Federal Judge Criticizes The SEC for “Incredible Government Overreach”

In what appears to be a trend resulting from Mary Jo White's efforts to create a more aggressive Securities andExchange Commission, ("SEC") - U.S. District Court Judge William H. Pauley III sharply criticized the SEC for overly aggressive, and possibly improper, enforcement tactics.

On May 21, 2015, in a hearing before Judge Pauley in SEC v. Caledonian Bank Ltd., et al., 15 Civ. 894 (S.D.N.Y.), the SEC admitted that it caused the collapse of Caledonian Bank. Despite knowing that the bank's net equity was only $25 million, the Commission refused to reduce the $76 million ex parte asset freeze it had obtained to $25 million, thereby freezing the accounts of innocent bank customers and causing the bank to fail. In a sharply worded exchange with Richard E. Simpson of the SEC's Washington office, Judge Pauley searched for an explanation for the SEC's refusal to lower the asset freeze to $25 million so that customer accounts would not be frozen.

THE COURT: Was the SEC aware at the time that it came before me with its ex parte application that Caledonian Bank's net equity was only $25 million and that anything above that amount represented depositors' money? MR. SIMPSON: No, your Honor. THE COURT: When did you learn that? MR. SIMPSON: I believe we learned that over the weekend after the filing of the complaint. THE COURT: When you learned that, did you bring that to the Court's attention or seek a reduction in the assets that were being frozen? MR. SIMPSON: We did not, your Honor. THE COURT: Why not? MR. SIMPSON: We were negotiating with Caledonian and I believe they requested a reduction in the freeze amount. We took that to a very high level within the commission and decided that we were not going to agree to that. THE COURT: How could the commission think that they are entitled to a freeze of seizing moneys that belong to depositors? MR. SIMPSON: Your Honor, I believe that we were negotiating with Caledonian on that issue and we did not specifically address that issue. THE COURT: The bank collapsed because of your actions, didn't it? MR. SIMPSON: Yes, your Honor. THE COURT: It's stunning. It's incredible government overreach.

The Court then took the extraordinary step of ordering the SEC to submit an affidavit explaining among other things, who at the SEC made the decision that the asset freeze should not be lowered to $25 million.

The SEC's refusal to lower the asset freeze and Mr. Simpson's inability to explain the basis for the refusal is another example of what many view as a problematic approach to enforcement at the agency. Indeed, the Commission itself is increasingly divided regarding the merits of enforcement cases the agency has brought. According to The Wall Street Journal, in the last few weeks, at least five cases have been brought by the SEC without the unanimous approval of all five members of the Commission. And, according to a former SEC enforcement director, the recent "fractures among commissioners you are seeing now" are historically rare.[1] So while the Commission's Division of Enforcement ("Division") has brought a record number of cases, the historically unusual dissension may be a signal that the Division set this record by bringing weaker cases in seeking to be a more aggressive enforcement agency.

Similarly, not only has the agency brought a record number of enforcement cases, Andrew Ceresney, the head of the SEC's Division of Enforcement, recently announced that the SEC would start bringing more insider trading and similarly complex cases in its in-house administrative courts instead of the federal courts. Although he denied this new approach had anything to do with increasing the SEC's chances of winning, many commentators argued this was nothing more than an attempt to exploit the SEC's far higher winning percentage in administrative courts (estimated at 90-100%) after losing several high profile cases in 2013 and 2014. This strategy was criticized by a number of people, including Judge Jed Rakoff, who criticized the strategy as replacing the impartiality of a federal court with "administrative fiat" from a Commission acting as a "law unto itself".[2] For a complete discussion of this very controversial policy, see the recent client alert by Sadis & Goldberg partner Sam Lieberman entitled "SEC Enforcement Issues New Guidance on Choosing In-House vs. Federal Courts".

As demonstrated by the Caledonian case, overly aggressive enforcement tactics can hurt investors and the public rather than help them. The Caledonian case, the recent dissension at the Commission, and the new policy of bringing complex cases in administrative courts (arguably to bolster its winning percentage), are all signs of an agency, that in this author's opinion, is engaging in overly aggressive enforcement tactics. Unless reigned in, the SEC's use of such tactics will cause the needless failure of other financial institutions, harming both the public and investors. If you have any questions about this Alert, please contact Douglas Hirsch at (212) 573-6670 or dhirsch@sglawyers.com. ******* [1] Wall Street Journal, "SEC Bickering Stall's White's Agenda", June 4th 2015. [2] N. Raymond, "U.S. Judge Criticizes SEC Use of In-house Court for Fraud Cases," (Nov. 5, 2014).

Cheryl Spratt