Monday, August 29, 2005
The common form of relief sought by the SEC in a securities fraud action is an injunction directing the defendant(s) not to violate the federal securities laws in the future. At one time, this was the most important equitable relief available to the Commission (along with disgorgement), and the civil money penalties and director & officer bars are a more recent legislative development to beef up its enforcement authority. In most settled cases, the SEC and the defendant agreed to a broad injunction ordering the defendant to "sin no more" under the securities laws. Because the parties agreed to the relief, district courts usually did not scrutinize the settlement papers very closely, including the permanent injunctions that could be the subject of a contempt prosecution if violated. In fact, SEC suits for violations of injunctions are fairly uncommon, although it does happen on occasion. In SEC v. Smyth (here), however, the Eleventh Circuit in a footnote issued a nice bit of dicta stating that these broad injunctions are unenforceable because they violate a defendant's due process rights. The footnote, which comes at the end of the opinion and deals with an issue that was not before the court (hence the term "dicta"), states:
The injunctions reach any violation of the securities laws and regulations Johns may commit. If the SEC believes that Johns has committed a violation, it has the right to move the district court for an order to show cause why he should not be adjudged in civil contempt and sanctioned. And it would matter not where the violation occurred, as we now explain. Paragraph II of the decree enjoins Johns from violating section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5. Thus, if Johns violated the statute and the rule by employing a "device, scheme, or artifice to defraud . . . in connection with the purchase or sale" of the shares of Corporation X in California, the district court could make Johns come to Atlanta on a rule to show cause, issued at the SEC’s behest, and explain why he should not be jailed, fined or otherwise sanctioned for the violation.
"[T]he Securities Exchange Act permits the exercise of personal jurisdiction to the limit of the Due Process Clause of the Fifth Amendment. . . ." E.g., SEC v. Unifund SAL, 910 F.2d 1028, 1033 (2d Cir. 1990). In the above hypothetical, because Johns committed the violations in California and had no presence in Georgia, the district court, and thus the SEC, could not obtain jurisdiction over his person if the SEC sued him in the Northern District of Georgia. By persuading the district court to sign the consent decree it presented pursuant to its stipulation with Johns, the SEC apparently is of the belief that the Due Process Clause would present no hurdle to the enforcement of the injunction it has obtained. Put another way, the Clause would effectively bar the prosecution of an independent suit in Atlanta based on the California violation (because in personam jurisdiction over Johns would be lacking), but it would not bar a contempt proceeding in Atlanta based on the same violation. The SEC is also apparently of the belief that the Rules of Civil Procedure would have little application in a contempt proceeding in Atlanta. If the SEC sued Johns in California, Johns would have the benefit of all of the rights the Rules provide a civil litigant, not to mention his Seventh Amendment right to a trial by jury. Not so in a contempt proceeding; the court would issue a show-cause order on the SEC’s motion, and would promptly convene a hearing to permit Johns to rebut the SEC’s proof that he violated the law. Whether the court would delay the hearing to afford Johns his rights under the Rules, including discovery, and a jury trial of the issues the court would ordinarily submit to a jury were the SEC to sue Johns in a separate action rather than seek enforcement of the injunction are issues a district court should consider in deciding whether to sign an obey-the-law consent decree such as the one the SEC drafted in this case.
Will the SEC have to take more care in writing its injunctions, at least in cases involving a settlement? The narrower the injunction, the more likely a crafty defendant can seek to engage in misconduct while avoiding the technical prohibitions in the injunction. 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. (ph)