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May 30, 2023

Actions in the Federal Courts – Month in Review Newsletter – May 2023


FEDERAL COURT REJECTS CHAMBER OF COMMERCE’S CHALLENGE TO SEC’s PROXY ADVICE RULE – Chamber of Commerce v. SEC, No. 3:22-cv-00561 (Apr. 04, 2023) – Middle District of Tennessee sides with SEC and investors in rejecting industry’s predictable attacks on proxy advice rule.

The Issue. The right to vote on corporate leadership and policy choices is one of the most fundamental shareholder rights. Meaningful exercise of corporate suffrage can help ensure that boards and management are accountable to shareholders and other stakeholders. And the right to vote not only on the selection of board members but also on the adoption of major corporate policies can help ensure that shareholders have a voice in corporate strategies affecting the company itself, the communities in which they operate, and even the world at large.

To that end, advisory services for shareholder proxy voting are a central feature of modern corporate governance and capital markets. These services help shareholders decide how to vote on extremely important issues, including the election of corporate executive compensation, and fundamental corporate policy, all matters of increasingly intense interest to shareholders in the era of ESG investing. The SEC has traditionally exempted the providers of these services from compliance with its proxy solicitation rules.  Yet, in 2020, the SEC issued a new rule to narrow this exemption.   In part, the 2020 rule conditioned the exemption on notice of the proxy advice to the company holding the vote and an opportunity for that company to respond in writing prior to the voting. These reforms were staunchly opposed by shareholders but heavily favored by company managers seeking to minimize interference with their control over company votes. In 2022, the Commission assessed the market response to the 2020 rule and decided to rescind the notice-and-response condition for reliance on the exemption.  The SEC reasoned that this condition had proved too costly and threatened the ability of the proxy advisory firms to provide timely and independent advice to their clients. However, like clockwork, the Chamber of Commerce challenged this rule in federal court, arguing that the SEC violated the Administrative Procedures Act (APA) in issuing the rule.

The Decision. In late April, the U.S. District Court in the Middle District of Tennessee rejected the industry’s now-typical laundry list of baseless attacks on SEC rulemakings, and it upheld the SEC’s rule protecting the right of investors to receive independent and timely advice about upcoming proxy votes. The court methodically considered and rejected numerous challenges to the SEC’s decision to revise the Trump-era rule that unduly burdened proxy advisory firms, undermined the public interest, and was met with staunch opposition from all but corporate management and their allies. Despite the industry’s long list of familiar claims to the contrary, the court found that the SEC’s rule squarely complied with the APA’s requirements. For example, the court found that the official 30-day comment period (which in reality was considerably longer) complied with the law, that the SEC’s qualitative economic analysis of its rule was sufficient, and that the SEC adequately explained the rule, including the decision to revisit and modify the misguided 2020 rule adopted under the Trump Administration.

Why It Matters. The court’s ruling will remove a cloud hanging over an important rule that investors need to ensure their access to independent, timely, and affordable advice regarding how their proxies should be voted.  Put differently, investor protection triumphed over corporate management’s attempt to burden and constrain proxy advisers. Unfortunately, the industry has continued its assault in the courts by appealing this decision to the Sixth Circuit Court of Appeals, hoping to find a panel of judges that will accept their claims. We’ll track the case as it is litigated in federal court, but we hope and expect the Sixth Circuit will affirm the lower court ruling and side with investors over corporate management.

ATTEMPTING TO FORCE ARBITRATION ON SHAREHOLDERS – The Doris Behr Irrevocable Trust v. Johnson & Johnson, No. 22-1657 (3rd Cir.) (May 09, 2023) – Third Circuit rebuffs pro-arbitration advocates’ attempt to force public company shareholders into mandatory arbitration — a biased, secretive, and anti-consumer forum.

The Issue. In this case, a federal court was 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 Decision. As we anticipated, the Third Circuit easily disposed of the Plaintiff’s request for a declaratory judgment and an injunction requiring Johnson & Johnson to include a mandatory shareholder arbitration proposal in the company’s proxy materials.  In a short, “non-precedential” opinion, the court ruled that the case was not justiciable under Article III’s case or controversy requirement for two reasons.  First, the claim was not ripe, as any notion that Johnson & Johnson’s prior refusal to include the proposal created a “taint” was too speculative.  Second, the claim was moot, since Johnson & Johnson has twice agreed to include the proposal in its proxy materials.

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 have been 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 consistently favors the industry. Investors and consumers rarely obtain meaningful recovery.

Because this case did not lead to a substantive decision about the legality under state or federal law of a mandatory shareholder arbitration by-law, its significance is limited. However, by dismissing the plaintiff’s request to impose mandatory arbitration on Johnson & Johnson shareholders, this decision in effect sided with investors and fended off a bid to deprive investors of meaningful relief when they are harmed by corporate malfeasance or mismanagement.

CHAMBER OF COMMERCE CHALLENGES SEC STOCK BUYBACK RULE IN FIFTH CIRCUIT COURT OF APPEALS – Chamber of Commerce v. SEC, No. 23-60255 (5th Cir.) (May 12, 2023) – Chamber of Commerce challenges SEC’s newly approved share repurchase disclosure rule.

The Issue. Following the SEC’s recent approval of the stock buyback rule, for which Better Markets submitted a comment letter in support, the Chamber of Commerce has filed a new suit in the Fifth Circuit challenging the rule. The SEC’s rule requires publicly traded companies to disclose more information about their share repurchase programs in their quarterly or semi-annual reports.  For example, under the new rule, issuers will be required to disclose the day the shares were repurchased, the number of shares purchased, and the average price at which they were repurchased. They must also disclose the objective or rationale for the buybacks and the criteria used to determine the size of the buyback.  And they must indicate whether certain directors or officers traded in the relevant securities within four business days before or after the public announcement of an issuer’s repurchase plan.

Why It Matters. Stock buybacks, especially by the largest corporations, have grown dramatically in recent years, both in terms of dollar amount and percentage of net income. In fact, for the last two decades, corporate spending on buybacks has represented roughly half of total net income. This type of activity is increasingly viewed as a way for corporate executives to line their pockets at the expense of the long-term health of the company, its employees, and its shareholders.

The stock buyback rule, while far from perfect, will go a long way in addressing the information asymmetries that currently exist between insiders on the one hand and investors, analysts, workers, and regulators on the other.  With more detailed information, investors will be better equipped to assess the impact of repurchases on stock price and to evaluate the underlying purposes of the repurchases — whether they are opportunistic choices made in the self-interest of management or genuinely prudent strategies in the interest of the company and its stakeholders.  This new lawsuit threatens the rule and all of the transparency benefits it can provide, and we will watch the case closely.


CRYPTOCURRENCY ENFORCEMENT – SEC v. Ripple Labs Inc.No. 1:20-cv-10832 (S.D.N.Y., filed Dec. 22, 2020) – The SEC deploys investment contract theory to protect investors from crypto abuses.

The Issue.  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 most 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.”

Why It Matters.  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. To its credit, the SEC has not hesitated to apply the securities laws to any issuers or promoters of crypto offerings that constitute securities.  A ruling against the SEC in this case would strike a blow against the agency’s ability to police the crypto markets, which are inflicting huge damage on investors.

Cross-motions for summary judgment are due from each party on June 13.

BEGINNING (FINALLY) TO ENFORCE REGULATION “BEST INTEREST” – SEC v. Western International Securities, Inc., No. 2:22-cv-04119 (C.D. Cal.) – The SEC files its first enforcement action 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.

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.  For now, jury trial has been set to begin January 30, 2024.

SEEKING TRANSPARENCY ABOUT DIVERSITY ON CORPORATE BOARDS – Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir.) – Opponents challenge 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, 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.

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. The court heard oral argument on August 29, 2022, but it has yet to issue an opinion.

SEEKING TO HOLD MARKET MANIPULATORS ACCOUNTABLE – In re: Overstock Securities, et al., No. 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.

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.  The court heard oral argument on February 9, 2023.

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 re Goldman Sachs Group, Inc.), No. 22-484 (2d Cir.) – A bank asserts a defense to fraud claims that in effect allows deception.

The Issue.  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 Supreme Court’s Decision. 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.  141 S. Ct. 1951 (decided June 21, 2021). However, the Court also decided to send the case back to the lower court, 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.

Following remand and another class certification in the district court, the case is once more before the Second Circuit and in July 2022, we once again filed an amicus brief similarly 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.  Oral argument was held before the Second Circuit on September 21, 2022, and we await that Court’s decision in light of the Supreme Court’s instructions.

Why It Matters. 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 insist that it only wants to avoid legal accountability for its supposedly little or generic lies, those falsehoods 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” misrepresentations 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 deceptive statements so that everyone knows which ones are supposedly “general” or “little” and which ones are major.

ATTEMPTING 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 file two challenges to guidance issued under the Department of Labor’s December 2020 best interest rule.

The Issue. Outdated Department of Labor (DOL) 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 parties have briefed dispositive motions in both cases.  In the Florida case, Securities Ass’n v. DOL, the court resolved the cross-motions for summary judgment in February 2023. In that ruling, the court rejected some of the plaintiffs’ claims but also vacated the DOL’s FAQ 7 addressing when rollover advice may be considered advice on a “regular basis.” In the Texas case, Federation of Americans for Consumer Choice v. DOL, dispositive motions have yet to be resolved.



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