Tag Archives: Gray Financial Group

SEC Hit with Double Whammy Rulings Barring It from Commencing Challenged Administrative Proceedings

On the afternoon of September 17, 2015, the SEC was rebuffed by two federal courts in separate cases challenging the constitutionality of the SEC’s administrative law enforcement proceedings.  As reported here, the Court of Appeals for the Second Circuit granted Lynn Tilton an order barring the SEC from proceeding with an administrative trial on charges against her, pending that court’s resolution of a dispute over whether the federal courts have jurisdiction to consider her complaint that the administrative proceeding would violate Article II of the Constitution.  At roughly the same time, New York federal district court Judge Richard Berman rejected a motion by the SEC to allow it to proceed with an administrative action against Barbara Duka while it appealed (to the Second Circuit) Judge Berman’s preliminary injunction barring that proceeding from moving forward, on the very same constitutional grounds.  Judge Berman’s preliminary injunction order can be read here: Order Issuing Preliminary Injunction in Duka v. SEC; and his order denying the SEC’s stay motion can be read here: Decision and Order in Duka v. SEC.

The result is that two more administrative proceedings are now barred by court orders, joining two others that were barred by orders of Judge Leigh May in the federal district court in Atlanta.  See Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding, and Order Enjoining SEC in Gray Financial Group v. SEC.

The Second Circuit order was brief and straightforward.  But Judge Berman’s denial of the SEC’s application for a stay is filled with meaty discussions of key issues, including reiterating that several of the SEC’s positions on jurisdiction and the merits are wrong, suggesting that the SEC plays a little fast and loose with the positions it argues, and emphasizing that the SEC might want to be more proactive in addressing allegations of potential bias in its administrative court.

Judge Richard Berman - NYLJ/Rick Kopstein 100614

Judge Richard Berman – NYLJ/Rick Kopstein

On the jurisdictional issue, Judge Berman restated his belief that his court does have jurisdiction over the Duka constitutional challenge (“The Court is, respectfully, convinced that it made the correct finding of subject matter jurisdiction,” slip op. at 3), and took the time to address the contrary position recently reached by the Seventh Circuit in Bebo v. SEC, 2015 WL 4998489 (7th Cir. Aug. 24, 2015) (see 7th Circuit Rules for SEC, Affirming Dismissal of Bebo Case on Jurisdictional Grounds).  He openly disagreed with the Seventh Circuit’s view that the Supreme Court decision in Elgin v. Dep’t. of the Treasury, 132 S. Ct. 2126 (2012), was on point because the factual circumstances differed significantly.  See slip op. at 8-9.

Judge Berman also made pointed statements elsewhere in his opinion arguing that immediate consideration of the consitutional issue was consistent with Second Circuit law and the public interest.  For example: “The SEC argues unconvincingly that a party in Ms. Duka’s shoes ‘must patiently await the denouement of proceedings within the [administrative agency],” . . . .  But Second Circuit precedent appears to refute such a notion.  See Touche Ross & Co. v. S.E.C., 609 F.2d 570, 577 (2d Cir. 1979) (‘[T]o require appellants to exhaust their administrative remedies would be to require them to submit to the very procedures which they are attacking.’).”  Slip op. at 15-16 (some cites omitted).  And: “With respect to the public interest, the Court submits that it is of the utmost importance to the public that complex constitutional questions be resolved at the outset, with finality, and by application of the expertise of the federal courts.  See, e.g., Massaro v. United States, 538 U.S. 500,504 (2003); see also Pappas v. Giuliani, 118 F. Supp. 2d 433, 442 (S.D.N.Y. 2000) affd, 290 F.3d 143 (2d Cir. 2002) (‘Although often highly competent in their designated area of law, administrative decision-makers generally have neither the training nor the experience to adjudicate complex federal constitutional issues.’); Austin v. Ford, 181 F.R.D. 283, 286 (S.D.N.Y. 1998) (‘Public interest in finality of judgment encompasses the development of decisional law, the importance of the opinion to nonparties, and the deterrence of frivolous litigation.’).”  Slip op. at 16 (some cites and footnote omitted).

All of these points could be impactful as the Second Circuit considers the same jurisdictional issue in the Tilton v. SEC appeal.

On the merits, Judge Berman restated his belief that Supreme Court case law leaves little doubt that the SEC’s administrative law judges are “inferior officers” within the meaning of that term in Article II, and, as a result, their appointments are subject to limitations in Article II’s Appointments Clause.  His finding that the High Court reasoning and holding in Freytag v. Commissioner, 501 U.S. 868 (1991), yields the conclusion that SEC ALJs are inferior officers because they exercised “significant authority pursuant to the laws of the United States” was not new – as he noted, he previously reached the same conclusion when he issued the preliminary injunction.  Slip op. at 9.  But it came within two weeks of the SEC reaching the opposite conclusion in its recent decision on the petition for review in In the Matter of Raymond J. Lucia Cos., Inc., File No. 15006 (see SEC Declares All Is Okay Because Its ALJs Are Just Employees and Not “Inferior Officers”), without even mentioning that decision or its analysis, suggesting Judge Berman found the SEC reasoning unpersuasive and sees no reason to defer to SEC views on the issue.  No doubt with knowledge of the specific analysis of the SEC in Lucia, he still wrote: “the SEC will not, in the Court’s view, be able to persuade the appellate courts that ALJs are not “inferior officers.”  Slip op. at 11.  Judge Berman’s bottom line: “Duka’s constitutional (Appointments Clause) challenge is (very) likely to succeed.”  Id. at 10.

On the SEC’s nimble willingness to revise its arguments to fit the circumstances, Judge Berman noted the “irony” of the SEC’s new-found emphasis on the compelling importance of judicial efficiency after it scoffed at Ms. Duka’s similar arguments in the original preliminary injunction hearing.  He wrote: “The Court’s reference to ‘irony’ [in an earlier ruling] refers to the fact that conservation of Duka’s resources was a core argument that she raised in objecting to participating in the SEC’s administrative proceedings prior to resolution of her constitutional challenge in federal court.  The SEC flatly opposed that argument, which it now appears firmly to embrace.”  He quoted his own statement during the oral argument that “I don’t understand why you reject that argument when Ms. Duka makes it but then at the same time in this Court you make the very same argument.”  Slip op. at 3 n.2.

And Judge Berman was surely making a point when he dwelled, without any apparent need, on the SEC’s opaque handling of publicly-disclosed evidence that its own administrative court could have a latent, or even intentional, bias in favor of the prosecution.  His opinion includes the following striking paragraph:

The Court is aware of recent allegations of undue pressure said to have been applied to an SEC ALJ to cause her to make SEC-favorable rulings.  “Lillian McEwen, who was an SEC judge from 1995 to 2007, said she came under fire from [Chief Administrative Law Judge Brenda] Murray for finding too often in favor of defendants.”  See Jean Eaglesham, SEC Wins with In-House Judges, The Wall Street Journal, May 6, 2015. . . .  And, in In the Matter of Timbervest, respondents allegedly sought to depose presiding ALJ Cameron Elliot, who was then allegedly invited by the SEC “to file by July I, 2015 an affidavit addressing whether he has had any communications or experienced any pressure similar to that alleged in the May 6, 2015 The Wall Street Journal article.”. . .  On June 9, 2015, ALJ Elliot emailed the following response: “I respectfully decline to submit the affidavit requested.”  See Jean Eagelsham, SEC Judge Declines to Submit Affidavit of No Bias, The Wall Street Journal, June 11, 2015. . . .  On July 24,2015, Chief Administrative Law Judge Murray issued an Order Redesignating Presiding Judge, designating Administrative Law Judge James E. Grimes “in place and stead of the Administrative Law Judge [ALJ Cameron Elliot] heretofore designated, to preside at the hearing in these proceedings and to perform other and related duties in accordance with the Commissioner’s Rules of Practice.”  See In the Matter of Barbara Duka, File No. 3-16349 (SEC).

During the September 16, 2015 hearing, the Court noted that it was “aware that there is some sort of flap at the SEC with respect to some of the ALJs,” that it “want[ed] to get further clarification about that matter,” and that “in this very case, [ALJ] Cameron Elliot . . . has been reassigned because he was not able or would not submit an affidavit.”. . .  While acknowledging that ALJ Elliot was removed from the Duka matter, Ms. Lin contended that “Judge Elliot has a very busy docket . . . and there is no suggestion, no connection whatsoever about [The Wall Street Journal article], about that particular former ALJ’s accusations to Judge Elliot’s reassignment in this case. . . .  And it’s not true that there would be any kind of connection.”. . .  The Court assumes that the SEC will want fully to investigate these matters.

Slip op. at 14-15 (citations omitted and emphasis added).

Apparently Judge Berman is as perplexed as yours truly when the Commission seems more insouciant than concerned in its reaction to serious public questioning of the fairness of its own administrative judicial process.  See SEC Bumbles Efforts To Figure Out How Its Own Administrative Law Judges Were Appointed; and SEC “Invites” ALJ Cameron Elliot To Provide Affidavit on Conversations “Similar” to Those Described by Former ALJ.  Indeed — although Judge Berman made no mention of this — it is downright embarrassing that 15 months ago the SEC’s General Counsel acknowledged that the Rules of Practice governing SEC administrative proceeding are archaic and need revamping and nothing has yet been done to address that issue.  See SEC Administrative Case Rules Likely Out Of Date, GC Says.  (Ms. Small said it was fair for attorneys to question whether the SEC’s rules for administrative proceedings were still appropriate, with the rules last revised “quite some time ago” when the SEC’s administrative proceedings dealt with different kinds of cases than the more complex administrative matters it now takes on or expects to take on — given the commission’s expanded authority under the Dodd-Frank Act — such as insider-trading actions.  It was “entirely reasonable to wonder” if those rules should be updated to reflect the changed situation, for instance by allowing more flexibility on current limits to trial preparation time or allowing for depositions to be taken.  “We want to make sure the process is fair and reasonable, so [changing] procedures to reflect the changes makes a lot of sense.”)

Anne Small -- SEC General Counsel

Anne Small — SEC General Counsel

When all of the dust settles on the Appointments Clause and other Article II constitutional challenges to these administrative courts, we will still be left with what every practicing securities litigator knows are vastly diminished due process rights in the SEC’s administrative courts as compared to the federal courts.  Judge Berman certainly seemed concerned about this in his opinion.  He said: “during the September 16, 2015 hearing, the SEC argued that administrative proceedings would serve the public interest because ‘it is a much faster process and it expedites the consideration and the determination of whether the underlying security violations had actually occurred and, more importantly, to impose the kind of remedy that would then help to prevent future harm.’. . .  The Court responded that ‘faster is [not] necessarily better because faster means no juries, no discovery, no declaratory relief.  In federal court you can get that . . . there’s a whole lot of protections, Ms. Duka argues, that are available in federal courts that are not available before the Commission.'”  Slip op. at 16.

If the SEC continues to be empowered to exercise effectively uncontrolled discretion over which cases are directed to the administrative courts (as a result of the expanded jurisdiction of those courts under the Dodd-Frank Act), and it continues to ignore obvious needs to modernize and balance the procedures for those proceedings to eliminate their “Star Chamber” similarities, the controversy over these actions will be unabated.

Straight Arrow

September 18, 2015

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What Is the SEC Backup Plan if It Loses the ALJ Constitutionality Issue in Court?

The saga of challenges to the constitutionality of the SEC’s administrative law proceedings — and in particular the appointments and removal protections of the administrative law judges — has played out over many months in both court and commentary.  After some early SEC victories on jurisdictional challenges, the Commission seemed content to try to fend off the court cases on such procedural grounds, and fight the merits by deciding the issue in its own favor on a petition for review of one of these proceedings (like the one now before it in the Timbervest case), with perhaps an upper hand once the case reached a federal appeals court.

If that was the early strategy, it now seems to be in need of reconsideration.  Two federal district court judges found jurisdiction over cases making such challenges in four separate cases, and ruled on preliminary injunction motions that the plaintiffs will likely succeed on the merits.  In three of those four cases, involving proceedings against Charles Hill, Gray Financial Group, and Barbara Duka, the SEC is now preliminarily enjoined from moving forward with its administrative proceedings.  (In the other, against Timbervest, the preliminary injunction was denied because the case had already been tried and was now before the SEC for review.)  See Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding; N.D. Ga. Judge Leigh May Issues Injunction for Gray Financial and Denies One for Timbervest; SDNY Court Ups the Ante, Allowing Duka Injunctive Action To Proceed on Appointments Clause Issue; Order Issuing Preliminary Injunction in Duka v. SEC.  The merits of the constitutionality issue now can no longer be dismissed as fringe advocacy.  The main issue in these cases — whether the SEC ALJs are “inferior officers” under Article II of the Constitution — has now been substantially vetted by two courts, which found they were, indeed, inferior officers under closely analogous Supreme Court decisions.  Beyond this, the SEC made embarrassing errors in court submissions about how its ALJs were appointed, and at a minimum seems incompetent at figuring out and reporting to the courts on this simple factual issue.  Indeed, even in the SEC’s own proceeding in Timbervest, the Enforcement Division refused to comply with an adjudicative order from the Commission to provide the Commissioners with a description of how the ALJs were appointed.  Whether it was because they couldn’t do so, or just didn’t want to do so, is not clear.  See SEC Bumbles Efforts To Figure Out How Its Own Administrative Law Judges Were Appointed.  In this context, the SEC itself will have difficulty writing an opinion in Timbervest upholding the constitutionality of the ALJs that would not be in significant danger of being overturned.

But the SEC continues to take a “business as usual” approach in its administrative court proceedings.  Many of these are ongoing, and more are assigned each day (or at least each week).  Any defense lawyer could be committing malpractice by failing to challenge a pending or new case on grounds of unconstitutionality.  Indeed, I question why the ALJs themselves don’t make clear in each such case that the constitutionality of their appointments is now at issue, and stating sua sponte that each respondent would be deemed to have challenged the proceeding on that ground, in the event the argument was ultimately upheld in the courts.

So, what happens if the SEC’s stonewalling defense posture fails; if the constitutionality challenge is ultimately upheld?  If the status quo prevails, my guess is near chaos.  To be sure, the ruling is likely to be applied prospectively, and stayed for some time to allow for some remedial steps to be taken, akin to the approach taken when the bankruptcy courts were ruled unconstitutional.  See Northern Pipeline Co. v. Marathon Pipe Line Co., 458 U.S. 50, 87-88 (1982).  But I don’t see how every case currently pending, or instituted between now and when such a decision occurs, in which such a challenge is made, would not be vacated.  See D.C. Circuit Invalidates Appointment of Former Acting GC for Labor Board (DC Circuit holds in SW General, Inc. v. NLRB, No. 1107, that NLRB action by Acting General Counsel serving unlawfully must be vacated).  That could be a lot of cases that need to be retried (or reconsidered or settled).  Perhaps the Commission is counting on the appellate courts (and the Supreme Court) to blanche at the prospect of vacating such a large number of prosecuted cases.

Even a Commission confident in its arguments needs to consider how to proceed in a way that minimizes chaos if it loses.  What could it do now to protect against that future result?  Two steps immediately come to mind.  First, at least for now, while the constitutionality issue remains in doubt, reverse its new policy of bringing more of its complex cases in the administrative court and go back to the model in which those cases were brought in federal court.  To save face, this need not be announced; it can be effected sub silentio.  The Commission seems to prefer secrecy over sunshine, although a little more open discussion of how it approaches these issues would probably do a lot more good than harm.  An open statement of this discretionary decision would evidence more good faith than we’ve seen over the past year.  Second, obtain a waiver of the constitutionality issue from fully informed respondents before commencing new proceedings, or continuing pending proceedings.  I haven’t researched the issue, but my bet is that the SEC and an opposing party can, by mutual consent, agree to any forum to resolve cases, and a fortiori, an agreement to use the administrative court with its current ALJs likely would be enforceable.  At a minimum, a party that agreed to proceed on this basis would likely be estopped from making a future challenge on this ground.  The SEC might have to make some concessions to get such an agreement — probably involving fairer rules for discovery and scheduling in these cases — but by now they should recognize that this might not be a bad thing.  Many respondents with limited defense resources could well prefer, and agree to, this approach.  That would take a lot of potential future vacated results off the table.

No doubt there are other steps that can be taken to avoid a potential future quagmire.  The important thing is that the Commission and its staff should be thinking about, and implementing, these kinds of steps, because, like it or not, the Commission may find itself on the losing end of the constitutional question.

Straight Arrow

August 12, 2015

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SEC Gambit To Avoid Judge May in Timbervest Case Seems To Have Failed

We previously wrote about the SEC’s desperate effort to avoid the assignment of Timbervest, LLC v. SEC, Civil Action No. 1:15-CV-2106 (N.D. Ga.), to District Judge Leigh Martin May.  See SEC, Desperate To Avoid Judge May, Challenges Related Case Designation in Timbervest Action and SEC Argues Common “Facts” Are Not Common “Issues of Fact” — I Kid You Not.  You recall that Judge May ruled in Hill v. SEC that the appointment of SEC ALJ James Grimes violated the appointments clause of Article II of the Constitution — see Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding.

Well, it appears that the SEC’s motion challenging the “related case” assignment of the Timbervest action to Judge May failed.  There is no order in the docket denying the motion, but a recent scheduling order issued by Judge May suggests she will continue to preside over the case.  See Timbervest v. SEC Scheduling Order.  In the Order, Judge May states that the SEC must respond to plaintiffs’ Motion for a Temporary Restraining Order and/or Preliminary Injunction by June 29, plaintiffs must file a reply brief by July 16, and “the parties will attend a hearing in this matter a hearing” on July 21, in Courtroom 2107.  Courtroom 2107 is listed in the N.D. Georgia directory as Judge May’s courtroom.

In the meantime, in the SEC administrative case brought against Gray Financial Group, In the Matter of Gray Financial Group, Inc. et al., File No. 3-16554, SEC ALJ Cameron Elliot declined to issue a stay of proceedings in response to an unopposed motion founded on the pending federal action for injunctive relief by Gray Financial in the same Georgia federal court, which was also assigned to Judge May.  He said: “Commission Rule of Practice 161 instructs that I ‘should adhere to a policy of strongly disfavoring’ stay requests unless ‘the requesting party makes a strong showing that the denial of the request or motion would substantially prejudice their case.’  17 C.F.R. § 201.161(b)(1).  Respondents have not made such a showing.  I will abide by an injunction if it is issued; however, as of now I have been instructed to resolve this proceeding within 300 days of service of the OIP.”  See Order Denying Unopposed Motion To Stay Administrative Proceeding Against Gray Financial Group.

So, chaos still reigns, and apparently the SEC is unsure about how best to bring it under control.  See SEC Rejects Easy Answers To Admin Court Challenges.  In that article, Law 360’s Stephanie Russell-Kraft reported on a discussion between Judge Richard Berman and a DOJ lawyer representing the SEC.  Judge Berman asked whether, in light of comments by Judge May that it might be easy to cure the appointments clause violation, the similar claims brought before him by Barbara Duka (in Duka v. SEC) could be resolved simply by having the Commission reappoint its current ALJs.  The DOJ lawyer declined to address whether that could be done, leading to the following colloquy:

“Is the commission opposed to an easy fix?” Judge Berman asked.

“The Department of Justice is very actively considering the best litigation approach to address this issue,” Lin answered.

“I’m asking you if [appointing the judges] would solve this issue,” Judge Berman pressed, pointing out that the case pending before him had nothing to do with the SEC’s litigation strategy.

“It’s not like if we pursue one of these options this case or other cases will go away,” Lin answered, adding that changing the way it appoints its judges is not a “meaningful way” to address Judge May’s decisions or a “practical way” for it to approach its long-standing administrative court scheme.

“The commission has to consider all the cases it has,” she said later, to which Judge Berman replied, “I don’t.”

Meanwhile, the SEC’s administrative proceeding against Laurie Bebo continues to be tried, even while the appeal of Ms. Bebo’s injunctive action moves forward in the Seventh Circuit.

The ship is plainly adrift.

Straight Arrow

June 23, 2015

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SEC Argues Common “Facts” Are Not Common “Issues of Fact” — I Kid You Not

Yesterday, we described the SEC’s desperate attempt to nullify the assignment of the case Timbervest, LLC v. SEC to Judge Leigh Martin May.  That was based on the argument that the other cases already before Judge May identified as “related cases,” Hill v. SEC and Gray Financial Group v. SEC, were not actually “related cases” because “the cases do not ‘involve the same issue of fact,’” and they “do not arise out of the same event or transaction.”  See SEC, Desperate To Avoid Judge May, Challenges Related Case Designation in Timbervest Action.  Timbervest argued this was wrong because “they all arise out of the same facts concerning how SEC administrative law judges (‘ALJs’) are hired and what authority and powers SEC ALJs possess,” and the factual differences in the underlying SEC allegations in each case have no bearing on the constitutional issues raised in the respective complaints in these actions.

Today, the SEC filed its response.  It can be read here: SEC reply in opposition to related case designation.  It acknowledges that the cases have some common “facts” but argues that common “facts” are not common “issues of fact.”  In the SEC’s words, “At best, Plaintiffs’ argument boils down to the contention that these cases involve some of the same ‘facts,’ rather than ‘issues of fact.’”  The SEC’s argument turns on the assertion, made without citation, that an “issue of fact” must be a “dispute of fact,” and because the SEC will not dispute the common “facts” in these cases, they cannot be considered “issues of fact” because they will be undisputed.  (“their arguments ignore the distinction between a mere ‘fact’ and an ‘issue of fact,’ i.e., a dispute of fact”).  The best the SEC can do to support this view is a cite to Black’s Law Dictionary, which is quoted as saying: “An ‘issue of fact’ is ‘[a] point supported by one party’s evidence and controverted by another’s.'”  I don’t have a copy of Black’s Law Dictionary handy, but I guarantee you this purported definition had nothing to do with the assignment of cases to district court judges.

I have to chuckle.  No wonder lawyers are not often trusted by ordinary folks.  They concoct these arguments whether they make sense or not.  What ordinary person out there would think that two paragraphs with identical facts would not have the same “issues of fact”?  In any case, that doesn’t really matter here because it is patently obvious that in the context at issue here — how to assign a newly-filed case — a court (actually, a clerk of court) cannot possibly apply the standard the SEC passionately espouses because there is no way to determine at that stage which “facts” will or will not be “disputed.”  At this stage, there is only one source that can be used to assign the case — the allegations in the complaint.  If the allegations in the complaint involve factual contentions that materially overlap the facts alleged in another pending case, then the “related case” designation should be appropriate.  Last I checked, no clerk of court sought input from the defendant in an action about what factual allegations would be disputed before making a “related case” assignment.  Got a cite for that, SEC?

I wonder whether, having made this cute argument, the SEC will argue against being judicially estopped from disputing any of the facts alleged in the complaint when it files its Answer.  SEC counsel has now represented there are no material “disputed” facts, right?

I also wonder what Judge May is thinking about all of these machinations conjured up by the SEC solely to avoid having her preside over the Timbervest complaint?  If she has a sense of humor, she’ll chuckle as well, and move on to the job of deciding whether the few important facts that differ between Timbervest v. SEC and Hill v. SEC — which involve the different status of the respective administrative actions when the complaints were filed — alters the jurisdictional analysis in her Hill opinion.

Straight Arrow

June 18, 2015

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Timbervest Files Complaint and TRO Motion To Halt SEC Proceeding

Today (June 12, 2015), Timbervest, LLC filed a complaint in federal court in the Northern District of Georgia seeking a halt to its ongoing SEC administrative proceeding, In the Matter of Timbervest, LLC at al.  We have previously discussed the Timbervest SEC proceeding, including recent developments involving Timbervest’s challenge to the constitutionality of the SEC administrative process and requests for discovery into possible systemic bias within the administrative court.  See Briefing of ALJ Constitutionality Before SEC Leaves Resolution in Doubt, SEC Broadens Constitutional Inquiry into Its Own Administrative Judges in Timbervest Case, SEC “Invites” ALJ Cameron Elliot To Provide Affidavit on Conversations “Similar” to Those Described by Former ALJ, and SEC ALJ Cameron Elliot Declines To Submit Affidavit “Invited” by the Commission.

With its efforts to pursue the constitutional challenge before the SEC meeting obstacles before the Commission, Timbervest opted to seek federal court intervention, commencing an action for injunctive relief, and moving for a temporary restraining order.  Those documents can be found here: Complaint in Timbervest v. SECMemorandum in Support of Motion for TRO in Timbervest v. SEC.

Because Timbervest is located in Atlanta, it filed its complaint in the federal district court for the Northern District of Georgia.  That is the same court that days ago halted a different SEC administrative proceeding, In the Matter of Charles L. Hill, Jr., in the action Hill v. SEC.  In that case, Judge Leigh Martin May found the appointment of ALJ James Grimes violated the appointments clause of Article II of the Constitution.  See Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding. And another case filed in that same court by yet another SEC respondent, Gray Financial Group v. SEC, was just assigned to Judge May as a related case.  See Ga. Judge Who Blocked SEC Admin Suit Gets Similar Case.  The new Timbervest complaint, which is case number 1:15-cv-02106-LMM, was also assigned to Judge May.

Judge May. an Obama appointee who is only in her first year of service as a judge, was active in the Democratic party before her appointment.  An article discussing her background can be read here: The Atlanta Judge Who Stuck A Thorn In The SEC’s Side.

In the Timbervest SEC proceeding, ALJ Cameron Elliot issued an Initial Decision as to which both the respondents and the SEC staff petitioned for Commission review, which was granted.  After briefing of the issues before the Commission, and supplemental briefing addressing constitutional issues, Timbervest sought discovery after the Wall Street Journal revealed possible pressures on SEC administrative judges to favor the SEC staff.  See Fairness Concerns About Proliferation of SEC Administrative Prosecutions Documented by Wall Street Journal.  Only days ago, the Commission held oral argument on the petitions for review.  But after Judge May”s decision in the Hill case, and ALJ Elliot’s refusal to provide information about possible pressures requested by the Commissioners, Timbervest felt it had to seek relief in federal court, saying: “Plaintiffs have appealed the ALJ’s Initial Decision to the Commission, but it has become clear that the Commission should not hear these arguments.  First, the Commission itself did not properly appoint the ALJ.  Second, the Commission has argued in other cases that its administrative forum is constitutional.  Thus, Plaintiffs’ appeal to the Commission is nothing more than an exercise in futility.”  Complaint ¶ 8.

The Timbervest complaint reveals an interesting issue about the handling of its case by the SEC’s ALJs.  The case was originally assigned to Chief Administrative Law Judge Brenda Murray, but then handed over to ALJ Elliot.  (ALJ Murray is the person identified by former ALJ Lillian McEwen as having told Ms. McEwen that she “questioned her loyalty to the SEC” because she did not treat the SEC staff sufficiently favorably.)  ALJs Murray and Elliot allegedly made a critical decision preventing Timbervest from using Brady material (material tending to show the respondents were innocent):

Given the age of the case, the primary evidence presented in support of the Division’s alleged violations was the faded and inconsistent memories of two Division witnesses.  As to one of those witnesses, Plaintiffs argued that the SEC had in its possession Brady material that the Commission’s staff disagreed with and argued was inadvertently produced.  The Brady material consisted of notes of two interviews the Commission’s staff conducted with that witness.  The Plaintiffs argued that the notes were exculpatory and, at the very least, were inconsistent statements that were required to be produced.  Pursuant to the SEC’s own administrative proceeding rules, it is required to produce Brady material.  Even though the SEC conducted an investigation that lasted over three years,speaking to numerous individuals over that time, the Commission’s staff did not produce any documents or information that it identified as Brady to the Plaintiffs.  Ultimately, ALJ Elliot, as well as ALJ Murray, ruled in favor of the Commission’s staff that the notes were not Brady, even though the notes were clearly inconsistent and exculpatory.

Complaint ¶ 28.

The Timbervest complaint also revealed that the SEC staff acknowledged that “ALJ Elliot was not hired through a process involving the approval of the individual members of the Commission.”  The staff could not state how ALJ Murray was appointed because “Chief ALJ Murray began work at the agency in 1988 and information regarding hiring practices at that time is not readily available.”  Complaint ¶ 36.  At a minimum, then, if Judge May retains her view that the SEC’s administrative law judges are “inferior officers” of the Executive Branch, a finding that ALJ Elliot was improperly appointed may come soon.  The only thing that might prevent such a ruling is if Judge May concludes that because the Timbervest SEC proceeding has already gone through trial and is before the SEC on review of the Initial Decision — a different set of circumstances than she faced in the Hill case — a federal court should not take jurisdiction over the case.

The SEC’s pot is now boiling over in, of all places, Atlanta, Georgia.

Straight Arrow

June 12, 2105

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Gray Financial Group v. SEC Is SEC’s Latest Constitutional Challenge

The latest constitutional challenge to an SEC administrative enforcement proceeding was filed in the United States District Court for the Northern District of Georgia on February 19, 2015 in a case captioned Gray Financial Group, Inc. v. SEC, No. 1:15-cv-0492 (N.D. Ga.).  Gray Financial is a registered investment advisor subject to SEC regulatory oversight, and, as a result, has not been newly subjected to SEC administrative proceedings by the Dodd Frank Act’s 2010 expansion of jurisdiction of SEC administrative law judges to non-regulated persons.  As a result, the theory of the case is limited to alleged constitutional shortcomings that are unaffected by whether or not the putative respondent is an SEC-regulated entity.  In this respect, of the recent cases challenging SEC administrative enforcement actions, Gray Financial most resembles Stilwell v. SEC, previously filed the Southern District of New York.  See Stilwell v. SEC.

The complaint alleges that Gray Financial is a small investment advisory firm registered with the SEC, and in Georgia and Michigan.  It established as an investment alternative for Georgia-based pension funds, and with advice of counsel, an “alternative investment” in the form of a fund of funds.  Georgia recently adopted a new pension law permitting alternative investments by public pension funds.  The SEC commenced an investigation of whether the new fund complied with the Georgia law.  The SEC staff thereafter issued a “Wells notice” on the theory that the fund was not in compliance with the Georgia pension law.  Gray Financial contends that the Georgia law is unclear, has never been interpreted by Georgia courts, and that it acted only on the advice of experienced counsel.  Nonetheless, the SEC argued the firm intentionally violated the Georgia law and insisted on a “draconian” settlement to avoid an administrative enforcement proceeding.  A copy of the complaint is available here: Gray Financial Group v. SEC Complaint.

The complaint describes the SEC administrative proceeding process and the role of SEC ALJ’s in detail, including the insulation of the ALJ’s from removal by the SEC or the President for other than good cause.  It then lays out its constitutional argument that the SEC administrative law judges are executive officers outside of the control of the President, in violation of Article II of the Constitution:

Article II’s vesting authority requires that the principal and inferior officers of the Executive Branch be answerable to the President and not be separated from the President by attenuated chains of accountability.  Specifically, as the Supreme Court held in Free Enterprise, Article II requires that executive officers, who exercise significant executive power, not be protected from being removed by their superiors at will, when those superiors are themselves protected from being removed by the President at will.

The SEC ALJs’ removal scheme is contrary to this constitutional requirement because SEC ALJs are inferior officers for the purposes of Article II, Section 2 of the U.S. Constitution, and because:

a. SEC ALJs are protected from removal by a statutory “good cause” standard; and

b. The SEC Commissioners who are empowered to seek removal of SEC ALJs – within the constraints of the “good cause” standard – are themselves protected from removal by an “inefficiency, neglect of duty, or malfeasance in office” standard; and

c. The MSPB members who are empowered to effectuate the removal decision – again limited by a “good cause” standard – are themselves protected from removal by an “inefficiency, neglect of duty, or malfeasance in office” standard.

Under this attenuated removal scheme, “the President cannot remove an officer who enjoys more than one level of good-cause protection, even if the President determines that the officer is neglecting his duties or discharging them improperly.  That judgment is instead committed to another officer, who may or may not agree with the President’s determination, and whom the President cannot remove simply because that officer disagrees with him.  This contravenes the President’s ‘constitutional obligation to ensure the faithful execution of the laws.’”  Free Enterprise [Fund v. Pub. Co. Accounting Oversight Bd.], 130 S. Ct. at 3147 (quoting Morrison v. Olson, 487 U.S. 654, 693 (1988)).

Because the President cannot oversee SEC ALJs in accordance with Article II, SEC administrative proceedings violate the Constitution.

Complaint, ¶¶ 60-63.  The relief sought is an injunction barring an SEC administrative proceeding.

Although the complaint describes many respects in which SEC administrative proceedings are less fair to respondents than federal court actions, it does not explicitly contend that the SEC’s threatened administrative proceeding would violate due process, the equal protection clause, the Seventh Amendment right to a jury trial in civil actions, or be an arbitrary and capricious agency action under the Administrative Procedure Act.  That likely is because SEC-regulated entities like Gray Financial have long been subject to administrative enforcement actions as part of the SEC’s overall authority over regulated entities.

The merits of the Article II theory laid out in the complaint were previously discussed in the earlier post: Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit.

Straight Arrow

February 24, 2015

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