In our first blog post in April 2014, we asked: “Why Isn’t the SEC Committed to a Just and Fair Enforcement Process?”. Several months later, the SEC’s new enforcement director announced the SEC’s plans to bring more prosecutions in its captive administrative court, taking them out of the federal courts. Whether coincidentally or not, this decision came in the midst of growing publicity on repeated SEC losses in federal court enforcement actions it brought: e.g., SEC v. Stoker; SEC v. Cuban; SEC v. Kovzan; SEC v. Obus; SEC v. Jensen; SEC v. Schvacho; SEC v. Steffes; SEC v. Petit (case dropped on eve of trial); SEC v. Graham; SEC v. Moshayedi. (We wrote posts about Obus, Graham, and Moshayedi.) We questioned this decision as a matter of fairness and public policy in our June 12, 2014 post: “SEC Enforcement Director Announces Future Plans To Avoid Jury Trials.” In his announcement, the enforcement director acknowledged that the SEC was at least partially motivated by a desire to move cases to a forum more hospitable to the SEC.
The SEC’s use of administrative proceedings to prosecute penal enforcement actions has many of the characteristics of a “Star Chamber” proceeding.
- The SEC enforcement staff convinces the Commission to bring a case in a private meeting.
- The case is commenced in a court overseen by an SEC administrative law judge (ALJ), who is hired by, and works in an Office within, the SEC.
- The case proceeds under Rules of Practice set by the SEC.
- The respondent in a proceeding has limited rights to gather evidence to defend the case — e.g., there is no right to subpoena evidence from the SEC or third-parties without ALJ approval (which the SEC litigators routinely oppose); there is no right to depose witnesses in advance of trial to learn what evidence they may have; there is no right to challenge the SEC enforcement staff’s unilateral determination of what gets included in the enforcement “file” that gets delivered to the respondent.
- The respondent must be ready to try the case under an expedited schedule, but the SEC typically has had years to develop and review evidence before the case is brought.
- The standard rules of evidence do not apply at trial.
- There is no jury.
- The judges are of varying quality (never having gone through an independent approval process), have much greater familiarity with the SEC lawyers than defense lawyers, tend to give great leeway (and sometimes deference) to the SEC lawyers, and are forced to decide complex cases under the deadline set by the SEC itself.
- After the ALJ rules, the right of appeal is to . . . the SEC. The very group that authorized bringing the case gets to rule on the appeal sitting in an administrative adjudicative capacity; the prosecutor becomes the judge.
- Only after that process is complete — and we’re now talking about years into the case with huge costs of defense — does the respondent have a right to appeal the decision to an independent court. Even then, the appellate court is saddled with a “standard of review” that allows it to overturn the SEC’s determination only if it is “arbitrary,” an “abuse of discretion,” or “contrary to law.” Essentially, only if no reasonable basis can be found to support the Commission’s findings, they must be affirmed. As a result, no person outside of the SEC reviews the evidence de novo to decide if it fairly supports findings against the respondents under the applicable burden of proof, or if the sanctions imposed are fair.
I am not suggesting that SEC administrative law judges knowingly stack the deck against respondents. I think they try to be fair. But they cannot alter the fact that the rules of these proceedings are stacked against respondents in the ways described above. And it is not surprising that they may tend to undervalue due process protections, and evidentiary niceties, that may make their jobs, and the jobs of the SEC litigators, more difficult. Of course, this is not a true “Star Chamber” because general notions of due process are still recognized, but the proof of the pudding is in the eating, and, there is no doubt that defense counsel prefer a judicial forum, and the SEC’s enforcement director himself noted that the SEC’s administrative courts seem to provide the SEC an advantage over those pesky federal courts.
The advantages to a defendant of a highly-qualified, independent, Article III judge cannot be over-emphasized. The entire pre-trial process is imbued with disputes about how information and evidence can be gathered and must be shared, as well as what can and cannot be included in the case, and on what issues there actually is disputed evidence that justifies a trial. And then, of course, there is the administration of the trial and the determination of evidence to be considered. Most federal district court judges approach these issues seriously, fairly, and with true understanding of the importance in a case brought by the Government that the defendant is getting a “fair shake.” One recent example of this (discussed in detail here) is Judge Scheindlin’s willingness to reject the SEC’s overbearing and totally unjustified effort to obtain so-called “disgorgement” from the Wyly brothers of $500,000,000 based on near-preposterous arguments about how the amounts they realized from stock options granted to them as management of highly successful companies were derived from non-disclosures about their control of stock held by offshore trusts. It is rare that ALJ’s repudiate the SEC so thoroughly in administrative cases (although, to be fair, it has happened on rare occasions).
There seems to be a rising sense of abuse of power in the SEC’s announced decision to bring more of its civil prosecutions before its administrative law court. Several articles or comments addressing this issue are linked in the “SEC Enforcement” section in the right margin of this blog. One of these articles discusses a recent comment by district court judge Jed Rakoff (a former head prosecutor for securities cases in the U.S. Attorney’s office) asking “from where does the constitutional warrant for such unchecked and unbalanced administrative power derive?”. Some suggest that the transfer of non-technical securities enforcement prosecutions to this forum to gain the advantage of reduced procedural protections violates due process requirements. Thus, cases not focused on rules violations like technical broker-dealer or investment advisory rules, but rather on broader accusations of “fraud,” seem suspiciously out of place in an administrative court, the stated purpose of which is to allow the application of special expertise to these cases.
Keep an eye on developments in this area. The SEC will not get a free ride on this. In my estimation, the D.C. Circuit court appeals will be considering this issue in the not-too-distant future.
August 7, 2014
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