WHAT’S NEW AND NOTEWORTHY IN THE FEDERAL COURTS
TEXAS DISTRICT COURT UPHOLDS DEPARTMENT OF LABOR (DOL) RULE CLARIFYING ABILITY OF FIDUCIARIES TO CONSIDER ESG FACTORS IN INVESTMENT DECISIONS – State of Utah, et al. v. Walsh, No. 2:23-CV-016-Z (Sept. 21, 2023) (N.D. Tex.) – Federal court appropriately defers to the DOL’s judgment under Chevron and easily dismisses “major questions” assault on the rule.
The Issue. In 2022, the DOL issued what is known as the “2022 Investment Duties Rule” (Rule). It clarified the duties of fiduciaries when selecting investments for retirement plans under the Employee Retirement Income Security Act (ERISA). Specifically, the new Rule made changes to a prior Trump-era 2020 rule that created confusion and had a chilling effect on the ability of retirement plan fiduciaries to consider environmental, social, and governance (ESG) factors in making their decisions about which investments to select for plans. The Rule made clear that the risk and return factors that plan advisers must always consider may include the ESG factors, depending on the facts and circumstances.
In January 2023, a group of 26 Republican state attorneys general brought a challenge to the Rule, alleging that it violated the statutory requirements of ERISA and was arbitrary and capricious in violation of the Administrative Procedures Act (APA).
The Decision. In a decision issued on September 21, 2023, Trump-appointed Judge Matthew Kacsmaryk rightly rejected the plaintiff’s arguments on both fronts, granting the DOL’s cross-motion for summary judgment and upholding the Rule.
With respect to the plaintiff’s statutory arguments under ERISA, the court applied the two-step analysis of the Chevron doctrine. It first held that Congress had not directly spoken to the issue presented. It then held that the DOL’s interpretation of the law embodied in the Rule was reasonable and indeed consistent with the DOL’s long held position. According to Judge Kacsmaryk, “[t]he 2022 Rule changes little in substance from the 2020 Rule and other rulemakings.” He further explained that “[f]or nearly three decades,” DOL has maintained the position that ERISA does not forbid fiduciaries from considering non-financial ESG factors in their investment decisions, so long as “the selection of competing investments . . . serve the plan’s economic interests equally.” Given this consistent regulatory history, the judge also summarily dispensed with the challengers’ contention, based on the major questions doctrine, that the DOL had asserted an authority of such extraordinary “history and breadth” that more clear Congressional authority was necessary.
Judge Kacsmaryk also rejected a large assortment of arguments that the Rule violated the Administrative Procedure Act. He began by articulating the governing principles of judicial review: The scope of the review is narrow, the court is not to substitute its judgment for that of the agency, and agencies have expertise in administering their statutes “that no court can properly ignore.” Based on these principles and others, the Court readily rejected all of the challengers claims about specific flaws in the Rule. And the judge reflected an appropriately objective application of the law when he wrote that “while the Court is not unsympathetic to plaintiffs’ concerns over ESG investing trends, it need not condone ESG investing generally or ultimately agree with the Rule to reach this conclusion.”
Why It Matters. This case is important for at least three reasons. First, it upholds an important rule that provides helpful clarity to ERISA fiduciaries facing increasing investor interest in ESG investments. The Rule removes impediments to the consideration of the ESG factors. At the same time, it preserves the overriding focus in ERISA on the financial risks and returns that investments offer. And it clarified the tiebreaker scenario in which fiduciaries may rely on the ESG factors in making a final selection between two options that “equally serve” the financial interests of the plan.
Second, the case is a reminder that litigation outcomes are unpredictable, even in courts such as the Fifth Circuit that many regard—with good reason—as ideologically slanted against regulation. The upshot is that the agencies must continue to fashion the most effective rules they believe are necessary to fulfill their statutory mandates and protect the public interest, regardless of the litigation threats they face.
Finally, this case illustrates the importance of the principles that guide judicial review of agency rules, particularly the Chevron doctrine. Here, the Court’s deference to the DOL’s expertise and judgment was an important factor in leading the Court to uphold the Rule, notwithstanding the judge’s own avowed reservations surrounding the ESG investment movement. That’s why the fate of the Chevron doctrine is so important, as we explain in our recent report on the Supreme Court.
SEC DEFEATS CHALLENGE TO NASDAQ’S RULE REQUIRING TRANSPARENCY ABOUT DIVERSITY ON CORPORATE BOARDS – Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir.) (decided Oct. 18, 2023) – Challengers lose bid to nullify the SEC’s approval of a new rule issued by the NASDAQ that helps investors select companies for investment and also advances the cause of social justice.
The Issue. The NASDAQ is a major national stock exchange that lists over 3,000 company stocks. It took a major step forward on the social justice 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 argued 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.
The Court’s Decision. In a decision issued on October 18, 2023, the Fifth Circuit rejected all of the Alliance’s arguments and upheld the NASDAQ’s rule. It held that the constitutional arguments did not apply because the NASDAQ is not a state actor; that the SEC had the authority to approve the rule; and that the SEC’s approval was neither arbitrary nor capricious.
- The Court first held that the challengers’ constitutional claims lacked merit because the NADAQ is a private entity, not a state actor subject to the alleged constitutional restraints. Nor the Court held, is the rule attributable to the government, since listing standards are not a traditionally public function, the SEC did not compel the rule, and the SEC did not act jointly or become closely intertwined with the rule. Mere approval of the rule by the SEC was simply not sufficient to render it government action.
- The Court then held that the SEC acted within its statutory authority when it approved the rule. In support of that conclusion, the Court explained that 1) the SEC appropriately considered subjective evidence of investors’ desire for the information provided by the rule; 2) a rule may require the disclosure of information that doesn’t necessarily constitute “material information” as defined in the context of a fraud action under the securities laws; 3) the rule did not regulate corporate governance, a matter traditionally reserved for the states; and 4) the rule did not violate the “major questions” doctrine.
The Court’s latter ruling was especially important and clear-cut, as the Court flatly rejected the notion that the rule would have enormous political or economic significance. Instead, the Court said, the rule represented the ordinary exercise of the SEC’s authority, calling it “business as usual” for the agency. Moreover, it observed, the securities laws gave the SEC clear authority to approve such exchange rules and provided clear standards for the agency to apply in the process.
- Finally, the Court held that the SEC’s approval of the rule was neither arbitrary nor capricious, since 1) it furthered the objectives of the law, including the maintenance of fair and orderly markets; 2) it did not discriminate unfairly against foreign issuers; 3) the SEC satisfied its limited duty under the law to conduct an economic analysis of the rule; 4) the SEC independently analyzed the data in the record; and 5) it considered the necessary factors in deciding to approve the rule.
Why It Matters. This is a major win for investors, for the cause of social justice, and for the SEC and NASDAQ, which showed commendable leadership by issuing the rule.
As recounted in the opinion, a broad array of investors have demanded more disclosure about the composition of corporate boards, as those investors navigate the markets and analyze the many investment opportunities available.
Disclosure of that information also promises real progress on the social justice front, as it can be expected over time to produce greater diversity in America’s corporate board rooms. Ultimately, that means progress in bringing minorities into the economic mainstream and centers of corporate power.
Finally, the result in this case is a significant win for the SEC. Its rules are subject to a constant barrage of attacks in court, based on a wide range of often weak arguments. Here, the outcome in favor of investors and greater diversity demonstrates that the shameless pattern of forum shopping in the Fifth Circuit doesn’t guarantee success: The three-judge panel took an objective look at the law and the facts and unhesitatingly reached the right result in favor of the rule and against the challengers.
A Brief Look at Other Recent Important Decisions
TEXAS COURT GRANTS INDUSTRY REQUEST TO BAR CFPB FROM POLICING COMPANIES FOR DISCRIMINATORY CONDUCT – CHAMBER OF COMMERCE v. CFPB, No. 6:22-cv-00381 (E.D. Tex., Sep. 08, 2023) – In March 2022, the Consumer Financial Protection Bureau revised its Examination Manual to clarify that discriminatory lending constitutes an unlawful, ‘unfair’ act or practice under the Dodd-Frank Act. The CFPB thus announced it would begin examining for discrimination, including disparate impact, and for whether companies are adequately “testing” for discrimination in their advertising, pricing, and other activities. The Chamber of Commerce sued the Bureau in federal district court in September 2022, alleging (1) that the policy change is invalid because the Bureau is funded in violation of the Appropriations Clause of the U.S. Constitution, as the Fifth Circuit previously held; and (2) that the Bureau’s changes to the manual exceeded its statutory authority and violated the Administrative Procedure Act. On September 8, Judge J. Campbell Barker of the U.S. District Court for the Eastern District of Texas issued a decision in favor of the industry plaintiffs. In a clear example of the impact of the “major questions” doctrine, Judge Barker ruled that the question of the CFPB’s authority to police against discrimination was “a question of major economic and political significance.” According to Judge Barker, a question of such significance should have been answered by a clear, express delegation of authority by Congress—something he found lacking here. Thus, the court vacated the March 2022 update to the examination manual and enjoined the CFPB from pursuing any examination, supervision, or enforcement action against any member of the trade group based on the Bureau’s interpretation of its UDAAP authority issued in the 2022 revised Examination Manual.
FEDERAL DISTRICT COURT DENIES SEC’S 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. On October 3, 2023, Judge Analisa Torres denied the SEC’s motion for an interlocutory appeal, holding that it did not meet the relevant legal standard of presenting a “pure question of law” that could “decided quickly and cleanly without having to study the record.”
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. 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 came to the fore again on September 22nd when the CFTC issued its long-awaited decision denying KalshiEx’s application to offer another political events contract, which would have allowed users to bet thousands of dollars on the outcome of federal elections—a proposal Better Markets has consistently opposed.
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 before the full court on August 1, 2023.
Other Cases We’re Tracking
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 was held on 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 took place on October 3, 2023, during which several of the conservative Justices conveyed their skepticism of the petitioners’ constitutional arguments.
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 was due on October 11, 2023. Oral argument is set for November 29, 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, and oral argument has been scheduled for 9:00 a.m. (Eastern Time) on Thursday, October 26.
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 continued briefing throughout the month of August, and oral argument was heard on Wednesday, September 20.
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.
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.
(For more detailed descriptions of the cases reviewed below, view our Case Tracker.)