Watts v. Securities & Exchange Commission

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued December 7, 2006 Decided March 30, 2007

No. 06-1307

PHILIP WATTS,
PETITIONER

v.

SECURITIES AND EXCHANGE COMMISSION,
RESPONDENT

On Petition for Review of an Order of the
Securities and Exchange Commission

Andrew J. Morris argued the cause and filed the briefs for
petitioner.

Melinda Hardy, Assistant General Counsel, Securities &
Exchange Commission, argued the cause for respondent. With
her on the briefs were Mark B. Stern and Tara Leigh Grove,
Attorneys, U.S. Department of Justice, Brian G. Cartwright,
General Counsel, and Kathleen Cody, Senior Counsel.

Before: BROWN and KAVANAUGH, Circuit Judges, and
WILLIAMS, Senior Circuit Judge.

Opinion for the Court filed by Circuit Judge KAVANAUGH.
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KAVANAUGH, Circuit Judge: Several Shell shareholders
sued Sir Philip Watts, a former Shell executive, and alleged that
he committed securities fraud. During discovery, which is still
ongoing, Watts served third-party testimonial subpoenas under
Federal Rule of Civil Procedure 45 on three Securities and
Exchange Commission employees. Watts thinks their testimony
might help his defense. The SEC did not permit the three
employees to testify, contending that their testimony would
cover privileged matters and be unduly burdensome. Watts has
sought review of the SEC’s refusal – not in the district court, but
directly in this Court. He has invoked the statute providing for
direct court of appeals review of SEC “orders.” See 15
U.S.C. § 78y(a); see also id. § 77i(a).

We lack subject-matter jurisdiction to reach the merits;
instead, Watts’s challenge must be decided by the district court
in the first instance. As the consistent practice of courts and
agencies reflects, an agency’s determination not to comply with
a third-party subpoena in an ongoing civil suit is simply an
agency’s ordinary litigation decision, not an “order” that a court
of appeals has separate jurisdiction to directly review. Disputes
over third-party subpoenas to agencies in civil litigation
therefore must commence in the district court under Rule 45.
We transfer this case to the United States District Court for the
District of Columbia. See 28 U.S.C. § 1631.

I

1. In March 2004, Sir Philip Watts resigned as the
Chairman of the Committee of Managing Directors at the
corporate predecessor of Royal Dutch Shell plc. Shell disclosed
in a series of announcements during 2004 that it had incorrectly
categorized as “proved oil and gas reserves” certain quantities
of the reserves it had previously reported in its financial
statements. Shell re-categorized those quantities, reducing the
 3

dollar value of Shell’s proved reserves for several fiscal years.

In August 2004, the SEC settled a cease-and-desist
proceeding with Shell. See In re Royal Dutch Petroleum Co.,
Exchange Act Release No. 50,233 (Aug. 24, 2004). The agency
issued related findings (which Shell neither admitted nor denied)
that Shell’s “overstatement of proved reserves, and its delay in
correcting the overstatement,” stemmed in part from Shell’s
failure to comply with the standards of Rule 4-10 of SEC
Regulation S-X. See 17 C.F.R. § 210.4-10; Release No. 50,233,
at 3. Under Rule 4-10, companies that issue federally registered
securities must disclose the value of their oil and gas reserves,
and they may report as proved reserves only those oil and gas
quantities that “geological and engineering data demonstrate
with reasonable certainty to be recoverable in future years.” 17
C.F.R. § 210.4-10(a)(2).

In describing the requirements of Rule 4-10 that Shell
allegedly failed to satisfy, the SEC’s cease-and-desist order
repeatedly referred to informal agency guidance concerning the
rule. See Release No. 50,233, at 4-5, 7-8, 12-15. The SEC staff
had published that guidance on its website in 2000 and 2001.
Employees of the SEC’s Division of Corporate Finance had
discussed that guidance with numerous oil and gas companies,
including Shell. The SEC employees involved in those
discussions included Roger Schwall, an assistant director at the
Division, and two of his subordinates, Ronald Winfrey and
James Murphy.

Following the SEC’s cease-and-desist proceeding, Shell
shareholders sued several persons, including Watts. In that
lawsuit – which is still ongoing in the United States District
Court for the District of New Jersey – the shareholders alleged
that the defendants had engaged in securities fraud by not earlier
disclosing the overstatement in proved reserves. The
 4

shareholders’ complaint referenced the SEC’s informal guidance
about Rule 4-10 and the SEC’s cease-and-desist order.

2. In February 2006, Watts served four testimonial
subpoenas under the authority of the United States District Court
for the District of Columbia. See Fed. R. Civ. P. 45. He
directed one subpoena to the SEC. (A government agency can
designate a knowledgeable person to give a deposition on the
agency’s behalf. See Fed. R. Civ. P. 30(b)(6).) Watts also
directed subpoenas to Schwall, Winfrey, and Murphy – the
individual SEC employees involved in administering Rule 4-10.

The testimonial subpoenas sought depositions on two
general topics: (i) the development, interpretation, and
application of the terms “proved oil and gas reserves,”
“reasonable certainty,” and “reasonable doubt,” as used in Rule
4-10 and the staff-written guidance; and (ii) communications
between the SEC and oil and gas companies concerning Rule
4-10 and the related guidance. Watts emphasized that the
depositions would support his defense in the shareholder
litigation. He argued that the informal guidance and SEC staff
contacts with Shell and other companies improperly tightened
the substantive standard of Rule 4-10, and that Shell’s reserves
re-categorization stemmed from that regulatory crackdown, not
from any fraud.

In an April 2006 letter to Watts, the SEC’s General Counsel
stated that the SEC objected to the depositions and would not
comply with the subpoenas. The General Counsel asserted that
the deliberative process privilege shielded the information Watts
sought, and that a deposition of the SEC’s Rule 30(b)(6)
designee would be unduly burdensome. Citing agency
regulations, see 17 C.F.R. § 200.735-3(b)(7), the General
Counsel also stated that the SEC would not authorize the three
individual employees to give depositions because of the
 5

deliberative process privilege.

Watts sought to contest the General Counsel’s
determinations along two routes in May 2006. First, regarding
the subpoena directed to the SEC, he filed a motion to compel
in the District Court for the District of Columbia. The District
Court has stayed that proceeding.

Second, regarding the subpoenas directed to the three SEC
employees, Watts initially sought Commission review of the
General Counsel’s action. The SEC denied Watts’s petition,
amplifying the General Counsel’s deliberative process argument
and adding that “allowing staff to appear for testimony would
place an undue burden on the Commission.” In re Royal
Dutch/Shell Transp. Sec. Litig., Exchange Act Release No.
54,259, at 3 (Aug. 1, 2006). Watts then filed a petition in this
Court for judicial review of the SEC’s action with respect to the
subpoenas to the three SEC employees. Watts pointed to
Section 25 of the Securities Exchange Act of 1934 as the source
of our subject-matter jurisdiction. See 15 U.S.C. § 78y(a)(1).

II

1. Limits on subject-matter jurisdiction “keep the federal
courts within the bounds the Constitution and Congress have
prescribed,” and those limits “must be policed by the courts on
their own initiative.” Ruhrgas AG v. Marathon Oil Co., 526
U.S. 574, 583 (1999). In this case, we therefore must address an
issue not presented to us by the parties: whether Watts’s petition
for review of the SEC’s privilege and undue burden assertions
belongs in this Court at this time.

Congress is free to “choose the court in which judicial
review of agency decisions may occur.” Five Flags Pipe Line
Co. v. Dep’t of Transp., 854 F.2d 1438, 1439 (D.C. Cir. 1988)
 6

(internal quotation marks and alteration omitted). Because
district courts have general federal question jurisdiction under
28 U.S.C. § 1331, the “normal default rule” is that “persons
seeking review of agency action go first to district court rather
than to a court of appeals.” Int’l Bhd. of Teamsters v. Pena, 17
F.3d 1478, 1481 (D.C. Cir. 1994). Initial review occurs at the
appellate level only when a direct-review statute specifically
gives the court of appeals subject-matter jurisdiction to directly
review agency action. Id.; accord Midwest Indep. Transmission
Sys. Operator, Inc. v. FERC, 388 F.3d 903, 908 (D.C. Cir.
2004).

The SEC is subject to such a direct-review statute for
judicial review of SEC “orders.” Section 25 of the Securities
Exchange Act of 1934 provides: “A person aggrieved by a final
order of the Commission entered pursuant to this chapter may
obtain review of the order in the United States Court of Appeals
for the circuit in which he resides or has his principal place of
business, or for the District of Columbia Circuit . . . .” 15
U.S.C. § 78y(a)(1) (emphasis added). Section 9 of the Securities
Act of 1933 similarly provides: “Any person aggrieved by an
order of the Commission may obtain a review of such order in
the court of appeals of the United States, within any circuit
wherein such person resides or has his principal place of
business,” or in this Court. 15 U.S.C § 77i(a) (emphasis added).

This case hinges on interpretation of the term “order” used
in Section 9 of the Securities Act and Section 25 of the
Exchange Act. Neither the Securities Act nor the Exchange Act
defines the term. We therefore look to the Administrative
Procedure Act, as we have done before when an agency’s direct-
review statute did not define “order.” See APCC Servs., Inc. v.
Sprint Communications Co., 418 F.3d 1238, 1249 (D.C. Cir.
2005) (looking to APA when interpreting “order” in 47 U.S.C.
§§ 407, 416(c)). The APA provides that an “order” is “the
 7

whole or a part of a final disposition, whether affirmative,
negative, injunctive, or declaratory in form, of an agency in a
matter other than rule making but including licensing.” 5 U.S.C.
§ 551(6); cf. Int’l Tel. & Tel. Corp. v. Local 134, Int’l Bhd. of
Elec. Workers, 419 U.S. 428, 443 (1975) (“[W]hen Congress
defined ‘order’ in terms of a ‘final disposition,’ it required that
‘final disposition’ to have some determinate consequences for
the party to the [agency] proceeding.”).

2. To decide whether we have jurisdiction to directly
review Watts’s challenge, we must determine whether the SEC’s
decision not to authorize its employees to give deposition
testimony in response to Watts’s third-party subpoena
constitutes “the whole or a part of a final disposition” of the
SEC “in a matter other than rule making.” 5 U.S.C. § 551(6).
We think not. A government agency’s decision to assert
privilege or otherwise not to comply with a subpoena in ongoing
civil litigation, or to decline to authorize employees to answer
subpoenas directed to them, is simply an ordinary litigation
decision, not an agency’s “final disposition” of the kind
referenced in the APA. “Subpoenas are process of the issuing
court . . . .” In re Sealed Case, 141 F.3d 337, 341 (D.C. Cir.
1998). Therefore, an agency’s response to a judicial subpoena
(even one obtained by private civil litigants in aid of discovery)
neither finally disposes of the subpoena, nor even disposes of
the agency’s responsibilities regarding it – because the subpoena
issues under the authority of the district court, not the agency.

Furthermore, direct review in this Court of agency
responses to third-party subpoenas would generate a variety of
odd analytical and practical consequences that help confirm that
the agency’s action is not an “order.” Cf. Buckeye Check
Cashing, Inc. v. Cardegna, 126 S. Ct. 1204, 1210 n.3 (2006).
For example, if the SEC’s subpoena decision were to qualify for
direct review, then many agency actions in ongoing district court
 8

litigation between private parties – including agency amicus
briefs, privilege assertions, letters about scheduling issues, and
the like – would be orders separately reviewable in the court of
appeals under a direct-review provision, while the litigation
itself chugged along in the district court. Such a bifurcated
procedure would be cumbersome, duplicative, and ultimately
nonsensical – and underscores the implausibility of labeling the
challenged agency action here an “order.”

Moreover, were an agency’s response to a third-party
subpoena in private litigation an order under the APA, it would
follow that the steps the agency took in generating its response
would be an APA “adjudication,” which is defined as “agency
process for the formulation of an order.” 5 U.S.C. § 551(7). In
deciding that an agency should not comply with a third-party
subpoena in private litigation, agency lawyers presumably
review the subpoena, the filings in the underlying case, and the
applicable case law, regulations, and agency precedents. And
there no doubt are internal agency meetings and consultations.
But that internal agency process for reaching a decision on
whether to comply with a judicial subpoena is not typically or
comfortably described as an “adjudication” (even given the
broad scope of formal and informal adjudications under the
APA). It would be particularly odd to classify as agency
adjudication the agency’s formulation of a response to a
subpoena in a pending district court adjudication. The potential
circularity of such an interpretation has a hall-of-mirrors quality
to it – where every agency filing in ongoing district court
litigation is simultaneously subject to review in the court of
appeals.

In addition, direct court of appeals review of subpoena
compliance decisions would frustrate the traditional role of
district courts in resolving discovery disputes. Federal Rule of
Civil Procedure 45 authorizes court-issued subpoenas to obtain
 9

discovery from third parties, and Rule 26, which generally
governs civil discovery, provides: “Parties may obtain
discovery regarding any matter, not privileged, that is relevant
to the claim or defense of any party . . . .” Fed. R. Civ. P.
26(b)(1). Rule 26 “vests the trial judge with broad discretion to
tailor discovery narrowly and to dictate the sequence of
discovery.” Crawford-El v. Britton, 523 U.S. 574, 598 (1998).
The basis for our deferential, abuse-of-discretion review of
district court discovery rulings is the recognition that
supervising the to-and-fro of district court litigation falls within
the expertise, in the first instance, of district courts and not
courts of appeals. See Pierce v. Underwood, 487 U.S. 552, 558
n.1 (1988) (“It is especially common for issues [such as
discovery sanctions] involving what can broadly be labeled
‘supervision of litigation,’ . . . to be given abuse-of-discretion
review.”). Endorsing direct court of appeals review of the
agency’s refusal to comply with a subpoena would turn that
principle on its head; it would suggest that appellate judges have
some advantage over district judges in resolving discovery
disputes, which no one believes.

Given all of this, it comes as no surprise that the parties
have not cited a single case holding that an agency’s assertion of
privilege or undue burden in ongoing district court litigation
between private parties is the kind of agency action falling
within a statute providing for direct court of appeals review. On
the contrary, initial review of federal agency decisions not to
comply with third-party subpoenas on privilege or other grounds
has occurred in the district courts. The consistent practice of
district court review in the first instance indicates that agencies
and courts alike have reached a sound conclusion (albeit perhaps
implicitly): Litigation decisions by agencies, including
assertions of privilege, are not the kinds of agency
determinations that are channeled to courts of appeals under the
direct-review statutes. See Schreiber v. Soc’y for Sav. Bancorp,
 10

Inc., 11 F.3d 217, 219-20 (D.C. Cir. 1993) (Federal Reserve
Board of Governors and FDIC); Friedman v. Bache Halsey
Stuart Shields, Inc., 738 F.2d 1336, 1339-40 (D.C. Cir. 1984)
(SEC and CFTC); see also Yousuf v. Samantar, 451 F.3d 248,
250 (D.C. Cir. 2006) (Department of State); Linder v. Calero-
Portocarrero, 251 F.3d 178, 179-80 (D.C. Cir. 2001)
(Departments of State and Defense and CIA); Northrop Corp. v.
McDonnell Douglas Corp., 751 F.2d 395, 398 (D.C. Cir. 1984)
(Departments of State and Defense); COMSAT Corp. v. Nat’l
Sci. Found., 190 F.3d 269, 273-74 (4th Cir. 1999); Edwards v.
Dep’t of Justice, 43 F.3d 312, 314 (7th Cir. 1994); Exxon
Shipping Co. v. Dep’t of Interior, 34 F.3d 774, 776 (9th Cir.
1994); Moore v. Armour Pharm. Co., 927 F.2d 1194, 1196 (11th
Cir. 1991) (FDA); Davis Enters. v. EPA, 877 F.2d 1181, 1183-
84 (3d Cir. 1989).

Watts suggests, however, that certain SEC regulations
nonetheless support judicial review directly in this Court. Under
SEC regulations, agency employees must decline to disclose
information in response to subpoenas unless the General
Counsel authorizes them to give “non-expert, non-privileged,
factual . . . testimony.” 17 C.F.R. § 200.735-3(b)(7)(ii),
(iii). Because the SEC consulted those regulations in deciding
not to comply with the subpoenas, Watts incorrectly assumes
that the SEC action is an order qualifying for direct court of
appeals review. Those SEC regulations ensure centralized
agency control over agency employees and are functionally
similar to the Department of Justice regulations examined in
United States ex. rel. Touhy v. Ragen, 340 U.S. 462 (1951). In
Touhy, the Supreme Court concluded that, because the Attorney
General could “validly withdraw from his subordinates the
power to release department papers,” a subordinate who invoked
the Attorney General’s regulation in refusing to answer a
subpoena could not be held in contempt. Id. at 465, 467-68. But
Touhy regulations have no relevance to the threshold question
 11

posed here; they do not determine which court has initial
jurisdiction to consider an agency assertion of privilege or undue
burden.

3. We have thus far established that the SEC’s decision to
object to the subpoena was not an “order” qualifying for our
direct review. As a result, the District Court is the proper forum
for Watts’s claim. The question remains whether such a claim
is properly styled as (i) a motion to compel under Rule 45, or
(ii) a petition for APA review of the agency’s final privilege or
undue burden decision (although not an “order,” that decision
was final agency action, see 5 U.S.C. § 704; Yousuf, 451 F.3d at
251).

Rule 45 gives the district courts authority to issue
subpoenas and instructs the courts how to address disputes over
subpoenas. We have held, moreover, that government agencies
are “persons” subject to Rule 45 subpoenas. See Yousuf, 451
F.3d at 257. Therefore, a challenge to an agency’s refusal to
comply with a Rule 45 subpoena should proceed and be treated
not as an APA action but as a Rule 45 motion to compel (or an
agency’s Rule 45 motion to quash). See 5 U.S.C. § 703 (“The
form of proceeding for judicial review is the special statutory
review proceeding relevant to the subject matter in a court
specified by statute . . . .”).

Rule 45 also supplies the standards under which district
courts assess agency objections to a subpoena. The rule requires
that district courts quash subpoenas that call for privileged
matter or would cause an undue burden. Courts have applied
these Rule 45 standards to document subpoenas issued to third-
party agencies or agency employees in federal civil suits. See
Houston Bus. Journal, Inc. v. Office of the Comptroller of the
Currency, 86 F.3d 1208, 1212 (D.C. Cir. 1996); see also Linder,
251 F.3d at 181. Rule 45 does not set forth a different standard
 12

for testimonial subpoenas issued under Rule 45 to an agency or
agency employee (nor would it be logical to apply a different
standard); Rule 45’s privilege and undue burden standard thus
applies to both document and testimonial subpoenas. See Exxon
Shipping, 34 F.3d at 779 (applying Rule 45 standard to third-
party testimonial subpoenas directed to federal agency
employees).* Moreover, an agency’s Touhy regulations do not
relieve district courts of the responsibility to analyze privilege
or undue burden assertions under Rule 45. An agency’s Touhy
regulations are relevant for internal housekeeping and
determining who within the agency must decide how to respond
to a federal court subpoena. See 5 U.S.C. § 301 (authorizing
Touhy regulations but providing: “This section does not
authorize withholding information from the public or limiting
the availability of records to the public.”); Yousuf, 451 F.3d at
257 (describing Touhy regulations as establishing “method[] by
which . . . an agency would respond to a subpoena”); Comm. for
Nuclear Responsibility, Inc. v. Seaborg, 463 F.2d 788, 793 (D.C.
Cir. 1971) (5 U.S.C. § 301 “does not confer a privilege”); see
also 9 JAMES WM. MOORE ET AL., MOORE’S FEDERAL PRACTICE
§ 45.05[1][b] (3d ed. 2006) (“[T]hough an agency regulation

*
In Houston Business Journal, we suggested in footnote dicta that the
APA arbitrary and capricious standard governed review of agency decisions
not to comply with a federal court’s testimonial subpoena (as opposed to a
federal court’s document subpoena). 86 F.3d at 1212 & n.4; see 5 U.S.C. §
706(2)(A). But Houston Business Journal arose out of an agency’s refusal
to provide documents in response to a document subpoena issued by a state
court. See 86 F.3d at 1210-11, 1213-14. In general, state court subpoenas
present entirely different issues (because of the Supremacy Clause and
sovereign immunity), and a state court litigant’s only recourse from a federal
agency’s refusal to comply with a state court subpoena is to bring an APA
claim – necessarily governed by the APA arbitrary and capricious standard
– against the agency in federal court. For reasons explained in the text, we
do not believe the APA arbitrary and capricious standard applies when a
court reviews an agency’s decision not to comply with a federal court
subpoena.
 13

may provide the method by which an agency head will comply
with or oppose a subpoena, the legal basis for any opposition to
the subpoena must derive from an independent source of law
such as a governmental privilege or the rules of evidence or
procedure.”).

One additional point warrants mention: The Rule 45
“undue burden” standard requires district courts supervising
discovery to be generally sensitive to the costs imposed on third
parties. See, e.g., Cusumano v. Microsoft Corp., 162 F.3d 708,
717 (1st Cir. 1998) (“concern for the unwanted burden thrust
upon non-parties is a factor entitled to special weight in
evaluating the balance of competing needs” in Rule 45 inquiry);
Misc. Docket Matter No. 1 v. Misc. Docket Matter No. 2, 197
F.3d 922, 927 (8th Cir. 1999) (quoting id.); see also Fed. R. Civ.
P. 45(c)(2)(B) (any court order to compel compliance with
document subpoena “shall protect any person who is not a party
or an officer of a party from significant expense” of
compliance). In addition, Federal Rule of Civil Procedure
26(b)(1)-(2) requires district courts in “[a]ll discovery” to
consider a number of factors potentially relevant to the question
of undue burden, including: whether the discovery is
“unreasonably cumulative or duplicative”; whether the
discovery sought is “obtainable from some other source that is
more convenient, less burdensome, or less expensive”; and
whether “the burden or expense of the proposed discovery
outweighs its likely benefit, taking into account the needs of the
case, the amount in controversy, the parties’ resources, the
importance of the issues at stake in the litigation, and the
importance of the proposed discovery in resolving the issues.”

With these tools, district courts in cases involving third-
party subpoenas to government agencies or employees can
adequately protect both the litigant’s right to evidence and the
“government’s interest in not being used as a speakers’ bureau
 14

for private litigants.” Exxon Shipping, 34 F.3d at 780 (internal
quotation marks omitted). As the court in Exxon Shipping
recognized, in other words, discovery under Rules 26 and 45
must properly accommodate “the government’s serious and
legitimate concern that its employee resources not be
commandeered into service by private litigants to the detriment
of the smooth functioning of government operations.” Id. at
779; see also Moore, 927 F.2d at 1197-98 (expected “onslaught
of subpoenas” in similar litigation raised substantial concern
about “cumulative impact” of individual subpoena) (internal
quotation marks omitted); Davis Enters., 877 F.2d at 1187
(agency had “legitimate concern with the potential cumulative
effect” and “proliferation of testimony by its employees” that
compliance with individual subpoena would entail).

III

We lack subject-matter jurisdiction to consider Watts’s
petition for review. However, we have discretion to transfer the
case to another court where it could have been brought at the
time it was filed. See 28 U.S.C. § 1631; Five Flags Pipe Line
Co. v. Dep’t of Transp., 854 F.2d 1438, 1442 (D.C. Cir. 1988).
We therefore transfer the case to the United States District Court
for the District of Columbia, where the SEC’s privilege and
undue burden assertions may be reviewed in the first instance
under the standards set forth in Federal Rule of Civil
Procedure 45.

So ordered.