2007 - The Year In Review

     The SEC administrative forum is important and should not be neglected by the agency tasked with significant prosecutorial and adjudicatory power over broker-dealers, investment companies, investment advisers, and publicly filing companies.  One should not forget that the SEC for all practical purposes invented the concept of insider trading in an administrative decision.  The duty of broker-dealers to supervise has largely been developed in this forum.  Such important concepts as the "shingle theory" holding broker-dealers to a duty of fair dealing with their customers was developed by the SEC in administrative disciplinary litigation.    

     SEC for some unknown reason does not post on its web site appeal briefs and pretrial and post trial briefs before Commission ALJs.  Nor does it post decisions by its ALJ's on procedural matters.  These are public documents and practitioners can only benefit from having access to the arguments of both the Division of Enforcement, FINRA, and respondents and appellants.  

     Jokes about transparency, full disclosure, and similar concepts should be avoided because irony does not seem to be appreciated at 100 F Street NE in Washington.

     Unfortunately, the SEC's record in dealing with its adjudicatory responsibilities now is underwhelming.  The Commission issued a total of forty eight decisions and orders this year.  This is less than meets the eye because twenty four of those decisions dealt with routine procedural matters such as motions to reconsider.  

     So, the SEC completed only twenty four substantive appellate decisions in calendar year 2007.  Fifteen decisions concerned appeals of NASD and NYSE disciplinary actions and only nine involved appeals of decisions by SEC administrative law judges. 

     Moreover, decisions on seemingly routine matters linger, often taking a year or more.  Decisions on routine motions take weeks and months.  Decisions on appeals from SEC administrative law judges and self regulatory organizations were completed in no less than six months and some decisions were labored on for more than a year. Indeed, in cases where the Division of Enforcement was seeking a bar from industry association based on a criminal conviction or fraud injunction in an earlier SEC enforcement case, the Commission never managed to complete its appellate review in less than 6 months.  These kind of routine "follow-on" administrative proceedings would not appear to normally raise very tough issues that require months to dispose of - after all, it isn't difficult to decide that a felon convicted of fraud should not be allowed to associate with a broker-dealer or investment adviser with the ability to, in the words of an ancient Commission decision, "meddle with other people's money."

     The SEC does not appear to be a believer in the aphorism that justice delayed is justice denied.  Such lack of promptness is surprising given that it is clearly in the public interest to promptly resolve the disciplinary matters the SEC deals with.  It almost goes without saying that it is in the public interest to discipline securities industry wrongdoers promptly.  

     The writing style of many of the opinions is at best turgid.  Gone are the days when some staffer could pen language like this that described a fraudulent research report as "unalloyed by even a chemical trace of the truth." Bruce William Zimmerman, 46 SEC 509, 110 (1976).  Or this revealing and very true description of the mind of a con-man, "we see a childlike credulity, an almost incredible naivete, a total indifference to prosaic and disconcerting facts, and a marked propensity to embroider the misrepresentations made to him by others with embellishments of his own devising." Richard C. Spangler, Inc., 46 SEC 238, 253 (1976).  

     Footnotes continue to proliferate.  The wise practitioner will read the footnotes first as often the most significant matters are buried there.  

     The Commission seems to be responding to the demands of appellate courts and articulating in specific detail its reasons for imposing sanctions.  Unfortunately, in many other instances it relies on a peremptory style heavily infected with ipse dixit disease.  In other instances it has made major policy pronouncements with hardly any analysis or discussion.  See particularly the Richard Kresge decision, which dramatically narrows the reach of Exchange Act Section 20(a) control person liability as well as the definition of a supervisor for purposes of Exchange Act liability.  

     The SEC has not used appropriately its ability to summarily affirm an ALJ's initial decision. See, for example the Jose P.  Zollino matter (Exchange Act. Rel. 55107).  There, the Commission took nine months to affirm an ALJ's bar (resulting from the Division of Enforcement's motion for summary disposition, i.e., there was no hearing) based on respondent's previous criminal conviction and anti-fraud injunction.    Why should the Commission should spend nine months to write a twelve page opinion in a matter like this?  

     Likewise, the Commission denied a Division of Enforcement motion for summary disposition in America's Sports Voice, Inc., (Exchange Act Rel. 55511), a proceeding to revoke the registration of a delinquent filing company.  The Commission simply opined, without explanation the bromide that "we have an interest in articulating our views on important matters of public interest" without bothering to explain what was in the public interest that needed articulation in this routine case. 

     The following is a brief summary of the more significant opinions  issues by the Commission in 2007.  Be warned however, some of these matters are included in this list because they deal with rather arcane procedural matters.

Richard F. Kresge, Exchange Act Rel. 55988

     This is a classic failure to supervise case that includes a laundry list of things not to do as the president of a small broker-dealer.  It contains strong guidance concerning supervisory duties.  However, this is probably the Commission's most significant opinion because of its pronouncements, with virtually no analysis, limiting the scope of both control person liability and the definition of a supervisor.  

     The Commission held that one can have control person liability under Exchange Act Section 20(a) only if one personally participates in the violative conduct.  This is a very significant statutory interpretation and policy ruling by the Commission.  It was added almost as an afterthought at the end of the decision with virtually no discussion.

     Also, in a footnote, the Commission implies that a person who cannot hire, fire, reward, or punish cannot be a supervisor for purposes of failure to supervise liability.  If the Commission, actually means this, it has great significance.

Donner Corporation International, SECS., Exchange Act Rel. 55313

   This matter involved glowing and canned "research reports" put out by a broker-dealer that were paid for by the issuers of the securities.  The purported research ignored the fact that the issuers involved were in financial distress, going concern qualifications of their financial statements, and negative information available in filings with the SEC.  The case is important not only for the guidance it provides about research reports, but also because much of that guidance applies across the board whenever a firm or registered representative recommends a security.  

  Firms are required to have policies and procedures concerning the preparation, review, and approval of published research.  When making a recommendation, all material information about the security should be disclosed, particularly information bearing on financial condition, solvency, and profitability.  It is simply not appropriate to disclose only selected positive information.  Further, recommending a stock as a speculative investment does not insulate the seller from the duty to make full and accurate disclosure of all material information.  Nor is the seller insulated from this duty by telling investors they should consult SEC filings for more details.  Further, going concern qualifications by auditors are per se material and must be disclosed.  Also, the opinion disposes of the claim that that research reports are not "in connection with" the offer, purchase, or sale of securities.

   Finally, for you trial lawyers out there -- inculpatory investigative testimony given closer in time to the events in question will be given more evidentiary weight than contradictory trial testimony.

Stephen J. Horning, Exchange Act Rel. 56886

    I will not comment extensively on this case because it was the last case I tried before I left the SEC.  It is an interesting failure to supervise case that involved the SIPC liquidation of a small Denver firm after back office personnel embezzled several million dollars of customer money market funds.  It should be studied by supervisors responsible for back office operations in order to identify practices to be avoided, particularly in the small firm context.

David Henry Disraeli and Lifeplan Associates, Inc. (Exchange Act Rel. 57027  

   This case dealt with the misuse of a the proceeds from a small private offering by an unregistered investment adviser.  It includes a comprehensive discussion of why misuse of offering proceeds is always material regardless of whether or not individual investors testify to the contrary.  It also notes that diversion of offering proceeds to pay personal expenses can not be cured by a general statement in offering documents that proceeds might not actually be used for the business purposes proposed. 

  Respondent was barred as an investment adviser, fined $85,000, and ordered to disgorge $84,300 plus prejudgment interest after he used $84,300 of a $100,000 private placement offering to pay personal living expenses.  The lesson from this case is that investment advisers, whether registered or not, are held to the highest standards of disclosure and honesty when dealing with clients and even violations involving a relatively small amount of money and only a few investors will result in the most severe sanctions.

  The Commission ruled that respondent had waived his claims of inability to pay disgorgement or penalties by failing to raise the issue before the trial judge.  Further, although he submitted financial statements in support of his claim at the appellate stage, he did not support those statements with any underlying documentation of his claimed liabilities and debts.

Phlo Corp., et. al., Exchange Act Rel. 55562

  The Commission declined to revoke the registration of a formerly delinquent issuer that had become current in its filigs.  Many delinquent issuers facing revocation proceedings try, but few succeed.  

  The Commission seems to have dealt with a long-running evidentiary issue. Here it considered as evidence a statement in a respondent's Wells submission that she attempted to contradict at trial.  Many Commission ALJ's have been reluctant to admit into evidence statements in Wells submissions.  This ruling would seem to  dispose of that issue.

  The Commission restated it's prior rulings that: 1) there is no specific intent requirement needed to establish the "willful" element required by the Exchange Act; 2) aiding and abetting can be established by reckless conduct; 3) no scienter is required to violate the reporting provisions of Exchange Act Section 13.

David Disraeli and Lifeplan Associates, Inc., Exchange Act. Rel. 56045

  No Virginia - you may not depose SEC staff to support claims of staff bias against you.

Warren E. Turk, Exchange Act. Rel. 55942

   This was an appeal from a NYSE action that involved allegations that because NYSE had coordinated with both the SEC and DOJ that NYSE was a state actor and could not sanction Turk for invoking the Fifth Amendment in its investigation.  The Commission remanded.  It restated previous rulings that self regulatory organizations are not state actors and may therefore discipline an individual for failing to cooperate in an investigation who invokes the Fifth Amendment.  However, here, it remanded to permit Turk to conduct discovery into the extent  of cooperation between the SEC, DOJ, and NYSE.  It did note, that mere cooperation between NYSE, SEC, and DOJ would not make NYSE a state actor and noted that the threshold for establishing NYSE as a state actor was high.  However, the opinion is a complete muddle in its prescription for the scope of discovery on remand.  On the one hand, it states that Turk should be given a "full opportunity" to conduct discovery.  On the other hand, it admonishes that Turk should not be allowed to use discovery to conduct an aimless fishing expedition. 

David A. Finnerty,  et. al., Exchange Act Rel. 56765

  This opinion sets out the standards the Commission will use in deciding motions for severance.  Severance is not appropriate where there are common factual issues. 

Morton Bruce Erenstein, Exchange Act Rel. 56768

  The Commission used as precedent civil discovery cases dealing with the ability to obtain tax return information in deciding whether or not it was appropriate for the NASD to seek to obtain such data in an investigation.  Those cases, however, do not provide for unfettered access to tax return information, but seem to require a heightened relevance standard.  The Commission does not explain why it believes a civil discovery standard is applicable to investigations.  Presumably the same standard will apply to its own staff investigations.  There are some court of appeals decisions limiting the ability of investigators to obtain tax information that are not discussed in this opinion.

Michael Sassano, et. al., Exchange Act Rel. 56874

  The Commission upheld an ALJ's order that the Division of Enforcement turn over to respondents a broad range of documents gathered pursuant to an "omnibus" formal order, not only those gathered in the specific investigation into their conduct.  Although this is inside baseball at its worst, perhaps this will cause the Division to forego the use of such omnibus investigative orders in the future.  

Richard I. Sacks, Exchange Act Rel. 57028 (December 21, 2007)

Order denying stay.

Pages - 5.

Summary

Sacks filed a petition for review in the Ninth Circuit after the Commission approved three FINRA rules changes. He filed a motion with the Commission to stay its order approving the rules changes pending review in the court of appeals.

FINRA rules were amended to allow non-lawyers to represent persons in arbitrations unless state law prohibits it.  The new rule does not permit persons previously barred from the industry to appear as a representative.  Sacks was previously barred and represents people in arbitrations.

Stays pending appeal may be granted by the Commission if "justice so requires."  Previously the Commission has considered four factors in deciding such motion: 1) whether petitioner has shown a strong likelihood he will prevail; 2) whether he will suffer irreparable injury; 3) whether there will be substantial harm to other parties if a stay is granted; and 4) whether a stay will serve the public interest.

The Commission denied the stay.  It noted that a stay pending appeal is an extraordinary remedy.  Among other things, Sacks did not comply with Commission rules that require that before a petition for stay is filed after the Commission acts pursuant to delegated authority as it did here, written notice must be sent to the Commission.  It also ruled that financial detriment (here Sacks claimed his business would be destroyed by the rule) does not constitute irreparable injury.

David Henry Disraeli and Lifeplan Associates, Inc., Exchange Act Rel. 57027, December 21, 2007

Time between appeal and decision - 8 months, 23 days

Time between final brief and decision - 5 months, 19 days

Pages - 33

Comment

This case includes a comprehensive discussion of why misuse of offering proceeds is always material regardless of whether or not individual investors testify to the contrary.  It also notes that diversion of offering proceeds to pay personal expenses can not be cured by a general statement in offering documents that proceeds might not actually be used for the business purposes proposed.  This decision contains a comprehensive nine page explanation of why the sanctions are appropriate.  

Respondent was barred as an investment adviser, fined $85,000, and ordered to disgorge $84,300 plus prejudgment interest after he used $84,300 of a $100,000 private placement offering to pay personal living expenses.  The lesson from this case is that investment advisers, whether registered or not, are held to the highest standards of disclosure and honesty when dealing with clients and the most severe sanctions will be imposed even when the violations involve a relatively small amount of money and only a few investors.  

Also, a note of significance to practitioners.  The Commission ruled that respondent had waived his ability to claim inability to pay disgorgement or a civil penalty because he had not raised the issue before the trial judge.  Further, the financial statements he submitted were vague, and had no supporting documentation.  Finally, the Commission found that because waivers due to inability to pay are discretionary, it would not grant a waiver due to the egregious nature of Disraeli's violations.

Summary

This is an appeal from an ALJ's initial decision by a pro se investment adviser and a corporation he incorporated.  The ALJ found that both respondents violated the anti-fraud provisions of Securities Act Section 17(a) and Exchange Act Section 10(b).  The ALJ also found that Disraeli violated: Section 206 and Rule 206(4)-4(a) of the Advisers Act by making materially false statements in connection with the offer and sale of securities; Advisers Act Sections 203A and 207 by registering with the Commission when he did not qualify to register and by making material misstatements and omissions on his application; Advisers Act Section 204 and various rules thereunder by failing to maintain books and records. 

The ALJ revoked Disraeli's adviser registration, barred him from association with a broker-dealer or investment adviser, imposed a $120,000 civil penalty, ordered him to pay disgorgement of $84,300 plus prejudgment interest, and imposed a cease and desist order on both respondents.

The Commission upheld the sanctions except that it lowered the penalty to $85,000.

Discussion

Disraeli offered and sold stock in Lifeplan Associates in a private placement offering to his investment advisory clients.  He claimed the $100,000 to be raised would be used to form two investment funds, one to be a hedge fund, and the other to purchase consumer debt.  The offering documents claimed that Lifeplan was registered with the SEC as an investment adviser.  Disraeli told investors that the funds would earn 20% per year.  By December 2003, nine clients had bought $95,000 of stock in Lifeplan from Disraeli.  Not all paid the same price for their shares.  $83,500 of the money raised was immediately transferred to Disraeli's personal bank account from which he made payments for personal living expenses.  

After becoming concerned about his disclosures concerning use of proceeds, after consulting with a lawyer, Disraeli distributed a new offering document and a rescission offer.  Despite the fact that Disraeli had started spending the proceeds of the offering after raising $30,000, the new offering document claimed that he would escrow the offering proceeds until he had raised the $50,000 minimum.  In addition to claiming the proceeds would be used to organize and fund the two investment vehicles, it stated that there could be no assurance that the funds would actually be used for those purposes.  Neither offering memorandum disclosed the use of funds by Disraeli for personal expenses.  Nor did they disclose a federal tax lien against Disraeli.  None of the funds raised were used for the purposes specified in the offering materials and no investments were purchased.

After the SEC staff began an investigation, Disraeli produced a promissory note whereby he purported to agree to repay the $84,300.  The ALJ found that the evidence strongly suggested that the note had been backdated.  The ALJ also found Disraeli not to be a credible witness. 

One investor testified at the hearing that he knew that Disraeli was going to use the offering proceeds for personal expenses and claimed he did not believe the use of proceeds was material.  Several other investors signed affidavits with similar claims.  Another investor testified he was not aware of Disraeli's use of the offering proceeds and that he would not have invested had he known those facts.  

Needless to say, the Commission found the undisclosed use of the offering proceeds to be a material departure from the representations in the offering materials.  It also found that Disraeli's failure to escrow funds until the minimum had been raised to be a material departure from the offering materials.  

The Commission rejected Disraeli's claim his misrepresentations were not material because his investors did not consider them to be.  It noted that "the reaction of individual investors is not determinative of materiality, since the standard is objective, not subjective (footnote omitted)."   It also found that investor ratifications of his conduct do not exonerate him because materiality depends on a finding of the significance of the information to an objective reasonable investor.

In other words, the Commission ruled that the use of offering proceeds for purposes not specified in offering documents is material as a matter of law.

Also, the Commission rejected Disraeli's claim that he did not commit fraud because his investors were sophisticated.  It noted that "the sophistication of investors does not justify misleading them. (footnote omitted)"

The Commission also noted that Disraeli was not protected by the statement in the second offering document that the use of proceeds might not actually conform to the disclosed uses. It noted that "[a] statement that the use of proceeds may vary from a company's current intentions cannot cure the diversion of offering proceeds from specific business expenses identified in offering memoranda to the personal use of the company's officers (footnote omitted)."  

Disraeli claimed he could not violate the anti-fraud provisions of the Advisers Act because when the offering began, he was not a registered investment adviser.  However, Section 206 of the Advisers Act is not limited to registered advisers.  While the offering was occurring, Disraeli was charging his clients fees for investment advice.  He therefore met the definition of an adviser and was subject to the anti-fraud provisions of Section 206.

Disraeli also violated Rule 206(4)-4(a) which requires an adviser to disclose to clients any material facts about his financial condition that are reasonably likely to impair his ability to meet his contractual obligations to clients.  His misappropriation of offering funds, and undisclosed IRS lien were facts that should have been disclosed.

Disraeli was registered with the Commission as an investment adviser from 1993 to 1997 when he voluntarily withdrew his registration after a change in the statute that prohibits an adviser from registering with the Commission unless it has more than $25 million of assets under management or is an adviser to a registered investment company.   In 2002 the state of Texas entered a cease and desist order against Disraeli.  In 2003 Lifeplan filed a registration application with the Commission despite the fact that it had only about $4 million under management.  Disraeli claimed, pursuant to Commission rules that he believed Lifeplan would meet the minimum registration requirements within 120 days.  The rule is designed to exempt only "start up" advisers.  The rule should only be relied on when the registrant has actual indications of interests from clients that they will transfer sufficient assets to the adviser. 

Lifeplan did not qualify as a start-up because it was the successor to Disraeli's previous advisory business.  Disraeli admitted that he had no indications of interest from clients sufficient to meet the $25 million minimum.  Nor was Disraeli able to claim the "muti-state" exemption from the minimum for advisers who operate and are required to register in at least 30 states because he had not actually obtained actual clients in 30 states.

Perpetual Securities, Inc., Cathy Y. Huang, Exchange Act Rel. 56962, December 13, 2007

Denial of motion to reconsider.

Summary

The Commission largely sustained NASD sanctions in an October, 4, 2007, opinion (see below) On October 26, 2007, after receiving an extension of time to file, respondents' filed a motion for reconsideration.

The Commission noted that such a motion is an "exceptional remedy designed only to correct manifest errors of law or fact in the previous opinion.  Further, factual matters raised in such motions will only be considered if additional factual evidence raised could not have been known or adduced before entry of the order being appealed.  

The Commission noted that here, respondents' had used their motion largely to rehash arguments they had made on direct appeal and had raised no new matters.  For example, respondents' reiterated their arguments that there was misconduct by the NASD in the underlying proceeding.  The Commission noted that it had considered those very arguments on appeal and had rejected them.  The Commission also rejected the claim that its Secretary's office had failed to serve its previous opinion, noting that delivery to respondents was by courier and confirmed after an initial problem transmitting it by facsimile.  Also, respondents' claimed that the opinion included a factual error.  The Commission noted that the statement in its opinion had been based on respondents' brief on appeal. 

Respondents' also made a claim of impropriety by the NASD staff that was not raised on appeal.  Because the matter could have been raised on appeal, the Commission ruled that this claim was not proper in a motion for reconsideration.  

Comment

Let the actual appeal begin.  The Commission labored for 6 weeks to issue a perfunctory 3 1/2 page opinion.  Delay in ruling on such motions only encourages more such motions as it allows appellants to delay final resolution of the matter.

Salvatore F. Sodano, Exchange Act Rel. 5691, December 13, 2007

Denial of motion for summary affirmance.

Summary

The ALJ dismissed the proceedings and the Division of Enforcement appealed.  The respondent filed a motion for summary affirmance.  In this order the Commission denies that motion.

Sodano was the Chairman and CEO of the AMEX.  The AMEX settled proceedings that charged it with violation of various option trading rules.  The ALJ dismissed the proceedings against Soldano after ruling that Section 19(h)(4) of the Exchange Act, the provision under which the case was brought, only authorizes proceedings against persons who are currently officers or directors of self regulatory organizations.  When the proceedings were brought, Sodano had previously resigned his positions as AMEX chairman and CEO.  

Although Rule 411(e)(2) permits the Commission to summarily affirm an ALJ's initial decision, the Commission has previously stated that it will grant such motions sparingly. Here, the Division of Enforcement argued that there is no Commission precedent that supports the ALJ's interpretation.  Also, it pointed out that the matter raises important policy issues as the ALJ's interpretation would permit someone to resign even after proceedings had been brought in order to avoid sanctions.

Because the appeal raises important policy considerations, the Commission denied the motion.

Comment

The motion was filed at the end of August 2007.  It took the Commission 3 1/2 months to deny this motion in a routine and rather perfunctory 2 1/2 page order.

Laminair Corp., TAM Restaurants, Inc., Upside Development, Inc., Exchange Act Rel. 56912, December 5, 2007

Extension of time for initial decision

Pages - 4

Summary

These are proceedings pursuant to Exchange Act Section 12(j) to determine if the registration of three companies should be suspended due to delinquent filings.  The Chief ALJ moved that the Commission extend the time for the initial decision.  The proceedings have been delayed due to the Commission's consideration of a Division of Enforcement motion to strike a party.  The Commission has previously ordered that the ALJ hold an evidentiary hearing to determine the relationship between the charged company and its successor.  

Commission rules provide for the Commission to set a deadline for the ALJ's initial decision at the time proceedings are instituted (120, 210, or 300 days).  The Commission's Chief Administrative Law Judge has discretion to determine whether a motion for an extension of time may be filed.  

The Commission announced that it intends to grant such motions only sparingly.  It further stated that a heavy trial docket alone is not sufficient cause for an extension.  Here the Chief ALJ's motion notes that the proceeding cannot be completed in the originally scheduled time because of the need for additional evidentiary hearings to resolve the issue surrounding the Division's attempt to drop a party.  Given this "unexpected complexity" the Commission granted the motion and extended the deadline by 120 days.

Comment

One wonders how long the Commission labored over this routine motion.  It should publish the date that the motion was submitted to it.  

Stephen J. Horning, Exchange Act Rel. 56886, December 3, 2007

Failure to supervise, Net capital, Broker-dealer books and records, SIPC trustee appointment

Time between appeal and decision - 1 year, 1 month, 24 days.

Time between final brief and decision - 10 months, 8 days.

Pages - 23

Summary

This was the last case I tried while I was still at the Commission so I will refrain from lengthy discussion or comment.  The ALJ barred respondent from association with a broker-dealer in a supervisor capacity and suspended him from all association for twelve months.  She found that he failed to supervise, that the firm or its associated persons committed various violations, including fraud, net capital, books and records and that the respondent caused those violations.   

On appeal, the Commission upheld the sanctions and findings of violations found by the ALJ.  It noted that even "simple neglect or nonfesance" provides grounds for sanctions under Exchange Act Section 14(b) when a SIPC trustee is appointed.  Note - this section authorizes sanctions against any person associated with a broker-dealer solely on the grounds that  a SIPC trustee was appointed.  

This is an interesting failure to supervise case against the principal of a broker-dealer that resulted from the embezzlement of several million dollars of customer funds by a back office employee of the firm.  The firm failed as a result and a SIPC trustee was appointed. 

Comment

I cannot resist --- 10 months and 8 days to issue an opinion?

Michael Sassano, Dogan Baruh, Robert Okin, R. Scott Abry, Exchange Act Rel. 56874, November 30, 2007

Interlocutory appeal, omnibus formal order, discretion of ALJ's to set pre-trial document discovery procedures

Pages - 6

Summary

The Division of Enforcement appealed an order by an ALJ that required it to turn over all evidence gathered with an omnibus formal order.  Note - omnibus formal orders are a device whereby the Commission authorizes numerous investigations, often by different offices, into matters that involve similar, but often unrelated conduct.  For example, it might authorize an  "omnibus" formal order to investigate frequent trading or mutual fund market timing at different mutual funds.  The investigation into conduct at fund x might not involve the same subjects as the investigation of trading at fund y. Further, the investigations might be conducted by different offices. Here, there were numerous investigations carried out under different file numbers, using the same formal order.

In this case, the Division used an omnibus formal order to investigate mutual fund trading, and opened a new investigative file number under the omnibus order to specifically investigate trading at Canadian Imperial Bank of Commerce.

Commission rules require that the Division shall make available to respondents documents obtained in connection with the investigation that leads to the proceedings.  Here, it provided documents related to its investigation of Canadian Imperial, but not all the documents gathered under the much broader omnibus investigative order that involved other investigations.  The ALJ, based on a motion by a respondent, ordered the Division to produce all documents gathered under the omnibus formal order that related to the mutual funds and other entities that were named in the order instituting proceedings.  The ALJ denied the Division's motion for interlocutory review.

In its motion for interlocutory review the Division noted that it had gathered tens of millions of documents pursuant to the omnibus order and that the task of selecting documents and preparing a privilege log would be a daunting task.  Respondent argued that even if the ALJ had ruled incorrectly on a "discovery" matter, interlocutory review was not warranted and further argued that it was irrelevant that the order placed a substantial burden on the Division for purposes of deciding whether interlocutory review was appropriate.

Commission rules permit discretionary interlocutory review of ALJ orders, even if the ALJ has not certified the matter for review.  However, it grants such review "only in extraordinary circumstances."

The Commission declined to review the ALJ's order.  It agreed with respondent that pre-trial discovery orders are "almost never appealable."  It further held that mere expense and inconvenience are not grounds for such an appeal.  The Commission did grant the Division sixty days to respond to the ALJ's order following this decision.  Further, at the Division's request, the Commission tolled the 300 day deadline for an initial decision to encompass the period of the Commission's consideration of the Division's motion and an additional 120 days. It also ruled that the documents did not need to be gathered in a single location for review by the respondents.

Comment

Apparently, the Commission has stayed the administrative proceeding since June 15, 2007, while it considered the Division of Enforcement's appeal.  Given the short shrift that the Commission gave to the Division's arguments, there is no good reason why this decision took five and one-half months.

The Division of Enforcement has in the past used omnibus formal orders as an "umbrella" for conducting broadly related investigations.  Often this was done to streamline the process of obtaining Commission authorization of an investigation.  While the ALJ was probably wrong in his or her interpretation of the relevant rule, the Commission's lack of concern for the difficulties and costs involved would seem to signal the end of the use of omnibus formal orders.  The Division simply cannot spend the resources preparing such vast volumes of documents for review or take the risk that it will be tied up in lengthy litigation concerning the quality of its document production.  The Commission is clearly signaling that it will give its ALJs great latitude in dealing with pre-trial discovery issues regardless of the exact wording of the relevant rules.