As noted in previous articles, Canada and the US have different approaches to regulatory enforcement. Canadian securities regulators overwhelmingly address regulatory non-compliance through enforcement proceedings commenced before their own adjudicative tribunals. In the US, the SEC staff often proceeds in the civil courts. However, enforcement actions can also be pursued by administrative law judges in certain circumstances.
In the noteworthy decision in Tilton et al. v. SEC, the US Second Circuit addressed the constitutionality of SEC administrative law judges, also known as ALJs, who are directly appointed by the SEC. Tilton is the latest in a series of cases to challenge the SEC’s power to appoint the judges before whom it brings prosecutions as a violation of the Appointments Clause of the US Constitution.
ALJs and procedural fairness
Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the SEC gained increased powers to bring prosecutions as administrative proceedings before ALJs. Since then, the SEC has brought an increasing proportion of its prosecutions in front of ALJs as opposed to Federal courts. A recent report by the New York University Center for Law & Business and Cornerstone Research, which analyzed data in the Securities Enforcement Empirical Database found that “[t]he SEC continued to use its administrative proceeding forum in the vast majority of its actions. In the first half of FY 2016, the SEC brought 88 percent of actions against public company defendants and related subsidiary defendants as administrative proceedings.” By comparison in 2010 only 33% of actions against public company defendants and related subsidiary defendants were brought as administrative proceedings.
As reported by the Wall Street Journal in May 2015, the SEC enjoys a statistical “home court advantage” in front of its own judges, with a 90% success rate when prosecuting in-house compared to a 69% success rate in Federal courts. That rises to an 88% success rate on appeals of these decisions (95% including those where the underlying conduct wasn’t in dispute), which are also brought in front of SEC-appointed judges. Moreover, bringing such an appeal carries significant risk for defendants: out of the 56 appeals brought by defendants between January 2010 and March 2015, only one resulted in a reduced fine while seven resulted in increased penalties.
The challenge at the heart of Tilton is that the appointment of ALJs by the SEC blurs what are supposed to be separate enforcement and adjudicating functions. As a result, it invites the question of whether basic fairness and due process for the accused have been compromised. This issue becomes more concerning given the increasing amount of proceedings the SEC is commencing before ALJs instead of before the courts.
The Second Circuit decision
Following similar rulings by the Seventh and D.C. Circuits, the Second Circuit court in Tilton held that constitutional and other challenges to SEC proceedings cannot be brought until the end of the administrative proceedings. The effect of this decision is that defendants will be required to complete administrative proceedings before being able to challenge their legitimacy. Given the length of these proceedings and the high settlement rate, this is likely to significantly insulate the administrative proceedings from constitutional challenge.
Implications for Canada
Most of Canada’s securities regulators are integrated agencies, in that their directing mind is the Commission, which also forms its adjudicative tribunal. In the US, the SEC authorizes enforcement proceedings, and appoints and employs its ALJs. Both structures have given rise to challenges to their perceived unfairness. And while the structure in most provinces has been found to be constitutional (See Brosseau v. Alberta Securities Commission,  1 S.C.R. 301), fairness related questions have often cast a shadow over the integrated structure (See the Report to the Fairness Committee to the OSC – March 5, 2004). For this and other practical reasons, some Canadian jurisdictions, for example, Quebec, reformed its structure to include a tribunal distinct from its regulator, the AMF. As noted in previously on our blog, the proposal for a cooperative capital markets regulatory system also includes a tribunal distinct from the regulatory body.
The decision in Tilton has deferred judgement on the constitutionality of the SEC appointment of ALJs. It remains to be seen whether a significant and growing majority of SEC cases will continue to be adjudicated by ALJs, and what impact the increasing scrutiny this draws to in house securities enforcement will have on future enforcement actions taken by the OSC.