Tag Archives: Rakoff

Ceresney Presents Unconvincing Defense of Increased SEC Administrative Prosecutions

The SEC has been besieged by criticism of the Division of Enforcement’s new determination to bring more antifraud civil prosecutions in the SEC’s administrative court, and was stung by a speech from Judge Jed Rakoff criticizing that decision in no uncertain terms.  The day after Judge Rakoff’s talk, Andrew Ceresney, the current Director of the Enforcement Division, tried to defend the decision.  He plainly needs more practice; or perhaps he could start with a better understanding of his own administrative proceedings.  The arguments he made were so off-base that they can be explained in only two ways: he either doesn’t know very much about defending SEC enforcement actions (which I hope is not true), or he is just presenting makeweight arguments in the hope that by mere repetition they might be believed.

In a PLI conference panel discussion the day after Judge Rakoff’s speech at the same conference, Ceresney attempted 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.  You can see a description of his comments here.  I don’t mean to be dismissive, but that’s a bunch of hooey.

He argued that respondents in these proceedings are not disadvantaged by the fact that they get no discovery, have limited subpoena power controlled by the ALJ, have very little time in which to prepare a case, are unprotected by the rules of evidence, and have no independent (that is, independent of the SEC, the prosecutor in these cases) review of the sufficiency of the “evidence” that gets presented in the administrative court.  His arguments are, to be kind, unconvincing.

Discovery.  Ceresney says the lack of discovery doesn’t matter because the SEC delivers all of its files to the other side.  That’s bunch of malarkey; a fiction; a mere pretense.  The SEC delivers to respondents a part of the official enforcement “case file,” but that may not include vast amounts of important information the SEC has bearing on the claims asserted.  For example, say the SEC were to bring an action alleging a company violated the antifraud provisions of the securities laws because its release of material information used a process that allowed certain investors to get a slightly faster data feed.  The enforcement division is investigating such potential charges in connection with high frequency and algorithmic trading right now.  The documents the SEC would deliver to respondents would be only the SEC’s own formal case file.  It would not include any information about the SEC’s own distribution of information, and how it may be doing the same thing (releasing information in a way that benefits certain traders) that it is charging as a fraud.  Such information would likely be obtainable in discovery in a federal court, but would not be delivered by the SEC in an administrative case and almost certainly would not be ordered to be produced by an administrative law judge (ALJ).  The SEC gains from the choice of an administrative court; the respondent loses.

Another example.  The SEC brings fraud charges against a public company alleging an improper accounting treatment to account for certain expenses.  The accounting approach, however, is in a gray area and is common in the industry.  The SEC’s enforcement file will include only its inquiry into the respondent’s accounting determinations.  What it will not include is information the SEC gathered about other industry participants, which would be relevant to determining the “generally accepted” approach in that industry.  Because that information is plainly relevant to the issue of scienter — whether the respondent knowingly or recklessly chose an incorrect accounting treatment — it would likely be obtainable in discovery in a federal district court, although the SEC would surely contest it.  But the chance of obtaining such information through an order by an ALJ is close to zero.  Once again, the SEC gains from being in the administrative court; the respondent loses.

Apart from the narrower scope of documents the SEC must deliver to respondents in an administrative proceeding, Ceresney ignores the SEC’s inevitable, overbroad assertions of work-product and “deliberative-process” privilege.  The SEC does not deliver to opponents documents in the “case file” over which they claim work-product or deliberative-process protections.  Often, these are the most important documents in the file.  In courts, the refusal to provide those materials in discovery can be (and has been) overruled, but the ALJs don’t do this.  For example, the SEC may have gathered 5 million pages of documents in electronic form.  They examine those materials for months, or more likely years, and identify the ones they think best support their case as well as ones that are harmful to their case.  When the “case file” is delivered, all the respondent gets is the 5 million pages (other information being withheld under claim of work product protection), and a short time before trial to try make head or tail out of them.  The SEC identifies as its exhibits the documents it found to be helpful and hopes the documents harmful to its case remain buried in the 5 million pages.  Federal courts can, and have, ordered that the SEC provide documents in the form they are kept in the SEC’s files (that’s what the Federal Rules of Civil Procedure require) — including files identifying what documents may be useful or harmful in certain areas.  ALJs are highly unlikely to do this.  The SEC gains; the respondent loses.

Likewise, the SEC will not deliver key interview material if there is no official transcript, claiming work-product privilege.  SEC lawyers often call potential witnesses during their investigation to learn what they might have to say on relevant issues.  They take notes of those interviews.  Some of those witnesses are subpoenaed for investigative testimony, which is transcribed.  But many of those potential witnesses are not subpoenaed for testimony, often because what they told the SEC lawyers is not helpful to prosecuting a case.  (The SEC investigative lawyers’ bias in creating an investigative record is another huge problem, but not the subject of this discussion.)  The SEC delivers the investigative transcripts as part of the case file, but keeps for itself all non-transcribed witness interviews.  As a result, evidence helpful to a respondent remains hidden.  In a federal court, discovery will likely allow the defendant to get copies of these untranscribed interviews, but an ALJ will never issue such an order.  The SEC gains; the respondent loses.

Ceresney says: “There is no discovery in criminal prosecutions, and I don’t think anyone claims due process violations there.”  That is wrong in many respects.  First, one justification for this is the considerably higher burden of proof the government faces in criminal cases.  Second, there are forms of discovery in criminal cases and judges to determine whether requested discovery should be permitted.  Third, criminal procedure rules mandate that materials obtained by prosecutors be delivered to defendants if they are exculpatory or can be used to impeach witnesses.  That is what is known as so-called “Brady material” (after the Supreme Court case Brady v. Maryland).  But the SEC, in its civil prosecutions, refuses to comply with Brady v. Maryland.  For administrative proceedings, there is a strange provision in the SEC Rules of Practice that lists documents the SEC must disclose, and those it may withhold, and then says the SEC may not “withhold, contrary to the doctrine of Brady v. Maryland, 373 U.S. 83, 87 (1963), documents that contain material exculpatory evidence.”  SEC Rule of Practice 230.  But the staff takes a narrow view of what is “exculpatory,” and does not look for exculpatory material outside of its own investigative file.  That, combined with the fact that the SEC administrative law judges are highly restrictive on what they consider “exculpatory,” means that much evidence that could be used by the defense to disprove SEC claims is never made available.  See, e.g., In the Matter of Thomas C. Bridge et al.,  File No. 3-12626 (Aug. 27, 2007).  When that happens in a federal court, a defendant at least has the chance to gather that same information in the civil discovery process.  But in the administrative court the SEC gets to try to bury evidence that a respondent can use to defend himself or herself.  The result?  You guessed it: the SEC gains; the respondent loses.

So much for Ceresney’s claim that the lack of discovery in administrative proceedings doesn’t harm respondents because the SEC delivers its case file.

ALJs as securities law experts.  Ceresney says the SEC administrative courts are better for these cases because they involve highly technical securities law issues that judges and juries just can’t understand as well as ALJs with securities law expertise.  To begin, there is no requirement that an SEC ALJ have securities law experience when he or she gets appointed.  Many of them learn on the job.  Beyond that, however, there is a kernel of truth in Ceresney’s argument, but not much more.  Over time, SEC ALJs may develop expertise in areas involving technical regulatory rules and industry practices.  But that expertise applies only to enforcement actions against SEC-regulated entities like broker-dealers or investment advisers.  The rules governing those businesses are detailed and non-intuitive, so previous experience with these cases can be helpful.  That is why for many, many years the only cases brought by the SEC in its administrative courts were those involving its own regulated entities.  But the issue raised by Judge Rakoff involves not those cases, but the broader, higher impact fraud cases like, for example, insider trading cases.  As Judge Rakoff noted, trying those cases in administrative courts is a relatively new phenomenon.  And because the SEC has resisted any clear statement of what are and are not fraudulent practices, and fraud cases that get tried (and not settled) often explore the outer edges of the fraud concept, ALJs have no meaningful technical edge on federal courts.  To the contrary, judges and juries are far more capable of applying the concept of fraud than ALJs are likely to be because in such case, technical skills are far less important than more intuitive understanding and application of common sense and community standards.

Timing advantages.  Ceresney says it is no great advantage that the SEC has been able to take months or years to prepare its case and the defense has no such luxury.  He argues that the defense has probably been doing its own investigative work during that period.  But defense counsel have no power to get people to talk to them or deliver documents.  When the SEC lawyers call people subject to SEC regulatory power, say they represent the U.S. government, and ask them to chat off the record, you can bet they get cooperation that defense counsel are unlikely to get.  That is especially true if the people contacted are subject to SEC investigation themselves.  SEC lawyers are not shy about playing on the fear of prosecution to encourage people to talk freely with them.  In fact, the Enforcement Division touts its policy of giving credit to cooperators.  Defense lawyers have no such leverage.  They get their leverage only through the use of subpoena power in a federal civil action, where ample time is allowed for discovery before trial.  Theoretically, defense lawyers can get subpoenas in administrative cases, but the time-frame is much shorter, making use of this process much more difficult.  And ALJs are reluctant to approve the issuance of subpoenas, each of which requires their approval, which almost always must come over SEC objection.  Finally, as noted above, defense lawyers also get hit with large volumes of materials a short time before trial.  The SEC has had months and years to examine and choose the few documents that favor their case.  The defense lawyers are left trying to scour those documents for the ones harmful to the SEC case, which the SEC has intentionally left in the haystack.  Try examining 5 million pages of electronic materials to prepare a case in a month or two.

Due process.  Cereseny says the respondents get great due process with multiple levels of protection. But the only meaningful levels of review of the evidence come from the SEC itself.  The ALJ is an SEC employee and deals every day with the SEC litigators but only rarely with each set of defense lawyers.  The ALJ’s ability to consider even complex cases is limited by the SEC, which sets time limits on the completion of decisions.  Once the ALJ has ruled, the only avenue of appeal is to the SEC itself.  Yes, that’s the same folks who decided to bring the case in the first place.  The Commissioners are supposed to take off their prosecution hats and don judicial hats.  Perhaps in some bizarre utopia this is viewed as due process, but in the real world, prosecutors don’t do so well at deciding they were wrong to bring a case (and incur the major expense in doing so).  And beyond that, the Commissioners will typically defer to the fact-finding of ALJs because they weren’t there to see and evaluate witnesses (like an independent judge or jury is in a federal court case).  After the SEC approves its employee’s decision, the respondent finally gets a chance to have an independent review  — only, of course, if he or she has the financial resources to continue this quest against the government, and many do not.  Even then the court of appeals that reviews the SEC decision is required to defer to SEC judgments unless it can find them unreasonable.  So the value of independent review is diminished by imposing a high bar before the SEC decision can be rejected.

All of those layers of protection touted by Ceresney are more like layers of inquisition.  The expense is enormous.  The review is limited.  The likelihood of reversal is small.  And the only independent review is done under standards that shackle the reviewers.  Compare that to being before an independent judge for the pretrial process and then having an independent judge and jury hear and consider the evidence.  No contest.  Once again, in the administrative process, the SEC wins and the respondent loses.

Despite his statements to the contrary, Ceresney knows the truth here.  He himself admitted it when he announced the new SEC policy of administrative prosecutions.  He said that the rationale for the SEC’s use of its captive courts is that it has a higher success rate in prosecutions brought there.  See here.  The SEC’s improved success rate is not because the administrative courts are fairer, it’s because the playing field is tilted in the SEC’s favor.

Straight Arrow

November 11, 2014

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Judge Rakoff Slams SEC for Increased Use of Administrative Proceedings

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.

Hear, hear!

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.

Straight Arrow

November 6, 2014 (updated November 10, 2014)

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