Lawyers Decry SEC’s Expanded Use of Administrative Law Proceedings

It is often referred to by securities lawyers as the “Rocket Docket,” and usually not in a complementary way.

With in-house judges, the Securities and Exchange Commission has been able to hold expedited trials to levy fines, discouragements, and disciplinary actions against defendants in what are known as administrative law proceedings. Congress authorizes federal agencies like the SEC to try certain cases internally, bypassing the gridlocked federal court system.

The system has worked well for decades. But now, as the SEC expands its use of administrative law proceedings, notably to prosecute insider-trading cases on its own terms, critics of the process are becoming increasingly vocal. Among their concerns:  the truncated nature of the trials, discovery and evidence rules that are too loose in some regards and overly restrictive in others, and the sense that an in-house forum stacks the deck against defendants.

“It is a venue that potentially poses problems for defendants,” says Matthew O’Hara, a partner and business trial lawyer for the law firm Hinshaw & Culbertson. “The SEC’s enforcement staff says they intend to bring more cases in the forum and we’ve begun to see that. Some of these cases raise cutting-edge issues, as opposed to run-of-the-mill enforcement actions, and parties who are averse to the SEC would prefer to be in a federal court, but they won’t necessarily have that option.”

Others agree that the venue can stack the deck against defendants. “The process isn’t as open and complete as a trial in federal court where you’ve got a judge who is appointed for life, a jury of your peers, and all the checks and balances we count on to ensure justice,” says Trace Schmeltz, a partner with the law firm of Barnes & Thornburg and member of its White Collar Crime Defense Practice Group.

Administrative law proceedings are neither new, nor rare. They were created in 1946 when the Administrative Procedure Act authorized the use of administrative law judges by government agencies. Administrative law judges, in the SEC context, rule on allegations of securities law violations in proceedings instituted by its commissioners.  They conduct public hearings, issue initial decisions for the commissioners to review and impose, and have authority to issue a broad range of sanctions, including ordering disgorgement, civil penalties, censures, cease-and-desist orders, and the suspension or revocation of securities registrations.

 In past years, the SEC has used the hearings sparingly, applying them mostly only to those under direct SEC regulation, oversight, and examinations—broker-dealers, investment companies and advisers, municipal securities dealers, and transfer agents. 

Lawyers assert that certain types of cases don’t lend themselves to being tried in front of administrative law judges. “There has always been a heavy presumption that unsettled complex cases seeking substantial penalties should be litigated in federal court as opposed to administrative proceedings,” says Russell Ryan, a partner with law firm King & Spalding, a 10-year veteran of the SEC’s Division of Enforcement, and a former assistant director. “Big cases, especially those that turn on credibility determinations, ought to be decided in court, preferably by a jury, rather than before a single administrative judge.”

The Dodd-Frank Act expanded how the SEC could use administrative law judges, opening up the process to pretty much any defendant it targets for a securities violation. Where once cases involving insider trading or accounting fraud were the domain of a federal district court, the SEC can now bring them before one of its judges.

It has taken some time for the SEC to take full advantage of the opportunity, but recently it has used administrative law proceedings in high-profile cases including insider trading. “Many investigations involving conduct that occurred after enactment of Dodd-Frank are just now reaching the charging phase, and I don’t think the SEC necessarily wanted to invite challenges by attempting to use its new Dodd-Frank powers in cases involving conduct that pre-dated the statute,” Ryan says. “Only now is the SEC really in a position to take advantage of this new authority.”

The SEC did, however, dip the occasional toe in the water. In 2011, its pursuit of former Goldman Sachs trader Rajat Gupta on insider trading charges was originally intended to go before an administrative law judge.  Objections from both Gupta’s legal team and District Court Judge Jed Rakoff of the Southern District of New York prompted the SEC to abandon the plan because his actions pre-dated Dodd-Frank. Gupta was later hit with a $14 penalty when his case eventually found its way to Rakoff’s courtroom.

After losing several high-profile insider-trading cases in courtrooms recently—notably an ill-fated pursuit of Marc Cuban—the SEC is more commonly pursuing its “home court advantage,” says Joel Cohen, a trial lawyer with the law firm Gibson Dunn. 

“The process isn’t as open and complete as a trial in federal court where you’ve got a judge who is appointed for life, a jury of your peers, and all the checks and balances we count on to ensure justice.”
Trace Schmeltz, Partner, Barnes & Thornburg

In a recent speech, Andrew Ceresney, head of the SEC’s Division of Enforcement, told members of the District of Columbia Bar there were plans to bring more insider-trading cases as administrative proceedings. “We have in the past,” he said. “It has been pretty rare, but there will be more going forward.” The SEC has also expanded its Office of Administrative Law Judges. Since June, the Commission has added new judges and law clerks, effectively doubling the size of the office.

Too Little, Too Hasty

Among the several complaints voiced by securities attorneys who represent clients before the SEC is that judges are required to issue an opinion within 300 days, leaving little time for pre-trial preparation. “When the 300-day rule was put in place, nobody dreamed that big complex cases were going to be litigated in contested administrative proceedings,” Ryan says. The deadline is even tighter for defendants because judges typically need two or three months, within the 300-day window, to decide on a case.

The rules of evidence in these venues are also much different than in federal court. Evidence that would not be allowed under the Federal Rules of Evidence, such as hearsay and unverified documentation, can still make their way before this specialized bench because it is not bound by those rules, critics say, lamenting that rules pertaining to discovery, evidence, and witnesses heavily favor the prosecution.

WHO ARE THE SEC’S JUDGES?

The following is the Securities and Exchange Commission’s overview of its Office of Administrative Law Judges.
In an Order Instituting Proceedings, the Commission directs that an Administrative Law Judge conduct a public administrative proceeding to determine whether the allegations in the Order are true and to issue an Initial Decision in a specified period of time. Administrative Law Judges are independent judicial officers who in most cases conduct hearings and rule on allegations of securities law violations initiated by the Commission's Division of Enforcement. They conduct public hearings at locations throughout the United States in a manner similar to non-jury trials in the federal district courts. Among other actions, they issue subpoenas, conduct prehearing conferences, issue defaults, and rule on motions and the admissibility of evidence.
At the conclusion of the public hearing, the parties submit proposed findings of fact and conclusions of law. The Administrative Law Judge prepares an Initial Decision that includes factual findings, legal conclusions, and, where appropriate, orders relief.
The Commission may seek a variety of sanctions through the administrative proceeding process. An Administrative Law Judge may order sanctions that include suspending or revoking the registrations of registered securities, as well as the registrations of brokers, dealers, investment companies, investment advisers, municipal securities dealers, municipal advisors, transfer agents, and nationally recognized statistical rating organizations.
In addition, Commission Administrative Law Judges can order disgorgement of ill-gotten gains, civil penalties, censures, and cease-and-desist orders against these entities, as well as individuals, and can suspend or bar persons from association with these entities or from participating in an offering of a penny stock.
Initial Decisions and significant orders are posted on the Commission's website under Administrative Law Judges and appear in legal research forums. Parties may appeal an Initial Decision to the Commission, which performs a de novo review and can affirm, reverse, modify, set aside, or remand for further proceedings. Appeals from Commission action are to a United States Court of Appeals.
Source: SEC.

“Documents get used in all sorts of wacky ways,” Schmeltz says. “You could have a witness on the stand that doesn’t remember anything. But rather than properly refresh their recollection, they could be handed a document, just read that document into the record, and it comes in as evidence. It’s a totally different ball game than in a federal court and the SEC does not investigate with your defense in mind.

Any appeal of an administrative law judge’s opinion must first go to the very SEC commissioners who initiated the proceedings. As a last resort, after that review, defendants can try their luck with an appeals court. “The SEC is wearing all the hats,” Ryan says. “That’s the problem.”

Even critics of the process are quick to point out that the SEC’s administrative law judges strive to be fair and impartial—and swear to do so by oath. But as the cases before them grow more complex, is their expertise is up to the challenge?

“An argument in favor of the process is that it’s a good idea to put specialized cases in the hands of experienced administrative law judges who are experts in the subject matter,” says a lawyer who asked not to be named because he represents clients before the SEC. “That argument completely falls apart.” Judges, who rise through the ranks of other agencies, typically have no prior experience with securities laws and “despite their best efforts, they are basically flailing about for the first couple of years when it comes to the subject matter,” the lawyer says.

Be Prepared

How should defendants facing an administrative law judge prepare and react? Preparation is key, Schmeltz says. “The day you get a subpoena, learn that a matter is under investigation, or even receive an informal request from the SEC, you need to assess your potential risk and preserve and produce not only the information the SEC is asking for, but any data you may need to ensure you can tell your complete story,” he suggests. Companies should also re-examine director and officer liability policies. “If a director or officer is going to have to defend cases in front of an administrative law judge now, it is a more onerous level of risk and you need to make sure your people are covered,” he says.

“Clients finding themselves in the SEC’s home court should press the Commission and the administrative law judge for more time and more discovery and consider all motions to admit or exclude evidence that would support their case if it were tried before a federal court,” Cohen says. “Don’t throw in the towel and assume failure just because the forum is unfair. Even administrative law judges can be fair, and one shouldn’t assume any less.”

The SEC is interested in pushing some new legal theories and flexing its muscle in cases where it hasn’t historically done so.”