Pure omissions cannot support private securities fraud claims without misleading statements, Supreme Court rules

By Lene Powell, J.D.

In a unanimous opinion, the Supreme Court ruled that absent a misleading statement, pure omissions are not actionable as securities fraud under Rule 10b–5(b). However, private parties remain free to bring claims based on Regulation S-K Item 303 violations that create misleading half-truths, and the SEC retains authority to prosecute violations of its own rules and regulations, including Item 303 (Macquarie Infrastructure Corp. v. Moab Partners, L.P., April 12, 2024, Sotomayor, S.).

The Supreme Court vacated and remanded the Second Circuit’s judgment, which found that the respondent investors could bring a private securities fraud claim based on failure to make disclosures under Item 303 “trends and uncertainties” provisions.

The ruling resolves a circuit split. The Second Circuit has allowed private securities fraud claims under Item 303, while the Third, Ninth, and Eleventh Circuits have not.

Alleged fraud. Macquarie Infrastructure Corporation owns infrastructure-related businesses, including a subsidiary that operates large storage terminals for fuel oil and other commodities. In 2016, the United Nations’ International Maritime Organization announced a new regulation that would cap sulfur content in fuel oil at.5% beginning in 2020. Macquarie stored No. 6 fuel oil, which has a sulfur content closer to 3%.

Macquarie did not disclose to investors any anticipated impact from the regulation. In February 2018, it announced that the amount of storage capacity contracted for use by its subsidiary’s customers had dropped in part because of the structural decline in the No. 6 fuel oil market. Macquarie’s stock price fell around 41 percent.

In a complaint filed in the Southern District of New York, Moab Partners, L. P. alleged that Macquarie and various officer defendants had violated Section §10(b) of the Exchange Act and Rule 10b–5. Moab argued that Macquarie’s public statements were false and misleading because Macquarie concealed from investors that its subsidiary’s single largest product was No. 6 fuel oil which “faced a near-cataclysmic ban on the bulk of its worldwide use through IMO 2020.” Moab contended that Macquarie violated Item 303 of Regulation S-K by failing to disclose the extent to which its storage capacity was devoted to No. 6 fuel oil.

Prior proceedings. The district court dismissed the complaint, finding in part that Moab had not actually pleaded an uncertainty that should have been disclosed, nor in what SEC filing or filings the defendants were supposed to disclose it.

The Second Circuit vacated and remanded, concluding that Moab had adequately alleged a “known trend or uncertainty” that gave rise to a duty to disclose under Item 303. Crediting Moab’s allegations as true, the panel found that IMO 2020’s significant restriction of No. 6 fuel oil use was known to Macquarie and reasonably likely to have material effects on Macquarie’s financial condition or results of operation. Under Second Circuit precedent, the court concluded that Macquarie’s Item 303 violation alone could sustain Moab’s §10(b) and Rule 10b–5 claim.

The Supreme Court granted certiorari to resolve a circuit split on whether a failure to make a disclosure required by Item 303 can support a private claim under §10(b) and Rule 10b–5(b) in the absence of an otherwise-misleading statement. The court heard oral argument on January 17, 2024.

Rule 10b-5(b): pure omissions and half truths. Focusing on the rule text, the court concluded that Rule 10b-5(b) does not proscribe pure omissions in the absence of a misleading statement. Rule 10b–5(b) makes it unlawful “[t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.”

The case turned on whether the prohibition bars only half-truths or instead extends to pure omissions, the court said. A pure omission “occurs when a speaker says nothing, in circumstances that do not give any particular meaning to that silence.” In contrast, half-truths are “representations that state the truth only so far as it goes, while omitting critical qualifying information.”

For example, said the court, if a company fails entirely to file an MD&A, then the omission of particular information required in the MD&A has no special significance because no information was disclosed.

“In other words, the difference between a pure omission and a half-truth is the difference between a child not telling his parents he ate a whole cake and telling them he had dessert,” the court wrote.

Statutory context confirmed the plain meaning of the rule text. While Congress imposed liability for pure omissions in §11(a) of the Securities Act of 1933, there is no similar language in §10(b) or Rule 10b–5(b).

Item 303. Turning to affirmative disclosure obligations, the court held that the failure to disclose information required by Item 303 of Regulation S-K can support a Rule 10b–5(b) claim only if the omission renders affirmative statements made misleading.

The court rejected the suggestion that a plaintiff does not need to plead any statements rendered misleading by a pure omission because reasonable investors know that Item 303 requires an MD&A to disclose all known trends and uncertainties. This argument failed because it reads the words “statements made” out of Rule 10b–5(b) and shifts the focus of that Rule and §10(b) from fraud to disclosure, said the court. It would also make §11(a)’s pure omission clause superfluous by making every omission of a fact “required to be stated” a misleading half-truth.

The court also disagreed that a lack of private liability for pure omissions under Rule 10b–5(b) would bring about “broad immunity” for issuers to fraudulently omit information required by the SEC to be disclosed. Here, the court noted that private parties are still free to bring claims based on Item 303 violations that create misleading half-truths. Further, the SEC retains authority to prosecute violations of its own regulations.

Outcome. The court found that pure omissions are not actionable under Rule 10b–5(b) and vacated and remanded the judgment to the Second Circuit.

This is case No. 22-1165.

CFTC Commissioner Johnson advocates for responsible AI integration in financial markets

By Elena Eyber, J.D.

CFTC Commissioner Kristin N. Johnson delivered keynote remarks at the NYU AI Convening, highlighting the importance of addressing the integration of AI in financial markets. Johnson discussed the adoption of a working plan by the Market Risk Advisory Committee (MRAC) aimed at enhancing the CFTC's oversight of AI integration. The plan includes initiatives such as conducting a survey on AI use in CFTC-regulated markets and providing recommendations for new guidance or rulemaking. Johnson advocated for responsible AI use in financial markets, proposing interventions such as greater transparency, a principles-based regulatory framework, heightened penalties for fraudulent AI use, and the creation of an inter-agency task force focused on AI regulation.

MRAC’s AI working plan. The MRAC's working plan includes initiatives such as conducting a survey on the use of AI in CFTC-regulated markets and providing recommendations for new guidance or rulemaking. Johnson underscored the importance of refining these initiatives and emphasized the need for responsible AI integration in financial markets due to potential risks related to market integrity, customer protection, data privacy, bias, and cybersecurity.

Proposed interventions. Johnson proposed several interventions to promote responsible AI use, including greater transparency and visibility regarding AI adoption among registrants, the development of a principles-based regulatory framework, and the consideration of heightened penalties for fraudulent or manipulative AI use. Additionally, Johnson advocated for the creation of an inter-agency task force focused on information sharing and composed of various market and prudential regulators. This task force would support the AI Safety Institute in developing guidelines, tools, and best practices for regulating AI in the financial services industry.

PCAOB proposes standardizing disclosure of firm and engagement metrics and modernizing PCAOB reporting framework

By Elena Eyber, J.D.

The PCAOB has released two proposals aimed at enhancing audit firm transparency, bringing consistency to the disclosure of audit firm and engagement metrics, and helping the PCAOB conduct its oversight. The first proposal mandates registered public accounting firms auditing accelerated filers to annually disclose specified metrics concerning their audit practices, covering areas like partner involvement and audit resources. The second proposal focuses on modernizing the PCAOB's reporting framework by amending annual and special reporting requirements, addressing areas such as financial information, audit firm governance, and cybersecurity. The PCAOB requests comments on both proposals by June 7, 2024 (Firm and Engagement Metrics, PCAOB Release No. 2024-002, April 9, 2024; Firm Reporting, PCAOB Release No. 2024-003, April 9, 2024).

The first proposal focuses on standardized disclosure of firm and engagement metrics, requiring registered public accounting firms auditing accelerated filers to publicly report specified metrics related to their audit practices annually. These metrics cover various aspects such as partner and manager involvement, workload, audit resources, and quality performance ratings. The proposal seeks to address inconsistencies in current voluntary reporting practices and increase the availability of decision-relevant information for investors and audit committees.

The second proposal aims to modernize the PCAOB's reporting framework by amending annual and special reporting requirements for registered public accounting firms. Key areas addressed in this proposal include financial information, audit firm governance, network information, special reporting, and cybersecurity. By enhancing reporting requirements and facilitating more complete, standardized, and timely information disclosure, the PCAOB aims to provide informative and useful data to investors, audit committees, and other stakeholders.

“Sound and consistent information bolsters confidence in our capital markets, and can drive audit quality,” said PCAOB Chair Erica Y. Williams. “Informed by extensive study and stakeholder input, today’s proposals would strengthen PCAOB oversight and equip investors, audit committees, and others with clear, consistent, and actionable data related to the audit.”

These are PCAOB Release Nos. 2024-002 and 2024-003.

A closer look at SEC’s jury win in Terraform crypto fraud action

By Lene Powell, J.D.

In the SEC’s big jury trial win against Terraform Labs PTE Ltd. and its former CEO, Do Kwon, the jury found that false or misleading statements were reckless or intentional, happened "in the offer or sale" of crypto tokens, and were distributed via the mails or an instrumentality of interstate commerce. The jury’s findings provide a look at what fact-finders might find in similar crypto enforcement actions (SEC v. Terraform Pte. Ltd.).

The jury’s verdict was delivered April 5 after a nine-day trial in federal district court in the Southern District of New York.

In a statement, SEC Division of Enforcement Director Gurbir S. Grewal highlighted the consequences of lack of registration and compliance.

“Through these deceptions, the defendants caused devastating losses for investors and wiped out tens of billions of market value nearly overnight,” said Grewal. “[I]t is high time for the crypto markets to come into compliance.”

Tokens as securities. As a threshold matter, the court instructed the jury as a matter of law that the tokens issued by Terraform (UST, LUNA, and wLUNA) are securities. The court ruled last December that the tokens are securities and investment contracts under Howey.

Fraud schemes. The court explained the two alleged fraudulent schemes.

First, the SEC alleged that the defendants falsely conveyed to investors that if the price of UST fell below $1.00 (known as the "peg"), it would correct to $1.00 through the operation of a Terraform algorithm, when in fact, when the price of a UST token fell below $1.00 in May 2021, the defendants secretly agreed with a company called Jump to have Jump make large undetectable purchases of UST to return the price to $1.00.

Second, the defendants deceived investors into believing that a company called Chai used Terraform's blockchain, when in fact the Chai transactions were simply copied onto Terraform systems to make it appear as though Chai was using Terraform's blockchain.

Terraform Labs and Do Kwon denied the allegations.

Jury instructions. The court instructed the jury on statutory requirements. Under Section 17 of the Securities Act, the jury was required to find:

• That the defendant, in the offer or sale of UST, LUNA, or wLUNA, made at least one false or misleading statement or misleading conduct regarding a material matter for the purpose of obtaining money or property;
• That the defendant acted intentionally, recklessly, or negligently;
• That the defendant caused to be used the mails or an instrumentality of interstate commerce. For example, the telephone, Internet, email or any other electronic communication, or any interstate or international delivery system.

The court explained that the jury was required to be unanimous that a given statement or conduct was false or misleading.

In considering “offer or sale,” the jury was instructed that it could consider whether the statements were made to urge investors to invest in Terraform securities. No actual investment was required, and the SEC was also not required to prove that any investor actually relied on any false or misleading statement or conduct.

Regarding Section 10b-5 under the Exchange Act, the court noted that on the facts of this case, there was only one difference from Section 17: a 10b-5 claim requires proof of fraudulent intent or recklessness and cannot rest on negligence.

Witnesses take the Fifth. The court also instructed the jury regarding witnesses Jeffrey Kuan, former head of business development for Terraform, Kanav Kariya, the president of Jump Crypto, and William DiSomma, a co-founder of Jump Crypto—who declined to answer certain questions on the grounds of their Fifth Amendment privilege against self-incrimination.

The court explained that in civil cases, a jury may draw the inference that the withheld information would have been unfavorable to one or more defendants.

Jury verdict. In finding liability on the Section 17 claim, the jury decided that Terraform acted recklessly and Do Kwon acted intentionally.

The jury also found the defendants liable on the Section 10b-5 claim.

Finally, the jury found control person liability for Do Kwon.

This is case No. 1:23-cv-01346-JSR.

In light of its stay, SEC asks court to deny motions for emergency stay of climate rules

By Rodney F. Tonkovic, J.D.

Citing its own stay, the SEC filed an omnibus opposition to all of the motions to stay its climate disclosure rules currently before the Eighth Circuit. Five groups of petitioners are seeking emergency relief to stay the Commission's final rules on the enhancement and standardization of climate-related disclosures. The Commission itself stayed the challenged rules on April 4, 2024, so, it argues, there is no basis for the court to grant the requested relief (Iowa v. SEC, April 5, 2024).

Climate rules challenged. The Commission adopted the final climate disclosure rules on March 6, 2024, and they were set to become effective on May 28, 2024. Soon after the rules were adopted, nine petitions for review were filed in several circuit courts, and they were consolidated in the Eighth Circuit on March 21, 2024.

By April 3, five motions to stay the rules had been filed with the Eight Circuit. The motion in Iowa v. SEC, for example, argues that the rule goes beyond the SEC's authority, violates the First Amendment, and is arbitrary and capricious. The petitioners, the motion says, have a strong likelihood of success on the merits and will also suffer irreparable injury if the rules take effect.

On March 29, the Commission filed a motion to establish a consolidated briefing schedule for the motions that had been filed and any future motions. Thirty-one petitioners then opposed this motion.

Commission stay. On April 4, 2024, the Commission issued an order staying the final rules pending the Eight Circuit's completion of judicial review of the consolidated petitions. According to the Commission, the rules are consistent with applicable law and its authority, but a stay will facilitate orderly resolution of the challenges while avoiding regulatory uncertainty.

The Commission argues that in light of its decision to stay the rules, the petitioners' motions for stay should be denied. While the petitioners did not seek a stay from the Commission, the agency concluded that the statutory standards were met and addressed the issue sua sponte. As a result, the stay preserves the status quo until the completion of judicial review and thus removes any need for the court to intervene. Plus, the petitioners' requests for stay were based on claimed harms from the rules taking effect, the Commission says, and the stay eliminates this possibility.

Briefing schedule. If the petitioners continue to seek relief, the Commission asks that the court order a briefing schedule allowing a single, consolidated response to any motions for relief. In addition, certain petitioners seek an alternative accelerated briefing and argument schedule, and while the Commission believes that its stay removes the predicate for this, it will confer with petitioners' counsel to determine a schedule that facilitates a timely ruling on the merits.

Sustainable Investment Caucus statement. The co-chairs of the Congressional Sustainable Investment Caucus, Representatives Juan Vargas (CA-52) and Sean Casten (IL-06) issued a statement about the SEC's stay. The representatives share the SEC's belief that the rule is lawful and are confident that the courts will reach the same conclusion.

The case is No. 23-1522.

Better Markets takes on detractors of SEC’s AI-focused predictive analytics proposals

By John Filar Atwood

Better Markets has written to the SEC to offer a defense of the agency’s predictive analytics proposals against critics who claim the proposals are unnecessary, flawed, and overbroad. The group said that the proposals are necessary to ensure the securities laws keep pace with innovations, especially the growing use of AI in the securities industry.

The rules proposed last July would require firms to identify and eliminate any conflicts of interest arising from the use of covered technologies, and to adopt appropriate policies, procedures, and recordkeeping measures. The foundation of the proposals is the increasing use of AI-based predictive analytics to direct individual investor behavior, and digital engagement practices like behavioral prompts and game-like features to engage retail investors when using a firm’s digital platforms for trading, advice, and financial education.

The proposals have generated some pushback from stakeholders, including a divided SEC Investor Advisory Committee which recommended in March that the Commission scale back the proposals by narrowing some proposed definitions and increasing the focus on disclosing conflicts of interest.

Better Markets sees three primary objections to the proposal: 1) the proposal is unnecessary because existing rules address conflicts of interest; 2) the proposal is flawed because it goes beyond requiring the disclosure of conflicts of interest; and 3) the proposal is overbroad because it covers even mundane uses of technology. The group believes these criticisms lack merit.

Unnecessary. According to Better Markets, the problem with the argument that the proposal is unnecessary because existing rules address conflicts of interest is that those rules only cover recommendations. Regulation Best Interest, for example, “requires broker-dealers in making recommendations to have a reasonable basis for believing that a series of recommended transactions.” Absent a recommendation, Reg. BI’s duties do not apply, the group noted. The proposed rules are needed, therefore, to eliminate the conflicts that arise when brokers use predictive analytics in a way that produces de facto recommendations and that induces investors to engage in a series of transactions that are not in their own interest, the group stated.

Better Markets also argued that AI-based practices in the securities industry and elsewhere use behavioral psychology to entice users into frequent usage. The group cited lawsuits in other industries claiming that hidden algorithms are manipulating users to keep them hooked on the app they are using. Accordingly, the SEC’s proposed rules are needed to prevent broker-dealers from using predictive data analytics, digital engagement practices, and gamification to similarly turn retail investors into investing addicts.

Flawed. To the claim that the proposals are flawed because they should require only that conflicts of interest from the use of predictive data analytics be disclosed, Better Markets said there are many reasons why a disclosure-based regime is ill-suited to protect retail investors. To begin with, the group said, retail investors tend not to read disclosures and have reduced time, resources, and capacity to understand and use any disclosures relative to their sophisticated counterparts. Incremental increases in disclosure will not necessarily lead to better decision making, the group stated.

The group cited academic studies that found how simple disclosure obligations may not be sufficient for machine learning algorithms, and that when it comes to conflicts that arise as a result of firms using technology in their interactions with investors, disclosure alone will not be an effective solution.

This is why Better Markets disagrees with the recommendation of the SEC’s Investor Advisory Committee to allow firms to disclose the existence of conflicts of interest with respect to their use of some technologies rather than eliminate those conflicts. The group agrees with another recent study that suggested this approach would leave investors exposed to predatory behavior on the part of firms who might draft or time their disclosures in a way that would cause investors to overlook or misunderstand them, particularly when the underlying product or service is complex.

Better Markets urged the SEC to retain the proposal’s requirement that firms eliminate or neutralize the conflicts of interest arising from their use of certain technology in their interactions with investors because disclosure alone is an insufficient tool to address them.

Overbroad. The group also urged the Commission not to be persuaded by claims that the proposal is overbroad because it applies to innumerable functions that are necessary to support day-to-day operations of broker-dealers and investment advisers. The group noted that the proposal clearly states that it applies only to “an analytical, technological, or computational function, algorithm, model, correlation matrix, or similar method or process that optimizes for, predicts, guides, forecasts, or directs investment-related behaviors or outcomes in an investor interaction.”

The proposal applies to technologies that have the potential to lead to conflicts of interest in investor interactions, according to Better Markets, and does not apply to a firm’s use of mundane technologies such as spreadsheets. The proposal’s concern is with the conflicts arising from the use of the specified technology, and there is nothing overly broad about requiring that firms use technological advancements in a way that does not prioritize their own interests over the interests of the investors, the group concluded.

SEC stays climate-related disclosures

By Rodney F. Tonkovic, J.D.

The SEC issued a stay of its final rules requiring climate-related disclosures pending the completion of judicial review. Adopted on March 6, 2024, the final rule amendments were almost immediately the subject of litigation, and the consolidated petitions are now before the U.S. Court of Appeals for the Eight Circuit. The statement notes that the Commission believes that the final rules are consistent with applicable law, but a stay in these circumstances will facilitate the resolution of the challenges to the rules and avoid possible regulatory uncertainty (In the Matter of the Enhancement and Standardization of Climate-Related Disclosures for Investors, Release No. 33-11280, April 4, 2024).

Regulatory uncertainty. The statement stresses that the SEC will continue to vigorously defend the rules’ validity. But, under these circumstances, the Commission finds that a stay will facilitate the orderly judicial resolution of the challenges to the rules and allow the court of appeals to focus on deciding the merits. Plus, a stay would avoid potential regulatory uncertainty if registrants become subject to the rules' requirements while the challenges to their validity are still pending.

Stays and motions to stay. On March 8, 2024, petitioner Liberty Energy Inc. filed a motion for administrative stay, which was issued by the Fifth Circuit on March 15. The petitions seeking review of the rules, which were also filed in several other circuits, were consolidated for review in the Eight Circuit on March 21, and the Fifth Circuit dissolved its stay. Soon after, Liberty Energy and other petitioners filed motions in the Eight Circuit seeking a stay pending judicial review.

The final rules were published in the Federal Register on March 28, with an effective date set for May 28, 2024. Finally, on March 29, the Commission filed a motion to establish a consolidated briefing schedule encompassing all motions seeking a stay, but on the next day, thirty-one petitioners opposed this motion and urged the court to expedite briefing on the stay motions.

The release is No. 33-11280.

Gensler resolves to continue updating ‘rules of the road’ for investors, issuers

By Suzanne Cosgrove

SEC Chair Gary Gensler Tuesday outlined his view of the agency’s long-term mission, calling U.S. capital markets “a national asset” and defending a series of recent Commission proposals, including central clearing for U.S. Treasury markets, the modernization of the definition of an exchange, rules regarding exchanges’ volume-based transaction rebates and fees, and the establishment of a best execution rule.

Capital market efficiency, competition and liquidity are public goods, he told attendees of the Practising Law Institute’s SEC Speaks conference in Washington, D.C., adding that President Franklin Roosevelt and Congress understood that in the 1930s when they sought to rein in markets that had become riddled with fraud and manipulation. In response, they passed the Securities Act of 1933, the Securities Exchange Act of 1934, and established the Securities and Exchange Commission, he noted.

The need for the SEC to promote these public goods is evergreen, but technology and business models “are everchanging,” Gensler said. As a result, “we will continue to update rules of the road for investors and issuers alike,” he told conference goers.

New authorities given in the 1970s. President Gerald Ford and Congress also understood the importance of efficiency and competition in the capital markets, and in the 1970s implemented reforms that would address problems related to fixed commissions. In the process, Congress broadened the SEC’s reach, giving it the authority to establish a National Market System for securities transactions and authority over the clearance and settlement of securities transactions, Gensler said. Further, “they gave us new and revised authority regarding review and setting of SRO rules,” he noted.

Congress also found, as noted in the Securities Acts Amendments of 1975, that it was in the public interest to assure “fair competition among brokers and dealers, among exchange markets, and between exchange markets and markets other than exchange markets,” he said.

The need for the SEC to promote these public goods is evergreen, but technology and business models, “are everchanging,” Gensler said. As a result, “we will continue to update rules of the road for investors and issuers alike,” he said in his address.

Climate rule’s “fundamental flaw.” Taking a very different stance, SEC Commissioner Mark Uyeda told the conference that he was concerned that the agency “has gone astray,” and used the SEC’s climate rule as the centerpiece of his argument.

Uyeda noted the Commission last month adopted amendments to Rule 605 under the Exchange Act, which updated the disclosure requirements for order executions in national market system (NMS) stock. On the same day, it adopted amendments to require issuers to disclose certain climate-related information.

“One of these rules will provide information that will better serve investors. The other rule is designed to alter the behavior of public companies in a manner that serves political interests that have otherwise failed to achieve such change through the legislative process,” he said. “The climate rule’s fundamental flaw is that it mandates disclosures not financially material to investors,” Uyeda said. “Absent financial materiality, the Commission lacks the authority to broadly regulate the operating activities of public companies under the pretext of disclosure requirements. Issues of national economic or political policy beyond the Commission’s narrow statutory remit should be addressed by Congress, not financial regulators,” he said.

Advocacy leading to the climate rule “demonstrates how the bedrock principle of materiality is under attack,” Uyeda contended. The proposed climate rule strayed so far from any concept of materiality that the final rule “stripped out the proposal’s boldest provision” – the requirement for a public company to disclose its Scope 3 emissions. The final rule added a materiality threshold to the requirement for certain companies to disclose Scope 1 and Scope 2 emissions, he said.

SAB 121 and related guidance. Commissioner Hester Peirce also quarreled with agency’s direction, but she focused largely on Staff Accounting Bulletin (SAB) No. 121 and its related guidance, which she said was prepared by the Office of the Chief Accountant (OCA) without input from the full Commission.

SAB No. 121 directs public companies that safeguard crypto assets for clients to put a liability and corresponding asset on their balance sheet and adjust them as the value of the asset changes. The SAB was issued without input from the public or banking regulators, who subsequently expressed their concerns about the directive, she said.

The Government Accountability Office last October ruled that the Commission should have submitted SAB No. 121 to Congress under the Congressional Review Act because it was an agency statement of future effect, “designed to interpret and prescribe policy,” she said. Notwithstanding the negative attention, OCA, through conversations after the SAB’s issuance, broadened its scope to cover all registered broker-dealers.

Enforcement actions expand. Separate from the commissioners’ complaints about aggressive agency rulemaking, the SEC increased its pursuit of basic securities fraud in the past year. According to Sanjay Wadhwa, deputy director, SEC Division of Enforcement, the Commission filed a total of 784 enforcement actions in fiscal year 2023, representing a 3 percent increase over the prior fiscal year. That total included 501 “stand-alone” actions, an 8 percent increase over the prior fiscal year.

In addition, Wadhwa reported, the Commission filed 162 "follow-on" administrative proceedings seeking to bar or suspend individuals from certain functions in the securities markets based on criminal convictions, civil injunctions, or other orders, and 121 actions against issuers who were allegedly delinquent in making required SEC filings.

The SEC obtained orders for just under $5 billion in financial remedies last year, the second highest amount in SEC history after the record-setting financial remedies ordered in fiscal 2022, he said. The remedies comprised nearly $3.37 billion in disgorgement and prejudgment interest and nearly $1.6 billion in civil penalties.

With 40 first quarter deals, 2024 IPOs are slightly off 2023 pace

By John Filar Atwood

The first three months of 2024 saw 40 companies make their public market debuts. The pace is a little slower than 2023 when 45 companies went public in the first quarter. It is also a slower start than in 2022 when 79 IPOs were completed in January through March, but is better than Q1 2020 (39 deals) and 2019 (34 deals). March ended with four new issues in its final week, including one by Australia’s Alta Global Group. ThinkEquity led the provider of martial arts and combat sports training programs to market. It was ThinkEquity’s third completed lead manager assignment of the year, already exceeding its 2023 total of two offerings. China’s U-BX Technology is publicly traded after spending 26 months in registration. Conversely, California-headquartered Boundless Bio priced in under a month. The current average number of days in public registration for 2024’s new issuers is 188 days. Florida-based blank check IB Acquisition completed the week’s other deal. It was the fifth IPO of 2024 for SIC 6770, the most of any industry group.

New registrants. The week’s activity included five new registrations. Marex Group, a global financial services platform based in London publicly registered. Marex, which acquired Cowen’s legacy prime services and outsourced trading business from Toronto-Dominion Bank in December 2023, provides connectivity to 58 commodities exchanges. Univest Securities was hired as first lead manager by preliminary filers Huge Amount Group and Reitar Logtech Holdings. Huge Amount is a mobile advertising service provider in China, while Reitar Logtech offers engineering design, management, and consultancy services to the logistics industry in Hong Kong. China also is home to new filers NETCLASS TECHNOLOGY and Xinxu Copper Industry Technology. NETCLASS filed a new Form F-1 on the same day that it withdrew a prior registration statement. Xinxu Copper is seeking to become the first SIC 3350 (Rolling Drawing & Extruding of Nonferrous Metals) new issuer since 2013. March tallied 24 new public registrations overall, which matches March 2023 and is 11 more than in February. The three-month total number of new filings was 57, down from 68 by the end of March last year.

Withdrawals. Six companies withdrew their pending registrations last week, including NETCLASS TECHNOLOGY which filed a new registration on the same day. The provider of education software and services in China reduced its expected IPO size from $16.8 million to $9 million. Blank check Biotech Group Acquisition, which initially registered in April 2022, opted not to proceed with its offering. The company last amended its registration in June 2023. Alternative asset manager The Gladstone Companies and nasal hydrogel developer Polyrizon backed out of their IPO plans. Both companies initially registered in 2022 and filed four amendments, but none since March 2023. California-based Opti-Harvest and Invea Therapeutics, which is indirectly controlled by BioXcel, also withdrew. The 2023 registrants each filed Amendment No. 2 in January 2024. The pace of withdrawals picked up considerably in March with ten after only two in February. Five companies filed Forms RW last March. As of the quarter’s close, 19 companies have withdrawn this year compared to 25 in 2023’s first quarter.

The information reported here is gathered using IPO Vital Signs, a Wolters Kluwer Regulatory U.S. database that includes all SEC registered IPOs, including REITs and those non-U.S. IPO filers seeking to list in the U.S. markets. IPO Vital Signs does not track closed-end funds, best efforts or non-underwritten deals, or IPO offerings for amounts less than $5 million.

Accounting firm seeks to stop PCAOB from enforcing ABD

By Elena Eyber, J.D.

A registered public accounting firm filed a complaint in federal district court in Texas, seeking declaratory and injunctive relief to stop the Public Company Accounting Oversight Board (PCAOB) from enforcing an investigative Accounting Board Demand (ABD) authorized by the Sarbanes-Oxley Act. The firm argues that the ABD, the latest in a series of demands, is part of an unlawful and secretive investigative process that violates constitutional principles and deprives them of due process. According to the complaint, without the relief sought, the firm faces severe penalties and lacks the opportunity for pre-enforcement judicial review, leaving them with the dilemma of complying with an unconstitutional demand or risking their business's future (John Doe Corporation v. Public Company Accounting Oversight Board, March 27, 2024).

Claims for relief. The first claim asserts that the delegation of legislative power to the PCAOB, particularly under Sarbanes-Oxley, lacks an intelligible principle as required by the Constitution. As alleged in the complaint, the PCAOB's rules for investigation and discipline lack clear direction, rendering them constitutionally illegitimate and unenforceable.

The second claim argues that the PCAOB, despite being a private entity, exercises core executive power without proper supervision or oversight. This constitutes a violation of Article II of the Constitution, as governmental power should only be wielded by the federal government or its subordinate agencies.

The third claim alleges a denial of due process under the Fifth Amendment. According to the complaint, the PCAOB imposes fines and punishments without allowing recipients of staff-issued demands the opportunity for judicial review, violating their right to due process of law.

The fourth claim contends that the PCAOB's actions violate Sarbanes-Oxley's requirement for fair procedures. According to the complaint, the PCAOB's lack of guidelines or limits on the issuance of demands, coupled with the absence of a meaningful process for review, denies affected parties’ fair procedures as mandated by the law.

The relief requested includes declaratory judgment, injunction against enforcing the demands, and award of attorneys' fees and costs.

The case is No. 4:24-cv-01103.

Short-swing profits exempt under director-by-deputization theory

By Anne Sherry, J.D.

The Southern District of New York dismissed a derivative lawsuit seeking disgorgement of short-swing profits. The challenged transactions satisfied an exemption from short-swing liability because they were between the issuer and a “director by deputization.” The policy rationale for this exemption—that the board’s approval serves a gatekeeper function—applied even if the board was unaware of this legal doctrine when it approved the transactions (Roth v. Armistice Capital, LLC, March 27, 2024, Rochon, J.).

Exchange Act Section 16(b) bars short-swing insider profits (and the court held that derivative plaintiffs do have Article III standing to bring Section 16(b) claims). But Rule 16b-3(d) provides an exemption where the insider is a director or officer who had advance board approval to acquire issuer equity securities directly from the issuer. Under Second Circuit precedent, an exempt director can include a “director by deputization,” or an investor who deputizes an individual to serve as its representative on the issuer’s board.

That was the case here: both the Chief Investment Officer and a managing director of the short-swing purchaser, Armistice Capital, sat on the issuer’s board. The issuer’s SEC filings confirmed its belief that the Armistice-affiliated directors were not independent, and representatives of the issuer testified that the board understood that the Armistice-nominated directors would be representing Armistice’s interests.

Both the plaintiff and the defendants relied on the SEC’s views about the Rule 16b-3(d) exemption as stated in a 2006 amicus brief. There, the SEC argued that board or shareholder approval is not effective gatekeeping where the board or shareholders were unaware that the person acquiring stock is a director. The plaintiffs particularly highlighted the SEC’s statement that the gatekeeping function would fail if the board “did not know that [the board member] had been deputized.”

But the court said that while the amicus brief was persuasive and perhaps even entitled to deference, it should not be parsed as rigorously as a statute. Reading the SEC’s reference to knowledge of deputization in context, it was best understood as requiring that the board know that the director sits on behalf of, and represents the interests of, the short-swing seller. The Second Circuit has already rejected the argument that a board must have acted for the express purpose of invoking the exemption. Gryl v. Shire Pharms. Grp. PLC (2d Cir 2002).

The case is No. 20-cv-08872.

Sam Bankman-Fried, FTX crypto exchange founder, receives 25-year sentence

By Suzanne Cosgrove

U.S. District Judge Lewis Kaplan Thursday sentenced Sam Bankman-Fried, the 32-year-old founder of the cryptocurrency exchange FTX and cryptocurrency trading firm Alameda Research, to 25 years in prison and imposed penalties of more than $11 billion in forfeiture for his role in the perpetration of multiple fraud schemes.

As reported previously by Securities Regulation Daily, last November a Manhattan jury found Bankman-Fried guilty of seven criminal charges following a month-long trial: two counts of wire fraud, two counts of conspiracy to commit wire fraud, one count of conspiracy to commit securities fraud, one count of conspiracy to commit commodities fraud, and one count of conspiracy to commit money laundering.

Prosecutors reportedly asked Kaplan for a prison sentence of 40 to 50 years, while Bankman-Fried’s attorneys argued for a far more lenient sentence of no more than six years.

“Samuel Bankman-Fried orchestrated one of the largest financial frauds in history, stealing over $8 billion of his customers’ money,” said U.S. Attorney Damian Williams for the Southern District of New York, in a prepared statement. “His deliberate and ongoing lies demonstrated a brazen disregard for customers’ expectations and disrespect for the rule of law, all so that he could secretly use his customers’ money to expand his own power and influence.”

Launched in 2019, FTX filed for bankruptcy in November 2022. The U.S. Attorney’s Office indicted Bankman-Fried in December 2022 on charges of fraud, money laundering, and campaign finance offenses. Bankman-Fried was arrested in the Bahamas that month and extradited to the U.S. to face charges.

An eighth count in the original DOJ indictment, which charged the defendant with conspiracy to make unlawful campaign contributions and allegations of foreign bribery, would likely have been the focus of a second trial if it had gone forward.

Multiple charges considered. The DOJ’s criminal charges against Bankman-Fried came on top of similar filings last year by the SEC and CFTC. The FBI also investigated the case.

According to court filings and trial evidence, Bankman-Fried took FTX customer funds for his personal use, to make investments and political contributions in the millions of dollars to U.S. candidates from both parties, and to repay billions of dollars in loans owed by Alameda Research, its affiliated cryptocurrency trading fund.

Bankman-Fried defrauded Alameda lenders and FTX equity investors by providing them with false and misleading financial information that concealed his misuse of customer deposits, repeatedly telling customers, his investors, and the public that customer deposits into FTX were held in custody for the customers, that the deposits were kept separate from company assets, and that customer deposits would not be used by FTX.

Co-conspirators enlisted to help. Bankman-Fried also falsely claimed that Alameda did not have privileged access to FTX and did not receive special treatment from FTX. In fact, Bankman-Fried moved billions of dollars in customer deposits from FTX to Alameda, and then used those funds to make investments for his own benefit, including political contributions and real estate purchases.

To carry out these deceptions, Bankman-Fried directed co-conspirators to alter FTX’s computer code to allow Alameda to withdraw effectively unlimited amounts of cryptocurrency from the exchange.

Former FTX co-founder Gary Wang and former Alameda CEO Caroline Ellison entered guilty pleas in related criminal cases brought against them by the U.S. Attorney’s Office. Both testified for the prosecution during Bankman-Fried’s trial.

“The FBI will aggressively investigate individuals, like Samuel Bankman-Fried, who engage in fraudulent schemes at the expense of the American public and our financial systems,” said FBI Director Christopher Wray. “We are proud of the successful collaboration that ended this massive mismanagement and misappropriation of billions of dollars,” he said. “Today's sentencing should serve as a warning to others looking to use fraudulent means for personal gain.”

This is case No. 1:22-cr-00673-LAK-1.

Rule amendments address investment advisers operating exclusively over the Internet

By R. Jason Howard, J.D.

The SEC has voted to modernize a 22-year-old rule by adopting amendments that apply to when investment advisers who provide advisory services exclusively over the internet can register with the SEC.

In July 2023, the Commission voted 5-0 to issue the internet advisers proposal and, at that time, SEC Chair Gary Gensler explained that in 2002 the SEC granted a narrow exception allowing internet-based advisers to register with the Commission instead of with the states. But in 21 years a lot has changed, and the 2002 exemption created gaps in 2023. The changes, according to a recent statement by the Chair, better reflect what it means in 2024 to provide an exclusively internet-based service and will “better align registration requirements with modern technology and help the Commission in the efficient and effective oversight of registered investment advisers.”

According to the SEC press release, the final rule will require an investment adviser who relies on the internet adviser exemption “to have at all times an operational interactive website through which the adviser provides digital investment advisory services on an ongoing basis to more than one client.” In addition, the amendments will eliminate the current rule’s “de minimis exception for non-internet clients, thus requiring an internet investment adviser to provide advice to all of its clients exclusively through an operational interactive website.”

In connection with the adoption of the final rule, the SEC has released a Fact Sheet which, among other things, explains that compliance with the rule, including the requirement to amend Form ADV to include a representation that the adviser is eligible to register with the Commission under the internet adviser exemption, must be done by March 31, 2025.

Advisers that are no longer eligible to rely on the amended exemption and that do not otherwise have a basis for registration with the Commission must register in one or more states and withdraw registration with the Commission by filing Form ADV-W by June 29, 2025.

SEC urges Supreme Court to deny Musk cert petition

By Rodney F. Tonkovic, J.D.

In its response to Elon Musk's petition for certiorari, the SEC argues that Musk's argument fails on its own merits. Musk's argument is based on the unconstitutional-conditions doctrine, but the SEC points out that he forfeited that claim by not making that argument before the district court. Even so, the Court has consistently held that to resolve litigation, parties can choose to waive even fundamental rights. In this case, the SEC says, the settlement was reasonably designed to minimize the likelihood that Musk would violate the securities laws, and further review is not warranted (Musk v. SEC, March 22, 2024).

Tempest in a tweet-up. In October 2018, Elon Musk and Tesla entered into consent judgments with the SEC. Earlier, Musk had tweeted that he had secured sufficient funding to take Tesla private. This tweet, and some similar ones made on the same day, caused Tesla's stock price to jump even though, as the SEC alleged, any such deal was far from certain. Enforcement actions against Musk and Tesla were quickly brought and settled, with Musk, among other concessions, agreeing to comply with procedures designed to reign in his communications about material Tesla business matters.

In 2019, the SEC brought contempt proceedings when Musk made another questionable tweet, and the settlement was revised to specify what is considered material. Musk posted additional tweets concerning his possibly selling part of his Tesla holdings in late 2021, and the SEC served subpoenas on Tesla and Musk; he did not comply and filed a motion to be relieved from the judgment. In 2022, the Southern District of New York rejected Musk’s attempt to back out of the tweet-vetting settlement.

The Second Circuit affirmed in a brief summary order. The panel rejected Musk's argument that changed circumstances made compliance with the consent decree more onerous. There was also no evidence that the SEC used the decree to conduct bad faith, harassing investigations of Musk's protected speech. The panel also pointed out that Musk had voluntarily entered into the consent decree.

Cert petition. Musk's petition for certiorari challenged the constitutionality of the settlement, asking whether his agreement to abide by certain conditions violates the unconstitutional-conditions doctrine. According to Musk, the lower courts erroneously focused on the fact that Musk had waived certain rights when accepting the settlement. The petition argues that under the unconstitutional-conditions doctrine, such conditions are invalid even when the non-governmental party accepted a benefit in exchange.

SEC's response. At the outset, the SEC's response argued that the Second Circuit found that Musk waived his argument that any waiver of his First Amendment rights is unenforceable. Since this issue was not properly preserved or passed on by the lower courts, the Supreme Court should not grant certiorari to review this issue, the SEC says.

The SEC went on to contend that Musk's argument fails on its own terms because the Court has consistently held that to resolve litigation, parties may choose to waive even fundamental constitutional rights. Musk had the choice between forgoing the future exercise of certain rights or proceeding to trial, and his choice of the former reflected a rational judgment.

Even if the argument had merit, the SEC said, this case would be a poor vehicle for evaluating any unconstitutional-conditions argument. Even if Musk had not forfeited the argument, he failed to identify any decision applying the doctrine to the settlement of legal claims, and the cases cited by Musk were not analogous to the matter at hand. To accept Musk's expansive notion of the doctrine would call into question traditional law enforcement practices and deprive parties of the benefits of waivers in settlement agreements. Plus, the settlement was designed to minimize future securities-law violations by Musk: he is not precluded from engaging in any form of speech or required to obtain pre-approval from a government official.

The Commission admits that there are cases suggesting that the government's ability to obtain waivers of First Amendment rights is not unlimited. There is no support, however, for Musk's position that a promise not to engage in activities otherwise protected by the First Amendment can never be a valid settlement term.

Finally, the SEC maintains that review is unwarranted for lack of practical significance. The related Tesla consent judgment produces the "same operational result," and Musk would still be subject to the same pre-approval procedures. Plus, the provision at issue in this case is idiosyncratic and unlikely to affect other litigants.

The case is No. 23-626.

Chancery erred in applying MFW framework to cleanse merger

By Anne Sherry, J.D.

The Delaware Supreme Court, sitting en banc, restored a challenge to a squeeze-out merger. While the chancery court was right to dismiss a coercion claim, it erred when it assessed the failure to disclose certain conflicts of interest and management fees. Those disclosure failures meant that the minority stockholders were not adequately informed, and that the transaction was not eligible for the safe harbor of the MFW framework (City of Dearborn Police and Fire Revised Retirement System (Chapter 23) v. Brookfield Asset Management Inc., March 25, 2024, Valihura, K.).

In 2020, a subsidiary of Brookfield Asset Management proposed to acquire the remaining outstanding shares of TerraForm Power, Inc. (Brookfield already owned 62 percent of TerraForm). The subsidiary conditioned its proposal on the approval of an independent special committee and a majority of the minority stockholders. Under the Court of Chancery’s 2013 MFW decision, the business judgment rule applies to a controller-led transaction that employs these two cleansing devices.

The plaintiffs challenged the merger, but the chancery court granted the defendants’ motion to dismiss. The court held that the plaintiffs failed to adequately allege coercion under MFW or that the special committee breached its duty of care by failing to disclose conflicts of interest.

Reviewing this dismissal de novo, the Supreme Court agreed with chancery that the plaintiffs did not state a claim for coercion. The plaintiffs theorized that Brookfield’s presentation of a “no growth” projection for TerraForm amounted to an implicit threat to let TerraForm “wither on the vine” if the special committee recommended against the transaction. But this theory rested on attenuated and unreasonable inferences.

However, the merger proxy’s failure to disclose conflicts of interest and a non-ratable upside for Brookfield rendered it misleading—and the stockholder vote not fully informed. Chancery had considered immaterial an undisclosed conflict of interest centering around Morgan Stanley, which both advised the TerraForm special committee and had $470 million in holdings in Brookfield.

The high court called chancery’s analysis “problematic.” Chancery had concluded that the conflict was not material because of the small size of Morgan Stanley’s stake in Brookfield relative to its overall portfolio, but the materiality determination has to consider the perspective of the stockholder. Delaware law prioritizes transparency in the special committee’s reliance on advisors, and it was reasonably conceivable that Morgan Stanley’s holding nearly half a billion dollars in Brookfield would be material to a stockholder assessing the advisor’s objectivity.

Similarly, the fact that another advisor had represented Brookfield in the past and concurrently represented a Brookfield affiliate should have been disclosed. This ongoing relationship raised the concern that the advisor would not want to push Brookfield too hard.

Furthermore, the proxy was deficient in its failure to disclose certain management fees Brookfield expected to realize from the merger. Knowing that Brookfield expected to gain $130 million in management fees would have helped stockholders evaluate whether Brookfield paid a fair price and whether the special committee leveraged the added value.

The case is No. 241, 2023.

Stay of SEC climate regulation dissolved for now

By Mark S. Nelson, J.D.

The Fifth Circuit today transferred the petition for review filed in that circuit challenging the SEC’s climate risk disclosure regulation that had prompted the court to stay the regulation to the Eighth Circuit and, at the same time, dissolved the administrative stay the court had issued. That order perhaps gives the SEC some temporary relief but under the applicable rules, the Eighth Circuit will have an opportunity to decide whether to re-instate the stay of the regulation (Liberty Energy Incorporated v. SEC, March 22, 2024).

Under 28 U.S.C. 2112(a)(4), a court can stay a matter pending the outcome of a random drawing held by the Judicial Panel on Multidistrict Litigation to designate a federal appeals court to hear multiple, consolidated petitions for review of an agency order. The transfer court may then modify, revoke, or extend the stay.

The Fifth Circuit’s order to dissolve the stay was issued per curiam but, significantly, one judge appeared to disagree with that portion of the order. A footnote to the order said, without any further explanation, that “Judge Jones believes the docket should stay as is pending transfer.”

The SEC also has provided the required notice to the Eighth Circuit that the MDL panel had designated that court to hear the consolidated petitions for review, which total nine. The petitions had been filed in the Second, Fifth, Sixth, Eighth, Eleventh, and D.C. Circuits with petitioners filing in circuits they believed most likely to rule in their favor. Although most of the petitioners are business groups, individual companies affected by the SEC’s regulation, or conservative state attorneys general, two environmental groups, believing the SEC’s final regulation fell short of what had been proposed, also filed suit in the Second and D.C. Circuits.

The case is No. 24-60109.

House committee hearings target SEC ‘overreach,’ escalate push for agency reform

By Suzanne Cosgrove

As the title of the hearing suggested, “SEC Overreach: Examining the Need for Reform,” the House Subcommittee on Capital Markets provided a two-hour forum Wednesday for its mostly Republican members to vent their displeasure with the SEC generally, and Chair Gary Gensler in particular.

In a pre-meeting memorandum, the GOP-led committee said it had “significant concerns” about Gensler’s “rapid push to propose and finalize numerous new rules, insufficient comment periods, neglecting bipartisan congressional concerns, and finalizing new rules that exceed the SEC’s statutory authority.”

The committee is currently reviewing about a dozen pieces of legislation related to the Commission, including H.R.78 – the SEC Regulatory Accountability Act.

A “flood” of rules. “Since taking office in 2021, Chair Gensler has flooded the marketplace with roughly 60 new proposals and more than 30 final rules,” commented Rep. Ann Wagner (R-Missouri).

“Democrats might argue that Chair Gensler has acted in the interest of investors,” Wagner said. “However, investors and companies in both the public and private markets know otherwise and have been raising the alarm through both public comment and the courts.

“Many of these proposed and final rules include sweeping new changes that were advanced without the requisite statutory authority; without a comprehensive cost-benefit analysis; or without satisfying the requirements of the Administrative Procedure Act,” she added.

The best example of this overreach was the SEC’s climate disclosure rule, adopted on March 6, Wagner said.

Her criticism was countered by Rep. Brad Sherman (D-Calif.), who asserted the SEC was just catching up and “is finally doing what we told them to do in Dodd-Frank in 2010.” As for criticisms that comment periods for new SEC rules are too short, they have been averaging about 67 days when measured from the date published on the SEC’s website rather than in the Federal Register, Sherman said.

Think tanks testify. The committee heard testimony from four representatives of think-tank and industry groups, including David Burton, senior fellow in economic policy from the Heritage Foundation and John Gulliver, executive director, Committee on Capital Markets Regulation.

Burton told the committee he believes the SEC does a poor job of informing policymakers of their actions. Further, he claimed the SEC exercises inadequate oversight of self-regulatory organizations and is pursuing “political and ideological objectives, unrelated to its core mission,” when it touched on regulation involving climate and DEI (diversity, equity and inclusion) disclosures.

His sharp critique was followed by comments from John Gulliver, executive director, Committee on Capital Markets Regulation, who said over the last three years, under Chair Gensler, “the SEC has embarked on an unprecedented rulemaking agenda … without a new statutory mandate or a market crisis presenting a need for holistic reform.

“Now is therefore precisely the right time to consider if reform of the SEC’s regulatory processes is needed,” Gulliver added.

Other controversial rules. In addition to heated debate over climate disclosure regulations and concerns that public comment periods are too short, the hearing touched on the SEC’s private fund advisor rule and requirements of the Administrative Procedure Act.

The House is considering legislation that calls for congressional disapproval of the private fund advisor rule. And as reported by Securities Regulation Daily earlier this week, several trade associations have sued the SEC over its dealer rules, alleging the agency has exceeded its statutory authority and has imposed an unnecessary burden on competition.

The trade associations, which represent managers of private funds that will be subjected to an expanded definition of “dealer” and will have to register with the SEC, asked a Texas judge to vacate the rule.

In testimony related to the private fund rules, Alexandra Thornton, senior director, Financial Regulation for Inclusive Economy at the Center for American Progress, noted private funds have grown in size, complexity and number in the past decade since Dodd-Frank Act required private fund advisors to begin registering with the SEC.

The private fund rule “takes on heightened importance given the rapid growth of private markets, generally,” with more capital now raised in the private market than in public markets, leaving pension and other funds materially exposed, she said.

Thornton estimated 5,000 private funds advisors now manage about $18 trillion in private fund assets.

APA requirements. Further, the processes required by the Administrative Procedure Act do not require an agency to make changes in response to every public comment, Thornton said, but rather to solicit relevant information so it can make a “rational connection between the facts found and the choice made.”

However, through numerous challenges to the SEC rulemaking, in court and otherwise, opponents are making the process more burdensome and impeding the ability of the agency to do its job, Thornton said.

MDL process will decide where SEC climate rule challenge is heard

By Mark S. Nelson, J.D.

The SEC filed the required notice to the Judicial Panel on Multidistrict Litigation informing the MDL panel that the agency had received multiple petitions for review of its recently adopted climate risk disclosure regulation that were filed in multiple federal appeals courts. The next step will be for the MDL panel to hold a random drawing to determine which of the six U.S. Courts of Appeal in which petitions for review have been filed will hear the consolidated petitions for review. Following a ten-day race to court, nine petitions for review have been filed, although four of them were filed in the Fifth Circuit, where two of the petitioners had already sought to join the petition filed by Liberty Energy Inc. that resulted in the Fifth Circuit issuing a stay of the SEC’s regulation (IN RE: Securities and Exchange Commission, MCP No. ___ The Enhancement and Standardization of Climate-Related Disclosures for Investors, Release Nos. 33-11275, 34-99678 (issued Mar. 6, 2024), March 19, 2024).

MDL designation process. The MDL panel becomes involved under 28 U.S.C. §2112 in selecting the federal appeals court to hear a petition for review of an agency order or rule when petitions for review of that rule are filed in multiple federal appeals courts within 10 days of the issuance of the rule. The agency, in this instance the SEC, must then notify the MDL that such a situation exists, and that will trigger a random drawing by the MDL by which it will designate one federal appeals court to hear the consolidated petitions for review.

Specifically, MDL Rule 25.5(a) states: “Upon filing a notice of multicircuit petitions for review, the Clerk of the Panel shall randomly select a circuit court of appeals from a drum containing an entry for each circuit wherein a constituent petition for review is pending. Multiple petitions for review pending in a single circuit shall be allotted only a single entry in the drum.”

The second sentence of Rule 25.5(a) would appear to apply regarding the SEC’s climate risk disclosure regulation because four petitions for review were filed in the Fifth Circuit. The circuit courts that could hear the consolidated petitions for review are the Second, Fifth, Sixth, Eighth, Eleventh, and D.C. Circuits.

Looking ahead. As the designation and appeal process unfolds, look for several issues to arise. First, the applicable statute governing the review of agency orders allows a court to issue a stay, which the Fifth Circuit granted regarding the climate risk disclosure regulation late last week. However, the federal appeals court designated by the MDL panel can modify, revoke, or extend the stay.

Second, expect the SEC to assert that at least some of the petitioners lack standing to bring their petitions. The SEC hinted at this approach in its opposition to Liberty Energy’s request for an administrative stay or stay pending appeal before the Fifth Circuit. There, the SEC said Liberty Energy neither resides nor has its principal place of business within the Fifth Circuit and that the final climate risk disclosure regulation does not require Liberty Energy to investigate another, related, petitioner in which Liberty Energy is a more than 10 percent shareholder, because the regulation grants companies leeway to define their organizational boundaries for purposes of emissions metrics, provided they disclose how they chose the boundaries. Article III standing issues also can arise regarding whether states can challenge federal agency regulations.

Beyond the procedural issues to be worked out in the days and weeks ahead, expect the petitioners’ substantive arguments to focus on the Supreme Court’s major questions doctrine and whether the SEC is seeking to displace EPA regulations that mandate similar GHG emissions disclosures. Also expect the petitioners to argue that the SEC’s regulation ran afoul of the Administrative Procedure Act and that at least portions of the regulation violate the First Amendment. This much has been previewed in the filings made by Liberty Energy and the SEC regarding the stay that was eventually issued by the Fifth Circuit (See, Liberty Energy’s request for stay and SEC’s opposition).

The case is No. Pending MCP No. 8.

CFTC Commissioner Johnson highlights potential and risks of AI at MRAC’s Future of Finance Subcommittee meeting

By Elena Eyber, J.D.

The Market Risk Advisory Committee’s (MRAC) Future of Finance subcommittee held a meeting on March 15, 2024, at the CFTC’s Washington, D.C. headquarters. The CFTC Commissioner Kristin N. Johnson's issued an opening statement, highlighting the significant potential and associated risks of artificial intelligence (AI) in various sectors, including finance. Johnson emphasized AI's positive impact on fields such as medicine and agriculture, as well as its efficiency in financial markets for trade execution, pricing prediction, and risk management.

However, Johnson warned about the potential perils of AI integration, citing a real-world example of a scam involving deep fake technology. Johnson stressed the need for proper oversight and regulation to address concerns such as governance, bias, transparency, and ethical considerations.

Further, Johnson discussed the White House's Blueprint for an AI Bill of Rights, outlining principles to guide safe AI deployment, and the establishment of an AI Safety Institute within the Commerce Department to develop guidelines and standards for AI risk management. Additionally, Johnson mentioned international efforts and standards regarding AI governance.

Commissioner Johnson advocated for a principles-based regulatory framework, greater transparency in AI adoption by financial institutions, and heightened penalties for AI-related fraud. Johnson proposed creating an inter-agency task force to facilitate information sharing and support the AI Safety Institute.

The meeting included panels on AI in financial markets, implications of AI on current market regulations, AI-related risks, and future trends in AI adoption and regulation. Various experts from both public and private sectors participated in these discussions, addressing key aspects of AI's role in finance and regulatory responses.

Court grants stay of climate rule

By Anne Sherry, J.D.

The Fifth Circuit granted a request to stay the SEC’s climate risk disclosure regulation. The brief unpublished order does not give any reason for the decision to grant the stay, but its issuance signals that the court saw merit in the challenge. A lottery will be held soon to determine which appeals court will hear the various petitions against the rule (Liberty Energy, Incorporated v. SEC, March 15, 2024, per curiam).

The stay itself is likely to have little practical effect on companies due to the long compliance horizon in the rule, which doesn’t require reporting until 2026 at the earliest. The petitioners had argued, however, that they would need to begin compliance measures immediately in order to be ready to collect the required data.

The stay is also vulnerable to being lifted or revised by another court. So far, petitions for review of the climate rule have been filed in not just the Fifth but also the Eighth, Eleventh, and District of Columbia Circuits. Under 28 U.S.C. § 2112, when petitions are filed in multiple courts in the first 10 days of a rule, the Judicial Panel on Multidistrict Litigation randomly draws one of those courts to review the consolidated petitions. In this case, that ten-day period expires at the end of Monday, March 18.

The real import of the stay is as a signifier that the Fifth Circuit sees merit in the petitioners’ arguments.

The court could have denied the motion for stay on procedural grounds. For example, Federal Rule of Appellate Procedure 18 states in part that “A petitioner must ordinarily move first before the agency for a stay pending review of its decision or order.” The SEC argued that it had not been given a chance to address the arguments for staying the final rule, but the challengers countered that they had requested a stay of the proposal back in 2022. The appeals court may have been satisfied that this request, as the petitioners argued, “easily satisfies FRAP 18.”

The petitioners also argued that they were likely to succeed on the merits of their challenge because the rule triggers the major-questions doctrine, lacks clear statutory authority, is arbitrary and capricious, and fails First Amendment scrutiny. As to that last point, the SEC’s conflict minerals disclosure rule was gutted through legal challenges largely grounded in First Amendment arguments.

The case is No. 24-60109.