Tag Archives: Lynn Tilton

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

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

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

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

Judge Richard Berman - NYLJ/Rick Kopstein 100614

Judge Richard Berman – NYLJ/Rick Kopstein

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

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

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

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

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

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

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

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

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

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

Anne Small -- SEC General Counsel

Anne Small — SEC General Counsel

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

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

Straight Arrow

September 18, 2015

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SEC Strengthens Appointments Clause Challenge to ALJs by Admitting It Was Not Responsible for at Least One ALJ Appointment

Court filings indicate that the SEC made a significant admission relevant to the constitutionality of its administrative law court during a hearing in the case brought by Lynn Tilton to enjoin the administrative proceeding brought against her.  A letter sent to Judge Richard Berman, who is presiding over the similar action brought by Barbara Duka, Duka v. SEC, No. 15-cv-357 (SDNY), lays out what happened with a quote from a hearing transcript in Tilton v. SEC, No. 5-cv-02472 (SDNY). The letter was sent by the Justice Department, and it lays out the parties’ positions on the significance of what occurred in the Tilton case.  (You can read a copy here: Letter to Judge Berman in Duka v. SEC.

The letter quotes relevant portions of the hearing in the Tilton case before Judge Ronnie Abram, in which counsel for the SEC admitted that the administrative law judge in the administrative action brought against Ms. Tilton, Carol Foelak, was not appointed by the SEC Commissioners, and that this strengthens the argument that, as to at least cases before that judge, SEC proceedings may violate the Appointments Clause in Article II on the Constitution.  That clause states:

[The President] shall nominate, and, by and with the Advice and Consent of the Senate, shall appoint Ambassadors, other public Ministers and Consuls, Judges of the supreme Court, and all other Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law: but the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.

This would appear to mandate that “inferior Officers” of the United States may be appointed, with Congress’s approval, only by the President, the Courts of Law, or “the Heads of Departments.”  The only way that could be satisfied as to the SEC ALJs (if they are “inferior Officers”) is if the SEC Commissioners are a “Head of Department” and they make the appointments of their ALJs.

Here is the quoted portion of that hearing transcript:

THE COURT: Can I ask you the factual question that I asked of Mr. Gunther? Who exactly appoints SEC ALJs? Can you tell me more about the appointment process?

MS. LIN: Your Honor, those facts are not in the record here, but we acknowledge that the commissioners were not the ones who appointed, in this case, ALJ [Foelak], who is the ALJ presiding –

THE COURT: There is no factual dispute, okay.

THE COURT: Let me just back up for a minute and ask you a question. If I find that the ALJs are inferior officers, do you necessarily lose?

MS. LIN: We acknowledge that, your Honor, if this Court were to find ALJ [Foelak] to be an inferior officer, that that would make it more likely that the plaintiffs can succeed on the merits for the Article II challenge, at least with respect to the appointments clause challenge.

In the letter to Judge Berman, Ms. Duka argues “this the first time the SEC has ever acknowledged that SEC Commissioners do not appoint SEC ALJs in some or all administrative proceedings” (emphasis in original), and seeks to amend her complaint to add an Appointments Clause violation as grounds for the injunctive relief she seeks.  She also argues that in his previous decision denying a preliminary injunction, Judge Berman wrote “[t]he Supreme Court’s decision in Freytag v. Commissioner, 501 U.S. 868 (1991) … would appear to support the conclusion that SEC ALJs are also inferior officers,” and the “[b]ased on SEC’s admissions,” a ruling to that effect “would mean that Plaintiff is likely to succeed on the merits of her claim.”  See In Duka v. SEC, SDNY Judge Berman Finds SEC Administrative Law Enforcement Proceedings Constitutional in a Less than Compelling Opinion.

 The SEC consented to the amendment of the complaint, but argued that its ALJs are “not Constitutional officers, and therefore the Appointments Clause is not applicable,” and that the amendment should not be grounds for new briefing of the motion for preliminary injunction.

As noted in an earlier blog post, the SEC itself asked for briefing on the Appointments Clause issue in its review of the Iniital Decision in In the Matter of Timbervest, LLC.  See SEC Broadens Constitutional Inquiry into Its Own Administrative Judges in Timbervest Case.

Straight Arrow

June 1, 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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