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From Securities Regulation Daily, January 6, 2015

Latest suit over SEC enforcement tactic says key reform law unconstitutional

By Mark S. Nelson, J.D.

A former CEO of a company that runs senior assisted living residences wants a court to stop the SEC’s administrative action against her because the Dodd-Frank Act provision that gave the agency power to bring the action is facially unconstitutional, according to a law suit she filed the day after New Year’s Day in the Milwaukee federal court. The SEC’s proceeding against Laurie A. Bebo, begun just over a month ago, alleges that she engaged in securities fraud and other violations in order to prop up a faltering lease deal. Bebo’s suit against the SEC is the third of its kind to be filed since last October (Bebo v. SEC, January 2, 2015).

Facial challenge; Article II redux. Bebo’s challenge to the SEC’s enforcement proceedings comes as two similar cases have briefly receded from the public spotlight (more on these cases later). While all three suits target the SEC’s administrative law judge (ALJs) under Article II of the U.S. Constitution, Bebo’s suit most clearly takes on the SEC’s use of its new powers to impose civil penalties given to it by the Dodd-Frank Act.

Dodd-Frank Act Section 929P(a) amended the Securities Act, Exchange Act, Investment Company Act, and the Investment Advisers Act to let the SEC impose civil penalties. As Bebo’s complaint notes, the SEC lacked this authority until the reform law gave the agency a choice between a federal suit and an administrative proceeding for many types of securities violations.

Bebo’s suit claims that giving the SEC a choice of forum violates her Seventh Amendment right to a jury trial because the SEC can elect to proceed in the forum that affords it the best chance of winning. This home court advantage theme also permeates the other two suits against the SEC.

Bebo also claims the SEC’s new powers violate equal protection of the laws, as read into the Fifth Amendment due process clause. Here, Bebo argues that the right to a jury trial must be granted to similarly situated persons; put another way, if a jury trial is available to persons charged with a particular violation, the right to a jury cannot be denied to others facing charges for the same violation.

Holding to the Fifth Amendment tack, Bebo also claims that the SEC’s choice of an administrative action denies her procedural due process. Her complaint argues that she will be denied access to key witnesses, including five of the seven board members of the company she once ran, because many of them reside in Canada. Bebo also cites the volume of data her counsels need to review and the short time frame for doing so, plus the lack of safeguards in SEC administrative proceedings akin to the Federal Rules of Evidence or the Federal Rules of Civil Procedure.

Bebo, like Jordan Peixoto and Joseph Stilwell in suits they filed last year, also invokes the Supreme Court’s 2010 Free Enterprise opinion about the Public Company Accounting Oversight Board (PCAOB), a private, nonprofit, but government-created and government-appointed entity. There, the court explained that the constitution limits the number of layers of good cause removal permitted to exist between the president and federal agency members under Article II of the U.S. Constitution. Bebo, Peixoto, and Stilwell would apply Free Enterprise to the SEC’s ALJs, whom they claim enjoy at least two levels of good cause tenure.

But the Supreme Court in Free Enterprise also averted a PCAOB shut-down by declaring that the unconstitutional tenure provisions in the Sarbanes-Oxley Act were severable, so the SEC can now fire PCAOB members at will. This preserved the PCAOB as an institution while maintaining the constitutional nearness of the president to those he is charged with holding accountable.

Pesky lease drives SEC action. The SEC’s administrative case against Bebo and John Buono (ALC’s ex-CFO, senior vice president and treasurer) turns on how Bebo and Buono allegedly leaned on ALC employees to help them alter data ALC disclosed in its SEC filings about financial covenants in the lease agreement ALC inked as part of a deal to buy 540 senior assisted living units from Ventas, Inc.

ALC already had 9,000 units of its own spread across 200 residences in the U.S. The SEC’s order kicking-off its action portrayed Bebo as strong backer of the Ventas lease deal, even if other ALC officers and directors may have fretted over the deal’s seemingly harsh financial covenants.

The lease required ALC to meet occupancy rate goals, which in turn impacted the cash flow component of the “coverage ratio” metric used to help gauge ALC’s lease compliance. If ALC broke the lease, Ventas could end the lease, evict ALC, and force ALC to pay damages that ranged from $16.7 million to $24.9 million for fiscal years 2009 to 2011. The SEC said Bebo told ALC’s directors the company would be able to handle the Ventas lease.

According to the SEC, Bebo and Buono battled against a possible lease default by having ALC staffers conjure “large numbers” of fake occupants for many of the assisted living units subject to the Ventas lease in order to meet the financial covenants. The SEC also alleged that ALC staff made off-setting journal entries to account for revenues from fake occupants. Moreover, the SEC said Bebo and Buono made quarterly lists of fake occupants that even included Bebo’s friend’s seven-year old nephew, current and former ALC employees, and new ALC hires who still had not formally begun work at ALC.

The SEC charged Bebo and Buono with securities fraud and with violating other laws or rules governing financial reporting, internal accounting controls, executive certifications, and the keeping of books and records. According to the SEC’s order, Bebo and Buono caused ALC to misrepresent its compliance with the Ventas lease in its Forms 10-K and 10-Q. As a result, the SEC wants to impose cease and desist orders, officer and director bars, disgorgement, civil penalties, and to bar Buono from practicing as an accountant before the SEC.

At the time of the Ventas deal, ALC’s common stock was registered with the SEC and the company traded on the New York Stock Exchange (NYSE). ALC would later forgo its NYSE listing when a private equity firm acquired it in 2013. In 2012, ALC settled a related civil case filed by Ventas.

ALJ Cameron Elliot stayed the SEC’s action against Buono last December to give the Commission time to review Buono’s pending settlement offer. Yesterday, ALJ Elliot denied Bebo’s request for relief from the Commission’s practice rules and instead scheduled a hearing for April 20, 2015 in Milwaukee, Wisconsin.

Test cases on hold. Bebo’s and the other two SEC enforcement targets filed their suits challenging the SEC just as the agency began to expand its ALJ ranks. The two suits filed in the Manhattan federal court are currently stayed, but are set for renewed activity late next week.

In one case, an administrative law judge cancelled a hearing that had been set for March 2015 in the SEC’s administrative proceeding against Peixoto, whom the agency said engaged in insider trading of Herbalife Ltd.’s securities. ALJ Elliot issued his order after the SEC’s Enforcement Division submitted a courtesy copy of a motion asking the Commission to dismiss the matter because the division will likely be unable to get key witnesses to attend the hearing. The federal suit is stayed until January 15 (Peixoto v. SEC, October 20, 2014).

As for the other case, Stilwell said he got a Wells notice from the SEC stating the agency’s belief that he ran afoul of the Investment Advisers Act by not disclosing to investors that he engaged in conflicted interest transactions by facilitating inter-fund loans. Stilwell said he disclosed the loans in audited financials and in a letter to investors.

When Stilwell’s federal case resumes on January 16, lawyers for Stilwell and the SEC may grapple over whether Stilwell has standing to sue the agency based solely on his receipt of a Wells notice and his allegation that the SEC told him it planned to “imminently” charge him with securities violations in an administrative case. The SEC has yet to formally charge Stilwell (Stilwell, et al. v. SEC, October 1, 2014).

The case is No. 15-cv-00003.

Attorneys: Mark A Cameli (Reinhart Boerner Van Deuren SC) for Laurie A. Bebo.

Companies: Assisted Living Concepts Inc.; Ventas, Inc.; Herbalife Ltd.; New York Stock Exchange

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