In January 2015, Barbara Duka, a former executive of Standard & Poor’s Rating Services, sued the SEC in an attempt to stop it from bringing charges against her before an Administrative Law Judge (ALJ). Ms. Duka’s lawsuit, which asserts a constitutional defense, is the latest in a string of recent challenges to the SEC’s growing practice of bringing cases before ALJs rather than in federal district court.
SEC administrative proceedings on the rise
Until recently, the SEC rarely brought cases before administrative judges. This changed in 2010, however, when the Dodd-Frank Act expanded the SEC’s authority to use administrative proceedings for cases involving corporate officers and inside traders. Under the Act, agency-appointed ALJs can impose fines and penalties comparable to those available in federal district court.
Since 2010, the SEC has filed charges before administrative judges more frequently—and with great success. According to a Wall Street Journal report from last October, the SEC won every contested administrative hearing that reached a verdict in the 12-month period ending in September—six out of six. By comparison, when the SEC brought cases in federal court that progressed to trial, it only succeeded in approximately 60% of those cases—11 out of 18.
Criticism of SEC administrative proceedings
Critics in the defense bar argue that the SEC enjoys a home-court advantage when it brings cases before administrative judges, who are appointed by the agency. Litigants do not receive the same procedural protections afforded to them in federal court. For example, ALJs accept certain evidence that would be excluded by the Federal Rules of Evidence in federal court. In addition, discovery is often limited to the record the agency developed during its investigation. While SEC attorneys can spend years familiarizing themselves with these documents, defense attorneys are often given an extremely short timeframe to review stacks of evidence. In a complex case, this could mean reviewing hundreds of thousands of documents within a matter of weeks. And even though defendants in administrative proceedings often face steep monetary penalties and restrictions on their livelihoods, they cannot request a trial by jury.
What’s particularly fascinating about the recent debate, however, is that the White Collar defense bar is not the only source of criticism. Prominent federal judge Jed Rakoff has also recently expressed skepticism about the SEC’s authority to send cases to ALJs that could otherwise be brought in federal court. In a speech last November, Judge Rakoff characterized this practice as “administrative creep” that “hinders the balanced development of the securities law.” Although defendants can eventually appeal their case to a federal appeals court, they first must seek review by the Commission. Afterward – as Judge Rakoff pointed out – judges usually defer to the agency’s interpretation of statutory law unless clearly unreasonable. “[T]his is unlikely . . . to lead to as balanced, careful, and impartial interpretations as would result from having those cases brought in federal court.”
The SEC’s response
In a November speech before the American Bar Association’s Business Law Section, Andrew Ceresney, the Director of the SEC’s Division of Enforcement, defended the agency’s use of administrative proceedings. According to Ceresney, the agency is not “shunning federal court in [its] litigated actions,” but he acknowledged that time is a major consideration. Administrative judges normally decide cases promptly. In federal court, on the other hand, the lengthy discovery process can lead to significant delays. Ceresney also noted that many of the issues critics have raised could just as easily help defendants in enforcement actions. For example, he argued, they may benefit from relaxed evidentiary rules just as much as SEC attorneys.
Recent constitutional challenges
In the past year, several targets of SEC enforcement actions have challenged the constitutionality of administrative proceedings. Initially, plaintiffs like hedge-fund manager George Jarkesy Jr. and money manager Wing Chau argued that the proceedings violated their due process and equal protections rights under the U.S. Constitution. Both cases, however, were dismissed by judges who said the litigants should raise their defenses before the SEC’s ALJ’s first.
Other plaintiffs, including S&P’s Barbara Duka, have argued that the ALJ’s tenure protection violates the Constitution’s separation of powers. The SEC can only remove ALJs for good cause. The President, likewise, can only remove the Commissioners for good cause. According to Duka, a similar double-layer of “good cause” protection was held unconstitutional by the Supreme Court in Free Enterprise Fund v. Public Company Accounting Oversight Board. Other litigants who have raised similar claims includes Jordan Peixoto, a Canadian business school student; Joseph Stilwell, an investment advisor; and Laurie Bebo, the former CEO of Assisted Living Concepts, Inc. Although the lawsuits brought by Stilwell, Bebo, and Duka remain pending, Peixoto withdrew his challenge on January 30th after the SEC dropped its administrative action against him.
Administrative proceedings brought by the SEC – even in highly complex cases – have become the new norm, and the constitutionality of these proceedings is unlikely to be settled for some time. In the meantime, despite growing criticism from the defense bar and prominent jurists, the SEC shows no intention of backing down. Indeed, with its increasing use of both ALJs and deferred and non-prosecution agreements, the SEC appears to be operating with more tools in its enforcement toolkit than ever before.