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 Supreme Court’s Jarkesy decision and its impact on the SEC’s use of in-house proceedings;

• The first conviction for insider trading using a Rule 10b5-1 plan;
• The SEC’s complaint against Consensys arguing staking tokens constitute securities;
• The Fifth Circuit’s decision to vacate in full a recent SEC rule regulating private fund advisers; and
• The Fifth Circuit’s decision to vacate the SEC’s rescission of a Trump-era rule regulating proxy voting advice.

1. Supreme Court Curbs SEC’s Use of Administrative Proceedings

On June 27, 2024, the Supreme Court decided SEC v. Jarkesy and held that defendants facing civil penalties in SEC enforcement actions have a constitutional right to a jury trial in federal court. Chief Justice Roberts, writing for a 6-3 majority, held that the SEC’s use of administrative law judges (ALJs) violated the Seventh Amendment right to a trial by jury in suits at common law.

The Jarkesy case dates back to 2010, when Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which purported to vest the SEC with the power to seek civil penalties through in-house proceedings rather than exclusively in federal court.[1] Shortly after the passage of Dodd-Frank, the SEC initiated an enforcement action against investment adviser George Jarkesy and his hedge fund for securities fraud. The SEC opted to adjudicate the matter before an ALJ. The ALJ found that defendants committed securities fraud by making material misstatements and omissions to investors and imposed, among other things, $300,000 in civil penalties.

After the Commission affirmed the decision, Jarkesy appealed to the Fifth Circuit, which overturned the decision on various grounds, including that the SEC’s use of an ALJ violated Jarkesy’s Seventh Amendment right to a jury trial. The SEC appealed the decision to the Supreme Court.

The Supreme Court affirmed, holding that the Seventh Amendment applied because the SEC’s anti-fraud provisions replicate common law fraud. The Court declined to apply the well-known “public rights” exception, which allows for adjudication outside Article III courts for matters that historically could have been determined by the executive or legislative branch alone. As the Court explained, “what matters is the substance of the action,” and here, the SEC action “regulate[d] transactions between private individuals interacting in a pre-existing market” and “target[ed] the same basic conduct as common law fraud, employ[ed] the same terms of art, and operate[d] pursuant to similar legal principles.” Thus, the Court concluded, the “public rights” exception did not apply, and Jarkesy was entitled to a jury trial in an Article III court.

For more information, read our client alert.

2. First Criminal Conviction for Trading Using a Rule 10b5-1 Plan

On June 21, 2024, a federal jury in Los Angeles convicted the former chief executive of a publicly traded healthcare company for insider trading. This verdict marks the first conviction based exclusively on a defendant’s unlawful use of a Rule 10b5-1 trading plan. Rule 10b5-1 trading plans traditionally provide a defense for corporate insiders at public companies who sell company stock through such a plan. But as this month’s conviction demonstrates, the defense is not absolute.

The jury found Terren Peizer guilty of one count of securities fraud and two counts of insider trading. At trial, prosecutors presented evidence that Peizer avoided $12.5 million in personal losses by trading pursuant to multiple Rule 10b5-1 trading plans. The existence of those plans did not save Peizer because, according to the prosecution, Peizer set up those plans while in possession of material non-public information. Indeed, shortly after learning that his company was at risk of losing its largest customer, Peizer set up two Rule 10b5-1 plans and began selling off his company stock. In reaching a guilty verdict, the jury found that Peizer unlawfully traded on the basis of material nonpublic information.

Though this is the first 10b5-1 trading plan conviction, DOJ says it will not be the last. Commenting on the case in a public statement, the head of DOJ’s Criminal Division said, “We will not let corporate executives who trade on inside information hide behind trading plans they established in bad faith.”

The SEC continues to pursue civil proceedings against Peizer for the same fraud scheme, though the civil case has been stayed pending the completion of the criminal proceedings. According to the judge in that case, the DOJ case will likely “narrow[] or eliminat[e] the issues to be decided in the SEC case,” though the impact of this verdict still remains to be seen.

For more information, read our client alert.

3. SEC’s Consensys Complaint Claims Liquid Staking Tokens Are Securities

On June 28, 2024, the SEC filed a complaint against Consensys Software Inc. (“Consensys”) in the Eastern District of New York, alleging the company engaged in the unregistered offer and sale of securities in violation of Sections 5(a) and (c) of the Securities Act of 1933 and acted as an unregistered broker in violation of Section 15(a) of the Securities Exchange Act of 1934. According to the SEC, Consensys collected over $250 million in fees.

The complaint alleges that the Consensys “MetaMask” platform allows investors to swap cryptocurrency assets, including an asset called a “staking token.” An investor can “stake” a token by committing it to a blockchain network for a certain amount of time. In exchange, the investor earns rewards, similar to the interest one would earn by holding money in a savings account. Using MetaMask as an intermediary, investors can commit their tokens to the Ethereum blockchain (“ETH”) and in exchange receive staking tokens from two third-party companies, Lido and Rocket Pool. Neither Lido nor Rocket Pool have registered with the SEC to sell their respective staking tokens, stETH and rETH.

According to the SEC, agreements to buy these tokens are investment contracts and, therefore, constitute securities. By facilitating the purchase of these tokens, Consensys allegedly acted as an unregistered broker. 

4. Fifth Circuit Vacates SEC Rule Regulating Private Fund Advisers

On June 5, 2024, the Fifth Circuit unanimously vacated the SEC’s Private Fund Adviser Rules. The rules, proposed in February 2022, adopted in August 2023, and set to go into effect in September 2024, are now vacated in their entirety. 

Although the Investment Company Act of 1940 provides requirements for investment companies, such as those providing services to retail investors, these same requirements have not been applied to private funds. The Advisers Act of 1940 (“Advisers Act”) and Dodd-Frank have, however, regulated advisers for private funds in specific respects. Over the years, the popularity of private funds has grown, especially in the context of pension funds. In response, the SEC adopted new audit, reporting, and fee disclosure rules for private fund advisers, asserting that there was “a need to enhance the regulation of private fund advisers to protect investors, promote more efficient capital markets, and encourage capital formation.”

Various industry associations challenged the new regulations in court, and the Fifth Circuit determined that the SEC exceeded its statutory authority by adopting these rules regulating private fund advisers. The court held that the provisions of the Advisers Act and Dodd-Frank relied upon by the SEC applied only to relationships between investment advisers and “retail customers.” In the private fund context, there are no retail investors; the customer is the fund itself. 

As for the provisions of these statutes that do apply to private investors, such as the anti-fraud provision, the court held that the SEC had failed to articulate any connection between the final rules and the statutory authority. In short, the court determined that the final rules do not “fit within the statutory design” or share a “close nexus” with the statutes. Thus, the court held that neither statute granted the SEC the authority to adopt the private fund advisers rules and the SEC exceeded its authority in doing so.

In response to the Fifth Circuit ruling, the SEC can either seek rehearing en banc, file a petition for certiorari with the Supreme Court, or propose a new set of rules that more closely hew to the statutory authority.

For more information, read our client alert.

5. Fifth Circuit Vacates SEC Rule Regulating Proxy Firm’s Voting Advice

On June 26, 2024, the Fifth Circuit unanimously vacated the SEC’s recission of a 2020 rule regulating proxy advisory firms. Proxy advisory firms assist institutional investors and investment advisers who are given the authority to vote on behalf of shareholders. But, as the SEC explained in 2020, “[a]s these firms have continued to grow in influence, . . . certain concerns have emerged about their practices.” The SEC noted that the proxy firm industry is effectively a duopoly, with two firms, Institutional Shareholders Services (ISS) and Glass Lewis, controlling approximately 97% of the market.

In adopting the 2020 rule, the SEC relied on a statutory provision prohibiting the solicitation of proxy votes “in contravention of such rules and regulations as the [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors.” 15 U.S.C.

§ 78n(a)(1). The SEC interpreted “providing proxy voting advice” as a form of solicitation and adopted a rule providing registrants with the opportunity to identify inaccuracies in voting advice before shareholder meetings. The rule required proxy advice to be made available to registrants at or before the time it is provided to proxy firms’ clients (the “notice requirement”) and it required firms to provide a reasonable way for clients to see registrants’ objections to the advice before the shareholder meeting (the “awareness requirement”). The SEC concluded that these requirements did not threaten the timeliness or independence of proxy voting advice.

The 2020 rule, however, never went into effect. With the change in administration, the SEC made what the court called an “about-face.” After suspending the rule shortly before enactment, the SEC ultimately rescinded it on July 19, 2022. In support of the 2022 rescission, the SEC explained that there was “strong opposition” to the notice and awareness requirements from institutional investors and other proxy firm clients.

The Fifth Circuit held that the SEC acted arbitrarily and capriciously by failing to explain

(1) its decision to disregard the prior finding that the notice and awareness provisions did not threaten the timeliness or independence of advice and (2) why these purported risks to timeliness and independence justified recission. As a result, the court vacated the 2022 rescission as to the notice and awareness provisions and remanded to the SEC. The provisions, therefore, remain in effect.

[1] 124 Stat. 1862–1864.

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