WHAT’S NEW AND NOTEWORTHY IN THE FEDERAL COURTS
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) – Texas Federal District Court Strikes Down Changes to CFPB Examination Manual, Which Clarified that Discriminatory Lending Constitutes an ‘Unfair’ Act or Practice in Violation of the Dodd-Frank Act.
The Issue. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Consumer Financial Protection Bureau has the power to police against “unfair, deceptive, and abusive acts and practices” (UDAAP) in the financial services marketplace. As part of this authority, the Bureau is empowered to name the specific acts or practices it considers as “unfair,” “deceptive,” or “abusive.”
Dodd-Frank also provided the CFPB with examination authority, which gives CFPB staff—known as “examiners”—access to important company information to monitor their compliance with banking laws. The CFPB’s examination practices are set forth in what is known as its “Supervision and Examination Manual.” According to the Bureau, “The manual describes how we supervise and examine these companies and gives our examiners direction on how to assess compliance with federal consumer financial laws.” As described by the district court in this case, “[a]gency examiners can request internal company data, interview a company’s managers and employees, and observe operations at company facilities.”
In March 2022, the CFPB revised its Examination Manual to clarify that discriminatory lending constitutes an unlawful, ‘unfair’ act or practice under its UDAAP authority. The Bureau thus announced that 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, along with a handful of other industry trade groups, sued the Bureau in federal district court in September 2022, alleging (1) that the rule is invalid because the Bureau is funded in violation of the Appropriations Clause of the U.S. Constitution, as the Fifth Circuit previously held; (2) that the Bureau’s changes to the manual exceeded its statutory authority under Dodd-Frank, and (3) that the Bureau’s changes to the manual violated the Administrative Procedure Act, both procedurally and substantively.
The Decision. 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. After disposing of the CFPB’s defenses based on sovereign immunity and standing, Judge Barker followed the Fifth’s Circuit ruling in Community Financial Services Assoc. v. CFPB and summarily held that the Bureau’s independent funding structure violated the Appropriations Clause of the U.S. Constitution, thus invalidating the enforcement manual changes.
However, because the status of the CFPB’s funding mechanism is under review before the Supreme Court, Judge Barker articulated a separate basis for striking down the manual. He ruled that the Bureau in fact exceeded its authority under Dodd-Frank by instructing its examination staff to review companies for discriminatory practices. In a clear example of the impact of the “major questions” doctrine, announced by the Supreme Court last year in West Virginia v. EPA, Judge Barker ruled that the question of the CFPB’s authority to police against discrimination was “a question of major economic and political significance.” He asserted that it would have large economic implications for the entire financial-services industry, as well as significant political implications as to the balance of state and federal authority to police discrimination. 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.
Although Dodd-Frank did empower the Bureau to define what constitutes an “unfair” practice, Judge Rakoff held that Congress intended for unfairness and discrimination to be separate concepts under Dodd-Frank:
[T]he Dodd–Frank Act treats discrimination and unfairness as distinct concepts. For instance, in setting forth its objectives for the agency, Congress directs the CFPB to exercise its authorities to ensure that, with respect to financial products and services, “consumers are protected from unfair, deceptive or abusive acts and practices and from dis-crimination.” Congress did not say “including discrimination” or “such as discrimination.” It used the word “and” to conjoin two distinct concepts—UDAAP and discrimination. And only the agency’s UDAAP authority is invoked in the manual provisions at issue here.
The court declined to reach the substantive and procedural arguments based on the Administrative Procedure Act, since it had found two independent grounds on which to strike down the manual revisions—the Appropriations Clause and the major questions doctrine. 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.
Why It Matters. The CFPB’s examination authority is an important information-gathering tool that helps financial regulators ensure compliance and stay apprised of real-time developments in financial-services companies. The decision in Chamber of Commerce v. CFPB denies the Bureau this vital information-gathering tool, leaving the agency ill-equipped to police financial practices that foster discrimination. It also helps entrench the major questions doctrine, an exceedingly vague principle that gives federal judges enormous discretion when deciding whether an agency seeking to protect the public has acted beyond its authority.
Despite these harmful effects, the decision is limited in scope insofar as the final injunction applies only to the specific companies represented by the trade groups that sued along with the Chamber of Commerce. Thus, it is possible that additional trade associations may seek to intervene in the case in an effort to obtain the benefits of the injunction for their members—a strategy that has proven effective in other litigation, such as the separate lawsuit challenging the CFPB’s small business data collection rule.
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. 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.
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, 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 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. Briefing is now complete and we await the court’s decision.
- 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.