Written by Chris Prentice and Michelle Price
WASHINGTON (Reuters) – A legal attack on the U.S. Securities and Exchange Commission has diminished its powers to oversee Wall Street and is likely to worsen with two impending Supreme Court rulings.
A US appeals court last week struck down a key Securities and Exchange Commission rule imposing stricter oversight of private money, in a new blow to Democratic President Gary Gensler's ambitious agenda to boost transparency and eliminate conflicts of interest on Wall Street.
The court took the unusual step of depriving the SEC of some of its authority to supervise investment advisers. Lawyers said that could make its other draft rules related to cybersecurity, crowdsourcing and predictive data analytics vulnerable to litigation.
The ruling from the New Orleans-based 5th U.S. Circuit Court of Appeals is another example of how business groups are using conservative-leaning courts to overturn SEC rules, limiting their ability to write similar rules and take enforcement actions.
While the “conservative war on the administrative state” aims to weaken federal agencies across the board, Gensler’s ambitious agenda has made the Securities and Exchange Commission, which oversees about 40,000 entities, a prime target.
“This is happening at the government level, and it's very acute at the SEC,” said Satyam Khanna, a former SEC attorney who advised two former Democratic commissioners through 2021. Brokers, and more – and the financial risks can be high.”
The agency faces several other lawsuits from financial companies and trade groups arguing that the agency is exceeding its authority to impose ill-advised and costly rules.
A Reuters review of Westlaw's filings showed a sharp rise in the number of open appeals against the SEC in the 5th Circuit Court of Appeals from 2019 to last year, although it faces litigation in other conservative-leaning courts as well.
Among those cases: Hedge funds sued in the Fifth Circuit to overturn SEC disclosures about short selling, and in a Texas district court to overturn new Treasury securities trading rules, while in March, business groups including the U.S. Chamber of Commerce , as well as Republican-led corporations, filed a lawsuit against the Securities and Exchange Commission's (SEC) climate change rules.
The Chamber is among the most aggressive groups in litigation systems. In December, it won a 5th Circuit challenge to the SEC's rules on stock buybacks and is tracking other draft rules for potential challenges.
“The current SEC has engaged in a remarkable amount of regulatory overreach,” said Darrell Josephfer, senior counsel at the Chamber's Litigation Center.
Reform advocates say the industry just wants to protect its profits, and that weakening the SEC would hurt ordinary Americans.
Speaking to Reuters last Wednesday, SEC Chairman Gary Gensler did not discuss the private funds ruling, but noted that only a few of the dozens of rules adopted under his leadership had been litigated. The agency has scored some notable victories, including in the 5th Circuit, over diversity and proxy voting rules, legal experts note.
But Gensler also said the agency will adjust to adverse rulings.
“We do everything according to the law and how the courts interpret the law. If the courts interpret the law differently than we thought, we tweak and pivot,” he said. He cited as an example the SEC's decision to approve bitcoin products in January after the D.C. Court of Appeals found the agency was wrong to reject them.
Trump appointed 54 judges to the U.S. appeals courts where many lawsuits are filed against federal agencies and pushed the Supreme Court to a 6-3 conservative majority.
When asked if he felt the courts were against him, Gensler said: “I'm a strong believer in the American democratic system and our constitutional system. We have three equal branches of government. That's something that's really important.”
Most of the lawsuits allege violations of the Administrative Procedure Act of 1946, which requires regulators to justify rules and allow time for public comment and full consideration.
Some of the cases depend on a 2022 Supreme Court decision that raised doubts about whether federal agencies have the authority to address major policy matters. That ruling was among the reasons the SEC decided to scale back the climate change rule, Reuters previously reported, and was cited in some lawsuits in March.
Cryptocurrency companies have often cited the “key questions” principle when challenging the SEC’s authority to regulate them.
The SEC made major changes to other key rules after industry opposition, including money market funds and activist investor disclosures.
“A strong industry response in comment filings often raises the specter of litigation,” Khanna said.
Gensler said the agency takes industry comments “very seriously.”
Scotts waves
The Supreme Court is also expected to rule this month in two other cases with major implications for the Securities and Exchange Commission.
One relates to its authority to use in-house judges with expertise in securities law to decide enforcement actions, which is often faster than going to court. Conservative judges last year expressed concern that defendants would be denied a jury trial.
The case comes on the heels of the Supreme Court's 2018 ruling that the SEC's process for selecting in-house judges violates the Constitution. Since then, the SEC has significantly reduced its use of the court, SEC data show.
Another SCOTUS case challenges a legal principle known as “ Chevron (NYSE:) Respect,” which calls on judges to defer to federal agencies' interpretations of U.S. laws that are deemed ambiguous.
Chevron is the cornerstone of the agency's rulemaking. According to 2017 research published in the Michigan Law Review, between 2003 and 2013, Chevron applied 66.7% of the time when litigating SEC rules in circuit courts, and in those cases the agency won just over 81%.
“It is very likely that the court will overturn or sharply reduce the Chevron ruling,” Josephfer said. As a result, he added, “agencies will be less successful in defending their interpretation of the laws, and as a result one hopes that agencies will be more careful in their rulemaking.”