Tag Archives: Securities and Exchange Commission

What Is the SEC Backup Plan if It Loses the ALJ Constitutionality Issue in Court?

The saga of challenges to the constitutionality of the SEC’s administrative law proceedings — and in particular the appointments and removal protections of the administrative law judges — has played out over many months in both court and commentary.  After some early SEC victories on jurisdictional challenges, the Commission seemed content to try to fend off the court cases on such procedural grounds, and fight the merits by deciding the issue in its own favor on a petition for review of one of these proceedings (like the one now before it in the Timbervest case), with perhaps an upper hand once the case reached a federal appeals court.

If that was the early strategy, it now seems to be in need of reconsideration.  Two federal district court judges found jurisdiction over cases making such challenges in four separate cases, and ruled on preliminary injunction motions that the plaintiffs will likely succeed on the merits.  In three of those four cases, involving proceedings against Charles Hill, Gray Financial Group, and Barbara Duka, the SEC is now preliminarily enjoined from moving forward with its administrative proceedings.  (In the other, against Timbervest, the preliminary injunction was denied because the case had already been tried and was now before the SEC for review.)  See Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding; N.D. Ga. Judge Leigh May Issues Injunction for Gray Financial and Denies One for Timbervest; SDNY Court Ups the Ante, Allowing Duka Injunctive Action To Proceed on Appointments Clause Issue; Order Issuing Preliminary Injunction in Duka v. SEC.  The merits of the constitutionality issue now can no longer be dismissed as fringe advocacy.  The main issue in these cases — whether the SEC ALJs are “inferior officers” under Article II of the Constitution — has now been substantially vetted by two courts, which found they were, indeed, inferior officers under closely analogous Supreme Court decisions.  Beyond this, the SEC made embarrassing errors in court submissions about how its ALJs were appointed, and at a minimum seems incompetent at figuring out and reporting to the courts on this simple factual issue.  Indeed, even in the SEC’s own proceeding in Timbervest, the Enforcement Division refused to comply with an adjudicative order from the Commission to provide the Commissioners with a description of how the ALJs were appointed.  Whether it was because they couldn’t do so, or just didn’t want to do so, is not clear.  See SEC Bumbles Efforts To Figure Out How Its Own Administrative Law Judges Were Appointed.  In this context, the SEC itself will have difficulty writing an opinion in Timbervest upholding the constitutionality of the ALJs that would not be in significant danger of being overturned.

But the SEC continues to take a “business as usual” approach in its administrative court proceedings.  Many of these are ongoing, and more are assigned each day (or at least each week).  Any defense lawyer could be committing malpractice by failing to challenge a pending or new case on grounds of unconstitutionality.  Indeed, I question why the ALJs themselves don’t make clear in each such case that the constitutionality of their appointments is now at issue, and stating sua sponte that each respondent would be deemed to have challenged the proceeding on that ground, in the event the argument was ultimately upheld in the courts.

So, what happens if the SEC’s stonewalling defense posture fails; if the constitutionality challenge is ultimately upheld?  If the status quo prevails, my guess is near chaos.  To be sure, the ruling is likely to be applied prospectively, and stayed for some time to allow for some remedial steps to be taken, akin to the approach taken when the bankruptcy courts were ruled unconstitutional.  See Northern Pipeline Co. v. Marathon Pipe Line Co., 458 U.S. 50, 87-88 (1982).  But I don’t see how every case currently pending, or instituted between now and when such a decision occurs, in which such a challenge is made, would not be vacated.  See D.C. Circuit Invalidates Appointment of Former Acting GC for Labor Board (DC Circuit holds in SW General, Inc. v. NLRB, No. 1107, that NLRB action by Acting General Counsel serving unlawfully must be vacated).  That could be a lot of cases that need to be retried (or reconsidered or settled).  Perhaps the Commission is counting on the appellate courts (and the Supreme Court) to blanche at the prospect of vacating such a large number of prosecuted cases.

Even a Commission confident in its arguments needs to consider how to proceed in a way that minimizes chaos if it loses.  What could it do now to protect against that future result?  Two steps immediately come to mind.  First, at least for now, while the constitutionality issue remains in doubt, reverse its new policy of bringing more of its complex cases in the administrative court and go back to the model in which those cases were brought in federal court.  To save face, this need not be announced; it can be effected sub silentio.  The Commission seems to prefer secrecy over sunshine, although a little more open discussion of how it approaches these issues would probably do a lot more good than harm.  An open statement of this discretionary decision would evidence more good faith than we’ve seen over the past year.  Second, obtain a waiver of the constitutionality issue from fully informed respondents before commencing new proceedings, or continuing pending proceedings.  I haven’t researched the issue, but my bet is that the SEC and an opposing party can, by mutual consent, agree to any forum to resolve cases, and a fortiori, an agreement to use the administrative court with its current ALJs likely would be enforceable.  At a minimum, a party that agreed to proceed on this basis would likely be estopped from making a future challenge on this ground.  The SEC might have to make some concessions to get such an agreement — probably involving fairer rules for discovery and scheduling in these cases — but by now they should recognize that this might not be a bad thing.  Many respondents with limited defense resources could well prefer, and agree to, this approach.  That would take a lot of potential future vacated results off the table.

No doubt there are other steps that can be taken to avoid a potential future quagmire.  The important thing is that the Commission and its staff should be thinking about, and implementing, these kinds of steps, because, like it or not, the Commission may find itself on the losing end of the constitutional question.

Straight Arrow

August 12, 2015

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Upon Further Review, SEC Memo on Use of Administrative Courts Was Indeed a Fumble

Penalty Flag“Upon further review,” as they say in the NFL, was the SEC’s recent “Division of Enforcement Approach to Forum Selection in Contested Actions,” entitled to a better call than we gave it in our Friday post: SEC Attempts To Stick a Thumb in the Dike with New Guidelines for Use of Administrative Court?  The definitive answer is: “No.”  The SEC clearly fumbled the ball with this publication, and made itself look pretty silly doing it.  I’m going to add a penalty flag.

SEC Chair Mary Jo White (Courtesy Salon) Her approval is inexplicable and depressing

SEC Chair Mary Jo White (Courtesy Salon)
Her approval is inexplicable and depressing

Our Friday post did not discuss any of the SEC’s vague descriptions, all-encompassing caveats, prevarications, and self-congratulatory pats on the back (to itself) in this document, so we will address some of them here.  This SEC memo is the equivalent of one of those “what were they thinking?” moments we now see on the internet all of the time, like a selfie someone might take (and actually post for all to see) of the author grinning before some solemn background, like the Vietnam War Memorial.  It’s an embarrassment for what it says and what it fails to say about the serious issue of assuring due process and fair treatment in SEC enforcement actions, particularly as to non-regulated persons.

“When recommending a contested enforcement action to the Commission, the Division recommends the forum that will best Utilize the Commission’s limited resources to carry out its mission.”

A false and misleading statement in at least two respects.  The Director of the Division of Enforcement already admitted that the Division chooses its administrative forum to pressure targets into settlement (“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 side we were going to do and they settled”), and that he believed federal court juries were not properly adhering to the required burden of proof (“Frankly, I think juries, while they’re instructed that we have a preponderance standard, I think apply a higher standard to us than preponderance”).  See SEC Could Bring More Insider Trading Cases In-House.  That has nothing to do with “best utilizing resources”; it has to do with maximizing the chance to win or force a settlement on SEC terms.  One of the key reasons for choosing the administrative forum is because it has a better chance of winning there, not to make careful use of enforcement resources.  And, as the Wall Street Journal recently documented, that is precisely the result.  The Division also makes no real effort to “best utilize” its resources in any other enforcement context.  It badly allocates its ample staff resources on investigative matters that have little overall public policy consequence.  That includes the  so-called “broken windows” approach to enforcement, which focuses staff attention on what the SEC itself describes as minor violations.  But it also includes expensive litigated cases involving trivial violations of law, even if all the allegations could be proved.  (See There They Go Again: SEC Wasting Taxpayer Dollars on Trivial Perquisite Enforcement Litigation in SEC v. Miller.)

“There is no rigid formula dictating the choice of forum.  The Division considers a number of factors when evaluating the choice of forum and its recommendation depends on the specific facts and circumstances of the case.  Not all factors will apply in every case and, in any particular case, some factors may deserve more weight than others, or more weight than they might in another case.  Indeed, in some circumstances, a single factor may be sufficiently important to lead to a decision to recommend a particular forum.  While the list of potentially relevant considerations set out below is not (and could not be) exhaustive, the Division may in its discretion consider any or all of the factors in assessing whether to recommend that a contested case be brought in the administrative forum or in federal district court.”

A long-winded way of saying: “We are going to list a whole lot of factors below, but there is no way to know which ones we will decide are important, or whether we will decide other unmentioned factors are more important.  That is, the Division will choose a forum on whatever basis it thinks makes sense, and we are not going to give you any way of predicting or understanding that decision”

“The Division may in its discretion consider . . .  [t]he cost ‐ , resource ‐ , and time ‐ effectiveness of litigation in each forum. . . .  In general, hearings are held more quickly in contested administrative actions than in contested federal court actions. . . .   When a matter involves older conduct, this may allow for the presentation of testimony from witnesses who have a fresher recollection of relevant events.”

In other words, since administrative proceedings move more quickly, that can justify our choice of that forum in pretty much any case.  And in an “older case” — which means, by the way, cases that Division of Enforcement lawyers have sat on for years on end — because our dilatory investigation makes it virtually impossible for any witness to remember accurately what really happened, we will lean towards the administrative forum because, in our discretion, we now think it is important to move at a breakneck pace, and not allow the defense the time to develop a complete understanding of the record or what witnesses may say at trial.

“The additional time and types of pre‐trial discovery available in federal court may entail both costs and benefits, which should be weighed under the facts and circumstances of a case.  Although pre‐trial discovery procedures exist in both administrative proceedings and district court actions, the mechanisms of discovery are different.  For example, in administrative proceedings, the Division must produce to respondents all non‐privileged documents from its case file and the Division has Brady and Jencks obligations, requirements that do not exist in civil district court litigation.  On the other hand, depositions are available in district court but generally not in administrative proceedings.”

This is no more than a transparent effort to create the misleading impression that a sow’s ear could be something other than a sow’s ear.  No aspect of the discovery limits in administrative proceedings are beneficial to a respondent.  The restrictions on discovery may be the single-most unfair aspect of these proceedings, but the SEC portrays them here as cutting both ways.  Hogwash! (In keeping with the sow metaphor.)  The lack of depositions, the inability to pursue reasonable discovery against the SEC, the more restrictive approach to third-party discovery (including that every subpoena must get prior approval from the ALJ, inevitably over opposition from the Division), and the incredibly short time-frame for doing any independent development of evidence, all mire the administrative respondent in a sloppy mud pen.  The SEC, however, had many years to develop its own case (and now uses its own delay as a reason to avoid court!), and no obligation to do so in a way that actually makes a fair record (in investigative testimony, leading and misleading questions, hiding key evidence from witnesses, vague questions that can be later misconstrued, and avoiding any discussion of exculpatory evidence, are the norm).  So the much-touted production of “all non-privileged documents from its case file” is a laugher as a benefit to the respondent.  The same production would be required in court (and typically is made by the SEC at the outset without waiting for a request), and intelligent discovery requests will be able to garner all Brady and Jencks material as well.  Not to mention the fact that the Division’s concept of what is “non-privileged” means they often refuse to produce many materials based on privilege claims (attorney-client, work-product, and the all-encompassing “deliberative process privilege”) that would not (and do not) withstand challenge in court.  But administrative judges are much more reluctant to force discovery on the Division, or the SEC more broadly, than federal court judges.

“Administrative Law Judges, who adjudicate securities law cases, and the Commission develop extensive knowledge and experience concerning the federal securities laws and complex or technical securities industry practices or products. . . .  If a contested matter is likely to raise unsettled and complex legal issues under the federal securities laws, or interpretation of the Commission’s rules, consideration should be given to whether, in light of the Commission’s expertise concerning those matters, obtaining a Commission decision on such issues, subject to appellate review in the federal courts, may facilitate development of the law.”

The hubris!  This could be the most offensive factor of all.  It suggests that administrative law judges and SEC Commissioners are better-suited to decide “unsettled and complex legal issues” to “facilitate development of the law” than federal court judges.  Let me see if I have this right.  An appointee not required to meet anything close to the standards that apply to federal judges is better to decide complex issues and the development of the law?  And Commissioners, who have virtually no adjudicative experience at all when they are appointed, all of a sudden become better at considering “complex and unsettled legal issues” when they are confirmed?  I think not.  Nor does district judge Jed Rakoff, who gave the exact opposite view on this issue (moving cases from the federal courts to the SEC’s captive administrative court “hinders the balanced development of the securities laws”).  See Judge Rakoff Slams SEC for Increased Use of Administrative Proceedings.

The SEC was not content here to talk about technical applications of SEC rules in the securities industry — as to which they could at least have a theoretical basis for making such an argument based on supposed agency expertise.  They argue here that ALJs and Commissioners may be viewed as better able to decide complex legal issues wholly apart from technical SEC regulatory compliance issues — for example, whether a non-regulated corporate official engaged in fraud in some respect or another.  There is no way to support the argument that ALJs or SEC Commissioners are better situated to decide complex and unsettled issues involving fraud allegations than federal judges.  The obvious example is insider trading cases, as to which the law is so nuanced, and so bound up in considerations of fraud and fiduciary obligation, that federal court judges are much more likely to get it right.  (The exact view expressed by Judge Rakoff: see Judge Rakoff PLI Speech.)  That doesn’t even take into consideration the fact the federal judges (and juries) are not conflicted on these cases like the SEC Commissioners are.  Only after having first approved the filing of a prosecution, and likely having rejected a proffered settlement as insufficient, do the Commissioners decide these cases, including whether to adopt views of the facts or the law that may be inconsistent with their own decision to prosecute.

As an attempt to make public policy, this document is an embarrassment.  Its objective is not to determine when an administrative forum is a fairer and more appropriate forum in which to litigate enforcement actions against non-regulated persons.  It is to provide a justification for any decision the SEC may make about where to litigate its cases, and to be able to argue that those decisions deserve deference because they reflect a reasoned agency determination under an adopted set of guidelines

The fact that Chair Mary Jo White signed off on such an atrocity is depressing, and, frankly, inexplicable.

Straight Arrow

May 11, 2015

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