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SEC's Increased Use of Administrative Proceedings Draws Criticism and Legal Challenges

The SEC’s plan to bring more enforcement actions as administrative proceedings before its own administrative law judges rather than in the federal district courts -- even in insider trading cases -- has been drawing increasing criticism and legal challenges.  Most recently, Judge Jed Rakoff of the U.S. District Court for the Southern District of New York questioned  the SEC’s use of administrative proceedings in a speech last Wednesday before the Practising Law Institute’s Annual Institute on Securities Regulation.  Judge Rakoff observed that the SEC's administrative powers, which were originally quite limited, have been expanded considerably by the Sarbanes-Oxley Act of 2002 and especially by Section 929P(a) of the Dodd-Frank Act of 2010, which respectively enabled the SEC to obtain administrative orders barring defendants from serving as officers and directors of registered companies and assessing monetary penalties.  While administrative proceedings may be more efficient for the SEC, they are not subject to the Federal Rules of Evidence and Federal Rules of Civil Procedure, there is no jury, and the SEC has a much higher winning percentage in front of its own administrative law judges than in the federal courts.  Judge Rakoff noted that under the two primary securities enforcement statutes -- Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act -- the law has been principally developed by the courts.  He said that the judiciary and the public should be concerned because the SEC's increased use of administrative proceedings could hinder the balanced development and interpretation of the securities laws in the future, since courts will tend to give deference to the SEC's interpretation of the law and its own regulations. Judge Rakoff’s concerns were echoed later in the conference in comments by former SEC Director of Enforcement William McLucas.

Current SEC Director of Enforcement Andrew Ceresney defended the increased use of administrative proceedings, noting that they offer a more streamlined process that leads to a quicker hearing and result than in court cases.  He touted the impartiality and expertise of the SEC's ALJs and denied that the increased use of administrative proceedings was a reaction to SEC court losses, citing a number of recent court victories.  He observed that while administrative proceedings do not provide the same degree of discovery as court proceedings, the SEC does turn over its non-privileged file to the defense, and he suggested that the process is comparable to a criminal court proceeding.  Finally, he noted that, excluding settled cases, the SEC continues to bring a relatively significant number of contested cases in federal court.

But a subsequent panel of prominent defense attorneys remained unconvinced. They complained that, while administrative proceedings themselves might be quicker than court cases, they are typically instituted only after years of investigation by the SEC and without opportunities for discovery by the defense.  They felt that administrative proceedings give the SEC "home court" advantage and are deficient because they lack the procedural and evidentiary safeguards available in federal court.

Meanwhile, several targets of SEC proceedings have filed suits this year seeking to enjoin the SEC's actions against them.  These suits include Jarkesy v. SEC, No. 14-cv-114 (D.D.C. filed Jan. 29, 2014), appeal pending, No. 14-5196 (D.C. Cir. filed Aug. 12, 2014); Chau v. SEC, No. 14-cv-1903 (S.D.N.Y. filed Mar. 18, 2014); Stilwell v. SEC, No. 14-cv-7931 (S.D.N.Y. filed Oct. 1, 2014); and Peixoto v. SEC, No. 14-cv-08364 (S.D.N.Y. filed Oct. 20, 2014).  Some of the plaintiffs in these cases allege the SEC's decision to pursue claims against them in administrative proceeding violates their constitutional equal protection and due process rights because the expedited timetable for administrative proceedings does not allow them enough time to prepare for trial and because they have been arbitrarily deprived of the right to a jury.  In addition, some plaintiffs contend that the good cause standard for removal of ALJs  by the SEC Commissioners, who are themselves removable only for cause, improperly insulates ALJs from the President's removal powers in violation of Article II of the Constitution, citing the Supreme Court's decision in Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477 (2010).  To date there has been no real substantive decision on these arguments in these cases.  Significantly, Jarkesy was dismissed on the ground that the district court lacked jurisdiction to hear the case; instead, the court held, the plaintiff's challenge would have to proceed before the SEC and then a federal appellate court.  But some of the constitutional arguments asserted in these actions recall those presented by the plaintiff in a similar complaint for injunctive relief in Gupta v. SEC, 796 F. Supp. 2d 503 (S.D.N.Y. 2011), where Judge Rakoff denied the SEC's motion to dismiss for lack of jurisdiction.

Whatever the outcome of these cases, it is clear that many members of the defense bar and at least one prominent federal judge believe that the pendulum has swung too far, and that the SEC's aggressive efforts to pursue enforcement actions in administrative proceedings, though authorized by statute, are fundamentally unfair and ultimately risk undermining the SEC's authority.

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Chip Phinney