By Matthew Bultman
US securities regulators’ expected crackdown on crypto firms and potential shakeups in insider trading cases are among the closely watched investor issues for the coming year.
Securities litigation involving companies’ environmental, social and governance (ESG) disclosures and practices will also keep court dockets busy. A slowdown in dealmaking likely means fewer lawsuits related to mergers and acquisitions, but a market downturn could spur more fraud cases.
Targets of Securities and Exchange Commission enforcement actions could also soon have a new avenue to fight off the agency’s complaints, as the US Supreme Court is expected deliver a decision in a closely watched case, SEC v. Cochran, by the end of June.
At issue in the case is whether parties facing enforcement actions can go straight to federal court with constitutional challenges—or must wait until the SEC’s in-house proceedings are over to raise such claims.
A decision against the government would reshape current rules and procedures, and may lead to additional constitutional challenges to SEC enforcement actions.
The SEC has been ramping up to be the lead regulator in the crypto market, and appears poised to tighten the clamps on the emerging-but-struggling industry. SEC chair Gary Gensler told Bloomberg News last week the agency’s patience with digital-asset exchanges and other firms that don’t register with the agency is wearing thin.
The SEC nearly doubled its Crypto Assets and Cyber Unit this year by adding 20 people. The high-profile collapse of FTX could add pressure for SEC enforcement.
“I think you can bet there’s going to be a lot of enforcement activity coming out of that unit,” said Toby Galloway, chair of the securities litigation and enforcement practice at Winstead PC. “When they tell you what their objectives are and what their priorities are, you probably ought to listen.”
The SEC has already filed cases against FTX co-founder Sam Bankman-Fried and his associates, Caroline Ellison and Gary Wang, alleging FTX investors were defrauded out of $1.8 billion. The complaint against Ellison and Wang also alleges FTX’s digital token, FTT, was sold as a security.
The agency in another closely watched case has accused Ripple Labs of misleading investors about its XRP crypto token. Both sides have asked the court for a ruling in their favor. A central question is whether XRP is a security.
Ripple also argues it didn’t have fair notice that XRP could be a security. Ripple executives have further said that securities laws, as applied to XRP transactions, are impermissibly vague. Should either defense gain traction, it could provide a road map for defendants in other cases, attorneys said.
Ripple during the litigation has also obtained numerous internal SEC documents, including emails related to a 2018 speech by an SEC official. That approach could also carry over to other cases, with defendants trying to access internal SEC communications.
“Those kinds of things transcend really any kind of SEC litigation,” Ropes & Gray LLP partner Amy Jane Longo said.
Following a record-setting level of activity in mergers and acquisitions in 2021, the volume of deals noticeably slowed in 2022. The third quarter of 2022 had the third-lowest global M&A deal volume in several years, a Bloomberg Law analysis found.
This year also saw historic lows for US initial public offerings. Through the first three quarters, companies raised $9.4 billion in IPOs. That is well below the 2021 pace, which brought in a record $190 billion, according to Bloomberg Law data.
Those slowdowns will probably translate into fewer new M&A and IPO-related lawsuits in the coming months.
“If you have fewer new deals, then you’re going to have fewer cases coming out of new deals,” said Jonathan Youngwood, global co-chair of the litigation department at Simpson Thacher & Bartlett LLP.
But that doesn’t mean fewer significant cases, Youngwood said.
“If the plaintiff’s bar is careful about what it pursues, they’re filing cases that they believe have more merit and are likely to go a longer distance,” he said.
An economic downturn could help drive an uptick in other kinds of cases, including those related to Ponzi-like schemes. There could also be more lawsuits related to misrepresentations of a company’s financial statements, Galloway said.
“Things come to light when the market is down,” Galloway said.
Following a rare loss in an insider trading case, the SEC is appealing to the US Court of Appeals for the Fourth Circuit. How the court rules could impact SEC cases that hinge on circumstantial evidence.
The district court in a 2021 ruling found the SEC simply “speculated” that Christopher Clark received inside information from his brother-in-law because Clark was “a little too successful” in trading. Clark is alleged to have made over $245,000 on the information.
The SEC, which has ramped up its use of data analytics to detect suspicious trading patterns, maintains there is “compelling circumstantial evidence” that Clark traded on a pipeline of inside information. A ruling for Clark could be a setback for the agency.
“One wonders if that could chill other cases the SEC might bring that are more on the bubble in terms of how strong the circumstantial evidence is,” Longo said.
Meanwhile, in an effort to combat insider trading, the SEC this month restricted when top executives can unload company shares. The agency is also forcing them to disclose more information about planned stock sales.
The measure is intended to close perceived loopholes in stock sale timing rules that executives could exploit, Gensler said.
A requirement for companies to publicly disclose more information about executives’ trading plans could also cause a new wrinkle in insider trading litigation. Courts could more easily consider the information earlier in the case in reviewing motions to dismiss. That would benefit defendants who would argue they bought or sold securities according to a trading plan and are shielded from insider trading liability.
“Now defendants should be able to make that defense out at an earlier stage of the case if this information is required to be widely available,” Longo said.
Communication technology and other emerging issues also could lead to new enforcement actions and litigation.
Several big banks were fined close to $2 billion in September for failing to monitor employees’ communications on messaging apps like WhatsApp and other “off channel” services. The SEC’s probe has expanded to other industry players, including asset managers, Bloomberg News reported.
Separately, the agency is working to finalize new climate disclosure requirements for companies. Attorneys expect the SEC will continue to look for ways to bring enforcement actions related to ESG issues under the existing regulations. ESG-related litigation from investors is expected to increase as well.
The SEC this year brought its first enforcement action for alleged violations of Regulation Best Interest, or Reg BI, which requires broker-dealers to act in the best interest of their clients.
The SEC action came almost two years after Reg BI took effect. There are signs that further enforcement is coming. The agency has issued subpoenas to dozens of broker dealers, attorneys said.
“They’ve got this rule that hasn’t been enforced a whole lot just yet,” Galloway said. “But they’re going to use it.”
To contact the reporter on this story: Matthew Bultman in New York at mbultman@correspondent.bloomberglaw.com
To contact the editor responsible for this story: Roger Yu at ryu@bloomberglaw.com; Keith Perine at kperine@bloomberglaw.com
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