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Conference Speaker Addresses the State of the Administrative State in Reviewing SEC Regulatory Environment

S.J. Steinhardt
Published Date:
Nov 18, 2022

The assault on the administrative state was the underlying theme of Richard Marshall’s presentation, “U.S. Regulatory Update,” at the Foundation for Accounting Education's Alternative Investment Fund Conference on Nov. 17.

Having to summarize a welter of regulatory and statutory developments in less than an hour was no easy task, and Marshall, a partner in the financial markets and funds practice at law firm Katten Muchin Rosenman LLP,  rose to the occasion in what could be termed a lightning round of overviews of changes past, present and future.

Marshall highlighted some, but certainly not all, of the developments to expect in the coming years under the Securities and Exchange Commission (SEC) chairmanship of Gary Gensler who, with a majority of Democrats on the commission, “has the votes to get what he wants through the end of 2024,” he said.

“There is a tidal wave of SEC proposal rules sitting out there that will change the landscape immensely,” he said, before reviewing a few cases that challenge the SEC’s rule-making authority. “Ultimately, it will be up to the courts to decide what will survive.”

Those cases amounted to what he called an assault on the administrative state, a creation over the past 100 years,” he said, calling it “a government independent of the constitution.”  

“Courts are beginning to push back,” he said. This is where the cases get decided.”

He singled out a few cases as examples. A prominent one is the case of SEC v. Cochran, which the Supreme Court heard on Nov. 7.

An accountant, Michelle Cochran was accused of engaging in improper professional conduct by the SEC in 2016. The crux of the case, and others like it, is the constitutionality of administrative law judges, who are appointed by SEC commissioners but cannot be removed due to civil service rules. This system is now being challenged in the courts under the appointments clause of the U.S. Constitution (Article II, Section 2), which states that judges must be appointed by the president and confirmed by the Senate.

In June, the high court ruled that the Environmental Protection Agency (EPA) lacked constitutional authority to regulate carbon dioxide emissions from power plants under the Clean Air Act. Last month, a federal appeals court ruled that the Consumer Financial Protection Bureau (CFPB)’s self-funding mechanism—the bureau receives its funding from the Federal Reserve Board, rather than form Congress—is unconstitutional.

“All of these [cases] are cutting back on an administrative state that has existed for decades and will be relevant to a flood of rules that are coming,” Marshall said.

After summarizing a raft of newly adopted rules, then new proposed rules—“this is where we go off a cliff because there are so many in terms of numbers”—Marshall turned to the topic of enforcement trends.

Under Chairman Gensler, “broken windows is back,” he said, referring to the 1982 theory by two social scientists that addressing low-level crimes and disorders right away deters further criminal behavior. The policy as it pertains to SEC enforcement was carried out under Commissioner Mary Jo White, who served from 2013 to 2017, and curtailed under her successor, Jay Clayton.

As examples, he cited text messaging as an issue that has attracted regulators’ attention. The SEC has taken the position that investment firms must maintain or preserve texts as part of their recordkeeping obligations under the federal securities laws. In September, when the SEC charged 16 firms with recordkeeping failures, Genser said, "Since the 1930s, such recordkeeping has been vital to preserve market integrity. As technology changes, it’s even more important that registrants appropriately conduct their communications about business matters within only official channels, and they must maintain and preserve those communications.” 

Marshall challenged that position.

“'I work for a private fund and I want to communicate—what’s wrong with that?'” he asked rhetorically in the voice of an adviser. Now, these messages must be captured and stored by the adviser.

Insistence on admissions in settlements was another example of stepped-up enforcement. Marshall said that there have been “a big wave of cases” in which, as part of the settlements, the advisers had to admit breaking the law, and they incurred “enormous” penalties. “There were no signs of misconduct,” he said. “They [the advisers] just want to keep the business working.”

Another enforcement trend is regulation by enforcement, particularly in crypto cases, Marshall said.

Under Director of Enforcement Gurbir Grewal, the SEC can “adopt, interpret and enforce rules by bringing a case,” he said. Grewal “says we’re permitted to make new law by bringing a case so we’re going to keep doing it.”  

“'How do you know when you’re wrong?'” he paraphrased Grewal’s policy. “'You’ll know when we see you and that’s when you’ll find out about it.'”

“I normally don’t talk this fast,” Marshall exhaled at the end. “It’s not my fault. It’s the fault of your government.”

“I hope we all survive.”

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