The Federal Judiciary Skeptical of Regulators?
In today's battered economy, where venerable giants like Lehman Brothers and Merrill Lynch now face bankruptcy or sale, a more subtle but equally intriguing phenomenon has taken hold. Beginning a few years ago and continuing today, more and more federal courts across the country have been standing up to the regulators, most notably evidenced by the rising number of dismissals of enforcement actions brought by the U.S. Securities and Exchange Commission, notwithstanding the looming specter of Enron, options backdating scandals, hedge fund shenanigans, and even more recently the auction rate securities fall-out.
The question is ... why?
Two recent cases evidencing this trend include S.E.C. v. Pasternak, 2008 WL 2501355 (D.N.J. June 24, 2008) and S.E.C. v. Mangan, 2008 WL 3925059 (W.D.N.C. August 20, 2008). In Pasternak, the SEC brought an action against supervisors and senior executives within a registered broker-dealer firm, for alleged violations of the anti-fraud and other provisions of the 1933 Securities Act and the 1934 Exchange Act. The defendants moved for judgment on partial findings after a two week trial, and the district court granted their motion across the board, holding that, among other things, the existence of fraudulent conduct was not established and the firm was not subject to primary or secondary liability.
Similarly, in Mangan, the SEC alleged that a registered represented of a broker-dealer engaged to acted as an underwriter and financial advisor to a hedge fund utilized material nonpublic information acquired during the process to effectuate a short sale of certain company stock in violation of various anti-fraud and insider trading provisions of the Securities and Exchange Acts. After hearing the parties' cross motions for summary judgment, the court granted Mangan's motion and denied the SEC's. Notably, in its decision, the court observed "[w]ithout citing any caselaw in support of its position, the SEC urges the court to evaluate the materiality of the trade at issue according to an “event window” posited by their expert witness" and later in its decision criticized the SEC for making what the court considered an "illogical" argument. Mangan at *3 fn 6 ("Even if the SEC could offer competent evidence of “leakage” it cannot claim that the information was nonpublic while simultaneously claiming that the information caused the price to decline prior to the public announcement. See SEC v. Butler, 2005 WL 5902637, *12 (W.D.Pa. April 18, 2005)(rejecting this same argument by the SEC as “illogical”)").
Clearly, there could be any number of reasons as to why the courts appear to be taking a harder look at SEC enforcement actions. Some industry pundits suggest the past eight years of Republican leadership in the White House and, for a majority of that time, Congress as well, filled a number of vacant judicial seats around the country with individuals distrustful of government and less willing to take at face value mass allegations by the regulators of corporate impropriety and conspiracy. Others, however, believe that the SEC and other agencies have either gotten greedy or are taking too aggressive of a stance in going after alleged wrong-doers, thereby forcing individuals to defend cases that would have otherwise settled.
Whatever the reason for this quiet turn of events, it's not likely to end anytime soon. The simple fact of the matter is that federal judges are appointed for life, and the growing number of enforcement actions being dismissed will only serve to embolden defendants to litigate claims they might have otherwise settled. Only time will tell whether SEC enforcement prosecutions will rebound. But for now, despite a sagging economy, corporate defendants appear to have some momentum.
