Tag Archives: Harding Advisory

SEC Wins First Skirmish on Constitutional Challenge to Chau Administrative Proceeding

On December 11, 2014, Judge Lewis Kaplan ruled that his court lacked jurisdiction to consider Wing Chau’s injunctive action to prevent an SEC administrative prosecution against him on due process and equal protection grounds.  Although the ruling was narrowly confined to the jurisdiction issue, it nevertheless was a significant victory for the Commission.

In October 2013, the SEC commenced an administrative proceeding against Chau and his firm, Harding Advisory, alleging misrepresentations in connection with the sale of collateralized debt obligations (“CDOs”) that imploded during the housing/mortgage crisis.  The allegations essentially charged that Chau and Harding misrepresented the nature of the process for selecting assets that went into the CDOs.  After seeking to work within the administrative process to get the kinds of discovery and preparation time that typically would be available if the action were brought in federal court, Chau and Harding commenced a federal action in the Southern District of New York to stop the administrative proceeding.  They asserted in their complaint (which can be reviewed here: Wing Chau v. SEC), that the SEC administrative action violated due process because it did not allow a fair defense to be developed, and denied equal protection of the law because they were singled out for administrative prosecution when similar actions against other persons were brought in federal court (and two of three were lost by the SEC).

The court had previously denied a temporary restraining order and the administrative trial went forward and was concluded.  The parties are awaiting an ALJ determination.

The threshold issue was whether such an action was permissible — whether the district court had jurisdiction to hear a claim to preempt the administrative action.  Applying the standards set forth in Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994), Judge Kaplan ruled there was no jurisdiction because (1) the plaintiffs could get meaningful judicial review in an appeal of the administrative action, (2) the claimed constitutional violations were not wholly collateral to the issues to be decided in the administrative action, and (3) the consideration of due process and equal protection claims were not outside of the SEC’s “expertise.”  A copy of the opinion can be found here: Chau v SEC Opinion.

The court found it significant that the due process claim “has been that the SEC’s procedural rules . . . are unfair in light of ‘facts and circumstances of [their] case'” and not that “the SEC’s rules are unconstitutional in every instance.”  Slip op. at 18-19.  The numerous grounds asserted to show that the respondents had been prevented from presenting a fair defense did not provide jurisdiction because they “all . . . are inextricably intertwined with [the] ongoing administrative proceeding and can be reviewed by a court of appeals.”  Id. at 20.  And because the challenges involve the day-to-day conduct of the proceeding, the due process arguments are not “wholly collateral” to the proceeding under Thunder Basin.  Id.  Finally, “plaintiffs fail to articulate any convincing reason why the SEC lacks the competence to consider the fairness of proceedings before its ALJs.”  Id. at 22.  The issue is the fairness of a particular hearing, not a determination that one of the SEC’s “constituent parts is unconstitutional,” and the “SEC is well equipped to evaluate claims of unfairness in proceedings before its ALJs — and if it fails to do so, the courts of appeals stand ready to correct the error.”  Id. at 22-23.

The equal protection claim yielded the same result.  Although a sister court found jurisdiction for such a claim in Gupta v. SEC, 796 F. Supp.2d 503 (S.D.N.Y. 2011), Judge Kaplan was not convinced to follow that decision.  He found the Gupta allegations of discriminatory conduct stronger, but also did “not find Gupta‘s application fo the Thunder Basin factors persuasive in these circumstances.”  Slip op. at 25.  In essence, he disagrees with the reasoning in Gupta and relied on modestly different facts to rule the other way.  He again also found no basis to conclude that the equal protection claim is outside of the SEC’s “expertise.”  But he did so with a circular argument.  He acknowledged that adjudicating such claims “is ‘not peculiarly within the SEC’s competence,'” but without addressing why equal protection analysis was within the SEC’s competence, stated that the SEC’s attempt to address the equal protection issues in an attempted interlocutory appeal from an ALJ decision “indicate that the SEC is competent to consider plaintiff’s constitutional claims.”  Id. at 31-32. 

At the end of the opinion, the judge noted that plaintiffs’ challenge “[t]aken to its logical conclusion . . . would upend all manner of administrative enforcement schemes.”  Id. at 32. He concluded that because “the normal channels of statutory review are adequate” his court lacked subject matter jurisdiction.

In an epilogue, Judge Kaplan took note that “the growth of administrative adjudication, especially in preference to adjudication by Article III courts and perhaps particularly in the field of securities regulation, troubles some.”  Id. at 34.  He singled out concerns that this approach could “increase the role of the Commission in interpreting the securities laws to the detriment or exclusion of the long standing interpretive role of the courts.”  This is a concern that has been raised by federal district judge Jed Rakoff (see here).  He also mentions concern that such SEC determinations might be accorded “broad Chevron deference to SEC interpretations of the securities laws in the determination of administrative proceedings.”  Id. at 34-35.  Concern about the proper scope of Chevron deference to SEC statutory interpretations was noted recently by Justice Scalia (see here).

Judge Kaplan said “[t]hese concerns are legitimate, whether born of self-interest or of a personal assessment of whether the public interest would be served best by preserving the important interpretative role of Article III courts in construing the securities laws – a role courts have performed since 1933.”  “But they do not affect the result in this case. . . .  This Court’s role is a modest one” — to determine subject matter jurisdiction.  Id. at 35.  In reaching its conclusion, the court “has not considered any views concerning the proper or wise allocation of interpretive functions between the Commission and the courts,” which “are policy matters committed to the legislative and executive branches of government.”  Id. at 35-36.

The takeaway from this decision is limited.  Although the jurisdictional issue required some consideration of the merits of the constitutional claims, the due process and equal protection concerns raised by Chau and Harding plainly were left for another forum to decide.  The very different constitutional issues raised by the plaintiffs in Stilwell v. SEC and Peixoto v. SEC (see here), were not mentioned.  As to those cases, even as to subject matter jurisdiction the analysis would have to be very different because, unlike Chau, they do involve a fundamental challenge to the structure of SEC administrative proceedings, i.e., they do require a determination whether one of the SEC’s “constituent parts is unconstitutional.”  It would be difficult to argue that the structural issues raised about SEC administrative law judges in Stilwell and Peixoto are even arguably within the competence of the SEC to decide for itself.  (For an in depth discussion of the merits of those issues, see here.)

But there remains no doubt that this is an SEC victory that, at a minimum, delays consideration of some aspects of the propriety of shifting SEC enforcement actions to its own administrative courts (see posts on this issue here and here).

Straight Arrow

December 15, 2014

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Michael Lewis Saved from Paying the Piper for False Portrayal in “The Big Short”

By virtue of a poorly reasoned opinion from Second Circuit Judge Richard Wesley, author Michael Lewis narrowly escaped answering to a jury for blatantly inaccurate and unfair descriptions of CDO manager Wing Chau in Lewis’s apocryphal book, The Big Short.  On November 14, 2014, a majority of the three-judge panel in Chau v. Lewis, No. 13-1217, affirmed a district court grant of summary judgment to Lewis on Chau’s claims that descriptions of him in The Big Short were libelous.  Although the majority’s ruling for Lewis was hardly a vindication – it acknowledged the falsity of Lewis’s statements but merely inoculated them against liability in a libel action – it also reflected a myopic elevation of legal nicety over the real world.  A copy of the majority opinion can be found here: Chau v. Lewis 2d Circuit Opinion (Opinion”) .

Courtesy Lucas Jackson/Reuters

Michael Lewis (Courtesy Lucas Jackson/Reuters)

Senior Judge Ralph Winter, a dean of the 2d Circuit bench and author of many securities law opinions over the years, tried to restrain himself, but could not avoid a satiric tinge in a dissenting opinion lambasting the majority for using trees to obscure the forest, even while claiming they were deciding the case based on “the context of the publication as a whole, not just the paragraph or chapter containing them.” Opinion, slip op. at 14.  A copy of Judge Winter’s dissent can be found here: Chau v. Lewis 2d Circuit Dissent (“Dissent”).  Perhaps the great disappointment was that Senior Judge Amalya Kearse, who is highly respected, joined in Judge Wesley’s weak effort.

For those who may be interested in looking at what the lawyers of Chau and Lewis had to say on appeal, copies of their briefs filed in redacted form (to omit the most juicy stuff) can be found here (Appellant Brief in Chau v Lewis) and here (Appellee Brief in Chau v Lewis).

The case originated in Lewis’s blockbuster work of purported non-fiction about the underpinnings of the 2007-2008 financial crisis in the massive market of mortgage-backed securities offerings, and in particular collateralized debt obligations built on subprime mortgages.  Lewis’s book was on the New York Times bestseller list for 28 weeks, but over time has been shown to be far from accurate in key respects.  Nevertheless, as is the way of the world nowadays, the book created impressions that last and are taken as fact, regardless of its degree of accuracy or inaccuracy.  The district court record in Chau v. Lewis includes an expert report from a Northwestern University Medill School of Journalism professor stating: ““Lewis’ methodology in researching, drafting, and fact-checking The Big Short fell far below the standard required by this profession.”  Lewis chose not to have an expert defend his work.  Revelations about Lewis’s factual sloppiness (to be kind) in The Big Short do not bode well for verity-checks of Lewis’s new tabloid-like charges in Flash Boys that the stock market is “rigged” for the benefit of high frequency traders. 

Wing Chau’s company Harding Advisory LLC served as collateral manager for many CDO offerings.  Lewis dwelled in particular on an attack on Wing Chau in Chapter 6 of the book, entitled Spider-Man at the Venetian.  Relying on a report from co-defendant Steven Eisman of a supposed conversation between Chau and Eisman at a dinner in Las Vegas, Lewis presented a no-holds-barred indictment of CDO managers in general, and Wing Chau in particular, for having fostered the origination of worthless mortgage loans which were packaged to create also-worthless CDOs, all to satisfy the wealth and greed of Wall Street, CDO managers, and Wing Chau himself.

Any person who read Chapter 6 came away from the book believing Wing Chau was an idiot, moron, fool, greedy bloodsucker, and fraudster.  That was Lewis’s plain intent and the obvious import of what he wrote.  It ruined Chau’s career, and is a picture he will never live down.  The problem is, Lewis based it on hyperbole, insidious mockery, Eisman’s questionable portrayals, and plainly false statements.  Presumably he relied on Eisman and did little in the way of independent analysis.  I don’t know what steps he took before deciding to commit Chau to a public pillory, but one thing we do know, at least if Judge Winter is reliable, is that Lewis “admits that he does not use a fact checker.”  Dissent, slip op. at 5.  No surprise there.

Judge Wesley decided that just because Lewis ridiculed and demeaned Chau professionally and personally with false statements is not an adequate reason to force him to explain to a jury why he did what he did.  Instead, Wesley wrote down the 26 nasty, snarky, and sometimes false things Lewis said (or Lewis said that Eisman said) and, one by one, explained why each one, standing alone, was not a valid basis for a libel claim.  His opinion is the definition of myopia.  It is as far as you can get from what Wesley portrayed as the correct approach, which requires examining “the context of the publication as a whole, not just the paragraph or chapter containing them.”  Opinion, slip op. at 14.  Somehow he decides that pages and pages of statements that disparaged Chau, portrayed him as a greedy profiteer who made tens of millions of dollars for doing nothing, and accused him of being a fraudster, was not libelous because each statement taken alone was either “opinion” or not sufficiently harmful to qualify as being defamatory.  How frightening that an appellate judge tucked away in his robes and life-tenured position could be so clueless.  By deciding in his view what “an average reader” would and would not view to be defamatory – a plain invasion of the province of the jury – Judge Wesley deprived Chau of his only chance to regain dignity and a future: a decision from a jury of his peers.

As Judge Winter pointed out in dissent, the opinion is just plain wrong.  Lewis used statements that were admittedly false, or in some instances could be proved to be false, to portray Chau as lawless, stupid, greedy, unethical, and immoral.  For example:

  • He wrote that Chau “spent most of his career working sleepy jobs at sleepy life insurance companies” before turning to CDO investing, to make the point that Chau lacked the skills to work as a CDO Manager.  This is now admitted to be false.
  • He said Chau invested in only “dog shit” subprime CDOs when in fact 40 percent of his CDOs were not in that category.  Faced with this, Judge Wesley lamely opined: that this was a “fine and shaded distinction[]” that would not matter to a reader.  Opinion, slip op. at 24.  That’s what juries are supposed to decide.
  • He said Chau “made it possible for tens of thousands of actual human beings to be handed money they could never afford to repay.”  There’s so much wrong with that statement it’s hard to know where to start.  Suffice it to say that there is an ample likelihood that it would be proved false at trial.
  • He said Chau “didn’t do much of anything” as a CDO manager, which almost certainly is inaccurate.
  • He said Chau was a “double agent” who “represented the interests of Wall Street bond trading desks” and not that of investors.  He surely had no facts to support that beyond Eisman’s meanderings, but its truth or falsity is certainly a jury issue.  Judge Wesley exonerates Lewis for this and some other statements because he cloaked them by referring to “CDO Managers” generally, but not Chau in particular.  Opinion, slip op. at 21.  But that is laughable, since the whole chapter is about Chau as a CDO Manager and Eisman’s purported discussion with Chau, as Judge Winter points out (Dissent, slip op. at 3).
  • He said Chau didn’t care about what his CDOs invested in because he “simply passed all the risk that the underlying home loans would default on to the big investors.”  The point is that he allegedly failed in his duties to investors because he passed on risk to others.  Another clear jury issue.
  • He said Chau served “as a new kind of front man for the Wall Street firms,” i.e., that Chau allegedly committed fraud on investors by favoring the Wall Street firms.  That could be true or false, but is again a jury issue.  Judge Wesley gave Lewis a pass on this because he viewed calling someone a “front man” for others is a matter of “opinion.”  Opinion, slip op. at 20.  Far from it.  It is an accusation that someone falsely portrayed himself as protecting investor interests when he was not doing so, in other words, that he committed mail, wire, and securities fraud.  Accusing someone of criminal conduct is not “opinion,” as Judge Winter recognized.  See Dissent, slip op. at 10 (“This description could easily serve as the opening statement in a civil or criminal fraud trial.”).
  • He said Chau took home $26 million in a single year for doing all this but “didn’t spend a lot of time worrying about what was in CDOs.”  That is patently false as to what he earned (by a factor of ten), and likely is false as to the rest.  It suggests, falsely, that Chau earned $26 million in return for betraying his duties to investors.

How an appellate judge could declare that pages of such statements were not actionable “because an ordinary person would not take the statement (albeit incorrect) in context to be sufficiently derogatory to make an actionable claim for defamation” is totally beyond comprehension.  Judge Wesley said that a statement is defamatory if it exposes an individual to, among, other things, “shame, obloquy, contumely, odium, contempt, ridicule, aversion, ostracism, degradation or disgrace.”  Opinion, slip. op. at 15 (emphasis added).  Let’s see.  Obloquy is “the condition of someone who lost the respect of other people.”  That seems pretty clear here.  Shame means “dishonor or disgrace.”  Ditto.  Ostracism — “exclusion by general consent from common privileges or social acceptance” — was actually reflected in evidence in the district court record.  Ridicule is patently apparent on the face of the publication.  Judge Wesley either didn’t read what he wrote or didn’t bother to take it seriously.  His only role was to decide whether a reasonable jury (not him) could look at the evidence and find any of those impacts on Chau, and it really seems beyond debate that the evidence would permit that.  

Judge Winter certainly thought so.  He wrote:

Michael Lewis’s book describes appellant as admitting to acts that a jury could easily find to have breached his obligations to investors in the fund that employed him and to have constituted civil or criminal fraud. . . .  [T]heir conclusion that certain statements are not defamatory is reached only by evaluating those statements in hermetic isolation from the context in which they were made.  They conclude that certain statements can have only a single and non-defamatory meaning even where the book clearly conveyed a different and defamatory meaning that was adopted by the book’s readership. . . .

*          *          *

 A trier of fact could easily find the following.

. . .  Appellant is portrayed as lining his own pockets and foisting doomed-to-fail portfolios upon investors.  Although he was paid to monitor the amount of risk in the fund’s portfolio, he worried only about volume because he was paid by volume.  And, knowing that the default rate of residential mortgages was sufficient to wipe out the fund’s holdings, appellant sold all his interests in the fund, passing all the risk to the fund’s investors, who believed he was monitoring that risk. The portrayal of the appellant is particularly graphic because it purports to show his state of mind and his actions out of his own mouth. . . .

 The book’s author admits that he does not use a fact checker, and much of what the book says about the appellant is known even now (before a trial) as false. . . .  These falsehoods provide the scenic background for the portrayal of the appellant as engaging in conduct that a trier of fact could find amounted to fraud in order to line appellant’s own pockets.  This portrayal can be described as non-defamatory only by declining to view it as a whole; by taking some of the statements and quotations entirely out of the context in which they were made; by finding that some statements have only a single and non-defamatory meaning when the book clearly intended a different and defamatory meaning, one adopted by readers, or so a trier could find; and by labeling some statements as opinion without regard to the facts that they imply.

Dissent, slip op. at 1, 3-4, 5-6.

Perhaps Judge Wesley’s willingness to give short shrift to the allegations of defamation here derive from an excessive willingness to see people in the financial business as acceptable targets of ridicule, hyperbole, and false accusations simply because they are involved in a big money business.  Remember, Wing Chau was not a public figure when Lewis savaged him; he was just a bit player in the huge financial markets.  Let’s do a little fictional mind experiment.  Imagine a self-absorbed author decided to try to make money writing a book sensationalizing sordid legal practices in upstate New York (I know this is far-fetched, but stick with me).  As part of this book, he decided to personalize the charges by including accusations he heard about a lawyer who practiced in a well-known firm in Rochester and then became a partner in a small firm outside of Rochester with a varied practice.  He accused all upstate lawyers of breaching fiduciary duties and used this lawyer as a poster child.  Without doing any fact-checking, he accused the lawyer of breaching fiduciary duties to his clients in order make big bucks by knowingly ignoring his clients’ needs.  The accusations were false.  The lawyer didn’t make such big bucks and didn’t ignore his clients’ needs.  The lawyer tried to save his reputation but was stymied when a judge said he hadn’t actually been defamed.  As a result he was unable to continue work as a lawyer, could not become elected an assemblyman, could not be elected to serve as a judge, and could never get appointed to the federal bench.  Instead, he got hauled before the Bar on charges that he violated the law (as Wing Chau has been hauled before an SEC administrative law court).  I have little doubt Judge Wesley would not look so skeptically at the claims that the lawyer was injured by a defamatory publication.

Judge Wesley’s error was to diminish the significance of the accusations made against Chau while showing excessive deference to allowing false publications, in an effort support “the free exchange of ideas and viewpoints.”  Opinion, slip op. at 27.  But Lewis wasn’t doing that.  He set out to make money on sensational “non-fiction” revelations.  Wing Chau became a vehicle for doing this — an exemplar villain of the financial markets who met face-to-face with Lewis’s faux anti-hero, Eisman.  Lewis skillfully went about crucifying Chau based on false accusations to promote Lewis’s own personal benefit, and should sit in the dock and face the music for doing so.  The majority opinion disingenuously diminishes the substance of what happened here.  This involves more than “simple slights” or “wound[ing] one’s pride.”  Id.  What Chau suffered is a lot more than “hurt feelings.”  Id.  He is professionally disgraced; his ability to support himself and his family is shattered.  That the court deprives him of his chance to stand up for his name and dignity is an affront to the legal process.

Michael Lewis is the villain here, and Judges Wesley and Kearse are accessories after the fact.

 Straight Arrow

November 17, 2014

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