Chamber to SEC in State Street appeal: No deference for you!

June 23, 2015

I had a feeling the U.S. Chamber of Commerce might have something to say about the Securities and Exchange Commission’s split ruling last December against former State Street chief investment officer John Flannery. And so it does. The Chamber has filed an amicus brief at the 1st U.S. Circuit Court of Appeals, arguing that the SEC overstepped its authority when it used the State Street case to re-interpret anti-fraud provisions of the Securities Act of 1933.

The SEC, which overruled its own in-house judge to find Flannery liable for deceiving investors, acknowledged in its decision that it was broadening the scope of liability under both Section 17a of the Securities Act and Rule 10b-5 of the Securities Exchange Act of 1934. The commission invoked the U.S. Supreme Court’s deference to the rulemaking authority of federal agencies in the 1984 case of Chevron v. Natural Resources Defense Council and said its new interpretation was necessary to resolve “confusion in the courts and inconsistencies across jurisdictions.”

But according to the Chamber of Commerce’s lawyers at Wilmer Cutler Pickering Hale & Dorr, the agency isn’t entitled to Chevron deference because of the rule of lenity, which insists ambiguities in criminal statutes must be resolved in favor of defendants.

What makes the Flannery case so interesting is that the rule of lenity ordinarily applies only in criminal cases. The former State Street CIO was found liable in an enforcement proceeding, not convicted in a criminal prosecution. The Chamber brief nevertheless contends that the rule of lenity prohibits the SEC from penalizing him under a re-interpretation of the Securities Act because the statute is a hybrid with both civil and criminal consequences.

“Applying the rule of lenity to hybrid statutes of this sort promotes consistent interpretation of the law, fair notice to the public of what the law requires and clear boundaries between the branches of government,” the Chamber brief said. (As I’ve previously reported, Flannery’s lawyers at McDermott Will & Emery made a similar argument in the former exec’s own appellate brief earlier this month.)

The question of the SEC’s authority to interpret hybrid civil-and-criminal securities laws erupted last November, in an unusual statement by Justice Antonin Scalia addressing a petition for certiorari by former investment manager Douglas Whitman, who was convicted of insider trading in 2012. Scalia and Justice Clarence Thomas, who joined the statement, said procedural defects precluded review of Whitman’s case. But the justices seemed very skeptical that the SEC is owed deference in its interpretation of a statute that contains criminal prohibitions. According to Scalia, “if a law has both criminal and civil applications, the rule of lenity governs its interpretation in both settings.”

The Chamber’s brief in the Flannery case points to Scalia’s Whitman statement, as well as analysis of the intersection of the rule of lenity and Chevron deference by Judge Jeffrey Sutton of the 6th U.S. Circuit Court of Appeals in his 2013 concurrence in Carter v. Welles-Bowen Realty. Sutton looked at the principles underlying both the age-old lenity doctrine and the modern reality that federal agencies must have the authority to fill gaps in the laws they administer. “Case law  makes clear that either the rule of lenity prevails across the board or the agency’s interpretation does. But which one? The better approach, it seems to me, is that a court should not defer to an agency’s anti-defendant interpretation of a law backed by criminal penalties,” Sutton wrote. “Agencies, no less than courts, must honor the rule of lenity.”

That is certainly the position the Chamber and Flannery would like the 1st Circuit to adopt in this appeal, but the Chamber does admit in a footnote to contrary holdings from the 4th and District of Columbia Circuits, which have both refused to apply the rule of lenity to an agency interpretation of a hybrid statute. The Supreme Court similarly said in a footnote in its 1995 decision in Babbitt v. Sweet Home, “We have never suggested that the rule of lenity should provide the standard for reviewing facial challenges to administrative regulations whenever the governing statute authorizes criminal enforcement.”

I’m sure the Sweet Home case will get big play in the SEC’s response to Flannery and the Chamber, which is due in July.

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