Authors: Chris Prentice and Michelle Price

WASHINGTON (Reuters) – A legal attack on the U.S. Securities and Exchange Commission is stripping it of its authority to police Wall Street and is likely to intensify with two upcoming Supreme Court rulings.

Last week, a U.S. appeals court struck down a major SEC order imposing tighter oversight of private funds, a up-to-date blow to Democratic Chairman Gary Gensler’s ambitious plan to raise transparency and eliminate conflicts of interest on Wall Street.

The court took the unusual step of denying some of the SEC’s authority to supervise investment advisers. Legal experts say it could make other draft regulations on cybersecurity, outsourcing and predictive data analytics vulnerable to litigation.

The ruling by the New Orleans-based 5th U.S. Circuit Court of Appeals is another example of how business groups are using conservative-leaning courts to invalidate SEC rules, limit their ability to create similar regulations and bring enforcement actions.

While the conservative “war on the administrative state” seeks to weaken all federal agencies, Gensler’s ambitious agenda has made the SEC, which oversees some 40,000 entities, a prime target.

“It’s happening all over the government, and it’s quite severe at the SEC,” said Satyam Khanna, a former SEC lawyer who advised two former Democratic commissioners as recently as 2021. “The SEC oversees a vast number of entities – funds, public companies, broker-dealers and more – and the financial stakes can be high.”

The agency faces several other lawsuits from financial firms and their industry groups, alleging that the agency is overstepping its authority by imposing ill-conceived and costly rules.

A Reuters review of Westlaw filings found a acute raise in the number of open appeals against the SEC in the Fifth Circuit Court of Appeals from 2019 to last year, although the case is also pending in other conservative-leaning courts.

Among those cases: Hedge funds are filing suit in the Fifth Circuit to overturn SEC short-selling disclosures and in a Texas district court to ban up-to-date rules on Treasury bond trading, while in March business groups including the U.S. Chamber of Commerce and Republican-led states, sued to block SEC climate change regulations.

The Chamber is one of the most aggressive groups in terms of procedural regulations. In December, it won a Fifth Circuit challenge to the SEC’s stock buyback rules and is monitoring other draft rules for potential challenges.

“The current SEC has committed significant regulatory abuses,” said Daryl Joseffer, general counsel at the chamber’s Litigation Center.

Reform supporters say the industry simply wants to protect its profits and that weakening the SEC will hurt ordinary Americans.

Last Wednesday, SEC Chairman Gary Gensler did not discuss the private funds ruling, but noted that only a few dozen regulations adopted under his leadership have been subject to litigation. As legal experts note, the agency has recorded several notable victories, including in the 5th Circuit, on diversity and proxy voting policies.

However, Gensler also said the agency would adjust to unfavorable rulings.

“We do everything in accordance with the law and in accordance with how the courts interpret the law. If the courts interpret the law differently than we thought, we adapt and change our position,” he said. As an example, he cited the SEC’s decision to approve bitcoin products in January after a D.C. appeals court found the agency wrongly rejected them.

Trump appointed 54 judges to the U.S. Courts of Appeals, where many lawsuits against federal agencies are filed, leading to a 6-3 conservative majority on the Supreme Court.

Asked if he felt the courts were stacked against him, Gensler replied: “I am a great supporter of the American democratic system and our constitutional system. We have three equal branches of government. And that’s a really important thing.”

Most of the disputes involve violations of the Administrative Procedure Act of 1946, which requires regulators to provide reasons for regulations and allow time to obtain and fully consider public comment.

Some of the cases build on a 2022 Supreme Court decision that raised questions about whether federal agencies have the authority to address major policy issues. The ruling was one of the reasons the SEC scaled back its climate change rules, Reuters previously reported and was cited in some of the March lawsuits.

Crypto companies have often invoked this “principal issues” doctrine when challenging the SEC’s authority to regulate them.

The SEC has made significant changes to other major rules in response to industry opposition, including money market funds and activist investor disclosures.

“Strong industry objections in comments often raise the specter of litigation,” Khanna said.

Gensler said the agency takes the industry’s comments “very seriously.”

SCOTUS LOOKS

The Supreme Court is also expected to hear two other cases this month with major implications for the SEC.

One is the authority to operate in-house judges with securities law expertise to decide enforcement actions, which is often faster than court proceedings. Last year, Conservative Justices expressed concern that it was denying defendants trial by jury.

The case follows a 2018 Supreme Court ruling that found the SEC’s process for selecting internal judges violated the Constitution. Since then, the SEC has dramatically reduced its operate of the tribunal, SEC records show.

The second SCOTUS case challenges a legal doctrine known as “ Chevron (NYSE:) respect,” which calls on judges to defer interpretations of U.S. laws deemed ambiguous by federal agencies.

Chevron is the backbone of agency rulemaking. According to a 2017 study published in the Michigan Law Review, between 2003 and 2013, the Chevron mark was used 66.7% of the time in SEC regulation litigation in district courts, and in those cases the agency won just over 81%.

“It is highly likely that the court will overturn Chevron’s decision or significantly limit it,” Joseffer said. As a result, “agencies would be less likely to be successful in defending their interpretations of statutes, so one would hope that agencies would be more careful in their rulemaking,” he added.