SEC Enforcement Director Grewal Flags "Perfect Storm Brewing Around AI"

Remarks at Program on Corporate Compliance and Enforcement Spring Conference 2024 – Gurbir Grewal

So looking ahead, where do we see potential risk?

Every day, we see revolutionary technological advancements in artificial intelligence, or AI, that promise to transform nearly every aspect of our lives, including our financial decision making.

Every day, we see individuals, corporations, analysts, and others touting these developments.

Every day, we see investors looking to incorporate AI into their investment strategies, or using it to analyze and recommend investments.

Every day, we see companies attempting to not only develop AI capabilities, or harness it to improve their productivity and growth, but also to attract and retain investors.

And in the end, every day, we see investors making larger and larger investments in these issuers or financial products.

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While perhaps not quite yet a perfect storm, there’s certainly one brewing around AI. And it is incumbent on each of us to make sure it does not come to pass and that investors are not harmed by noncompliance with the securities laws when it comes to this new technology.

FTX Controversy Derails Top Law Firm’s Bid for Binance Role

The Department of Justice is retreating from picking an elite New York law firm for a key assignment overseeing cryptocurrency exchange Binance Holdings Ltd. because of its work for FTX, according to people with knowledge of the matter.

Sullivan & Cromwell was close to winning approval to serve as independent monitor for Binance on behalf of both the Justice Department and the Treasury Department’s Financial Crimes Enforcement Network, Bloomberg reported in February. The monitorships were a condition of the $4.3 billion deal by which Binance pleaded guilty to violating US money-laundering regulations and trade sanctions.

But Justice Department officials have since expressed concern about the criticism the firm has faced over its work for FTX, a onetime major rival of Binance. The department is now reviewing other options for the lucrative monitorship, said the people, who asked not be identified because the discussions are not public. FinCEN still intends to use Sullivan & Cromwell, the people said.

The Shortseller Enrichment Commission?: Whistleblowers, Activist Short Sellers, and the New Privatization of Public Enforcement

Two developments have transformed the detection of corporate fraud since the global financial crisis: the SEC whistleblower bounty program (WBP) and the rise of activist short sellers. Considered separately, these are generally understood to be two valuable innovations that help detect and deter fraud.

But, it turns out, they are not so separate.

In a new paper, I document extensive activist short involvement in the WBP, show why this involvement may undermine deterrence, and offer reforms.

Drawing on data obtained under the Freedom of Information Act, I find that activist shorts and other outsiders account for about 40% of awards issued by the WBP in the most recent years. In addition to supplying their own tips directly to the SEC, activist shorts also frequently recruit insider tipsters to participate – in some cases offering up trading profits in exchange for cooperation. These well-financed outsider tipsters often go far beyond providing factual evidence, and also provide the SEC with legal analysis, expert reports, witness lists, and draft pleadings.

Introduction to SEC v. Panuwat: Understanding “Shadow” Insider Trading

It is difficult to overstate the expansion Panuwat represents for potential liability for insider trading. To be sure, the defense bar will attack this unfair and unwise regulation-through-litigation, and the defense bar will be joined by academics, public interest groups, and supporters in the business community. In the meantime, every entity and individual involved in the capital markets—from public companies to retail traders—need to take head of the increased risks and perils that comes with trading in a post-Panuwat market. For companies, this includes at least re-evaluating insider trading policies and educating directors, officers, and employees on the new landscape. And securities lawyers need to adjust their advice to clients and strategies for defending insider trading investigations, regulatory actions, and prosecutions.

Ultimately, Congress needs to step in and define by legislation what is and is not illegal insider trading, which it has never done to date. One can debate what should and should not be permitted, but Congressional action would provide the best opportunity for consideration of the competing considerations of the scope and contours of the insider trading laws.

Crypto’s Counteroffensive Suits Underscore Need for Regulation

The plaintiffs seek declaratory and injunctive relief in the complaints filed in the Texas federal courts by Lejilex and Crypto Freedom Alliance of Texas and by Beba LLC and DeFi Education Fund. Lejilex describes itself as “a non-custodial digital asset trading platform that allows users to trade digital assets through the use of underlying smart contracts” in “blind bid/ask transactions.”

It seeks to avoid being required to register “as a securities exchange, broker, or clearing agency.” And the complaint in Beba LLC describes the lead plaintiff as a small online apparel company that has “incorporated digital assets into its business” and distributed its BEBA token for free via an airdrop.

That complaint alleges the SEC “will take the position that BEBA tokens are investment contracts and that the airdrop is a securities transaction.” Both complaints argue the SEC lacks jurisdiction to undertake enforcement action against them.