Tag Archives: In re Bebo

Some SEC Administrative Law Judges Are Thoughtful and Even Judicious

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Straight Arrow

April 14, 2015

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SEC ALJ in Bebo Case Refuses To Consider Constitutional Challenge and Denies More Time To Prepare Defense

SEC Administrative Law Judge Cameron Elliot continued his run of decisions against respondent Laurie Bebo with two orders issued April 7, 2015.  The approach reflected in these decisions reinforces the view that his court is not serving as a fair forum for Ms. Bebo.  See Bebo Case Continues To Show Why SEC Administrative Proceeding Home Advantage Is Unfair.

In one ruling, he refused to consider major motion papers filed on behalf of Ms. Bebo challenging the constitutionality of the administrative proceeding because he decided that should be considered a “motion for summary disposition,” and, as such, was filed out of time, and would not be considered.  See Order on Respondent’s Motion for Declaratory and Injunctive Relief for Constitutional Violations and Request for Leave To File Overlength Motion

In the second, he rejected a request for an extension of time before the administrative trial commences (it is scheduled to start in fewer than two weeks), holding that “the  proceeding is neither unusually complex nor is the investigative file particularly large, and granting the requested relief would jeopardize my ability to complete the proceeding under the timeline” set by the SEC in its order initiating the proceeding.  See Order Denying Renewed Motion for Relief from Rule 360(a)(2) Presumptive Hearing Schedule.

These orders ooze parochialism and tunnel vision, again showing the administrative forum is no place for enforcement actions of this magnitude.

The refusal to consider the constitutional issue on a procedural ground seems bizarre.  If Mr. Elliot were on the basketball court, he would be one of those players desperately trying to avoid taking the clutch shot.  Mr. Elliot knows this is a key issue of some notoriety, and knows that the world is watching how he conducts his proceeding, but insisted on focusing on minutiae.  He certainly had the discretion to consider the motion.  Declining to do so using the crutch of a procedural time-limit, and with the lame statement that the “arguments may be renewed post-hearing,” shows the world that he is just not ready for prime time.  He must know that if there is a constitutional violation, he exacerbates it by requiring that the respondent go through the trial before even considering the issue.

Mr. Elliot showed his true colors, however, by trying to have it both ways, when he opted to comment on one of the points in Ms. Bebo’s submission even while declining to consider it.  He wrote a long footnote arguing that one of the (minor) grounds for considering SEC administrative law judges to be “inferior officers” for constitutional purposes — because they “can issue final decisions under certain circumstances” — is wrong, because even if the ALJ’s order does not get reviewed the SEC must issue an order that makes it final.  Whether he’s right or wrong on this point, it is peculiar that he should choose to give an advisory view on this lesser issue while declining to consider the broader constitutional arguments.

A quality judge would approach the constitutionality issue head on, knowing he will have to do so eventually anyway, and by doing so at the outset, substantial resources could be conserved.  Indeed, any judge worth his salt would look forward to doing so.  But, of course, we know (and so does he) that Mr. Elliot will not give serious consideration to the arguments (that is above his pay-grade), and he is conflicted on the issue to boot (his own job could be at stake).  That’s one reason why the Wisconsin federal court presented with these arguments ruled the wrong way when it found no jurisdiction to hear the challenge.  See Court Dismisses “Compelling and Meritorious” Bebo Constitutional Claims Solely on Jurisdictional Grounds.

The ruling declining to delay the commencement of the trial to allow the defense more time to prepare is yet another example why enforcement proceedings of this type simply don’t belong in the administrative forum.  Mr. Elliot was more focused on meeting the SEC-mandated schedule than whether Ms. Bebo can adequately prepare to defend a case that will determine her future ability to be an executive or director in a public company.  This is a major, life-changing, proceeding for Ms. Bebo, but Mr. Elliot gives no hint that he recognizes that.  His reason for denying the motion focused on administrative precedent that showed he had the discretion to reject it (but not how he should exercise that discretion), and his deferral to the SEC (“in setting the time frame for the case, the Commission has already considered the complexity of the case”).  A real judge would balance the prejudice to either side from granting the relief — which Mr. Elliot strangely does need even address — and almost certainly conclude that in light of the stakes for Ms. Bebo, the much longer period the SEC staff has had to learn the record and prepare its case, and the negligible prejudice to the SEC from a delay, a modest extension was warranted.

Make no mistake.  Cameron Elliot is a homer, which does not bode well for Ms. Bebo.

Straight Arrow

April 8, 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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Court Dismisses “Compelling and Meritorious” Bebo Constitutional Claims Solely on Jurisdictional Grounds

On March 3, 2015, Eastern District of Wisconsin District Judge Rudolph Randa dismissed the action brought by Laurie Bebo, former CEO of Assisted Living Concepts, Inc., to enjoin the SEC’s administrative enforcement proceeding against her.  The opinion is available here: Order Dismissing Complaint in Bebo v. SEC.  We previously discussed Ms. Bebo’s complaint here: New Challenge to the Constitutionality of an SEC Administrative Proceeding Filed in Bebo v. SEC, and followed up with discussions of the merits of her claims here (In re Bebo Shows Why SEC Administrative Proceedings Have Fairness Issues) and here (SEC ALJ Cameron Elliot Shows Why In re Bebo Should Be in Federal Court).

The judge found that even if Ms. Bebo’s arguments have merit, she is required to defend the administrative action in the SEC’s administrative law court, present her arguments there, and if needed, seek review by the SEC itself, and ultimately by a federal court of appeals.  Judge Renda thus adopted the same approach as SDNY Judge Lewis Kaplan in Chau v. SEC, which is discussed here: SEC Wins First Skirmish on Constitutional Challenge to Chau Administrative Proceeding.  Judge Kaplan’s decision is now on appeal to the Second Circuit court of appeals.

Judge Randa concluded he was jurisdictionally bound to reject the Bebo action, but he didn’t stand totally mute.  He started out his opinion by saying: “The Court finds that Bebo’s claims are compelling and meritorious, but whether that view is correct cannot be resolved here.”  Slip op. at 3.  But, after whetting our appetite with that comment, he proceeded to explain why he believed Ms. Bebo is required to submit to the entire administrative enforcement process and make her arguments there, rather than seeking immediate intervention by a federal court.  He noted that the Securities Exchange Act of 1934 provides that “a ‘person aggrieved’ by a final SEC order ‘may obtain review of the order in the United States Court of Appeals for the circuit in which he resides or has his principal place of business'” (quoting 15 U.S.C. § 78y(a)(1)), and that such provisions “’generally preclude de novo review in the district courts, requiring litigants to bring challenges ‘in the Court of Appeals or not at all.’’”  Id. at 3-4 (quoting Altman v. SEC, 687 F.3d 44, 45-46 (2d Cir. 2012)).  Although the Supreme Court, in Free Enterprise Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477 (2010), found that a district court could properly exercise jurisdiction over an injunctive action to address the allegedly unconstitutional proceeding in that case, that did not apply here because in Free Enterprise Fund, no proceeding had yet commenced when the action was brought in federal court.  Slip op. at 5-6.  The judge also found that Ms. Bebo could make an adequate record during the administrative proceeding to allow a court of appeals a sufficient basis for considering her grounds for challenging the proceeding.  Id. at 6-9.

Judge Randa concluded by quoting Judge Kaplan’s decision in the Chau case:

Ultimately, Bebo’s argument regarding the lack of meaningful judicial review lies in her objection to being subject to a procedure that she contends is wholly unconstitutional.  But as one judge observed, district court jurisdiction “is not an escape hatch for litigants to delay or derail an administrative action when statutory channels of review are entirely adequate.”  Chau v. SEC, No. 14-cv-1903 (LAK), — F. Supp. 3d —-, 2014 WL 6984236, at *6 (S.D.N.Y. Dec. 11, 2014).  If the process is constitutionally defective, Bebo can obtain relief before the Commission, if not the court of appeals.  See, e.g., Landry v. F.D.I.C., 204 F.3d 1125 (D.C. Cir. 2000) (addressing Article II challenge to FDIC’s method of appointing ALJs on appeal from a final FDIC Order).  Until then, Bebo must “patiently await the denouement of proceedings within the Article II branch.” USAA Fed. Sav. Bank v. McLaughlin, 849 F.2d 1505, 1510 (D.C. Cir. 1988).

If other district courts hearing challenges to pending or threatened SEC administrative proceedings follow the same path as Judges Kaplan and Randa, it will take awhile to get any reasoned judicial analysis of the validity of the SEC’s expanded use of its administrative courts to impose sanctions under the 2010 authority provided in the Dodd Frank Act.  At this point, all we have is Judge Randa’s teasing dicta “that Bebo’s claims are compelling and meritorious.”

In the meantime, our own discussion of some of the issues raised by Ms. Bebo, and other cases challenging the constitutionality of the SEC administrative proceedings under the standard laid out in Free Enterprise Fund, can be found here: Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit.

Straight Arrow

March 4, 2015

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SEC ALJ Cameron Elliot Shows Why In re Bebo Should Be in Federal Court

The administrative enforcement action brought by the SEC against Laurie Bebo, the former CEO of Assisted Living Concepts, Inc. (“ALC”) is serving as a case study showing why it is highly improper to use the administrative forum to prosecute serious fraud claims against individuals or entities not subject to SEC regulatory authority.  We previously discussed elements of unfairness in this proceeding in our post In re Bebo Shows Why SEC Administrative Proceedings Have Fairness Issues.  A new ruling by the administrative law judge in that case shows once again how the administrative forum tilts the field significantly (and unfairly) in favor of the SEC in comparison to federal courts, to the point that due process of law is threatened.

The SEC filed a motion in limine to allow it to introduce a broad range of hearsay evidence: 16 sworn declarations and three deposition transcripts.  By all appearances, none of these documents would be admissible as evidence in federal court because there is no apparent exception to the hearsay rule that would allow the SEC to avoid live testimony, subject to live cross-examination.  Ms. Bebo opposed the motion.  Administrative Law Judge Cameron Elliot ruled that the evidence would be admitted under a provision of the SEC Rules of Practice allowing an ALJ to admit into evidence the prior sworn statement of a witness, other than a party, if “it would be desirable, in the interests of justice, to allow the prior sworn statement to be used.” SEC Rule 235(a)(5), 17 C.F.R. § 201.235(a).  This notwithstanding the fact that the Rules of Practice state: a “presumption that witnesses will testify orally in an open hearing.”  ALJ Elliot’s order can be read here: In re Bebo Ruling on Introduction of Hearsay Evidence.

ALJ Elliot apparently thought it was important that Ms. Bebo did not “dispute the truth of the Declarants’ statements or of the Deponents’ testimony.”  Yet, he accepted that counsel for Ms. Bebo “did not participate in any interviews of the Declarants, and so far has been able to speak to only one Declarant.”  In other words, in the ALJ’s view, Ms. Bebo was saddled with the extreme burden of disputing the truth of statements without ever having access to the declarants, which seems bizarre.  Since the “truth” of statements is heavily dependent on context and possible equivocation, it is a near-impossible burden to challenge “truth” without access to context.

Keep in mind that this is not just a private party drafting an affidavit and asking another person to sign.  It is the Government telling people who may have law enforcement exposure themselves that it would like them to sign a document, and perhaps making statements or representations about the case to encourage them to do so.  Most folks will do what they can to keep the Government off their backs.

The end result is that statements of many witnesses are now coming into evidence even though the respondent has had no opportunity to develop an understanding of what those witnesses said, and may say, outside of the four corners of declarations carefully drafted by SEC lawyers.  Moreover, because deposition discovery is not generally available in these administrative proceedings, Ms. Bebo’s counsel is placed in the impossible situation of deciding whether to call these witnesses into court to examine them without having any understanding of what they may say, or of ways in which the SEC-drafted declarations could be misleading or deceptive because of important omissions.

This could never happen in federal court. The SEC would have to identify these people as potential witnesses and they could be noticed for depositions.  Those depositions might show that what the witnesses have to say is not as clear-cut as the SEC contends – or may even vary significantly from what the SEC says.  In all likelihood, the SEC would have to decide whether to bring these witnesses into court to testify, and to take the risk that their proffered witnesses would provide unhelpful testimony in response to non-leading questions and the right of cross-examination.  Even if the SEC were permitted to introduce such declarations into evidence – which is highly unlikely – the defense would be in a position, based on pretrial discovery, to decide which should be brought in as live witnesses. In short, the advantage to the SEC created by ALJ Elliot’s ruling allowing SEC-drafted declarations as evidence in this case is palpable.

ALJ Elliot blithely ignores these issues, notwithstanding that even under SEC Rules of Practice that are less demanding than the Federal Rules of Evidence, he is obligated to allow this to occur only if “it would be desirable, in the interests of justice.”  There is precious little discussion in his opinion of how justice is served by putting the respondent behind the 8-ball with respect to 16 witnesses by allowing into evidence hand-crafted statements by SEC lawyers signed by people who need never appear in court.  (Is the ALJ truly ignorant of how these declarations are typically crafted to leave out things that may be helpful to the opposition?)  ALJ Elliot simply takes no cognizance of the burden this imposes on the defense, and the near-impossibility of overcoming that burden without full, fair, and open discovery in advance of trial.  He merely says that “it will not be unreasonable or unduly burdensome to place on Bebo the burden of calling the Deponents as witnesses,” and it is not “a violation of due process to admit undisputed hearsay.”  But why does it serve the interests of justice to impose this burden and to admit this evidence? It is the SEC’s burden to show this, and the ALJ’s duty to make appropriate findings in support of his order, but, incredibly, the ALJ appears to proceed based on the presumption that easing the burden on the SEC at the expense of the respondent is what justice is about.

SEC administrative law judges are used to a regime in which they let the SEC enforcement lawyers cut procedural and evidentiary corners in administrative actions involving respondents associated with SEC-regulated entities.  But after the new expansion of ALJ jurisdiction under Dodd-Frank, they are hearing prosecutions of non-regulated persons that often will involve “nuclear” punishments, like lifetime bars from ever serving as an officer or director of any public company.  In such cases, they have to learn that justice requires a less “loosey-goosey” approach to adjudicating the claims before them.  When a person’s future ability to earn a living and support his or her family is at stake, that person is entitled to considerations of “the interests of justice” that take account of the stakes in the case.  ALJ Elliot doesn’t seem to get that; he’s acting as if he’s hearing just another charge against a delinquent broker.  The common practice of giving the SEC lawyers the home-court advantage in cases against regulated persons is wrong, and should be stopped.  But using those flawed standards in the new higher-profile cases the ALJ’s are now hearing amplifies the problem to the point that due process is threatened.

If ALJ Elliot were focused on fairness and justice, which seems not to be the case, he would have told the SEC: if a witness’s evidence is important to your case but you want to avoid in-court testimony, you should take a deposition that allows full cross-examination by the opponent, and then make your motion to allow portions of the out-of-court deposition into evidence, to which the opponent could respond with fair knowledge about what the witness has to say on the issue.  By shifting the burden to Ms. Bebo of showing injustice from the admission of SEC-drafted declarations, ALJ Elliot tilted the playing field against Ms. Bebo, violated the SEC Rules of Practice, and, in my view, violated due process of law.  None of this, of course, could happen if the SEC brought its case in federal court, where it should be.

Straight Arrow

February 9, 2015

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In re Bebo Shows Why SEC Administrative Proceedings Have Fairness Issues

We previously discussed the challenge brought by Laurie Bebo, the former CEO of Assisted Living Concepts, Inc. (“ALC”), against an SEC administrative enforcement action brought against her: New Challenge to the Constitutionality of an SEC Administrative Proceeding Filed in Bebo v. SEC.  We now provide an example of why SEC procedures create at least the appearance of bias, and likely more than that, in these proceedings.

You see, the SEC Commissioners have already entered into a settlement with Bebo’s co-respondent, John Buono, who was the CFO of ALC who reported to Ms. Bebo.  As is typical in these administrative cases, the settlement agreement results in a filing in which the SEC literally makes “findings” consented to by the settling respondent, laying out what supposedly happened and why it was unlawful.  Indeed, the document issued by the SEC is an “Order Making Findings and Imposing Remedial Sanctions.”  See the Order just issued in the case captioned In the Matter of Laurie Bebo and John Buono, CPA here: In re Bebo and Buono Administrative Findings.  The Order says that it is “not binding on any other person or entity in this or any other proceeding,” but it also plainly is, and is intended to be, “findings” of the Commission justifying the “remedies” — actually penalties — it imposes.

Laurie Bebo

Laurie Bebo

John Buono

John Buono

Here, the Order presents 54 paragraphs of detailed factual “findings” and another six paragraphs laying out multiple violations of law “found” by the Commission against Mr. Buono.  The Order says that the Commission has already “found” that Mr. Buono “willfully violated” section 10(b) of the Securities Exchange Act of 1934 (the “1934 Act”) and Rule 10b-5 thereunder, “willfully aided and abetted and caused” violations by ALC of section 13(a) of the 1934 Act and rules thereunder, “willfully violated” SEC Rule 13a-14, “willfully violated” section 13(b)(5) of the 1934 Act, “willfully violated” SEC Rules 13b2-1 and 13b2-2,  and “willfully aided and abetted and caused” ALC’s violations of sections 13(b)(2)(A) and 13(b)(2)(B) of the 1934 Act.

The fact that these are “findings,” and not “allegations,” which is what the SEC files in federal court cases, is no mere accident.  It is a long-standing practice for administrative settlements.  The difference is meaningful in some areas.  For example, the existence of “findings” of violations by the SEC creates potential insurance coverage or licensing issues that “allegations” do not.  As a result, in some cases settling parties would prefer to settle a case based on allegations in federal court than accept an administrative settlement based on SEC “findings.”

The Commission also imposed severe penalties on Mr. Buono, including permanent bars against him ever serving as an officer or director of a public company, or ever practicing accounting before the Commission (i.e., taking an accounting job with any public company), plus a $100,000 penalty.  It thus has already concluded that its “findings” warrant those draconian penalties.  (For a 51-year-old professional, likely supporting a family, who has just been effectively barred from the employment for which he is most suited, there is no doubt these are severe penalties.)

Now, Ms. Bebo is being forced to appear at trial before an administrative law judge who reports to the Commission that made these “findings.”  And once that administrative judge issues a ruling, Ms. Bebo’s only path of appeal goes through the very same Commission that made “findings” of illegality by her colleague and imposed severe penalties on that basis.  (Only after the SEC adjudicates a challenge to the ALJ decision is there an appeal to a federal appellate court, and that appeal requires that court to treat SEC findings with deference.)  The Buono findings are not “binding” on Ms. Bebo or the Commission in  her case, but the notion that the same people who decided the case against Mr. Buono as they did will ultimately hear the case being litigated by Ms. Bebo strikes at the heart of fundamental concepts of fairness.  Does anyone want to take odds that the SEC will not take contrary positions in Ms. Bebo’s case to the ones they already approved in Mr. Buono’s case?  Contact me and we’ll work out a bet.

The potential bias arising out of the adjudicators’ “findings” against co-respondents is just one of numerous fairness issues raised by SEC administrative proceedings that may impose severe penalties against persons unregulated by the SEC.  Some others were discussed in our previous posts: Ceresney Presents Unconvincing Defense of Increased SEC Administrative Prosecutions, and Opposition Growing to SEC’s New “Star Chamber” Administrative Prosecutions.

Straight Arrow

January 30, 2015

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