By Toby Galloway and Chase Medling
Special Contributing Writers for The Texas Lawbook
(October 25) – Senior Securities and Exchange Commission officials have recently said that the SEC will increasingly bring administrative proceedings before SEC administrative law judges in lieu of federal district court actions.
The Division of Enforcement’s success rate before ALJs is statistically higher than in federal enforcement actions. Skeptics would point out that this is hardly surprising, given that the ALJs are employed by the SEC.
But the increase in administrative proceedings also correlates to fairly recent changes in legislation and the SEC’s desire to have a visible presence policing the market.
The SEC can try a larger number of cases in administrative proceedings in a shorter period. A side benefit is that the SEC can avoid federal scrutiny over settlements that require no admission of wrongdoing. (See Texas Lawbook‘s July 17 article discussing SEC’s shift in policy to require admissions of wrongdoing in some settlements, following rejection of neither-admit-nor-deny settlements by some federal courts).
Understanding the differences between proceedings in federal court and those before ALJs is essential for the SEC practitioner.
Dodd-Frank Granted the SEC’s ALJs Sweeping New Powers
Before enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, almost all administrative proceedings involved registered entities or persons, such as brokers, dealers, investment advisers, and investment companies.
Dodd-Frank, however, greatly expanded the remedies available to ALJs in all cases, not just those involving individuals and entities directly regulated by the SEC.
For instance, Dodd-Frank empowered ALJs to impose civil penalties to the same extent as federal district courts, including such potential respondents as day traders, CFOs of public companies, bank executives, and penny-stock promoters. This made the administrative forum suitable for cases that previously would have been brought in federal court.
Overview of the Administrative Process
An SEC administrative proceeding begins with an Order Instituting Administrative Proceedings filed by the SEC’s Division of Enforcement. The Division of Enforcement prosecutes the case in its own name, rather than that of the SEC, because the SEC’s ALJ will render a decision that will be appealable to the SEC itself.
Within a prescribed time limit, the ALJ conducts a hearing, the parties submit post-hearing briefs and proposed findings of fact and conclusions of law, and the ALJ prepares an Initial Decision.
In the Initial Decision, the ALJ may suspend or revoke registrations of securities offerings as well as brokers, dealers, investment companies, and investment advisers. Further, the ALJ can order disgorgement of ill-gotten gains, censures, civil penalties, and cease-and-desist orders. These remedies are available to the SEC without stepping foot in a federal courthouse.
Once the ALJ’s Initial Decision is final and appealable, the losing side may appeal to the Commission. Again, skeptics may question whether the body that authorized the enforcement action in the first place – the Commission – can impartially review the ALJ’s decision.
After Commission review, however, a party may appeal to a federal circuit court of appeals. A respondent may appeal to the D.C. Circuit Court of Appeals or to the court of appeals where he lives or has his principal place of business.
High-Profile Administrative Proceedings
Recently, the SEC has not shied away from bringing high-profile cases through the administrative system. Steven A. Cohen, founder and CEO of prominent hedge fund S.A.C. Capital, was charged with failing to supervise two senior employees who allegedly engaged in insider trading on his watch, which resulted in a multi-million dollar windfall.
His case, which remains pending, was brought as an administrative proceeding.
Likewise, two months ago, an ALJ found former executives of a broker-dealer owned by convicted Ponzi-schemer R. Allen Stanford liable for various violations of the federal securities laws, including securities fraud.
The ALJ issued a cease-and-desist order, ordered disgorgement of millions of dollars and civil penalties of $260,000.00, and barred each respondent from the securities industry.
Pros and Cons of Administrative Proceedings
Critics point out that administrative proceedings are not governed by the Federal Rules of Civil Procedure or the Federal Rules of Evidence, and that an accused is not entitled to a trial by jury.
Moreover, ALJs are employed by the SEC and respondents are required to appeal in the first instance to the same governmental body that first issued the Order. These are legitimate concerns. On the other hand, the ALJs are still charged with being independent judicial officers.
Discovery is quite limited in administrative proceedings. Depositions are rare. Interrogatories are unheard of. And requests for admission are non-existent.
To compound matters, ALJs are required to render their initial decisions within a compact time-frame. The deadline for the initial decision is 120, 210, or 300 days from the date of service of the Order, depending on the nature, complexity, and urgency of the case.
If the Enforcement Division has a fully developed investigative record, it will have a distinct informational advantage and likely be prepared for trial well before a respondent can ready himself in this rocket-docket arena.
Administrative proceedings are not without their protections for respondents. For instance, unlike in a federal district court civil proceeding, the Division of Enforcement is obligated to produce certain items required to be produced in criminal cases to satisfy due process concerns.
For instance, under Brady v. Maryland, “[t]he suppression by the prosecution of evidence favorable to an accused upon request violates due process where the evidence is material either to guilt or to punishment.” 373 U.S. 83 (1963).
Further, “[w]hen the reliability of a given witness may well be determinative of guilt or innocence, nondisclosure of evidence affecting credibility” fails to satisfy due process. Giglio v. United States, 405 U.S. 150 (1972).
An accused is also entitled to prior statements of a testifying government witness relating to the subject matter as to which the witness has testified. 18 U.S.C.A. § 3500 (the “Jencks Act”).
Thus, Brady, Giglio, and Jencks apply to SEC administrative proceedings, but not to federal civil actions. In an administrative proceeding therefore, you are entitled to exculpatory material, evidence that may impeach government witnesses, and prior witness statements. These protections may make the administrative forum actually more advantageous in some respects than federal court.
Other Considerations
Administrative proceedings also help the SEC avoid harsh judicial scrutiny in the event of a settlement. In the wake of the most recent American financial crisis, the SEC’s longstanding neither-admit-nor-deny policy came under scrutiny by a various federal district judges.
As a result, the SEC has declared that it will require admission of wrongdoing in certain select cases. ALJs do not question the terms of an SEC settlement, as those matters go directly to the Commission for approval.
Judicial scrutiny over a potential settlement may be a significant consideration when choosing venue.
Ponzi schemes and a housing market crash are overt challenges to the SEC’s ability to patrol the market and maintain investor confidence. SEC Chair Mary Jo White emphasizes the importance of reacting aggressively to these challenges in a post-Madoff landscape: “when investors realize there is a strong and effective cop on the beat, they have greater confidence and are more willing to participate in the markets.”
And if Chair White’s speech is any indication, there will be more enforcement actions: “we should neither shrink from bringing the tough cases, nor fail to fail to bring smaller ones…[i]f we do not have the evidence to bring a case charging intentional wrongdoing, then bring the negligence case that does not require intent.”
The SEC is an agency with limited resources; administrative proceedings conserve these resources in allowing more prompt resolutions.
Conclusion
Simply put, SEC practitioners must be familiar with the metes and bounds of the SEC’s administrative proceedings. Your next insider-trading case may be before an ALJ. Take extra precautions and prepare for anything. A home-court advantage can be neutralized or minimized by an attorney familiar with the surroundings.
Toby Galloway, a partner at Kelly Hart & Hallman in Fort Worth, is the former chief trial counsel for the SEC’s Fort Worth Regional Office. Chase Medling is a lawyer at Kelly Hart who focuses on complex commercial litigation.