In order to provide an overview for busy in-house counsel and compliance professionals, we summarize below some of the most important SEC enforcement developments from the past month, with links to primary resources. This month we examine:

  • The SEC's continued focus on environmental, social, and governance ("ESG") disclosures and cryptocurrency markets;
  • The SEC's in-house courts under attack;
  • The Second Circuit's decision in Noto v. 22nd Century Group, Inc.; and
  • The SEC's billion-dollar case against a prominent investment adviser.

1. SEC Brings ESG Enforcement Action and Proposes New ESG Rules

On May 23, 2022, the SEC charged a registered investment adviser with misrepresenting its approach to ESG-related investments. In a settled order resolving a matter pursued by the SEC's Climate and ESG Task Force, the SEC found that between July 2018 and September 2021, the adviser represented that all of its stock and bond picks had undergone quality reviews of ESG risks and opportunities associated with those investments, but numerous investments had no such quality review scores at the time of investment. The SEC found that the adviser included false or otherwise misleading statements in mutual fund prospectuses, statements to the funds' boards, and in requests for proposals from investment firms considering investing in the funds at issue.

The adviser agreed to a $1.5 million fine, a cease-and-desist order, and censure for violations of various Investment Advisers Act antifraud provisions—none of which require a finding of scienter—and for lacking policies and procedures "reasonably designed to prevent the inclusion of untrue statements of fact" in their various disclosures. The adviser appears to have been spared more severe sanctions based on cooperation and remedial efforts that the SEC acknowledged in its order, including providing detailed factual summaries and substantive presentations on key topics and revising its disclosures and internal policies.

The SEC is clearly not done focusing on ESG disclosures. Indeed, while this case shows the SEC using its traditional enforcement tools—here, the Investment Advisers Act and Investment Company Act—the Commission is also considering additional tools to use in addressing ESG-related disclosures. For example, on May 25, 2022, just two days after announcing the settlement, the SEC announced proposed rules specifically focused on "greenwashing," or the exaggeration of a fund's adherence to ESG principles and practices.

SEC Chair Gary Gensler described the proposed rules as intended to "establish disclosure requirements for funds and advisers that market themselves as having an ESG focus." They would require certain investment advisers and investment companies, among others, "to provide additional information regarding their [ESG] investment practices" in fund prospectuses, annual reports, and adviser brochures based on the ESG strategies they pursue using Forms N-CEN and ADV Part 1A.

Considered in tandem with the SEC's settlement in this matter, the proposed rules reaffirm that the SEC's focus on ESG is here to stay. #ESGdisclosureenforcement #ENFandESG #besttocooperate #goodbyegreenwashing

2. SEC Brings Charges Against Gaming Chip Giant, NVIDIA, and Mulls Tighter Crypto-Related Regulations

May was another busy month for the SEC in the crypto space, as the Commission continued its focus on cryptocurrency in both enforcement and rule-making.

On May 3, 2022, the SEC announced that the newly named Crypto Assets and Cyber Unit (formerly known as the Cyber Unit) will nearly double in size to a staff of 50 and will and focus on "polic[ing] wrongdoing in the crypto markets while continuing to identify disclosure and controls issues with respect to cybersecurity." The new personnel will include additional supervisors, trial counsel, and fraud analysts in multiple SEC offices and will focus on crypto offerings and exchanges, lending and staking products, DeFi platforms, NFTs, and stablecoins.

On May 6, 2022, the SEC settled charges against chipmaker NVIDIA Corp. for inadequate public disclosures in its Forms 10-Q regarding the role cryptomining played in significantly boosting sales numbers in 2018. As the SEC summarized the problem:

NVIDIA had information indicating that cryptomining was a significant factor in the year-over-year growth in revenue from the sale of [graphics processing units] that NVIDIA designed and marketed for gaming[, but] did not disclose this in the company's [filings] as required by former Regulation S-K, Item 303(b)(2) (currently Item 303(c)(2)), part of the company's Management's Discussion and Analysis of Financial Condition and Results of Operations . . . disclosure requirements.

NVIDIA's crypto-driven growth, the SEC found, was material information, as its omission would significantly hamper investors' ability to predict the company's future performance.

NVIDIA agreed to a cease-and-desist order and to pay a $5.5 million fine based on allegedly misleading disclosures—though as with ESG-related matter above, there was no finding of scienter—and a lack of adequate disclosure controls and procedures.

The NVIDIA case serves as an important reminder that the antifraud provisions at the SEC's disposal—here, Section 17(a) of the Securities Act—must be read in conjunction with the rules and regulations promulgated thereunder, as they impose specific requirements focused on making important information available to investors. We expect the SEC to use rules like Regulation S-K to scrutinize crypto-related disclosures and to address perceived failures to disclose to investors the specific effects of cryptocurrencies on their businesses, even where there is no expressed concern about the legitimacy of any crypto-related revenues. Indeed, this case shows the breadth of the SEC's interest in regulating the crypto space, as it charged NVIDIA based on disclosures not related to any trading, lending, or other crypto investing but to the arguably ancillary activity of cryptomining.

Expect the SEC's focus on crypto to continue. At the annual FINRA meeting held on May 16, 2022, Chair Gensler reiterated his call for greater oversight over digital tokens, explaining that the SEC is working with the CFTC to differentiate certain tokens as securities and others as commodities and to clearly demarcate their respective jurisdictions. #cryptoregulations #RegS-K #securitiesorcommodities? #focusoncrypto

3. SEC's Use of ALJs Continues to Be Under Attack

On May 16, 2022, the Supreme Court granted certiorari in SEC v. Cochran to review the Fifth Circuit's en banc decision that district courts have jurisdiction to hear challenges to ongoing administrative enforcement actions from claimants who argued that SEC administrative law judges (ALJs) are unconstitutionally protected from removal. Then, on May 18, 2022, the Fifth Circuit in Jarkesy v. SEC issued an even broader attack on the SEC's use of ALJs, holding the Commission's use of their in-house judges to be unconstitutional. As discussed in our recent client alert, Jarkesy and Cochran, if not overturned, could upend the enforcement regimes of the SEC and numerous other agencies who rely on ALJs to perform similar functions.

Cochran: In Cochran, the Supreme Court will review a Fifth Circuit ruling that a respondent in an ongoing SEC administrative enforcement proceeding could challenge the constitutionality of that action on the basis that the assigned ALJ was unconstitutionally insulated from removal. Previously, multiple courts had held that litigants must wait for an adverse order from the Commission before challenging that order in a federal court of appeals.

Jarkesy: Jarkesy stems from a 2013 administrative proceeding against fund manager George Jarkesy and his funds' investment adviser, Patriot28. Jarkesy and the adviser were found to have defrauded investors by inflating the value of fund assets, thereby increasing incentive fees. In its 2013 order, the SEC imposed civil penalties, among other remedies. After the SEC rejected respondents' constitutional challenges to the ALJ's authority, they petitioned the Fifth Circuit for review.

The Jarkesy majority held that: (1) the SEC's use of in-house administrative proceedings violated a defendant's Seventh Amendment right to a jury trial; (2) Congress unconstitutionally delegated legislative powers to the SEC without an intelligible principle by which to use that legislative power; and (3) ALJs were unconstitutionally insulated from removal in violation of the Take Care Clause of Article II of the Constitution. This decision appears to create a circuit split with numerous other courts who had rejected similar challenges to the SEC's use of ALJs.

Jarkesy and Cochran pose serious questions about the SEC's—and similarly situated agencies'—ability to utilize ALJs. Indeed, the potential relevance to agencies other than the SEC is underscored by the Supreme Court's decision to consolidate briefing for Cochran with briefing in Axon Enterprise, Inc. v. FTC, a case addressing when and where litigants can raise constitutional challenges to the FTC's structure.Until the Supreme Court resolves Cochran, and potentially Jarkesy, or Congress acts to address the problems those cases highlight, regulated entities and individuals should remain vigilant in preserving their right to raise constitutional challenges in administrative proceedings. #ALJsunderattack #enforcementregimesinquestion

4. Second Circuit Complicates Analysis of When to Disclose Ongoing SEC Investigations

On May 24, 2022, the Second Circuit, in Noto v. 22nd Century Group, Inc., restored a securities class action against 22nd Century Group, Inc. ("22nd Century"), a publicly traded company aiming to genetically engineer tobacco and cannabis plants to regulate nicotine and cannabinoid levels, and two former officers. In a unanimous decision, the Court held that 22nd Century's alleged failure to disclose an ongoing SEC investigation in its public statements—and its subsequent public denial of such an investigation—was sufficient to plead a Rule 10b-5 violation. The Court simultaneously affirmed the dismissal of claims based on alleged failures to disclose payments for media promotion, as 22nd Century was not the "maker" of the statements under the Supreme Court's Janus Capital Group v. First Derivative Traders decision and had no independent duty to disclose such payments.

As explained in our recent client alert, Noto is an important decision because it complicates the analysis of when companies—at least those in the Second Circuit—are obligated to disclose the existence of an SEC investigation. Generally, under Section 13 of the Securities Exchange Act, Regulation S-K Item 103, a company must "[d]escribe briefly any material pending legal proceedings . . . known to be contemplated by governmental authorities," but an investigation on its own has not been treated as a "pending legal proceeding" for these purposes until an agency like the SEC makes known that it is contemplating filing suit or bringing charges.1

Consistent with this rule, the Noto Court did not identify any independent duty to disclose a government investigation. That a company cannot falsely deny the existence of an SEC investigation is not controversial. But the Court went further, holding that 22nd Century's disclosure of material weaknesses in its internal financial controls and the implementation of a remedial plan to eliminate those weaknesses triggered a duty to disclose the SEC investigation into those issues, which would "bear on the reasonable investor's assessment of the severity of the reported accounting weaknesses."

As the Noto Court explained, companies contemplating the disclosure of an SEC investigation must be mindful that "[e]ven when there is no existing independent duty to disclose information, once a company speaks on an issue or topic, there is a duty to tell the whole truth." The Court's application of that principle in Noto suggests a broad view of what constitutes "the whole truth," and requires companies to pay close attention to how much they can say about the subject matter under SEC investigation before triggering a duty to disclose the investigation itself. #disclosinginvestigations #2dcircuit

5. SEC and DOJ Charge Investment Adviser and Former Senior Portfolio Managers with Fraud, Securing Multi-Billion Dollar Settlement

On May 17, 2022, the SEC and the DOJ unveiled a coordinated effort to bring civil and criminal charges against an investment adviser who managed, as of the end of 2020, nearly $150 billion in client assets, and three former senior portfolio managers for fraudulently concealing the extreme downside risks associated with their complex options trading strategy, Structured Alpha. The SEC filed a civil complaint in the Southern District of New York and issued individual orders against the adviser and its former portfolio managers, in concurrent enforcement actions against the alleged fraudsters. That same day, the DOJ announced guilty pleas by the adviser and the same portfolio managers, and indictments for certain other allegedly involved individuals.

In many ways, this matter is a conventional fraud case, albeit with extremely high stakes. As alleged by the SEC, defendants doctored reports to investors to vastly understate the true risk of their investment strategy while overstating the funds' actual performance, enabling them to secure $11 billion in capital investments and over $550 million in fees. In a few particularly egregious instances, respondents directly altered numbers in their risk reports, something they described as "smoothing." When the market crashed briefly in March 2020 as COVID-19 was declared a pandemic, billions of dollars on Structured Alpha's books vanished overnight, and the fraud was exposed.

The egregious nature of the fraud, along with efforts to hide the activity from the SEC (which included agreements to testify falsely when called by the SEC) led to particularly severe sanctions. The adviser admitted specific conduct and that such actions violated the federal securities laws, and agreed to pay more than $1 billion in fines and disgorgement plus interest. As part of defendants' broader settlement with the government, the adviser and its parent agreed to pay over $5 billion in restitution to victims.

This case is just the latest instance of the SEC alleging fraud involving complex financial instruments, a fact that Chair Gensler focused on in the SEC's press release, stating, "We've seen a recent string of cases in which derivatives and complex products have harmed investors across market sectors." Following similar statements made in connection with the SEC's Archegos action, the chair's statements remind companies engaging in trading complex instruments that they should expect increased scrutiny from this SEC. #complexfinancialinstruments #concealmentmeansbigsanctions

Sherwin J. Nam, a Law Clerk in our New York office, contributed to the writing of this alert.


1. Richman v. Goldman Sachs Grp., Inc., 868 F. Supp. 2d 261, 272 (S.D.N.Y. 2012) (citing 17 C.F.R. § 229.103) (additional citations omitted).

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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