Top 5 SEC Enforcement Developments for April 2024

Each month, we publish a roundup of the most important SEC enforcement developments for busy in-house lawyers and compliance professionals. This month, we examine:

• The SEC’s first “Shadow Trading” trial;
• SCOTUS’s limitation on private 10(b) claims based on violations of Item 303;
• Crypto-related lawsuits filed against the SEC;
• A flurry of other cases challenging SEC authority; and
• The SEC’s initial observations regarding investment advisers’ compliance with the recently amended Marketing Rule.

1. Jury Finds Former Corporate Executive Liable in SEC “Shadow Trading” Case

On April 5, 2024, a jury in California federal court found a former corporate executive liable for insider trading in SEC v. Panuwat, an enforcement action involving conduct known as “shadow trading.” In Panuwat, the SEC took the position that the insider trading laws apply where an insider uses material non-public information about his or her own company to trade securities of another company, such as a competitor or peer company in the same industry. The SEC asserted that this is not a novel theory but a straightforward application of the elements of the misappropriation doctrine.

Specifically, the SEC alleged that Matthew Panuwat, an executive at biopharmaceutical company Medivation, used confidential information that Medivation would soon be acquired to buy options in Incyte, a competitor. Shortly after the Medivation acquisition, the stock price of Incyte increased, and Panuwat made more than $100,000 in profits. The SEC sued Panuwat for insider trading and argued that Panuwat had breached his duty of trust and confidence to Medivation, which had an insider trading policy that prohibited trading the securities of any public company based on material non-public information. The jury agreed with the SEC.

Given the pivotal role that Medivation’s insider trading policy appears to have played in this case, companies would be wise to review their insider trading policies for vague language that could unintentionally broaden the scope of liability for employees or insiders. For more information, please see our client alert on this topic.

2. SCOTUS Limits Certain 10(b) Claims Based on Violations of Item 303

On April 12, 2024, the U.S. Supreme Court resolved a split among appellate courts regarding the scope of liability for private securities claims under Section 10b-5 of the Securities Exchange Act. In the unanimous Macquarie Infrastructure Corp. v. Moab Partners, L.P. decision, the Court held that a corporation’s failure to reveal information regarding known trends or uncertainties required by Item 303 of SEC Regulation S-K cannot be the basis for private securities litigation under 10b-5(b), unless the omission would make an affirmative statement misleading. Item 303 requires companies to disclose “known trends or uncertainties that have had or that are reasonably likely to have a material favorable or unfavorable impact” on the company’s net sales, revenues, or income from continuing operations in the Management’s Discussion and Analysis section of periodic reports.

Macquarie Infrastructure Corporation operated terminals for No. 6 fuel oil, the use of which was to be significantly curtailed by 2020 per 2016 UN regulations. Macquarie did not discuss this regulation in its public offering documents. When the company later “announce[d] that the amount of storage contracted for use by its subsidiary’s customers had dropped in part because of the structural decline in the No. 6 fuel oil market,” Macquarie’s stock price fell 41%. Plaintiff brought claims under Section 10(b) and Rule 10b-5, alleging that Macquarie’s failure to disclose its assessment of the UN regulations was an actionable omission.

In its decision, the Supreme Court emphasized that “pure omissions are not actionable under Rule 10b-5(b).” Instead, the “Rule requires identifying affirmative assertions before determining if other facts are needed to make those statements ‘not misleading.’” 10b-5(b) was contrasted with Section 11(a) of the Securities Act, which expressly prohibits any registration statement that “omit[s] to state a material fact required to be stated therein.” Finding no equivalent language in Section 10(b) or Rule 10b-5(b), the Court inferred no congressional or SEC intent to impose liability for similar omissions under 10b-5(b). For more information, please see our client alert on this topic.

3. SEC Faces More Crypto-Related Suits Related to the Expanded Dealer Definition and Decision to Regulate Ether as a Security

On April 23, 2024, two crypto industry groups jointly sued the SEC in the U.S. District Court for the Northern District of Texas seeking to overturn its expanded dealer definition, claiming that the SEC violated the Administrative Procedure Act (APA) in its rulemaking process.

The Crypto Freedom Alliance of Texas and the Blockchain Association argued that the expanded dealer definition failed to address industry comments submitted during the “highly compressed” 39-day comment period. The groups noted that the broadened definition is vague and fails to clarify how it applies to various digital asset market participants. This lack of clarity, they asserted, could capture individuals and entities not traditionally considered dealers, including liquidity providers and software-governed “automated market makers” that set prices, leading to unnecessary regulatory burdens. The groups claim that the rule exceeds the SEC’s statutory authority by defining “dealer” based on an individual’s trading activity rather than the kinds of services they provide to consumers, and by not meeting the APA’s requirements for adequate notice and reasoned decision-making.

On April 25, 2024, software development company Consensys filed a similar lawsuit in the Northern District of Texas alleging that the SEC had orchestrated an unlawful campaign to “seize control over the future of cryptocurrency” with enforcement actions aimed at regulating Ether (ETH) as a security. The company cited the SEC’s record – including Chair Gary Gensler’s statements – declaring that ETH was not a security as early as 2018, warning of the potential ramifications of the Commission changing its position after firms had built businesses based on regulatory precedent.

Companies operating in the cryptocurrency space should monitor these cases as they progress, given the SEC’s related enforcement actions and the industry’s unsettled regulatory environment.

4. The SEC in the Courtroom: Climate Regulations, the SEC Proxy Rule Battle, and SEC Data Privacy Concerns

April saw a barrage of other proceedings filed against the SEC.

On April 4, 2024, less than one month after adoption, the SEC voluntarily stayed its climate disclosure rules pending judicial review. Following adoption of the rules, many petitions seeking judicial review were filed and consolidated in the U.S. Court of Appeals for the Eighth Circuit. The SEC maintains that the Final Rules are legal, but recognized the procedural complexities associated with the consolidated litigation. The stay will likely delay the final implementation date of the climate disclosure rules. While the Final Rules are on hold, the existing SEC guidance on climate disclosure remains in effect. Companies can continue to rely on the 2010 guidance and the 2021 sample comment letter for their disclosures.

On April 16, 2024, The National Center for Public Policy Research, a self-described conservative think tank, filed a lawsuit in the Western District of Texas challenging the SEC’s market surveillance tool known as the consolidated audit trail (CAT), arguing that the database threatens the security of the personal information of millions of Americans. The challengers claim that the CAT represents the largest government dataset outside the National Security Agency and that it was created without congressional authority. They also allege that the database violates constitutional protections against unlawful search and seizure, the taking of property, and free association by forcing individuals to reveal which companies they invest in and other information about their trading strategies. Further developments in this case are upcoming and should be monitored.

In addition to the above cases, several states, led by Texas, filed a lawsuit challenging an SEC regulation requiring fund managers to make it easier for investors to identify environmental, social, and governance (ESG) issues on corporate ballots. The rule, scheduled to go into effect this July, will require fund managers to place the votes they cast on behalf of investors into a number of pre-determined buckets that include several categories that the challengers argued are politically charged. The Fifth Circuit has since ruled in the SEC’s favor, holding that the states did not establish standing.

5. SEC Publishes Risk Alert on Initial Observations Regarding Advisers Act Marketing Rule Compliance

On April 17, 2024, the Division of Examinations of the SEC published a risk alert with observations following its review of investment advisers’ efforts to comply with Rule 206(4)-1 under the Investment Advisers Act of 1940 (the “Marketing Rule”).

The alert addresses the Compliance, Books and Records, and Marketing Rules:

• Compliance Rule: The staff observed that advisers typically provided training on the Compliance Rule, included processes to comply with the rule in policies and procedures, and required preapproval of advertisements before dissemination. However, the staff noted that policies and procedures sometimes lacked specificity, did not address marketing channels used by advisers, were informal and incomplete, were not tailored to address advisers’ specific advertisements, did not adequately address the preservation and maintenance of advertisements and related documents (i.e., copies of questionnaires or surveys used in preparing a third-party rating) and were not implemented appropriately.
• Books and Records Rule: The staff noted that advisers typically had updated policies and procedures to reflect books and records maintenance and preservation requirements. However, the staff noted deficiencies in advisers’ preservation efforts, including for records such as completed questionnaires or surveys used in the preparation of a third-party rating, copies of information posted to social media, and supporting data for performance claims included in advertisements.
• Marketing Rule: The staff observed deficiencies related to the Marketing Rule’s General Prohibitions, including:
• Untrue or unsubstantiated statements of material fact, such as advertisements that contain statements that are untrue or lack a reasonable basis (observations include statements related to conflicts of interest, product or service offerings, awards and accolades);
• Omissions of material facts or misleading inferences, where advertisements appear to omit material facts that are necessary to make the included statements not misleading (observations include performance claims, third-party ratings, and testimonials);
• Failure to provide fair and balanced treatment of material risks or limitations, such as when the advertisement includes statements about the potential benefits connected with the adviser’s services but does not appear to provide fair and balanced treatment of any material risks or limitations associated with the potential benefits;
• References to specific investment advice that were not presented in a fair and balanced manner; and
• Advertisements that were otherwise materially misleading, such as an unreadable font on websites or in videos.
• Form ADV: The staff also observed numerous Marketing Rule-related deficiencies on advisers’ Form ADVs, including a failure to include sufficient information regarding third-party ratings, performance results, and hypothetical performance where other disclosures triggered a need to publish such information.

Investment advisers should treat the staff’s observations as a signal as to what the SEC is likely to focus on in examinations and investigations and review their policies and procedures accordingly.