D.C. CIRCUIT RULES THE SEC’S IN-HOUSE FORUM IS CONSTITUTIONAL

Multiple federal circuit courts have previously ruled that they did not have jurisdiction to hear a collateral challenge to the constitutionality of the SEC’s administrative proceedings before an Administrative Law Judge (“ALJ”) and that the respondents must raise challenges to the forum’s constitutionality as an appeal after the administrative proceeding concludes. In Raymond J. Lucia Companies, Inc. v. SEC, however, the D.C. Circuit became the first federal appellate court to consider the merits of the issue and concluded that the SEC’s administrative forum’s use of ALJs—who are not appointed by the President—does not violate the Appointments Clause, which requires the President to appoint all “Officers of the United States.”

The SEC instituted an administrative action against Raymond J. Lucia and Raymond J. Lucia Companies, Inc. (“petitioners”) alleging violations of the Investment Advisers Act of 1940. An ALJ heard the case, concluded that the petitioners were liable based on one of the four charged misrepresentations, and imposed sanctions. The SEC granted a petition for review, found that the petitioners committed anti-fraud violations, imposed the same sanctions as the ALJ, and concluded that its ALJs are employees, not Officers, and that their appointment did not violate the Appointments Clause. Petitioners then sought review with the D.C. Court of Appeals, which agreed with the SEC’s determination.

The D.C. Circuit explained that the Appointments Clause applies to judicial Officers but not employees or other “lesser functionaries,” and that an appointee is only an Officer if he or she exercises “significant authority pursuant to the laws of the United States.” The criteria for determining whether an appointee is an Officer are: “(1) the significance of the matters resolved by the officials, (2) the discretion they exercise in reaching their decisions, and (3) the finality of those decisions.” The D.C. Circuit determined that the SEC’s ALJs do not issue final decisions and thus cannot be Officers within the meaning of the Appointments Clause.

The D.C. Circuit agreed with the SEC that an ALJ’s initial decision only becomes a final decision when the SEC issues a finality order, and that the SEC must issue a finality order (either through issuing a new decision after a de novo review of the ALJ’s initial decision or by issuing an order advising that it has declined to grant review) in every case. The D.C. Circuit relied heavily on its 2000 decision in Landry v. FDIC, which held that ALJs of the FDIC were not Officers because they could only issue “recommending decisions” that are then forwarded to the FDIC Board of Directors for a final decision. After determining that the SEC’s use of ALJs passed constitutional muster, the D.C. Circuit also affirmed the finding of liability and lifetime industry bar sanction against the petitioners.

View the opinion - Raymond J. Lucia Companies, Inc. v. SEC, No. 15-1345, 2016 U.S. App. LEXIS 14559 (2d Cir. Aug. 9, 2016).

LAW FIRM SUED FOR BUSINESS LOST FROM CLIENT TO CLIENT- A CAUTIONARY TALE

A long-time insurance company client of Greenberg Traurig has sued the law firm, KPMG, and ten other defendants under conspiracy and other theories in district court in the Southern District of Florida, case number 9:16-cv-80618. The law firm had assisted plaintiff with the development of an offshore insurance product. The Complaint alleges defendants helped form a competitive insurance company that stole clients from plaintiff forcing the plaintiff into a receivership.

Three allegations in the Complaint provide a cautionary tale for both lawyers and their clients. Plaintiff asserts there was an oral agreement at the relationship’s inception that the law firm would not represent a competitor of plaintiff. A complete written client agreement should fully address such issue for the benefit of both sides.

Some of the law firm invoices had numerous redactions. Redactions would usually seem incompatible with the duties of the law firm.

Finally, the Complaint asserts Greenberg Traurig provided plaintiff crucial tax opinions for four years then declined to give needed updates thereafter while doing tax opinions for the competitor. There is a suggestion that the refusal was a result of plaintiff failing to pay its legal invoices. The value of including in a client agreement a clear-cut right to terminate the relationship cannot be overstated.

FEDERAL COURT ASSESSES WHETHER A NOTE IS A SECURITY UNDER THE TEXAS SECURITIES ACT

Is a promissory note a security under the Texas Securities Act? (“TSA”). For starters, the TSA defines “security” to include a “note.” But as a recent Western District of Texas opinion shows, the test is hardly so simple. Vodicka v. Barlin stems from three loans made by the plaintiffs to the defendants, purportedly for a real estate development. No. 1:10-CV-00076-DAE, 2016 U.S. Dist. LEXIS 11283 (W.D. Tex. Feb. 1, 2016). Instead, according to the plaintiffs, the defendants pocketed the money as part of a Ponzi scheme.

At issue in the court’s most-recent opinion was whether the notes issued to the plaintiffs were securities under the TSA. Despite the TSA’s straightforward definition, it only creates a presumption of a security. The presumption can be rebutted by showing the notes are similar to specific types of notes that are not securities. For example, a note securing a home mortgage or a note delivered in consumer financing is typically not a security.

The decision turned on four factors laid out by the United States Supreme Court in Reves v. Ernst & Young, which has been labeled the “family resemblance test.” First, what were the motivations of a reasonable buyer and seller? Because these investors sought a high-interest return, it suggested “an investment rather than a pure commercial or consumer transaction,” and weighed towards a security. Second, was the note subject to common trading for speculation or investment? Since the notes were not commonly traded, and there was no apparent secondary market, that factor weighed against a security. Third, what was the reasonable expectation of the investing public? Based on alleged representations by the defendants, the court determined the notes’ “fundamental character” was that of an investment, and therefore a security. Fourth, were there risk-reducing factors, such as a regulatory scheme, collateral, or insurance? The court found Texas’s limited protections for creditors and debtors were not a regulatory scheme. The notes were not insured, but they were collateralized. Therefore, the court found this factor was neutral.

The court concluded the presumption from the TSA’s definition of a security, coupled with the factors discussed above, established these notes were securities. But the opinion stressed that determining whether a note is a security under the TSA typically requires a detailed analysis.

SEC’S ANNUAL REPORT ON THE DODD-FRANK WHISTLEBLOWER PROGRAM POINTS TO EXPANDING RESPONSE TO PROGRAM—MORE WHISTLEBLOWER TIPS AND MORE AWARDS TO WHISTLEBLOWERS

On November 16, 2015, the SEC released its Annual Report to Congress on the Dodd-Frank Whistleblower Program. The Report touts the success of the Whistleblower Program by highlighting its receipt of over 4,000 tips in fiscal year 2015. This number is up 8% from fiscal year 2014, 20% from fiscal year 2013, and 30% from fiscal year 2012. The Report also emphasizes that out of 130 award claims, 8 whistleblowers were awarded a total of more than $37 million in fiscal 2015. This $37 million is a substantial percentage of the $54 million paid to 22 whistleblowers since the new whistleblower rules went into effect in August 2011. Additionally, the Report highlights that whistleblowers come from all sorts of different places. In fiscal year 2015, whistleblower tips came from every state and 61 foreign countries. In particular, the number of different foreign countries from which tips originated points to the international growth of the program. Surprisingly, less than one half of all whistleblower tips came from corporate insiders. According to the Report, those non-insiders include victimized investors and individuals with a “personal relationship with the alleged wrongdoer.”

Also of interest is that almost 4 out of 5 whistleblowers stated that they raised their concern internally before going to the Commission or that their supervisors were aware of their concerns before they went to the Commission. This may shed additional light on the reasoning behind the SEC’s August 4th release of a rule interpretation supporting its view that a person who reports possible wrongdoing internally, but not to the SEC, is still protected as a “whistleblower” on which we have previously blogged. Click here to read the prior post.

In addition to touting the numerical success and growth of the Program, the Report highlights the whistleblower program’s involvement with Enforcement staff in helping ensure individuals feel safe reporting to the Commission without fear of reprisal from their employer. In pursuit of that end, the Commission brought charges under Rule 21F-17(a) against a company for including language in confidentiality agreements that impeded whistleblowers from reporting to the Commission by prohibiting employees from discussing the substance of interviews they gave in internal investigations without approval of the company’s legal department. Further, 2015 saw the Commission’s first successful anti-retaliation enforcement action under the Dodd-Frank Act stemming from a whistleblower’s original information. That whistleblower received a 30% award, the statutory maximum, for providing the Commission with original information that led to the successful enforcement action.

The steady growth of the whistleblower program in terms of number of tips, dollar amount of awards, and geographic diversity of where tips originate seem to point to the continued expanded response to the Program.

Click here to read the entire Annual Report.