Tag Archives: Andrew Ceresney

Chamber of Commerce Report Details Concerns with SEC Enforcement and Proposed Reforms

On July 15, 2016, the U.S. Chamber of Commerce released a lengthy and detailed report discussing a range of shortcomings in the SEC’s law enforcement investigative and adjudicative processes.  Little of what was said is new, in the sense that it raises issues or presents ideas not previously discussed by parties or commentators.  But it may be the most comprehensive discussion of SEC enforcement issues in recent years.  It discusses how and why the scope and nature of SEC law enforcement has changed over the years, and, importantly, dwells on why rules, procedures, policies, and practices developed or adopted in the past have become obsolete in light of the changed scope and nature of both the SEC’s enforcement actions and the vastly changed information-storage environment which now dominates all forms of litigation.

The report makes 28 wide-ranging recommendations for revised SEC practices, policies, and oversight of the enforcement process.  Many of these focus upon and address the increased scope and use of administrative courts to pursue SEC enforcement actions, but they also address issues of fairness, efficiency and cost of the Division of Enforcement’s investigative process, the development and presentation of enforcement recommendations to the Commission, the standards to be used by the Commission in making enforcement prosecutorial decisions, the management and oversight of the enforcement activities of the Division of Enforcement, and the coordination of SEC enforcement with that of other law enforcement agencies.  The full report can be read here: Examining U.S. Securities and Exchange Commission Enforcement: Recommendations on Current Processes and Practices.

There is a lot of material here in wide-ranging areas.  But by all appearances, the driving force behind the publication of the report is the festering issue of the untethered use of administrative proceedings to pursue SEC enforcement actions of all types, and the increasingly obsolete and unfair tilt of those proceedings in ways that plainly favor the Enforcement Division and impair the ability of respondents to defend themselves.

The tone of the report is measured, and its points are made with context and analysis. The in-depth discussion of fairness issues in SEC administrative proceedings, in light of the antiquated set of rules and procedures governing those proceedings, stands in contrast with the conclusory, and ill-supported, claims of the SEC’s Director of Enforcement that the SEC administrative process gives respondents an equal shot at prevailing over the Division.  It also spotlights the particular unfairness of a set of policies and procedures that grants the Division the right to pursue its actions before a jury if it wishes to do so, while respondents are powerless to do so, even though the Supreme Court has made it clear that in many such cases brought in federal court, there is a constitutional right to trial by jury.  The discussion also takes the Division of Enforcement to task for the analysis and explanation of its newly-adopted pseudo-policy for determining whether cases should be brought administratively or in court, noting that all of the factors weighed in that document are limited to the vantage point of the Enforcement Division; none of the considerations of fairness, efficiency, and public interest take into account impacts on the persons accused of law violations in these cases.

The report is also useful in reminding us that where we stand now is the artifact of the Gerry-built history of SEC law enforcement powers.  As a result, it is not surprising, but to be expected, that there is an ill fit between the peculiarities of the SEC’s administrative court proceedings and the design of a fair and efficient law enforcement process.

Hopefully, the report can serve as a catalyst for the SEC to get past the current no holds barred effort to beat back litigation efforts to balance the litigation playing field and turn to serious, genuine, adult consideration and resolution of the underlying fairness issues.  If not, perhaps the report can get lawmakers to do that if the SEC commissioners continue to turn a blind eye to the problem.

Some aspects of the report may assist in turning what has been a vacuum of policy discussion into a productive effort to make things better.  First, is the report’s emphasis on the difference between the SEC’s role as the steward of our securities and capital markets and capital, which differs significantly from the prosecutorial role of the Division of Enforcement — and least since that prosecutorial arm moved in recent years from a focus on the public interest to one of wielding crippling punitive sanctions.  Second, is the report’s reminder of how the SEC’s enforcement process got to where it is today, and how the development of steroid-like bulking up of SEC enforcement powers outstripped the quaint procedural concepts that of the SEC’s administrative courts, as well as the managerial means of guiding and controlling the army of enforcement lawyers seeking to flex those new muscles.

The report reminds us that the SEC needs to keep in mind that its goal is broader and more complex than just to win enforcement actions.

The report rightly starts out with a discussion of what the SEC should be trying to accomplish as it considers its enforcement program generally, and the specific aspects of that program that are causing controversy.:

The Division of Enforcement, as the prosecutor, should consider the different aspects and implications of the two forums in making its recommendation to the Commission.  However, the Commissioners acting as a decisional body should not view their role in the same way as a prosecutor.  The Commission has a responsibility to consider the broader statutory questions of what is “necessary and appropriate in the public interest for the protection of investors.”  More broadly, it must also adhere to its multiple statutory mandates to protect investors, promote capital formation, and ensure fair and orderly markets.  Accordingly, the Commission should predicate its forum selection decisions solely upon a clear determination that its choices uphold and further its responsibility as a government agency to promote the public interest and the protection of investors, while respecting the important rights of those whose conduct the SEC chooses to scrutinize.

Report at 3 (footnotes omitted).

This gets to the heart of the Commission’s failure over the last year to show that it is willing to confront and discuss, in a serious, adult, way, how its enforcement policies may be undercutting, rather than achieving, important broader goals, including respect for its decisiion making process.

The report makes it clear that the history of the growth of SEC enforcement powers shows the current model is founded on happenstance, not design.

The report provides a history lesson about how the SEC got to where it is now.  That history shows repeated efforts to enhance and expand SEC enforcement powers and flexibility, but no effort whatsoever to build an managerial and procedural infrastructure necessary to assure that these new-founded powers are used in ways that achieve the SEC’s broader mission.  Here is some of that discussion:

Since the SEC’s creation, it has had the authority to bring administrative proceedings to address violations of the securities laws.  The scope of its authority to bring an administrative proceeding and the sanctions that can be ordered in an administrative proceeding have grown dramatically over time.

Early in the history of the SEC, the administrative proceeding was limited to proceedings to halt an offering of securities to the public, a so-called stop order, under section 8 of the Securities Act, and proceedings to reject an application for or revoke the registration of a broker-dealer or investment adviser.  Administrative proceedings were adjuncts of the Commission’s authority to register securities and register broker-dealers, investment advisers, and investment companies.  When the occasion arose to deny a registration or to revoke one, the administrative proceeding was the vehicle to provide the affected entity with a right to hearing prior to Commission action.

In 1964, Congress amended the Exchange Act and provided the Commission with the authority to institute administrative proceedings to censure, place limitations on the activities of, suspend for a period up to 12 months, or bar associated persons of broker-dealers.  The grounds for denying or revoking a broker-dealer registration or other disciplinary sanction were also expanded.  These new bases included willful violations of the Investment Company Act or the Investment Advisers Act, willful aiding or abetting violations, and importantly, a broker-dealer’s failure reasonably to supervise a person who commits a violation. In 1970, Congress amended similarly the Investment Advisers Act. Comparable authority is also contained in the Investment Company Act.  This authority has become a staple of the SEC Enforcement Program.

In 1990, Congress enacted the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the Remedies Act).  The Remedies Act dramatically expanded the nature of SEC administrative proceedings.  For the first time, the Commission could proceed administratively against persons and entities not directly registered with the Commission and, also for the first time, it could impose monetary penalties on registered entities and associated persons.  It authorized the Commission to enter a cease and desist order against any person who is violating, has violated, or is about to violate any provision of the securities laws or any rule or regulation thereunder.  In a cease and desist proceeding, the Commission can order a party to take steps to comply with its rules, to provide an accounting, and to disgorge profits gained or losses avoided.  This Act also created a proceeding to enable the SEC to issue a temporary cease and desist order.  While the Commission has used its cease and desist authority extensively, it has brought only one proceeding under its temporary cease and desist authority.

The Remedies Act also expanded the remedies that the SEC can order in an administrative proceeding against broker-dealers, investment advisers, investment companies, and persons associated with these registered entities.  The SEC can order disgorgement and civil penalties comparable to those available in an injunctive action.  The Sarbanes-Oxley Act (SOX) expanded the remedies available in a cease and desist proceeding by authorizing the SEC to bar an individual from serving as an officer or director of a public company if they violated the antifraud provisions of the Securities Act or Exchange Act. Section 602 of SOX added section 4C to the Exchange Act and provided explicit statutory authority for administrative proceedings against an attorney, an accountant, or other professional such as an engineer or geologist, engaging in improper professional conduct. This codified Commission rule 102(e).

Section 925 of the Dodd-Frank Act (Dodd-Frank) further expanded the Commission’s sanctioning power to include a “collateral” bar from association under all of the securities laws.  It also provided the authority to impose money penalties against persons or entities not registered with the Commission.  In effect, the Commission could, in an administrative proceeding, impose substantially the same penalties available in a civil injunctive action. The substantial expansion in administrative proceeding authority, both in the scope of who may be charged in an administrative proceeding (AP) and in the penalties available in an AP, has coincided with a dramatic increase in the total number of administrative proceedings brought by the SEC.  While the controversy over this shift in policy has been largely focused on the period following Dodd-Frank, and in particular the past two years, the increased reliance on administrative proceedings has been growing steadily for more than two decades.

Report at 11-12 (footnotes omitted).

At a later point, the report discusses some of the current procedural rules governing the administrative proceedings, and makes the telling point that these rules were adopted long before the Commission (or anyone else) had any conception that this process would be used to try to adjudicate complex enforcement cases that went well beyond the areas subject to SEC regulation:

Commission rule 360 provides that “Under the 300-day timeline, the hearing officer shall issue an order providing that there shall be approximately 4 months from the order instituting the proceeding to the hearing, approximately 2 months for the parties to obtain the transcript and submit briefs, and approximately 4 months after briefing for the hearing officer to issue an initial decision.”  At the time they were adopted, the Division was not bringing complex matters administratively, and there was little experience with the explosion of electronic documents that is commonplace today.  As such the time periods in Rule 360 never considered the possibility that litigants in some matters would be forced to review in four months literally millions of pages of documents turned over by the staff.  Of course in 1994, when the Commission last completed a material update of its Rules of Practice, it also did not consider the possibility of complex litigation in an AP.  This explains why the rules provide only the most limited forms of discovery and depositions for respondents.  The lack of adequate discovery opportunities and sufficient time to prepare for trials are serious disadvantages that raise fundamental issues as to the efficacy of bringing complex litigation under the existing Rules of Practice.

Report at 16-17 (footnotes omitted).

And later:

The most significant difference between an administrative proceeding and a civil action is in the area of pre-trial discovery.  Through its investigation and the use of investigative subpoenas, the Commission’s staff will have developed an extensive investigative record over a significant period of time, before instituting an enforcement action.  The Division of Enforcement effectively has had extensive discovery.  While the current Rules of Practice
create a possibility for issuance of subpoenas by an ALJ, the rigorous deadlines for completion of a proceeding often result in ALJ reluctance to delay a hearing by approving the issuance of subpoenas.  The disparity in discovery rules between Commission administrative proceedings and federal litigation is a sore point with SEC defense counsel.

The Commission’s Rules of Practice have not been significantly amended since 1993.  The comprehensive review at that time reflected the substantial changes in authority and sanctions contained in the Remedies Act.  Since the new authority was in its infancy, there was limited experience to provide a benchmark.  It was also not possible to anticipate the additional expansions affected by SOX and Dodd-Frank.  As such the project was an
effort to anticipate what would be needed to ensure that administrative proceedings would be conducted and adjudicated in a timely, fair, and impartial manner. It is fair to conclude that no member of the Task Force working on that project envisioned what the norm is more than 20 years later.  For this reason, the Commission should update and review its Rules of Practice.  This should not be a controversial recommendation, given that the current
general counsel of the SEC has publicly suggested that it is time for a review.

Report at 20-21 (footnotes omitted).

The report puts to rest the bona fides of the ill-conceived response from the Enforcement Director arguing that the rules and procedures governing administrative actions do not favor the Division as prosecutor, and the memorandum from the Division of Enforcement purporting to rationalize the Division’s forum-choice decisions.

When the Director of Enforcement acknowledged a new policy of using the administrative forum more frequently to pursue enforcement cases even in complex actions involving unregulated persons, there was an outcry that this was an effort to stack the deck unfairly in the Enforcement Division’s favor (is there a way to stack a deck fairly?).  See, for example, SEC Enforcement Director Announces Future Plans To Avoid Jury Trials, and Former SEC Enforcement Leaders Urge SEC To Reform Administrative Enforcement Process.   Instead of acknowledging a problem that needed to be discussed and resolved, Enforcement Director Andrew Ceresney gave a premeditated, yet ludicrous, response that respondents were not harmed at all by being forced into the administrative forum.  See Ceresney Presents Unconvincing Defense of Increased SEC Administrative Prosecutions.

When this plainly incorrect response failed to quell the sense of outrage, the Division of Enforcement published a memorandum purportedly explaining how it decided, and would decide, which forum to use in a prosecution, presumably in an effort to show that those decisions were not arbitrary.  See SEC Attempts To Stick a Thumb in the Dike with New Guidelines for Use of Administrative Court, and Upon Further Review, SEC Memo on Use of Administrative Courts Was Indeed a Fumble.

The report lays waste to each of these efforts to avoid the key substantive fairness issues raised by the increased use of the administrative forum in its current form.  It hopefully puts to rest any serious contention that respondents are significantly disadvantaged when the Commission chooses to file a complex case administratively at the same time it dissects the Division of Enforcement memorandum to show it is written without adequately considering impacts of this policy outside of the Division itself, and often relies on false premises:

In early May 2015, the Division of Enforcement posted on its page on the SEC website a document titled Division of Enforcement Approach to Forum Selection in Contested Actions.  As the title indicates, the document provides an explanation of the factors that the Division will consider when making a forum recommendation to the Commission. . . .

Four factors are identified and discussed:

• The availability of the desired claims, legal theories, and forms of relief in each forum (factor 1);
• Whether any charged party is a registered entity or an individual associated with a registered entity (factor 2);
• The cost-, resource-, and time-effectiveness of litigation for the Commission in each forum (factor 3); and
• Fair, consistent, and effective resolution of securities law issues and matters (factor 4).

Factor one acknowledges that certain causes of action are unique to each forum. . . .

Factor two restates the long-standing use of the AP process for actions against registered entities and associated persons. . . .

Factor three describes additional time and resource benefits that the staff derive from each type of forum, under certain circumstances.  These time and resource considerations
highlight the benefits exclusive to the Division.  No recognition or consideration is given to the impact of the forum decision on the parties charged.  In this respect, the policy is most troubling.  While the apparent efficiency of an administrative proceeding may be a benefit to the Division, it may be a serious and inequitable impediment to the person charged.  As a factual matter, the claimed rapidity of an administrative proceeding over a federal court action may also be incorrect.

The speed of the AP process is largely a byproduct of two factors.  One factor is the limited availability of pre-hearing discovery.  The second factor is the time limits imposed by Commission rule on the length of the process.

The lack of pre-hearing discovery adversely affects the respondent rather than the SEC staff. This is because the staff has been able to compile its evidentiary record, including sworn depositions, through its investigation process.  In effect, the staff is able to conduct its prehearing discovery before beginning the proceeding.  The respondents in an administrative proceeding have no comparable opportunity.  While they may be provided with the staff’s investigative record, this does not provide them with an opportunity to ask their own questions of witnesses  or seek documentation to support their position.  More important, they may have only a very short amount of time in which to review an investigative file, compiled over years of investigation and encompassing literally millions of pages of material.  The unequal impact of this limitation is discussed further below, under the discussion of factor three.

The second factor, specific time deadlines, may not result in the level of efficiency that the Division suggests. . . .  Factoring in the extended time period for completion of the Commission’s review suggests that the overall period for completion of an administrative proceeding is likely slower than the time required to complete a trial in district court.

Factor three also refers to the costs and benefits arising from the “additional time and types of pre-trial discovery available in federal court.”  While the current AP rules may provide benefits to the staff in terms of resources, they affirmatively disadvantage the respondents in these proceedings. . . .   At the time [these rules] were adopted, the Division was not
bringing complex matters administratively, and there was little experience with the explosion of electronic documents that is commonplace today. . . .  The lack of adequate discovery opportunities and sufficient time to prepare for trials are serious disadvantages that raise fundamental issues as to the efficacy of bringing complex litigation under the existing Rules of Practice. . . .

The fourth factor broadly raises these fundamental considerations of fairness and efficacy.  The only aspects of it that are discussed in the Division’s statements are the traditional statement concerning the superior expertise and experience of ALJs and the Commission, and the benefits that may come from having these experts be the first to examine and interpret the law, subject to appellate review.

Notably absent from this factor is the issue of the right to a jury trial.  One of the core constitutional protections is the right of persons to demand a jury trial.  The Supreme Court
has held that a defendant is entitled to a jury every time the government demands a civil penalty. . . .   Ironically, under the new forum choice process, instead of the defendant controlling the right to request a jury, through the choice of forum the government will have complete control over the right to a jury.  If the Division believes a jury would be advantageous, then it can file in district court.  If the Division prefers not to have a jury hear a case, then it can file an administrative proceeding.  Of all the consequences of the choice of forum controversy, it is likely that most objective persons would view this usurpation of a defendant’s right to request a jury as the most objectionable consequence.

Other fairness issues are also worthy of examination.  As previously explained, the lack of time and lack of discovery options also raise serious fairness issues.  In addition, one should be careful not to overstate the superior expertise that resides with the Commission’s adjudicators. Under the procedure governing the appointment of ALJs, direct substantive expertise in the applicable law is a minor consideration.  The dominating factor in the selection process is experience as an ALJ in the federal government.  During the past 30 years, the SEC has not hired a single ALJ who had directly relevant experience or expertise related to the federal securities laws.  While one may reasonably assume that each ALJ will, over time, acquire this expertise, currently only two of the six SEC ALJs have been at the Commission for more than two years.

This lack of substantive experience is particularly relevant when one considers the different standard for appellate review of SEC opinions compared to federal district court decisions….  This limited standard of review applies even in matters in which the Commission interprets the law differently from judicial interpretation. . . .

Report at 14-17 (footnotes omitted).

The report makes many recommendations for action by the Commission.  Many are fairly obvious for laying a foundation of fairness in this process.  Others may ask too much.  But each is a serious proposal meriting thought, analysis, and discussion, beyond the scope of this article.  The point to be made first is that the report leaves little doubt that it is time for the SEC commissioners to join in a “conversation” about how best to reform the SEC’s enforcement and administrative process, rather than mutely filing briefs in the administrative and federal courts that do their best to try to prevent anyone from causing meaningful reform.

Straight Arrow

July 16, 2015

 

Division of Enforcement Continues To Refuse To Comply with SEC Orders in Timbervest Case

Two days ago, we wrote about the Division of Enforcement’s refusal to comply with an SEC adjudicative order in In the Matter of Timbervest, LLC.  Instead of complying with a Commission Order to supply information about the circumstances of the hiring of ALJs Brenda Murray and Cameron Elliot, the Division provided information that it deemed sufficient to address the Appointments Clause issue raised by the respondents.  Then, amazingly, the partial response the Division deigned to supply, based on what it decided was relevant, was wrong, which was learned when ALJ Elliot corrected the errors on the record in a different proceeding.  See SEC Bumbles Efforts To Figure Out How Its Own Administrative Law Judges Were Appointed.

Well, paraphrasing a former President’s famous one-liner: “There they go again!”

Yesterday, the Division made another filing in the Timbervest administrative proceeding that refused to comply with a Commission Order.  Instead, the Division again told the Commission that it really shouldn’t have asked for the submission it ordered, and declined to respond.  If there were any further evidence needed of the inherent unfairness of the administrative adjudicatory process to respondents, and the inability of the Commission to address fundamental constitutional issues under its own roof, this is it.  The Division would not dare thumb its nose in the face of a district court judge in this manner, even if it were really upset that it was being ordered to make submissions it really preferred not to make.  But here, Mr. Ceresney has no reason for concern because the “chief judge” he is facing — Mary Jo White — is his former law partner, and the person who appointed him head of the Enforcement Division.  Conflict of interest?  Perhaps not, technically.  But how fair would you think this adjudicative forum is if you were in Timbervest’s shoes on the other side of the “v.” from Mr. Ceresney when the Division was allowed to make its own decisions about the extent it would comply with Commission orders?

Here is what happened.  In response to a motion from the respondents, on May 27, 2015, the Commission, sitting in its capacity as adjudicator of the Timbervest enforcement action:

ORDERED that the parties shall file simultaneous supplemental briefs, not to exceed ten double-spaced pages, by July 1, 2015. The briefs shall be limited to the following two issues: (1) whether, assuming solely for the sake of argument that the Commission’s ALJs are “inferior officers” within the meaning of Article II, Section 2, Clause 2 of the Constitution, their manner of appointment violates the Appointments Clause; and (2) the appropriate remedy if such a violation is found.

The Order “assum[ed] solely for the sake of argument” that the Commission’s ALJs are ‘inferior officers'” under Article II, Section 2, Clause 2, and mandated short submissions on two specific points: (1) under that assumption, have the appointments of SEC ALJs violated the Appointments Clause, and (2) “if such a violation is found,” what should be the appropriate remedy?

The parties’ responses were filed yesterday.  The respondents’ submission can be read here: Brief of Respondents In Response to the Commission’s May 27, 2015 Order.  The Division of Enforcement’s submission, personally signed by Enforcement Director Andrew Ceresney, can be read here: Division of Enforcement’s Response to the Commission’s May 27 Order

The respondents submitted what the SEC ordered.  They laid out their argument why the appointment of the ALJ who presided over most of their proceeding violated the Appointments Clause, assuming he was indeed an “inferior officer” under that clause.  They then argued that the violation makes the proceeding and findings of the ALJ invalid, requiring that the Initial Decision be vacated.  If a new proceeding is to be commenced (which they argue is not in the public interest), it must be, they say, before an ALJ properly appointed under the Appointments Clause.

The Division, on the other hand, chose (again) not to submit what the Commission ordered.  The Division’s brief acknowledges that, based on the known circumstances of the appointment of SEC ALJs, if one assumes “for the sake of argument” that the SEC’s ALJs are “inferior officers,” their appointments did not comply with the Appointments Clause:

In response to the Commission’s first question, “assuming solely for the sake of argument that Commission ALJs” who presided over Respondents’ administrative hearing are “‘inferior officers’ within the meaning of Article II, Section 2, Clause 2 of the Constitution,” the Division believes that their manner of appointment would be inconsistent with the terms of the Appointments Clause.

SEC Brief at 1.

But on the second issue — the appropriate remedy in the event such a violation is found — the Division gave no response.  Instead, it argued (again) that SEC ALJs are mere employees, and that therefore no remedy is needed.  In short, the Division refused to comply with the SEC’s Order:

In response to the Commission’s second question, the Division strongly urges the Commission to refrain from fashioning a fix for a non-existent constitutional violation. Rather, and for the additional reasons explained below, the Commission should find that ALJ Elliot was hired in a manner consistent with Article II, Section 2, Clause 2 of the Constitution because he is an employee, and not a constitutional officer, and that there is therefore no Appointments Clause defect to remedy.

SEC Brief at 2.  Later in the submission, the Division says:

Because there is no constitutional violation under the Appointments Clause, there is no basis for a “remedy.”  If, however, the Commission holds that SEC ALJs are inferior officers and that their hiring violated the Appointments Clause because they were not hired with the approval of the Commissioners, the Division requests that it be permitted to submit additional briefing about components of any appropriate remedy, such as ratifying SEC ALJs’ prior hiring.  To be clear, the Division does not seek any remedy, including as an alternative measure, at this juncture.  Because of the potential ramifications of such a remedy [fn] and because Congress has set out a scheme, implemented by OPM, for the hiring of these employees, the Division believes that any Commission efforts to superimpose on this scheme a remedy to rectify a problem that does not exist is inadvisable at this time.

[fn]: Such a remedy is not only unnecessary but also fails to resolve the ongoing litigation before the Commission and in district courts around the country given the other constitutional claims raised in this case and others that would not be addressed by such action.  Further, it seems likely to prompt new issues in litigation, whether in this case or others.

SEC Brief at 5-6.

Not to belabor the point, but if the Division believed the submission it was ordered to make was inadvisable at this time, for tactical litigation reasons involving other cases or for whatever other cause, it should have asked for relief from the Order and allows the Commission to decide whether the Order should be revised.  Simply refusing to comply and asking for the right to address the issue later if necessary is contemptuous of the adjudicator (here, the Commission), and of the proceeding itself, which does not permit parties to dictate when they will and will not comply with the administrative court’s orders.

Straight Arrow

July 2, 2015

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Bebo Case Continues To Show Why SEC Administrative Proceeding Home Advantage Is Unfair

SEC Administrative Law Judge Cameron Elliot just issued another procedural ruling in In the Matter of Laurie Bebo and John Buono, File No. 3-16293, that shows how SEC prosecutors are accorded great advantages in their home administrative courts.  The order is available here: Order Denying Motion To Compel and Granting in Part Motion n Limine.  We previously discussed the unfairness of Ms. Bebo’s administrative proceeding here: SEC ALJ Cameron Elliot Shows Why In re Bebo Should Be in Federal Court, and here: In re Bebo Shows Why SEC Administrative Proceedings Have Fairness Issues.

Bebo moved to compel the notes of interviews conducted by SEC lawyers of potential witnesses in the case.  ALJ Elliot denied that motion, and ordered that SEC lawyers could not be called to testify about those interviews as well.  He ruled that “Each set of notes is plainly an ‘internal memorandum, note or writing prepared by a Commission employee.’  17 C.F.R. § 201.230(b)(1)(ii).  Such documents are, with certain exceptions inapplicable here, not subject to production.  Id.  To the extent Bebo seeks material exculpatory evidence contained within the notes, such evidence need not be disclosed by production of the notes themselves….  Although Bebo correctly observes that the Federal Rules of Civil Procedure provide a mechanism for discovery of attorney work product, those Rules are inapplicable here.”  Bullseye!

On the issue of calling SEC lawyers as witnesses he said: “demanding the deposition or examination of opposing trial counsel is almost always pure gamesmanship.  I am deeply disappointed that Bebo has chosen this course instead of simply following my guidance.  I intend to give both sides a fair hearing, and I expect all parties and all counsel to behave like professionals; if not, it will be a very long hearing indeed.”  He may be “deeply disappointed,” but it is he, not the lawyers, who is acting unprofessionally by making such a comment.  They are doing the best job they can to defend their client in an uphill battle in an unfair forum.  He has no business calling that “unprofessional.”  In fact, SEC lawyers on a prosecution team have been ordered to testify in discovery depositions in federal court enforcement proceedings if they may have relevant testimony that could have a bearing on the case.  By attacking defense counsel for trying to get a similar order here, ALJ Elliot is showing questionable fitness for the job of adjudicating a case in which Ms. Bebo’s future freedom to serve as an executive or director in a public company is at issue.  Filing a motion in court is not “unprofessional,” Mr. Elliot.  It is called “making a record” so that ultimately real judges in real courts have before them the necessary facts to rule on the legality of your proceeding.

So ALJ Elliot provided a short, neat lesson to SEC Enforcement Director Andrew Ceresney on why the SEC is so much more successful in administrative enforcement proceedings than in those litigated in federal court.  See Ceresney Presents Unconvincing Defense of Increased SEC Administrative Prosecutions.  Not only is Bebo’s attempt to even the playing field by learning about what potential witnesses said to the SEC barred by the SEC Rules of Practice, but Ms. Bebo has no way to gather that information for her defense because there is no possibility for discovery depositions of these third parties.  And the judge gets belligerent with defense counsel just for doing their jobs.  The end result: the SEC knows what these potential witnesses have to say, how strong their testimony might be, and how favorable or unfavorable they are towards Ms. Bebo, and Ms. Bebo’s counsel is forced to litigate in the dark.  And the judge serves notice that aggressively pursuing Ms. Bebo’s case will be met with rancor.  You call that fair, Mr. Ceresney?

Hopefully, Ms. Bebo’s strong record of how she is being disadvantaged in the administrative forum will bear fruit when she finally gets the chance to have a court of appeals review the constitutionality of transferring important law enforcement actions against non-regulated persons into the SEC’s administrative courts.

Straight Arrow

April 6, 2015

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SEC Suffers Another Major Loss in Willie Gault Case

A jury ruled against SEC charges of fraud against former pro football player Willie Gault, another in a string of embarrassing high-profile litigation losses in cases tried by the SEC.  The jury found Gault liable for lesser charges of false SOX certifications and circumventing internal controls.  Director of the Division of Enforcement Andrew Ceresney gave a faux victory statement that he was “pleased with the jury’s verdict holding Willie Gault accountable for securities law violations.”  And perhaps the jury’s findings represent somewhat more than the defense counsel’s post-trial description of “the equivalent of a traffic ticket.”  But make no mistake, this is another troubling trial loss for the SEC because the fraud charges are what these cases are all about.  It is highly likely the case could have been settled a long time ago on the lesser charges (and at much less expense for both the Government and the defense).

The SEC’s use of major resources in the effort to “get” Gault on the fraud charges should be seriously re-examined by Ceresney and other key enforcement managers.  Instead, Ceresney may well chalk this up as another example of a flawed jury being unable to understand the evidence, or unwilling to see the case as the SEC staff does, and therefore representing another reason why such cases should be directed to the SEC’s administrative court to avoid independent fact-finding.

The case involved an alleged “pump and dump” of Heart Tronics, Inc. stock, orchestrated by the company’s former outside counsel, Mitchell Stein.  Stein was previously convicted of criminal securities fraud and is in prison.  The SEC contended that Stein “installed” Gault “as a figurehead co-CEO . . . in order to generate publicity for the company and foster investor confidence,” and “orchestrat[ed] a campaign of misinformation designed to inflate the price of Heart Tronics stock” before selling some of his wife’s stock in the company.  She owned 85% of the company’s stock.

The SEC’s complaint described in detail the steps of an elaborate scheme by Stein, but says precious little about Gault’s supposed role in the scheme.  In fact, the SEC’s theory against Gault with regard to the alleged pump and dump scheme seemed to be no more than the contention that he “rarely questioned Stein’s direction,” “abdicated [his] fiduciary responsibilities to Heart Tronics shareholders, ” and “signed, or unlawfully authorized to be signed, public Commission filings containing false statements about the Company’s purported sales.”  It appears that the only serious fraud theory against Gault was not participation in Stein’s extensive stock scheme, but that Gault allegedly assisted in an effort to induce a single investor to loan money to the company based on misrepresentations, and then diverted some of those funds for personal use.  Pre-trial motions to exclude these separate transactions from the case as not involving securities were denied by the district court.  A copy of the complaint can be found here: Complaint in SEC v. Heart Tronics et al.

One might question the wisdom of pursuing a fraud case against someone who could easily be argued to be a victim of the fraud, not one of its perpetrators.  If the SEC lacked any real evidence that Gault participated in the pump and dump fraud scheme, no case should have been brought on that theory.  Arguing to the jury that Gault was a fraudster without real evidence to support that charge could easily cause the jury to distrust the SEC and its trial counsel.  This may be another example of the SEC overcharging its case by imprudently focusing on fraud charges.  See SEC’s Single-Minded Focus on Fraud Theory Results in Loss on Appeal.  In any event, we know from our own experience that the SEC will move to trial on fraud cases with scant evidence that the defendant actually participated in a fraud, based on the personal views (or even pique) of enforcement lawyers, rather than a serious, disinterested evaluation of the evidence a jury will see.

Hopefully, we will learn over time more about why the jury didn’t buy the SEC’s case.  Often, an effort to prove fraud based solely on neglect and breach of fiduciary duty (neither of which constitutes “fraud”), based on an expansive theory of “recklessness,” will, and should, be unsuccessful.  And the specifics of Gault’s role in the one investor’s loan to the company may well have been less important than the SEC alleged, or the jury may just have questioned its significance in the context of a case focused on a broader alleged scheme in which Gault was not even alleged to be a meaningful participant.

Whatever the reason, the loss, along with other recent losses, should cause management in the SEC’s Division of Enforcement to engage in serious self-examination about the cases the Division brings to trial, and its process for deciding whether they are truly trial-worthy.  That would be a much more sensible reaction than simply trying to shift more cases to the administrative court in order to avoid the annoyance of independent juries.

Straight Arrow

March 19, 2015 

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