When in Doubt, Don’t Show Up: DC Circuit Reversed and Remanded SEC’s Default Order in Rapoport v. SEC
In Rapoport v. SEC, the D.C. Circuit Court of Appeals granted petitioner Rapoport’s petition for review, vacated the Security and Exchange Commission’s (“SEC”) default order, and remanded for further proceedings. The court concluded that the SEC had arbitrarily applied Rule 155(b) of its Rules of Practice and failed to provide a comprehensible standard for what constituted a reasonable time to file a motion to set aside a default. Rapoport v. SEC, 2012 WL 2298772 (D.C. Cir., June 19, 2012).
The SEC entered a default judgment against Dan Rapoport (“Rapoport”), a Russian citizen, for failing to respond to administrative proceedings alleging violations of Section 15(a) of the Exchange Act. According to the SEC’s Order Instituting Proceedings (“OIP”), Rapoport “solicited institutional investors in the United States to purchase and sell thinly-traded stocks of Russian companies . . . without registering as a broker-dealer as required by Section 15(a) of the Exchange Act” or meeting an exemption under Rule 15a-6. 17 CFR 240.15a-6.
Rapoport filed a motion to set aside the default. Under Rule 155(b) of the Exchange Act, a motion to set aside a default must (1) be made within a reasonable time; (2) state the reasons for the failure to appear or defend; and (3) specify the nature of the proposed defense to the original proceeding. 17 C.F.R. § 201.155(b). If the SEC finds “good cause shown,” the default can be set aside at any time.
The SEC determined that Rapoport failed to file his motion within a reasonable time and that his reason for failing to defend the OIP lacked merit. Because the first two prongs of Rule 155(b) were not met, the SEC did not consider the merits of Rapoport’s defenses.
The court held that by failing to consider Rapoport’s defenses, the SEC departed from its previous interpretation of Rule 155(b) and did so without justifying the inconsistency. The court stated that “[a]lthough the Commission is not bound to follow its precedent, it may not depart from its precedent without offering a reasoned explanation.”
The DC Circuit also held that the Commission “failed to provide any intelligible standard to assess what constitutes a ‘reasonable’ amount of time for filing a motion to set aside a default order under Rule 155(b).” It was unclear when the “reasonable time” clock started ticking and what amount of time was reasonable to file a motion to set aside a default after the clock had begun.
Finally, the court suggested that the SEC review the sanctions it applied in the default judgment. Rapoport was charged with a second-tier penalty for each year of the alleged violations. There were, however, no specific allegations of Rapoport’s violations to support the charges. The SEC instead relied on conclusory allegations that Rapoport willfully violated Section 15(a), which alone are not enough to justify maximum second-tier penalties without further explanation. The court held that the SEC’s further explanation “was not just superficial, it was non-existent.”
The primary materials for this case may be found on the DU Corporate Governance website.