Former SEC Enforcement Leaders Urge SEC To Reform Administrative Enforcement Process

Two former high-level SEC enforcement officials took on the SEC today in the Wall Street Journal, addressing “how to rein in” the SEC’s move towards shifting enforcement actions from federal courts to the SEC’s own administrative courts.  See How To Rein in the SEC.  The two officials, one of the most highly regarded former Directors of the Division of Enforcement, William McLucas, and a recent SEC chief litigation counsel, Matthew Martens (both now partners at the WilmerHale law firm), note that “[a]dministrative proceedings involving litigation of independent agency enforcement actions have been part the regulatory landscape for decades,” and “it would be easy for the SEC to take comfort in both the court rulings to date and its own sincere belief that its proceedings are fair.”  But they argue that “legitimate questions loom regarding the agency’s authority to sit as prosecutor, judge and appellate tribunal on its own cases,” and “when those regulated by the SEC—a broad swath of the population—begin to view the exercise of governmental power as potentially unfair, there is a problem” because “Democratic self-governance requires that the governed be generally convinced of the system’s evenhandedness.”

They note that the “timing” of the decision “to move toward more in-house proceedings couldn’t have been worse” because it immediately followed several stinging federal court defeats, most notably the jury verdict in favor of Mark Cuban, who was prosecuted civilly by the SEC for alleged insider trading violations.  They gently observe that some could question the rationale of SEC officials for making an important policy change at this time to keep more cases away from the federal courts – and juries – when the authority to make such a move remained largely dormant until the SEC’s court losses started to proliferate.  They conclude: “One need not be a conspiracy theorist to wonder whether at least part of the SEC’s rationale was to avoid the federal courts. In government as in comedy, timing is everything.  And here the SEC’s timing raises serious questions about the agency’s move toward the in-house forum.”

The solution, they suggest, is for the SEC to “reclaim the high-ground in this debate and demonstrate the legitimacy of its in-house proceedings” by taking several steps:

  1. To develop “meaningful criteria for exercising its discretion to bring matters in-house,” meaning “objective criteria to guide the choice of forum” which would be determined only after considering “comments from interested parties, including the defense bar.”  This is an implicit swipe at the Division of Enforcement’s feckless attempt to describe a process for determining when to use its administrative courts, which commentators, including yours truly, universally saw as so vague and ridden with caveats that it served only as a transparent effort to justify the Commission’s continued unfettered discretion to decide where to commence its cases.  See Upon Further Review, SEC Memo on Use of Administrative Courts Was Indeed a Fumble.
  2. “[T]o modernize the rules of procedure governing its in-house proceedings,” which the SEC’s General Counsel recognized a year ago were antiquated.  They explain: “With cases now brought in-house that involve evidentiary records spanning millions of pages and testimony gathered over several years by the SEC’s enforcement staff, it is unfair to force a respondent to trial with, at most, 120 days to prepare.”  A respondent’s “limited ability to obtain documents needed for a defense, with no opportunity to depose witnesses like the SEC did during the often multiyear investigation leading to the charges, and with insufficient time to locate defense expert witnesses to respond to the SEC’s experts,” leave these proceedings “stacked in favor of the SEC.”  This only touches upon the many respects in which the Division of Enforcement has a huge advantage against respondents when prosecuting SEC cases on the administrative forum.  See Ceresney Presents Unconvincing Defense of Increased SEC Administrative Prosecutions.
  3. “SEC commissioners should avoid finding, on appeal, additional violations and imposing additional penalties beyond those assessed by the administrative law judges.”  Unlike the SEC itself, the ALJs who preside over the SEC’s in-house cases are independent government employees, have no role in authorizing the charges against defendants, and hear the evidence directly from the witnesses in the hearings. . . .  The commission, by contrast, is the same body that brought charges against the respondent,” and it “never hear[s] from witnesses themselves.”  That makes it “troubling” if the “commission, acting as an appellate body, [goes] further than the findings of the ALJ who conducted the hearing to find new violations and penalties.”

The authors conclude: “The Supreme Court has, for nearly 40 years, authorized federal agencies to use administrative proceedings to pursue enforcement cases.  But the agencies must use that power in judicious ways.  The SEC’s approach to administrative proceedings leaves something to be desired. It isn’t too late to fix that.”

These are not new points and new arguments.  Several commentators have raised these and other issues over the last year, and Andrew Ceresney, the Director of the Division of Enforcement, repeatedly responds by extolling the quality of the Emperor’s clothes . . . that is, insisting that the SEC is acting fairly, impartially, and in the public interest, and that its litigators have no material advantage over the defense in the SEC’s home court.  What is new here – or almost new (former Director of Enforcement George Canellos made similar comments recently — see SEC ex-enforcement chief calls for reforms to system of in-house judges) – is that respected former officials are telling Mr. Ceresney to open his eyes, get off his soap box, and work with the General Counsel and the Commission to fix what is a real problem.

One respect in which Messrs. McLucas and Martens give their former employer too much deference is their apparent acceptance of the view that it is settled law that the SEC can be lawfully empowered to bring enforcement actions in its administrative courts against persons the SEC does not oversee as a regulator.  There remain serious questions whether the powers granted by Congress to the SEC in the Dodd-Frank Act to commence such actions are constitutionally sustainable.

The “40 years” of Supreme Court authority for “federal agencies to use administrative proceedings to pursue enforcement cases” that the authors mention twice in their article is a judicial authority originally founded in the context of enforcement actions for the purpose of implementing and enforcing specific regulatory authority conferred on the agency.  Persons who engage in the regulated conduct effectively consent to resolve regulatory disputes in the agency’s forum of choice.  The Supreme Court has never approved the notion that Congress is empowered to transfer law enforcement prosecutions outside of those agency regulatory boundaries from Article III courts to administrative fora, which have no juries, and the decisions of which are reviewed by the agency itself.

Indeed, this issue is apparent from the Supreme Court’s most recent consideration of the exercise of judicial authority by non-Article III courts to decide common law disputes that arise in the course of bankruptcy proceedings.  In Wellness Int’l Network, Ltd., et al v. Sharif, 575 U.S. ___ (2015), the Court held that there is no violation of the separation of powers doctrine when a bankruptcy court, an Article I court, adjudicates claims normally required to be decided by Article III courts, as long as the parties mutual waive any objections to the use of the bankruptcy court for this purpose.  Even in that circumstance, Chief Justice Roberts vociferously objected to the decision, which he said allowed for the possibility of a piece-by-piece dismantling of exclusive Article III judicial powers.  And the recent Supreme Court case normally cited in support of allowing administrative courts jurisdiction over Article III cases and controversies itself also depended to a significant extent on the waiver of any objection to the proceeding.  See Commodity Futures Trading Comm’n v. Schor, 478 U. S. 833 (1986).

To be sure, the authors are correct that the SEC should – must – take compelling action to make its enforcement adjudication process fair, and to subject the exercise of discretion over the forum to be used for these cases to reasoned limits.  But even if this occurs, there remain serious due process, equal protection, jury, and separation of powers issues that may ultimately require this Dodd-Frank experiment with broadened administrative adjudication to be overturned.

Straight Arrow

June 3, 2015

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