SEC, CFTC Come Under Fire for Letters Blessing Company Actions

Financial regulators’ use of staff letters to guide industry players is under heightened legal scrutiny that could prompt changes to a widely used agency practice.

Division-level employees at the Securities and Exchange Commission and the Commodity Futures Trading Commission frequently write “no-action letters” in response to requests from companies unsure whether certain conduct would violate the law.

The letters, which allow regulators to move quickly and clarify rules, have long been treated as decisions of the agency’s staff that can’t be reviewed by a court.

The US Court of Appeals for the Fifth Circuit challenged that perception in a recent ruling against the CFTC. Two manufacturing groups now argue in a new lawsuit that SEC no-action letters relating to a public disclosure requirement for some securities are a final agency action, subject to court review.

The disputes could discourage federal agencies from issuing no-action letters, regulators warn, jeopardizing a tool that’s been used to greenlight everything from crypto tokens to broker-led investment research. Even if the agencies keep issuing the letters, attorneys say it could take longer to get them as agencies eye a more rigorous process.

“Administrative agency action is something that is the subject of a lot of litigation right now,” said Amy Jane Longo, a Ropes & Gray LLP partner and former senior SEC trial attorney. “This is another front of that.”

Fifth Circuit Rules

Businesses for decades been able to ask regulators for no-action letters to help determine whether a particular action will be subject to agency enforcement. If granted, SEC staff say they won’t recommend enforcement.

The SEC’s Division of Corporation Finance, for instance, issues dozens of responses every year giving companies the go-ahead to block shareholder proposals from proxy ballots.

To challenge an agency move under the Administrative Procedure Act, the conduct must be an “agency action” and it must be “final.” No-action letters have traditionally flunked that test.

“There’s a whole body of law that says no-action letters are not final agency action,” said William Funk, a Lewis & Clark Law School professor who specializes in administrative law.

The Fifth Circuit separated from precedent in a July ruling, finding the CFTC’s decision to revoke a no-action letter issued to PredictIt, a platform used to bet on elections, could be a final agency action. The court, in a 2-1 opinion, likened it to revoking a license.

The Fifth Circuit ordered a lower court to enter a preliminary injunction blocking the CFTC from shutting down PredictIt while the case plays out. It found the CFTC’s rescission of the no-action letter was likely arbitrary and capricious, and sent the case to the district court for further proceedings.

On the heels of that ruling, the National Association of Manufacturers and the Kentucky Association of Manufacturers filed a lawsuit that argues, among other things, three SEC no-action letters are final agency actions.

The first letter, from September 2021, stated the SEC wouldn’t enforce a public-disclosure rule as it related to fixed-income securities until January 2022. Subsequent letters pushed the enforcement date back to January 2025.

The manufacturing groups argue these letters were the first indication that the rule applied to bonds and other fixed-income securities, including those issued by private companies for resale to institutional investors.

The letters’ extension of the rule is arbitrary and capricious “because they lack any reasoned explanation,” said the Sept. 12 complaint, filed in the US District Court for the Eastern District of Kentucky. The groups also filed a petition with the US Court of Appeals for the Sixth Circuit, raising an alternative argument that relates to the rule.

Widespread Use

Other agencies use similar letters to bless regulated entities’ proposed activities, expanding the potential impact of the recent legal challenges.

The Consumer Financial Protection Bureau and the Federal Energy Regulatory Commission, for example, issue their own no-action letters. The Treasury Department’s Office of Foreign Assets Control has “cautionary” letters, while the Internal Revenue Service has a private letter practice.

The CFTC, in filings with the Fifth Circuit, warned that a court finding no-action letters are a final agency action that could be challenged in APA litigation would discourage agencies from giving such letters.

That kind of ruling harms industry participants “by forcing them to pursue more prescriptive, costly, and burdensome formal processes that today are unnecessary,” the CFTC, which regulates US derivatives markets, argued in the February filings.

Others are critical of how regulators occasionally use the letters. The New Civil Liberties Alliance, a nonprofit group that frequently challenges federal agency actions, told the Fifth Circuit agencies can “effectively bind private parties through regulatory ‘guidance,’ such as staff-level ‘no-action’ letters.”

That’s especially concerning, NCLA said, “when that guidance contradicts policy positions previously articulated by the same agency without reasoned explanation for the change.”

In the NAM-led case, the manufacturing groups’ complaint is with the SEC’s interpretation of the securities rule, as reflected in the agency’s no-action letter, Funk, the law professor, noted. A judge may be sympathetic to the argument that there isn’t a clear route to judicial review, attorneys say.

Agency Changes

Financial regulators may consider changing how they issue no-action letters in response to the litigation, attorneys say. Agency staff could be hesitant to grant relief marketwide, as opposed to a specific company, out of concern it would be considered final agency action.

Agencies could also look to expand their internal reviews or build out the letters with additional reasoning to better withstand a court challenge.

“Having more rigor around no-action letters and their rationales could be an effort to avoid the no-action letter being seen as arbitrary and capricious,” Ropes & Gray’s Longo said.

That kind of effort can be time-consuming, however, and companies likely would have to wait longer for a no-action response.

“On an industry-wide basis, one of the most likely results is that no-action relief at the very least goes through a more bureaucratic process than it previously did,” said Neal Kumar, a Willkie Farr & Gallagher LLP partner and former attorney in the CFTC’s general counsel office.

The NAM case is Nat’l Ass’n of Manufacturers v. SEC, E.D. Ky., No. 23-cv-00058.