THE SEC AND CONSISTENCY
Consistency is sometimes a virtue and, at other times, the “hobgoblin of small minds” to borrow an old phrase. In SEC v. Pentagon Capital Management PLC, Case No. 08 Civ. 3324 (S.D.N.Y. Filed April 3, 2008), the SEC learned in a ruling issued on St Patrick’s Day that it should pay more attention to the virtue. No luck of the Irish for the SEC.
Pentagon Capital is a market timing case brought against a UK-based hedge fund adviser and its principal. The amended complaint alleges that the two defendants orchestrated a scheme to defraud U.S. mutual funds and their investors through late trading and deceptive market timing. Defendants sought to establish that the U.S. mutual funds the SEC claimed to have been deceived in fact permitted market timing. This would undercut the position of the SEC.
To prove their point, the defendants sought to admit in evidence the Orders from a series of settled SEC administrative enforcement actions. The settled proceedings were against Alliance Capital Management, Banc One Investment Advisors, Deutsche Asset Management, Evergreen Investment and several others. The findings in each administrative order contradicted the SEC’s position that the U.S. mutual funds were deceived.
Admissibility of the SEC OIPs is governed by Rule 803 of the Federal Rules of Evidence. That Rule provides that certain kinds of evidence are not excluded by the hearsay rule even though the declarant is available as a witness. Subsection (8) applies to research, reports, statements of public officials or agencies, “setting forth . . . factual findings resulting from an investigation made pursuant to authority granted by law.”
Here, in each instance, the order resulted from an investigation which the SEC was empowered by statute to conduct. In each instance, the order contains findings regarding the conduct of the respondent. In each instance, the SEC reached conclusions about violations of law by the respondent.
Each document and the findings in it, however, is part of a settlement. Each notes that the findings are made as part of an offer of settlement and that they are not binding on any other person. In fact, each offer of settlement was made without admitting or denying the facts. This disclaimer, however, does not control admission under Rule 803, the court held. In reaching this conclusion, the court found it significant that the parties had agreed not to make any statements which are inconsistent with the findings and which might be viewed as a denial.
Likewise, the fact that the OIPs are settlements does not preclude admission under the circumstances here. Rule 408 of the Federal Rules of Evidence provides that evidence of settlements is not admissible to prove liability or the invalidity of a claim or its amount. Here, however, the defendant “are not trying to use the settlements to establish liability against the parties who settled, but to offer the evidence as a shield because the SEC’s findings that others were aware of, and facilitated, market timing and late trading tend to negate the Commission’s allegation that the defendants in this action deceived those parties. Such evidence is not precluded by Rule 408 because it is being offered for a purpose other than to establish liability.”
The court held that the OIPs could be admitted for the limited purpose offered. Perhaps in the future the SEC will take care to be consistent.
Thanks to Frank Razzano of Pepper Hamilton, who is litigating the case, for a copy of the opinion.