First Circuit Overturns SEC Ruling In Flannery v. SEC

The First Circuit's decision underscores the limits of court deference to Commission decisions, gives teeth to the "substantial evidence" standard of review, and provides a valuable roadmap for evaluating and defending allegations of material misstatements.

On December 8, the US Court of Appeals for the First Circuit vacated a US Securities and Exchange Commission (Commission) order imposing sanctions against two former employees of State Street Bank and Trust Company: James D. Hopkins (a former vice president) and John P. Flannery (a former chief investment officer). The Commission had found Hopkins liable under Section 17(a)(1) of the Securities Act of 1933, as well as Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. Flannery was found liable under Section 17(a)(3) of the Securities Act. The First Circuit disagreed with the Commission's interpretation of the facts, held that the Commission had abused its discretion, and vacated the findings of liability.

The First Circuit's decision underscores the limits of court deference to Commission decisions and gives teeth to the "substantial evidence" standard of review—particularly in cases where the Commission's conclusions differ from those reached by the administrative law judge (ALJ) who conducted the trial and heard witnesses in person. The decision also provides a valuable roadmap for evaluating and defending allegations of material misstatements, particularly in cases involving investments sold to institutional investors.

The Commission's divided opinion had set out its own legal interpretation to resolve the impact of Janus Capital Group v. First Derivative Traders, in which the US Supreme Court limited primary liability for false and misleading statements under Rule 10b-5 of the Exchange Act to those who had the "ultimate authority" to make a statement—typically, the speaker of the statement. Citing the "agency's experience and expertise in administering securities law," the Commission held that the limits Janus placed on private claims did not apply to the SEC, and that Janus did not apply to Section 17 of the Securities Act. Although the First Circuit does not address this aspect of the case, its reversal is significant for that reason as well.

Background

The SEC brought charges against Hopkins and Flannery in 2010 based on allegedly misleading communications to investors in a State Street-managed fund known as the Limited Duration Bond Fund (LDBF or the Fund), an...