Tag Archives: injunctive relief

7th Circuit Rules for SEC, Affirming Dismissal of Bebo Case on Jurisdictional Grounds

On August 24, 2015, the Seventh Circuit handed the SEC a major victory in the ongoing battle over alleged constitutional infirmities of the SEC’s administrative judicial process.  It agreed with the lower court that Laurie Bebo’s federal court challenge to her administrative proceeding cannot be heard in the case filed by her seeking injunctive relief against an SEC administrative proceeding.  The court found that the circumstances of Bebo’s case were such that she was required to wait to present her constitutional objections before a federal appellate court on review of whatever action the SEC might ultimately take against her.  The opinion can be read here: 7th Circuit Decision in Bebo v. SEC.

The court found that the Bebo case — and presumably others like hers — was not like the PCAOB case in which the Supreme Court decided the constitutional challenge could be heard immediately, in Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477 (2010).  The court summarized: “It is ‘fairly discernible’ from the statute that Congress intended plaintiffs in Bebo’s position ‘to proceed exclusively through the statutory review scheme’ set forth in 15 U.S.C. § 78y.  See Elgin v. Dep’t of Treasury, 567 U.S. —, 132 S. Ct. 2126, 2132–33 (2012).  Although § 78y is not ‘an exclusive route to review’ for all types of constitutional challenges, the relevant factors identified by the Court in Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477, 489 (2010), do not adequately support Bebo’s attempt to skip the administrative and judicial review process here.  Although Bebo’s suit can reasonably be characterized as ‘wholly collateral’ to the statute’s review provisions and outside the scope of the agency’s expertise, a finding of preclusion does not foreclose all meaningful judicial review. . . .  And because she is already a respondent in a pending administrative proceeding, she would not have to ‘‘bet the farm … by taking the violative action’ before ‘testing the validity of the law.’’ . . .  Unlike the plaintiffs in Free Enterprise Fund, Bebo can find meaningful review of her claims under § 78y.”

The court then addressed the arguments in greater detail:

The statutory issue here is a jurisdictional one: whether the statutory judicial review process under 15 U.S.C. § 78y bars district court jurisdiction over a constitutional challenge to the SEC’s authority when the plaintiff is the respondent in a pending enforcement proceeding.  Where the statutory review scheme does not foreclose all judicial review but merely directs that judicial review occur in a particular forum, as in this case, the appropriate inquiry is whether it is “fairly discernible” from the statute that Congress intended the plaintiff “to proceed exclusively through the statutory review scheme.” Elgin v. Dep’t of Treasury, 567 U.S. —, 132 S.Ct. 2126, 2132–33 (2012). 

This inquiry is claim-specific.  To find congressional intent to limit district court jurisdiction, we must conclude that the claims at issue “are of the type Congress intended to be reviewed within th[e] statutory structure.”  Free Enterprise Fund, 561 U.S. at 489, quoting Thunder Basin Coal Co. v. Reich, 510 U.S. 200, 212 (1994).  We examine the statute’s text, structure, and purpose. . . .

. . . .  Our focus in this appeal is whether Bebo’s case is sufficiently similar to Free Enterprise Fund to allow her to bypass the ALJ and judicial review under § 78y.  Based on the Supreme Court’s further guidance in Elgin, we believe the answer is no.

. . . .

Read broadly, the jurisdictional portion of Free Enterprise Fund seems to open the door for a plaintiff to gain access to federal district courts by raising broad constitutional challenges to the authority of the agency where those challenges (1) do not depend on the truth or falsity of the agency’s factual allegations against the plaintiff and (2) the plaintiff’s claims do not implicate the agency’s expertise.  That’s how Bebo reads the case.  She argues that Free Enterprise Fund controls here because her complaint raises facial challenges to the constitutionality of the enabling statute (§ 929P(a) of Dodd-Frank) and to the structural authority of the agency itself, and the merits of those claims do not depend on the truth or falsity of the SEC’s factual claims against Bebo or implicate the agency’s expertise.  While Bebo’s position has some force, we think the Supreme Court’s more recent discussion of these issues in the Elgin case undermines the broader reading of the jurisdictional holding of Free Enterprise Fund.

. . . .

[T]he Elgin Court specifically rejected the plaintiffs’ argument, advanced by Bebo in this appeal and by the dissent in Elgin, that facial constitutional challenges automatically entitled the plaintiffs to seek judicial review in the district court. . . .

The Elgin Court also read the jurisdictional portion of Free Enterprise Fund narrowly, distinguishing it on grounds directly relevant here. . . .  [In Elgin, b]ecause the [controlling statute] provided review in the Federal Circuit, “an Article III court fully competent to adjudicate petitioners’ claims [of unconstitutionality],” the statutory scheme provided an opportunity for meaningful judicial review.

. . . .

Elgin established several key points that undermine Bebo’s effort to skip administrative adjudication and statutory judicial review here.  First, Elgin made clear that Bebo cannot
sue in district court under § 1331 merely because her claims are facial constitutional challenges.  Second, it established that jurisdiction does not turn on whether the SEC has authority to hold § 929P(a) of Dodd-Frank unconstitutional, nor does it hinge on whether Bebo’s constitutional challenges fall outside the agency’s expertise.  Third, Elgin showed that the ALJ’s and SEC’s fact-finding capacities, even if more limited than a federal district court’s, are sufficient for meaningful judicial review.  Finally, Elgin explained that the possibility that Bebo might prevail in the administrative proceeding (and thereby avoid the need to raise her constitutional claims in an Article III court) does not render the statutory review scheme inadequate.

. . . .  We think the most critical thread in the case law is the first Free Enterprise Fund factor: whether the plaintiff will be able to receive meaningful judicial review without access to the district courts.  The second and third Free Enterprise Fund factors, although relevant to that determination, are not controlling, for the Supreme Court has never said that any of them are sufficient conditions to bring suit in federal district court under § 1331.  We therefore assume for purposes of argument that Bebo’s claims are “wholly collateral” to the administrative review scheme.  Even if we give Bebo the benefit of that assumption, we think it is “fairly discernible” that Congress intended Bebo to proceed exclusively through the statutory review scheme established by § 78y because that scheme provides for meaningful judicial review in “an Article III court fully competent to adjudicate petitioners’ claims.”

. . . .

Bebo’s counter to this way of synthesizing the cases is that the administrative review scheme established by § 78y is inadequate because, by the time she is able to seek judicial review in a court of appeals, she will have already been subjected to an unconstitutional proceeding. The Supreme Court rejected this type of argument in FTC v. Standard Oil Co., 449 U.S. 232, 244 (1980), holding that the expense and disruption of defending oneself in an administrative proceeding does not automatically entitle a plaintiff to pursue judicial review in the district courts, even when those costs are “substantial.”

This point is fundamental to administrative law. Every person hoping to enjoin an ongoing administrative proceeding could make this argument, yet courts consistently require plaintiffs to use the administrative review schemes established by Congress. . . .  It is only in the exceptional cases, such as Free Enterprise Fund and McNary, where courts allow plaintiffs to avoid the statutory review schemes prescribed by Congress. This is not
such a case.

Although several courts have now reached differing conclusions on this jurisdictional issue (see In Duka v. SEC, SDNY Judge Berman Finds SEC Administrative Law Enforcement Proceedings Constitutional in a Less than Compelling Opinion, and Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding), the Seventh Circuit is the first appellate court to do so, and that alone is likely to carry weight elsewhere.  But this is also a strongly-stated opinion, which examines seriously and in depth the somewhat varying Supreme Court precedent.  The fact that the court takes on Ms. Bebo’s arguments directly and rejects them on the basis of its interpretation of the Supreme Court precedent makes it even more likely to be influential.

The D.C. and Eleventh Circuits may be the next appellate courts to consider the jurisdictional issue.  The D.C. Circuit heard argument on this jurisdictional issue in Jarkesy v. SEC, and it may issue the next appellate opinion.  See Appeals panel considers SEC’s use of in-house courts.  And the 11th Circuit has already received the SEC’s brief on appeal in Hill v. SEC, which it appealed from the preliminary injunction issued by Judge Leigh May in the Northern District of Georgia.  See SEC 11th Circuit Appeal Brief in Hill v. SEC.  Because Judge May decided her court had jurisdiction, and then went on to find a likely constitutional violation, The 11th Circuit briefs will address both the jurisdictional issue and the merits of some of the constitutional arguments.  If the 11th Circuit agrees with the 7th Circuit that there is no jurisdiction to bring these cases, however, it will vacate the preliminary injunction and not address the merits of Mr. Hill’s claim.

Depending on what these appellate courts do, and whether they concur in the 7th Circuit’s analysis, the door to injunctive relief in the federal courts for these alleged constitutional violations may slam shut.  That would focus attention on the merits of the claims in cases decided by the SEC on a petition for review from an administrative decision.  The case likely to be the first such SEC decision that could be appealed would seem to be In the Matter of Timbervest, LLC, in which the SEC is still receiving supplemental briefing addressing constitutional and discovery issues.  See SEC Broadens Constitutional Inquiry into Its Own Administrative Judges in Timbervest Case and Division of Enforcement Continues To Refuse To Comply with SEC Orders in Timbervest Case.

Stay tuned.

Straight Arrow

August 24, 2015

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Tilton v. SEC: Lynn Tilton Files Latest Challenge to SEC Administrative Proceeding

On April 1, 2015, Lynn Tilton and the private equity funds she runs filed a complaint against the SEC seeking declaratory and injunctive relief against the SEC’s pursuit of an enforcement action against them in the SEC’s captive administrative law court.  The complaint is available here: Tilton v. SEC Complaint.  The complaint follows the general formula of other actions of this nature filed recently.  Perhaps even moreso than usual, since her lawyers, Skadden Arps, were the architects of the action filed by Joseph Stilwell when he was the target of an SEC administrative enforcement action (Stilwell v. SEC).  The Stilwell action was never decided; the SEC case against Stilwell was settled (In the Matter of Joseph Stilwell and Stilwell Value LLC).  Rumor has it that the SEC was especially eager to do so to rid itself of Stilwell’s legal action in the SDNY, but we can’t attest to that.  We previously wrote that the constitutional challenges to the SEC’s administrative law court are far from frivolous in light of existing Supreme Court precedent: Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit.

The Tilton complaint does have some new tweaks, however.  It still presents the theory that the SEC ALJs do not comply with Article II of the Constitution because they are “officers” that have “double insulation” against removal by the President — they cannot be removed from office by the SEC Commissioners other than for cause, and the SEC Commissioners cannot be removed other than for cause by the President.  This is precisely what was found unconstitutional by the Supreme Court in Free Enterprise Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477 (2010).  The only dispute can be whether the SEC ALJs are “officers” within the meaning of Article II.  But the Tilton complaint adds a second theory: that “SEC ALJs have not been appointed by the SEC Commissioners, as the Constitution requires.”  That theory is based on the argument that the SEC is “a “Department” of the United States,” that “the Commissioners collectively function as the ‘Head’ of the Department with authority to appoint such ‘officers,’ but that the SEC ALJs are not, in fact, appointed by the Commissioners.  The complaint alleges that: “The Commissioners have not appointed ALJs, as constitutionally required. SEC ALJs are hired by the SEC’s Office of Administrative Law Judges, with input from the Chief Administrative Law Judge, human resource functions and the Office of Personnel Management.  In some cases, ALJs have been simply transferred to the Commission from FERC and other federal agencies.  The Commissioners themselves are not involved in the appointment of ALJs.”

The Tilton complaint is also supplemented with new allegations based on events after the Stilwell and Peixoto complaints were filed.  These include the call by Commissioner Piwowar for the adoption of standards for determining the forum to be used in SEC enforcement actions, and the inability of Enforcement Director Ceresney to identify in Congressional testimony any such standards.  And, unlike the Stilwell case, Ms. Tilton and her private equity funds are not subject to statutorily-mandated SEC regulatory control.

The actions that have been filed against the SEC to enjoin an administrative proceeding have so far run into a roadblock because federal judges have concluded that even if the complaints had merit, the requirements for injunctive relief are not satisfied because the plaintiffs can eventually get their constitutional challenges heard if they lose their administrative case and pursue an appeal to a federal court of appeals.  See SEC Wins First Skirmish on Constitutional Challenge to Chau Administrative Proceeding.  One of the judges even dismissed the claim despite finding that the “claims are compelling and meritorious.”  See Court Dismisses “Compelling and Meritorious” Bebo Constitutional Claims Solely on Jurisdictional Grounds.  These courts say that the SEC’s targets will not suffer “irreparable harm” from being forced to use the administrative process to adjudicate their constitutional challenges. That’s lawyer-speak for telling folks that they have to suffer through years of a potentially unlawful proceeding, and the expense of that proceeding, in order to get a court to decide whether it was lawful in the first place.  Not exactly a shining moment for the American judiciary, but judges are lawyers, and lawyers have, in the words of a former colleague of mine, “an instinct for the capillary.”

Ms. Tilton tries to overcome this obstacle by alleging in her complaint that there are special reasons in her case why that kind of delay would be debilitating, and therefore her case does satisfy the irreparable harm requirement.  She alleges:

The SEC’s administrative machinery does not provide a reasonable mechanism for raising or pursuing Plaintiffs’ claims.  The SEC’s Rules of Practice do not permit counterclaims against the SEC, nor do they allow the kind of discovery of the SEC personnel necessary to elicit admissible evidence of such claims, such as interrogatories and demands for admissions.  Meaningful judicial review cannot await an appeal to the U.S. Court of Appeals following a final Commission decision. The curtailed ALJ proceeding is unlikely to create a full record on Plaintiffs’ claims adequate for review in the Court of Appeals. As described in greater detail below, Plaintiffs perform a sensitive role managing investment funds and deeply distressed companies that employ tens of thousands of people.  If they are forced to undergo an unconstitutional administrative proceeding, and are found liable, it may well be too late to salvage important value for the funds.  The OIP allegations do not take issue with Ms. Tilton’s and Patriarch’s performance of their vital function in executing the investment strategy of turning around distressed businesses, and an unconstitutional administrative proceeding should not be permitted to interfere with such performance and put American jobs at risk.  The SEC ALJ is in no position to rule that he or she has been unconstitutionally appointed and has no legal authority whatsoever. And the Commission, having ordered the administrative proceeding and directed action by the SEC ALJ, is in no position to take a fresh look at the constitutional infirmities of its own ALJ program.

*          *          *

Without injunctive relief from this Court, Plaintiffs will be required to submit to an unconstitutional proceeding. This violation of a constitutional right, standing alone, constitutes an irreparable injury. The lack of traditional procedural safeguards in SEC
administrative proceedings further exacerbates that harm.

Allowing the SEC to pursue an administrative proceeding while the instant complaint is pending would require the expenditure of substantial legal fees defending against an unconstitutional action.  Moreover, plaintiffs cannot assert counterclaims or seek declaratory relief in an administrative proceeding, foreclosing any possibility of review until an appeal to a federal circuit court of appeals.  The burdens incurred during an administrative proceeding would be for naught, because such administrative proceeding is unconstitutional and the SEC likely would try to reprise its case in a lawful setting, such as federal district court.  However, forcing Plaintiffs to litigate twice would compound costs, lost time, and reputational risk….

The availability of an appeal after an administrative proceeding to a federal circuit court of appeals cannot avoid it, because the administratively-imposed sanction already may take effect – and the damage therefore already substantially and harmfully done – by the time the appellate court made a ruling.

Likewise, the harm cannot be remedied after the fact by money damages.  Various immunity doctrines substantially constrain Plaintiffs’ ability to seek damages from the SEC.  Furthermore, even if damages were procedurally available, the reputational harm to Ms. Tilton and Patriarch – possibly permanent and devastating to Ms. Tilton’s business – should the SEC impose administrative sanctions would be impossible to monetize.  And because Ms. Tilton’s business model involves debt and equity positions in private distressed companies, which positions are illiquid, accurately calculating the value of the lost ownership opportunities that would result from an unfavorable ruling in an unconstitutional administrative proceeding would be well-nigh impossible.

We will see whether this effort is successful, or perhaps whether the judge hearing the case, Judge Ronnie Abrams, has a more realistic sense of what constitutes irreparable harm in an action in which the very forum that is used to adjudicate the SEC’s claims is the subject of a constitutionality challenge, and the financial entities involved may well be defunct before judicial consideration is possible.

Straight Arrow

April 2, 2015

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SEC Gets Reasonable Relief in Life Partners Case — but only 2.5% of $2 Billion Request

On August 22, 2014, we discussed the SEC’s outrageous request for a $2 billion award of disgorgement and penalties in SEC v. Life Partners Holdings, even after getting no fraud judgment.  See SEC Again Runs Amok, Seeking $2 Billion in Texas Case.  The final judgment is now in, and Judge James Nowlin gave a thoughtful and well-reasoned package of relief of just below $50 million, only $1,950,000,000 less than the SEC argued was the proper result.  So the SEC can be 2.5% right and still cause a lot of pain.  You can read the court’s Final Judgment here: Judgment in SEC v Life Partners Holdings.

Fraud violations of section 17(a)(1) of the Securities Act of 1933 were found by the jury, but the judge set aside that portion of the verdict because the SEC’s only evidence of securities fraud involved a time period not charged in the complaint.  Judgment was issued only on the jury’s findings of reporting violations of section 13(a) of the Securities Exchange Act of 1934 and SEC Rules thereunder, but it was plain from the opinion that the judge found serious culpability at least for the individual who controlled and guided the company’s conduct.

Brian D. Pardo

R. Scott Peden

 

Individual defendants Brian Pardo and R. Scott Peden

 

 

 

Judge Nowlin gave short shrift to the testimony of the SEC’s putative “expert,” Larry Rubin, who testified that there should be a “disgorgement” remedy of $500 million, on the theory that “retail investors would have paid $500 million less than they actually did” if Life Partners used accurate life expectancy information in its disclosures.  (Life Partners is in the “life settlement” business, acquiring and reselling life insurance policies that generate payments when the insured person dies; longer life expectancies result in delays in revenue or lower resale values.)  The court wrote that it “is not satisfied that Larry Rubin’s testimony supports the SECs proposition that $500 million is a reasonable estimate of [Life Partners’] illicit gains….  [T]he task of discerning the good money from the bad — as the law requires — is exceptionally complicated in this case, and the SEC offers a meat cleaver when a scalpel is required.  Such an approach is not a reasonable means of calculating how much [Life Partners] should have to pay back.”  Slip op. at 9-10.

Judge Nowlin was forced to resort to his own analysis in an effort to do rough justice where the SEC failed to even attempt to do so.  He excoriated the defendants’ bad faith in issuing a series of false disclosures, and made an effort to distinguish between gains obtained as a result of misleading Life Partners investors, which was the subject matter of the allegations, and benefits derived from overpricing resales of policies by Life Partners, which were not securities violations.  That analysis showed that an order to disgorge $500 million would be “neither justified nor just.”  Id. at 11.

Without the benefit of any useful expert analysis, the judge came up with a disgorgement number he felt comfortable with — $15 million.  He found this was “sufficiently large — it is more than half the current market capitalization of [Life Partners] — to deter future wrongdoers,” yet he was “confident that it does not overstate the ext[e]nt of [Life Partners’ ill gotten gains.”  Id. n.5.

The judge also went through a reasonable analysis of the other forms of relief awarded.  He granted the SEC’s request for an injunction against future violations — which the SEC seeks in every case — but not before explaining in detail why injunctive relief was warranted.  Here, he explained, the key defendant who controlled the company was a recidivist with a previous injunction against him, who presided over a company that made no efforts to remedy past violations and operated with an ill-informed and inactive Board of Directors.  The judge dwelled on how grossly uninformed one the directors was.  This was not an example of rote issuance of an injunction merely because a violation was found.  See slip op. at 3-7.

The judge also made a reasonable effort to calculate civil penalties, choosing an amount below the maximum ($2 million) for a defendant with lower culpability, and hitting the repeat offender who made the company’s decisions with penalties several times higher ($6 million).  Penalties against the company were assessed at $23.7 million.  Given the size and economic wherewithal of the company, this is a huge award.  The judge justified it based on his review of the evidence showing blatant violations of law that were at least reckless, even though the violations adjudicated against the defendants were non-fraud reporting violations of Section 13(a).

In the end, the SEC obtained major relief against the defendants, but showed truly bad form in doing so.  It’s proposed disgorgement and penalties were a joke, and hence were not taken seriously by the judge.  Another judge might have reacted more harshly to this combination of puerile gamesmanship and spectacularly poor judgment.  But Judge Nowlin did his job notwithstanding the SEC’s overreaching, and it looks like rough justice was done.

Straight Arrow

December 3, 2104

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