We have previously discussed the controversial decision of the SEC’s Division of Enforcement to move enforcement actions cases from the federal district courts to the SEC’s administrative court process. This is particularly troubling as to civil prosecutions involving large potential “civil” penalties and ancillary relief like lifetime bars that can be debilitating to individual and corporate respondents. Serious due process and separation of powers constitutional issues have been raised about this approach. See our previous posts here, here, and here.
On November 5, 2014, U.S. District Court Judge Jed Rakoff, a constant thorn in the side of the SEC, told a gathering of SEC enforcement lawyers he was troubled by this policy as well. A copy of Judge Rakoff’s speech is available here: Judge Rakoff PLI Speech.
Judge Rakoff did not venture into the merits of the legal challenges to these proceedings now proliferating in the courts. Instead, he addressed the wisdom — or lack of wisdom — of the policy decision. He first placed the SEC’s enforcement powers in historical context, noting that “When the SEC was first created in the 1930’s, its enforcement powers were largely limited to seeking injunctions in federal district courts to enjoin violations of the securities laws, and the only express provision for administrative hearings was to suspend or expel members or officers of national securities exchanges.” In the next 50 years, expansions of the SEC’s enforcement powers were “tied to the agency’s oversight of regulated entities or those representing those entities before the Commission, and even then was largely ancillary to the broader remedies and sanctions it could obtain only by going to federal court.” The power to seek monetary relief in these proceedings, in the form of so-called “disgorgement,” was not added until 1990. And it was not until the Sarbanes-Oxley Act in 2002 that the SEC was accorded the extraordinary “power to employ administrative proceedings to bar any person who had violated the securities laws from serving as an officer or director of a public company.” Finally, the 2010 Dodd-Frank Act gave the SEC “the power through internal administrative proceedings to impose substantial monetary penalties against any person or entity whatsoever if that person or entity has violated the federal securities laws, even if the violation was unintentional.”
Almost all of these accretions in SEC enforcement power, Judge Rakoff noted, came about “at the request of the SEC, usually by tacking the provisions authorizing such expansion onto one or another statute enacted in the wake of a financial scandal,” based on “a claim greater efficiency.” Judge Rakoff’s acerbic nature is reflected in his reaction to this: “While a claim to greater efficiency by any federal bureaucracy suggests a certain chutzpah, it is hard to find a better example of what is sometimes disparagingly called ‘administrative creep’ than this expansion of the SEC’s internal enforcement power.” This “efficiency,” he noted, is achieved by depriving the targets of enforcement actions of key procedural protections. “Superficial” “streamlining” comes about “for the simple reason that SEC administrative proceedings involve much more limited discovery than federal actions, with no provision whatsoever for either depositions or interrogatories. Similarly, at the hearing itself, the Federal Rules of Evidence do not apply and the SEC is free to introduce hearsay. Further still, there is no jury, and the matter is decided by an administrative law judge appointed and paid by the SEC.” As a result: “It is hardly surprising in these circumstances that the SEC won 100% of its internal administrative hearings in the fiscal year ending September 30, 2014, whereas it won only 61% of its trials in federal court during the same period.”
Beyond this concern, Judge Rakoff identifies another serious policy concern: moving cases from the federal courts to the SEC’s captive administrative court “hinders the balanced development of the securities laws.” He notes that SEC enforcement actions often involve charges of fraud, which is a concept with little statutory or administrative, as opposed to judicial, development. “Indeed, the SEC has often resisted any attempt to replace these provisions with something more specific, on the theory that such broad statutory provisions provide the flexibility needed to deal with the new schemes that fraudsters are constantly devising.”
His prime example is the area of insider trading, where the SEC “has repeatedly resisted any effort by Congress to statutorily define insider trading, preferring to leave the concept sufficiently flexible as to be able to adjust to new developments.” “Fair notice” of what does, and does not, constitute insider trading fraud comes from “federal courts, where the law of insider trading has been developed and elaborated in much-publicized cases.” Judge Rakoff noted that in two recent insider trading cases, SEC v. Cuban and SEC v. Obus, the SEC suffered “stinging defeats.” As a result, “the SEC might well be tempted in the future to bring such cases as administrative enforcement actions, and thereby likely avoid the sting of well-publicized defeats. But the result would be that the law in such cases would effectively be made, not by neutral federal courts, but by SEC administrative judges.” And the availability of judicial review of these decisions, after they are reviewed by the SEC itself, is extremely limited because the SEC’s decision must be “presumed correct unless unreasonable” under the required appellate review standard.
Here is Judge Rakoff’s devastating conclusion:
In short, what you have here are broad anti-fraud provisions, critical to the transparency of the securities markets, that have historically been construed and elaborated by the federal courts but that, under Dodd-Frank, could increasingly be construed and interpreted by the SEC’s administrative law judges if the SEC chose to bring its more significant cases in that forum. Whatever one might say about the SEC’s quasi-judicial functions, this is unlikely, I submit, to lead to as balanced, careful, and impartial interpretations as would result from having those cases brought in federal court.
In the short-run, this would be unfair to the litigants. In the longer-run, it might not be good for the SEC itself, which has its own reputation for fairness to consider. But, most of all, in the both the short-run and the long-run, it would not be good for the impartial development of the law in an area of immense practical importance. . . .
I see no good reason to displace [the Article III judicial process] with administrative fiat, and I would urge the SEC to consider that it is neither in its own long-term interest, nor in the interest of the securities markets, nor in the interest of the public as a whole, for the SEC to become, in effect, a law onto itself.
The plot thickens on the SEC’s enforcement power grab. Judge Rakoff, who had considerable prosecutorial experience in the securities area before he was appointed to the bench, has an extensive following on the issues of securities law enforcement. The new Republican Congress is not likely to be enamored of an enforcement process that enhances administrative powers at the expense of individual rights. SEC Chair Mary Jo White should get prepared for a bumpy ride.
Update on SEC response:
In a panel discussion the next day at the same PLI conference, Andrew Ceresney gave a rejoinder to the Rakoff criticism. Essentially, he argued that the SEC has no comparative advantage when it litigates in front of its own administrative law judges. An extended analysis of his arguments can be found here. In sum, he’s wrong, and badly so. You can see a description of his comments here. Cereseny needs to do some homework before he makes comments that show he simply doesn’t understand the issues.
November 6, 2014 (updated November 10, 2014)
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