Some SEC Administrative Law Judges Are Thoughtful and Even Judicious

We have now on several occasions bemoaned the fate of Laurie Bebo, former CEO of Assisted Living Concepts, Inc., to be forced to litigate her professional future before SEC Administrative Law Judge Cameron Elliot, whom we believe to be, shall we say, not the brightest star in the firmament.  See SEC ALJ Cameron Elliot Shows Why In re Bebo Should Be in Federal Court; Bebo Case Continues To Show Why SEC Administrative Proceeding Home Advantage Is Unfair; and SEC ALJ in Bebo Case Refuses To Consider Constitutional Challenge and Denies More Time To Prepare Defense.  And we have argued that the SEC’s home administrative law court is not a fair forum for the resolution of career-threatening enforcement actions against non-regulated defendants, notwithstanding that the Dodd Frank Act permits such cases to go forward.  See Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit; Ceresney Presents Unconvincing Defense of Increased SEC Administrative Prosecutions; and Opposition Growing to SEC’s New “Star Chamber” Administrative Prosecutions.  That might make a reader think we believe that all SEC ALJs lack the ability or temperament to preside over and decide important cases.  So, to set that record straight, allow us to say that, like almost almost any other place, the SEC administrative law courts are administered by appointees with a range of abilities and demeanors.  It is not the lack of judicial ability that makes the SEC’s administrative courts a poor forum for such cases, it is that the forum is bereft of procedural protections that enhance the chance that a respondent will get a fair shake even when the presiding ALJ is one of poor judicial timber.

In federal court, there are also good judges, bad judges, and a range in between.  But the scales of justice have calibrating factors other than the judge.  In a federal court, equal access to potential evidence through liberal discovery; equal opportunity to develop familiarity with the record over a reasonable period of time; evidentiary rules designed to assure that unreliable evidence, and excessively prejudicial evidence, is excluded; and, of course, the fact that a jury sits to consider the evidence, and use their combined common sense to find facts, all combine to make it possible for a defendant to overcome poor judging.  There is a vacuum of such protections in the administrative law court.  That makes the quality, or questionable quality, of the judge/trier of fact, much more important.  When the judge fails to understand, or care, that he or she is essentially the only factor between a fair proceeding and one tilted in favor of the prosecutor, justice suffers.

So, in celebration of the new baseball season, I’d like to throw a change-up today and discuss an SEC administrative law judge who, although appointed only recently, is showing great potential to be worthy of his position.  I’ve not seen SEC ALJ Jason Patil in the courtroom, but I’ve been very impressed with his approach in some recent cases.  He’s shown he can act with independence, thoroughness, attention to detail, and a strong dose of common sense.  So this blog post is to give credit where credit is due.

All the more credit is due because Jason Patil is the proverbial “new kid on the block.”  He was appointed to the SEC’s ALJ bench on September 22, 2014, after receiving a Stanford degree in political science in 1995, a law degree from from the University of Chicago Law School in 1998, and an L.L.M, from Georgetown University Law Center in 2009.  He served at the Department of Justice for 14 years.

Fewer than 3 months after ALJ Patil started at the SEC, the Second Circuit rocked the boat of the DOJ and the SEC with its insider trading decision in United States v. Newman.  ALJ Patil had to consider the impact of that decision in a case before him: In the Matter of Bolan and Ruggieri.  The SEC’s enforcement lawyers made every effort to obtain an early, post-Newman ruling from ALJ Patil in that case that would limit the scope of the Newman opinion through the adoption of a standard that would not apply Newman‘s holding to insider trading cases based on the misappropriation theory, rather than the so-called “classical” insider trading theory on which the Newman and Chiasson prosecution was founded.  ALJ Patil resisted the SEC’s full-court press to make him an early adopter of an approach that essentially ignored key language in the Second Circuit opinion.  He rejected that effort, ruling that, as the Newman court said, the standard for liability was the same under either the classical or misappropriation insider trading theory.  See SEC ALJ in Bolan and Ruggieri Proceeding Rules Misappropriation Theory Mandates Proof of Benefit to Tipper.

That showed intelligence, independence, and, to be frank, guts, for a newly-appointed ALJ.  But it was a later decision that showed me that ALJ Patil seems to have the stuff of a good judge.  In the Matter of Delaney and Yancey, File No. 3-15873, was not a high profile insider trading case, but it was apparent from the Initial Decision he wrote that he was able and willing to evaluate cases fairly and decisively.  His decision in that case is available here: ALJ Initial Decision in the Matter of Delaney and Yancey.  In that case, he wrote a careful opinion, weighing the evidence, distinguishing between the roles and conduct of the respondents, weighing expert testimony, considering (and often rejecting) varying SEC legal theories, and applying a strong dose of common sense.

The case was a technical one, involving charges against two individuals, the President and CEO of a broker-dealer that was a major clearing firm for stock trades (Mr. Yancey), and that firm’s Chief Compliance Officer (Mr. Delaney).  The SEC alleged many violations by the firm of SEC regulations governing the settlement of trades.  Mr. Delaney was charged with aiding and abetting, and causing, numerous violations of SEC regulations by virtue of his conduct as the Chief Compliance Officer.  Mr. Yancey was charged with failing adequately to supervise Mr. Delaney and another firm employee, allowing the violations to occur.  ALJ Patil exhaustively reviewed the evidence to reach reasoned decisions, with cogent explanations supporting his views.  In doing so, he was not shy about chiding the SEC for fanciful theories and woefully unsupported proposed inferences.

The opinion is long, detailed, and more in the weeds than many of us like to get.  The aiding and abetting charge against Mr. Delaney required proof that he assisted the violations through either knowing or extremely reckless conduct (i.e., scienter).  The SEC enforcement staff is quick to accuse people of knowing or reckless misconduct, and is often willing to draw that inference with little in the way of supporting evidence.  ALJ Patil’s review of the evidence presented in support of the scienter element was precise and thorough.  He dissected the evidence piece-by-piece, in impressive detail.  Here is some of what he said:

The Division has failed to show that Delaney acted with the requisite scienter, and
therefore its aiding and abetting claim against Delaney fails.  As an initial matter, I note that the Division is unable to articulate or substantiate a plausible theory as to why Delaney would want to aid and abet [his firm’s violations].  While the Division correctly argues that motive is not a mandatory element of an aiding and abetting claim, numerous courts have noted its absence when finding that scienter has not been proven. . . .    The Division also failed to establish that Delaney had anything to gain from the alleged misconduct.  The Division’s original theory was a wildly exaggerated belief that [the] . . . violations resulted in millions of dollars of additional profits. . . .  The Division was forced to abandon that theory, and in the end agreed that the “only specifically quantified benefit” to [the firm] . . . was a meager $59,000.  I do not find that sum would have given Delaney any motive to aid and abet the . . . violation. . . .  Although the Division also argues that there would have been “substantial costs to [the firm] . . . that . . . could expose the firm to significant losses,” the Division produced no evidence to quantify the costs or losses, and the testimony to which the Division points is general and speculative. . . .  As the Division did not provide any evidence quantifying the purported costs or losses, I am unable to determine whether there were any.

One of the SEC’s major points was the contention that Mr. Delaney’s knowing misconduct was apparent because he was shown to be a liar by misstatements in the Wells Submission submitted to the SEC on his behalf by his lawyers.  ALJ Patil forcefully torpedoed this theory:

I disagree with the Division’s conclusion that “Delaney has not been honest or
truthful” and “[i]nstead . . . has been evasive and inconsistent.”. . .  The Division’s
primary evidence for this alleged dishonesty are statements made in Delaney’s Wells
submission.  The Division argues, “either the statements Delaney approved about his knowledge and actions were lies to the Commission in his Wells submission or his repudiation of those statements are lies to the Court now.”. . .  Based on my careful review of that document, I conclude that it is primarily comprised of argument by counsel and grounded in incomplete information. . . .  It is based not just on Delaney’s understanding at that time, but on his counsel’s characterization of other evidence selectively provided to Delaney by the Division. . . . .  In contrast to that argumentative submission, Delaney testified five times under oath, including at the hearing. . . .  I find that Delaney’s testimony was overwhelmingly consistent, and the handful of inconsistencies alleged by the Division in such testimony either do not exist or are easily explained by the circumstances. . . .  In this case, where Delaney testified multiple times under oath at the Division’s request, as did other witnesses, I have decided to base my decision on that testimony and other documents in the record, which I find more probative than past characterizations made by Delaney’s counsel. . . .  I do not accept the Division’s insistence that everything in the [Wells Submission], particularly the statements in the legal argument section, should be taken, in essence, as testimony of Delaney.

Perhaps most telling was ALJ Patil’s careful review of supposed inconsistencies in testimony by Mr. Delaney.  His evaluation of that testimony reflected thoughtful consideration of the facts and circumstances both when the events at issue occurred, and when the testimony was given.  The decision took the SEC lawyers to task for arguing that testimony was inconsistent when the supposed inconsistencies were more plausibly explained by poor questioning by the SEC staff during their numerous examinations of him:

To the extent that Delaney’s testimony could be at all be characterized as “evasive” or
“inconsistent” . . . , it may be because he lacks a completely clear recollection of what
took place years ago regarding his alleged conduct.  Delaney credibly and convincingly
explained that his initial testimony was given with virtually no preparation or opportunity to
review documents, thus preventing him from having a full and fair recollection of the events he was asked about. . . .  While his conduct with respect to [the Rule at issue] is especially
important in the present action, at the time of such conduct, Delaney was in the business of
putting out “fires,” . . . and [the Rule], though undeniably important, was most assuredly not the top priority for the compliance department. . . .  [T]he Division argues that “Delaney quibbled about whether he had seen the release [for the Rule] in the same exact format as that in the exhibit used at the hearing and during his testimony.” . . .  Several exhibits copy or link to the text of the releases . . . with the appearance and formatting of each differing dramatically from the way the text of such releases is ultimately arranged in the printed version of the Federal Register, the document Delaney was shown at the hearing. . . .  When someone is testifying about a document that may not look anything like the version he had read, it is not “quibbling” to explain that one has never seen something that looks like the exhibit.  I in fact thought that the Federal Register version of the releases looked considerably different from the other copies and would have been hesitant to say I had read the exhibit without first looking it over. . . .  Despite his exasperation at the Division’s repeated insinuations that he was lying, I found Delaney a credible and convincing witness. My perception, that his hours of testimony were sincere and truthful, is consistent with the attestation of all the hearing witnesses regarding Delaney’s honesty and integrity.

Finally, the Division asserts that Delaney contradicted himself because, on the one hand,
in August 2012 he did not recall being concerned about the contents of [a FINRA letter] and, on the other hand, in July 2013 he testified that a disclosure in that letter would be a big deal for [his firm]. . . .  However, because Delaney was asked somewhat different questions on the two different occasions (as opposed to being asked the same question on both occasions), his answers were consistent.  In August 2012, Delaney was asked whether he was concerned about the letter, not the conduct at issue. . . .  When asked about the purported contradiction at the hearing, Delaney reasonably explained that he was not concerned about the letter disclosing the conduct, which was accurate as he understood it, but at the same time was concerned about the underlying rule violations. . . .  It is telling that the Division, who has had Delaney testify so often, seizes on such minor supposed contradictions.  I find all of the purported inconsistencies identified by the Division are
either immaterial or have been adequately explained by Delaney.  I found, on the whole,
Delaney’s testimony to be credible, with the exception, noted previously, that he may not recall comparatively minor events and discussions that took place up to six years before the hearing.

Having found no evidence of knowledge, ALJ Patil went on to reject the SEC staff’s suggestions that Mr. Delaney’s conduct was nevertheless “reckless.”  He carefully distinguished between evidence of negligence and “extreme recklessness.”  He then dissected individual emails presented by the staff as “red flags” to show, one-by-one, that they were no such thing.

ALJ Patil nevertheless found Mr. Delaney liable for “causing” some of the firm’s violations, based on his conclusion that Mr. Delaney acted negligently.  He found violations “because the evidence supports that Delaney contributed to [the firm’s] violations and should have known he was doing so.”  He did so on the basis of testimony “that according to SEC guidance, in situations ‘where
misconduct may have occurred’– as opposed to ‘conduct that raises red flags’ – compliance
officers should follow up to facilitate a proper response.”  He provided a lengthy and lucid explanation of why he reached the conclusion that Mr. Delaney faced such a situation and failed to act prudently.

The case against Mr. Yancey failed entirely.  ALJ Patil found that Mr. Yancey, as CEO, was Mr. Delaney’s supervisor, but the evidence did not show intentional conduct by Mr. Delaney, and a supervisory violation can occur only when “[t]he supervised person must have ‘willfully aided, abetted, counseled, commanded, induced, or procured’ the securities law violation.”  But even if Mr. Delaney had willfully aided an abetted the firm’s rules violations, “the Division has failed to show that Yancey did not reasonably supervise Delaney . . . because “[a] firm’s president is not automatically at fault when other individuals in the firm engage in misconduct of which he has no reason to be aware.”  He concluded: “Yancey had no reason to believe that any ‘red flags’ or ‘irregularities’ were occurring at [the firm] that were not already the subject of prompt remediation.  Given the absence of such evidence, I find that the Division did not prove that Yancey failed reasonably to supervise Delaney, even were such a claim viable here.”

As for the supervisory charge regarding the second firm employee, who was a registered representative who did act willfully, Yancey “persuasively dispute[d]” that the employee was not subject to the CEO’s “direct supervision.”  “[A]s an initial matter, a president of a firm ‘is responsible for the firm’s compliance with all applicable requirements unless and until he or she reasonably delegates a particular function to another person in the firm, and neither knows nor has reason to know that such person is not properly performing his or her duties.’ . . .   I find that Yancey is not liable for [the employee’s] intentional misconduct because the record supports that Yancey reasonably delegated supervisory responsibility over [him] . . . and then followed up reasonably.”  ALJ Patil rejected several theories of the SEC staff why Mr. Yancey should nevertheless be considered a supervisor.  He ultimately found no liability for Mr. Yancey.

On the issue of sanctions, ALJ Patil did not rubber stamp SEC staff requests.  He gave a reasoned explanation for issuing a cease and desist order against Mr. Delaney, found he could not issue a bar order against him because he did not act willfully, and imposed what seem to be reasonable civil penalties, totaling $20,000, for the conduct involved.  His order on the SEC’s disgorgement request was, perhaps unintentionally, amusingly tongue-in-cheek: “I have opted not to order disgorgement in this case, because the amount at issue is negligible. The Division contends, in effect, that Delaney must pay back the portion of his $40,000 in bonuses during the relevant time period that arose from the Rule 204T/204 violations.  The quantified benefit of the violations, $59,000, is approximately 0.008 percent of [the firm’s] revenue during that period. . . .  Even if all of Delaney’s bonuses were based on [the firm’s] performance (which, they are not, since the parties seem to be in general agreement that such performance was only one of three factors in bonuses), based on the preceding figures, the percentage of Delaney’s bonuses tied directly to the quantifiable benefit . . . is three dollars and twenty cents.  Even accounting for prejudgment interest, a disgorgement order is unwarranted.”

Kudos to ALJ Patil for what appears to be a fine job of adjudicating a tiresome case.  In a careful ruling, he handed the SEC a substantial defeat and a partial victory.  If he keeps this up in his tenure as an SEC ALJ, we should see some high-quality, thoughtful, and independent decisions penned by him.

Straight Arrow

April 14, 2015

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One thought on “Some SEC Administrative Law Judges Are Thoughtful and Even Judicious

  1. Pingback: SEC ALJ Jason Patil Stings Enforcement Division with Dismissal in Ruggieri Case | Securities Diary

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