Wednesday, January 18, 2017

Petition urges ‘look through’ of motions to vacate arbitration awards for jurisdiction

By Amy Leisinger, J.D.

Two investors have asked the Supreme Court to determine that a party seeking to vacate an arbitration award under Section 10 of the Federal Arbitration Act is entitled to the same “look through” analysis for jurisdiction as a party seeking to compel arbitration under Section 4. In addition, the petitioners ask the Court to consider whether federal subject matter jurisdiction arises under the “manifest disregard” of law when arbitrators found no margin call despite a mandatory call by operation of law (Goldman v. Citigroup Global Markets Inc., December 23, 2016).

Arbitration. When their financial advisor moved to Citigroup Global Markets Inc. during the start of the financial crisis, the investors transferred their accounts. However, the advisor and the firm did not warn the couple that they would be subject to a margin call upon receipt of the securities, one higher than could expected based on their status as “new investors.”

The investors filed an action with FINRA for arbitration. Following evidentiary battles and a determination that there was no margin call, the couple lost their claim. They then filed a motion to vacate under FAA Section 10, but the district court dismissed the action for lack of subject matter jurisdiction. A Third Circuit panel affirmed, finding that a court cannot look through a Section 10 motion to the arbitration subject matter to establish federal-question jurisdiction.

Cert petition. The petitioners seek reversal of this holding in accord with the Seventh, Ninth, and D.C. Circuits and urge the Supreme Court to the Second Circuit’s holding in Doscher v. Sea Port Group Securities, LLC, which was decided just after the Third Circuit’s decision in the petitioners’ case. In Doscher, the Second Circuit overruled its own precedent and held that the district court could look through a motion to vacate to determine if the underlying dispute involved substantial questions of federal law. The petitioners ask the Court to resolve the circuit split by adopting the Second Circuit position and apply the principles of the Supreme Court’s decision in Vaden v. Discover Bank to motions to vacate. In Vaden, the Supreme Court held that a federal court may look through a petition to compel arbitration under FAA Section 4 in order to determine whether the petition is predicated on an action arising under federal law. Those subjected to arbitration should have the same rights as those who seek to compel it, according to the petitioners.

Moreover, the petitioners argue, the motion to vacate itself raised federal-question jurisdiction by demonstrating “manifest disregard” of federal margin laws by the arbitrators, who refused to regard evidence of the margin call that arose by operation of law. “That manifest disregard of law also demonstrates the evident partiality or outright corruption of arbitrators in this case,” the petitioners stated. The Third Circuit panel ignored this evidence in finding that the motion to vacate failed to raise a substantial question of federal law, the petitioners concluded.

The petition is No. 16-874.

Tuesday, January 17, 2017

CFTC swap data proposals align with Congress’s FAST Act


CFTC Chairman Timothy Massad has announced the proposal, by a unanimous vote, of Commodity Exchange Act (CEA) rule amendments making it easier for domestic and foreign regulators to access swap data repository (SDR) swap data.

The Dodd-Frank Act promulgated new CEA Section 21 to create SDRs for housing swap data that other CEA rules required swap dealers (and other parties) to report on from their swaps transactions. CEA Section 21 also mandated that domestic and foreign regulators, to receive this swap data, had to first agree in writing to abide by a CEA Section 8 confidentiality agreement, as well as indemnify the SDR and CTFC for any expenses arising from litigation pertaining to the confidentiality agreement.

When the CFTC, in its preamble to the 2011 final rules adopting the above Dodd-Frank provision, and in a 2012 interpretive statement, expressed concern that domestic and foreign regulators would have trouble complying with the indemnification clause because of their respective home country laws, Congress repealed the indemnification clause in the Fixing America’s Surface Transportation (FAST) Act. But the December 3, 2015-adopted FAST Act retained the confidentiality agreement, specified that “swap” data as opposed to “all” data must be provided to entities, and authorized the CFTC to determine which “other foreign authorities” are appropriate to receive SDR swap data.

Massad expressed his pleasure that with the FAST Act in place, the CTFC can now eliminate the indemnification provision in the current proposal and make other swap and non-swap changes to Part 49 of the CEA rules to conform to Congress’s intent for a seamless process that allows domestic and foreign regulators to access SDR information, while simultaneously protecting confidentiality.

CEA Rules, Part 49. The CFTC would propose the following amendments to Part 49 (RIN 3038-AE44), Sections 49.2, 49.9, 49.17, 49.18 and 49.22:
  • 49.2 adds “other foreign authorities” to the list of foreign regulators identified in Section 49.2(a)(5), consistent with the FAST Act’s amendments to CEA Section 21(c)(7)(E) which include “other foreign regulators” among the entities that the CFTC may consider appropriate to access SDR swap data;
  • 49.9 makes clarifying changes;
  • 49.17 and 49.18 delete all references to the indemnification requirement and/or indemnification agreement, among proposing other similar changes; and
  • 49.22 omits a reference to indemnification, to conform to the corresponding FAST Act amendment to the CEA.
CEA Rules, Parts 3 and 9. Separately, the CFTC voted to propose updates to Parts 3 and 9 (RIN 3038-AE15) of the CEA rules. Part 3 governs registration, and Part 9 contains the rules related to review of exchange disciplinary, access denial, and other adverse actions. The proposed amendments, technical in nature, would integrate existing advisory guidance, incorporate swap execution facilities (CEFs) and update designated contract market (DCM) provisions. The proposed revisions to Part 9 would specifically delete numerous cross-references to previously deleted Part 8 regulations during Dodd-Frank implementation and add citations to applicable parallel provisions in Part 37 for SEFs and Part 38 for DCMs. The proposal would also address the publication of final disciplinary and access denial actions that SEFs and DCMs took on their exchange websites.

Monday, January 16, 2017

Dr. King's legacy must be remembered

[In commemoration of Martin Luther King, Jr. Day, we republish a post by the late Jim Hamilton from January 20, 2014, honoring Dr. King and his legacy.]

By Jim Hamilton, J.D., LL.M.

"I was taking a part of the South to transplant in alien soil. To see if I could respond to the warmth of other suns."

- Richard Wright

"Rosa Parks rode it. Dr. King paved it. It’s cicadas making noise with a Southern Voice."

- Tim McGraw

In her prize-winning book, "The Warmth of Other Suns,’" New York Times reporter Isabel Wilkerson details the Great Migration of six million Southern African-Americans to the North and West to escape the segregated South. Because of Dr. Martin Luther King, Jr., who we celebrate today, no one has to seek the warmth of other suns. In fact, there is now occurring a reverse migration back to the South. One of the great achievements of Dr. King is that this civil right revolution was accomplished largely non-violently. In our age of sometimes bitter legislative partisanship, we must remember that Dr. King appealed to our sense of common humanity and a shared sense of social justice. In this 50th anniversary year of the War on Poverty, Dr. King's concern for poverty and the opportunity for all people to rise out of poverty should be remembered. We must never forget his legacy.

Friday, January 13, 2017

OCIE announces examination priorities for 2017

By Jacquelyn Lumb

The SEC’s Office of Compliance Inspections and Examinations this year will focus on areas of importance to retail investors, risks affecting elderly and retiring investors, and the assessment of market-wide risks. OCIE believes these areas carry the greatest potential risk to investors or to the integrity of the financial markets. Each year, OCIE publishes its examination priorities so that registrants can consider whether their compliance programs are in need of improvement. The priorities are selected in consultation with other SEC offices and divisions.

Retail investors. In connection with its focus on retail investors, OCIE will examine the use of electronic investment advice, wrap fee programs, exchange-traded funds (ETFs), never before examined investment advisers, recidivist representatives and their employees, multi-branch advisers, and share class selections.

During its examination of the use of investment advice via automated or digital platforms, the staff will consider registrants’ compliance programs, marketing, formulation of recommendations, data protection, and disclosures about conflicts of interest. The staff will also review registrants’ compliance practices for overseeing algorithms that generate investment recommendations.

The examination of wrap fee programs, in which investment advisers or broker-dealers charge a single bundled fee for advisory and brokerage services, will include whether investment advisers are acting in a manner that is consistent with their fiduciary duty and whether they are meeting their contractual obligations to clients.

The staff will review ETFs for compliance with any exemptive relief they have been granted, along with their unit creation and redemption processes. Another area of focus for ETFs will be on their sales practices and disclosures regarding the suitability of broker-dealers’ recommendations to purchase ETFs with niche strategies.

The staff will use data analytics to identify individuals with past records of misconduct and will examine the investment advisers with which they are employed.

Multi-branch advisers—those that provide advisory services from multiple locations—can pose unique risks, according to OCIE, which is why the staff will review the design and implementation of their compliance programs and their oversight of the services provided at the branch offices.

The staff will look for possible conflicts in connection with recommendations that investors acquire or remain invested in certain mutual fund share classes, such as classes with higher loads or distribution fees. It will also assess the formulation of investment recommendations and the management of client portfolios.

Senior investors. OCIE will continue its ReTIRE initiative which focuses on retirement account services. The examinations will include reviews of the recommendations and sales of variable insurance products and target date funds, and will include assessments of the controls over cross-transactions, with a particular focus on fixed income securities.

The staff will examine public pension advisers to assess how they are managing conflicts of interest and how they are fulfilling their fiduciary duties, in addition to looking at risks specific to these advisers such as pay-to-play and undisclosed gifts and entertainment.

The staff will also evaluate firms’ interactions with senior investors and whether they are able to identify any exploitation of seniors.

Market-wide risks. The market-wide risks on which OCIE will focus include those associated with money market funds, payment for order flow, clearing agencies, FINRA, Regulation Systems Compliance and Integrity (SCI), cybersecurity, national securities exchanges, and anti-money laundering programs.

The money market fund reviews will assess compliance with rules adopted in 2014. The payment for order flow reviews will assess how broker-dealers are complying with their duty of best execution. The review of clearing agencies will be determined through a risk-based approach in collaboration with the Division of Trading and Markets. OCIE plans to enhance its oversight of FINRA and will continue to examine whether SCI entities are complying with Regulation SCI.

In addition to the priorities outlined above, OCIE advised that it will also allocate some of its examination resources to municipal advisers, transfer agents and private fund advisers. OCIE also may conduct examinations relating to risks, issues, and policy matters that arise from market developments or new information that comes from tips, complaints and referrals.

Thursday, January 12, 2017

‘HALOS’ capital bill sails through House

By Mark S. Nelson, J.D.

The House once again passed the Helping Angels Lead Our Startups (HALOS) Act, a bill sponsored by Steve Chabot (R-Ohio) that seeks to clarify the general solicitation rules targeted by the Jumpstart Our Business Startups (JOBS) Act regarding demo days events. The bill also would clarify what it means to be an angel investor (H.R. 79). The latest version of the HALOS Act passed by a vote of 344-73. In the last Congress, the House passed a version (Report No. 114-509) of the bill by a similar margin, but the equivalent Senate bill languished.

Amendments defeated. The bill faced little drama beyond an attempt to add investor protection provisions via two amendments, which ultimately faltered by similar margins on separate recorded votes. Representative Nydia Velazquez (D-NY) sought to ensure that attendees at demo days events receive information about the nature of the event. The amendment also would have clarified that attendance at these events is not by itself a preexisting relationship. The existence of a preexisting relationship is a key part of SEC guidance for some aspects of Regulation D.

Another amendment, offered by William "Lacy" Clay Jr. (D-Mo) on behalf of House Financial Services Committee Ranking Member Maxine Waters (D-Cal) would have disallowed the bill’s favorable treatment to blank check companies and it would have limited fees that can be collected by event sponsors.

House FSC Chairman Jeb Hensarling (R-Tex) told members on the floor that the HALOS Act would clarify existing law and create jobs to grow the economy. Co-sponsor Kyrsten Sinema (D-Ariz) echoed Hensarling’s observation that the bill has wide bipartisan support.

Not a general solicitation. The JOBS Act lifted the ban on general solicitation in some Regulation D Rule 506 offerings, but the HALOS Act seeks to push the SEC to adopt an amendment to the current ban on general solicitation in other offerings conducted under Regulation D Rule 502(c) that may apply to certain events commonly attended by issuers seeking to raise capital. Specifically, the Commission would have to provide that “demo days” events sponsored by, among others, angel investor groups, enjoy an exception from the ban.

Lawmakers promoting the bill argued that it will clarify the status of demo days while existing SEC guidance can be read to raise doubts over whether the verification requirement in Regulation D applies to these events. A pair of no-action letters (Michigan Growth Capital Symposium; Citizen VC) and a set of Compliance and Disclosure Interpretations (Securities Act Rules C&DIs) issued by the SEC’s Division of Corporation Finance spurred lawmakers’ worries. Members who opposed passage of the HALOS Act said it lacked sufficient investor protections.

Other requirements imposed by the bill for these events would include that advertising not mention specific securities offerings and that the sponsor not provide investment recommendations or advice to those in attendance. But a rule of construction limits the Commission’s mandate to amendments for presentations and communications and not purchases or sales. The required regulatory changes would need to be made within six months of enactment.

Elsewhere, the bill would define “angel investor group” to mean a group of accredited investors who invest their own capital in early-stage companies; who hold regular meetings and adhere to a process for making investments; and who are not associated or affiliated with brokers, dealers, or investment advisers.

Wednesday, January 11, 2017

Outgoing CFTC chief warns against dismantling global market reforms

By Brad Rosen J.D.

In remarks before the London School of Economics, CFTC Chairman Timothy Massad proclaimed that repealing or dismantling the market reforms that emerged globally in the wake of the 2008 economic crisis would be a major mistake. Massad, who will be resigning from the commission effective inauguration day, January 20th, returned to some familiar themes. He pointed to the success of the Dodd Frank reforms and the resilience they provide to the financial system. He also underscored the central role international coordination and harmonization played in these reforms.

In his address, Massad reviewed some of the economic events and developments, and the dramatic changes in the regulation of derivatives that have occurred over the past eight years under President Obama. The chairman recalled the depths of the financial crisis which resulted in nine million Americans losing their jobs, five million losing their homes, and a loss of 13 trillion dollars in family wealth. He also reminded of the causes that lead to the meltdown—a housing bubble, excessive risk assumed by banks, mounting household and corporate debt, and a regulatory system plagued by gaps and deficiencies. Since the 2010, the chairman noted that 15.5 million jobs have been added in the U.S., the unemployment rate has been halved, housing prices have rebounded, and the Dow Jones index is nearing 20,000, compared to less than 8500 on inauguration day 2009.

Massad also recalled the 2009 agreement among the U.S., the UK and other G20 member nations which served as the basis for the Dodd Frank legislation in the U.S. These points of agreement leading to the reforms included standardized swaps cleared through central clearinghouses, margin required for uncleared contracts, swaps traded on regulated platforms, and contracts reported to trade repositories. According to Massad, the resulting reforms have worked as over 80 percent of swap transactions worldwide are being cleared today as compared to only 15 percent in 2007, and margin is being posted and collected for uncleared swaps.

Despite the accomplishments under Dodd Frank and related global reforms, Massad is well aware these reforms are at risk of being undone, observing, “the presidential election in the U.S. and the Brexit vote here in the UK have been interpreted as evidence of deep discontent with governmental policies and economic conditions, particularly by working class voters. To many commentators, these votes called into question assumed wisdom about the benefits of international trade and globalization.” He continued “[i]n the United States, there is talk of repealing many of the reforms taken in response to the crisis, as they have been said to hinder economic growth. And in the UK, the Brexit vote raises questions about the future of London as an international financial center.”

Massad also realizes there is much that can still be done to fine tune and improve upon the existing regulatory framework, and there is room for differing opinions on how to best implement the framework. In particular he suggested that the role of central clearing, issues surrounding market liquidity, and cybersecurity concerns continue to receive the attention and support of regulatory authorities. In concluding, Chairman Massad reflected, “[w]e are unlikely to predict what will cause the next financial crisis. But the measures we have implemented in response to the 2008 financial crisis have made the global financial system more resilient. The international cooperation in their implementation has been unprecedented.”

Tuesday, January 10, 2017

Davis Polk, National Association of Corporate Directors voice objections to universal proxy proposal

By Amy Leisinger, J.D.

In recent comments, Davis Polk & Wardwell LLP and the National Association of Corporate Directors objected to the SEC’s universal proxy proposal, citing several regulatory and administrative concerns. According to Davis Polk, the proposal likely exceeds the Commission’s authority and lacks sufficient supporting data to ensure that the proposed changes would not adversely affect board effectiveness, and, if the SEC proceeds with the changes, an optional approach limited to contested elections would be more appropriate. Alternatively, the NACD noted that universal ballots could result in a “mix and match” voting approach causing investor confusion and ultimate election of directors not suited to the specific company.

Universal proxy proposal. Under the current proxy rules, only shareholders who attend a meeting in person at which directors are elected are able to vote for nominees on both management and dissident proxy cards; those who vote by proxy must submit their votes on one or the other and cannot choose a combination. The proposed amendments to the proxy rules would require proxy contestants to provide a universal proxy card that includes the names of registrant and dissident nominees, allowing shareholders to choose among all of the candidates rather than casting an all-or-nothing vote.

Davis Polk. Davis Polk suggested that the proposal, if adopted, would exceed the SEC’s Exchange Act authority and may also be vulnerable to a challenge under the Administrative Procedure Act. In previously preserving the bona fide nominee rule many years ago, the firm noted, the SEC implicitly concluded that it lacked authority to prescribe universal proxies. Exchange Act Section 14(a) was designed to address proxy-process abuses, and, if the Commission intends to reinvent the process in addition to policing it, it needs additional congressional authority, Davis Polk stated. Further, when an agency seeks to reverse an established policy, the courts and the Administrative Procedure Act impose a high bar. Before mandating universal proxies, the SEC would need to provide specific evidence justifying its policy reversal, which it does not currently possess, the firm explained.

If the Commission proceeds with the proposed changes, it should make the use of universal proxies optional, require any users to solicit all shareholders, and address only contested elections, according to the firm. An optional approach allowing the dissident and management the choice either to list only its own nominees or to use a universal proxy that lists the nominees of all parties would allow the Commission to study the impact of universal proxies before mandating use to meet its goals while minimizing investor confusion, Davis Polk explained. In addition, requiring solicitation of all shareholders (rather than the majority stated in the proposal) would create a level playing field for all parties involved, the firm concluded.

NACD. The NACD noted that the “mix and match” approach permitted by universal proxies could result in boards less-than suited to serve specific companies. Slates are typically created by individuals who have given extensive thought to the group that would make up an optimal board, the organization said, and shareholders choosing among names on a universal proxy could end up voting for a random set of nominees instead of a cohesive group put together with particularized focus on the needs of the company.

The NACD said that, ideally, an election would not be contested because boards and shareholders would communicate effectively but opined that, if dissident slates arise, the contest should be among the groups. “[A] mix and match of board-nominated and dissident-nominated candidates in a universal proxy is not the solution,” the NACD concluded.

Monday, January 09, 2017

FINRA provides industry with guidance for 2017

By Brad Rosen, J.D.

FINRA has provided member firms with a compliance road map for the year ahead with the release of its 2017 Regulatory and Examination Priorities Letter. As in past years, the letter focuses on “core blocking and tackling issues of compliance, supervision, risk management” matters as noted in introductory comments by FINRA President and CEO, Robert Cook. Cook took the helm at FINRA in August of last year after spending many years as a partner in the securities practice at Cleary, Gottlieb, Steen and Hamilton.

Cook explained, “[a]ttention to core regulatory requirements identified in the letter—and how to address them in light of new business challenges and market developments—will serve investors and markets well.” The letter describes five areas of concerns where the FINRA will focus its attention this year.

High-risk and recidivist brokers. In dealing with the industry’s bad apples (or those with propensities to become bad apples), FINRA said it will “devote particular attention to firms’ hiring and monitoring of high-risk and recidivist brokers including whether firms establish appropriate supervisory and compliance controls for such persons.” Toward this end, the regulator has already formed a dedicated examination unit to identify and examine high-risk brokers. It has also beefed up examination protocols to review firm procedures for the hiring and subsequent supervision these type of brokers.

Sales practices. Protecting seniors will remain one of FINRA’s main priorities, especially with regard to selling the elderly complex or inappropriately risky products. The regulator will also be on the lookout for fraud in connection with penny stocks or microcaps, an area where seniors are often targeted by unscrupulous operators and especially vulnerable. Other issues on FINRA’s radar include product suitability, excessive and short-term trading, outside business activities, as well as emerging social media practices and electronic communications.

Financial risks. Last year, FINRA identified firms that lacked liquidity risk management plans, failed to conduct stress tests, failed to use sufficiently rigorous assumptions in their stress tests, or that failed to maintain sufficient sources of funding. Accordingly, the regulator will step up efforts to review firm funding and liquidity plans, and whether firms have adequately assessed their liquidity requirements in light of applicable stresses

Operational risks. Not surprisingly, FINRA view cybersecurity threats as one of the most significant risks many firms face in 2017. Accordingly, the regulator may scrutinize controls firms use to monitor and protect customer data as well as examining controls to protect sensitive information from insider threats. FINRA also sees the need for member firms to enhance controls related to the use of passwords, encryption of data, use of portable storage devices, as well as the physical security of assets and data.

Market integrity. Deterring and detecting manipulation remains a critical priority for FINRA and it will continue to provide members with tools and guidance to address these problems. The regulator is also committed to assuring that members comply with best order execution obligations, and maintain and monitor controls around market access.

The examination and priorities letter provides FINRA members and other industry participants with a useful window into the thinking and likely actions of examiners as the 2017 exam cycle starts. It also promotes an ongoing dialogue between the regulator and the regulated with the ultimate goal of furthering FINRA’s mission of investor protection and market integrity.

Friday, January 06, 2017

Chair White expresses support for continued efforts toward global accounting standards

By Jacquelyn Lumb

As her time as SEC chair nears an end, Mary Jo White issued a statement urging her successor, together with a full Commission, to continue to advance the objective of high quality globally accepted accounting standards. While U.S. constituents do not support either the adoption or the option of using international financial reporting standards at this time, White said it does not lessen the importance of their engagement on IFRS or the broader efforts to enhance globally accepted standards. She urged the next chair and Commission to build on past efforts and to give the goals of high quality globally accepted accounting standards the attention this critical issue deserves.

White noted that she has strongly encouraged engagement on this issue during her term as SEC chair and early on ordered a broad review by the Office of the Chief Accountant. U.S. investors make investment decisions based on the financial statements of foreign companies that use IFRS, she said. While U.S. companies use U.S. GAAP, it is not to the exclusion of IFRS since they make acquisitions and enter into joint ventures in reliance on IFRS information. In addition, multinational companies often are required to use IFRS for their reporting with respect to their foreign subsidiaries.

Although FASB and the IASB have completed their high priority convergence projects, White said their progress must continue. Their continued engagement opens the door to what she referred to as a sequential approach, which can result in convergence over time as the two boards evaluate each other’s independently adopted standards.

While U.S. GAAP and IFRS will continue to coexist for the foreseeable future, White emphasized the importance of continuing to narrow the differences between the two. She said the pursuit of high quality globally accepted accounting standards is part of the SEC’s continuing responsibility to encourage, facilitate, and direct efforts to enhance the quality of all financial reporting that affects investor protection and strengthens the markets.

Thursday, January 05, 2017

CII sings the praises of SEC’s universal proxy proposal

By Amy Leisinger, J.D.

In recent comments, the Council of Institutional Investors applauded numerous aspects of the SEC’s universal proxy proposal. Noting its own ongoing efforts to facilitate the use of universal proxy cards in contested elections, the CII also offered its support for proposed revisions to the form of proxy and disclosure requirements with respect to voting options and voting standards applicable to all director elections. The organization did, however, offer some suggested modifications to further enhance the benefits of universal proxies for shareholders.

Universal proxy proposal. Under the current proxy rules, only shareholders who attend a meeting in person at which directors are elected are able to vote for nominees on both management and dissident proxy cards; those who vote by proxy must submit their votes on one or the other and cannot choose a combination. The proposed amendments to the proxy rules would require proxy contestants to provide a universal proxy card that includes the names of registrant and dissident nominees, allowing shareholders to choose among all of the candidates rather than casting an all-or-nothing vote. Proxy contestants would be required to provide each other with a list of their director candidates, and dissidents would be required to solicit shareholders representing at least a majority of the shares entitled to vote. The contestants would have to refer shareholders to each other's proxy statements to obtain information about their nominees, and dissidents would have to file their definitive proxy statement with the SEC by the later date of 25 calendar days before the meeting or five calendar days after the registrant files its definitive proxy statement.

CII universal proxy support. In its comments, the CII stressed that requiring opposing sides engaged in a contested election to use a proxy card naming all management and dissident nominees with equal prominence would allow shareholders (particularly retail investors) to vote for their preferred combination of nominees, providing investors voting by proxy with the same ability to vote for a mix as those attending the meeting in person. Specifically, the CII praised the proposed change to the “bona fide nominee rule” to require that a nominee consent to being named in any proxy statement, as opposed to providing specific consent for an opponent’s proxy card, but suggested that requiring nominees of each party be grouped together clearly with applicable statements of support would address any potential concerns regarding inaccurate appearances of approval. Further, the CII noted, if this rule is amended as proposed, but the universal proxy requirement is not adopted, the short slate rule should be made optional in order to allow a dissident to select registrant nominees to round out its own slate of nominees.

The CII also agreed that the use of universal proxy cards should be mandatory as proposed, as an optional system would not effectively facilitate the equivalent proxy and in-person voting and would provide opportunities for inappropriate tactical use of universal proxy cards. According to the organization, the proposal properly requires a dissident to solicit the holders of shares representing at least a majority of the voting power of shares in order to prevent the dissident from capitalizing on inclusion on the registrant’s universal proxy card without undertaking meaningful efforts. The organization also applauded the proposed requirement that each soliciting person in a contested election refer shareholders to the other party’s proxy statement for information about other nominees.

While further agreeing with the Commission proposed notice and filing periods, the CII commended the proposed change to require the form of proxy for a director election governed by a majority voting standard to include a means for shareholders to vote “against” each nominee and a means for shareholders to “abstain” from voting in lieu of providing a means to “withhold authority to vote.” This change would alleviate confusion with respect to the effects of whether a vote is cast or withheld, according to the organization. However, the CII requested that the SEC also prohibit companies from providing an “against” option if that choice has no legal impact and require them to refer to voting options consistently throughout their materials.

Split-ticket voting will likely increase if the proposed changes are adopted, and shareholder costs and inconvenience will decrease without shifting burdens to registrants, the organization noted. Most importantly, however, “removing constraints on shareholder voting choices through universal proxy cards will result in election outcomes that better reflect shareholder preferences,” the CII concluded.

White paper examines potential regulatory changes under the Trump administration

President-elect Trump’s administration will likely have a significant impact on federal laws and regulations. A white paper authored by Wolters Kluwer editorial staff, Trump’s Win Expected to Bring Significant Legal and Regulatory Changes, discusses potential changes to these areas, including: Tax, Health, Life Sciences, Labor and Employment, Federal Securities, Banking and Finance, Antitrust and Competition Law, Energy and Environmental Law, Government Contracts, Employee Benefits, Payroll, and Pension and Retirement.

Each section analyzes the potential changes the Trump administration may implement based on Trump's statements and proposals during his campaign and his cabinet nominee’s positions on issues; and the risks and impact on the practice of law, businesses, and individuals. In the Securities section, contributor Mark S. Nelson, J.D. discusses the impact of the election on the Dodd-Frank Act and federal regulation of the financial services industry.

Wednesday, January 04, 2017

DOL updates guidance for ERISA plan fiduciaries

By Mark S. Nelson, J.D.

The Department of Labor replaced existing guidance for ERISA plan fiduciaries on proxy voting with a new interpretive bulletin that restores much of the department’s mid-1990s guidance in order to clarify the scope of proxy voting by plan fiduciaries. The new guidance also updates DOL policy on proxy voting related to environmental, social and governance (ESG) matters. The DOL’s new guidance (IB 2016-01), which it issued just before the close of 2016, is already effective.

According to the DOL, its 1994 guidance (IB 94-2) along with its ESG and other guidance detailed in twin 2008 bulletins (IB 2008-1 and IB 2008-2), plus the department’s more recent guidance (IB 2015-1), could be misunderstood to hinder plan fiduciaries from voting proxies that involve ESG and other matters.

IB 94-2 stated a general principle that plan fiduciaries can engage with corporations on a range of matters if there is a reasonable expectation the action likely will enhance the plan’s investment in light of the costs. That guidance, said the DOL, was intended to spur proxy voting unless the costs of voting were beyond the best interests of the plan. But confusion may result if plan fiduciaries strictly quantify the cost-benefit analysis regarding engagement with companies via proxy voting. Moreover, third parties, such as proxy advisers, now provide voting advice at comparatively lower costs.

The DOL also said its existing guidance on proxy voting was poorly aligned with domestic and international trends on ESG matters. The department cited several examples: increased monitoring of companies’ ESG issues by other types of institutional investors; legally required corporate disclosures as exemplified by the Dodd-Frank Act’s say-on-pay shareholder advisory vote; voluntary actions by companies to be more proactive about ESG matters; and the development of stewardship codes by other countries.

“This guidance removes perceived impediments to the prudent management of plans’ rights as shareholders, and encourages fiduciaries to manage those rights in the best interest of plan participants and beneficiaries,” said Phyllis Borzi, Assistant Secretary of Labor for Employee Benefits Security.

Tuesday, January 03, 2017

Court determines investors’ ‘scheme liability’ claims against Medtronic satisfy statute of limitations

By Brad Rosen, J.D.

An Eighth Circuit panel revived an investors’ class action suit against Medtronic finding that its scheme liability claim was not barred by the statute of limitations. Additionally, the court rejected Medtronic’s alternative argument that scheme liability was barred as a matter of law because the investors sought to hold it secondarily liable for the fraudulent statements of others. The court reversed the district court’s grant of summary judgment and remanded the matter for further proceedings (West Virginia Pipe Trades Health & Welfare Fund v. Medtronic, Inc., December 28, 2016, Gruender, R.).

Background. The investor appellants are retirement and investment funds who brought a consolidated class action for securities fraud against Medtronic and related parties in connection with the development, marketing and promotion of its INFUSE product. INFUSE causes the body to develop new bone tissue and is part of the company’s multi-billion dollar spinal line of products. Medtronic obtained FDA approval for INFUSE for certain uses in 2002. Medtronic sponsored the initial FDA clinical trials. Additionally, 13 articles supporting approval were authored by physician consultants who had financial interests in INFUSE.

In 2008, the FDA issued a public health notification warning of certain life threatening side effects associated with the off label use of INFUSE. A party unrelated to this matter brought a class action against Medtronic for its promotion of those uses. Thereafter, INFUSE has been under continued public scrutiny and controversy. In 2010, a number of articles appeared in the Milwaukee Journal Sentinel expressing concerns that that those physicians who had a financial ties to Medtronic were more likely to report favorable results and would withhold unfavorable developments. In letters to the editor, Physicians connected with Medtronic disputed those claims.

In 2011, the U.S. Senate Finance Committee launched an investigation into Medtronic and INFUSE. In October 2012, the committee issued its investigative report finding that Medtronic “was heavily involved in drafting, editing, and shaping the content of medical journal articles authored by its physician consultants who received significant amounts of money through royalties and consulting fees from Medtronic.” The investors filed suit on June 27, 2013 alleging several securities laws violations.

Appellate review and the statute of limitations. Ultimately, all claims were dismissed by the district court. The only claim brought on appeal was the claim for scheme liability. The primary question before the court was whether the investor appellants satisfied the applicable statute of limitation by bringing this case within “2 years after the discovery of the facts constituting the violation.” Accordingly, the threshold question for the court was whether the investors had discovered the operative facts prior to June 27, 2011. While acknowledging that appellants had reason to be suspicious of Medtronic’s conduct concerning INFUSE prior to June 27, 2011, the court held that a reasonably diligent plaintiff would not have discovered facts sufficient to prove and allege scienter based on public information prior to that time. Rather, the court concluded that facts rising to the level of scienter did not become apparent until October 2012 when the Senate Finance Committee issued it highly critical report of Medtronic.

Attack on secondary liability also rejected. Medtronic also asserted that as a matter of law, it could not be held secondarily liable for the misrepresentations or omissions of others. The appellate court rejected this contention as well, finding that the investors’ claims went well beyond mere misrepresentations or omission, and observed that “Medtronic shaped the content of medical journals by paying physicians … to induce their complicity in concealing adverse events and side effects associated with the use of INFUSE …” Finally, the court found that the investors relied on Medtronic’s deceptive conduct finding that “A company cannot instruct individuals to take a certain course of action, pay to induce them to do it, and then claim any causal connection is too remote when they follow through.”

The case is No. 15-3468.

Friday, December 30, 2016

Tenth Circuit splits, determines SEC ALJs are unconstitutionally appointed ‘inferior officers’

By Amanda Maine, J.D.

A divided panel of the U.S. Court of Appeals for the Tenth Circuit has gone against other recent appellate court decisions siding with the SEC regarding its in-house administrative regime. The majority found that the SEC inappropriately determined the Commission’s administrative law judges (ALJs) were not “inferior officers” under the Constitution. According to the panel, the SEC, as well as other district and circuit courts, misinterpreted the Supreme Court’s decision in Freytag v. Commissioner of Internal Revenue (1991) because it concentrated on the lack of finality of the administrative court’s decision instead of the power an ALJ actually possesses (Bandimere v. SEC, December 27, 2016, Matheson, S.)

Administrative proceeding. The SEC brought an administrative proceeding against David F. Bandimere in 2013, alleging various securities fraud and registration charges. The ALJ’s initial decision found that Bandimere was liable for the violations and barred him from the securities industry, ordered him to cease and desist from violating securities laws, imposed civil penalties, and ordered disgorgement. Bandimere appealed to the circuit court, challenging the ALJ’s authority on the grounds that SEC ALJs are inferior officers, and that the ALJ in his case was appointed unconstitutionally under the Appointments Clause. This argument has been met with very little success in other circuits, with most deeming that they lack personal jurisdiction over SEC administrative proceedings that are ongoing under the statutorily approved regime.

Freytag. The Tenth Circuit panel, voting 2-1, broke with its appellate colleagues in ruling that SEC ALJs are inferior officers under the Constitution. Judge Matheson, writing for the majority, disagreed with other circuit courts’ conclusion that the Freytag case hinged on the “finality” of a decision in whether to deem an administrative judge an inferior officer or an employee.

In Freytag, the Supreme Court concluded that special tax judges (STJs) appointed by the Tax Court were inferior officers, and not employees. According to Judge Matheson, the SEC’s argument was based on the argument that ALJs, whose initial decisions can be appealed to the full Commission and then to the appellate court, cannot render final decisions. Judge Matheson advised that this was a misreading of Freytag. Instead, a test of whether a person is an inferior officer should be based on whether that person exercises a great deal of discretion and performs important functions. While final decision-making power is relevant to determining whether a public servant exercises “significant authority,” the judge wrote, it does not mean that final decision making power is dispositive to deeming that the person is an “inferior officer” under the Constitution.

Dissent. Judge McKay dissented from the majority opinion. In addition to voicing his concern about the consequences of declaring ALJs inferior officers, which could “effectively render … invalid thousands of administrative actions,” Judge McKay disagreed with the majority opinion that the STJs of the Tax Court in Freytag were analogous to the SEC’s ALJs. According to Judge McKay, the Tax Court was required to defer to the findings of the STJs. The Commission, hearing an appeal, is not limited by the record and may engage in fact-finding and hear additional evidence, unlike the STJs in Freytag, Judge McMay wrote.

The case is No. 15-9586.

Thursday, December 29, 2016

AES must include shareholder proposal to modify proxy access bylaw

By Jacquelyn Lumb

John Chevedden was successful in his efforts to have AES Corporation include a proposal in its proxy materials to amend its proxy access bylaws in order to align them more closely with the best practices published by the Council of Institutional Investors. The proposed revision would permit the number of shareholder nominees that appear in the proxy materials to be 25 percent of the directors then serving, or two, whichever is greater; would eliminate the number of shareholders who can aggregate their shares to achieve the required three percent threshold; and would remove the limitation on the re-nomination of shareholders based on the number or percentage of votes received in any election. Chevedden said the board should be commended for adopting a proxy access bylaw, but it contains provisions that impair shareholders’ ability to use it.

Basis for omission. AES wrote the SEC of its intent to omit the proposal from its proxy materials on the basis that Chevedden failed to provide the required proof of ownership in response to its request and because the proposal was vague and contained materially false and misleading statements. Chevedden had provided a letter from Fidelity which addressed his ownership in several companies, but AES said the letter did not provide the dates from which he held the shares. AES noted that he must provide proof of continuous ownership of the required number of shares for a one-year period preceding and including October 21, 2016, the date upon which he submitted his proposal.

AES maintained that the three elements in Chevedden’s proposal were subject to multiple and potentially conflicting interpretations and were irreconcilable with the other provisions of the bylaws as amended and restated on November 25, 2015. The proposal also contained false and misleading statements about Delaware law, in AES’s view, referred to an external standard (CII’s best practices) without explaining the context, and materially misrepresented the shareholder base.

AES said it was unclear whether the proposal seeks to modify or to eliminate the eligibility and procedural requirements relating to proxy access nominees or to modify the annual meeting cap on the number of board seats available to those nominees. It was also unclear, in AES’s view, whether the proposal seeks to modify or eliminate the requirements with respect to the number of shareholders who may act as a group or the types of shareholders who may aggregate their shares to validly nominate a proxy access nominee. In addition, AES said it was unclear whether the proposal seeks to modify or to eliminate the limitations and requirements relating to the re-nomination of nominees.

Proponent’s response. Chevedden advised that the Fidelity letter confirming his ownership of the requisite number of shares in three companies, including AES, included a date from which the shares were held that related to all three, not merely the last one to which the letter referred. He added that this same format was used for dozens of 2016 proposals without triggering a no-action letter request.

Chevedden also addressed each of the elements with which AES took issue and suggested that AES was applying twisted logic to challenge the intended interpretations. He added that shareholders do not have to read CII’s best practices to understand the issues on which they would be voting, so guidance or context were not necessary.

Staff response. The staff advised that it was unable to concur with AES’s view that the proposal could be omitted under Rules 14-8(b) or (f) with respect to proof of ownership, and it was unable to concur that the proposal could be omitted under Rule 14a-8(i)(3) as vague or indefinite. The staff added that AES had not demonstrated objectively that the proposal was false or misleading, so it could not be omitted on that basis.

Wednesday, December 28, 2016

Court did not "like" Facebook's argument about common damages

By Rodney F. Tonkovic, J.D.

A Second Circuit panel has given a thumbs up to the district court's handling of the late 2015 settlement between investors and Nasdaq for the problematic 2012 Facebook IPO. In a summary order, the panel found that a settlement provision deferring the question of common damages to be decided in a related action against Facebook and its underwriters was not required to be resolved by the district court under the PSLRA, and leaving the question open did not violate principles of finality (In re Facebook, Inc., IPO Securities and Derivative Litigation, December 27, 2016, per curiam).

Widely anticipated to be one of the largest IPOs in history, Facebook's public launch was beset with technical glitches that set off a string of lawsuits and a $10 million fine from the SEC. Two groups of actions relating to the IPO were eventually consolidated into two class actions: the "Nasdaq action," which alleged losses arising from the technical malfunctions, and the "Facebook action," which alleged losses arising from misrepresentations in the IPO prospectus. In November 2015, a $26.5 million settlement between investors and Nasdaq for the buggy IPO was approved by the federal district court in Manhattan.

Damages deferred. The settlement of the Nasdaq action gave rise to this appeal, brought by the defendants in the Facebook action to vindicated their interests in that ongoing litigation. There was no objection to the substance of the settlement. The dispute on appeal instead concerned the settlement's judgment credit provision, which, in pertinent part, provides that any judgment against the Facebook defendants arising from the same matters alleged in the Nasdaq complaint will be reduced by the greater of the amount paid by the Nasdaq defendants to the common plaintiffs for common damages.

The appellants challenged the inclusion of the phrase "for common damages." That is, they objected to the implication that the damages alleged in the two actions might not be common, and that the issue is left to be litigated and decided in the Facebook action. The appellants maintained that they should receive judgment credit in the Facebook action for the full amount of the Nasdaq settlement paid to common plaintiffs because all of the damages were common. They argued further that the district court was obligated to settle the issue.

In short, the appellants did not object to the settlement itself, but they instead challenged the district court's decision to defer the question of common damages to the Facebook action. They argued that the district court had to decide the issue because the PSLRA required it and because the failure to resolve them violated principles of finality.

Affirmed. The panel affirmed the district court's judgment. Looking to Second Circuit precedent, the panel noted that class settlements have frequently been approved when, as in this case, they apply a specific judgment reduction formula giving nonsettling defendants credit for the greater of the settlement amount or a proportionate share of the settling defendants' fault.

The panel was similarly unpersuaded by the argument that the settlement approval violated principles of finality, stating that the Nasdaq action was final and that all of the parties to it were satisfied. The open question of common damages will have no effect whatsoever on the Nasdaq action, and can be litigated just as well in the Facebook action, the panel concluded.

The case is No. 15-3983.

Tuesday, December 27, 2016

Theory, evidence drive post-trial DRW briefs

By Mark S. Nelson, J.D.

The CFTC and Donald Wilson, founder and CEO of the eponymous DRW Investments, LLC, both asked Judge Richard Sullivan of the U.S. District Court in Manhattan to rule in their favor now that the bench trial over whether DRW manipulated a futures contract has ended. The parties’ post-trial motions are an amalgam of legal theory and evidentiary claims that frequently cite legal precedents that led some amici to argue before trial that the CFTC’s suit against DRW sought to lower the standard for holding traders liable for market manipulation (CFTC v. Wilson, CFTC Brief and Wilson Brief, December 21, 2016).

According to the CFTC, manipulation is especially pernicious in an illiquid market, like the one at issue in its case against DRW. The agency analogized the DRW case to a congested market where prices are “hypersensitive” because the limited number of contracts available has the effect of draining liquidity from the market. The CFTC noted that similar conduct in thinly-traded securities has been held to be manipulation. Moreover, the agency cited its own administrative action in In the Matter of Indiana Farm Bureau Cooperative Association, Inc. to explain how intent can be inferred from certain market-impacting behaviors.

The CFTC then turned to DRW’s legal theories, which the agency argued were too subjective and, if adopted by the court, could cast aside long-held understandings of the Commodity Exchange Act’s anti-manipulation provisions. Here, the CFTC said DRW had specific intent to set prices and that the agency’s theory of the case would not hinder other traders’ activities done “for the purpose of trading.”

DRW countered that the CFTC had confused intent to affect prices and artificiality. In DRW’s view, there can be no manipulation without intent to create an artificial price. DRW went on to cite authority for the proposition that economic rationality is not necessarily the touchstone if bids are executable. DRW explained that it is economically rational and a reflection of actual demand for a single bidder (DRW) to place orders if it is willing to transact at the stated price.

Moreover, DRW offered a point-by-point rebuttal of the CFTC’s theories of artificiality. First, the firm disputed whether intent to influence price is unlawful. The CFTC had argued that, primary or not, DRW’s intent was to undermine the forces of supply and demand for its own profit. DRW also argued that the court should reject expert opinion regarding whether bids were above the corresponding rate because the expert, whose work the CFTC relied on, had cited different products.

Another key point of contention between the CFTC and DRW was whether DRW’s bids could have been hit. DRW said its bids could have been hit and cited the firm’s efforts to consummate a busted trade with MF Global (DRW claimed that firms like MF Global could see trades on screen and could transact via a voice broker). But the CFTC said there was no evidence DRW wanted its bids to get hit because DRW was the only firm with the needed electronic capability to transact.

DRW also disputed the CFTC’s characterization of its activities as banging the close. According to DRW, such cases involve uneconomic activity not present in this case; DRW also said it could transact in the market only if it offered higher prices. The CFTC noted that it believed banging the close cases can occur even if trades are “economic” or “profitable.”

The case is No. 13-cv-07884 (CFTC brief) and (Wilson Brief).

Friday, December 23, 2016

El Paso merger extinguishes standing, $171M award reversed

By John M. Jascob, J.D., LL.M.

The Delaware Supreme Court has reversed a $171 million award to former limited partners in a suit alleging that a conflicts committee knowingly approved a transaction that was unduly favorable to the general partner. The plaintiff’s contractual overpayment claim was exclusively derivative in nature because under the partnership agreement, the partnership owned the claim. Accordingly, the plaintiff’s standing was extinguished when the limited partnership was acquired in a merger before there was a judicial ruling on the merits of his suit (El Paso Pipeline GP Co. v. Brinckerhoff, December 20, 2016, Valihura, K.).

Conflict transaction. El Paso Pipeline Partners, L.P. was a publicly-traded Delaware master limited partnership based in Houston, Texas. By means of two "dropdown" transactions in 2010, El Paso Corporation, the parent company that owned the sole general partner of El Paso Pipeline Partners, sold two of its subsidiaries to El Paso Pipeline Partners. The plaintiff then initiated derivative lawsuits challenging both dropdowns, alleging that the conflicts committees that reviewed the transactions approved them without believing they were in the best interests of the limited partnership they were charged with protecting.

Although dismissing the claims related to the first dropdown, the Chancery Court ultimately awarded damages of $171 million against the general partner, amounting to the overpayment caused by its breach of the partnership agreement with respect to the second transaction. After the trial was completed and before any judicial ruling on the merits, however, El Paso Pipeline Partners was acquired in a related-party merger with Kinder Morgan, Inc. that brought an end to El Paso Pipeline Partners’ separate existence as a publicly traded entity. The plaintiff did not challenge the merger.

The general partner then moved to dismiss, contending that the plaintiff’s claim was derivative and that the closing of the merger must lead to dismissal. The Court of Chancery, however, rejected the defendants’ argument, reasoning that the plaintiff’s claim, although always treated by him as derivative before the merger was announced, could also be considered direct. In the chancery court’s view, the plaintiff’s claim was “dual-natured” because, even apart from the “contractual angle,” the second dropdown had inflicted injury on both the partnership and the unaffiliated unitholders, allowing him to litigate the claim directly post-merger. And even if considered to be derivative, the claim should survive the merger for the core policy reason that dismissal would leave the unaffiliated limited partners without recompense for the general partner’s prior unfair dealing.

Partnership owned the claim. On appeal, however, the Delaware Supreme Court reversed, holding that the overpayment claim was exclusively derivative in nature. The court observed that under the limited partnership agreement, the limited partnership itself was entitled in the first instance to sue and obtain recovery against the general partner and its co-defendants for any claim that the transaction was economically unfair to the limited partnership. The fact that individual limited partners might press the limited partnership’s rights as derivative plaintiffs did not make the claims ones which belonged to them individually, the court stated.

Claim not “dual-natured.” In addition, the state high court held that the claims of the derivative plaintiff were not dual in nature. Although agreeing that some recent case law could be read as undercutting the traditional rule that dilution claims are classically derivative, the court declined to further expand that case law in the limited partnership context. This was especially true in the present case, the court observed, where the plaintiff sought only monetary relief for the limited partnership and there was no plausible argument that the transaction had the effect of increasing the voting power or control of the general partner at the expense of the unaffiliated unitholders.

Merger extinguished the plaintiff’s claim. Finally, the state high court held that the merger extinguished the plaintiff's standing because a plaintiff who ceases to be a shareholder, whether by reason of a merger or for any other reason, loses standing to continue a derivative suit. The claims, which were an asset of the partnership, passed by operation of law to Kinder Morgan as a result of the merger. Accordingly, the merger extinguished the plaintiff’s standing to assert the claims. The plaintiff’s remedy was to challenge the merger, but he elected not to do so.

The case is No. 103, 2016.

Thursday, December 22, 2016

Trump’s win expected to bring significant legal and regulatory changes

The election of Donald J. Trump to the presidency, along with Republican control of Congress, will have a significant impact on federal laws and regulations. A new White Paper authored by Wolters Kluwer editorial staff analyzes the potential impact of the Trump Administration on Tax, Health Care and Life Sciences, Banking and Financial Services, Federal Securities, Antitrust and Competition, Labor and Employment Law, Employee Benefits, Payroll, Pension and Retirement, Energy and Environmental Law, and Government Contracts.

Each section analyzes the potential changes Trump’s administration may implement based on his statements and proposals during his campaign and his cabinet nominee’s positions on issues; and the risks and impact on the practice of law, businesses, and individuals. Other practice areas, including Intellectual Property and Products Liability, are less likely to face immediate changes under the Trump Administration. 

With the new administration taking office in January, along with Republican control of Congress, the stage is set to bring about changes in securities regulation. In this White Paper, contributor Mark S. Nelson, J.D. discusses the impact of the election on the Dodd-Frank Act, federal securities regulation, and on related financial services industry issues.

Wednesday, December 21, 2016

ALJ regime challenge properly tossed for lack of jurisdiction

By Amy Leisinger, J.D.

Joining the Second, Seventh, Eleventh and D.C. Circuits, a Fourth Circuit panel held that challenges to the validity of the SEC’s administrative regime must first be addressed by the Commission. In affirming the district court’s decision to dismiss an action by an adviser attacking the constitutionality of administrative law judges for lack of subject-matter jurisdiction, the panel found that the adviser has the opportunity for meaningful judicial review within the current SEC statutory framework (Bennett v. SEC, December 16, 2016, Duncan, A.).

Injunction to halt proceedings rejected. In September 2015, the SEC instituted administrative proceedings against a host of a local radio show about investing and her financial services firm, Bennett Group Financial Services, LLC, for allegedly exaggerating the amount of assets under her management and inflating claims of investment returns. The adviser filed an action in Maryland federal court to enjoin the proceedings, also asking the court to declare unconstitutional both the statutory and regulatory provisions and practices for selecting and designating SEC ALJs and the provisions providing for the position of SEC ALJs and related tenure protections. She also asked the court to enter a preliminary injunction to prevent the administrative proceeding from moving forward during the pendency of the district court action.

The district court rejected her arguments, finding that it lacked subject-matter jurisdiction over the claims and that the adviser must assert her constitutional challenges to the SEC procedures before the Commission itself. The adviser appealed to the Fourth Circuit, arguing that the district court’s conclusion would have the effect of eliminating district court jurisdiction in every case where an administrative proceeding is pending and that, were she to wait for the SEC proceedings to be finalized to appeal, her claim for an injunction against her would be moot.

Meaningful judicial review. In Thunder Basin Coal Co. v. Reich, the Supreme Court said that a statute providing for agency review will divest the federal courts of jurisdiction if the statutory scheme displays a fairly discernible intent to limit jurisdiction and the claims at issue are of the type Congress intended to be reviewed within the statutory structure. The Thunder Basin Court also said that Congress did not intend claims to be reviewed within the statutory scheme by the agency if a finding of preclusion could foreclose all meaningful judicial review, if the suit was wholly collateral to a statute’s review provisions, and if the claims were outside the agency’s expertise.

Reviewing these factors, the panel agreed with the district court that the adviser’s constitutional claims must first be reviewed through the administrative process, followed by review at the Court of Appeals, and not through a district court action. The panel rejected her contention that the harm to her is the existence of an unconstitutional proceeding that can only be remedied by halting the proceeding before it occurs. Unlike in Free Enterprise, where the challenge was not connected with a particular proceeding, the adviser’s claim targets an aspect of an ongoing Commission action, which will conclude in a reviewable administrative adjudication, the panel noted. The appeal constitutes meaningful judicial review, the panel found, notwithstanding the fact that the adviser first must complete the administrative process.

Other factors. Further, the panel explained, a claim is not wholly collateral if it is brought after an administrative proceeding commences and if it is the means by which the aggrieved party seeks to prevail against the agency, as it is in the current case. In addition, the panel found that the agency-expertise factor does not support subject matter jurisdiction, as the SEC could resolve the matter by coming down in the plaintiffs’ favor on questions the agency routinely considers, and the Supreme Court has noted that “one of the principal reasons to await the termination of agency proceedings is ‘to obviate all occasion for judicial review.’”

No subject-matter jurisdiction. If the adviser’s arguments prevail, the panel concluded, “[a]nyone could bypass the judicial-review scheme established by Congress simply by alleging a constitutional challenge and framing it as ‘structural,’ ‘prophylactic,’ or ‘preventative.’” As such, the panel affirmed the district court’s determination regarding lack of subject-matter jurisdiction.

The case is No. 15-2584.