Friday, August 24, 2018

Bankruptcy trustee loses Kokesh-based challenge to settlement

By Anne Sherry, J.D.

The federal district court in Massachusetts held that it lacked subject matter jurisdiction to revisit a 2014 settlement of an SEC administrative proceeding against F-Squared Investments. The bankruptcy trustee in charge of winding down F-Squared challenged the settlement in light of Kokesh v. SEC (U.S. 2017), which held that disgorgement in a civil enforcement proceeding constitutes a penalty. However, the court concluded that F-Squared validly waived judicial review, and the statutory process for review of SEC orders in administrative proceedings does not involve the federal courts (Jalbert v. SEC, August 22, 2018, Saylor, F.).

F-Squared was the largest actively managed ETF strategist when, in December 2014, it agreed to pay a $5 million civil penalty and $30 million in disgorgement to settle an SEC administrative proceeding alleging that the firm falsely advertised its flagship portfolio. In 2015, F-Squared filed for bankruptcy, and Craig Jalbert was appointed as the trustee of the liquidating trust. Jalbert filed a complaint against the SEC in which he sought to represent a class of all securities-law violators who have paid disgorgement to the SEC in the last six years. He alleged that the SEC exceeded its statutory authority by obtaining disgorgement in enforcement actions and violated procedural requirements by failing to obtain an accounting of profits before ordering disgorgement.

The trustee argued that in light of Kokesh, the SEC’s imposition of disgorgement was unlawful because it was a penalty, and Congress separately provided statutory authority for civil money penalties. The court noted the many hurdles in the way of this argument. First, because the SEC has explicit statutory authority to order disgorgement in administrative proceedings, the settlement is valid unless the SEC illegally exercised that authority. Second, because F-Squared expressly waived judicial review of the settlement, the court could only step in if that waiver was void or ineffective. Third, because the statutory process for judicial review of orders in SEC administrative proceedings does not involve the federal courts, the court would have subject-matter jurisdiction only if that scheme were somehow inapplicable.

The court seemed skeptical of the trustee’s argument about the SEC’s statutory authority to order disgorgement, noting that many statutory schemes provide for overlapping penalties and that Congress was likely aware of the SEC’s longstanding practice of exercising disgorgement authority when it enacted the statute for administrative proceedings. Ultimately, however, the court did not need to resolve the issue because the argument was validly waived as part of the settlement.

The trustee countered that the waiver was unenforceable because it was based on a mutual mistake of law—the parties incorrectly assumed that the SEC could impose punitive disgorgement and were not corrected on this point until the Supreme Court ruled in Kokesh. However, the court observed that even if Kokesh changed disgorgement law as to civil enforcement proceedings, which the opinion specifically noted it did not, it said nothing about disgorgement in administrative proceedings. Even if the SEC acted outside the scope of its enforcement authority in ordering disgorgement, that error was waivable.

Finally, F-Squared failed to petition one of the applicable circuit courts of appeals for review within sixty days of the disgorgement order as required by both the Investment Advisers Act and Investment Company Act. Under Supreme Court precedent, a statute forecloses district court jurisdiction when that intent is fairly discernible in the statutory scheme and the litigant’s claims are of the type Congress intended to be reviewed within that scheme. F-Squared had access to meaningful judicial review, and the trustee’s claims were not wholly collateral to the statutory scheme. It was a closer question whether the particular claims advanced by the trustee fell within the SEC’s expertise, but the court reasoned that agencies routinely address such statutory claims as the interpretation of the term “disgorgement,” and the availability of meaningful judicial review argued against bypassing the statutory scheme.

The case is No. 17-12103-FDS.