Arecent ruling by the 11th Circuit Court of Appeals is expected to prompt changes in the way the Securities and Exchange Commission crafts one of its most widely used enforcement tools, experts say.
In a footnote near the end of its opinion in SEC v. Smyth, the U.S. Court of Appeals for the 11th Circuit in Atlanta recently ruled that the broad, "obey the law" injunctive orders the SEC commonly seeks are "unenforceable," and reiterated its stance that injunctions must be written so defendants know exactly what conduct is prohibited.
Sauer
Such injunctions, commonly used by the SEC, “usually just quote the statute and say ‘don’t violate the law,’” notes Rick Sauer, a former SEC enforcement director who is now a partner at Vinson & Elkins.
Sauer and other former SEC enforcement officials say that the SEC is likely to have to change the way it drafts such injunctions in light of the opinion.
“The 11th Circuit has given a good deal of attention to whether the language of an injunction meets the standard articulated by the Circuit," said Sauer, adding that “‘don’t violate the law’ injunctions don’t fly.” Sauer adds that while the Smyth opinion is “not the first of its kind," it has been getting some attention from the securities bar.
While the consent decree’s injunctions in the Smyth case were not before the Circuit for review, the court noted, “Because the injunctions are still before the district court, we would be remiss if we did not inform the court that they are unenforceable” (see the full text of the Smyth footnote in the box at right). Noting that, “This Circuit has held repeatedly that ‘obey the law’ injunctions are unenforceable,” the Circuit in its decision said, “The specificity requirement of Rule 65(d) is no mere technicality…An injunction must be framed so that those enjoined know exactly what conduct the court has prohibited and what steps they must take to conform their conduct to the law.”
Asked whether the SEC plans to change the way it drafts such injunctions as a result of the Circuit’s opinion, an SEC official told Compliance Week, “We’re looking at the decision and deciding what to do,” but declined to comment further.
Getting Specific
McLucas
William McLucas, who served as the director of the SEC’s Enforcement Division for eight years and now serves as co-chair of the securities department at Wilmer Cutler Pickering Hale & Dorr, agrees that the decision will have an impact on the SEC. “Basically, the SEC, at least in this Circuit, will have to make a decision,” says McLucas. “It can either draft injunctive decrees more tailored to the charges that gave rise to the proceeding, or they can choose to proceed with the standard statutory injunctions that the court criticized, and the district judges will have to determine whether, under the law in the 11th Circuit, they can or should enter those injunctions.
Ryan
Russ Ryan, a former assistant director of the SEC's Enforcement Division who is now a partner in the Washington, D.C., office of King & Spalding, says the Smyth footnote is important “because the sweeping nature of the injunctions in that case was no different than that of just about any other SEC injunction.” As a result, the decision may have an impact on other Circuits, and on cases already decided. “If other courts follow the 11th Circuit’s lead, the SEC may have to get much more specific in the way its injunctions are worded, and it may have trouble getting courts to enforce the injunctions it has obtained in prior cases, especially those within the 11th Circuit,” says Ryan.
“The problem for the SEC and other government agencies that obtain these types of ‘don’t violate the law’ orders is that, if the orders are too broad, it’s possible that they won’t be enforceable," says Sauer. On the other hand, if they’re too specific, they may not have any real practical value, he adds. As an example, Sauer cites cases related to accounting fraud. A narrower order that prohibits a defendant from committing the same exact accounting dodge again isn’t of much use as a deterrent, says Sauer, because there are so many varieties of accounting fraud.
McLucas points out that injunctions that are narrower in scope may make it easier to hold people in contempt of orders entered in SEC enforcement proceedings. “In the past, it has been more difficult to hold someone in contempt because the defendant could always argue that the judgment wasn’t specific enough to tell him or her what they were restrained from doing,” says McLucas.
Henning
But more specific wording could also make it easier for some to get around violating an injunction. “The narrower the injunction, the more likely a crafty defendant can seek to engage in misconduct while avoiding the technical prohibitions in the injunction," wrote Wayne State University Law School professor Peter Henning in a Weblog he maintains. "Yet, the Eleventh Circuit's concern with an ‘obey-the-law’ injunction is legitimate (even if the opinion is dicta) if the court order is little more than a license for the SEC to bring a separate case in a jurisdiction with no other connection to the subsequent violation, a valid concern for a federal court,” he added.
An Outdated Tool?
How the SEC will act going forward remains to be seen. Observers differ on their views of whether the case could bring focus to the issue of the use of injunctions in general.
“It will be very interesting to see how the SEC reacts to this unexpected challenge to its most basic enforcement weapon,” says Ryan of King & Spalding. “It would be great if the case prompts some thoughtful discussion about the SEC’s use of injunctions generally, starting with whether the SEC really needs to get them in every case.”
Ryan and others note the injunction has been the cornerstone of the SEC’s enforcement program since its inception, “largely because it was the only weapon Congress originally gave the agency to pursue people outside the regulated securities industry.” But beginning in the 1980s, Congress gave the SEC other tools, such as monetary penalties, officer-director bars, and cease-and-desist orders, “so injunctions are no longer the only way to remedy securities violations, or even the most effective,” says Ryan.
In more recent years, observers say the SEC’s enforcement efforts have increasingly focused on the use of civil penalties as a deterrent. But while they are no longer the only tool or even the most powerful tool in the SEC’s enforcement arsenal, civil injunctions are still typically standard whenever the SEC brings an enforcement action.
“Injunctions and cease and desist orders are still the most fundamental remedies sought in enforcement actions, although they’re somewhat less important than they used to be with the SEC’s greater emphasis on seeking civil penalties,” says Sauer.
While Ryan says injunctions are “still appropriate when there is ongoing or imminent misconduct,” he adds, “the Smyth case presents a good opportunity to reassess whether they’re useful or appropriate in the ordinary case where the misconduct ended long before the case was filed.”
Sauer agrees that, “people have questioned the use of injunctions, especially in situations where it’s unlikely the defendant will repeat the illegal conduct.” However, he doesn’t see the SEC moving away from injunctions any time soon. “While there’s been some question about whether the SEC needs to obtain injunctions in all the [litigated] cases that it does, I don’t see the SEC moving away from routinely seeking injunctions in district court actions,” Sauer tells Compliance Week. “I believe they will continue to do so in almost every case, whether or not those injunctions ultimately prove to be enforceable.”
“I would not over react to the significance of this decision,” adds McLucas at Wilmer Cutler Pickering Hale & Dorr. That's because the real emphasis of the SEC’s enforcement program in the past few years has been on financial penalties and on criminal prosecutions, he says. "That doesn’t mean people should ignore the significance of court imposed injunctions. But I don’t know that this is an overly dramatic development with respect to the SEC’s overall enforcement program.”
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