Thursday, February 11, 2016

Raymond Lucia Fires Opening Salvo in ALJ Court Challenge, Aided by Mark Cuban

By John M. Jascob, J.D., LL.M.

Raymond J. Lucia, Sr. and his eponymous investment advisory firm have fired the first shot in their court challenge to the SEC’s use of administrative law judges. In their suit opposing the SEC’s administrative enforcement regime, the petitioners urged the D.C. Circuit to vacate the Commission’s order barring Lucia and his company from the advisory business for misrepresenting their investment results. In their view, the SEC flouted explicit constitutional protocols in appointing the ALJ, who then found intentional fraud by the petitioners based on “the thinnest of allegations and nonexistent proof” (Raymond J. Lucia Companies, Inc. v. SEC, February 1, 2016).

Separately, businessman and investor Mark Cuban has filed an amicus brief supporting Lucia’s appeal. Cuban, who himself defeated an attempt by the SEC to sanction him for insider trading in October 2013, claims an interest in the case as a “victim of SEC overreach.” Cuban contends that both the statutory language and legislative history clearly show that Congress specifically intended that SEC hearings only be held before constitutional officers.

The Lucia appeal represents one of the latest of a series of actions by respondents taking aim at the SEC’s in-house enforcement proceedings. Among other things, respondents have argued that the Commission’s rules of practice give the agency a “home court advantage” by denying them the protections of the procedure and evidence rules of the federal courts. Nevertheless, the SEC has issued several opinions backing its use of ALJs in the face of these varied constitutional challenges.

Buckets of money. The SEC's Enforcement Division had charged Lucia and his firm with violating the Advisers Act by misleading investors about the backtesting of results of a portfolio re-balancing strategy called “Buckets of Money,” which they claimed would produce comparatively superior returns in a sharp market decline. Despite a strongly-worded dissent from Commissioner Piwowar and then-Commissioner Gallagher, the Commission sustained findings by ALJ Cameron Elliott that the petitioners’ presentations to investors contained intentionally fraudulent statements and omissions. Lucia, a 40-year veteran of the advisory business, was barred from the securities industry. In addition, the Commission imposed civil penalties of $250,000 on the company and $50,000 on Lucia.

“Unwise wager.” In their appeal, the petitioners contend that the Commission’s decision cannot stand on constitutional grounds because the ALJ who presided over their case was an “officer” who was not appointed pursuant to the requirements of the Appointments Clause. According to the petitioners, the SEC’s contention that ALJs are mere “employees” contradicts Supreme Court precedent, which holds that all officials in posts established by law who exercise “significant authority” are “officers.” Federal statutes and even the SEC’s own regulations refer to the Commission’s ALJs as “officers,” and their authority is at least as great as other adjudicators the Supreme Court—in a long line of decisions exemplified by Freytag v. Commissioner of Internal Revenue (1991)—has concluded are constitutional officers.

In the petitioners’ view, the SEC has made an “unwise wager” by staking its contrary view on the D.C. Circuit’s divided decision in Landry v. FDIC (2000), where the court held that ALJs of the FDIC are not inferior officers. The Landry ALJs were not officers, the respondents noted, because they could not issue final decisions and the FDIC owed no deference even to their factual findings. In contrast, the SEC’s ALJs can and do issue final decisions. Moreover, the SEC does not review most ALJ rulings at all, and when it does it defers to the ALJs’ credibility findings.

The petitioners also argue that the SEC’s decision and order should be vacated because the SEC failed to identify any materially misleading statements that were made with scienter. The SEC’s “principal bogey-man”—passing descriptions of historically inspired hypotheticals as “backtests”—could not have been false simply by their use of certain assumptions. The petitioners contend that there was (and is) no settled definition of the term. Instead, the SEC made up its own definition and then arbitrarily punished them for using the term differently years earlier. In any event, Lucia and his firm expressly disclosed that the hypotheticals were based on some assumed figures and some historical facts, the brief concludes.

Cuban’s amicus brief. In his amicus brief supporting Lucia, Mark Cuban argued that the SEC has ignored the plain language of the Securities Act, which requires all hearings to be public and held before “the Commission or an officer or officers of the Commission.” Moreover, he argued, the legislative histories of the Securities Act, the Exchange Act, and the Administrative Procedure Act all show that Congress intended SEC ALJs to be inferior officers in the constitutional sense. Asserting that he has "an abiding interest in challenging the SEC when it takes misguided and incorrect positions in litigation," Cuban stated that the SEC has done exactly that by claiming that Congress’s chosen language is “irrelevant” and places no impediment on the agency’s attempts to degrade the stature of those who preside at SEC hearings.

The case is No. 15-1345.