Over the years, the Securities and Exchange Commission has increased its reliance on the use of in-house judges and self-contained administrative proceedings to adjudicate cases that might otherwise wind up in federal court. In doing so, it created a tempest.
While the Commission sees benefits to the streamlined approach administrative proceedings bring, those who are dragged into the process (or who merely might be) have a long list of complaints.
A common grievance is that the deck is stacked against them and in favor of the SEC. In-house judges, some say, are biased in favor of the agency that employs them, as evidenced by a much higher success rate for the SEC in those venues than it sees in federal courts. Procedural rules are similarly slanted in favor of the prosecution, as is an appeals process that gives Commissioners the final say, detractors lament.
According to research by New York University and Cornerstone Research, in the first half of Fiscal Year 2016, the SEC brought 88 percent of its actions against public company defendants as administrative proceedings, compared to just 33 percent in 2010. The SEC’s success rate is in the 90 percent range.
In response to the growing outcry, on July 13, the SEC adopted amendments updating its rules of practice governing its administrative proceedings. It codifies proposals to modify the rules of practice that were unveiled in September 2015.
“The amendments to the Commission’s rules of practice provide parties with additional opportunities to conduct depositions and add flexibility to the timelines of our administrative proceedings, while continuing to promote the fair and timely resolution of the proceedings,” Chairman Mary Jo White said in a statement.
“It is probably a little early to predict what it all means, but the fact that the SEC is taking concerns seriously and is in a communicative mode with the industry about the way it is going to go about its enforcement practices is certainly a good thing.”
Mark Kornfeld, Partner, BakerHostetler
Changes, effective in September, include:
Extending the potential length of the prehearing period from the current four months to a maximum of 10 months for the cases designated for the longest timelines.
Allowing parties in the cases designated for the longest timelines the right to notice three depositions per side in single-respondent cases and five depositions per side in multi-respondent cases, and to request an additional two depositions.
Clarifying the types of dispositive motions that may be filed at various stages of proceedings and the applicable procedures and legal standards for the motions.
Making additional clarifying and conforming changes to other rules, including rules regarding the admissibility of certain types of evidence, expert disclosures and reports, the requirements for the contents of an answer, and procedures for appeals.
The amendments also address, among other things, procedures for the service of the order instituting proceedings in foreign jurisdictions, disclosures regarding expert witnesses and reports prepared by expert witnesses, and procedures governing appeals to the Commission.
Do the SEC’s changes pass muster with both critics and those forced to rely on the process?
“The Commission has taken some steps to blunt criticisms that its process is unfair to respondents,” says Joshua Newville, partner with law firm Proskauer and former senior counsel in the SEC’s Division of Enforcement.
“These are incremental steps towards making the process more objectively fair for respondents,” he says. “Practitioners will think these are a step in the right direction, but woefully inadequate.”
In Newville’s view, the SEC has “inched slightly more toward expanding deposition rights and prehearing deadlines,” although stopping well short of allowing a full discovery process. The process is still very limited and compressed compared to a civil action in federal court and “the number of depositions allowed under the rule seems a bit arbitrary, though there is some flexibility in the final rule.”
“The timing issue is big,” he says. “The Enforcement Division has years to investigate a case, explore theories, and do their work. After the case is filed, however, the respondent will only have a period of months to really do trial prep. It is not what one would necessarily call an equal process on both sides. Most practitioners will think it is a step in the right direction to expand the process. It just doesn’t go far enough to where they would say, ‘Ok, it is a fair process on behalf of defendants.’ ”
The broader conflict may be a structural one. The SEC’s use of administrative proceedings was established when it didn’t have the authority to impose penalties. The proceedings were primarily used to bar registered individuals and entities from the securities industry. Over the past 30 years, however, the SEC gained the ability to impose disgorgement and penalties against any respondent in a proceeding. The Dodd-Frank Act expanded that oversight to non-registered individuals. Potential remedies now apply to nearly any individual or entity respondent.
CHANGES AFOOT FOR ADMINISTRATIVE PROCEEDINGS
The following is a look at changes to the Securities and Exchange Commission's administrative proceedings process:
Initial decision of hearing officer and timing of hearing (Rule 360): Under amended Rule 360, orders instituting proceedings would designate the time period for preparation of the initial decision as 30, 75 or 120 days from the completion of post-hearing or dispositive motion briefing or a finding of a default. Amended Rule 360 also would extend the length of the prehearing period from the current four months to a maximum of 10 months for cases designated as 120-day proceedings, a maximum of six months for 75-day cases, and a maximum of four months for 30-day cases.
Depositions upon oral examination (Rule 233): Amended Rule 233 would permit parties in 120-day proceedings the right to notice three depositions per side in single-respondent cases and five depositions per side in multi-respondent cases, and would permit each side to request an additional two depositions under an expedited procedure.
Answer to allegations (Rule 220): Amended Rule 220 would require a respondent to disclose in its answer to an order instituting proceedings whether the respondent is asserting any “reliance” defense and whether the respondent relied on the advice of counsel, accountants, auditors, or other professionals in connection with any claim, violation alleged, or remedy sought.
Dispositive motions (Rule 250): Amended Rule 250 would provide that three types of dispositive motions may be filed at different stages of an administrative proceeding and would set forth the standards and procedures governing each type of motion.
Evidence (Rule 320): Amended Rule 320 would exclude evidence that is irrelevant, immaterial, unduly repetitious, or unreliable and would provide that hearsay may be admitted if it is relevant, material, and reliable.
Depositions upon oral examination (Rule 233): Amended Rule 233 would permit parties in 120-day proceedings the right to notice three depositions per side in single-respondent cases and five depositions per side in multi-respondent cases, and would permit each side to request an additional two depositions under an expedited procedure.
Answer to allegations (Rule 220): Amended Rule 220 would require a respondent to disclose in its answer to an order instituting proceedings whether the respondent is asserting any “reliance” defense and whether the respondent relied on the advice of counsel, accountants, auditors, or other professionals in connection with any claim, violation alleged, or remedy sought.
Dispositive motions (Rule 250): Amended Rule 250 would provide that three types of dispositive motions may be filed at different stages of an administrative proceeding and would set forth the standards and procedures governing each type of motion.
Evidence (Rule 320): Amended Rule 320 would exclude evidence that is irrelevant, immaterial, unduly repetitious, or unreliable and would provide that hearsay may be admitted if it is relevant, material, and reliable.
Source: SEC
“When the process was set up, hearings would be heard by a hearing officer and the subjects would typically be limited to whether an entity or individual would be barred from the industry or a fraudulent offering would be stopped,” Newville says. “There was a more limited set of proceedings and, in those types of cases, maybe a truncated, streamlined proceeding would be more appropriate.”
Oddly enough, for a process that is so controversial, the SEC’s initial proposals failed to draw a deluge of comment letters. Only 13 of them were received with most supporting efforts to update the rules, expand the discovery process, and enlarge the timetables in administrative proceedings.
“Some commenters argued that the proposed amendments were too incremental,” the SEC says in the final rule. “Others focused on the legitimacy of the Commission’s administrative forum, and in so doing offered suggestions that went beyond the scope of the proposed amendments.”
A letter from manufacturer Navistar International, unsigned by a specific individual, argued that “the proposed amendments do not go far enough in providing respondents in administrative proceedings with sufficient protections to ensure the fairness of the proceeding, particularly when compared against the protections provided to defendants in actions commenced in federal district courts.”
Among its complaints were that the expanded administrative proceeding schedule does not give respondents sufficient time to prepare in complex cases, and the availability of limited depositions does not provide respondents with sufficient discovery.
Tom Quaadman, senior vice president for the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, was critical of “an uneven playing field” where “defendants do not have the opportunity for full discovery, right to depositions, evidentiary safeguards, and only given 120 days to prepare for trial.”
“The Commission has unfettered power for discovery and can take years to prepare its case,” he wrote. “This lack of balance in due process raises issues of fairness and impedes the credibility of the Commission to be the strong cop on the beat needed for efficient capital markets.”
“The SEC is obviously responding to an avalanche of criticism and frustration from the industry,” says Mark Kornfeld, a partner with law firm BakerHostetler. “They are trying to make things a little more fair and balanced in terms of the perception. In terms of practice, because the changes are so new and going to undergo a lot of commentary and industry surgery, it is probably a little early to predict what it all means, but the fact that the SEC is taking concerns seriously and is in a communicative mode with the industry about the way it is going to go about its enforcement practices is certainly a good thing. Anything the SEC does in its rulemaking and processes that bring transparency, clarity, and fairness is a good thing.”
The need for transparency and two-way communication between the regulator and the regulated may be as important as ever with an SEC chairman as focused on enforcement as White is.
“We advise clients that this is the new normal and the industry needs to adapt to the way the game is being called by the referees,” Kornfeld says.
“All the industry participants want to get to the same place,” he adds. “They want to know what the rules are. What they don’t want is rulemaking by litigation. They don’t want to know after the fact that they ran afoul of some rule or process. If you give people the rules of the road, they have a chance to follow them. If the rules of the road are hard to follow, that’s when you get this kind of tension and comments from one side to the other.”
In the meantime, as all parties adapt to the new procedural changes, expect attacks on administrative proceedings to continue with both Congressional interference and legal challenges.
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