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Annually, the SEC’s Office of Inspector General offers its “independent perspective” on the “top management and performance challenges” facing the SEC. What stands out in the 2024 Inspector General’s Statement on the SEC’s Management and Performance Challenges?  It’s that the SEC is confronting several serious challenges—particularly significant litigation challenges to its rulemaking—but, at the same time, is facing serious budget constraints. Not only have many of the recent rulemakings been challenged in court, but, in light of SCOTUS’s decision last term in Loper Bright, which put the kibosh on Chevron deference, the OIG expects that “SEC rulemaking will continue to face searching judicial scrutiny.” In addition, the OIG predicts that the “current regulatory environment may lead to increased forum shopping by petitioners and extended periods of uncertainty about the permissible scope of agency action.”  In light of this heightened judicial scrutiny, the OIG advises, the SEC “must continue to develop a thorough administrative record, including meaningful opportunity for public participation and reasoned responses to public submissions.  The SEC already invests considerable resources toward these ends, but should be prepared for additional litigation, as industry and public interest groups may take opportunities to challenge regulations.”  At the same time, the OIG cautions, the dearth of resources under the current budget environment “may hinder the Agency’s ability to meet these challenges, mitigate its risks, and pursue its vital mission.” In particular, as a result of flat funding for fiscal 2024, the SEC was required to freeze hiring and eliminate certain employee benefits, while increased  “personnel costs limit the resources available to update and improve legacy information systems, including information security.” Yet, “the changing regulatory environment will likely increase operational demands on the Agency and its staff,”  rendering the financial constraints all the more problematic. 

You can probably tell that this post was written prior to the vote count last night. The election results and coming change in Administration will certainly affect the SEC’s rulemaking agenda and probably its litigation posture; however, to the extent that Democrats adopt a litigation strategy with regard to rulemaking by the new Administration that follows the current Republican playbook, many of the challenges identified by the OIG could well remain.

SideBar

As you may recall, Loper Bright Enterprises v. Raimondo  concerned whether the National Marine Fisheries Service had the authority to require Atlantic herring fishing vessels to pay some of the costs for onboard federal observers who were required to monitor regulatory compliance. But the broader consequences of the case had little to do with fishing and everything to do with the authority of administrative agencies to regulate: the question presented to SCOTUS was whether the Court should continue the decades-long deference of courts, under Chevron U.S.A., Inc. v. Nat. Res. Def. Council, to the reasonable interpretations of statutes by agencies. The doctrine of Chevron deference mandated that, if a statute did not directly address the “precise question at issue” or if there was ambiguity in how to interpret the statute, courts had to accept an agency’s “permissible” (think, “reasonable”) interpretation of a law unless it was arbitrary or manifestly contrary to the statute. In a majority opinion by Chief Justice John Roberts, the Court rejected the doctrine: the “deference that Chevron requires of courts reviewing agency action cannot be squared with the [Administrative Procedure Act].” As Kagan wrote in her dissent, this decision “puts courts at the apex of the administrative process as to every conceivable subject—because there are always gaps and ambiguities in regulatory statutes, and often of great import. What actions can be taken to address climate change or other environmental challenges? What will the Nation’s health-care system look like in the coming decades? Or the financial or transportation systems? What rules are going to constrain the development of A.I.?  In every sphere of current or future federal regulation, expect courts from now on to play a commanding role.” (See this PubCo post.)

The OIG report indicates that, since 2021, the SEC has proposed 55 rules and finalized 43 rules.  However, a number of these rulemakings have faced litigation:

  • “The Climate Disclosure Rule was challenged in the Fifth, Second, Sixth, Eighth, Eleventh, and District of Columbia (DC) Circuits, in actions ultimately consolidated before the Eighth Circuit. The SEC voluntarily stayed implementation of the rule, pending judicial review. 
  • The Private Fund Adviser Rule was vacated by the Fifth Circuit on the grounds that the SEC exceeded its statutory authority in adopting the rule.
  • The Share Repurchase Rule was also vacated by the Fifth Circuit, finding the SEC’s adoption of the rule arbitrary and capricious due to an absence of reasoned decision making and failure to conduct a proper cost-benefit analysis.
  • A DC district court found that the SEC exceeded its authority in promulgating 2020 amendments to proxy rules.”

How is the OIG planning to address the issue?  The OIG is auditing the SEC’s rulemaking processes and internal controls, with a report expected to be completed in fiscal 2025. The audit is focused on:

  • “The opportunity for interested persons to participate in rulemaking;
  • Assessing and documenting the impact of proposed rules on competition, efficiency and capital formation; and
  • Ensuring that staff with appropriate skills and experience are involved in formulating and reviewing proposed rules.”

The OIG also identifies more fallout for the SEC from decisions by SCOTUS this past term. In SEC v. Jarkesy SCOTUS held that, in the SEC’s action seeking civil monetary penalties against Jarkesy for securities fraud, Jarkesy was entitled to a jury trial under the Seventh Amendment.  (See this PubCo post.) Consequently, the SEC’s in-house administrative enforcement proceedings are no longer available for use in contested securities fraud actions for civil penalties.  According to the OIG, the “decision may have broader implications for the SEC’s enforcement program, as open questions remain, such as the constitutionality of seeking civil penalties in other types of administrative proceedings.  It is difficult to predict whether the availability of a federal jury trial will make defendants more likely or less likely to resolve claims in advance of litigation.  The uncertainty surrounding the SEC’s ability to adjudicate other enforcement actions administratively, as well as the additional resources required to bring actions in federal court, pose challenges for the SEC.”

SideBar

Although the OIG did not specifically identify these cases, there were at least a couple of other cases this past term that contributed to the drubbing administered to the administrative state, both of which could also affect the SEC.  One of them, Corner Post, Inc. v. Board of Governors of the Federal Reserve System, had the effect of extending the statute of limitations under the Administrative Procedure Act.  But, for this purpose, the potentially critical repercussion of Corner Post was articulated in the dissent by Justice Ketanji Brown Jackson, who argued that the case effectively decimated the limitations period for facial challenges to agency regulations, setting up the potential for a never-ending series of challenges to long-standing regulations and perhaps even, yes, gaming of the system. The majority held “that the broad statutory term ‘accrues’ requires us to conclude that the limitations period for [APA] claims runs from the time of a plaintiff’s injury.” The dissent would distinguish between facial and as-applied challenges. In Jackson’s view, it was plain from the text and context of the statute that, “for facial challenges to agency regulations, the 6-year limitations period…starts running when the rule is published.  The “baseless conclusion” of the majority “means that there is effectively no longer any limitations period for lawsuits that challenge agency regulations on their face. Allowing every new commercial entity to bring fresh facial challenges to long-existing regulations is profoundly destabilizing for both Government and businesses.  It also allows well-heeled litigants to game the system by creating new entities or finding new plaintiffs whenever they blow past the statutory deadline.” (See this PubCo post). 

Another case, Ohio v. EPA, in which SCOTUS put a temporary hold on the “good neighbor” provision of the Clean Air Act because EPA failed to “reasonably explain” its action,  will likely also have some impact. In Ohio, Justice Neil Gorsuch, writing for the majority, concluded that enforcement of EPA’s rule should be stayed because the challengers were likely to prevail on the merits.  Why? Because EPA had provided an inadequate explanation for the continued application of the emission control measures in the plan in response to comments. Where have we heard this “failure-to-explain” theory recently?  How about Chamber of Commerce of the USA v. SEC, vacating the SEC’s share repurchase rule for, among other things, failure to respond to petitioners’ comments (see this PubCo post) or even National Association of Manufacturers v. SEC, vacating the 2022 rescission of certain proxy advisor rules for arbitrarily and capriciously failing to provide an adequate explanation to justify its change (see this PubCo post).  Justice Amy Coney Barrett dissented, joined by Justices Sonia Sotomayor, Elena Kagan and Ketanji Brown Jackson, contending that the majority opinion “risks the ‘sort of unwarranted judicial examination of perceived procedural shortcomings’ that might ‘seriously interfere with that process prescribed by Congress.’” As characterized by Professor Nicholas Bagley of the University of Michigan Law School in Michigan Law, in its “broad strokes,” the dissent asserted that “courts shouldn’t be in the business of fly-specking lengthy notice-and-comment records,” especially with the benefit of hindsight. The question, he continued, “is whether the agency has behaved arbitrarily and capriciously, and that’s a pretty demanding standard.” With this decision, SCOTUS amplified the increasingly powerful role of the judiciary in overseeing federal agencies, adding to the decisions this term seeking to rein in the administrative state. (See this PubCo post.)

Another challenge identified by the OIG lies in the SEC’s responsibility for oversight of the extensive U.S. capital markets totaling “more than $100 trillion and approximately 40,000 entities.”   The OIG cautions that, in light of limited resources, the SEC must “conduct effective risk-based oversight and leverage technology and analytics.”   While most of the discussion concerned examinations of broker-dealers and others, the OIG also advised that, in fiscal 2025, it will complete an audit of Corp Fin’s Disclosure Review Program “to determine whether the program concentrated its resources on critical disclosures by implementing a risk-based process for selecting and reviewing filers’ periodic reports and transactional filings.”

The report also discussed the increase in complaints to the SEC about alleged crypto scams, with an office of the SEC having “received 5,876 crypto-related complaints, more than double that of any other type of complaint received.  In comparison, OIEA received 1,075 crypto-related complaints in FY 2020.  Additionally, 18 percent of the SEC’s tips, complaints, and referrals in FY 2024 were  crypto-related.”  According to the report, the FBI reported that, “in 2023, Americans suffered losses of $3.96 billion from ‘cryptocurrency-related investment fraud schemes.’ Individuals over the age of 60 reported the highest losses.” The SEC has brought a number of enforcement actions related to crypto. 

The OIG reports that, while “the SEC considers its workforce to be its most important asset,” flat funding for fiscal 2024 and increased personnel costs led the SEC to “implement austerity measures, including a freeze on filling vacant positions and substantial benefit cuts,” such as contributions to employees’ supplemental retirement benefits.  The OIG suggests that, in the absence of a budget increase in fiscal 2025, “the SEC may be forced to eliminate additional benefits.”  Although attrition is down from the higher level identified in last year’s report, the OIG contends that the “long-term effects” of these funding challenges on the workforce and on the SEC’s operations “are unlikely to be positive.”  

For those interested, other challenges discussed in the report include the need to protect “systems and data from compromise by malicious actors,” and contract management.

Posted by Cydney Posner

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