The Supreme Court
Recently, the Supreme Court has issued a number of high-profile and extraordinarily controversial decisions concerning major social policy issues, including abortion rights and gun control. But the fact remains that every term, the U.S. Supreme Court also decides cases addressing important financial and economic issues that profoundly affect Americans’ lives. We regularly issue 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, a set of legal principles that can determine the fate of the agency rules that regulate our markets. We’ve profiled three Justices so far, including Justices Kavanaugh (here), Barrett (here), and Jackson (here). Those reports showed that the pro-business and anti-regulatory attitudes of Justices Kavanaugh and Barrett would hamper the ability of agencies to effectively regulate the financial markets and deprive many investors and consumers of the chance to seek meaningful relief in court for the damages they’ve sustained at the hands of a too-often predatory financial system. On the other hand, our profile of Justice Ketanji Brown Jackson showed that she promises to be an exemplary Justice, one who is more likely to uphold strong regulation and give investors and consumers a fair opportunity to seek redress.
In addition to our reports, we also track a number of individual Supreme Court cases addressing financial regulation, the rights of investors to seek relief in court, and administrative law. Here are some of those cases and the issues they present.
Overturning Agency Action. On June 15, 2022, the Court issued its decision in American Hospital Assoc. v. Becerra, 967 F.3d 818 (2020) (S. Ct. Docket No. 20-1114). The Court unanimously held, in an opinion written by Justice Kavanaugh, that the federal Medicare statute did not authorize the Department of Health and Human Services (HHS) to vary the prescription drug reimbursement rates for certain groups of hospitals, in this case hospitals serving low-income and rural communities. Contrary to what many Court watchers expected, the Court never reached the question of whether HHS’s interpretation of the statute deserved judicial deference under the Chevron doctrine. Under Chevron, courts generally defer to reasonable or permissible agency interpretations of the law, unless Congress has clearly spoken to the issue and resolved it in the statutory language. Here, the Court apparently felt that the statutory language and structure of the Medicare law were clear-cut, preventing the HHS from calculating reimbursement rates under its different reading of the statute. In the words of the opinion, “Under the text and structure of the statute, this case is . . . straightforward,” adding “we do not agree with HHS’s interpretation of the statute.”
Nevertheless, the Chevron doctrine may figure prominently during the Court’s next term beginning in October. The degree of deference that federal courts must afford to an agency’s interpretation of the law is a question that has drawn increasing attention as Justice Gorsuch and other conservative Justices have expressed strong opposition to the deference rule, viewing it as giving agencies—often referred to as the “administrative state”—too much power or influence. It matters a great deal, since the doctrine can in many cases determine whether an agency rule, written by an expert agency to protect the public’s health, safety, and financial security, will survive judicial review.
Attack on the Administrative Agency Enforcement Process. In another significant development, the Supreme Court recently agreed to hear a case involving 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.
Adding fuel to the anti-regulatory fire kindled by the Cochran case is a May 18 decision from the Fifth Circuit. In Jarkesy v. SEC, No. 20-61007, a divided three-judge panel ruled that (1) the SEC’s administrative adjudication of an enforcement action against a hedge fund manager for fraud violated the Seventh Amendment right to a jury trial; (2) Congress unconstitutionally delegated legislative power to the SEC by failing to provide an intelligible principle by which the SEC would determine which cases to try before an ALJ and which to pursue in federal court; and (3) the statutory removal restrictions on SEC ALJs conflicted with the President’s Article II duty to “take care that the laws be faithfully executed.” This case, along with Cochran, indicates that attacks on regulatory agencies are on the rise and may receive increasingly sympathetic attention from the courts.
Other Cases of Interest in the Federal Courts
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 we expect the Court will soon schedule oral argument, with a decision to follow typically several months thereafter.
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 will start in July), 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 tentatively set oral argument for the week of August 29th.
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, including on the SEC’s motion to dismiss the case.