The Securities and Exchange Commission is asking a court of appeals to delete a footnote ruling that most legal experts expected would prompt changes in the way the Commission crafts civil injunctions, one of its most widely used enforcement tools, Compliance Week has learned.

NOTE

Update

According to an email received the morning this story was published, the 11th Circuit has denied the Securities and Exchange Commission's petition for a rehearing on the case mentioned at left.

Related Resources

View The SEC Petition For Panel Rehearing

Download Original 11th Circuit Court Opinion

Original Coverage

Ruling To Spark Changes In Wording Of Civil Injunctions (Sept. 2005)

As Compliance Week reported in its Sept. 7 edition, 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 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.

In light of that widely publicized opinion, legal experts, including some former SEC enforcement officials, told Compliance Week they expected the court’s decision to prompt the SEC to get much more specific in the way its injunctions are worded, particularly if other courts followed the 11th Circuit’s lead (see original coverage at right).

Injunctions have been the cornerstone of the SEC’s enforcement program since its inception. However, experts say their relevance has diminished somewhat as other tools—such as monetary penalties, officer-director bars, and cease-and-desist orders—have come into use. Despite the fact that civil injunctions are no longer the most powerful tool in the SEC’s enforcement arsenal, they are typically standard whenever the SEC brings an enforcement action.

The SEC has requested that the 11th Circuit delete “footnote 14” from its opinion on the basis that the enforceability of the injunction was not an issue in the appeal, and that the parties involved didn’t get to argue their position on the issue. The SEC also said the court overlooked the fact that a settling defendant can waive his rights under Rule 65(d) of the Federal Rules of Civil Procedure.

In the so-called Smyth footnote, which appeared in the court’s Aug.10 decision, the 11th circuit had stated that:

“Although…the consent decree’s injunctions are not before us for review, they are still before the district court, which retained jurisdiction to enforce them, and therefore are subject to the court’s inherent power to modify or revoke them. Because the injunctions are still before the district court, we would be remiss if we did not inform the court that they are unenforceable.”

Noting that it 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.”

In its petition for rehearing filed Sept. 23, the SEC argued that, “That statement, about an issue that was neither presented by this appeal nor briefed by the parties, risks casting a shadow over all the injunctions typically entered in Commission cases. Moreover, the Commission may be unable to seek further review of the panel’s statement from the entire Court or the Supreme Court, both because the injunctions were entered by consent, and because the statement is dictum.”

“We believe the issue of whether the injunctions ordered in this case are enforceable should not be summarily resolved without allowing the Commission an opportunity to be heard,” the SEC wrote. “Therefore, we respectfully request that the Court delete the footnote, reserving the question of the enforceability of injunctions like those in this case for an appeal in which the issue is raised and briefed.”

The SEC did not respond to a request for comment.

Into The Open

Wolensky

While he said the SEC’s petition is “not unexpected,” Michael Wolensky, an attorney for Smyth defendant Arnold E. Johns Jr. and a partner at Schiff Hardin LLP in Atlanta, told Compliance Week, “I’d be surprised if the court granted the petition, in light of the low number of petitions for rehearing that are granted.”

“The court fully understood what it was doing when it wrote that footnote,” Wolensky added. “The SEC didn’t tell the court anything it didn’t already know.” He noted that, under the court’s rules, “Mr. Johns is not permitted to file anything in response to the petition unless the court requests him to do so.”

Sauer

“In its petition for rehearing, the Commission provides significant authority for the view that injunctions that simply track statutes are not per se unenforceable,” said Rick Sauer, a former SEC enforcement director who is now a partner at Vinson & Elkins. “It also contends plausibly that this is an issue of sufficient significance that it should have been dealt with only when squarely presented in litigation, rather than in footnote dicta.”

Nevertheless, Sauer said, “The Commission's ‘obey the law’ injunctions often go to provisions that are among the most broad and general in federal statutory and administrative law, including, in particular, the anti-fraud provisions. In litigated cases—and not just in the 11th Circuit—courts may prove sympathetic to arguments that such injunctions do not satisfy the specificity requirements of Rule 65(d).”

Also, in cases in which such injunctions have been entered, Sauer said, “the Commission may have difficulty enforcing them through contempt sanctions when the alleged violative conduct is factually dissimilar to that giving rise to the injunction. I believe the Commission has recognized this problem for many years—which is one reason it has sought civil contempt sanctions from repeat offenders infrequently. This decision, however, brings that issue into the open.”

Ryan

“If the court agrees with what the SEC is saying, it will help the SEC preserve any settlements that are on the books and well as the agency's ability to continue business as usual with respect to injunctions in settlements,” noted 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.

If the SEC prevails upon the court to remove footnote 14, Ryan added, “I’m afraid it will be a lost opportunity for some fresh thinking about injunctions in a broader sense.”

“This case presented an excellent opportunity to reconsider not just the breadth of typical SEC injunctions, but more fundamentally the SEC’s historical practice of seeking injunctions in every single case it files in federal court,” said Ryan. “Judging from the SEC’s petition for rehearing in the Smyth case, I’m not optimistic that the SEC or its staff are eager to undertake any such reconsideration.”

“One inconvenient fact for the SEC in this particular case is that, for some reason, the settlement papers apparently did not include a standard provision explicitly saying that the defendant was waiving his rights under Rule 65(d), whereas many other SEC settlements do include such a provision,” Ryan added. “You can bet the message has gone out to all the SEC’s enforcement attorneys that future settlements must now include this explicit waiver.”

Henning

“The SEC has a good argument,” Wayne State University Law School professor Peter Henning told Compliance Week. “The court reached out to decide an issue that wasn’t really before it and provided what was in effect, an advisory opinion. In the federal system especially, that raises all sorts of red flags.”

“I’m not sure the SEC is right in the sense that Circuit’s dictum is, in fact, an incorrect application of law; but the dictum argument is a reasonable argument,” adds Henning. “The only issue before the court in the appeal was the disgorgement and prejudgment interest—the enforceability of the injunction was not an issue. Johns didn’t dispute the validity of the injunction; in fact, he agreed to it, as the SEC pointed out. The SEC is saying they never had a chance to argue the point—they were blindsided by the footnote.”

However, Henning notes that even if the footnote is deleted, its impact will remain. “Even if the Eleventh Circuit panel does what the SEC has asked and deletes the footnote—which I would expect it to—the effects of the footnote have already been felt,” he said. “The SEC is aware of it, and the securities bar is certainly aware of it—the message will have been sent. The SEC is on notice that it should be more careful in how it drafts its injunctions.”

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