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| Thomas K. Potter |
Challenges to SEC Forum
Last week, Joseph Stilwell and his newly registered investment advisory firm, Stilwell Value LLC, sued the SEC for declaratory and injunctive relief to prevent an administrative enforcement action threatened by the staff during the Wells process. Stilwell v. SEC, No. 1:14-cv-07931 (S.D.N.Y. Oct. 1, 2014) (complaint available here).
Stilwell’s suit raises an Article II challenge: Although it rests on tenure and removal provisions apparently designed to protect ALJs from political reprisals, it is patterned after the successful challenge to the Sarbanes-Oxley Public Company Accounting Oversight Board provisions from Free Enterprise Fund v. Pub. Co. Accounting Oversight Bd, 561 U.S. 477 (2010). An initial conference set this week is being continued because the SEC has yet to appear.
Stilwell’s challenge is just the latest salvo in a renewed fight that might be gaining momentum.
Gupta. When the SEC decided to institute administrative proceedings against only Raj Gupta among the 28 Galleon insider trading defendants — the first use of its new Dodd-Frank administrative reach — Gupta challenged the action in federal court alleging an equal protection violation and retroactive application of the Dodd-Frank. The SEC argued that the ’34 Act § 25(a)(1) vested exclusive jurisdiction to review commission orders in the D.C. Circuit.
Judge Jed Rakoff rejected the SEC’s motion to dismiss, holding that: (1) denial of jurisdiction would preclude meaningful judicial review; (2) the suit was “wholly collateral” to statute’s review provisions; and (3) equal protection claims are outside the SEC’s expertise. Gupta v. SEC, 796 F. Supp. 2d 503, 511-13 (S.D.N.Y. 2011).
The court held Gupta’s complaint adequately alleged this three-point test for exceptional judicial review under APA § 703 and Thunder Basin Coal Co. v. Reich, 510 U.S. 200, 212-213 (1994)(citing Free Enterprise Fund above). The parties later settled, with the SEC dropping its administrative claims and Gupta his constitutional ones. Gupta ultimately was convicted of criminal charges brought by the U.S. Department of Justice and SEC and fined in a parallel SEC enforcement action (in U.S. district court) based upon them.
Chau. This past March, investment adviser Hardin Advisory LLC and its CEO, Chau, sought to enjoin administrative proceedings by the SEC on alleged violations regarding a 2006 collateralized debt obligation. Judge Lewis Kaplan denied the temporary restraining order for lack of irreparable harm, but the case remains pending with the motion for preliminary injunctive relief going “normal course.” Chau v. SEC, No 14-cv-1903 (S.D.N.Y. Mar. 19, 2014).
Jarkesy. Then in June, an investment adviser and his fund management group tried to enjoin SEC administrative proceedings. Citing § 25(a)(1) and the Thunder River line of cases, the D.C. district court held it lacked jurisdiction, denied the temporary restraining order and dismissed the action. Jarkesy’s appeal to the D.C. Circuit is pending. Jarkesy and Patriot28 LLC v. SEC, Fed. Sec. L. Rep. ¶ 97,990 (D.D.C. June 10, 2014)(No. 14-114 ), appeal pending, No. 14-5196 (DC Cir. filed Aug. 12, 2014).
During the summer, SEC Enforcement Director Andrew Ceresney told a conference he expected the commission would use its administrative forum more frequently; that seemed a shift from earlier commission statements that it would “try more cases” — understood among the defense bar to mean “in court.” The commission also expanded its ALJ roster from three to five. So ex-SEC Enforcement staff Russell Ryan took up the banner, arguing that the expanded SEC administrative forum:
- violated separation of powers;
- curtailed respondents’ opportunities for discovery — often after extensive SEC investigations;
- imposed a hurried pretrial schedule;
- deprived the accused of a jury; and
- required intermediate commission review of ALJ decisions, with only deferential judicial review thereafter.
R. Ryan, The SEC as Prosecutor and Judge, WALL ST. J. (Aug. 4, 2014).
Others replied that the APA provides due process protections (by the ALJ Association) and that the securities industry itself limits aggrieved customers to the Financial Industry Regulatory Authority arbitration forum (by an ex-SEC staffer).
Which Court — The Jurisdictional Conundrum
Last week I wrote about the D.C. district court’s rejection of an assault on the SEC’s investment adviser pay-to-play rules. (Read the blog post here). In that case, the court held it had no jurisdiction to consider the constitutionality of the SEC rules forbidding pay-to-play among advisers, because circuit precedent required “rules” to be treated as “orders” — even though they’re clearly not. New York Republican State Committee v. SEC, No. 14-01345 (DDC Sept. 30, 2014), citing Investment Co. Inst. v. Board of Governors of the Federal Reserve System, 551 F. 2d 1270 (DC Cir. 1977)(under the Bank Holding Act judicial review provision). So, it held jurisdiction lay first with the D.C. Circuit.
The Second Circuit held earlier that under ’34 Act § 25(a)(1) review of final order lies only to the D.C. Circuit. Altman v. SEC, 687 F. 3d 44 (2d Cir. 2012).
But last year, the D.C. Circuit held it lacked jurisdiction to hear a challenge to the SEC’s “Resource Extraction” Rules. American Petroleum Inst. v. SEC, 714 F. 3d 1329 (D.C. Cir. 2013). Although ’34 Act § 25(a) provides the D.C. Circuit shall review final orders, § 25(b) gives it jurisdiction only over rules under certain listed sections of the act. And the resource extraction rule wasn’t under them, so its review rested with the district court.
And, if you can meet the three points of the Thunder Basin exception, you may be able to file in your home (federal) court. See Gupta v. SEC, 796 F. Supp. 2d 503 (S.D.N.Y. 2011). So now, the smart money files “protective” suits in both places.
An Uphill Battle or a New Angle?
There is long-settled authority upholding the SEC administrative enforcement regime against constitutional challenge — even when finding the SEC has made a mistake within it. See, e.g., Blinder Robinson & Co. Inc. v. SEC, 837 F. 2d 1099 (D.C. Cir.)(rejecting constitutional challenges but remanding to SEC for further proceedings), cert. denied, 488 U.S. 869 (1988); Wright v. SEC, 112 F. 2d 89 (2nd Cir. 1940).
The U.S. Supreme Court used the Article II argument to invalidate some of the PCAOB provisions in the Sarbanes-Oxley reforms. With that same argument, Stilwell now challenges the Dodd-Frank reforms expanding SEC administrative jurisdiction. And the Chau and Jarkesy challenges — though rejected as TROs — remain pending.
—By Thomas K. Potter III, Burr & Forman LLP
Tom Potter is a partner in Burr & Forman's securities litigation practice and managing partner of the firm's Nashville, Tennessee, office. Licensed in Tennessee, Texas and Louisiana, he has more than 28 years of experience representing financial institutions in litigation, regulatory and compliance matters.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.