SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 42502 / March 8, 2000
Admin. Proc. File 3-8527-EAJ
In the Matter of
RITA C. VILLA
Los Angeles, California
Opinion of the Commission
Equal Access to Justice Act Proceedings
Applicant, who had prevailed in Commission cease and desist proceedings, sought an award of attorneys' fees and costs under the Equal Access to Justice Act. Held, the application is denied since the Division of Enforcement's position in the underlying action was substantially justified.
Eric Landau, Steven J. Aaronoff, and Eric R. Maier, of Christensen, Miller, Fink, Jacobs, Glaser, Weil & Shapiro, LLP, for Rita C. Villa.
Richard M. Humes, Samuel M. Forstein, John J. Nicholas, and Kathleen Cody, for the Division of Enforcement.
October 15, 1998
April 12, 1999
The Division of Enforcement appeals from the decision of an administrative law judge awarding Rita C. Villa attorneys' fees and costs under the Equal Access to Justice Act ("EAJA"). 1 Villa, a certified public accountant, was chief accounting officer, controller, and a vice president of First Capital Holdings Corp. ("FCH"), a financial services holding company. Villa was responsible for FCH's financial reporting and for maintaining the company's books. One of FCH's two principal subsidiaries was First Capital Life Insurance Company ("FCL"), which was domiciled in California.
The Commission action underlying Villa's EAJA claim charged that Villa caused FCH to violate reporting and recordkeeping provisions of the Securities Exchange Act 2 in connection with the reporting and recording of FCL's assets. In an oral decision, the law judge in that action granted Villa what he termed a "directed verdict." On review, we dismissed the charges against Villa, concluding that they had not been established by a preponderance of the evidence. 3 Thereafter, Villa filed the EAJA claim that is now before us.
The EAJA provides that a respondent who has prevailed against the government in an adversary adjudication may recover the fees and expenses that were incurred unless "the position of the agency was substantially justified." 4 The Division's principal contention on review is that its position in the underlying case against Villa was substantially justified. Our findings are based on an independent review of the record.
Villa was part of a small group of senior executives who ran FCH, a group that included Philip A. Fitzpatrick, FCH's executive vice president and chief financial officer, and Gerry R. Ginsberg, FCH's chief operating officer. Villa acknowledged that there was a free flow of information within the group, and that she was generally aware of any important matter affecting the company.
Under terms of a $275 million bank credit agreement to which FCH was a party, FCL was required to maintain minimum statutory capital and surplus of $100 million at each year-end beginning in 1990. 5 FCL used reinsurance treaties to increase its statutory surplus through "reserve credits." 6 At year-end 1990, absent the reserve credits claimed pursuant to its reinsurance treaties, FCL would have had insufficient statutory capital and surplus for purposes of the credit agreement.
In 1990, the California Department of Insurance ("CDI") conducted a regular triennial examination of FCL for the period ending December 31, 1989. The purpose of the examination was to ensure that the amounts reported in FCL's annual financial statement were supported by its books and records. Among other things, the CDI examined FCL's reinsurance treaties and the acceptability of the reserve credits claimed by FCL thereunder for the purpose of meeting statutory capital and surplus requirements. Pursuant to thosetreaties, FCL claimed about $75 million in reserve credits in 1989, and about $65 million in 1990.
On November 7, 1990, the CDI examiner-in-charge wrote to Brian Klemens, FCL's controller, asking him to respond to the attached memorandum prepared by Eugene E. Jacks, the CDI actuary assigned to review FCL's actuarial reserves (the "Jacks memorandum"). The Jacks memorandum proposed that $73,799,121 of FCL's reserve credits be disallowed as of year-end 1989, concluding that either FCL's reinsurers had no binding obligation to reimburse the company for benefits that FCL had to pay policyholders, or that the present value of the reinsurers' obligation was no greater than the present value of the future consideration FCL had to pay under its reinsurance treaties.
Following FCL's receipt of the Jacks memorandum, Villa heard a discussion of the memorandum between Fitzpatrick and Ed Mekeel, FCL's chief financial officer, on Fitzpatrick's speakerphone. Mekeel told Fitzpatrick that the memorandum had been given to FCL's auditors, and Villa was admittedly aware that the position taken by Jacks on the surplus relief claimed by FCL "was an important issue."
On December 13, 1990, Fitzpatrick, Ginsberg, and officers of FCL met with Norris Clark, chief of the CDI's Financial Analysis Division. Clark stated that, even if the reserve credits under FCL's reinsurance treaties were accepted, the company was still undercapitalized, and that the National Association of Insurance Commissioners had placed FCL on its list of potentially troubled companies. He emphasized that the biggest issue confronting the company was the fact that the transfer of risk under its reinsurance treaties appeared to be insufficient to justify the taking of reserve credits. Villa was aware of this meeting, and discussed with Ginsberg what had occurred.
Shortly after the December meeting, the CDI put FCL on a monthly financial reporting status, instead of the normal quarterly requirement, because of the CDI's determination that FCL "was in a hazardous condition." Villa was admittedly informed of the new reporting requirement.
On February 19, 1991, Clark wrote to Ginsberg (the "Clark letter") noting that the $75 million in reserve credits claimed by FCL as of December 31, 1989 was in dispute, and that, even giving FCL the benefit of the doubt, the $75 million was "in essence, borrowed temporary surplus [that had to] be amortized over three years." Clark requested that FCH submit a definitive business plan by March 1 that would address, among other things, FCL's need for additional capital and the reinsurance question. The letter closed by stating that the CDI considered "this entire matter [one] of utmost urgency."
Villa admitted that she "at least scanned" the Clark letter, and that, logically, she would have discussed it with Ginsberg. FCH's above noted credit agreement provided that a copy of any communication from the CDI that "directly question[ed] in any material respect the financial soundness of [FCL]" had to be sent to the bank lending group within 5 days after receipt. Villa admitted that she was concerned that a copy of the Clark letter would have to be sent to the bank group pursuant to the credit agreement, although she claimed that her concern was limited to an earlier version of the letter. 7 In fact, on February 20, the day after FCH's receipt of the Clark letter, Fitzpatrick sent a copy of the letter to the bank group. Villa admitted that she talked to Ginsberg, and possibly Fitzpatrick, about the forwarding of the letter.
On March 18, 1991, FCH filed its Form 10-K for the year ended December 31, 1990. In the Management Discussion and Analysis ("MD&A") section and in note 10 to the financial statements, FCH stated that FCL and FCH's other life insurance subsidiary had reported consolidated statutory capital and surplus for 1990 of $229,365,000. This figure included $107,447,113 attributable to FCL, of which $65 million represented reserve credits under FCL's reinsurance treaties that the CDI had indicated would be disallowed. Note 10 also stated that, as of December 31, 1990, FCH's two insurance subsidiaries would be able to pay $46,178,000 in dividends "without prior approval of the insurance departments." In fact, without the questioned credits, FCL could not pay any dividends. Villa participated in drafting the MD&A section of FCH's Form 10-K and note 10 to the Form's financial statements. She also read the entire Form 10-K before it was filed, and signed it as FCH's chief accounting officer.
The Form 10-K made no mention of the CDI's proposed disallowance of FCL's reserve credits, or of the effect that disallowance would have on FCH's business. Indeed, it made only a single vague reference to FCL's problems with the CDI, and coupled it with misleading language as follows:
[FCH] believes that [its insurance subsidiaries] have well established relationships with nationally recognized reinsurers and intend to continue to cede portions of their mortality risks as necessary. . . . [F]inancial reinsurance contracts . . . increase statutory earnings and surplus and allow [FCH] to increase the writing of new insurance business. The [CDI] has begun to discourage the use of such reinsurance.
On April 10, 1991, the CDI issued its FCL examination report for the period ended December 31, 1989, disallowing $73,799,121 in claimed reinsurance reserve credits. On April 30, the CDI issued a limited examination report on FCL for the year ended December 31, 1990. The report disallowed $65,241,124 of reserve credits claimed by FCL as of that date. The disallowance, together with some lesser adjustments, reduced FCL's statutory capital and surplus at year-end 1990 from the $107 million reported in the Form 10-K to $35 million. On May 10, 1991, the CDI ordered FCL to cease and desist from doing business in California and, on May 14, placed the company in conservatorship.
Villa, urging the Commission to uphold the law judge's decision, argues that the appropriate standard for reviewing his determination in her favor is abuse of discretion. However, we think it clear that the de novo review we normally accord a law judge's determinations is also proper here. 8
As noted above, the Division contends that its position in bringing proceedings against Villa was "substantially justified" and, therefore, that Villa is not entitled to be reimbursed for fees and expenses under the EAJA.
An agency position can be substantially justified even though, in the final analysis, the evidence adduced is insufficient to prove the violations alleged. It is sufficient if the position is justified to a degree that could satisfy a reasonable person, i.e., if it has a reasonable basis in law and in fact. 9 Because the standard applied under the EAJA differs from the standard applied in the underlying action, the conclusions reached in the initial proceeding are not dispositive. Instead, an "independent evaluation [must be conducted] through an EAJA perspective." 10 Making theoutcome of the underlying case dispositive would "virtually eliminate the 'substantially justified' standard from the statute." 11
Because of the different legal standard that must be applied in ruling on a claim under the EAJA, the law judge was obligated to make an independent evaluation of the evidence in the underlying proceeding. However, in reaching his determination that the case against Villa was not substantially justified, he failed to make any such evaluation, and simply relied on the conclusions that were previously reached. Moreover, in doing so, he misconstrued our decision dismissing the proceeding. When we dismissed this matter, we did not agree with the original law judge that the Division had failed to establish a prima facie case. 12 Rather, we considered that, while the Division had introduced sufficient evidence as a matter of law to warrant its submission to the trier of fact, 13 we were not satisfied that the evidence justified our making findings against Villa.
We must now proceed to do what the law judge failed to do, evaluate the evidence under the EAJA's substantial justification standard.
FCH was required by Section 13(a) of the Exchange Act and Rule 13a-1 thereunder to file annual reports on Form 10-K containing the information required by our rules and regulations. Rule 12b-20required the disclosure of any material information necessary to make the required statements not misleading. And Regulation S-K required the disclosure of "any known material trends, favorable or unfavorable, in [FCH's] capital resources." 14
As one court has stated, "[t]he reporting provisions of the Exchange Act are clear and unequivocal, and they are satisfied only by the filing of complete [and] accurate. . . reports." 15 The Form 10-K filed by FCH for the year ended December 31, 1990 failed in significant respects to meet those standards. The report was materially misleading in its concealment of the fact that the CDI was highly likely to disallow FCL's reserve credits, substantially reducing that company's statutory capital and surplus and nullifying its ability to pay dividends. Indeed, the Clark letter warned FCH that, at best, $75 million of FCL's claimed 1989 reserve credits would have to be amortized over three years. Yet, the subsequently filed 10-K for 1990 (the first of those years) gave no indication that such an adjustment would almost certainly have to be made. Nor does the record reflect that any adjustment was made in FCH's books although Section 13(b)(2)(A) of the Exchange Act required the company to maintain accurate books and records.
We think it clear that the evidence supports findings that FCH violated the reporting and recordkeeping provisions cited above. 16
As previously noted, the underlying proceeding against Villa charged her with "causing" FCH's violations. Under Section 21C of the Exchange Act, 17 a person "causes" a violation if that person is guilty of "an act or omission the person knew or should have known would contribute to such violation."
We previously determined that the Division failed to prove that Villa caused FCH's violations. The question now before us is whether the evidence for charging Villa with being a cause of FCH's misconduct satisfies the EAJA standard of "substantial justification."
As noted above, and as set forth in the legislative history of the EAJA, "[t]he test of whether or not a Government action is substantially justified is essentially one of reasonableness. Where the Government can show that its case had a reasonable basis both in law and fact, no award will be made." 18 The legislative history cautions that, in making that determination, heightened scrutiny should be given to a case such as the one now before us, where the proceedings were dismissed at the close of the government's case. 19 We accordingly turn to a consideration of the facts and circumstances disclosed in the record.
In our prior opinion in this matter, we noted that, by the time FCH's 10-K report for 1990 was signed on March 14, 1991, the CDI had made clear to various members of FCH's senior staff that disallowance of FCL's reinsurance credits was "highly likely." 20 In fact, the Clark letter had warned that, at best, $75 million of FCL's claimed 1989 reserve credits would have to be amortized over three years. Under these circumstances, we think it clear that an appropriate adjustment should have been made in FCH's books, and that the company's 1990 Form 10-K should have disclosed this clearly material issue. Villa participated in drafting portions of the Form 10-K, read the remainder, and, as chief accounting officer of the company, signed it.
The outcome of the underlying proceeding hinged upon the Division of Enforcement's ability to persuade us that Villa was sufficiently aware of the reinsurance problem to be a cause of FCH's misconduct. At the hearing, the Division presented a wide array of largely circumstantial evidence in support of this position:
- Villa was one of a small group who ran FCH, and she generally knew of any important matter affecting the company.
- She was aware of the Jacks memorandum and its proposed disallowance of FCL's reserve credits.
- She knew of the December 1990 meeting between Clark of the CDI and officials of FCH and FCL, and discussed what had occurred with Ginsberg.
- She knew that, shortly after the meeting, the CDI put FCL on a monthly financial reporting status.
- She read the February 1991 Clark letter, and admitted that she probably discussed it with Ginsberg. She also discussed with Ginsberg whether the letter had to be forwarded to the bank group.
Although Villa did not present a full defense to the charges against her, she was called to testify by the Division and, through her testimony, outlined her involvement in the matters at issue. She argued that reinsurance was not her area of expertise, that she was not involved in FCH's discussions with the CDI, and that, in preparing the Form 10-K, she relied upon the people responsible for reinsurance matters to ensure that the disclosure was adequate.
We weighed the evidence and, as the ultimate trier of fact, were not satisfied that Villa's knowledge of the events in question was sufficient to warrant our finding her a cause of FCH's violations. However, weighing the same evidence under the EAJA standard, we are convinced that the Division was substantially justified in bringing charges against Villa. The reinsurance issue was clearly material to FCH. Villa's involvement in the daily operations of the company, coupled with her testimony indicating at least some level of awareness of that issue, leads us to conclude that the Division was substantially justified in charging that Villa "knew or should have known" that she was contributing to FCH's violations by breaching her affirmative duties of accurate reporting and recordkeeping. 21
We recognize that the charges against Villa were dismissed at the close of the Division's case and, for that reason, we have given this matter the heightened scrutiny that those circumstances demand. In the end, of course, the determination of whether there was substantial justification to initiate a proceeding must be made largely on the basis of the evidence submitted by the Division. After a careful examination of that evidence, we are satisfied thatthere was a reasonable basis in fact and law for bringing proceedings against Villa. We shall accordingly deny her claim under the EAJA for attorneys' fees and costs. 22
An appropriate order will issue. 23
By the Commission (Chairman LEVITT and Commissioners JOHNSON, HUNT, CAREY, and UNGER).
Jonathan G. Katz
UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 42504 / March 8, 2000
Admin. Proc. File 3-8527-EAJ
In the Matter of
RITA C. VILLA
Los Angeles, California
ORDER DENYING APPLICATION UNDER THE EQUAL ACCESS TO JUSTICE ACT
On the basis of the Commission's opinion issued this day, it is ORDERED that the application of Rita C. Villa for an award of attorneys' fees and costs under the Equal Access to Justice Act be, and it hereby is, denied.
By the Commission.
Jonathan G. Katz
5 U.S.C. § 504. The law judge awarded Villa $142,157.26 for attorneys' fees and an additional $29,172.18 to reimburse her for costs.
Sections 13(a) and 13(b)(2)(A) of the Exchange Act (15 U.S.C. §§ 78m(a) and 78m(b)(2)(A)), and Rules 13a-1 and 12b-20 thereunder (17 C.F.R. §§ 240.13a-1 and 12b-20).
Rita Villa, Securities Exchange Act Release No. 39518 (January 6, 1998), 66 SEC Docket 772. Although Villa did not formally present her own defense, she did take the stand and testify during the Division's case. After weighing the evidence presented by the Division, including Villa's testimony, we concluded that the "preponderance of the evidence" was in Villa's favor.
5 U.S.C. § 504(a)(1).
California insurance companies are subject to both Generally Accepted Accounting Principles and statutory accounting principles. Under statutory accounting principles, an insurance company must compute statutory capital and surplus, essentially its assets minus its liabilities.
When an insurance company writes an insurance policy, it must create reserves, which are used to pay claims on the policy. Under a reinsurance treaty, the insurer cedes some of the insurer's liability under a policy to the reinsurer and pays the reinsurer part of the premium. Under then-applicable California insurance requirements, the insurer could reduce its required reserves if the particular reinsurance treaty transferred the risk of payment on claims to the reinsurer. The "reserve credits" or "surplus relief" thus created raised the issuer's surplus and capital.
If a treaty did not comply with California Department of Insurance requirements, the resulting surplus relief would be disallowed, and the company would have to "recapture" it by reducing its statutory surplus.
The record does not show that an earlier version of the Clark letter was sent to FCH, or that any earlier version existed.
See Lion Uniform, Inc. v. NLRB, 905 F.2d 120, 123-124 (6th Cir.) (an administrative agency must review de novo a law judge's decision on EAJA fees), cert. denied, 498 U.S. 992 (1990).
Pierce v. Underwood, 487 U.S. 552, 565, 566 n.2 (1988). See also Jackson v. Bowen, 807 F.2d 127, 130 (8th Cir. 1986) (The standard is met when "one permissible view of the evidence leads to the conclusion that the government has shown a reasonable basis in fact and law for its position.").
FEC v. Rose, 806 F.2d 1081, 1087 (D.C. Cir. 1986). See also Sierra Club v. Secretary of the Army, 820 F.2d 513, 518 (1stCir. 1987).
Broad Avenue Laundry and Tailoring v. U.S., 693 F.2d 1387, 1391-92 (Fed. Cir. 1982).
In reaching his determination on substantial justification the EAJA law judge stated, "I credit the decision of the administrative law judge which established that the Division's evidence was legally insufficient to establish a prima facie case. An independent review of the proceeding by the Commission found the Division's evidence similarly lacking." However, our opinion did not make that finding. As noted above, we found that the charges against Villa had not been established by a preponderance of the evidence. And, since we reviewed the matter and issued our own decision, the original law judge's findings ceased to have any effect.
See 9 Wignore, Evidence § 2494 (Chadbourne rev. 1981). (A "prima facie case" is commonly understood to mean "a sufficiency of evidence to go to the jury.")
17 C.F.R. § 229.303(a)(2)(ii).
SEC v. Savoy Industries, Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979).
Although not dispositive in this proceeding, we note that FCH, without admitting or denying the allegations against it, consented to the entry of an injunction against further violations of Sections 10(b), 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 13a-1, 13a-13 and 12b-20 thereunder. SEC v. First Capital Holdings Corp., Civil Action No. 94-8469 HLH (Kx)(C.D. Cal. March 17, 1995). See Litigation Rel. No. 14444 (March 17, 1995), 58 SEC Docket 3002.
15 U.S.C. § 78u-3.
H. Rep. No. 1418, 96th Cong., 2d Sess. 10 (1980); S. Rep. No. 253, 96th Cong., 1st Sess. 6 (1979).
"Certain types of case dispositions may indicate that the Government action was not substantially justified. A court should look closely at cases, for example, where there has been a judgment on the pleadings or where there is a directed verdict or where a prior suit on the same claim has been dismissed. Such cases clearly raise the possibility that the Government was unreasonable in pursuing the litigation." H. Rep. No. 1418, supra, at 11; S. Rep. No. 253, supra, at 6-7.
Rita Villa, supra, 66 SEC Docket at 774.
See Ray M. Vanlandingham, 49 S.E.C. 535, 544 (1986).
In view of our determination, we need not reach the parties' contentions with respect to the amount of the award made by the law judge.
Villa requested oral argument in this matter pursuant to Rule 451 (17 C.F.R. § 201.451) of our Rules of Practice. Rule 100 of those rules (17 C.F.R. § 201.100) states that, "[u]nless provided otherwise," the Rules of Practice govern Commission proceedings "under the statutes it administers." We do not consider the EAJA a statute that we "administer" within the meaning of Rule 100. In any event, we have issued regulations that specifically govern the conduct of EAJA proceedings. Rule 31 of those regulations (17 C.F.R. § 201.31) specifies that such regulations "explain . . . the procedures . . . that [this] Commission will use in ruling on [EAJA] applications." Rule 57 of those regulations (17 C.F.R. § 201.57) governs our review of appeals from initial decisions on EAJA fee applications. That rule makes no provision for oral argument. We have concluded that such an argument is unnecessary for our determination of the issues in this matter. We accordingly deny Villa's request.
-- We have considered all of the contentions made by the parties. We reject or sustain them to the extent that they are inconsistent or in accord with the views expressed herein.