Column: US appeals court rejects lenient test for asset freezes in SEC enforcement actions
The opinions expressed here are those of the author, a columnist for Reuters.
By Alison Frankel
July 10 (Reuters) -A U.S. appeals court has just deepened a split among the federal circuits on the proper test for asset freezes in cases brought by the U.S. Securities and Exchange Commission.
The Philadelphia-based 3rd U.S. Circuit Court of Appeals ruled on Tuesday that the SEC cannot sidestep the stringent, four-part test for obtaining a preliminary injunction when it seeks to freeze the assets of a defendant in an enforcement action.
That conclusion is at odds with precedent from the New York-based 2nd Circuit, which requires the SEC only to meet one element of the four-part test. To obtain an asset freeze in the 2nd Circuit, the SEC must simply establish an inference that a defendant violated federal securities laws.
The 3rd Circuit rejected both the limited scope and the low bar of that test in Tuesday's decision. It held not only that the SEC must prove a likelihood of succeed on the merits of its allegations -- a more stringent standard than the 2nd Circuit's "inference" requirement -- but also that trial courts must consider the three other traditional preliminary injunction factors before freezing the assets of an SEC target. (Those factors, in case you've forgotten, are irreparable harm, a balance of equities and the public interest.)
The 1st Circuit has also ruled that courts must take irreparable harm into account when the SEC moves for an asset freeze.
“We can understand why the SEC likes [the 2nd Circuit] approach, but there is no statutory basis for it,” wrote 3rd Circuit Judge Kent Jordan for a panel that also included Judges Thomas Ambro and Stephanos Bibas. “Nor can we see any other reason to hold the SEC to a lower burden when it argues for an asset freeze.”
The appeals court nevertheless held that even under the more stringent test, U.S. District Judge John Vazquez of Newark, New Jersey, acted within his discretion in freezing most of the assets of Dale Chappell, a scientist and investor whom the SEC has sued for insider trading in the New Jersey-based biopharmaceutical company Humanigen HGENQ.PK.
The 3rd Circuit concluded that the SEC was likely to succeed on the merits of its claim that Chappell, a majority shareholder of several investment funds that, in turn, control a majority of Humanigen’s shares, sold off Humanigen shares based on confidential information. The SEC claims that Chappell, who also served as Humanigen's chief science officer, avoided nearly $40 million in losses by dumping shares after learning that the U.S. government was likely to reject Humanigen’s application for emergency use of its only product, an anti-inflammatory drug.
The appeals court also found the SEC adequately alleged a risk of irreparable harm because Chappell, who has relinquished his U.S. citizenship and now lives “lavishly” (in the 3rd Circuit’s word) in Switzerland, might try to shield assets from U.S. authorities. The other two preliminary injunction factors, the appeals court said, also weigh in favor of an asset freeze. (The trial judge modified the freeze to allow for legal expenses, educational costs for Chappell’s children and $50,000 for Chappell’s wife.)
The SEC did not respond to a query on the new ruling.
Chappell counsel Marc Rosen of Kleinberg, Kaplan, Wolff & Cohen said via email that the 3rd Circuit reached the right result on the proper standard of review for SEC asset freeze requests but that he and his client are “certainly disappointed with the appellate court’s application of that standard in this case.”
Chappell told the 3rd Circuit that he acted in good faith when he heeded concerns of his funds' minority investors and sold off part of the funds' holdings in Humanigen. Chappell pointed out that he disclosed his plans to sell shares to Humanigen’s board and obtained approval for the sales from the company’s compliance team.
Chappell moreover argued that the U.S. government’s warning that it was likely to deny Humanigen’s emergency use application was not material to investors, as the board concluded when it decided not to disclose the tentative determination in SEC filings.
Chappell ultimately lost more than $100 million from his investment in Humanigen, according to his brief. Chappell counsel Rosen said his side believes the full record will prove Chappell and his funds did not trade illegally.
The 3rd Circuit’s decision is the latest example of courts refusing to grant special treatment to federal agencies. As Jordan explained in Tuesday’s ruling, the 2nd Circuit’s lenient test for SEC asset freezes is based on language in federal securities laws that grants the agency authority to seek injunctions “in its discretion.”
But the 3rd Circuit said the 2nd Circuit had overread the statutes by assuming Congress intended to relax the traditional preliminary injunction test, even though Congress did not expressly say that. The appeals court cited the U.S. Supreme Court’s ruling last month in Starbucks Corporation v. McKinney, which held that the National Labor Relations Board must meet the traditional standards for a preliminary injunction despite statutory language giving the agency authority to seek injunctions to preserve the status quo during its investigations.
Obviously, requiring federal agencies to meet the same standard as everyone else to obtain a preliminary injunction is not as consequential as ending Chevron deference or setting doctrinal limits on agencies’ ability to expand their power beyond explicit Congressional authorization.
But the 3rd Circuit’s new ruling is one more piece of evidence that the heyday of federal agencies is ending.
Read more:
US Supreme Court backs Starbucks over fired pro-union workers
US Supreme Court curbs federal agency powers, overturning 1984 precedent
U.S. Supreme Court just gave federal agencies a big reason to worry
(Reporting By Alison Frankel)
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