The week of June 24, 2024 may be remembered as one of the worst in recent memory for the SEC, which – along with the “administrative state” generally – was beaten up by some very significant decisions handed down by the U.S. federal courts.
Securities Fraud Claims Seeking Civil Penalties Must Be Brought in Federal Court
On June 27, the U.S. Supreme Court announced its decision in Securities and Exchange Commission v. Jarkesy, holding that the SEC must bring securities fraud actions seeking civil penalties before a federal court, rather than before the Commission or an administrative law judge.
The Dodd-Frank Act, enacted in the wake of the financial crisis in the early years of the 21st century, authorized the SEC to impose civil penalties without having to resort to the federal courts. Pursuant to this authority, the SEC brought an enforcement action against the defendants in Jarkesy in 2013, alleging violations of the antifraud provisions of federal securities laws, opting for proceedings before an administrative law judge. The proceedings resulted in a civil penalty of $300,000 and other remedies. Upon review, the US Court of Appeals for the Fifth Circuit vacated the SEC’s order on three grounds, and the SEC appealed to the Supreme Court.
In its decision, SCOTUS addressed only one of the Fifth Circuit’s bases for vacating the SEC order – namely, that the pursuit of civil remedies for antifraud violations violated the Seventh Amendment right to a jury trial. According to the majority opinion, actions resembling a common law cause of action for which remedies are traditionally available at common law must be brought in federal court. Because the violations alleged in Jarkesy are similar to common law fraud (claims that were “legal rather than equitable”), the Court found that the action should have been brought in federal court.
The impact of Jarkesy remains to be seen. For example, it does not appear to apply to matters not involving common law causes of action, even when those matters result in a civil penalty, such as the SEC’s recent enforcement action against R. R. Donnelley & Sons Co., or where other remedies, such as disgorgement, are sought. However, the admonition to “watch this space” seems applicable here.
The SEC’s Rescission of Proxy Advisory Firm Rules Is Vacated
The Jarkesy decision came just one day after a Fifth Circuit decision vacating the SEC’s 2022 rescission of rules affecting proxy advisory firms that had been adopted a mere two years earlier.
The rules adopted in 2020 imposed a number of requirements on proxy advisory firms, such as Institutional Shareholder Services and Glass Lewis. Among other things, the rules required proxy advisory firms (1) to promptly notify companies of their voting recommendations and (2) to notify their investor clients of companies’ written responses to those recommendations. The following year, the SEC proposed to “amend” these requirements – i.e., to rescind them – and adopted those amendments the following year. This flip-flop surprised and frustrated many constituencies, including corporate America, resulting in the litigation in question.
In its opinion, the Fifth Circuit found the SEC’s actions in reversing the rule to be arbitrary and capricious. Among other things, the Court noted that “[t]he 2020 rule[s] never went into effect” and also commented on the questionable timing of the proposal to rescind the rules:
“The agency’s proposal… was published in November 2021, following a closed-door meeting between Chairman Gensler and opponents of the 2020 [rules]… . The comment period for the proposal was thirty-one days and encompassed portions of the Thanksgiving, Hanukkah, and Christmas holidays…. Unsurprisingly, far fewer comments were filed during this highly truncated period than had addressed the 2019 Proposed Rule. After the comment period closed, the SEC adopted the proposed rescission over the dissent of two commissioners.”
It seems likely if not certain that the SEC will appeal the Fifth Circuit’s decision, but the Jarkesy decision and a third decision handed down this week, discussed below, suggest that the appeal’s success is far from assured.
Chevron “Deference” Falls by the Wayside
To end the week, on June 28 SCOTUS handed down its decision in Loper Bright Enterprises v. Raimondo. While this case does not involve the SEC, it will likely be the most significant of them all. Specifically, the decision overturned a 1984 precedent, in Chevron v. Natural Resources Defense Council, that permitted judges to defer to federal agencies’ interpretations of law in rulemaking. In striking down the so-called “Chevron deference” doctrine, the Court stated that it improperly prioritized the legal interpretations of the executive branch over those of the judicial branch.
While this decision impacts many agencies other than the SEC, it seems likely if not certain that the SEC’s rulemaking decisions will come under greater scrutiny and be subject to more second-guessing by the federal courts than is currently the case.
The Moral of the Story?
The moral of this story, at least for now, seems to be that if you don’t like an SEC rule or practice, just wait around. It will likely be challenged. And, based on these and other cases, the federal courts – and, in particular, the Fifth Circuit – appear willing to oblige.