Chris Prentice and Michelle Price
WASHINGTON (Reuters) – The legal assault on the U.S. Securities and Exchange Commission is eroding its authority to oversee Wall Street and is likely to intensify with two upcoming Supreme Court decisions.
A U.S. appeals court last week struck down a landmark Securities and Exchange Commission (SEC) rule imposing stricter oversight of private funds, the latest blow to Democratic Chairman Gary Gensler’s ambitious agenda to increase transparency and eliminate conflicts of interest on Wall Street. .
The court took the unusual step of denying the Securities and Exchange Commission some of its oversight powers over investment advisers. That could leave other draft rules covering cybersecurity, outsourcing and predictive data analytics vulnerable to litigation, legal experts say.
The decision by the New Orleans-based 5th U.S. Circuit Court of Appeals is another example of business groups using conservative courts to overturn SEC rules, limit its ability to write similar rules and bring 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 SEC, which oversees some 40,000 organizations, a prime target.
“It’s happening throughout government, and it’s quite acute at the SEC,” said Satyam Khanna, a former SEC lawyer who advised two former Democratic commissioners as recently as 2021. “The SEC oversees a huge number of entities—funds, public companies, brokers and many others—and the financial stakes can be high.”
The agency is facing several other lawsuits from financial firms and their trade groups alleging the agency is overstepping its authority and imposing ill-conceived and costly regulations.
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 also faces challenges in other conservative courts.
Among the cases: Hedge funds sued in the 5th Circuit to overturn SEC short-selling disclosures and in Texas district court to overturn new Treasury bond trading rules, while in March business groups including the Chamber of Commerce The United States and Republican-led states have sued to block Securities and Exchange Commission (SEC) rules on climate change.
The chamber is among the most aggressive groups in regulatory litigation. In December, the company won a challenge to the SEC’s 5th Circuit rules on stock buybacks and is monitoring other draft rules for potential problems.
“The current Securities and Exchange Commission (SEC) has committed significant regulatory violations,” said Daryl Josephfer, chief counsel of the Chamber Litigation Center.
Reform advocates say the industry simply wants to protect its profits and that weakening the SEC would hurt everyday Americans.
Speaking to Reuters last Wednesday, SEC Chairman Gary Gensler would not discuss the private funds decision but noted that only a few dozen rules passed under his leadership have been challenged. And the agency has scored some notable victories, including in the 5th Circuit on diversity rules and proxy voting, legal experts say.
But Gensler also said the agency is adapting to unfavorable decisions.
“We do everything in accordance with the law and in accordance with how the courts interpret the law. If the courts interpret the law differently than we thought, we adjust, we change,” he said. As an example, he cited the SEC’s decision to approve bitcoin products in January after a D.C. appeals court found the agency was wrong to reject them.
Trump appointed 54 judges to the U.S. appeals courts, where many lawsuits against federal agencies are filed, and won a 6-3 conservative majority on the Supreme Court.
When asked if he believes the courts are biased against him, Gensler responded, “I have great faith in the American democratic system and our constitutional system. We have three equal branches of government. And that’s a really important thing.”
Most of the lawsuits allege violations of the Administrative Procedure Act of 1946, which requires regulators to justify rules and allow time for and full consideration of public feedback.
Some of the cases rely on a 2022 Supreme Court decision that raised doubts about whether federal agencies have the authority to decide important policy issues. The decision was one of the reasons the Securities and Exchange Commission (SEC) rolled back its climate change rule, Reuters previously reported and was cited in some of the March filings.
Crypto firms have often invoked this “essential issues” doctrine when challenging the SEC’s authority to regulate them.
The Securities and Exchange Commission (SEC) has made significant changes to other major rules following industry opposition, including those related to money market funds and activist investor disclosure.
“Industry’s vehement opposition in comment files often raises the threat of litigation,” Khanna said.
Gensler said the agency takes industry comments “very seriously.”
SCOTUS EXPRESSES
The Supreme Court is also expected to rule this month in two other cases with major implications for the SEC.
One relates to its authority to use staff judges with expertise in securities law to decide enforcement actions, which is often faster than trying cases in court. Conservative judges last year expressed concern that they were denying defendants a jury trial.
The case followed a 2018 Supreme Court ruling that the SEC’s process for selecting tenured judges violated the Constitution. Since then, the SEC has sharply reduced its use of the tribunal, SEC data shows.
Another SCOTUS case challenges a legal doctrine known as Chevron (NYSE:) deference,” which urges judges to defer to federal agencies’ interpretations of U.S. laws deemed ambiguous.
Chevron is the backbone of the agency’s rulemaking. According to a 2017 study published in the Michigan Law Review, between 2003 and 2013, Chevron was used in 66.7% of SEC rule challenges in district courts, and in those cases the agency won just over 81%.
“It is very likely that the court will overturn Chevron’s decision or dramatically reduce it,” Josepher said. Consequently, “agencies are less likely to defend their interpretation of the laws, and as a result, one would hope that agencies would be more cautious in their rulemaking,” he added.