In a recent post we described the SEC’s aggressive theory in an action brought against Jordan Peixoto for alleged insider trading involving securities of Herbalife Ltd. See SEC Insider Trading Cases Continue To Ignore the Boundaries of the Law. Mr. Peixoto will not “go gentl[y] into that good night,” and instead will “rage against the dying of the light,” that is, if the light is the Constitution of the United States. See Peixoto v. SEC, 14 CV 8364 (S.D.N.Y.).
Stating a claim for a declaratory judgment largely identical to the recent action filed by Joseph Stilwell against the SEC in Stillwell v. SEC, 14 CV 7931 (S.D.N.Y.), Peixoto contends that his SEC administrative proceeding is unconstitutional because the SEC’s administrative law judges are executive branch “officers” within the meaning of Article II, but are improperly protected against removal by the President. This allegedly renders the proceedings they oversee unconstitutional.
Another SEC administrative respondent raised constitutionality issues challenging the fairness of the administrative proceeding in Wing Chau v. SEC, 14 CV 1903 (S.D.N.Y.). That claim is founded on alleged disparate treatment of Wing Chau and Harding Advisory LLC in being prosecuted in the SEC’s administrative court rather than in federal district court. The plaintiffs allege that by doing so, the SEC imposes an unacceptably short schedule to trial in a complex matter, prevents discovery of an allegedly tainted SEC official’s misconduct during the investigation, and avoids a jury because the SEC previously lost two of three cases on similar issues tried to juries. The case involves complex collateralized debt obligation (CDO) transactions for which Harding Advisory was the collateral manager. The SEC filed a motion to dismiss in that case, which according to court records is fully briefed and awaiting a decision. In the meantime, the administrative trial in that case has been completed and a decision from the ALJ should be forthcoming soon.
These assertions of constitutional violations all stem from the SEC’s decision to use its captive administrative law court as the forum for major enforcement actions rather than sticking to the more limited traditional role of those courts of adjudicating SEC actions against securities industry regulated persons. We have discussed this decision, and how harmful it is to enforcement defendants, in earlier posts. See Opposition Growing to SEC’s New “Star Chamber” Administrative Prosecutions and SEC Enforcement Director Announces Future Plans To Avoid Jury Trials.
Mr. Peixoto’s action is founded on the alleged Article II shortcoming, but it plainly is motivated by concern that the SEC is trying to gain an unfair advantage by choosing the administrative forum for an insider trading case. His allegations are focused on equal protection and due process concerns. For example, he notes that the SEC almost never brings insider trading cases as administrative actions, and that with the exception of two cases (the forum for one of which was changed), “the Commission has filed all litigated insider trading proceedings against non-regulated defendants in district court since the passage of Dodd-Frank in July 2010. This means the Commission has gone to district court to make allegations against 156 non-regulated insider trading defendants since Dodd-Frank.”
He then suggests the reason for departing from this norm was to deprive him of due process:
Mr. Peixoto denies all allegations of wrongdoing and stands ready to mount a defense against each and every one of the Commission’s allegations. Yet, under current Commission rules, Mr. Peixoto would be deprived of a jury trial, the right to use the discovery procedures of the federal court to shape his defense, and the protections of the Federal Rules of Evidence which were crafted to bar unreliable evidence. The Commission is denying Mr. Peixoto these rights, even though the General Counsel of the Commission, Anne K. Small, specifically acknowledged in a public forum merely four months ago speaking to members of the District of Columbia bar that the current administrative proceeding rules are inadequate for an insider trading case. In a question and answer session between Small and members of the District of Columbia Bar, Small stated that it was fair for attorneys to question whether the SEC’s rules for administrative proceedings were still appropriate, with the rules last revised “quite some time ago,” especially as the rules do not consider complex matters such as insider trading cases.
(See an article about Ms. Small’s speech here: SEC Administrative Case Rules Likely Out Of Date.)
Mr. Peixoto also notes that Andrew Ceresney, the SEC’s Director of Enforcement, acknowledged that the reason the SEC was using the administrative forum was to gain leverage against defendants when he said: “I will tell you that there have been a number of cases in recent months where we have threatened administrative proceedings, it was something we told the other we were going to do and they settled.” (See the discussion of Mr. Ceresney’s comments in SEC Enforcement Director Announces Future Plans To Avoid Jury Trials.) Mr. Peixoto concludes: “In other words, the Commission itself unashamedly and, importantly, unlawfully wields the sword of an improper proceeding against defendants to compel settlement. The Commission is fully aware and has acknowledged that the administrative process is a star chamber where only the Commission emerges as the victor and the defendant is defenseless. The mere specter of the process renders submission from the defendant because the process is rigged against him. Here, the Commission is consciously doing exactly what the SEC Director of Enforcement indicated, by attempting to unfairly force Mr. Peixoto to settle, despite his case for innocence and without regard to the disparate treatment established by the data, thus, establishing discriminatory intent and impact.”
The constitutional issues surrounding the SEC’s enforcement powers in both district court and administrative actions are not trivial. They raise serious issues involving the separation of powers issues, Article II tenure, and due process. They have been litigated in various forms over many years, but the Supreme Court has never considered the viability of the “civil” prosecutorial scheme for enforcement actions brought by the SEC, which was originally created as an administrative agency designed to be “independent” of both the President and the Congress.
The Article II issue is real, not fabricated, and requires more elaborate discussion in a separate post. If Administrative Law Judges are inferior executive “officers” in the Article II sense, their shielding from discipline by the President could well violate Article II.
Likewise, there are real due process issues attached to the use of administrative courts to impose substantial penalties. The timing requirements for hearing of claims and making decisions that are imposed by the SEC may be inconsistent with a fair trial on complex issues. In addition, the SEC Commissioners who approve filing the claims (and consider proposed settlements of the claims) are the same people who must review the initial decision of the administrative law judges. The only non-SEC review is on appeal, where the court of appeals applies a deferential review standard and therefore cannot consider the complex findings of fact that are critical to these cases. Whether this satisfies due process in light of the built-in conflict of interest the SEC Commissioners have as prosecutors and adjudicators is a serious matter.
Finally, the Supreme Court has never considered whether, under the standards set forth in Morrison v. Olson, 487 U.S. 654 (1988), the SEC violates the separation of powers doctrine when it brings civil law enforcement actions because the Commissioners do not serve at the will of the President. The SEC is designed to be an “independent” administrative agency that functions above (or at least beyond) the political fray, but that may not be consistent with the directive that the Executive Branch is to make law enforcement decisions. Morrison, which sustained the constitutionality of the independent prosecutor statute, laid out specific factors that must be considered to determine when prosecutors shielded from Executive control may exercise prosecutorial authority without violation the separation of powers doctrine. The validity of the SEC’s authority has not been considered by an appellate court since Morrison was decided.
As the SEC’s enforcement tactics become more aggressive (and questionable), these fundamental issues about the lack of checks and balances on SEC prosecutorial power and authority become all the more critical.
We will discuss these complex issues in later posts.
October 21, 2014
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