Crypto Crackdown Will Help Shape 2023 Securities Law Scenarios

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U.S. securities regulators expect a crackdown on crypto firms and potential upheaval in insider trading cases among closely watched investor issues for the year ahead.

Securities litigation involving corporate environmental, social and governance (ESG) disclosures and practices will also occupy court records. A slowdown in transactions likely means fewer M&A-related lawsuits, but a slowing market could lead to more fraud cases.

Targets of Securities and Exchange Commission enforcement action may also soon have a new way to fight agency complaints, as the U.S. Supreme Court is expected to rule in a closely watched case, SEC v. Cochran, by the end of June.

At issue in the case is whether parties facing enforcement action can go directly to the Federal Court with constitutional challenges or must wait for the end of internal SEC proceedings to raise such claims.

A ruling against the government would overhaul current rules and procedures and could lead to additional constitutional challenges to the SEC’s enforcement actions.

Application of cryptography

The SEC has established itself as the primary regulator of the crypto market and looks poised to tighten ties on the emerging but struggling industry. SEC Chairman Gary Gensler told Bloomberg News last week that agencies’ patience with digital asset exchanges and other companies that don’t register with the agency is running out.

The SEC nearly doubled its Crypto Assets and Cyber ​​Unit this year by adding 20 people. The highly publicized collapse of FTX could add pressure for SEC enforcement.

I think you can bet there will be a lot of enforcement activity coming out of this unit, said Toby Galloway, president of securities litigation and enforcement practice at Winstead PC. When they tell you what their goals are and what their priorities are, you should probably listen to them.

The SEC has already filed lawsuits against FTX co-founder Sam Bankman-Fried and associates Caroline Ellison and Gary Wang, alleging that FTX investors were defrauded of $1.8 billion. The lawsuit against Ellison and Wang also alleges that the FTX digital token, FTT, was sold as collateral.

The agency, in another closely watched case, accused Ripple Labs of misleading investors about its XRP crypto token. Both parties asked the court to rule in their favor. A central question is whether XRP is a security.

Ripple also maintains that it was not properly warned that XRP could be a security. Ripple executives have further stated that securities laws, as applied to XRP transactions, are unacceptably vague. If either defense gains traction, it could provide a roadmap for defendants in other cases, the lawyers said.

Ripple during the litigation also obtained numerous internal SEC documents, including emails related to a 2018 speech by an SEC official. This approach could also apply to other cases, with defendants trying to access internal SEC communications.

This stuff really transcends any type of litigation with the SEC, said Amy Jane Longo, partner at Ropes & Gray LLP.

Slowdown in mergers and acquisitions and IPOs

After a record level of M&A activity in 2021, deal volume has slowed noticeably in 2022. The third quarter of 2022 saw the third-lowest global M&A deal volume in several years, according to an analysis by Bloomberg Law.

This year has also seen historic lows for IPOs in the United States. In the first three quarters, the companies raised $9.4 billion in IPOs. That’s well below the pace of 2021, which brought in a record $190 billion, according to data from Bloomberg Law.

These slowdowns will likely translate into fewer new lawsuits related to mergers and acquisitions and IPOs in the months ahead.

If you have fewer new settlements, then you’ll have fewer new settlement cases, said Jonathan Youngwood, global co-chairman of litigation at Simpson Thacher & Bartlett LLP.

But that doesn’t mean fewer significant cases, Youngwood said.

If the plaintiffs’ bar is careful about what it pursues, it files cases that it believes have more merit and are likely to go further, he said.

An economic downturn could help drive up other types of cases, including those related to Ponzi schemes. There could also be more lawsuits related to misrepresentation of a company’s financial statements, Galloway said.

Things turn out when the market is down, Galloway said.

Insider trading

Following a rare loss in an insider trading case, the SEC is appealing to the United States Court of Appeals for the Fourth Circuit. How court rules could impact SEC cases that rely on circumstantial evidence.

The district court, in a 2021 decision, found that the SEC simply speculated that Christopher Clark received inside information from his brother-in-law because Clark was a little too successful in trading. Clark reportedly earned over $245,000 from this information.

The SEC, which has stepped up its use of data analytics to detect suspicious trading patterns, maintains there is compelling circumstantial evidence that Clark traded on an inside information pipeline. A decision for Clark could be a setback for the agency.

One wonders if that might cool other cases the SEC might bring that are more on the bubble in terms of the strength of the circumstantial evidence, Longo said.

Meanwhile, in an effort to curb insider trading, the SEC this month limited when senior executives can offload company stock. The agency also requires them to disclose more information about planned stock sales.

The measure is intended to address perceived loopholes in stock sale timing rules that executives could exploit, Gensler said.

Requiring companies to publicly disclose more information about executives’ trading plans could also lead to a new wrinkle in insider trading litigation. Courts could more easily consider information earlier in the case when considering motions to dismiss. This would benefit defendants who argue that they bought or sold securities according to a business plan and are shielded from insider trading liability.

Now, defendants should be able to present that defense at an earlier stage in the case if that information is to be widely available, Longo said.

Emerging issues

Communications technology and other emerging issues could also lead to further enforcement and litigation.

Several major banks were fined nearly $2 billion in September for failing to monitor employee communications on messaging apps like WhatsApp and other off-channel services. The SEC investigation has extended to other players in the industry, including asset managers, Bloomberg News reported.

In addition, the agency is working on finalizing new climate disclosure requirements for companies. Lawyers expect the SEC to continue to seek ways to take enforcement action related to ESG issues within existing regulations. ESG-related litigation from investors is also expected to increase.

The SEC filed its first lawsuit this year over alleged violations of Best Interest regulations, or Reg BI, which require brokers to act in the best interests of their clients.

The SEC action came nearly two years after Reg BI went into effect. There are signs that more enforcement action is coming. The agency issued subpoenas to dozens of brokers, attorneys said.

They have this rule that hasn’t been enforced much yet, Galloway said. But they will use it.

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