The SEC ALJs: A Six-Month Checkup


Nearly six months ago, the Supreme Court issued its opinion in Lucia v. SEC, in which the Court, in an opinion authored by Justice Kagan, found that the SEC used an unconstitutional appointment process for selecting its administrative law judges. While the case in its early stages may have appeared to pose a threat to SEC administrative enforcement, the Lucia matter ended with a sigh rather than a bang. The SEC (perhaps) remedied its defective hiring procedures, Raymond Lucia got his new hearing, and the Commission remanded approximately 200 cases previously before ALJs or on appeal to the SEC to different administrative judges for reconsideration.

The existential threat to administrative enforcement has largely devolved into a bureaucratic annoyance since last June. While another Supreme Court securities enforcement decision, Kokesh v. SEC, fundamentally changed the way the SEC selects cases to prosecute, Lucia has basically become a problem of resource allocation that will eventually fade into the sunset as the remanded cases become final. Until the last of the remanded cases reaches finality, however, the administrative law judges have a sizable backlog to work through.

 

The Results So Far

So what have the SEC ALJs been doing since June? While a quick look indicates that they have been very busy, disposing of 77 cases at the time of this writing. A closer examination shows that the judges have racked up these rather impressive case closure numbers by snipping the low-hanging fruit. The overwhelming majority of these cases have resulted in default judgments and involve actions to revoke registrations failed to file timely periodic reports with the Commission, in violation of Exchange Act Section 13(a) and Rules 13a-1 and 13a-13. These revocation actions are routine and are rarely contested.

Most of the cases involving issues other than filing delinquencies still do not involve heavy judicial lifts. One of the non-failure to file cases was a follow-on proceeding in which the SEC sought and received an industry bar. The action flowed from a civil enforcement case in which the SEC prevailed and the district court enjoined the defendant from future antifraud and registration violations of the provisions of the federal securities laws. In another case, the respondent did not challenge the pre-Lucia decision against him and received an industry bar.

 

The Glaring Exception

One ALJ proceeding stands out from the rest of the list of default judgments and filing delinquency cases decided in the wake of Lucia. Administrative Law Judge Jason S. Patil heard the case of Roni Dersovitz, a New York-based attorney and hedge fund manager, and his fund. The Dersovitz fund invested in the legal receivables of attorneys in connection with settlements those attorneys had obtained on behalf of their clients. As alleged, Dersovitz and the fund defrauded investors by marketing and selling investments in the fund based on misrepresentations concerning the type and diversification of assets under management in the fund, and by improperly withdrawing money from the fund using valuations based on unreasonable assumptions (the judge dismissed the valuation claim earlier in the case). As alleged, the fund’s disclosures falsely stated that its receivables portfolio came exclusively from resolved cases, rather than those still in litigation. According to the Order Instituting Proceedings, the Enforcement Division sought disgorgement and civil penalties, as well as other remedies.

Judge Patil heard the case in its initial stages. After the Lucia decision and the expiration of the SEC’s stay of all administrative cases, the parties submitted a joint agreement in which the respondents waived their right or entitlement to a new hearing before a different judge and elected to proceed before Judge Patil on the existing record.

Two elements set this case apart from the routine procedural cases that make up the bulk of the recent ALJ initial decisions. The first is the nature of the hearing, as Judge Patil took evidence in the case for more than a month, while the second involves the star-studded roster of defense counsel employed by Dersovitz and the fund. The defense team included former SEC Commissioner Roel C. Campos, and Terence Healy, a former Senior Assistant Chief Litigation Counsel for the SEC’s Division of Enforcement, as well as three partners from the prominent firm of Boies Schiller Flexner LLP.

Judge Patil’s initial decision was a mixed bag for Dersovitz. The judge granted Dersovitz’s motion to dismiss the valuation allegations at the conclusion of the hearing, leaving only the allegations of misrepresentations concerning the fund’s investment portfolio. Judge Patil found that the Enforcement Division failed to show an intent to deceive, and concluded that the information concerning the fund and the access and responsiveness provided by the respondents to all investors, whether automatically or upon request, rebutted the Enforcement Division's scienter allegations. Due to this finding of a lack of scienter, the judge dismissed the SEC’s claims based on Exchange Act Section 10(b) and Rule 10b-5 and Securities Act Section 17(a)(1).

The SEC did establish, however, that the respondents acted negligently with regard to their investment portfolio disclosures concerning the mix of receivables from resolved cases and matters still involving litigation risk. According to Judge Patil, the inaccurate language in the fund’s disclosures were "inconsistent with the reasonable care a hedge fund should take when it in fact had substantial positions in receivables based on pending litigation rather than settlements and judgments." Because Judge Patil found that the respondents failed to adhere to the appropriate standard of care and repeatedly made materially misleading statements over a period of several years, he found them liable for willfully violating Securities Act Sections 17(a)(2) and (a)(3).

Judge Patil, after finding that the deficiencies were serious and recurring, and that the respondents would be in a position to commit further Section 17(a)(2) and (a)(3) violations, issued a cease and desist order. He denied the division’s request to bar Dersovitz permanently from the securities industry, but did issue a six-month suspension “to ensure that Dersovitz and similarly situated industry actors understand the serious consequences of even negligent violation of the antifraud provisions.”

Due to extenuating and mitigating circumstances, Judge Patil set the civil penalty amounts at half the maximum amount authorized for each violation. He imposed 15 penalties of $3,750 each on Dersovitz, for a total of $56,250, and ordered the fund to pay 10 penalties of $37,500 and five of $40,000, for a total of $575,000.