A legal assault on the U.S. Securities and Exchange Commission is chipping away at its powers to oversee Wall Street, and this effort is likely to intensify with two imminent Supreme Court rulings.
Last week, a U.S. appeals court overturned a major SEC rule that imposed stricter oversight of private funds, delivering a fresh blow to Democratic Chair Gary Gensler’s ambitious agenda to boost transparency and stamp out conflicts of interest on Wall Street. The court denied some of the SEC’s authority to oversee investment advisers, potentially making its other draft rules on cybersecurity, outsourcing, and predictive data analytics vulnerable to litigation, according to lawyers.
The New Orleans-based 5th U.S. Circuit Court of Appeals’ ruling exemplifies how business groups are using conservative-leaning courts to overturn SEC rules, limit its ability to write similar ones, 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 around 40,000 entities, a top target.
“It’s happening government-wide, and it’s quite acute at the SEC,” said Satyam Khanna, a former SEC attorney who advised two former Democratic Commissioners as recently as 2021. “The SEC oversees a vast number of entities – funds, public companies, brokers, and more – and the financial stakes can be high.”
The agency faces several other lawsuits from financial firms and their trade groups arguing that the SEC is overstepping its authority by imposing ill-conceived and costly rules. A Reuters review of Westlaw filings showed a sharp uptick in the number of open appeals against the SEC in the 5th Circuit Court of Appeals from 2019 to last year, although the SEC is also facing litigation in other conservative-leaning courts.
5th Circuit suit
Among the cases, hedge funds are suing in the 5th Circuit to overturn SEC short-selling disclosures and in a Texas district court to kill new Treasuries trading rules. In March, business groups including the U.S. Chamber of Commerce, as well as Republican-led states, sued to block SEC climate change rules. The Chamber, one of the most aggressive groups in litigating regulations, won a 5th Circuit challenge to SEC rules around stock buybacks in December and is tracking other draft rules for potential challenges.
“The current SEC has engaged in remarkable amounts of regulatory overreach,” said Daryl Joseffer, chief counsel at the Chamber’s Litigation Center. Reform advocates argue that the industry just wants to protect its profits and that weakening the SEC will hurt everyday Americans.
Speaking to Reuters last Wednesday, SEC chair Gary Gensler did not discuss the private funds ruling but noted that only a handful of dozens of rules adopted under his leadership have been litigated. He highlighted that the agency has notched some notable wins, including in the 5th Circuit, on diversity rules and proxy voting. “We do everything according to law and how courts interpret law.
SEC approval of Bitcoin
If the courts interpret law differently than we thought, we adjust, we pivot,” Gensler said. He cited the SEC’s decision to approve bitcoin products in January after a D.C. appeals court found the agency had been wrong to reject them as an example.
Trump appointed 54 judges to the U.S. appeals courts, where many suits against federal agencies are filed, and pushed the Supreme Court to a 6-3 conservative majority. When asked if he felt the courts were stacked against him, Gensler said, “I’m a huge believer in the American democratic system and our constitutional system. We have three co-equal branches of government. And that’s a really important thing.”
Most of the litigation alleges violations of the 1946 Administrative Procedure Act, which requires regulators to justify rules and allow time for, and fully consider, public feedback. Some cases lean on a 2022 Supreme Court decision that raised doubts over whether federal agencies have the authority to tackle major policy questions. That ruling was among the reasons the SEC scaled back its climate change rule, Reuters previously reported, and was cited in some of the March suits.
Crypto firms
Crypto firms have frequently cited that “major questions” doctrine when disputing the SEC’s authority to regulate them. The SEC has made significant changes to other major rules following industry pushback, including on money market funds and activist investor disclosures. “Vigorous industry pushback in comment files often raises the specter of litigation,” said Khanna. Gensler said the agency takes industry comments “very seriously.”
This month, the Supreme Court is also expected to rule on two other cases with major implications for the SEC. One case relates to its authority to use in-house judges with securities law expertise to decide enforcement actions, which is often speedier than going through the courts. Conservative Justices last year expressed concern that this denies defendants a jury trial. The case follows a 2018 Supreme Court ruling that found the SEC’s process for selecting in-house judges violated the Constitution. Since then, the SEC has dramatically scaled back its use of the tribunal, SEC data shows.
The other SCOTUS case challenges a legal doctrine known as “Chevron deference,” which calls for judges to defer to federal agencies’ interpretations of U.S. laws deemed to be ambiguous. Chevron is a bedrock of agency rulemaking. According to 2017 research published in the Michigan Law Review, between 2003 and 2013, Chevron was applied 66.7% of the time when litigating SEC rules in circuit courts, and in those cases, the agency won just over 81%. “It’s highly likely that the court will overrule Chevron or sharply curtail it,” said Joseffer. Consequently, “agencies would succeed less often in defending their interpretation of statutes, and as a result one would hope agencies would be more cautious in their rulemakings,” he added.
