Securities Litigation

Five years after the SEC brought charges that cost two fund executives their jobs, the U.S. First Circuit overturned the sanctions, chiding the SEC for misreading critical evidence, lacking substantial evidence for its findings and disregarding its own Chief ALJ's opinion. The case illustrates the extraordinary burden respondents in SEC administrative actions must carry before getting a shot at vindication in the Courts. On September 30, 2010, the SEC instituted administrative proceedings charging two State Street executives involved with Limited Duration Bond Fund with fraud under '33 Act § 17(a) and '34 Act § 10(b)/Rule 10b-5 based upon one "typical portfolio composition" slide used in roadshows and two letters from the CIO explaining the fund's objectives in responding to the financial crisis. The Respondents were, by all accounts, upstanding people. The First Circuit observed that Hopkins had worked in the industry for 35 years "with an unblemished record." CIO Flannery "had an unblemished record in the industry and a reputation for being very honest and having a great deal of integrity." Hopkins and Flannery geared up for the SEC's accelerated trial schedule. After 11 days of hearings, 19 witnesses and over 500 exhibits, the SEC's Chief ALJ Brenda Murray dismissed Enforcement's case, finding there were no materially false or misleading statements or omissions. That Initial Decision was rendered October 28, 2011. But Enforcement appealed to the Commission. Over a thousand days later, the Commission reversed and rendered by 3-2 vote, imposing on each a one-year suspension, with a cease-and-desist and fines. In the Matter of John P. Flannery, AP File No. 3-14081, 2014 WL 71456245 (Dec. 15, 2014). On appeal, the First Circuit held there simply was no substantial evidence to support the Commission's findings. The PowerPoint slide was labeled "typical," and was unaccompanied by any representations that it was the present actual composition. Enforcement presented only a single witness to say he felt mislead by it, despite no mention of the slide in that witness's contemporaneous notes of the presentation. To the contrary, Respondents presented expert testimony that rebutted both the materiality of and any justifiable reliance upon such a slide by sophisticated institutional investors who also had access to actual portfolio composition data. The Court noted that the "Commission has failed to identify a single witness that supports a finding of materiality." The Commission had sanctioned Flannery for a deceitful course of conduct based on just two letters - one of which he did not send. As to the other, the Court held the Commission and Enforcement staff simply "misread the letter," conflating a statement of an objective ("prompting us to take steps to seek to reduce risk") with a representation it had been achieved. The Court noted the prosecution had not even attempted to show that the steps taken had not in fact reduced the perceived risk. Perhaps most astoundingly, "Indeed, at oral argument, the Commission acknowledged that there was no particular sentence in the letter that was inaccurate." 1,501 days after first winning their case, Hopkins and Flannery were exonerated by the Courts. The opinions are Flannery v. SEC, No. 15-1080 (1^st Cir. Dec. 8, 2015); Hopkins v. SEC (No. 15-1117) (1^st Cir. Dec. 8, 2015). Thomas K. Potter, III (tpotter@burr.com) is a partner in the Securities Litigation Practice Group at Burr & Forman, LLP. Tom is licensed in Tennessee, Texas and Louisiana. He has over 29 years' experience representing financial institutions in litigation, regulatory and compliance matters. See attorney profile. © 2015 by Thomas K. Potter, III (all rights reserved).