WHAT’S NEW AND NOTEWORTHY IN THE FEDERAL COURTS
Spotlight on Massachusetts Victory
HIGH COURT IN MASSACHUSETTS UPHOLDS STATE FIDUCIARY DUTY RULE – Robinhood Financial LLC v. Secretary of the Commonwealth, SJC-13381 (Supreme Judicial Court of Mass., Aug. 25, 2023) – Court unanimously reverses lower court, rejects slew of challenges to the state’s strong state fiduciary duty rule, and allows enforcement action against Robinhood to proceed.
The Issue. All too often, and for many years, broker-dealers have been providing investment recommendations to their retail investor clients that are corrupted by powerful conflicts of interest. They saddle their clients with over-priced, risky, and under-performing products while pocketing large commissions and fees for their own benefit. In 2019, the SEC issued a weak rule, labeled “Regulation Best Interest,” that did little to curb these abuses. Accordingly, in 2020, the Massachusetts Secretary of the Commonwealth, William Galvin, stepped up to fill the gap and promulgated a state fiduciary duty rule. It was designed to compensate for the SEC’s failure to establish a strong and uniform fiduciary standard of care and loyalty applicable to all who dispense investment advice, whether they be broker-dealers or investment advisers.
In 2021, the Secretary brought an administrative enforcement action against Robinhood, alleging that it was taking advantage of its clients in violation of the state’s fiduciary duty rule. Specifically, the Secretary alleged that Robinhood made investment recommendations that encouraged frequent, risky, and unsuitable trading by inexperienced investors on its online trading platform. Robinhood defended by attacking the fiduciary duty rule in state court, claiming that it exceeded the Secretary’s authority, unlawfully abrogated the common law, violated the non-delegation doctrine, and was preempted by virtue of the SEC’s so-called “best interest rule.” The state’s Superior Court agreed with Robinhood and struck down the rule, and the Secretary appealed directly to the Supreme Judicial Court.
The Decision. On August 25, 2023, the Supreme Judicial Court issued a decision squarely and unanimously reversing the lower court and upholding the rule. In a clear and concise opinion, the Court recapped the allegations of abuse against Robinhood; canvassed the evolution in advisory practices among broker-dealers, who have become indistinguishable from investment advisers in the minds of investors; and methodically rejected all four of the legal attacks advanced by Robinhood. It held first that the Secretary had ample authority under Massachusetts law to promulgate the rule and was not bound by “existing norms” or required to seek uniformity in the law governing advisers. Next it held that the rule did not abrogate the common law, as the legislature can and did authorize remedies that go beyond the common law. It then held that the rule did not violate the non-delegation doctrine, as the rule did not represent a fundamental policy shift, the law provided guidance to the Secretary as it fashioned the rule, and safeguards—including judicial review—were in place to ensure compliance with the law.
Finally, the court held that the SEC’s “Reg BI” did not preempt the state rule. The court cited multiple reasons, including the strong presumption against preemption of state law, Congress’s awareness of long-standing state securities regulation and refusal to preempt it, and the SEC’s similar refusal to preempt state law in Reg BI. The court concluded that the SEC’s Regulation “Best Interest” “constitutes a regulatory floor that does not foreclose State regulation to more clearly protect investors.”
Better Markets filed an amicus brief in the case in support of the Secretary and the rule. We highlighted the threat to investors from adviser conflicts of interest and focused particular attention on the flaws in Robinhood’s preemption argument.
Why It Matters. This decision is a significant victory for investors, for Massachusetts, and for all states that seek to strengthen investors protections against damaging conflicts of interest among advisers. It also means that Robinhood will face accountability for the damage it has done to investors through its conflict-ridden trading platform. And we hope and expect that other states will be prompted by the decision to strengthen their own rules and establish a strong and uniform fiduciary obligation requiring all advisers to act in the best interest of their clients without regard to their own financial gain.
A Brief Look at Other Recent and Important Decisions
DISTRICT COURT HOLDS CRYPTOCURRENCY OFFERINGS ARE SECURITIES, REJECTING FLAWED REASONING IN THE RIPPLE CASE – SEC v. Terraform Labs PTE LTD & Do Kwon, 1:23-cv-1346 (S.D.N.Y., July 31, 2023) – In February 2023, the SEC filed an action in the U.S. District Court for the Southern District of New York alleging that Terraform Labs PTE, Ltd. and Do Kwon had orchestrated a multi-billion dollar crypto asset securities fraud involving an algorithmic stablecoin and other crypto asset securities. In April 2023, the defendants filed a motion to dismiss the case, asserting that the digital assets at issue were not securities. On July 31, 2023, Judge Jed S. Rakoff denied the defendants’ motion, finding that defendants’ products were unregistered investment-contract securities that enabled investors to profit from the supposed investment activities of defendants and others. In doing so, Judge Rakoff expressly rejected the approach recently taken by a different judge in SEC v. Ripple, which held that Ripple’s cryptocurrency was not a security when sold to ordinary retail investors on exchanges. The Terraform decision is a huge win for investors, who continue to be bombarded with countless crypto offerings, as it will help ensure that investors receive the vital registration, disclosure, and anti-fraud protections under the securities laws that have protected investors for almost a century.
SECOND CIRCUIT SAYS SYNDICATED LOANS ARE NOT SECURITIES – Kirschner v. JP Morgan Chase Bank, N.A., No. 21-2726 (2d Cir. Aug. 24, 2023) – Are syndicated loans, where banks underwrite a loan to a company and then divide the loan into parts and sell those parts to investors, securities? On August 24, the Second Circuit said no, even though it recognized that investors expect to profit through interest payments. The court’s ruling means that investors in syndicated loan transactions are left without the protections of the securities laws. The syndicated loan market is lightly regulated, despite the similarities between syndicated loans and instruments that are treated as securities. For example, investors in syndicated loans expect to profit from the efforts of others. And interests in syndicated loans are expected to be widely distributed and traded. The failure to extend the protections of the securities laws to syndicated loans leaves that significant market vulnerable, which could have far-reaching ramifications for investors and the broader economy.
SECOND CIRCUIT EFFECTIVELY GRANTS BANKS A LICENSE TO LIE, AS LONG AS THEIR FALSEHOODS ARE SUFFICIENTLY “GENERIC” – Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., (In re Goldman Sachs Group, Inc.), No. 22-484 (2d Cir., AUG. 10, 2023) – On August 10, 2023, the Second Circuit reversed the certification of the class of Goldman Sachs shareholders who sought to hold the bank accountable for misrepresentations concerning its sale of mortgage-backed securities. In a long and convoluted opinion, the court held that given the generic nature of the alleged misrepresentations, the “mismatches in specificity” between the alleged misstatements and the subsequent corrective disclosures, and the special challenges surrounding allegations of deception by failure to disclose, the bank had shown by a preponderance of the evidence that the misrepresentations did not impact Goldman’s stock price, thus rebutting the normal presumption of reliance and precluding class certification. By arguing that it should not be liable for its false statements because they were too generic, Goldman effectively asked the court to give it a license to lie. Unfortunately, the Second Circuit has in effect granted that request with its decision. The holding will undermine investor protection by raising the already challenging hurdles for class certification, here with respect to the presumption of investor reliance necessary for a securities fraud class action to proceed.
FIFTH CIRCUIT GIVES POLITICAL GAMBLING CONTRACTS AT LEAST A TEMPORARY BOOST – Clarke v. CFTC, No. 22-51124 (5th Cir., July 21, 2023) – In August 2022, CFTC staff withdrew a no-action letter it had previously granted to PredictIt, a platform offering event wagering contracts, and instructed PredictIt to wind down its political betting operations in the United States. PredictIt then sued the CFTC, alleging that the revocation of the no-action letter was arbitrary and capricious in violation of the Administrative Procedure Act, and seeking an injunction of the revocation pending the litigation of that challenge. On July 21, 2023, the Fifth Circuit held that the withdrawal of the no-action letter was final agency action subject to review, that the withdrawal was not unreviewable as subject to agency discretion, and that a preliminary injunction pending resolution of the merits was warranted. The court held that PredictIt was likely to succeed on the merits, as the withdrawal of the no-action letter failed in the court’s view to adequately explain the grounds for the revocation. The Fifth Circuit’s decision casts doubt over the CFTC’s power and authority to regulate an emerging trend—the rise of political event contracts, which pose significant threats to the public interest. The future of those contracts will come to the fore again soon as we await the CFTC’s decision on Kalshi’s application to offer another political events contract.
Other Notable Cases We’re Tracking
(For more detailed descriptions of the cases reviewed below, view our Case Tracker.)
- SUPREME COURT WILL REVIEW RULING THAT WEAKENS PROTECTIONS AGAINST WHISTLEBLOWER RETALIATION – Murray V. UBS Securities, LLC, No. 22-660 – The Supreme Court has agreed to review a Second Circuit decision holding that a whistleblower’s Sarbanes-Oxley Act claim for retaliation requires a showing that the employer took an adverse employment action against the whistleblower with “retaliatory intent,” as opposed to merely showing that the whistleblower’s actions were a “contributing factor” in the adverse employment action. This case has broad implications for whistleblowers and whether they can feel safe coming forward without fear of reprisal from their employers. Oral argument is set for October 10, 2023.
- SUPREME COURT WILL DECIDE CONSTITUTIONALITY OF CFPB’S FUNDING STRUCTURE, WITH IMPLICATIONS FOR THE FEDERAL RESERVE AND OTHER SIMILARLY-FUNDED AGENCIES – Consumer Financial Protection Bureau v. Community Financial Services Association of America, No. 22-448 – The Supreme Court has agreed to review the 5th Circuit’s decision that the Consumer Financial Protection Bureau’s funding structure violates the Appropriations Clause of the U.S. Constitution. This case is part of the relentless and ongoing assault on one of the most effective consumer protection agencies in the history of financial regulation. Oral argument is set for October 3, 2023.
- SUPREME COURT WILL REVIEW CONSTITUTIONALITY OF THE SEC’S ADMINISTRATIVE ENFORCEMENT PROCESS – Securities and Exchange Commission v. Jarkesy, No. 22-859 – The Supreme Court has also agreed to review the Fifth Circuit’s decision that the SEC’s administrative enforcement proceedings before administrative law judges or “ALJs” violate the Constitution’s separation of powers doctrine, the non-delegation doctrine, and the Seventh Amendment right to a jury trial. The lower court decision delt a serious blow to a vitally important mechanism the SEC uses to fight fraud in the securities markets. The SEC filed its brief on the merits on August 28 and the respondents’ merits brief is due on October 11, 2023.
- NINTH CIRCUIT CLOSES THE COURTHOUSE DOORS TO WRONGED INVESTORS, JEAPORDIZING THE RIGHT OF SHAREHOLDERS TO HOLD COMPANIES ACCOUNTABLE – Lee v. Fisher, No. 21-15923, 2023 WL 3749317 (3:20-cv-06163-SK) (9th Cir., June 1, 2023) (en banc); Lee v. Fisher, 34 F.4th 777 (9th Cir. May 13, 2022) – Can a company adopt bylaws to cancel or nullify federal securities laws, including those designed to hold companies accountable for misconduct that hurts shareholders? Unfortunately, an en banc panel of the Ninth Circuit recently said “yes” in an opinion issued on June 1st in Lee v. Fisher. In a recent procedural move, the plaintiff/appellant, Lee, petitioned the court for another rehearing, this time by all of the judges on the Ninth Circuit. In November 2022, Public Citizen, joined by Better Markets and the Consumer Federation of America, filed an amicus curiae brief in the case in support of Lee. We weighed in again on July 3rd with another amicus brief to support this latest bid by Lee to correct the court’s flawed decision, which leaves her with no forum in which to bring her derivative claim that The Gap made misrepresentations in its proxy materials. Unfortunately, however, the Ninth Circuit denied Lee’s petition for a rehearing en banc on August 2, 2023.
- FEDERAL DISTRICT COURT REJECTS CHAMBER OF COMMERCE’S CHALLENGE TO SEC’S PROXY ADVICE RULE – Chamber of Commerce v. SEC, No. 3:22-cv-00561 (M.D. Tenn., Apr. 4, 2023) – The U.S. District Court for the Middle District of Tennessee sided with the SEC and investors in a strong opinion rejecting industry’s attacks on the SEC’s improvements to its proxy advice rule. Those rule changes were necessary to ensure that shareholders can get independent and timely advice on how to vote their proxies. The Chamber of Commerce has recently appealed the ruling to the Sixth Circuit (No. 23-5409). Both parties filed briefs with the Sixth Circuit during the month of August, although the court has yet to schedule oral argument.
- CHAMBER OF COMMERCE CHALLENGES SEC STOCK BUYBACK RULE IN FIFTH CIRCUIT – Chamber of Commerce v. SEC, No. 23-60255 (5th Cir., May 12, 2023) – The Chamber of Commerce has challenged the SEC’s recently finalized share repurchase or “buyback” disclosure rule, alleging it violates the rulemaking procedures set forth in the Administrative Procedure Act. In fact, the SEC’s rule simply ensures that investors have more information about when, how, and why companies are spending their excess capital on buybacks, often used to enrich executives, instead of enhancing operations and employee welfare. On August 16, 2023, Better Markets filed an amicus curiae brief with the U.S. Court of Appeals for the Fifth in support of the SEC, noting that the share repurchase rule provides key information to investors and should be upheld against these baseless attacks. The parties have continued briefing throughout the month of August, and oral argument is currently scheduled for Wednesday, September 20.
- SEC SEEKS INTERLOCUTORY APPEAL IN RIPPLE – SEC v. Ripple Labs Inc., No. 1:20-cv-10832 (S.D.N.Y.) – In 2020, the SEC filed a major enforcement action in federal district court against Ripple Labs, Inc. and two of its principals, alleging that since 2013, the defendants had been selling digital assets (known as “XRP”) that were unregistered securities under the Howey investment contract test. In July, the court issued a mixed ruling on the parties’ dispositive motions, holding that Ripple’s XRP cryptocurrency is both a security and not a security, depending on who purchases the digital asset. Its ruling thus affords protections to “sophisticated” institutional investors but not to individual retail investors purchasing crypto on a public exchange—an outcome that cannot be reconciled with the letter or spirit of the securities laws or the Supreme Court’s broad test in Howey. On August 18, the SEC filed a motion in the district court seeking leave to pursue an interlocutory appeal of that ruling. The district court has yet to rule.
- SEC HAS BEGUN TO ENFORCE REGULATION “BEST INTEREST” – SEC v. Western International Securities, Inc., 2:22-cv-04119 (C.D. Cal.) – The SEC is litigating its first enforcement action alleging violations of its “Best Interest” rule aimed at protecting investors from conflicted investment advice. The outcome will help determine whether the so-called “best interest” rule will have any teeth and provide real protections for investors who are sold inferior investments by advisers seeking to line their own pockets. For now, a jury trial has been set to begin January 30, 2024.
- INDUSTRY OPPOSES TRANSPARENCY ABOUT DIVERSITY ON CORPORATE BOARDS – Alliance for Fair Board Recruitment v. SEC, 21-60626 (5th Cir.) – Opponents have challenged the SEC’s approval of a rule issued by the NASDAQ that would help advance the cause of racial and gender justice by requiring each company listed on the NASDAQ exchange to publicly disclose the self-identified gender, racial, and LGBTQ+ status of each member of the company’s board of directors. The rule also requires each listed company to have, or explain why it does not have, at least two members of its board who are diverse, including at least one director who self-identifies as female and at least one director who self-identifies as an underrepresented minority or LGBTQ+. The court heard oral argument on August 29, 2022, but it has yet to issue a decision.
- INVESTORS SEEK TO HOLD MARKET MANIPULATORS ACCOUNTABLE– In re: Overstock Securities, et al., 21-4126 (10th Cir.) – Investors seek to recover damages for a brazen market manipulation scheme allegedly perpetrated by Overstock’s CEO, Patrick Byrne, and others. A Utah district court wrongly dismissed the claims under the theory that deception is an essential element of market manipulation claims. In the appeal, Better Markets and Consumer Federation of America filed an amicus brief in February 2022 explaining not only the legal errors in the district court’s decision but also the more far-reaching harm that the decision threatens unless it is reversed. In our brief, we showed that the securities laws and rules were written broadly to cover fraud and manipulation as two separate forms of illegal conduct, driving home the point that manipulation schemes distort share prices and inflict harm on investors regardless of whether they were carried out using lies or deceit. The court heard oral argument on February 9, 2023, but it has yet to issue a decision.
- THE INSURANCE INDUSTRY ATTEMPTS TO TEAR DOWN EVEN MODEST PROTECTIONS FOR RETIREMENT SAVERS – Federation of Americans for Consumer Choice v. DOL, No. 3:22-cv-00243(N.D. Tex., filed February 2, 2022) and American Securities Ass’n v. DOL, No. 8:22-cv-00330 (M.D. Fla., filed February 9, 2022) – Industry associations filed two challenges to pro-investor guidance issued under the Department of Labor’s December 2020 best interest rule. That guidance clarifies when even a single piece of advice to roll over retirement assets can be considered the beginning of an ongoing relationship and therefore covered under the DOL’s rule. In the Florida case, American Securities Ass’n v. DOL, the court resolved cross-motions for summary judgment in February 2023. In that ruling, the court rejected some of the plaintiffs’ claims but also vacated part of the Department of Labor’s guidance. In the Texas case, Federation of Americans for Consumer Choice v. DOL, dispositive motions have yet to be resolved. While a magistrate has issued recommended findings and conclusions for the court’s consideration, and the parties have lodged their own objections, the court has yet to issue its opinion.