United States: First Circuit Overturns SEC Commissioners' Sanctions Order

As we have discussed before, the SEC's increased use of in-house administrative proceedings in enforcement actions involving allegations of fraud has been a subject of considerable debate. Commentators have questioned the fairness of proceedings where the SEC gains an automatic home field advantage by bringing claims before its own administrative law judges (ALJs), with appeals being heard by the SEC's own commissioners. But a determined defense can still defeat the SEC by ensuring that it plays by the rules, as demonstrated by a decision issued last week by the U.S. Court of Appeals for First Circuit in a case where Mintz Levin attorneys Jack Sylvia, Andy Nathanson, Jess Sergi, McKenzie Webster, and Geoff Friedman represented one of the petitioners.

The First Circuit vindicated two former employees of State Street Global Advisors (SSgA) who had been targeted by the SEC for alleged securities violations during the 2007 subprime mortgage crisis. Despite applying the highly deferential "substantial evidence" standard of review for agency factfinding, the First Circuit concluded that the SEC abused its discretion in holding Mintz Levin's client, former SSgA Vice President James Hopkins, liable under Section 17(a)(1) of the Securities Act, Section 10(b) of the Exchange Act, and Exchange Act Rule 10b-5. The First Circuit also vacated the Commission's order holding Mr. Hopkins' co-defendant, SSgA CIO John Flannery, liable under Section 17(a)(3) of the Securities Act.

A long and tortured path led to the First Circuit's widely-reported decision. It began in September 2010, when the Commission issued an Order Instituting Proceedings against Mr. Hopkins and Mr. Flannery, alleging that they each made several material misrepresentations and omissions that misled investors about the SSgA Limited Duration Bond Fund (LDBF) and its exposure to subprime securities. The case was initially tried before the SEC's Chief Administrative Law Judge. After an eleven-day hearing, involving nineteen witnesses (generating thousands of pages of transcripts), the ALJ issued a 58-page decision finding that neither Mr. Hopkins nor Mr. Flannery made any false or misleading statements. In light of the SEC's 90% success rate before its own ALJs, this was a truly rare defeat for the SEC on its home turf.

Undeterred, the SEC's Division of Enforcement appealed the ALJ's decision to the five-member Commission. Three more years passed. Finally, in December 2014, the commissioners issued a 3-2 decision effectively reversing the ALJ. In Mr. Hopkins' case, the majority focused on a single slide that he had allegedly used at a presentation to a group of investors. This slide described LDBF's "typical portfolio exposures" in several broad categories including asset-backed securities, commercial mortgage-backed securities, and mortgage-backed securities. A majority of the commissioners took the position that this slide was materially misleading because it represented that typically only 55% of the fund was invested in asset-backed securities when its actual investment in asset-backed securities in September 2006 through June 2007 was substantially higher. Based on this single slide, the Commission suspended Mr. Hopkins for one year from association with any investment adviser or company and assessed a civil monetary penalty of $65,000. With regard to Mr. Hopkins' co-defendant, John Flannery, the Commission found he was liable for alleged misstatements in two letters concerning LDBF and similarly imposed a one-year suspension and a civil fine.

On a petition for review to the First Circuit, Judges Lynch, Stahl, and Kayatta vacated the Commission's order in its entirety. With regard to Mr. Hopkins, the Court concluded that the SEC's purported showing of materiality was "marginal" and that the SEC had failed to demonstrate that he had acted with scienter. "Context," the court emphasized, "makes a difference." The court noted that the single slide cited by the Commission was clearly labeled "typical," and it was only one slide in a deck of at least twenty. Moreover, investors had access to specific information about LDBF's actual investments through quarterly fact sheets and the fund's audited financial statements. "[W]hen a slide is labeled 'typical,' and where a reasonable investor would not rely on one slide but instead would conduct due diligence when making an investment decision, the availability of actual and accurate information is relevant," the court reasoned. Further, based in part on this "thin materiality showing," the court held that scienter, even in the form of recklessness, also was lacking. The court took note of Mr. Hopkins' testimony that he did not recall ever discussing the typical portfolio slide or being asked a question about actual sector breakdowns during a presentation and that he did not update the slide's breakdowns because he did not think they were important to investors. Moreover, when making an investor presentation, he would prepare notes with specific current information about the LDBF's sector investments. The court therefore concluded that Mr. Hopkins' presentation of this single slide did not rise to the level of recklessness required to show scienter for a securities fraud claim, i.e., "an extreme departure from the standards of ordinary care" that is either known to the defendant or so obvious that he must have been aware of it. As for Mr. Flannery, the court concluded that one of the two letters cited by the Commission was not misleading, and that even assuming that the other might have been, that single alleged misstatement would not suffice to hold him liable under the Commission's interpretation of Section 17(a)(3).

Two aspects of the court's decision merit particular mention.

First, while the court applied the deferential "substantial evidence" test in reviewing the Commission's decision, the court emphasized the more searching aspects of that test. The court observed that in determining whether the Commission's decision was supported by substantial evidence, "[t]he substantiality of the evidence must take into account whatever in the record fairly detracts from its weight," noting in particular that "evidence supporting a conclusion may be less substantial when an impartial, experienced examiner who has observed the witnesses and lived with the case" – in this case the ALJ who initially heard the evidence – "has drawn conclusions different from the Commission's." In that situation, the First Circuit said, "our review is slightly less deferential than it would be otherwise." Following this less deferential standard of review, the court cited aspects of the record the ALJ credited but the Commission did not. For example, the court noted the ALJ's finding that Hopkins had "worked in the securities industry for thirty-five years with an unblemished record"—a fact conspicuously absent from the Commission's opinion. The court also cited expert testimony that a typical investor would not have relied on the information contained in a single, pre-prepared slide in performing diligence, testimony that was also cited favorably by the ALJ but not the Commission. Building this evidentiary record in the administrative proceeding proved crucial to obtaining a reversal in federal court.

Second, the First Circuit's discussion of materiality and scienter provides useful guidance as to when a single, allegedly misleading statement may be non-actionable. While the court made it clear that it was "not suggest[ing] that the mere availability of accurate information negates an inaccurate statement," the court also indicated that the materiality of the alleged misstatement and the maker's scienter must be considered in the context of its presentation and the other information available to investors.

This striking defense victory will feature prominently in the ongoing debate about the SEC's use of administrative tribunals to prosecute securities law violations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Chip Phinney
In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.