Suit to Enjoin SEC Forum Selection Dismissed

Many have expressed concern regarding the increasing use of administrative proceedings by the SEC. Those concerns range from the fairness of the forum to the impact of its lack of discovery on complex cases to the right to a jury trial and the development of the law. At the same time the decision regarding forum selection is vested in the discretion of the SEC under the statutes. The difficulty of challenging that authority is illustrated by the Court’s decision in Chau v. SEC, Case No. 14-cv-1903 (S.D.N.Y. Opinion issued Dec. 11, 2014).

Chau centers claims regarding securities law violations brought by the SEC in an Order Instituting Proceedings which names as Respondents Wing Chau and Harding Advisory LLC. The Order alleges that the Respondents – plaintiffs in this action – violated the securities laws in connection with the sale of interests in a CDO called Octans I CDO Ltd. during the market crisis. Specifically, the Order alleged that the collateral was to be selected by Respondents when in fact they failed to disclose that a hedge fund, whose interests were not aligned with those of Octans I and its investors, had substantial influence over the selection. In the administrative proceeding Respondents moved for an adjournment for time to prepare, to have the Federal Rules apply to the proceeding and that the documents be produced in a manner more to their liking. Each motion was denied as was a request for interlocutory review before the SEC. The hearing in that case has concluded. The initial decision has not been issued.

This action was initiated while the initial proceedings were taking place before the ALJ. The complaint alleges violations of the due process and equal protection clauses of the Constitution. The former keyed on the procedural differences between an SEC administrative proceeding and a district court action. Plaintiffs claimed that the time limits imposed on those proceedings would not permit adequate preparation in view of the fact that 22 million documents were dumped on them by the Division. This concern was amplified by the lack of discovery and pleading standards.

The equal protection claim centered on an argument that three other cases brought by the Commission based on very similar facts were brought in district court. In a footnote in a motion plaintiffs appeared to tie that claim to the right to a jury trial since in the other three similar cases the defendants had the right to a trial before a jury.

In considering a motion for a preliminary injunction by the plaintiffs and a motion to dismiss by the SEC, the Court, in an opinion authored by Judge Lewis Kaplan, concluded that it lacked subject matter jurisdiction. Two key decisions guided the Court’s conclusion. The first is Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994). There the Supreme Court considered a pre-enforcement suit seeking injunctive relief that would preclude the application of certain regulations to the company arising out of a dispute regarding the representative of Thunder Basis’ employees. The district court granted the injunction but was reversed by the Tenth Circuit. The Supreme Court affirmed, concluding that the requested injunction would be inimical to the structure and purpose of the Mine Act. The Court stated that three factors should be considered to determine whether a statutory review scheme divests the district courts of jurisdiction as to pre-enforcement challenges to an administrative action: 1) whether a finding of preclusion could foreclose all meaningful judicial review; 2) if the suit is wholly collateral to a statute’s review provisions; and 3) whether the claims are outside the expertise of the agency.

The second is Free Enterprise Fund v. PCAOB, 561 U.S. 477 (2010). There plaintiffs challenged the structure of the PCAOB, arguing that it violated principles of separation of powers. Following Thunder Basin the Court concluded that a pre-enforcement constitutional challenge to the existence of the Board was permissible. If the challenge was not permitted it would foreclose judicial review. Likewise, the claim was “wholly collateral” to any SEC adjudication since the suit challenged the very existence of the PCAOB. Finally, the Court found that the SEC had no special expertise to consider the challenge.

Application of these decisions results in the dismissal of plaintiffs’ claims in this case, according to the Court. First, in considering the due process claims the Court focused on the difference between a facial challenge to the scheme which argues that it is unconstitutional in all instances and one in which the question is if the application of the scheme results in the claimed infirmity. Courts are more likely to sustain pre-enforcement claims regarding the former as in Free Enterprise Fund rather than the latter. Indeed, the application of the Thunder Basin factors dictates against jurisdiction when a pre-enforcement constitutional claim relates to factual issues that are the subject of a pending administrative adjudication, according to the Court.

This is precisely the case here. First, an SEC adjudication would not foreclose all meaningful judicial review of the due process claim. To the contrary plaintiffs in this case developed a record in the hearing before the ALJ and can raise their issues on appeal first to the SEC and if necessary to a circuit court. Second, the due process arguments are not wholly collateral to the SEC proceeding. In fact, they are actually central to its day-to-day conduct. Finally, plaintiffs have not articulated any “convincing reason why the SEC lacks the competence to consider . . .” the issues raised.

The Court also rejected the equal protection claims raised by plaintiffs. At the outset plaintiffs do not claim to be part of a protected class. Likewise, the decision in Gupta v. SEC, 796 F. Supp. 2d 503 (S.D.NY. 2011), where the court concluded it had jurisdiction, is distinguishable. There the SEC brought actions in the district court against 28 persons and entities associated with Mr. Rajaratnam but an administrative proceeding against Mr. Gupta. Following Thunder Basin the court found that judicial review of the constitutional claim would be effectively foreclosed because of the lack of discovery, that the request for an injunction was wholly collateral because the claim would survive even if Mr. Gupta were found guilty and finally that the equal protection claim was not peculiarly within the expertise of the SEC. Gupta is distinguishable, according to Judge Kaplan, because he was one member of a class treated differently while here plaintiffs only point to three similar cases. And, in any event “this Court does not find Gupta’s application of the Thunder Basin factors persuasive in these circumstances.” To the contrary, applying those factors here compels dismissal. First, judicial review will not be precluded since plaintiffs have been litigating it. Second, it is not wholly collateral to the SEC proceeding. Where as here the claimed injury is the burden of going through the agency proceeding the party must await judicial review in accord with the statutory scheme. Finally, the claim is not outside the expertise of the SEC.