Initial Decision of an SEC Administrative Law Judge
In the Matter of
In the Matter of
June 27, 2000
William P. Hicks, William A. Rees, and William S. Dixon for the Division of Enforcement, Securities and Exchange Commission
Peter J. Anderson, Kristen Jones Indermark, and Todd Ratner of Sutherland, Asbill & Brennan LLP for Respondent Kirk Montgomery
Carol Fox Foelak, Administrative Law Judge
This Initial Decision grants Kirk Montgomery's application for fees and expenses pursuant to the Equal Access to Justice Act, in the amount of $211,943.27. Montgomery had been exonerated of all charges in an administrative proceeding against him, and this Decision concludes that there was no substantial justification for initiating and prosecuting those charges. It further concludes that he incurred attorney fees and other expenses exceeding $400,000 in defending himself. The amount awarded was reduced from the actual fees and expenses, pursuant to a maximum hourly rate for attorney fees set by the Commission's Rules as authorized by statute.
A. Procedural Background
This Initial Decision concerns an Application for Fees and Expenses pursuant to the Equal Access to Justice Act (EAJA), 5 U.S.C. § 504, and Sections 201.31-.59 of the Securities and Exchange Commission's (Commission) Rules, 17 C.F.R. §§ 201.31-.59, timely filed April 5, 2000, by Kirk Montgomery.1 The Division of Enforcement (Division) filed an Answer, and Montgomery, a Reply, pursuant to 17 C.F.R. §§ 201.52 and .53, respectively.
Montgomery's EAJA application followed a final disposition that was favorable to him in a proceeding against him. Richard Hoffman and Kirk Montgomery, 71 SEC Docket 1510 (A.L.J. Jan. 27, 2000) (Initial Decision). The date of final disposition of the proceeding was March 6, 2000, when the Initial Decision became the final decision of the Commission. Notice that Initial Decision has Become Final, 71 SEC Docket 2430 (Mar. 6, 2000). See 17 C.F.R. § 201.44(b). Montgomery's filing on April 5 was thirty days later, and thus timely under the EAJA and the Commission's Rules. See 5 U.S.C. § 504(a)(2); 17 C.F.R. §§ 201.44(a), .160.
The Commission's Rules disfavor further proceedings, such as an evidentiary hearing, on matters at issue in an EAJA application, and emphasize a prompt decision by the administrative law judge. See 17 C.F.R. §§ 201.55, .56. The findings and conclusions in this Decision are based on the record, which includes the record in the original proceeding and filings in the EAJA proceeding. Pursuant to the EAJA, 5 U.S.C. § 504(a)(1), and 17 C.F.R. § 201.35(a), "[t]he burden of proof that an award should not be made to an eligible prevailing applicant is on [the Division]." 17 C.F.R. § 201.35(a). All arguments and proposed findings and conclusions that are inconsistent with this Decision were considered and rejected.
B. Allegations and Arguments of the Parties
Montgomery argues that he reasonably incurred fees and expenses, which were necessary to defend the proceeding against him and to litigate the EAJA proceeding, that total $306,366.27, when attorney fees are reduced to $125 per hour, the maximum allowable in the EAJA. He argues that the position of the Division in the proceeding against him was not "substantially justified" within the meaning of 5 U.S.C. § 504(a).
The Division argues that its position in the proceeding against Montgomery was substantially justified, and that the fees and expenses for his defense were not "incurred" by Montgomery within the meaning of 5 U.S.C. § 504(a).
II. FINDINGS OF FACT
The Commission commenced a proceeding, seeking various sanctions under the securities laws, against Montgomery and Richard Hoffman by an Order Instituting Proceedings (OIP) on December 9, 1998. Hoffman was charged with mutual fund switching and other improper mutual fund sales practices in violation of the antifraud provisions. Montgomery was charged with failure to supervise Hoffman with a view to preventing his violations. The record of evidence was compiled in eleven days of hearings during May and June 1999 in Allentown, Pennsylvania (mostly concerning Hoffman) and Atlanta, Georgia (mostly concerning Montgomery).2 The January 27, 2000, Initial Decision, which became the final decision of the Commission, concluded that no violation alleged in the OIP was proved and dismissed the proceeding as to both Hoffman and Montgomery.
A. Background and Other Undisputed Facts Concerning Montgomery
The following facts, concerning which there was no dispute, were found in the Initial Decision based on the record; citations to the record are in the Initial Decision. See Richard Hoffman, 71 SEC Docket at 1512-13, 1527-33. During 1994, the time at issue, Hoffman and Montgomery were associated with FSC Securities Corporation (FSC), a broker-dealer headquartered in Atlanta, Georgia, that operates through registered representatives and small branch offices that are independent contractors. FSC conducts primarily a retail business in mutual funds, variable annuities, and securities. It conducts a large mutual fund wire order business. General securities transactions are cleared through Pershing, on a fully-disclosed basis. During the time at issue FSC had over 600 registered representatives in approximately 485 branch offices, including approximately 155 Offices of Supervisory Jurisdiction (OSJ),3 many of which were one-person offices. Hoffman was a one-person OSJ in Palm, Pennsylvania. His business consisted of selling mutual funds. Montgomery was FSC's chief compliance officer at its home office.
During the time at issue, FSC's senior management was comprised of E. James Wisner, president, and four senior vice-presidents, including Thomas Hutchins, chief operating officer, who reported to Wisner. Wisner was the principal shareholder of FSC's parent, Financial Services Corporation; Hutchins had an approximately 10% interest in Financial Services Corporation. Montgomery was middle management, subordinate to senior management. He reported to Hutchins. The position of chief compliance officer was added to Montgomery's other duties in August 1991 after FSC received a deficiency letter from the Commission. Montgomery left FSC in 1995, frustrated that he was not able to accomplish more in the compliance area.
As chief compliance officer, Montgomery was expected to spend 20% of his time on supervision of FSC's compliance and registration functions; the remainder of his time was to be spent on business, legal, and administrative matters. LaVerne Zellman, the director of compliance, reported to Montgomery. As head of the compliance department, she was expected to spend all of her time on compliance and was responsible for its day-to-day operation. Montgomery always supported her efforts to improve oversight of OSJ principals.
In his position at FSC, Montgomery could make recommendations to senior management but had no authority to implement changes in policies and procedures; to hire additional staff; or to fire, discipline or refuse to hire registered representatives who had compliance problems; nor could he reverse a trade if he discovered an improper switch or unsuitable trade. From time to time Montgomery and Zellman would be apprised of problems concerning registered representatives discovered by audits or by principals on the trading desks. No problems or red flags concerning Hoffman were brought to Montgomery or Zellman's attention. Moreover, had the compliance department called any of Hoffman's customers in 1994, the customer would have said that he or she was happy with Hoffman and the service he rendered.
After receiving the deficiency letter, Wisner, accompanied by Hutchins, Montgomery, and Zellman, met with Commission staff to gain a greater understanding of its views and prepare to remedy any problems. Montgomery was tasked with developing a plan to respond to the staff's concerns and correct problems at FSC. Some of his recommendations were implemented, for example, requiring offices to submit daily blotters. Others were not, for example, requiring mutual fund switch letters. Supervision by FSC of one-person OSJs was not discussed at the 1991 meeting, and FSC did not understand this to be among the Commission's concerns until a follow-up investigation in 1994. The proceeding against Hoffman and Montgomery grew out of the investigation into FSC. On December 9, 1998, the Commission released a consent order requiring FSC to pay a civil money penalty and retain and implement the recommendations of a consultant, which would review its supervisory, compliance, and other policies and procedures.4
Montgomery's action plan concerning the deficiency letter included daily transmission of blotters, requiring more transactions to be submitted by wire order, and establishing a number of automated exception reports. Montgomery also tried to improve the compliance function by asking, unsuccessfully, for increased staffing, mandatory switch letters, and happiness letters sent directly to clients without going through the OSJ. Although the number of registered representatives increased, his requests for more staff were denied.
Annual audits were part of FSC's compliance system. Zellman was responsible for annual audits of OSJs, like Hoffman. During the time at issue, there were four FSC employees whose full time was devoted to such audits, and there were about 175 OSJs. Expert testimony was received from both parties concerning the audits and supervision. The Division's expert, E. Ferguson, opined that the performance of the audits of Hoffman's business was insufficient. However, E. Ferguson acknowledged that it was reasonable for Montgomery to delegate responsibility for audits to Zellman and that more effective supervision and audits required more resources, which FSC denied to Montgomery.
B. Montgomery was not Hoffman's Supervisor
The position of the Division was that Montgomery was Hoffman's direct, line supervisor. There was not, however, a scintilla of evidence to support a finding that Montgomery was Hoffman's supervisor. The testimony of all FSC witnesses, including Montgomery's supervisor Hutchins and compliance director Zellman, was consistent. Supervision was by a combination of areas of the firm, and Montgomery was not Hoffman's direct supervisor. Tr. 1223-25, 1234, 1308 (Hutchins); Tr. 1335-37, 1376 (Zellman); Tr. 1454-56, 1477-78 (Montgomery); Tr. 1570-71, 1573-75 (Young). All these witnesses were called by the Division in its direct case. Hoffman did not recognize Montgomery (or anyone in particular) as his direct supervisor; when he was questioned about this, he displayed difficulty in understanding what was being asked. Tr. 614-16, 645-49.
The Division's fact witnesses all agreed that Montgomery was not Hoffman's supervisor. However, expert testimony concerning whether Montgomery was Hoffman's supervisor was received from E. Ferguson on behalf of the Division. Essentially, she opined that Montgomery was Hoffman's supervisor because no one else was. Her opinion included a strained and manifestly incorrect interpretation of documents in evidence, as discussed in the Initial Decision. See Richard Hoffman, 71 SEC Docket at 1529-30. Reliance on E. Ferguson's opinion to show facts, contrary to the evidence of fact witnesses whom the Division called in its direct case, was not reasonable as to fact. In sum, to prove that Montgomery was Hoffman's supervisor, the Division was not substantially justified in relying on E. Ferguson's opinion that Montgomery was Hoffman's supervisor because no one else was.
C. Fees and Expenses
The expenses of Montgomery's defense from the date of the OIP, December 9, 1998, onward and of his EAJA application exceeded $306,366.27.5 This includes attorney fees for 1,821.7 hours billed at or above $125 per hour for the proceeding against him, for which he seeks recovery at the rate of $125 per hour; and 66.6 hours billed at or above $125 per hour, for which he seeks recovery at $125 per hour, and 0.4 hours at $95 per hour for the EAJA proceeding. Appl. at Anderson Decl., Exs. 1-3; Reply at Anderson Aff., Ex. 1. The hourly rates that were charged are the prevailing market rates in the Atlanta area for the type and quality of work performed. Appl. at Anderson Decl., pp. 1-2. After the Allentown phase of the hearing ended, Montgomery offered to waive any EAJA claim if the case against him were dismissed at that time.6 Appl. at Ex. A. The offer was not accepted, and further fees and expenses accumulated.7 See, e.g., Appl. at Anderson Decl., Ex. 1 pp. 7-8, 15-19, 25-29, 38-41; Reply at Anderson Aff., Ex. 1.
Montgomery had a net worth of approximately $300,000 at the time of the OIP. Appl. at Montgomery Aff., Ex. 1. FSC, Montgomery's former employer, advanced the money to fund his defense.8 Without these advances, Montgomery would not have been able to defend himself against the charges, and it weighed heavily on his mind, throughout the proceeding, that FSC could discontinue financing the litigation at any time. It is undisputed that FSC was not contractually obligated to pay or to advance Montgomery's fees and expenses. Its advances were voluntary and could be discontinued at any time. Montgomery will use any award to repay FSC's advances.
III. CONCLUSIONS OF LAW
There is no dispute that Montgomery has met the following requirements of the EAJA: The proceeding against Montgomery was an "adversary adjudication" within the meaning of the EAJA, 5 U.S.C. § 504(b)(1)(C).9 He was "prevailing" in that the adversary adjudication against him was dismissed since he had committed no violation. Additionally, he is a "party" consistent with the requirements of 5 U.S.C. § 504(b)(1)(B) in that his net worth did not exceed $2,000,000 at the time the adversary adjudication was initiated.
Three additional issues are discussed in this section. First, the amount that can be claimed for fees and expenses is reduced, to comply with the $75 per hour maximum attorney fees permitted by the Commission's Rules. Second, the Division's position in the proceeding against Montgomery was not substantially justified. Third, Montgomery incurred the fees and expenses within the meaning of the EAJA.
A. Fees and Expenses
The Division has not disputed Montgomery's accounting for fees and expenses, corrected for the statutory maximum provided in 5 U.S.C. § 504(b)(1)(A) to total $306,366.27. The undersigned has examined the schedules of fees and expenses submitted with the Application and Reply and found them to be reasonable and necessary in the defense of Montgomery's case and the EAJA proceeding. There is no evidence that the amount sought exceeds the prevailing rate for similar services in the community in which counsel for Montgomery ordinarily performs services. Reasonable attorney fees in an EAJA proceeding include fees for litigating the EAJA proceeding as well as the original adversary adjudication. See Russo Sec., Inc., 71 SEC Docket 74, 78 (Nov. 10, 1999) (citing Commissioner, INS v. Jean, 496 U.S. 154 (1990); Trichilo v. Secretary of HHS, 823 F.2d 702, 707 (2d Cir. 1987)).
As a matter of law, however, the total must be reduced to $211,943.27 to reflect a maximum attorney fee payable of $75 an hour.10 The EAJA was amended, effective March 29, 1996, to raise the maximum attorney fee payable to $125 an hour, for adversary adjudications commencing on or after that date. The adversary adjudication against Montgomery was commenced after that date, and Montgomery's accounting includes attorney fees over $75 and up to $125 an hour. The Commission, however, has not amended its Rules to raise the allowable maximum, which remains at $75 per hour. See 17 C.F.R. § 201.36(b).11 Montgomery argues that the higher EAJA rate is controlling. This argument is without merit. The EAJA proscribes agency awards above the maximum; it does not require agencies to award fees at the maximum. Specifically, it provides, "attorney or agent fees shall not be awarded in excess of $125 per hour." 5 U.S.C. § 504(b)(1)(A)(ii). In any event, the undersigned must follow the Commission's Rules.
B. Substantial Justification
"[T]he position of the agency was substantially justified" within the meaning of the EAJA if it was "reasonable in law and fact." 17 C.F.R. § 201.35(a); Pierce v. Underwood, 487 U.S. 552, 565 (1988). An independent evaluation of the evidence in the adversary adjudication must be conducted through an EAJA perspective to determine whether or not the agency's position was substantially justified. See Rita Villa, 71 SEC Docket 2438, 2443-44 (Mar. 8, 2000).
The position of the agency was articulated in the OIP and the Division's conduct of the proceeding, including posthearing pleadings: Hoffman violated the antifraud provisions through mutual fund switching and other improper mutual fund sales practices, and Montgomery failed reasonably to supervise Hoffman so as to prevent violations by Hoffman. The Initial Decision concluded that Hoffman did not violate the antifraud provisions, and thus the failure to supervise charge failed. Additionally, it concluded, assuming, arguendo, that Hoffman did violate the antifraud provisions, that Montgomery was not Hoffman's supervisor; in the alternative, Montgomery's supervision was reasonable under the attendant circumstances.
During the hearing, both Respondents moved to dismiss the proceeding at the close of the Division's direct case. The undersigned deferred ruling on the motions, citing the desirability of compiling a full and complete record and the Commission's disfavor of such rulings, especially from the bench, as articulated in the Rita Villa case.12 Tr. 1704-05, 1717-18. Thus, the fact that the undersigned did not grant the motions from the bench is not an indication that the Division's position in the proceeding was substantially justified.
As concluded in the Initial Decision, Hoffman did not commit the violations charged in the OIP. Thus, the failure to supervise charge against Montgomery failed as well. However, in making an independent evaluation through an EAJA perspective, it will be assumed that Hoffman did commit the violations -- mutual fund sales practice abuses that violated the antifraud provisions -- charged in the OIP.13 Thus the question to be examined is whether there was substantial justification for the position that Montgomery was Hoffman's supervisor or otherwise had the requisite degree of responsibility, ability, or authority to affect Hoffman's conduct that was at issue.
1. Baseless Allegations in the OIP
The OIP contained some allegations that lacked substantial justification as a matter of law, for example, concerning an automated mutual fund switching exception report, the OIP alleged, at paragraph III.H., "[a]s part of his failure reasonably to supervise Hoffman, Montgomery: . . . 2. Failed to employ the automated mutual fund switching exception report which he represented was `operational' to monitor for mutual fund switching [which] contributed to the . . . failure to detect the switching in which Hoffman was engaging in 1993 and 1994." OIP paragraphs III.C and III.D also concern the switching report. However, the Division's February 1, 1999, Response to Respondents' Motions for a More Definite Statement (M. Ex. 191 at 2) states, "the Division is not alleging and is not aware, at this time, of any law requiring Montgomery to . . . employ an automated mutual fund `switching' exception report." E. Ferguson, the Division's expert witness in the area of securities industry standards and practices regarding supervision of registered representatives and producing OSJs, agreed that there was no such requirement. Tr. 1682-84.
Nonetheless, much evidence was introduced concerning FSC's efforts to develop a switching report.14 The Division did not continue to argue that Montgomery was required to employ a switching report. Nor was Montgomery charged with fraud or with filing any kind of inaccurate or false reports with the Commission. Instead, the Division changed to asserting that the switching report evidence showed a lack of credibility by Montgomery. An April 7, 1994, letter from Montgomery to the National Association of Securities Dealers described the switching report as, "[t]o be run." Tr. 1463-64; M. Ex. 71 at 5. In contrast, other reports are described as, "[i]t is run daily." Allegedly, "to be run" was a misrepresentation because the exception report was still under development at the time of the letter and many problems had been encountered. This interpretation of a representation that the report was expected to be run at some time in the future was extremely strained. It simply was not a misrepresentation, and to claim otherwise is not reasonable. Likewise, an October 29, 1991, letter from James Wisner to the Commission described a switching exception report as "to be operational within 90 days." M. Ex. 25 at 4. M. Ex. 41 is also referred to in the transcript as Div. Ex. 112; M. Ex. 71, as Div. Ex. 113; and M. Ex. 25 as Div. Ex. 111.
The switching report evidence focused in particular on the truth or falsity of a statement in the six-page, November 5, 1992, letter from Montgomery to Commission staff that "[w]e are currently operational on the following exception reports: . . . . d.) `Switching' exception report." M. Ex. 41 at 3; see also, Tr. 1213-14, 1216-17, 1254-61, 1275, 1279-80, 1317, 1381, 1401-03, 1459-64, 1483-85, 1492-94, 1528-34, 1572, 1639, 1651, 1682-89, 1749-66, 1783-1807, 1874-75; M. Exs. 25, 26, 27, 41, 48, 49, 70, 71, 157, 161, 163. The only reasonable interpretation of the evidence was that the inaccurate statement was an oversight or misunderstanding by Montgomery and not an intentional misrepresentation. See Richard Hoffman, 71 SEC Docket at 1531-32. The record is clear that the statements in all three letters were made in good faith. See id. There is no evidence in the record inconsistent with this. To argue that the switching report evidence diminished Montgomery's credibility, particularly after acknowledging that the evidence could not be used for its originally intended purpose, was not reasonable. In sum, Montgomery was forced to defend himself against the switching report allegations, which lacked any substantial justification in the OIP as a matter of law.
Likewise, the OIP alleged, at paragraph III.H., "[a]s part of his failure reasonably to supervise Hoffman, Montgomery: . . . 1. [f]ailed to ever conduct a review of all of Hoffman's accounts for evidence of sales practice abuses or to ensure that anyone else regularly conduct such a review." However, the Division's February 1, 1999, Response to Respondents' Motions for a More Definite Statement (M. Ex. 191 at 2) states, "the Division is not alleging and is not aware, at this time, of any law requiring Montgomery to review or ensure the regular review of Hoffman's customer accounts." NASD Conduct Rule 3010 does not require a principal to review the day-to-day transactions of a one-person OSJ or for one person to be designated his supervisor. Tr. 1422, 1440-41, 1496-97, 1651, 1662, 1876. Again, Montgomery was forced to defend himself against an allegation with no basis at all in law and thus lacking substantial justification.
2. Substantial Justification Concerning Failure to Supervise
[D]etermining if a particular person is a "supervisor" depends on whether, under the facts and circumstances of a particular case, that person has a requisite degree of responsibility, ability, or authority to affect the conduct of the employee whose behavior is at issue.
Patricia Ann Bellows, 67 SEC Docket 2910, 2912 (Sept. 8, 1998) (citations omitted).15 There is no dispute between the parties on this statement of the law.
The Commission distinguishes between persons who are clearly direct, line supervisors, for example, a branch manager, and employees of brokerage firms, who, like Montgomery, have legal or compliance responsibilities. A branch manager is presumed to be a supervisor for the purpose of a failure to supervise charge, while a compliance officer must be shown to have the responsibility, ability, and authority to affect the conduct of an employee who has violated the securities laws in order to be considered his supervisor. Compare James J. Pasztor, 70 SEC Docket 2611, 2620-22 & nn.27-28 (Oct. 14, 1999) with John H. Gutfreund, 51 S.E.C. 93, 113 (1992), and Patricia Ann Bellows, 67 SEC Docket at 2912.
As discussed above, as a question of fact, Montgomery was not Hoffman's supervisor, and there was no evidence on which it would be reasonable to find that he was his supervisor. The Division's position that Montgomery was Hoffman's supervisor was without substantial justification. The next question is whether there was substantial justification for the position that Montgomery, as an FSC employee who had compliance responsibilities, can be held accountable as a supervisor.
There is little dispute between the parties on the relevant facts (apart from the contorted reasoning of Division expert E. Ferguson that Montgomery was Hoffman's supervisor). They are that Montgomery had a role in compliance procedures, and was tasked with planning and coordinating FSC's response to the deficiency letter. Zellman was in charge of day-to-day compliance activities, including audits. Montgomery could recommend or ask for actions from senior management. Management's denial of his requests for more staff limited the amount of resources that could be devoted to such activities as audits of OSJs, such as Hoffman's. No problems or red flags concerning Hoffman were ever brought to the attention of Montgomery or Zellman. Had the compliance department contacted any of the customers whom Hoffman allegedly switched, the customer would have said that he or she was happy with Hoffman and the service he rendered. The evidence concerning all these matters was developed in the Commission's investigation of FSC. It was available to the Division before and throughout the proceeding.
The inescapable conclusion to be drawn from the undisputed facts is that Montgomery lacked the responsibility, ability, or authority to affect the conduct of Hoffman. A contrary conclusion would not be reasonable. Montgomery had no responsibility, ability, or authority to discipline Hoffman or any other individual registered representative or OSJ; he could and did bring problems or potential problems to the attention of senior management, but, at times, his recommendations to discipline, fire, or not to hire were ignored. Nor did Montgomery have the responsibility, ability, or authority to implement general procedural changes that would detect questionable sales practices by Hoffman or any other registered representative or OSJ. Again, he could make recommendations to senior management, who would, at times, reject them. Examples of such rejections that are relevant to this case are his recommendation to require mutual fund switching letters and his several attempts to increase the compliance staff. In short, he was not Hoffman's supervisor within the meaning of Section 15(b) of the Exchange Act. A contrary conclusion would not be reasonable.
The Division argues, citing Gutfreund, 51 S.E.C. at 113, that since Montgomery could and did recommend disciplinary actions, he had the requisite degree of responsibility, ability, or authority to affect the conduct of Hoffman. In the situation the Division cites, however, a firm's legal officer who had made recommendations in the past concerning disciplinary action was informed of serious misconduct of an employee and did nothing. It is undisputed, however, in this case, that Montgomery was not informed of any problems or even red flags concerning Hoffman.
In the alternative, assuming for the sake of argument, that Montgomery was Hoffman's supervisor, his supervision was reasonable under the attendant circumstances. See Louis J. Trujillo, 49 S.E.C. 1106, 1110 (1989). A contrary conclusion would not be reasonable. There were no red flags concerning Hoffman's sales practices that came to Montgomery's attention. Montgomery could not, without the approval of senior management, change procedures or hire more compliance staff. He continuously urged that FSC require mandatory switch letters and continuously asked for more compliance staff. His requests were not granted. If his requests had been granted, the assumed improper switches might not have occurred or might have been detected. Likewise, Montgomery was powerless to speed up FSC's development and implementation of the mutual fund switching report.
In short, the proceeding against Montgomery lacked substantial justification. It was not reasonable in fact or in law. The evidence was lacking to support the position that he was Hoffman's supervisor, that he had the responsibility, ability or authority to affect Hoffman's conduct within the meaning of the securities laws, or that his conduct regarding Hoffman was in any way unreasonable. Montgomery was forced either to defend himself against meritless charges in a proceeding that included eleven days of hearings or to enter an unjust settlement. While the substantial justification analysis above was restricted to the case against Montgomery, it should be remembered that, as a result of the decision to bring the proceeding against Montgomery, he had to participate in the case against Hoffman to defend himself.
C. Montgomery Incurred Fees and Expenses Within the Meaning of the EAJA.
The Division argues that Montgomery has not "incurred" fees and expenses in connection with the proceeding because FSC advanced him funding for the litigation. Further, it argues that FSC, which will receive the proceeds of any award to Montgomery, is ineligible for the award since it was not a party to the proceeding against Montgomery. The Division also suggests that FSC is required under Georgia law to indemnify Montgomery. As discussed below, however, Montgomery incurred the expenses of his defense within the meaning of the EAJA. To rule otherwise would thwart the purposes of the EAJA.
"Incur" is not defined in the EAJA, and its meaning is interpreted so as to promote the purpose of the EAJA. The EAJA's goals are to encourage private parties to vindicate their rights and to curb unreasonable government action. See Commissioner, INS v. Jean, 496 U.S. at 164-65 & n.14. "[T]he specific purpose of the EAJA is to eliminate for the average person the financial disincentive to challenge unreasonable governmental actions." Id. at 163; see also Ed A. Wilson, Inc. v. GSA, 126 F.3d 1406, 1410 (Fed. Cir. 1997) ("deterring unreasonable government action");16 SEC v. Comserv, 908 F.2d 1407, 1415 & n.10 (8th Cir. 1990) (citing Cornella v. Schweiker, 728 F.2d 978, 981 (8th Cir. 1984); Spencer v. NLRB, 712 F.2d 539, 549-50 (D.C. Cir. 1983)) (to diminish the deterrent effect of the expense of defending against unreasonable government action).17 In Comserv the court concluded, "EAJA awards should be available where the burden of attorneys' fees would have deterred the litigation challenging the government's actions, but not where no such deterrence exists." Comserv, 908 F.2d at 1415-16.
Pursuant to Georgia law, FSC is required to indemnify Montgomery "against reasonable expenses" incurred in the proceeding to which he was a party because he was "wholly successful." See Ga. Code Ann. §§ 14-2-850(2), (4), (7), (8), -852, -857(c).18 FSC was not, however, required, either by law or by contract, to advance funding for Montgomery's defense. It cannot be emphasized too strongly that without FSC's voluntary advances, Montgomery would not have been able to challenge the government's action against him and litigate the proceeding. He would have had to settle and accept a sanction and loss of reputation while knowing he was innocent of the charges against him.
Without the advance funding, Montgomery would not have been "wholly successful," because he would have had to settle, and FSC would not have been required to indemnify him. Nor would he have been a "prevailing party" under the EAJA. Nor could Montgomery be assured at the inception of the proceeding against him that he would be "wholly successful" and "a prevailing party," and borrow money from another source secure in the knowledge that he would be able to repay it from indemnification or an EAJA award. There can be no question that the burden of attorney fees would have deterred the litigation challenging the government's actions. Montgomery simply could not have afforded it.
Similarly, to deny Montgomery an EAJA award because it will be passed on to FSC, itself EAJA-eligible, would thwart the EAJA's purpose. If FSC had not advanced funding for Montgomery's defense, he would have had to settle, to his deficit. He would not have been "wholly successful," and FSC would not have been liable to indemnify him for any expenses.
The fact that FSC is a small business within the meaning of the EAJA, 5 U.S.C. § 504(b)(1)(B)(ii), supports Montgomery's case for an award. Cf. United States v. Paisley, 957 F.2d 1161, 1162-64 & n.1 (4th Cir. 1992) (parties did not incur expenses advanced by their former employer, Boeing, because Boeing was obligated by contract to indemnify them; Boeing did not qualify for recovery of fees under EAJA because its net worth was too great). The court in Comserv observed that the deterrence purpose of the EAJA is not served by passing fees on to such an ineligible applicant who would not have been deterred by the cost of the litigation it funded. See Comserv, 908 F.2d at 1416 and cases cited therein. Certainly Montgomery is not a stand-in seeking fees that, if received, will be passed on to an ineligible litigant.19
IV. RECORD CERTIFICATION
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), it is certified that the record includes the items set forth in the record index issued by the Secretary of the Commission on January 21, 2000, and the items filed in this EAJA proceeding. Those items are (1) Respondent Kirk Montgomery's Application for Fees and Expenses and Memorandum in Support of Fees and Expenses, filed April 5, 2000; (2) the Response of the Division of Enforcement to Kirk Montgomery's Application for Attorneys Fees, filed May 8, 2000; and (3) Respondent Kirk Montgomery's Reply in Support of Application for Fees and Expenses, filed May 22, 2000.
IT IS ORDERED that Kirk Montgomery's Application for Fees and Expenses IS GRANTED in the amount of $211,943.27, and IS OTHERWISE DENIED.
This order shall become effective in accordance with and subject to the provisions of Section 201.57 of the Commission's Rules, 17 C.F.R. § 201.57. Pursuant to that rule, a petition for review of this initial decision may be filed within 21 days after service of the decision. If neither party seeks review and the Commission does not take review on its own initiative, this initial decision shall become a final decision of the Commission on July 27, 2000.
Carol Fox Foelak
Administrative Law Judge
|1||Montgomery's initial filing (Appl.) contains two parts, titled: "Application for Fees and Expenses," to which are attached Montgomery Affidavit (Aff.), Anderson Declaration (Decl.), and Exhibits (Ex.) 1, 2, and 3; and "Memorandum in Support," to which are attached Exs. A and B. Attached to his Reply are Anderson Aff. and Ex. 1.|
|2||Citations to exhibits offered in the hearing by the Division, Hoffman, and Montgomery, and to the transcript of the hearing will be noted as "Div. Ex. __," "H. Ex. __," "M. Ex. __," and "Tr. __," respectively.|
|3||As defined in National Association of Securities Dealers (NASD) Conduct Rule 3010. The NASD is a self-regulatory organization, operating under Commission supervision, of firms in the over-the-counter market. One of its basic purposes is to establish and enforce fair and equitable rules of securities trading.|
|4||FSC Sec. Corp., Order Instituting Public Proceedings Pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934, Making Findings and Imposing Sanctions, 68 SEC Docket 2318 (Dec. 9, 1998).|
|5||Actual fees and expenses exceeded $400,000. Appl. at Anderson Decl., Ex. 1; Reply at Anderson Aff., Ex. 1.|
|6||The offer suggested that the Allentown evidence indicated that the case against Hoffman would not necessarily be resolved against him. Additionally, evidence that would tend to exonerate Montgomery was received from Hoffman's customers who had allegedly been subject to improper mutual fund practices. None ever complained to FSC about him. Almost all testified that, had FSC called him or her in 1994, the customer would have said that he or she was happy with Hoffman and the service he rendered. Tr. 109-10, 133, 156-58, 199-200, 226, 261-62, 278-79, 483-84, 504-05, 904, 925. Even the Division's witnesses expressed negative opinions concerning the government's decision to bring charges against Hoffman. Tr. 60-61, 159. This undisputed evidence tends to show that, had Montgomery commenced an investigation of Hoffman, the investigation would not have uncovered wrongdoing or changed Hoffman's business practices.|
|7||For example, an additional 594.8 hours of attorney fees were billed (totaling $106,685, unadjusted for EAJA), as well as other expenses following the rejection of his settlement offer, in the proceeding against Montgomery. Additionally, $8,363 is claimed for the EAJA proceeding.|
|8||At the time of the OIP, FSC had a net worth of about $6 million and about 250 employees. Appl. at Ex. B.|
|9||Section 504(b)(1)(C) defines "adversary adjudication" as "an adjudication under section 554 of this title in which the position of the United States is represented by counsel or otherwise, but excludes an adjudication for the purpose of establishing or fixing a rate or for the purpose of granting or renewing a license." The OIP cited Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 (Exchange Act) as authority for the proceeding against Montgomery. Thus the proceeding was "on the record, after notice and opportunity for a hearing." See Sections 15(b)(6)(A) and 19(h)(3) of the Exchange Act. Statutory requirements for adjudications under the Administrative Procedure Act are found at 5 U.S.C. §§ 554-59; 5 U.S.C. § 554(a) commences, "[t]his section applies . . . in every case of adjudication required by statute to be determined on the record after opportunity for an agency hearing."|
|10||Montgomery sought recovery of attorney fees for 1,821.7 hours billed at $125 per hour for the adversary adjudication and 66.6 hours at $125 per hour and 0.4 hours at $95 per hour for the EAJA proceeding. Thus, the total reduction of $94,423 represented 1,888.3 hours reduced by $50 per hour, and 0.4 hours by $20 per hour.|
|11||This section also provides, "[n]o award to compensate an expert witness may exceed the reasonable rate at which the Commission pays witnesses with similar expertise." 17 C.F.R. § 201.36(b). Montgomery's application seeks recovery of fees paid to an expert witness at the rate of $200 per hour, totaling $23,200, averring that this complies with the factors listed in 17 C.F.R. § 201.36(c)(2)-(4). The Division has not challenged this figure, and the undersigned can properly have no independent knowledge of the rate at which the Commission pays such witnesses in its enforcement investigations and prosecutions. Accordingly, the figure for expert fees and expenses is accepted as reasonable and necessary for Montgomery's defense.|
|12||Rita Villa, 66 SEC Docket 772, 777 (Jan. 6, 1998).|
|13||By assuming violations, it is unnecessary to decide whether there was substantial justification for the case against Hoffman. This assumption is not a conclusion that there was substantial justification for the case against Hoffman.|
|14||The Commission has ruled that administrative law judges should be inclusive in making evidentiary determinations in its proceedings: "if in doubt, let it in." See City of Anaheim, Order Vacating Grant of Motion to Exclude Evidence, 71 SEC Docket 191, 193-94 & nn. 4-8 (Nov. 16, 1999).|
|15||The settlement and Report of Investigation Pursuant to Section 21(a) of the Exchange Act reported at John H. Gutfreund, 51 S.E.C. 93, 113 (1992) in which the "responsibility, ability, or authority" test was articulated has been referenced many times by the Commission in litigated cases -- both in administrative proceedings and in review of NASD disciplinary proceedings for violation of the broader NASD Conduct Rule 3010 (formerly Art. III, Rule 27). See administrative proceedings James J. Pasztor, 70 SEC Docket 2611, 2620-23 nn.27-28 (Oct. 14, 1999), Patricia Ann Bellows, 67 SEC Docket 2910, C. James Padgett, 52 S.E.C. 1257, 1266 n.32 (1997), aff'd sub nom, Sullivan v. SEC, 159 F.3d 637 (D.C. Cir. 1998) (Table); review of NASD disciplinary proceedings Steven P. Sanders, 68 SEC Docket 982, 997 & n.30 (Oct. 26, 1998), Michael H. Hume, 52 S.E.C. 243, 248 n.14 (1995), Rita H. Malm, 52 S.E.C. 64, 70 n.22 (1994), Conrad C. Lysiak, 51 S.E.C. 841, 844 & n.13 (1993), aff'd, 47 F.3d 1175 (9th Cir. 1995) (Table), Douglas Conrad Black, 51 S.E.C. 791, 795 n.13 (1993).|
|16||In Wilson, the litigation expenses of a small business had ultimately been borne by its insurance company, which was to receive EAJA proceeds by subrogation. The government argued that the insurance company, not Wilson, incurred the expenses. The court rejected this argument because to do otherwise would thwart the EAJA's purpose and would circumvent Congress' stated desire to deter unreasonable governmental action. To deny the award would result in increased insurance premiums for the prevailing party, a disincentive for a small business to contest unreasonable government action.|
|17||In Comserv an EAJA award was denied to one Johnson, who left Comserv's employment with a severance agreement whereby Comserv agreed to pay his legal fees for the investigation and litigation at issue. Possibly a state statute required this as well. The court stated, "[w]hat is relevant is that, from the inception of the underlying lawsuit, Johnson was able to pursue his defense in the SEC action secure in the knowledge that he would incur no legal liability for attorneys' fees." Comserv, 908 F.2d at 1414. Unlike Johnson, Montgomery was not able to pursue his defense in the SEC action secure in the knowledge that he would incur no legal liability for attorneys' fees. He had no contract with FSC requiring FSC to pay his fees in the litigation irrespective of outcome.|
|18||The references are to the official version of the Georgia statutes, known as the Official Code of Georgia Annotated.|
|19||The case against Montgomery grew out of the investigation into FSC, which settled the related proceeding against it for specified sanctions and undertakings. To deny Montgomery an EAJA award because FSC would ultimately receive the proceeds, in essence, increases the sanctions imposed on FSC beyond what was agreed to in the settlement.|
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