By Anne Sherry, J.D.
In a forcefully stated keynote address to the SEC Regulation Outside the United States conference in London, Enforcement Director Gurbir Grewal insisted that the SEC does not “regulate by enforcement” when it applies longstanding regulations to new and emerging technologies and products. Grewal cited several actions in which the Commission cracked down on unregistered ICOs using the Howey test established in 1946 and emphasized that the SEC looks to the substance of underlying product rather than how it is labeled.
Contrasting Lewis Carroll’s The Hunting of the Snark, Grewal said that just because a statement is repeated doesn’t make it true. Specifically, the refrain he has heard in his three months on the job is that the SEC is “regulating by enforcement,” particularly in the context of emerging technologies and products. The director said that SEC staff uses the statutes enacted by Congress and rules adopted by the SEC to fulfill the agency’s three-part mission of protecting investors, maintaining fair markets, and facilitating capital formation. So when the Commission last year brought more standalone enforcement actions than the year before, this is not “regulating by enforcement” in Grewal’s view, but simply using all of the tools available to pursue wrongdoers.
Crypto enforcement. Regarding crypto, Grewal said that the SEC encourages the use of new technologies for capital formation, but that all securities sold to U.S. investors must comply with the U.S. securities laws. The agency has brought dozens of cases for unregistered and fraudulent ICOs and for related touting violations, often securing meaningful relief for investors. In each of these cases, the threshold issue is whether the digital asset or token is a security, a question that goes back to Congress’s definition of “security” in the 1930s, the Supreme Court’s Howey decision in the 1940s, and the Court’s Reves v. Ernst & Young decision in 1990. “The Howey court showed great foresight in describing the Howey test as ‘flexible’ and ‘capable of adaptation,’” Grewal said, adding that “courts have done just that in the crypto space.”
For instance, in holding that the “Kin” token was a security under Howey, the Southern District of New York rejected the defendant’s argument that the term “investment contract” was unconstitutionally vague. The court wrote that “Howey provides a clearly expressed test for determining what constitutes an investment contract, and an extensive body of case law provides guidance on how to apply that test to a variety of factual scenarios.” In other words, Grewal said, the regulations applied to crypto misconduct are longstanding and established. While the court also said that the government is not required to “reach out and warn all potential violators,” the SEC has issued guidance and investor alerts specific to digital assets.
ESG. Grewal similarly denied that the SEC is regulating ESG issues by enforcement. The Enforcement Division has a Climate and ESG Task Force that works closely with other divisions and offices to detect climate- and ESG-related misconduct, but there is nothing new about how they operate: they look to make sure that current rules and laws are followed. If an issuer chooses to say something on climate or ESG, those statements must not be materially false or misleading. And if an asset manager markets an ESG fund or strategy, it must do so in a way that is not materially false or misleading while adhering to client mandates and restrictions.
Back in 2008, the SEC settled charges against Pax World Management for buying securities that were prohibited under its promised “socially responsible investing” restrictions. In 2020, the agency settled charges against Fiat Chrysler for announcing that an internal audit confirmed that vehicles complied with environmental regulations concerning emissions. The statements failed to disclose the limited scope of the audit and that it did not include a comprehensive review of compliance. These cases, Grewal said, demonstrate that the requirements of accurate disclosure and fiduciary duties are not new. After declaring “this is not regulation by enforcement” three times, Grewal again quoted Lewis Carroll: “What I tell you three times is true.”