, constitutional takings claims, and contractual claims. The litigation has dragged on, but last August, the plaintiff-shareholders saw some semblance of light at the end of their decade-plus tunnel in court. After determining that the FHFA breached its implied covenant of food faith and fair dealing, a jury awarded the plaintiffs $612.4 million in damages. Though the FHFA is expected to appeal, the outcome is significant in that it is the first victory for the plaintiff-shareholders since the rise of the litigation. 

Before the 2008 financial crisis, Fannie Mae and Freddie Mac were highly profitable juggernauts that collectively owned or guaranteed nearly half of the entire United State mortgage market. Though they were both created by acts of Congress, Fannie and Freddie were subsequently converted into private corporations to boost competition in the secondary mortgage market. For decades, they increased access to mortgage credit for homebuyers by adding liquidity to the mortgage market. Operating with an implicit government guarantee, Fannie and Freddie were able to purchase mortgages at cheaper rates and issue securities at lower yield, which ultimately resulted in lower mortgage rates for borrowers. But with the crash of the housing market, Fannie and Freddie quickly fell from grace. 

The aftermath of the housing crash and the ensuing litigation shows the limits of regulatory policymaking while also revealing the strategies that could prove successful for future plaintiff-shareholders who find themselves in similar situations as those at the heart of the litigation. While shareholders that invest in highly regulated financial institutions cannot have unreasonable expectations of compensation, the government also does not have a free pass to act unreasonably to the terms of a contract to which it is a party. In this case, the contracts were the stock purchase agreements that the FHFA and Treasury entered into with Fannie and Freddie upon them being placed under the conservatorship of the FHFA. 

Ultimately, the litigation shows that the legality of a regulatory response has an upper bound. The government can enact a policy that significantly reduces the worth of an investor’s property, but it cannot violate its contractual obligation to not act arbitrarily or unreasonably, which it was found to have done here. 

Sources:

Perry Capital LLC v. Lew, 70 F.Supp.3d 208, 217-18 (2014).

Perry Capital LLC v. Mnuchin, 864 F.3d 591, 634 (2017).

Petition for a Writ of Certiorari to the U.S. Supreme Court, Andrew T. Barrett v. U.S., 26 F.4th 1274, 8 (2022) (No. 22-99).

Alison Frankel, DOJ: Fannie, Freddie Shareholder Demands Endanger Housing Market, Reuters (Jun. 18, 2014), https://jp.reuters.com/article/idUS297733741120140604/.

Kessler Topaz Meltzer & Check, LLP, KTMC Wins Historic $612 Million Jury Verdict For Fannie Mae and Freddie Mac Stockholders (Aug. 15, 2023), https://www.ktmc.com/news/ktmc-wins-historic-612-million-jury-verdict-for-fannie-mae-and-freddie-mac-stockholders.

New SEC Disclosure Requirements for the Private Funds Industry

BY: Henry Colocotronis

On August 23, 2023, the Securities and Exchange Commission (“SEC”) released final rules imposing new disclosure requirements on private fund advisers and restricting their ability to offer preferential terms to favored investors. Supporters argue that these regulations are long overdue given ordinary investors’ increased exposure to the industry, but critics believe that they will harm advisers and investors by imposing unnecessary costs and impeding their ability to strike mutually beneficial arrangements. However, both sides agree that these rules will have a major impact on the private funds industry.

The private funds industry, which includes hedge, venture capital, and private equity funds, has historically enjoyed light regulation. Funds were formerly only allowed to accept investments from “sophisticated” investors, but in exchange, regulators gave them wide latitude to structure their investment agreements. Two major developments created pressure to increase regulation. First, the major financial scandals of the late 1990’s and early 2000’s and the 2008 Crisis increased scrutiny of the financial industry. Second, the private funds industry has grown enormously over the past twenty-five years, driven primarily by increased flows from pension and endowment funds, who manage money for investors who would ordinarily not be able to invest in the space. 

The 2023 Rules prohibit any adviser from offering any investor special withdrawal rights or access to information. Any rights to withdraw money from or receive access to information about the fund must be offered to all investors on the same terms. They also require advisers to disclose any other special material terms to all investors in the fund. In addition, the Rules limit the ability of advisers to charge investors for expenses related to regulatory investigations and enforcement, impose mandatory audit and disclosure requirements, and place additional regulations on the sale of stakes in a live fund. 

Chair Gensler has explained that the Rules are meant to give investors more transparency into funds’ assets and activities and limit the ability of advisers to prefer favored investors. Investors will have greater ability to compare the performance of funds and more leverage to negotiate with advisers. Critics have two major objections to the Rules. One is a standard efficient contracting argument. These regulations will limit the ability of advisers and investors to craft bespoke agreements that suit their unique needs. When private parties can make individualized agreements, they are able to spread costs more efficiently. It may make sense to regulate the kind of agreements that parties are able to make where bargaining asymmetries exist, but the private funds industry is populated by sophisticated actors who can look out for their own interests. Additionally, they argue that the rules will disadvantage smaller funds, leading to less competition. New advisers frequently use preferential agreements to attract investors. The disclosure requirements impose fixed costs that large advisers will be able to spread across their funds, but smaller advisers will either have to internalize them or raise fees. 

The actual impact of the Rules remains to be seen, but commentators have offered several predictions. First, there will likely be more standardization in the industry. The industry will likely adopt a relatively uniform set of terms and reporting formats. Because these Rules favor larger funds over smaller competitors, the industry may see more consolidation. Finally, investors will enjoy increased power, although the nature of the industry means that advisers will retain significant influence. Regardless, the once lightly regulated private funds space will be more regulated and mature.

Key Sources

Statement, Gary Gensler, Chair, SEC, Statement on Private Fund Advisers (Aug. 23, 2023), https://www.sec.gov/news/statement/gensler-statement-private-fund-advisers-082323

Statement, Hester M. Peirce, Commissioner, SEC, Uprooted: Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews (Aug. 23, 2023).

Alt. Inv. Mgmt. Ass’n., Comment Letter on Private Fund Advisers: Documentation of Registered Investment Adviser Compliance Reviews, at 21 (Apr. 25, 2022), https://www.sec.gov/comments/s7-03-22/s70322-20126739-287453.pdf

T.J. Bright Et. Al., The SEC’s New Private Fund Adviser Rules: A Guide to Compliance, K&L Gates 11 (2023) 

https://files.klgates.com/webfiles/The_SECs_New_Private_Fund_Adviser_Rules_A_Guide_To_Compliance.pdf

Issa J. Hanna Et Al., SEC Adopts Sweeping New Private Fund Adviser Rules, Eversheds Sutherland (Oct. 2, 2023), https://www.corporatecomplianceinsights.com/sec-private-fund-adviser-rules/

AT1 Bond Market Still Vibrant as Ever!

BY: Marc Woernle

On June 12, 2023, UBS completed their acquisition of Credit Suisse, following controversial intervention from the Swiss regulator FINMA, and an effective wipeout of the holders of certain special bond classes, namely “AT1” bonds, after which holders of Credit Suisse equity received 1 UBS share for each 22.48 Credit Suisse shares. This price reflected the economic collapse of one of the largest Swiss banks, ending in the creation of a “consolidated banking group.” 

The root of the controversy were clauses written into the Additional Tier 1 bonds, particularly the clause mentioning a “Viability Event,” contained in all the AT1 prospectuses. These clauses mandated that in the event of an extraordinary government assistance (such as that which was extended to Credit Suisse in the form of liquidity on March 19, 2023,) FINMA could authorize or instruct Credit Suisse to write down the value of these bonds in bankruptcy. FINMA did in fact so order that “Credit Suisse’s Additional Tier 1 Capital (deriving from the issuance of Tier 1 Capital Notes) in the aggregate nominal amount of approximately CHF 16 billion will be written off to zero.” This was based on the prospectus, where the relevant condition of “irrevocable commitment of extraordinary support from the Public Sector” was met.

Recently, UBS Group issued new batches of AT1 bonds, and interestingly, there was no provision mandating the writedown of these bonds upon a Viability Event. This reflected investor and public sentiment, which generally spawned several lawsuits against Swiss regulator FINMA. According to Reuters, “European banks have resumed fundraising in the AT1 market, but a UBS deal has been long awaited as a next step for its recovery,” and fix the damage to the alternative bond market created by the Credit Suisse crisis. Furthermore, the key difference between AT1 bonds issued by Credit Suisse, which were written down to 0, and the AT1 bonds UBS issued (announced November 8, 2023), is the Viability Event Clause. 

Specifically, this clause now provides that in the event of extraordinary government support, or the dramatic fall of capital levels (a “Viability Event,”) AT1 bonds and other similar instruments will be converted to equity rather than written down according to regulatory mandate. This will prevent investors from being completely wiped out in the case of bankruptcy. Previously issued UBS AT1 bonds have a similar form of this equity provision, according to various prior amendments, pre-dating the Credit Suisse meltdown. The newly-issued AT1 bonds have a structure which fit into a standard understanding of strong priority rules. It is also likely to heal some of the uncertainty created by the Credit Suisse meltdown in the large alternative debt instrument market. The outcome of the various claims against FINMA by Credit Suisse AT1 bondholders remains to be seen, but they have clearly had an effect, as shown by the difference between the two bonds. 

Key Sources:

Credit Suisse Group AG, U.S.$2,250,000,000 7.500 per cent. Tier 1 Capital Notes, 71-72 (issued Dec. 11, 2013).

Media Release, Ad hoc announcement pursuant to Art. 53 LR: Credit Suisse and UBS to Merge, Credit Suisse (Mar. 19, 2023). 

Press Release, FINMA provides information about the basis for writing down AT1 capital instruments, FINMA (Mar. 23, 2023), https://www.finma.ch/en/news/2023/03/20230323-mm-at1-kapitalinstrumente/ 1.

UBS Group AG, Additional Tier 1 capital (Basel III-compliant), 19-20 (issued Aug. 7, 2015); UBS Group AG, High-trigger loss-absorbing additional tier 1 capital instrument, 92-93 (issued Nov. 13, 2023). 

UBS Group AG, UBS completes Credit Suisse acquisition, Ubs, (June 12, 2023), https://www.ubs.com/global/en/media/display-page-ndp/en-20230612-ubs-credit-suisse-acquisition.html.

Yoruk Bahceli & Noele Illien, UBS marks new chapter for AT1 bonds with first since Credit Suisse deal, Reuters (Nov. 9, 2023), https://www.reuters.com/markets/rates-bonds/ubs-sells-first-at1-bonds-since-credit-suisse-takeover-2023-11-08/.

Modernization of Cosmetics Regulations Act (MoCRA)

BY: Elisabeth Kotsalidis

The Modernization of Cosmetics Regulation Act (MoCRA) was signed into law on December 29, 2022.  MoCRA is the first major update to the Food and Drug Administration’s (FDA) rulemaking and enforcement authority over the cosmetics industry since 1938. It was crafted with support and input from the Food and Drug Administration, consumer groups, and the cosmetics industry.

MoCRA’s provisions create a variety of new compliance obligations for cosmetic companies. For instance, MoCRA stipulates that cosmetic companies must register both their domestic and foreign facilities with the FDA. MoCRA requires that companies list each cosmetic product offered for distribution in the United States with the FDA. MoCRA also compels companies to report serious adverse events associated with the use of cosmetic products to the FDA. In an effort to increase the safety of cosmetic products, MoCRA requires safety substantiation of the products marketed and distributed in the United States through tests and research that support a reasonable certainty that the cosmetic products are safe. 

MoCRA has significantly increased the FDA’s authority, allowing the agency to inspect the cosmetics manufacturing and processing facilities, as well as their records. MoCRA grants the FDA the authority to request a recall of a product if it determines that there is probability that the product is adulterated or misbranded, and its use will cause serious adverse health consequences or death. The FDA has also been instructed to develop regulations that establish and require standardized testing methods for identifying asbestos in talc-containing cosmetic products and assess the use of perfluoroalkyl and polyfluoroalkyl substances in cosmetics. However, MoCRA does recognize that the cosmetics industry is known for its many successful small businesses and therefore offers some flexibility through exemptions from many requirements for small businesses. 

As of the Winter of 2024, the FDA is in the process of issuing draft guidance and requesting public comments. Small and large businesses and trade associations from all over the world have been sharing suggestions, expressing concerns, and requesting clarification. Cosmetics companies should keep an eye on the FDA’s website, where the agency releases frequent updates to ensure they do not miss new draft guidance or the period for public comments. 

Although the full effect of MoCRA and the FDA’s ensuing regulations is still unknown, lawyers have expressed concerns over the potential for increased litigation, incoming discovery requests on their adverse event reporting data, and the threat of negligence allegations if they fail to comply with the new manufacturing practices rules. There are also concerns about the increased costs businesses will face associated with the creation and maintenance of adverse event reporting recording systems, employment of more regulatory affairs and compliance employees, and annual product listing updates. Even though MoCRA introduces new burdens on cosmetics companies, it was a long overdue overhaul of the FDA’s authority over cosmetics, brings cosmetics regulation more into line with the agency’s authority over food, drugs, and devices, and ultimately provides greater safety to users of cosmetics. 

Key Sources

Modernization of Cosmetic Regulation Act of 2022, Pub. L. No. 117-328, sec. 2, § 3502, Stat. 1389 (codified at 21 USC 361).

Food and Drug Admin., Modernization of Cosmetics Regulation Act of 2022, COSMETICS LAWS & REGULATIONS (Sept. 18, 2023), https://www.fda.gov/cosmetics/cosmetics-laws-regulations/modernization-cosmetics-regulation-act-2022.

Kristen R. Klesh, MoCRA Increases FDA Oversight of the Cosmetics Industry, Loeb & Loeb LLP Client Alerts/Reports (March 2023), https://www.loeb.com/en/insights/publications/2023/03/mocra-increases-fda-oversight-of-the-cosmetics-industry.

Wade Ackerman, Jessica O’Connell & James Holloway, MoCRA: 6 Key Takeaways From The New Cosmetics Law, Covington & Burling LLP News and Insights, 4 (Jan. 20, 2023), https://www.cov.com/-/media/files/corporate/publications/2023/01/mocra-6-key-takeaways-from-the-new-cosmetics-law.pdf.

Frederick R. Ball, Alyson Walker Lotman & Kelly A. Bonner, MoCRA[1] Is Here—Now What? Unpacking Litigation and Regulatory Risk for Cosmetics Brands Following MoCRA’s Enactment, Food and Drug Law Institute (2023), https://www.fdli.org/2023/02/mocra-is-here-now-what-unpacking-litigation-and-regulatory-risk-for-cosmetics-brands-following-mocras-enactment/.

U.S. Food and Drug Administration, Modernization of Cosmetics Regulation Act of 2022 – Key Terms and Provisions, YouTube (Apr. 12, 2023), https://www.youtube.com/watch?v=p4UsMzXKyck&t=282s.

Developments in the Chinese Stock Market

BY: Andrew Andrade

A Hong Kong court on January 29, 2024, ordered Evergrande Group, one of the largest Chinese real estate companies, to liquidate. This order is the result of a series of bankruptcy filings by the former real estate giant. Evergrande had been one of the world’s most valuable real estate brands between 2016 and 2022, topping the list in 2018. The company then filed Chapter 15 bankruptcy in August of 2023 in the Southern District of New York in an attempt to restructure its foreign debt, a sum of around $25.4 billion. Foreign debt was not the company’s only issue as Evergrande’s total liabilities amassed to over $335 billion, ten times its total revenue. Although it seems abrupt, there were warning signs of Evergrande’s eventual demise. Between 2020 and 2021 their assets to debt ratio changed from $333 billion in assets and $282 billion in debt to a staggering $326 billion in assets and $400 billion in debt. This divide widened in 2023, where their liabilities were above their asset value by roughly $90 billion. This steady plunge in assets and increase in liabilities followed the trend that had been occurring in the Chinese real estate market.  

The Chinese economy has been hampered by their real estate sector for years. A boom in housing prices between the 2000s and 2010s caused a shift from government-controlled housing to a more privatized housing market. This shift caused housing, land, and vacancy rates to skyrocket. In turn, these large real estate companies, like Evergrande, who had acquired large swaths of real estate to create apartment buildings and other housing projects found themselves in a conundrum. These large real estate companies were unable to fill their buildings and therefore they had no way to pay their debts. This has caused an ever-increasing bubble in the Chinese economy, not unlike the housing bubble in the U.S. in the late 2000s. 

So how has this liquidation order affected the Chinese stock market and investor faith in the Chinese economy? Although this is a very recent decision, Asian markets reacted to the order almost immediately. The same day as the order, shares of Evergrande plunged over 20% causing a stop in trading of the company’s shares for the day. The next day Asian markets generally fell, showing a further repudiation of the Asian (and mainly Chinese) markets by investors. Hong Kong’s Hang Seng index fell 2.4% and China’s CSI 300 fell nearly 1.8%. China’s economy has already had a torrid time as of late. Evergrande’s liquidation is just another blow for the world’s second largest economy. This decision highlights just how dire the situation is, as there are still major questions about China’s real estate issues and their effects on China’s total GDP and stock markets. The most pressing of these questions is now, “how much worse can it get?”

Key Sources:

Zongyuan Zoe Lie, Does Evergrande’s Collapse Threaten China’s Economy?, Council on Foreign Relations, Feb. 13, 2024.

Kanis Leung & Zen Soo, China Evergrande has been Ordered to Liquidate. The Real Estate Giant Owes over $300 Billion, Associated Press, Jan. 29, 2024. 

Clare Jim & Xie Yu, China Evergrande Ordered to Liquidate in Landmark Moment for Crisis-Hit Sector, Reuters, Jan. 29, 2024. 

Lim Hui Jie & Shreyashi Sanyal, Hong Kong, China Markets Slide in the Wake of Evergrande Liquidation Order, Consumer News and Business Channel, Jan. 30, 2024.