Hedge Fund Files Existential Suit Against SEC

MANHATTAN (CN) - An activist hedge fund manager trying to save his $200 million firm took aim in a federal complaint against the very foundation of the Securities and Exchange Commission.

Joseph Stilwell and his Wall Street-adjacent firm Stillwell Value filed the suit Wednesday with the prestigious firm Skadden, Arps, Slate, Meagher & Flom.

"Mr. Stilwell's area of expertise is activism in the banking and insurance sectors," the 18-page complaint states. "Specifically, Mr. Stilwell's limited partners come to him in large part for his ability to identify undervalued companies in those industries, obtain a level of influence in those companies by acquiring a significant ownership stake through the stock market, and use that influence to help turn the companies around, attempting to raise the share price and thereby the value of his limited partners' investment."

Stillwell ran his firm as an unregistered investment adviser "because register was not required under the regulatory regime prevailing" until early 2012.

But the Dodd-Frank Wall Street Reform and Consumer Protection Act that year required him to register with the SEC as an investment advisor, which he did in March 2012.

Four months later, the SEC launched an "examination" of Stilwell Value. While that probe was ongoing, the SEC ordered an investigation into interfund loans, claiming that the loans, which are now closed and paid, were a conflict of interest that should have been disclosed to investors.

"No investor was harmed as a result of the inter-fund loans," the complaint states. "Mr. Stilwell did not incur any personal pecuniary benefit from the inter-fund loans."

Stilwell also says that certain funds were disclosed in audited financial statements that were "made available to investors upon request."

Nevertheless, acting on its own discretion, "guided by no statute, regulation or established practice," the SEC announced in July 2014 that it would charge Stilwell unless he agreed to "draconian" settlement terms "that would inflict a significant risk of financial harm to Stilwell's investors," according to the complaint.

The SEC allegedly said it would enforce its actions in an SEC administrative proceeding rather than in a federal court.

"Stilwell believes that the commitment of the enforcement action will become imminent after Mr. Stilwell's second day of investigative testimony before the SEC," the complaint states. Stilwell's testimony concluded Tuesday.

Administrative proceedings limit discovery, generally do not involve depositions, and are not heard before juries, according to the complaint.

Stilwell said the agency's ALJs also enjoy certain job protections that make it impossible for the president of the United States to remove them.

"Because the president cannot oversee SEC ALJs in accordance with Article II, SEC administrative proceedings violate the Constitution," the lawsuit states.

Furthermore, the SEC "rules and practice do not provide respondents the opportunity to test the SEC's legal theories before trial via motions to dismiss, which are available in federal court," it continues.

Stilwell says the SEC decided to hold the administrative proceeding, as opposed to trying its cases in federal court, because it has "succeeded much more often" in these forums "than in federal district courts."

"Nothing in the rules or statutes prevents the commission from making the ALJ's sanction effective before the respondent has had an opportunity to appeal the commission's order, and in fact the commission routinely makes sanctions effective immediately," he said.

Such a forum allegedly means Stilwell "will be required to submit to an unconstitutional proceeding."

"The lack of traditional procedural safeguards in SEC administrative proceedings further exacerbates that harm," his lawsuit continues.

"The burdens incurred during an administrative proceeding would be for naught, because such administrative proceeding is unconstitutional and the SEC likely would try to reprise its case in a lawful setting, such as federal district court.

"However, forcing Stilwell to litigate twice would compound costs, lost time and reputational risk."

Stilwell says the proceeding "threatens to damage Stilwell's business and the investments of the approximately 192 limited partners" and is "irreparable."

He wants U.S. District Judge Katherine Forrest to strike as unconstitutional the provisions that provide "for the position of SEC ALJ and the tenure protections for that position." Forrest is also being asked to stop the administrative hearing against Stilwell.

In addition to Steven Glaser with Skadden Arps, Stilwell is represented by Peter Hardy with Post & Schell. Neither Skadden Arps nor the SEC returned requests for comment.

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