Tuesday, September 13, 2016

Tilton renews attack on SEC’s administrative courts

By Amanda Maine, J.D.

In an ongoing battle with the SEC, Lynn Tilton and her Patriarch Partners entities have filed suit against the Commission, requesting declaratory and injunctive relief from the SEC’s administrative proceedings. Tilton’s latest complaint attacks the Commission’s administrative law judge regime as unconstitutional on equal protection grounds, in addition to attacking the SEC’s procedures as unconstitutionally infringing on the due process rights of respondents in SEC administrative proceedings (Tilton v. SEC, September 9, 2016).

Earlier proceedings. The SEC first brought administrative proceedings against Tilton and her Patriarch affiliates, which specialize in restructuring distressed companies, in March 2015, alleging that they provided false and misleading information and engaged in a deceptive scheme regarding three collateralized loan obligation funds that they managed (the Zohar Funds). Two days after the Commission issued its order instituting administrative proceedings, Tilton sued in federal district court to enjoin the proceedings on the grounds that that SEC administrative law judges (ALJs) are unconstitutionally appointed “inferior officers” under the Appointments Clause, and not employees as argued by the SEC. The district court dismissed her request to enjoin the SEC’s proceedings against her for lack of subject matter jurisdiction, and the Second Circuit affirmed. Tilton’s hearing before the SEC’s ALJ is now scheduled for October 24, 2016.

Due process arguments. Tilton’s complaint recites a scathing litany of accusations about the SEC’s treatment of respondents in its administrative proceedings, in particular those who have challenged the Commission’s in-house court system of hearings before ALJs. Among the patterns and practices that violate the due process rights of these respondents, according to Tilton, include delaying formal charges while Enforcement staff conducts its investigations. Tilton pointed out that the SEC began investigating the Zohar Funds more than five years ago, but under the rules governing the current administrative proceedings, an SEC ALJ is required to issue an initial decision within 300 days of the issuance of the OIP, putting respondents at a “severe disadvantage,” the complaint explains.

Other practices that result in a denial of due process to respondents include supplying them with insufficient notice of the charges against them (including the refusal to identify the particular statutory provisions allegedly violated, the investors who were allegedly defrauded, or the transactions at issue); using discovery and evidentiary rules to skew proceedings in the SEC’s favor, such as “deliver[ing] voluminous and disorganized investigative files to respondents” and employing experts who are not subject to the federal courts’ standards for experts in Daubert v. Merrell Dow; making it difficult for respondents to obtain exculpatory material; and “arbitrarily and reflexively” denying respondents’ requests to take depositions, which, according to Tilton, have been fruitless under the SEC’s existing rules no matter how compelling the reason except for the unavailability of the deponent (a rule, the complaint points out, which does not apply to a witness for the Division of Enforcement).

Alleged targeting of ALJ critics. Tilton is not the first respondent in an SEC administrative proceeding to challenge the SEC’s ALJ regime (see, e.g., Hill/Gray, Jarkesy, Bebo, Raymond J. Lucia). Tilton’s complaint points to a number of respondents who, she alleges, have been “targeted” by the Commission due to their constitutional challenges of the SEC’s in-house court proceedings in federal district court.

The complaint notes that, in response to the scrutiny over the SEC’s use of its administrative proceedings as an enforcement tool, the Commission proposed and later adopted amended rules to its Rules of Practice which afford respondents greater procedural protections. However, Tilton observes, the parts of the amended rules that would be most helpful to the current challengers to the ALJ regime, such as rules allowing for depositions and flexibility in the timing of hearings, do not apply to these particular respondents, including Tilton. The amended rules apply only to proceedings in which the prehearing conference has not yet been held as of September 27, 2016 (the effective date of the rules).

The application of the amended rules, according to Tilton, has been “carved out” by the Commission against respondents who “had the temerity to mount facial challenges to the constitutionality of the SEC’s internal administrative tribunals” and who wished to seek to have their cases heard in federal court. The SEC’s “deliberate decision” to withhold application of these provisions to the challengers of its administrative proceedings violates the equal protection rights of those individuals, including those of Tilton and other respondents who have recently challenged the ALJ process, the complaint argues.

Relief sought. Tilton’s complaint requests, among other things, that the court declare as unconstitutional the SEC’s administrative proceedings which, it asserts, deny respondents opportunities to develop and present their defenses. The complaint also requests an order directing the SEC to apply its amended rules of practice to Tilton and other similarly situated SEC respondents. In addition, Tilton demands a trial by jury on the triable issues described in the complaint.

The case is No. 16-cv-7048.

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