After being hit with fraud charges by the US Securities and Exchange Commission (SEC) on Monday, turnaround queen Lynn Tilton is hitting back, filing a lawsuit that claims the commission’s administrative enforcement proceedings violate Article II of the US Constitution.
Tilton and her private debt firm Patriarch Partners are challenging the process by which the SEC appoints its administrative law judges (ALJs). Her 24-page suit, filed just two days after the SEC filed its own 13-page complaint, states that because the SEC is a department of the United States and ALJs are executive branch “officers,” they should be appointed and evaluated directly by SEC Commissioners. In the current process, they are hired by the SEC’s Office of Administrative Law Judges.
“It is quite different, and constitutionally infirm, to fill that crucial presiding role through bureaucratic means far removed from our elected President and Congress,” states the complaint filed in the US District Court of the Southern District of New York.
The suit was filed in response to the SEC’s decision to bring charges against Tilton and Patriarch funds before an ALJ rather than in a US District Court, where there are greater discovery rights and the right to a jury trial.
The SEC alleges that Tilton defrauded investors in three collateralized loan obligation (CLO) funds by providing false and misleading information about loan asset performance, leading Tilton and her firm to capture an extra $200 million in unwarranted fees. Investigators say Tilton used a discretionary approach to the Zohar fund valuations, which was never disclosed to investors. Patriarch has contributed $350 million to its own funds, Tilton claims.
Tilton appeared on CNBC Tuesday to defend her firm, saying she was “baffled” by the charges and that investors had never raised any issues with her disclosures in more than a decade.
“After five and a half years of investigation, unleashed subpoena power and one-sided testimony, not to give me a chance to have the means and the time to defend myself seems unfair and inequitable,” Tilton said in the interview.
Tilton is not the first to dispute the constitutionality of the SEC’s in-house administrative proceedings. Multiple claims have unsuccessfully argued that the procedure violates the Seventh Amendment and right to due process. Hedge fund manager Joseph Stilwell recently made an argument similar to Tilton’s about the ALJs themselves. Stilwell’s suit, filed last fall, questions the ALJs’ multiple layers of tenure protection. His suit remains ongoing in court.
Tilton has been fighting to move the case to district court since receiving a Wells Notice from the Division of Enforcement in October, noting that the SEC’s administrative proceedings would not be the appropriate place to defend the complex contractual interpretation of the Zohar fund trust indentures.
Tilton broached the issue in her CNBC interview, echoing concerns of some in the industry that the SEC still does not fully understand private equity.
“I think they’ve completely misunderstood my business,” she said.
The SEC declined to comment.