By Jonathan Stempel
NEW YORK (Reuters) - A divided federal appeals court on Wednesday rejected New York financier Lynn Tilton's constitutional challenge to a U.S. Securities and Exchange Commission case that accuses the Patriarch Partners chief of defrauding her investors.
The 2-1 decision by the 2nd U.S. Circuit Court of Appeals in New York bolstered the SEC's efforts in pursuing more fraud cases through in-house administrative proceedings, where it has a high success rate, rather than in federal court.
Tilton, known as the "Diva of Distressed" for turning around troubled companies, and other defendants in SEC civil cases have said federal courts should halt such proceedings.
They have argued that the appointment of SEC administrative law judges, and hurdles that can make it impossible for the president to remove those judges, are unconstitutional.
Three federal appeals courts have rejected such challenges. Wednesday's decision lets the SEC resume its case against Tilton and Patriarch, which the defendants had sued to halt shortly after it began in March 2015.
The SEC accused Tilton and Patriarch of hiding the poor performance of assets underlying their Zohar collateralized loan obligation funds, for which they raised more than $2.5 billion and according to the SEC collected nearly $200 million of improper fees.
Tilton considers the SEC claims "utterly meritless" and is reviewing her legal options, Patriarch spokesman Richard White said in a statement."Ms. Tilton and Patriarch Partners should not be required to contest the SEC's claims before an unconstitutional administrative law judge," he said.
SEC spokeswoman Erin Stattel declined to comment.
Critics say administrative proceedings stack the deck against defendants because they are handled by judges on the SEC payroll, lack juries and have limited discovery and depositions.
In her appeal, Tilton said such proceedings violate the constitution because administrative law judges are not appointed by SEC commissioners.
A federal judge last June let the SEC pursue its case, but the 2nd Circuit put it on hold during Tilton's appeal.
Writing for the appeals court panel's majority, Circuit Judge Robert Sack said Tilton's lawsuit was premature because there was no final decision in the SEC administrative case against her.
"By enacting the SECʹs comprehensive scheme of administrative and judicial review, Congress implicitly precluded federal district court jurisdiction over the appellants' constitutional challenge," Sack wrote.
"The litigantʹs financial and emotional costs in litigating the initial proceeding are simply the price of participating in the American legal system," he added.
Circuit Judge Christopher Droney dissented, saying it was unfair to force Tilton and Patriarch to defend themselves in a proceeding that could later prove unconstitutional.
In a report in February, SEC Inspector General Carl Hoecker found a lack of evidence that SEC judges were biased in the regulator's favor.
The SEC began pursuing more cases in-house under powers granted by the 2010 Dodd-Frank financial reforms.
Tilton in February announced plans to turn Patriarch into a "family office" and step aside as collateral manager of the Zohar funds, after years of legal battles with bond insurer MBIA Inc.
In April, new collateral manager Alvarez & Marsal sued Tilton and Patriarch, claiming they were withholding even basic information about the Zohar funds' health.
The case is Tilton et al v SEC, 2nd U.S. Circuit Court of Appeals, No. 15-2103. OLUSMONEY Reuters US Online Report Money 20160601T184320+0000