Quarterly Securities Enforcement Briefing
- 2nd and 11th Circuits Reject District Court Challenges to Constitutionality of SEC In-House Courts
- SEC Looks to Renew Focus on Accounting Fraud
- 11th Circuit Holds That SEC is Subject to Standard Five-Year Statute of Limitations in Enforcement Actions Seeking Disgorgement
Our ongoing coverage of challenges to SEC in-house courts continues with rulings from the 2nd and 11th Circuits regarding whether defendants must bring challenges to the constitutionality of the SEC’s in-house administrative court in that in-house court before raising the claim in federal court. We have previously covered this issue here, here, and here. As previously reported, the SEC has made increasing use of its in-house administrative proceedings (“in-house courts”) before SEC-employed Administrative Law Judges (“ALJs”). Appeals from ALJ decisions are reviewed by the Commission, the same body that approves bringing civil enforcement actions, before litigants may appeal to the federal courts of appeal.
In the latest cases from the 2nd and 11th Circuits, Tilton et al. v. Securities and Exchange Commission and Gray Financial Group Inc. et al. v. U.S. Securities and Exchange Commission, respectively, the question was whether a defendant who is the subject of an ongoing SEC in-house proceeding can challenge the constitutionality of that proceeding by filing suit in a federal district court rather than having to go through the in-house proceeding first. In Tilton, the SEC brought an administrative claim against Tilton in March 2015, alleging that she hid the poor performance of companies in which her fund invested. Two days later, Tilton challenged the SEC complaint in federal court on the ground that the impending administrative proceedings were unconstitutional under the Appointments Clause because the SEC hires them instead of the President appointing them. The federal district judge dismissed the suit in June 2015 on the ground that the court lacked jurisdiction over the claims. On June 1, 2016, the 2nd Circuit ruled in favor of the SEC, reasoning that Tilton will be able to obtain meaningful review through administrative channels. Tilton’s case may not be over, however. She has sought rehearing and requested a stay precluding the SEC administrative case from proceeding pending rehearing. The 2nd Circuit granted a similar stay in a similar case recently, and it seems likely that it will grant Tilton’s request for a stay pending rehearing as well.
In the 11th Circuit case, Gray Financial Group Inc. et al. v. U.S. Securities and Exchange Commission, the panel issued a June 13, 2016, ruling that also sided with the SEC, successfully arguing that Congress gave the SEC power to hold administrative proceedings and that the agency’s in-house court must rule on constitutional challenges to the in-house court before defendants can appeal them to the federal courts. As the panel wrote, “Enduring an unwanted administrative process, even at great cost, does not amount to an irreparable injury on its own.”
With the above rulings, the 2nd and 11th Circuits become latest federal appellate courts to rule that district courts cannot hear challenges to the SEC in-house courts except on appeal from SEC administrative proceedings.
SEC Looks to Renew Focus on Accounting Fraud
By John A. Goldmark
The SEC recently emphasized its intent to renew enforcement efforts on accounting fraud cases, and advised company executives to prioritize strong internal controls. Following the 2008 financial crisis, SEC enforcement of accounting fraud took a back seat to inquiries and enforcement actions involving the perceived causes of the meltdown. In recent years, however, the SEC has returned its attention to financial reporting fraud—its traditional bread and butter.
In remarks last month, the head of the SEC’s New York office, Andrew Calamari, highlighted that the SEC’s financial reporting cases have more than doubled in the last two years, and emphasized that these cases will remain “one of the core pieces of the [SEC’s] enforcement program.” Mr. Calamari noted that problems with a company’s internal controls often underlie accounting fraud cases, and stated that he expects the SEC to continue to focus on enforcement in this area. According to Mr. Calamari, “The message of these cases is that senior leadership should place strong emphasis on the importance of designing and implementing strong internal controls, and what is needed is not just involvement from senior leadership but also from the auditing community.”
The SEC reportedly has improved capabilities to gather and analyze large amounts of data to identify accounting issues, including a Corporate Issuer Risk Assessment (CIRA) tool, and aims to use these tools to quickly review and identify red flags for suspicious reporting.
The SEC’s focus puts added importance on a company’s financial reporting gatekeepers, including audit committee members and external auditors, and implementing internal controls to investigate situations suggesting material inaccuracies in financial reporting.
On May 26, 2016, the Securities and Exchange Commission suffered another significant loss in its efforts to seek remedies more than five years after the commission of an offense. As we have previously covered here, the Supreme Court held in SEC v. Gabelli that in enforcement actions seeking civil penalties the SEC does not get the benefit of the “discovery rule,” under which the statute of limitations only starts after a party discovers an offense. In Gabelli, the Supreme Court left open the question of whether the general five-year statute of limitations under 28 U.S.C. § 2462 applies to claims for equitable relief such as disgorgement.
Before Gabelli, both the 9th Circuit and the D.C. Circuit held that disgorgement was not subject to the five-year statute of limitations. In Graham, the 11th Circuit disagreed. The case required interpretation of 28 U.S.C. § 2462, which bars any “action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture … unless commenced within five years from the date when the claim first accrued.” The 11th Circuit held that declaratory relief is a penalty and disgorgement is tantamount to forfeiture, both subject to section 2462’s five-year limitations period.
The SEC spent no time licking its wounds after this loss. In a brief the SEC filed in the 8th Circuit a mere week later, the SEC made its position going forward clear: “Graham is incorrect.”1 In asking the 8th Circuit to come out the other way, the SEC argued that “Graham’s holding that disgorgement and forfeiture are synonymous… is without legal merit.” The SEC chose not to seek rehearing of Graham before the 11th Circuit. However, given the circuit split the issue may end up before the Supreme Court.
Unless and until the Supreme Court weighs in, Graham is likely to impact the SEC’s strategy in pending and future investigations. In the past decade, the SEC has used its disgorgement power to settle a substantial number of matters that look back more than five years, including many brought under the Foreign Corrupt Practices Act. In light of Graham, the SEC is likely to be more aggressive in seeking tolling agreements while it conducts investigations.
1 Appellee’s Brief, SEC v. Collyard, App. No. 16-1405, 2016 WL 3157530 at *39 (8th Cir. June 3, 2016).