Tag Archives: SDNY

N.D. Ga. Judge Leigh May Issues Injunction for Gray Financial and Denies One for Timbervest

Events are flowing fast and furious on the continuing litigation of the constitutionality of the SEC’s administrative enforcement proceedings.  We previously reported that S.D.N.Y. Judge Richard Berman issued a favorable ruling to Barbara Duka and withheld deciding whether to issue a preliminary injunction for seven days pending possible SEC action.  See SDNY Court Ups the Ante, Allowing Duka Injunctive Action To Proceed on Appointments Clause Issue.  Now, N.D. Ga. Judge Leigh May, who was the first to rule that the appointment of SEC administrative law judges was likely to be in violation of Article II of the Constitution in Hill v. SEC (see Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding), has issued another preliminary injunction based on the same analysis in Gray Financial Group, Inc. v. SEC.  See Order Enjoining SEC in Gray Financial Group v. SEC.

But the respondents in the administrative proceeding In the Matter of Timbervest, LLC et al.were denied a preliminary injunction by Judge May.  See Order Denying Preliminary Injunction in Timbervest v. SEC.  Unlike the Hill and Gray Financial cases, the administrative trial in the Timbervest administrative proceeding was already completed — and petitions for review from both the Timbervest respondents and the Division of Enforcement were in the midst of consideration by the Commission — when the Timbervest parties commenced their action seeking preliminary relief after Hill v. SEC was decided.  The fact that the case was at a different stage was critical to Judge May, who find that becuase the burden of an extensive administrative trial could no longer be avoided, the justification for a preliminary injunction was far less compelling for Timbervest as compared to the other cases.

Judge May still found that, like the other cases, Timbervest was likely to succeed on the merits of its case, but that was not enough to support the issuance of the preliminary injunction.  Here is what she said on that:

The Court finds that Plaintiffs have not satisfied the remaining preliminary injunction factors as Plaintiffs have failed to meet their burden that they will be irreparably harmed if this injunction does not issue.  Plaintiffs seek limited relief: they request the Court enjoin the SEC’s ability to publish its decisions or enforce those decisions against them until this matter is resolved; they do not seek to enjoin the proceeding or prevent the SEC from issuing its final order. However, unlike the procedural posture in the Court’s prior decisions in Gray and Hill, Plaintiffs waited until the ALJ had issued his initial decision and this case was before the SEC itself before filing this motion.  Plaintiffs have already gone through the entirety of the administrative procedure before the ALJ—thus, no injunction will cure or prevent Plaintiffs’ prior obligation to defend itself before
the ALJ.  And any harm which Plaintiffs have already suffered by virtue of the initial decision being published has already been experienced; removing the ALJ’s initial decision from the website would not prevent a future harm.

Plaintiffs argue that by virtue of the initial decision being posted, they are subject to the results of an unconstitutional procedure. . . .  But even if the Court were to order the initial decision to be taken down, the initial decision has been publicly available since August 2014 and articles have been published about it.  Reality dictates that the results of the initial decision will still be available in the public domain even if the decision is removed, albeit not in its most formal version.

Plaintiffs also argue that they may be subject to additional harm if the SEC publishes a final order or imposes additional future action against them while their appeal from the SEC’s final order is pending.  The Court finds that any future harm as to the judgment is speculative at this point as it has not yet been imposed.  See Winter v. Natural Res. Def. Council, Inc., 555 U.S. 7, 22 (2008) (noting that plaintiffs must show “irreparable injury is likely in the absence of an injunction” and stating that “[i]ssuing a preliminary injunction based only on a possibility of irreparable harm is inconsistent with our characterization of injunctive relief as an extraordinary remedy that may only be awarded upon a clear showing that the plaintiff is entitled to such relief.”) (emphasis in original).  And the SEC stated at the hearing that the SEC often stays its final orders pending appeal, so even if the SEC decides to impose future action against Plaintiffs, the SEC could agree to stay that harm (e.g., any bars, fines, or suspensions) pending appeal.  Therefore, the Court DENIES Plaintiffs’ Motion.

Slip op. at 27-29.

Finally, in connection with the appeal of the preliminary injunction issued in Hill v. SEC, Judge denied the SEC’s request for a stay of her order pending appeal.  See Order Denying SEC Stay Motion in Hill v. SEC.  She said:

The Court finds that a stay of the preliminary injunction pending appeal is not warranted. First, for the reasons stated in this Court’s Order in this case, . . . and the reasons the Court has since stated in two other very similar cases, Gray Financial Group, Inc. v. SEC, No. 1:15-cv-492-LMM, and Timbervest, LLC v. SEC, 1:15-cv-2106, the Court finds that the SEC has not made a strong showing it is likely to succeed on the merits.  As well, the Court notes that the SEC is only foreclosed from conducting an administrative proceeding in front of an ALJ who was not appointed by the SEC itself—the SEC Commissioners may conduct the hearing against Plaintiff at any time or appoint the SEC ALJ directly.  They may also elect to bring their claims in district court. Thus, the Court does not find the SEC is irreparably injured or the public interest is affected as the SEC still has a channel to pursue Plaintiff—even through an administrative proceeding if it chooses.  However, if the stay is lifted, Plaintiff would have to participate in a likely unconstitutional proceeding which would cause a substantial injury. Thus, the SEC’s Motion to Stay is DENIED.

Order at 4.

In showing she is willing to parse through the different factors in these cases and reach varying decision based on the applicable standards, Judge May gains credibility for a reasoned approach to this volatile issue.

Straight Arrow

August 6, 2015

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In Duka v. SEC, SDNY Judge Berman Finds SEC Administrative Law Enforcement Proceedings Constitutional in a Less than Compelling Opinion

Southern District of New York federal Judge Richard Berman yesterday decided that Barbara Duka, a former Standard & Poor’s employee charged with securities law violations by the SEC, cannot enjoin the SEC administrative enforcement action brought against her.  In doing so, Judge Berman rejected the argument that he lacked jurisdiction over the case, unlike two previous federal court judges.  See SEC Wins First Skirmish on Constitutional Challenge to Chau Administrative Proceeding, and Court Dismisses “Compelling and Meritorious” Bebo Constitutional Claims Solely on Jurisdictional Grounds.  As a result, he addressed the merits of Ms. Duka’s constitutional argument, finding the she was “unlikely to succeed on the merits” of that claim. Likely success on the merits of the claim is a requirement for granting the preliminary injunctive relief sought by Ms. Duka.  The opinion is available here: Order Denying Relief in Duka v. SEC.

Jurisdiction

Judge Berman rejected the jurisdictional argument accepted by two prior judges because, unlike them, he concluded that the relief sought by Ms. Duka could not be satisfied within the administrative adjudication process, the challenge made addressed not the substance of the claims against her but the very suitability of the forum to adjudicate those claims, and the constitutional issue fell outside of the SEC’s area of expertise.

On the availability of a remedy, here is what the court said:

The Court concludes that the absence of subject matter jurisdiction “could foreclose all meaningful judicial review” of Plaintiff’s claim. . . .  The Court of Appeals obviously would not be able, upon appellate review of any final SEC order, to enjoin the SEC from conducting the Administrative Proceeding, as Duka asks this Court to do.  And, while the Court of Appeals could, presumably, vacate an adverse decision (order) by the SEC on constitutional grounds, it would be unable to remedy the harm alleged by Plaintiff in this Court, i.e., the “substantial litigation and resource burdens incurred during [the] administrative proceeding,” and the “reputational harm” associated with her defending the Administrative Proceeding. . . .

Plaintiff is not here challenging the outcome of her Administrative Proceeding or any order(s) issued by the SEC.  Rather, Plaintiff seeks to enjoin the proceeding itself, and the (injunctive and declaratory) relief she seeks is to prevent the Administrative Proceeding from occurring in the first place. . . .  If Plaintiff were required, as the Government urges, to await the completion of the Administrative Proceeding to seek (any) judicial intervention, important remedies could be foreclosed.  That is, her claim for injunctive and declaratory relief would likely be moot at that stage because the allegedly unconstitutional Administrative Proceeding would have already taken place. Simply put, there would be no proceeding to enjoin. . . .

Slip op. at 10-12 (cites and footnotes omitted).

And this on whether the relief sought was collateral to the substance of the underlying proceeding, or an appropriate part of that proceeding:

The Court concludes that Plaintiff’s claim for injunctive and declaratory relief is “wholly collateral” to “any Commission orders or rules from which review might be sought” in the Court of Appeals. . . .  In Free Enterprise, the Supreme Court found that the petitioners’ Article II claim was collateral because “petitioners object[ed] to the Board’s existence, not to any of its auditing standards.”. . .  Similarly, Duka contends that her Administrative Proceeding may not constitutionally take place, and she does not attack any order that may be issued in her Administrative Proceeding relating to “the outcome of the SEC action.”  Chau [v. SEC], 2014 WL 6984236, at *13; see Gupta [v. SEC], 796 F. Supp. 2d at 513 (where plaintiff “would state a claim even if [he] were entirely guilty of the charges made against him . . . .”).

Unlike the plaintiffs in Chau, Duka does not assert an “as-applied” challenge to agency action “in light of the facts of a specific case.”  Chau, 2014 WL 6984236, at *6.  Rather, she contends that Administrative Proceedings are “unconstitutional in all instances—a facial challenge.”  Id.  As Judge Kaplan noted in Chau, “courts are more likely to sustain preenforcement jurisdiction over broad facial and systematic challenges.” Id. (internal quotation marks omitted).

Slip op. at 12-13.

On the issue of the SEC’s expertise to decide the constitutional issue, Judge Berman wrote:

Without in any way diminishing ALJ Elliot’s exceptional legal background, the Court concludes that the constitutional claim posed in this injunctive/declaratory judgment case is outside the SEC’s expertise.  This aspect of executive agency practice is governed by clear Supreme Court precedent.  See Thunder Basin [Coal Co. v. Reich], 510 U.S. at 215 (“[A]djudication of the constitutionality of congressional enactments has generally been thought beyond the jurisdiction of administrative agencies.”); see also Free Enterprise [Fund v. Pub. Co. Accounting Oversight Bd.], 561 U.S. at 491 (“Petitioners’ constitutional claims are also outside the Commission’s competence and expertise . . . .  [T]he statutory questions involved do not require ‘technical considerations of [agency] policy’. . . .  They are instead standard questions of administrative law, which the courts are at no disadvantage in answering.”).

Slip op. at 14.

Likelihood of Success on the Merits

When he turned to the merits of the constitutional issue, Judge Berman was unwilling to apply the Supreme Court’s Free Enterprise Fund decision to the SEC’s administrative law judges. Not, however, because he doubted that SEC ALJ’s are “inferior officers” of the Executive Branch in constitutional terms.  He did not decide that issue, because he said it was unnecessary, but plainly viewed prior Supreme Court precedent regarding Tax Court special trial judges in Freytag v. Commissioner likely to be determinative: “The Supreme Court’s decision in Freytag v. Commissioner, 501 U.S. 868 (1991), which held that a Special Trial Judge of the Tax Court was an “inferior officer” under Article II, would appear to support the conclusion that SEC ALJs are also inferior officers. See Freytag, 501 U.S. at 881–82 (“[S]pecial trial judges perform more than ministerial tasks. They take testimony, conduct trials, rule on the admissibility of evidence, and have the power to enforce compliance with discovery orders. In the course of carrying out these important functions, the special trial judges exercise significant discretion.”).  Slip op. at 16.  As noted, however, Judge Berman decided he “need not resolve that issue.”  Id.

That is because he reasoned that even if the SEC’s ALJ’s are inferior officers, the double-layer of removal protection they are accorded by statute does not undermine the President’s Executive power.  He noted that the Free Enterprise Fund Court “specifically excluded ALJs from the reach of its holding,” and rejected Ms. Duka’s argument that Free Enterprise Fund established a “categorical rule” forbidding two levels of “good cause” tenure protection.  Slip op. at 17.

Instead, Judge Berman created “a functional test to determine whether and when statutory limitations on the President’s power to remove executive officers violate Article II” based on other Supreme Court precedent.  He relied on the Supreme Court’s special prosecutor case, Morrison v. Olson, 487 U.S. 654 (1988), to argue for a test focused on whether Congress “interfere[d] with the President’s exercise of the ‘executive power’ under Article II” (quoting Morrison, 487 U.S. at 689-90). Although Free Enterprise Fund had no similar language regarding the double-layer of removal protection, Judge Berman argued that the Free Enterprise Fund decision “likewise focused upon whether the statutory restrictions on removal of PCAOB members were so structured as to infringe the President’s constitutional authority by ‘depriv[ing] the President of adequate control over the Board.’ Free Enterprise, 561 U.S. at 508.”  Slip op. at 17-18.

Judge Berman went on to reason “that congressional restrictions upon the President’s ability to remove ‘quasi judicial’ agency adjudicators are unlikely to interfere with the President’s ability to perform his executive duties.”  He argued that SEC ALJs exercise adjudicative power rather than executive power, and therefore the limits on removal of ALJs do not interfere with the President’s exercise of executive power.  He contrasted the Free Enterprise Fund case, which involved a subordinate entity of the SEC that “determines the policy and enforces the laws of the United States.”  Slip op. at 19-20.  In contrast, he said: “SEC ALJs perform solely adjudicatory functions, and are not engaged in policymaking or enforcement.”  Id. at 20.  As a result, “[t]he challenged (good cause) limitations upon the removal of an SEC ALJ will in no way ‘impede the President’s ability to perform his constitutional duty.’  Morrison, 487 U.S. at 691.”

Indeed, he argues that if the President could dismiss ALJ’s without cause, that would “undermine” the agency adjudication process, citing an article by Elena Kagan, written before she became a Supreme Court justice. Slip op. at 21.

How Good Is the Opinion, and How Influential Might It Be

Having elided the issue of whether the SEC ALJs are “inferior officers,” the opinion strikes me as somewhat superficial and relatively weak effort at resolving the constitutional issues that arise if they are, indeed, officers in the Executive Branch.  Judge Berman dispenses with this issue in a mere 4-1/2 double-spaced pages. His treatments of the Supreme Court decisions in Morrison v. Olson, Wiener v. United States, and the grandfather of them all, Humphrey’s Executor v. United States, are largely superficial.  In Judge Berman’s view, the fact that ALJ’s perform their executive duties as part of an adjudicative process insulates them from the need for control or influence by the Chief Executive.  He makes no real effort to examine the constitutional consequences of exempting large numbers of Executive Department officers from the need for Presidential control, and fails even to address the conundrum of treating an Executive Department officer within a law enforcement agency as if he or she were just another judge.  The nuances of how to accord administrative judges the freedom to act as an independent judicial branch within a powerful law enforcement department of the Executive Branch are basically ignored.  In sum, the effort lacks the depth and studiousness of an opinion likely to persuade appellate courts, and possibly other district courts as well.  It may well be that a proper, complete, and thorough argument along these lines can be made, but it is not reflected in this opinion.

Judge Berman effectively creates an adjudicative exception to the need for Presidential control over “inferior officers” involved in an adjudicative process within the Executive Branch. That is, essentially, formed out of whole cloth.  His core argument — “that congressional restrictions upon the President’s ability to remove ‘quasi judicial’ agency adjudicators are unlikely to interfere with the President’s ability to perform his executive duties” — is pure ipse dixit.  Short references to Humphrey’s Executor, Wiener, and Morrison, none of which involved facts and circumstances even vaguely like this case, hardly suffice to justify such a broad-reaching conclusion.  Many of the Supreme Court decisions addressing the role of the Executive in non-Article III courts are not examined, or even mentioned. Included among these is the separation of powers discussion in Freytag v. Commissioner, which Judge Berman acknowledged in the first part of his opinion and ignored thereafter (Freytag has an extensive discussion of the separation of powers implications of performing adjudicative functions outside in non-Article III courts).  Since Free Enterprise Fund plainly treats the SEC as an Executive Department, and there is abundant case law addressing the constitutional treatment of non-Article III courts, an in-depth analysis of those cases would seem necessary before reaching Judge Berman’s conclusions. I haven’t delved into those cases any more than he does (which is to say, not at all), but I’m certain that a reasoned resolution of the issue requires a lot more spade work than I see reflected in Judge Berman’s four pages on the issue.

Judge Berman’s decision also proceeds on the assumption that it is not important – and, indeed, could be harmful – for the President to be able to exercise authority over officials within the Executive Branch who perform adjudicative-like functions. That fails totally to consider the context in which the SEC ALJs function.  Judge Berman seems to think all ALJs perform the same kind of function, and none of them do things the Chief Executive cares much about.  But some ALJs, like those in the SEC, are critical cogs in a law enforcement process addressing large portions of the Nation’s economic and financial infrastructure.  They play a critical role in an Executive process to enforce the law, and exercise considerable discretion in doing so, without any direct supervisors.  The SEC’s enforcement actions already proceed with, at best, limited input from, or control by, the President. To the contrary, the SEC touts itself as being “independent” of the President.  If the SEC’s ALJs are, indeed, executive officers playing key roles in implementing a quintessentially executive function – the enforcement of the laws – why does the fact that ALJs follow an adjudicative-like process as part of that function mean they should be doubly insulated from Presidential influence? Judge Berman effectively postulates this as a necessary aspect of having an agency-based adjudicatory function, but the stated support for that – even if it is a law review article by Elena Kagan — is slim indeed, putting aside whether the very concept of an independent judiciary, functioning within an independent law enforcement agency, has any place in Articles I, II, or III of the Constitution.

There also is no mention or apparent consideration of potential Appointments Clause issues in this context. That may well be because Ms. Duka’s counsel never pressed those issues.  But if the SEC’s ALJs are officers of the Executive Branch, the Appointments Clause applies, and it is not at all clear whether the appointment process for SEC ALJs complies with that process.

Conclusion

To be sure, this decision represents a victory for the SEC in another battle in this campaign.  The loss on the jurisdiction issue is more than outweighed by the favorable ruling on the merits issue.  (Although it may encourage the DC Circuit to reach the merits of the constitutional issue in the recently-argued appeal in Jarkesy v. SEC).  The approach taken by the court does suggest that the SEC may not fare well in its arguments that its administrative law judges are not “inferior officers,” but the overall rejection of the Free Enterprise Fund double-insulation theory provides the groundwork for future SEC arguments on the merits in other courts.  One of those courts may take the time and make the effort to provide a more thorough consideration of the merits issue, but for now, count this as a significant, if not definitive, victory for the Commission.

Straight Arrow

April 16, 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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Final Disgorgement Order in SEC v. Wyly Is Far from “Final” Because of Unnecessary Pre-Judgment of Pending Tax Issues

On February 26, 2015, Judge Shira Scheindlin issued a final disgorgement order in SEC v. Wyly, implementing her previous opinions in September and December 2014.  We previously discussed those opinions here (Wyly Brothers Hit with More than $300 Million Securities Law Disgorgement Order for Unpaid Taxes) and here (SEC v. Wyly: New Scheindlin Disgorgement Opinion Shows How SEC Remedy Has Gone Awry).  The newest opinion can be read here: Final Disgorgement Opinion and Order in SEC v. Wyly, and the final judgment in the case can be found here: Final Judgment in SEC v. Wyly.

The new decision does not depart from the earlier opinions, it merely resolves disputes about how to implement them.  As a result, the parties are left with a set of varying rulings contingent on what may happen (1) on appeal, and (2) in an ongoing Internal Revenue Service audit.

In September, the judge decided that the SEC was entitled to a “disgorgement” remedy that included payment of federal taxes that she found were avoided in the Wylys’ offshore trust transactions.  Even though the transactions themselves violated no securities laws, and the Wylys’ tax returns violated no securities laws, she decided that because the Wylys’ nondisclosure of beneficial ownership in those trusts under section 13(d) of the Securities Act of 1934 may have caused the IRS to miscalculate taxes that were due, the taxes avoided were “causally related” to the securities violations.

In December, the judge considered SEC contentions on securities profits gained because of the nondisclosure, which was based on expert analysis founded on no generally accepted underlying theory or economic literature, but she nevertheless was inclined to accept that analysis as sufficient to satisfy the Second Circuit’s low threshold for ordering a disgorgement.  But she decided that a disgorgement ordered on that basis would yield an inequitable result, and declined to issue that order.  Obviously not keen on getting the case back on remand, she said that in the event the Second Circuit disagreed that she had the discretion to act as she did, she was ruling in favor of the SEC on the theory it presented.  See SEC v. Wyly: New Scheindlin Disgorgement Opinion Shows How SEC Remedy Has Gone Awry.

In the February 2015 opinion, Judge Scheindlin addresses specific proposed orders to implement the earlier decisions.  The end result is a “final judgment” that is far from “final” – it includes multiple possibilities depending on what the court of appeals decides, and what taxes the Wylys may yet be required to pay to the IRS.  You need a flow chart to get it all straight.  But the contingent order-writing to take account of future tax determinations was unnecessary — and, in my view, wholly inappropriate – in a disgorgement order for securities law violations.  That is because whatever happens in the future as to taxes owed, those determinations should fully and adequately assure that the Wylys retain no “ill gotten gains” in the form of taxes unlawfully avoided.

Judge Scheindlin’s stubborn insistence on making the tax issues part and parcel of the securities relief accomplishes nothing other than creating potential future headaches and possible injustices.  As we previously wrote, what is the purpose of pre-judging the tax issues in the context of a securities enforcement action, knowing that the IRS is addressing them?  The IRS is not obligated to, and may not, accept her ruling. Indeed, Judge Scheindlin acknowledges that the IRS is not bound by her view about how the disgorgement should be treated by tax authorities (“the IRS may take notice of this Court’s conclusion that there should be an offset for amounts paid to the SEC, even though the IRS is not a party here. Should the IRS disregard that language, the Wylys may return to this Court and move to vacate the final judgment….”  Slip op. at 6-7.).  That’s a future time bomb.

The prospect of disagreement goes both ways: she is not prepared to defer to a possible IRS decision that her analysis was wrong and taxes were not unlawfully avoided.  She only allows the Wylys to “pursue all available remedies should another court determine that the IOM Trusts are tax-exempt.”  Id. at 7 (emphasis added).  In other words, if a tax court rules the taxes were not owed, the Wylys may (or may not) get their money back by seeking relief from Judge Scheindlin’s judgment, but they are not permitted to ask for that relief if the IRS decides no taxes were owed, and the issue never gets to court.  The latter result seems blatantly unfair.  It is inconsistent with the concept of “disgorgement” because it mandates that they “return” proceeds that were not unlawfully obtained.  It could also be an improper judicial refusal to defer to an agency judgment in its own area of expertise.  All of this nonsense could be avoided if the court did not take up live tax disputes as part of a securities enforcement proceeding.

 What we wrote in our earlier post still seems correct:

[W]hichever way the tax process goes, it is wrong for the judge to jump the gun and order a tax-based disgorgement before the IRS acts.  If the IRS agrees with the judge, the tax will be paid, and no disgorgement is appropriate because there will be no undue tax benefits remaining.  If the IRS or a tax court disagree with the judge, no tax will have been unlawfully avoided, and there is no benefit to disgorge.  Either way, Judge Scheindlin should limit a disgorgement order to unlawful proceeds derived from the securities violations found, not supposed tax avoidance based on underlying transactions that did not themselves violate the law (only the nondisclosure of stock ownership violated the law).

(One of the pleasures of blogging is that you get to quote yourself with impunity.)  🙂

As we discussed earlier this week (see Let’s Get Real: When SEC “Disgorgement” Remedy Is Used as Punishment It Should Be Treated that Way), the legal standards governing the disgorgement remedy badly need serious thought and judicial leadership.  The SEC will try to “shoot the moon” in almost every case, and courts need to exercise reasoned discretion over how far they are prepared to go with this “equitable remedy” which more and more often is used to try to get defendants to pay far more than a realistic and well-conceived return of their own “ill-gotten gains.”  That is all that “disgorgement” should be.  To her credit, Judge Scheindlin resisted the SEC’s “shoot the moon” efforts a couple of times in the Wyly case.  But she lost her bearings on the tax-based disgorgement theory, leaving more than a little bit of a mess in the end.

Straight Arrow

March 6, 2015

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First Post-Newman Shoe Drops: Insider Trading Guilty Pleas Vacated in U.S. v. Conradt

We now have the first official judicial reaction to the Second Circuit’s recent opinion in United States v. Newman and Chiasson.  On January 22, 2015, District Judge Andrew Carter of the Southern District of New York vacated previously-accepted guilty pleas in United States v. Conradt, 12 Cr. 887 (ALC) (S.D.N.Y.).

Conradt is an insider trading prosecution based on securities trades by alleged tippees who learned and traded on the basis of nonpublic information about an impending IBM acquisition of a software firm. Briefly, the facts are as follows.  A law firm employee learned about the impending IBM acquisition of SPSS and improperly communicated that information to a friend, Trent Martin.  There apparently is no evidence that the lawyer who leaked the information in the first place received any proceeds or benefits from doing so.  Martin was a roommate and friend of defendant Thomas Conradt, and told Conradt about the SPSS deal.  Conradt told other defendants about the deal.  The defendants bought SPSS options and profited on them when the transaction was announced.  Four defendants pleaded guilty to insider trading charges before Newman was decided. The fifth, Benjamin Durant, pleaded not guilty and is scheduled for trial on February 23.  The four pleading defendants admitted in their plea allocutions that they committed insider trading and knew what they did was illegal.

We previously wrote a post about the Department of Justice’s brief arguing against dismissal of the Durant indictment, explaining that the DOJ’s grounds for distinguishing U.S. v. Newman ­– that Newman involved the “classical” theory of insider trading and the Durant prosecution was based on the “misappropriation” theory – were specious and should be rejected by the court.  You can review that discussion here: U.S. v. Durant: DOJ Argument that Newman Reasoning Does Not Apply to Misappropriation Theory Misses the Mark.

Having reviewed the DOJ position, Judge Carter rejected it in the context of considering the four previously-accepted guilty pleas. His decision is brief and decisive. It can be read here: United States v. Conradt, but this is the core of what he says:

[T]his Court finds that, as indicated in Newman, the controlling rule of law in the Second Circuit is that “the elements of tipping liability are the same, regardless of whether the tipper’s duty arises under the ‘classical’ or the ‘misappropriation’ theory.”. . . Additionally, even if Newman did not specifically resolve the issue, the Court is swayed by the fact that Newman’s unequivocal statement on the point is part of a meticulous and conscientious effort by the Second Circuit to clarify the state of insider-trading law in this Circuit. Accordingly, even assuming arguendo that the Government is correct that the cited language in Newman is dicta, it is not just any dicta, but emphatic dicta which must be given the utmost consideration. . . . Finally, the Court notes that it agrees with Newman’s articulation of the requirements of tipping liability and its statement that such analysis applies equally in misappropriation cases.

Conradt, slip op. at 2-3.  The court also rejected the DOJ argument that previous Second Circuit cases held that a personal benefit to the tipper is not required in misappropriation cases, noting that “Newman construes each one of the authorities the Government cites in this regard to be consonant with its holding.” Id. at 3 n.1.

In other news, today (January 23) the DOJ announced that it would seek en banc review from the Second Circuit of the Newman decision. See Bharara To Appeal 2nd Circ.’s Landmark Newman Decision.

Straight Arrow

January 23,2015

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