May 16, 2022

Volume XII, Number 136

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May 16, 2022

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SEC Enforcement Director Rejects "Regulation by Enforcement" Criticism

SEC Division of Enforcement Director Gurbir Grewal rejected criticism that the agency is "regulating by enforcement" when it comes to cryptocurrency, and environmental, social and governance matters.

In remarks at the Scott Friestad Memorial Keynote Address, Mr. Grewal said that the agency "welcome[s]" new technologies but must also prioritize investor protection by ensuring compliance with the federal securities laws. In the past four years, he noted, the agency has brought cases against fraudulent and unregistered initial coin offerings and intermediaries (e.g., exchanges and broker-dealers) who facilitated trading in unregistered securities. Mr. Grewal acknowledged that standalone enforcement actions increased this fiscal year over last, but denied that this constitutes "regulation by enforcement."

Mr. Grewal defended the SEC's reliance on SEC v. Howey and Reves v. Ernst & Young to determine whether an instrument is a security. He noted that the application of both tests has been criticized for predating cryptocurrency by decades and for vagueness in application. Mr. Grewal denied claims made (specifically in SEC v. Kik Interactive Inc.) that the SEC's application of Howey was "unconstitutionally vague," saying that these tests have been affirmed by courts many times and praising Howey as "flexible" and "capable of adaptation." (The Kik Court agreed, concluding that Howey clearly expresses the definition of an "investment contract.") Mr. Grewal also rejected the criticism that the SEC's guidance has been insufficient. He said that the Court in Kik rejected the argument, adding that the agency is not required to "reach out and warn all potential violators." Mr. Grewal went further, stating that the agency has issued guidance on the application of U.S. securities laws to distributed ledger technology and digital assets, and investor alerts on the risks of investing in cryptocurrency.

Separately, Mr. Grewal warned market participants that attempting to avoid securities regulation through "labeling" will not succeed. Specifically, Mr. Grewal stated that the use of terms such as "decentralized," a "lending program" and "stable" will not change its inquiry as to whether or not the instrument is a security.

On ESG matters, Mr. Grewal said there is nothing "new" about how the agency investigates climate and ESG misconduct. Rather, he noted that the agency applies its "long-standing principles" of (1) materiality and disclosure for all issuers, and (2) fiduciary duties and honest disclosure in the asset management sector. Mr. Grewal also noted the longevity of the agency's ESG mandate, starting in 2008 when it settled charges against Pax World Management for breach of fiduciary duty concerning socially responsible mutual funds. More recently, the SEC settled a case against Fiat Chrysler for misleading disclosures from an internal audit concerning emissions control systems.

© Copyright 2022 Cadwalader, Wickersham & Taft LLPNational Law Review, Volume XI, Number 313
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About this Author

Philip S. Khinda Attorney Securities Law Cadwalader Law Firm Washington DC
Partner

Philip Khinda is one of the nation's leading securities lawyers, litigators, and advisers to public companies, corporate boards, special committees, and financial institutions dealing with corporate crises, shareholder and derivative litigation, and government and internal investigations. 

Phil’s leadership of the CalPERS Special Review, its fee recovery of more than $200 million for the nation's largest state pension fund, and its public report on pay-to-play and public corruption issues are notable representative efforts. He has also...

202-862-2262
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