SEC Division of Enforcement Director Gurbir Grewal rejected criticism that the agency is "regulating by enforcement" when it comes to cryptocurrency, and environmental, social and governance matters.
In remarks at the Scott Friestad Memorial Keynote Address, Mr. Grewal said that the agency "welcome[s]" new technologies but must also prioritize investor protection by ensuring compliance with the federal securities laws. In the past four years, he noted, the agency has brought cases against fraudulent and unregistered initial coin offerings and intermediaries (e.g., exchanges and broker-dealers) who facilitated trading in unregistered securities. Mr. Grewal acknowledged that standalone enforcement actions increased this fiscal year over last, but denied that this constitutes "regulation by enforcement."
Mr. Grewal defended the SEC's reliance on SEC v. Howey and Reves v. Ernst & Young to determine whether an instrument is a security. He noted that the application of both tests has been criticized for predating cryptocurrency by decades and for vagueness in application. Mr. Grewal denied claims made (specifically in SEC v. Kik Interactive Inc.) that the SEC's application of Howey was "unconstitutionally vague," saying that these tests have been affirmed by courts many times and praising Howey as "flexible" and "capable of adaptation." (The Kik Court agreed, concluding that Howey clearly expresses the definition of an "investment contract.") Mr. Grewal also rejected the criticism that the SEC's guidance has been insufficient. He said that the Court in Kik rejected the argument, adding that the agency is not required to "reach out and warn all potential violators." Mr. Grewal went further, stating that the agency has issued guidance on the application of U.S. securities laws to distributed ledger technology and digital assets, and investor alerts on the risks of investing in cryptocurrency.
Separately, Mr. Grewal warned market participants that attempting to avoid securities regulation through "labeling" will not succeed. Specifically, Mr. Grewal stated that the use of terms such as "decentralized," a "lending program" and "stable" will not change its inquiry as to whether or not the instrument is a security.
On ESG matters, Mr. Grewal said there is nothing "new" about how the agency investigates climate and ESG misconduct. Rather, he noted that the agency applies its "long-standing principles" of (1) materiality and disclosure for all issuers, and (2) fiduciary duties and honest disclosure in the asset management sector. Mr. Grewal also noted the longevity of the agency's ESG mandate, starting in 2008 when it settled charges against Pax World Management for breach of fiduciary duty concerning socially responsible mutual funds. More recently, the SEC settled a case against Fiat Chrysler for misleading disclosures from an internal audit concerning emissions control systems.
Commentary Philip S. Khinda
The new enforcement director seems to be paying for the SEC's lack of guidance and rulemaking over the last four years. Time will tell whether the agency, under new leadership, will retake its role as regulator first and enforcer second, or whether the "regulation by enforcement" critiques will take an even greater hold.
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