Securities

The SEC and Retroactivity: A Question of Fairness

Dodd-Frank significantly added to the weapons available to the SEC. New provisions extended its authority to bring actions based on aiding and abetting while lowering the proof requirements to recklessness. Collateral bars were added and a provision making civil penalties available against all respondents in administrative proceedings.

While this new authority clearly applies to future conduct, a critical question is whether it can be applied to acts which occurred prior to the passage of Dodd-Frank. Stated differently can these new weapons be applied retroactively?

Earlier this year Commissioner Kathleen Casey discussed the retroactivity of the Dodd-Frank provisions in enforcement actions. While the Commissioner outlined the basic principles which stem from the Supreme Court's decision in Landgraf v. USI Film Products, 511 U.S. 244 (1994) she did not specifically analyze the various Dodd-Frank provisions where such an issue might arise. Rather, the Commissioner stressed the key to resolving these issues is fairness: "But is it necessary for us to decide exactly where the line of legality lies? Could the Commission instead choose to be guided . . . by notions of fairness and a respect for the principle of anti-retroactivity? Could the Commission elect to stand comfortably behind the line of legality in order to ensure that it does not inadvertently cross it?" SEC Commissioner Kathleen Casey, Address at PLI's SEC Speaks in 2011 Program, www.sec.gov/news/speech/2011/spch02041klc.htm.

Perhaps a partial answer to this question came in a recent Initial Decision by Chief Administrative Law Judge Brenda Murray in In the Matter of John W. Lawton, Adm. Proc. File No. No. 3-14162 (April 29, 2011). The action was brought under Section 203(f) of the Advisors Act which permits the Commission to order certain sanctions in the public interest if the Respondent is found to have been criminally convicted or enjoined under certain circumstances.

Mr. Lawton, who apparently appeared pro se, previously managed a multi-million hedge fund through an investment adviser, Crossroads Capital Management, LLC. As a result of his misconduct over fifty investors lost somewhere between $2.5 million and $7 million. The Respondent pleaded guilty to one count of mail fraud and one count of false statements in a criminal case. U.S. v. Lawton, No. 09-cr-319 (D. Minn.). He also consented to the entry of a permanent injunction in SEC v. Lawton, No. 09-cv-00368 (D. Minn.). Based on this record a request for summary disposition was granted.

The critical question in the case was the application of Section 925 of Dodd-Frank. That Section amended Advisors Act Section 203(f). Previously the Section only authorized the imposition of a bar from associating with an investment adviser. The amendment expands that into a collateral bar.

The Division of Enforcement argued for a collateral bar. Judge Murray, sua sponte, raised and analyzed the question of retroactivity, rejecting a portion of the Division's request. Citing Landgraf the Initial Decision notes that there is a presumption against retroactivity. That presumption is grounded in elementary notions of fairness. In addition, provisions which attach new legal consequences to events which previously took place thereby enhancing the penalty are not retroactive. There is an exception where the new provision provides for prospective relief.

Here Section 203(f) prior to amendment provided only for the imposition of a bar from the investment advisory industry. Exchange Act Section 3(a)(39) however provided a statutory disqualification which effectively prohibited Respondent from association with a broker, dealer, municipal securities dealer, and transfer agent the court found. To the extent these provisions correspond to the new Dodd-Frank Section, there is nothing new. What is new however is the ability to impose a bar as to municipal advisors and NRSROs. Since that bar did not exist at the time of the conduct, Judge Murray concluded that it would be impermissible to apply it here.

In the future there will undoubtedly be other cases which present difficult questions regarding the application of the Dodd-Frank provisions.. The section providing that reckless conduct is sufficient for aiding and abetting could, for example, significantly ease the burned of proof for the Commission if applied retroactively in some jurisdictions. The new provision granting the Commission authority to seek a civil money penalty against all respondents in an administrative proceeding could be result in enforcement cases which traditionally were brought in district court being instituted in that forum for similar reasons. Such gamesmanship decries the principles of fundamental fairness which are suppose to guide retroactivity. It would also ignore the Commission's traditions as outlined by Commissioner Casey in her call for fundamental fairness.

For more cutting edge commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.

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