The Supreme Court
The Supreme Court’s decisions have been dominating the legal headlines for some time and it’s no surprise given the impact the Court has on controversial social policy issues, including abortion rights and gun control. But every term, the U.S. Supreme Court also decides cases addressing important financial and economic issues that profoundly affect Americans’ lives.
Some cases that come before the Court directly shape financial regulation. They determine how the securities laws, banking laws, and other financial statutes are interpreted and applied. Will the Court interpret statutes literally and narrowly or in accordance with their underlying purposes and legislative intent so as to achieve their objectives? That approach often defines the scope of the legal authority that agencies have to regulate the industry and protect consumers and investors from fraud, abuse, and conflicts of interest. Other cases present more general legal issues that apply not only in the realm of financial regulation but more broadly. Those decisions also can have a profound impact on the way the Court addresses disputes that affect Americans’ wallets. They raise these types of questions:
- Administrative law – Has an agency exceeded its authority? Has it failed to comply with the procedural requirements applicable to rulemaking under the Administrative Procedure Act (APA), including issuing public notice and giving all stakeholders an opportunity to comment? How much deference should courts afford to the judgments that agencies have made in the rulemaking process? And should an agency be required to demonstrate exceptionally clear delegation of authority from Congress when it seeks to address problems in ways that have major economic or political significance?
- Standing – Have plaintiffs seeking relief suffered (or are they threatened with) the type of concrete and imminent injury that entitles them to be heard in court at all?
- Class action litigation – What hurdles must a group of aggrieved parties surmount before they can band together and bring their claims in court on a collective basis—often the only way many types of injury can be meaningfully redressed.
- Arbitration – Will those harmed by corporate misconduct be forced into arbitration, a secretive and biased process dominated by industry that has proven to be woefully ineffective for investors and consumers, or will they instead be allowed to have their claims heard in a neutral and open courtroom subject to procedural rights and the opportunity to appeal?
- Separation of Powers – Is a regulatory agency structured in a way that violates Constitutional requirements, potentially threatening the validity of its past actions and orders and its viability going forward?
- Transparency – Has an agency adequately responded to public requests seeking access to government documents, or is it improperly invoking exemptions to withhold information?
We’ve issued a number of reports highlighting these critically important economic and financial cases. Read our preview of the current term here, and our recap of the last term here. In our Supreme Court reports, we also focus on the Justices picked to serve on the Court, examining how their judicial philosophy is likely to affect the Court’s approach to financial regulation and administrative law. We’ve profiled three Justices so far, including Justices Kavanaugh (here), Barrett (here), and Jackson (here), highlighting the harmful impact of the conservatives Justices and their antipathy to regulation while expressing hope for a critical counterweight in Justice Jackson.
In September, we’ll issue another report recapping the Court’s major decisions from the past term in the area of financial regulation and administrative law and also examining the important cases pending on the Court’s docket for the upcoming October 2022 term. Two cases deserve special mention here.
THE ASSAULT ON THE ADMINISTRATIVE STATE – West Virginia v. EPA, No. 20-1530 (decided June 30, 2022). In this extraordinarily consequential decision, the Supreme Court squarely applied the “major questions doctrine” to invalidate the EPAs interpretation of the Clear Air Act, holding that Congress did not grant the EPA, in Section 111(d) of the Act, the authority to devise emissions caps based on the approach it took in the Clean Power Plan. The Court invoked the doctrine asserting that where an agency action would have extraordinary “economic and political significance,” it must rest on exceptionally clear congressional authority, something the Court found lacking in this case. The case has huge implications and has provided fresh ammunition to those who seek to attack and nullify a host of other agency rules designed to protect the public interest, including the SEC’s recently proposed climate risk disclosure rule.
The notion underlying the doctrine is that if an agency tackles a problem with major economic or political significance, then it must be able to cite especially clear legislative authority to do so from Congress. But this is a misguided legal contrivance being invoked by those seeking to dismantle or weaken the post-New Deal administrative state that was created to promote the broad public interest by protecting the health, safety, and welfare of all Americans. Recognizing that Congress did not have the expertise and was not structured or able to address some of the most important issues facing the country, it created regulatory agencies to hire experts, gather and analyze data, seek and receive public input, and enact regulations to respond to the many complex issues that arise from a vast and complex economic system and a sprawling, technologically advanced country. The broad public interest is the overriding priority and guidepost of those regulatory agencies.
However, many of the decisions of those regulatory agencies have been opposed by Corporate America, which has sought for decades now to cripple if not kill some of the most important regulatory agencies in the country. This tortured and benighted decision is the result of that decades-long effort. It substitutes the ideology of six unelected, hyper-conservative justices for the data-driven decisions of experts who are mandated to protect the American people. There is little doubt that the Court’s hyper-conservative majority intends to extend this anti-regulatory ideology to the rest of the regulatory agencies. If the doctrine is widely applied, it will mean no regulation, not better regulation, since tying the agencies’ hands and relying on Congress—a divided one at that—to protect the American people means paralysis and inaction in the face of important challenges. The result will be significantly fewer protections for the American people from corporate misconduct, dirty air and water, unsafe toys and other products, dangerous predatory conduct by Wall Street banks, and other threats to the health, safety, and welfare of the American people.”
ATTACK ON THE ADMINISTRATIVE AGENCY ENFORCEMENT PROCESS. The Supreme Court agreed to hear a case in the upcoming term involving yet another attack on the administrative law judges (“ALJs”) that hear most of the SEC’s enforcement actions. In SEC v. Cochran, No. 21-1239, an accountant, Michelle Cochran, was fined over $20,000 and suspended for five years in an SEC administrative enforcement action for violating federal auditing standards. After the Supreme Court ruled in Lucia v. SEC that the SEC’s corps of ALJs had been unconstitutionally appointed in violation of the Constitution, the SEC sent Cochran’s case back for rehearing before a properly appointed ALJ. However, in a defensive maneuver, Cochran challenged the enforcement action on yet another Constitutional ground, asking a federal district court to block the proceeding because the ALJs could only be terminated for cause. She alleged that those limitations on removal of the SEC’s ALJs hampered the President’s ability to see that the law is faithfully executed, in violation of the separation of powers doctrine in the Constitution.
The real issue presented to the court is actually a procedural or jurisdictional one, namely whether the federal district court can entertain her request for an injunction against the enforcement action, since under the Securities laws, respondents must generally wait until a final agency order has been issued and then proceed to a circuit court, not a federal district court, to challenge the order.
Ultimately, the underlying merits of Cochran’s constitutional challenge will be decided, but before then, the Court’s disposition of the jurisdictional issue will be significant. If the Court sides with Cochran and allows such challenges, other respondents will be encouraged to file district court cases seeking to derail administrative enforcement actions against them, at least where they launch Constitutionally-based challenges to the proceedings. And the Court’s decision will also shed light on how the Justices align on matters involving the so-called “administrative state.” The more conservative Justices may well seize the opportunity to complain about what they view as the excessive and unaccountable power of regulatory agencies to write and enforce rules. Of course, this ideology starkly conflicts with the unquestionably successful and longstanding role that the regulatory agencies have played in implementing and enforcing federal statutes to protect the public from a wide range of threats to their health, safety, and financial well-being. The Court will consider and decide the case during the next term, which begins in October.
Other Cases of Interest in the Federal Courts
Noteworthy . . .
CRYPTOCURRENCY ENFORCEMENT – SEC v. Ripple Labs Inc., No. 1:20cv10832 (S.D.N.Y., filed Dec. 22, 2020). Cryptocurrency offerings are grabbing huge attention, as their prices fluctuate wildly, investors take a beating in the latest crypto market plunge, and policymakers wrestle with how to regulate them. The SEC’s position is that many crypto offerings are securities in the form of investment contracts, and an enforcement action filed in December of 2020 illustrates the approach. The SEC filed its case 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. The SEC is seeking an injunction, disgorgement, and civil monetary penalties. The complaint explains that under the Supreme Court’s landmark decision in SEC v. W.J. Howey Co., 328 U.S. 293 (1946), investment contracts are instruments through which a person invests money in a common enterprise and reasonably expects profits or returns derived from the entrepreneurial or managerial efforts of others. The theory advanced in this case is that investors are being asked to speculate on the value of XRP and that its value hinges on the “efforts of others” i.e. the success of the promoters who are trying to generate demand for XRP as a medium for financial firms to effect money transfers. In its complaint, the SEC also highlights the informational vacuum created when promoters fail to register their securities offerings:
Because Ripple never filed a registration statement, it never provided investors with the material information that every year hundreds of other issuers include in such statements when soliciting public investment. Instead, Ripple created an information vacuum such that Ripple and the two insiders with the most control over it—Larsen and Garlinghouse—could sell XRP into a market that possessed only the information Defendants chose to share about Ripple and XRP.
The case is being hotly contested on the merits and also in the discovery stage, and it’s worth watching as one test of the SEC’s application of the investment contract theory to cryptocurrency offerings.
WILL BANKS BE GRANTED A LICENSE TO LIE, AS LONG AS THEIR FALSEHOODS ARE SUFFICIENTLY GENERIC? Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., in the United States Court of Appeals for the Second Circuit, on remand from the Supreme Court.
In the years before the 2008 financial crisis exploded and began dismantling our economy, Goldman Sachs organized, promoted, and sold mortgage-backed securities that, unbeknownst to investors, were essentially designed to fail. Goldman had become convinced that the residential mortgage market was headed for collapse, and it saw a rich profit opportunity. So it bet against the investments even as it foisted them onto countless unsuspecting investors who were persuaded to take the “long side” of the deal. The bank thus had a huge and undisclosed conflict of interest. And in addition to misleading investors, Goldman also misled the public—including its own shareholders—by falsely proclaiming that it had “extensive procedures and controls in place” to manage such conflicts of interest and by reassuring everyone that clients “always come first.” When the truth came out, the bank’s stock price fell, and shareholders suffered losses.
Many of those shareholders, including pension funds, have been struggling for years in the courts to hold the bank accountable for its misrepresentations. The threshold issue now is whether the case can be brought as a class action. And to beat back the shareholder claims, Goldman is advancing the strained argument that its deceptive assurances, which concealed profound conflicts of interest, were too immaterial, typical for the industry, or “exceedingly generic” to have any impact on the bank’s stock price by artificially propping it up.
The case went to the Supreme Court, which held that the general nature of a misrepresentation is a factor a trial court should consider as it decides whether a misrepresentation about a company could have affected the market price of the company’s stock. However, the Court also decided to send the case back to the Second Circuit, since it wasn’t convinced the lower court took the generic nature of Goldman’s misrepresentations properly into account when it allowed the case to go forward. We filed an amicus brief in the Supreme Court supporting the shareholders, detailing Goldman’s history of mishandling its conflicts of interest, and showing why it was clearly important for Goldman’s shareholders to have truthful disclosures about the way the bank managed—or mismanaged—its conflicts.
Now the case is before the Second Circuit and we once again filed an amicus brief urging the court to consider the context and the history of Goldman’s conflicts of interest, something every investor would care about regardless of how “generic” the false representations may have been. By arguing that it should not be liable for its false statements about key subjects like its conflicts of interest because, it claims, they were too generic, Goldman is effectively asking the courts to give them a license to lie. While Goldman may claim that it only wants to avoid legal accountability for its supposedly little or generic lies, those are still lies and they still deceive investors and others, particularly when considered in the context of Goldman’s history regarding its handling of conflicts of interest. In fact, they were hardly “little” in this case. As we have argued, if the courts buy Goldman’s argument, then they should at least require banks to color-code their deception so that everyone knows which ones are supposedly “general” or “little” and which ones are major.
Cases We Continue to Track . . .
SEEKING TO HOLD MARKET MANIPULATORS ACCOUNTABLE – A class-action lawsuit on appeal in the 10th Circuit (In re: Overstock Securities, et al.) in which investors seek to recover damages for a brazen market manipulation scheme allegedly perpetrated by Overstock’s CEO, Patrick Byrne, and others.
- The issue. The plaintiffs have alleged, among other frauds, that Byrne artificially inflated the stock price of Overstock by orchestrating what’s known as a “short squeeze,” a series of actions that forced short sellers to buy stock to cover their positions, thus driving up the price of the stock. They allege that Byrne succeeded; cashed in his own shares at inflated prices, reaping tens of millions of dollars; and essentially admitted the manipulation. The district court in Utah rejected the claims as a matter of law, relying in part on the argument that an essential element of market manipulation is deception, something the court deemed was absent in this case given the overt nature of the defendants’ conduct.
- What we did. On February 2, 2022, Better Markets, joined by the Consumer Federal of America, filed an amicus brief 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 traditional forms of deceit. We also highlight the damaging impact that the district court’s decision will have unless it is reversed. The plaintiffs will almost certainly be left without any remedy for their losses, and over the long-term, market manipulators will be able to fashion schemes that skirt the law but nevertheless wreak havoc in the markets and inflict untold harm among investors.
- Why it matters. Our securities markets are already viewed as unfair and rigged in many ways, and a ruling that immunizes a broad swath of market manipulation schemes is the last thing that investors or the markets really need. That’s why we urged the Tenth Circuit to reverse the district court and allow the claims to be heard.
- Status. Briefing on the merits has wrapped up and oral argument is set for September 28, 2022.
ATTEMPTING TO FORCE ARBITRATION ON SHAREHOLDERS –A lawsuit filed in New Jersey federal district court, and now on appeal (The Doris Behr Irrevocable Trust v. Johnson & Johnson), attempting to force public company shareholders into mandatory arbitration, a biased, secretive, and anti-consumer forum.
- The issue. In this case, a federal court is being asked to decide if a public company can be forced to impose mandatory arbitration not just on its customers but also on any shareholders with claims against the company for fraud, mismanagement, or other breaches of duty. The stakes are high. If the court gets this wrong and allows this dramatic—and dramatically bad—legal development, then the toxic effects of mandatory arbitration will be further broadened, incentivizing corporate lawbreaking by limiting the legal rights of shareholders to enjoin it and hold those responsible accountable. Given that shareholders are the owners of public companies, who rely on legal actions as one important way to protect their investments and police management, such a decision could have a significant and adverse impact on capital formation and allocation.
- Why it matters? Mandatory or forced arbitration takes away the rights of consumers and investors to seek relief in open court before unbiased judges when they are ripped off by banks and corporations. These often fine-print clauses force defrauded investors and other victims into secret, unfair, and biased arbitrations. Those proceedings are generally run by an industry self-regulatory organization that, no surprise, consistently favors the industry. Investors and consumers rarely obtain meaningful recovery.
- Status: In a positive recent development, the district court once again granted defendant Johnson & Johnson’s (J&J’s) motion to dismiss. The court ruled that there’s no real “case or controversy” between the parties because the Trust’s claims are either moot (already resolved) or unripe (not yet ready for resolution). Obviously disappointed by the court’s ruling, the plaintiffs filed their “notice of appeal” to the U.S. Court of Appeals for the Third Circuit on April 8. That means more briefing (which has been delayed at appellants’ request), oral argument, and then a decision from the appellate court months down the road. Depending on which specific legal issues the parties pursue on appeal, this may be a case in which Better Markets decides to file an amicus brief to help defeat attempts to impose mandatory arbitration on shareholders.
TRYING TO MAKE THE MARKETS LESS RIGGED – An industry challenge in the D.C. Circuit (Citadel Securities LLC v. SEC) to the SEC’s approval of a new type of trading order that helps protect investors from predatory trading activity by sophisticated high frequency trading firms.
- The issue. The SEC approved an innovative new order type developed by a pro-investor exchange known as IEX, which helps neutralize the trading advantages that firms like Citadel have because of their high-speed trading technology and preferential data access. Citadel wants to nullify the SEC’s decision and preserve its profits, so it went to court.
- What we did. We filed an amicus brief, explaining the advantages that HFTs enjoy and the harm they inflict on investors. We also showed how the D-Limit Order, which automatically resets its price when HFTs are about to strike, helps neutralize the HFTs’ unfair advantage. Fortunately for investors, the SEC’s mission is to protect investors and the integrity of the markets, not Citadel’s coveted business model, so it approved the IEX order type in accordance with the securities laws and all the requirements surrounding rulemaking. We urged the Court to affirm the SEC’s decision.
- Why it matters. This case will determine whether the SEC can level the playing field for all investors or whether Citadel will succeed in protecting the status quo so it can continue raking in huge and unfair profits. The case will have an enormous impact on the ability of everyday investors to protect their money from being siphoned away by high frequency trading (HFT) firms like Citadel, which is fighting to protect its ability to generate near-certain profits through privileged data access and sophisticated trading technology.
- Status: The case was argued before the D.C. Circuit on October 25, 2021, and we’re watching for the Court’s decision on the merits.
SEEKING TRANSPARENCY ABOUT DIVERSITY ON CORPORATE BOARDS –A challenge in the 5th Circuit (Alliance for Fair Board Recruitment v. SEC) to the SEC’s approval of a new rule issued by the NASDAQ that would help advance the cause of racial justice.
- The issue. The NASDAQ, a major national stock exchange that lists over 3,000 company stocks, recently took a major step forward on the racial injustice front by issuing a new rule that would require each company listed on the 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 SEC approved the rule in August 2021, and the petitioner, the “Alliance for Fair Board Recruitment,” promptly challenged it in the U.S. Court of Appeals for the Fifth Circuit. The Alliance is based in Texas, and its website simply declares that its mission is to “promote the recruitment of corporate board members without regard to race, ethnicity, sex and sexual identity” and further that “The identities of our members are confidential.” The Alliance is arguing that the rule violates the petitioners’ right to equal protection under the Fifth Amendment to the U.S. Constitution, that it also violates the First Amendment by requiring disclosure of controversial information, and that the SEC lacked authority under the securities laws to approve the rule. Briefing is underway.
- Why it matters. A victory in the case by the Alliance will invalidate an important measure that provides key insights into the composition of thousands of boards of directors, information that would undoubtedly and ultimately lead to greater diversity in America’s board rooms and progress toward bringing minorities into the economic mainstream.
- Status: Briefing in the case is wrapping up and the Court has set oral argument for August 29, 2022.
BEGINNING (FINALLY) TO ENFORCE REGULATION “BEST INTEREST” – The first enforcement action filed by the SEC (SEC v. Western International Securities, Inc., No. 2:22-cv-04119 (W.D. Cal.)), alleging violations of its rule aimed at protecting investors from conflicted investment advice.
- The issue. For decades, financial advisers have been allowed to recommend investments that line their own pockets with huge fees and commissions but saddle their clients with low returns and high risks. Those recommendations, heavily influenced by incentives that promote the adviser’s self-interest, have siphoned away billions of dollars in Americans’ hard-earned money every year. In 2019, the SEC issued a rule, titled “Regulation Best Interest” or “Reg BI,” which it claimed would require advisers always to act in the best interest of their retail clients when recommending securities investments. In reality, the rule is weak, vague, and confusing. Nevertheless, it became effective in mid-2020 and even investor advocates believed it could help protect investors from adviser conflicts of interest if it was aggressively enforced by the SEC. Although it took the SEC two years to act, the agency has now taken a step in the right direction and filed the first case alleging violations of the rule.The SEC’s complaint alleges that the defendants, including a broker-dealer and five individual registered representatives, sold over $13 million in high-risk, unrated, and illiquid bonds to retirees and other investors who had only moderate risk tolerances. It specifically claims that the defendants recommended the bonds without having a reasonable basis to believe the bonds were in their customers’ best interest, in violation of the explicit requirements in Reg BI. It also claims the defendants violated their compliance obligations under Reg BI by failing to establish and enforce written policies and procedures reasonably designed to achieve compliance with the rule. The SEC alleges that the defendant firm and the named individuals collectively reaped hundreds of thousands of dollars in commissions and fees from the sale of the risky bonds.
- Why it matters. Even the best rules can have only limited effect if they are not enforced, and even the weakest rules can do some good if they are aggressively enforced. This enforcement action is therefore significant because it will at least send a signal to advisers that the SEC expects compliance with Reg BI as written. That message needs to be sent because the evidence so far—including data gathered by state securities regulators and FINRA, the brokerage industry’s self-regulatory body—indicates that when it comes to managing conflicts of interest, advisers have largely continued with business as usual in the two years since Reg BI was finalized. Thus, even with its flaws, Reg BI can perhaps begin to curb the conflicts of interest that have continued to contaminate investment advice and harm investors.
- Status: We’ll track the case as it is litigated in federal court. We’ll also be watching to see if the SEC follows up with additional enforcement actions under Reg BI to limit the harm that adviser conflicts of interest are having on countless everyday American investors. Finally, we’ll be looking for more guidance from the SEC that can put additional meat on the bones of Reg BI.
ATTEMPTING TO TEAR DOWN EVEN MODEST PROTECTIONS FOR RETIREMENT SAVERS – Two challenges to guidance issued under the Department of Labor’s December 2020 best interest rule (Federation of Americans for Consumer Choice v. DOL (N.D. Tex. filed February 2, 2022) and American Securities Ass’n v. DOL (M.D. Fla. filed February 9, 2022)).
- The issue. OutdatedDepartment of Labor rules have long provided that the law protecting investors from conflicted advice doesn’t apply when an adviser tells a client they should roll their entire nest egg out of a 401(k) account and into other investments, such as annuities that reward advisers with huge commissions. For over a decade, the DOL has been trying to develop new rules to close those gaps and provide better protections for retirement savers. In 2016, it issued a set of strong new rules, but they were struck down by the U.S. Court of Appeals for the Fifth Circuit—the only court, among half a dozen federal courts to hear challenges to the rules, that accepted industry’s arguments. Under the Trump Administration, in December 2020, the DOL came up with a watered-down set of protections that left major gaps intact. However, those rules at least indicated that “rollovers” could be covered under the law, potentially requiring an adviser to make such recommendations only if they were in the client’s best interest. In April 2021, the DOL released a series of “frequently asked questions” in which the agency provided guidance confirming that rollovers, including an initial rollover recommendation to a client, could fall under the rule’s best interest standard. The insurance industry is especially upset at the rule and the guidance because they eat into huge profits from the sale of annuities. They have challenged the guidance in federal courts in Texas and Florida, arguing that the DOL failed to abide by the notice and comment rulemaking requirements set forth in the Administrative Procedure Act.
- Why it matters. For decades, many financial advisers subject to powerful conflicts of interest have been enriching themselves at the expense of their clients by recommending overpriced, poor-performing, and overly risky investment products. The damage has amounted to tens of billions of dollars a year, a cost that is especially harmful to everyday Americans struggling to save and invest for a decent and dignified retirement. If even the modest protections in the DOL’s 2020 rule governing rollovers, as informed by the challenged guidance, fail to survive this legal challenge, then retirement savers will be that much more exposed to the predatory advisers who recommend rollovers to line their pockets, not serve the best interests of their clients.The case is just one example of the relentless assault on DOL’s efforts to protect retirement savers from harmful investment offerings and advice. Earlier this month, a retirement plan provider filed a lawsuit challenging cautionary guidance about cryptocurrency investment options, which was issued by the DOL in March this year. That guidance appropriately cautioned employers to use special care before offering cryptocurrency investments through retirement plans, as cryptocurrencies are among the most volatile and risky investments available today. The lawsuit claims, once again, that the DOL’s guidance violated the APA and exceeded the agency’s authority. See ForUsAll Inc. v. DOL, 1:22-cv-01551 (D.D.C.).
- Status: Briefing on dispositive motions is underway.