Rakoff, Practitioners Question SEC Practice Of Sending More Enforcement Cases to ALJs

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By Stephen Joyce

March 3— A prominent federal judge and securities law practitioners are questioning the Securities and Exchange Commission's decision to send more enforcement cases to administrative proceedings rather than federal district court, arguing that fairness and the pursuit of truth demand the cases be adjudicated at jury trials.

Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. No. 111-203) made changes that essentially allow the SEC to obtain similar remedies from respondents in both administrative proceedings and federal court. The ALJ proceedings in general can be less costly, require fewer resources and take less time, according to the SEC.

At a March 2 New York City Bar Association conference, Judge Jed Rakoff of the U.S. District for the Southern District of New York and others debated whether the SEC's decision to send more cases to administrative forums is constitutional, fair and serves the public interest.

SEC Enforcement Division Director Andrew Ceresney in a Nov. 21 speech in Washington defended his agency's increased use of the administrative venues, saying the move is “largely because of efficiency” and the process is “eminently proper, appropriate, and fair to respondents”.

Others aren't so sure. “It seems to me that the SEC is making a mistake,” Rakoff said at the conference. “I hope that [the SEC] will think twice about this recent trend to send their important cases in many situations to the administrative law judges and will instead send them, as they historically have done, to the federal district court,” he said.

Is it Constitutional?

Harvard Law School professor and conference speaker Adrian Vermeule argued that the SEC's action is within the law and that any challenge to its constitutionality will probably fail. The U.S. Supreme Court has even permitted federal agencies to engage is “forum shopping,” allowing an agency to decide whether to send a case to an administrative law judge or federal court based on the likelihood of obtaining a hoped-for outcome, Vermeule said.

As the SEC sends more enforcement matters to administrative law judges, however, practitioners worry about whether respondents are being treated fairly and have available to them the tools—more limited in an administrative proceeding compared with a jury trial—to mount a robust defense.

King & Spalding LLP partner William Johnson and Davis Polk & Wardwell LLP partner Linda Chatman Thomsen, who both previously worked at the SEC's enforcement division, said the two venues are very different. In administrative hearings, which must be concluded in 300 days, depositions of witnesses are generally not permitted, hearsay may be admissible and the discovery process is truncated, they said. Respondents' troubles can only deepen as the complexity of SEC enforcement cases increases, Johnson said.

“Why do we have depositions in civil cases? It's because we don't believe in trial by ambush,” Rakoff said. “The great engine of truth is cross-examination,” Rakoff said, quoting from the U.S. Supreme Court case Lilly v. Virginia, “and you can't cross-examine hearsay.”

Existing Court Cases

While Vermeule said he is confident that the U.S. Supreme Court would reject any claim challenging the SEC's ability to send cases to administrative hearings, at least three pending court cases challenge the SEC's forum selection process, Pillsbury Winthrop Shaw Pittman LLP partner Michael Halloran said at the conference.

In one of those cases, brought by the activist investor Joseph Stilwell, the defendant stated that because the U.S. president can't oversee SEC administrative law judges in accordance with Article II, SEC administrative proceedings violate the Constitution.

More generally, Yale Law School professor Jonathan Macey questioned whether the SEC and its constituencies truly benefit from the practice. The practice may discourage young lawyers seeking trial experience from applying for jobs at the SEC, could harm the SEC's reputation for fairness and could color the view of administrative law judges, if the SEC continues to win an overwhelming number of administrative hearings, he said.

“It may be constitutional, but it isn't good. It doesn't serve the SEC's interest,” he said. “This is kind of a self-inflicted wound.”

Insider Trading Cases

Rakoff focused many of his comments on SEC insider-trading cases, saying administrative proceedings aren't “really as well calculated to either be fair or to arrive at the truth,” compared with jury trials and Article III judges.

In the SEC's insider-trading case against entrepreneur and Dallas Mavericks owner Mark Cuban, for example, the agency prevailed in its view of the law but lost at trial, Rakoff said. “It lost on the facts. I have to tell you, it is my view unlikely the facts would have come out, found in the same way, in an administrative law proceeding in the SEC as the jury found them,” he said.

And referring to a more recent insider-trading case in which the SEC wasn't successful at trial—the Newman case— Rakoff said “it would be almost impossible for an administrative law judge to come out the way the Second Circuit recently did in Newman.”

Development of Law

More broadly, Rakoff said he was concerned the development of law would be limited if SEC administrative law judges preside over a larger percentage of important SEC enforcement cases.

“Much of the most important developments in SEC law have been judge-made law,” he said. No federal statute outlaws insider trading, and “if you look at the law it's almost all been developed in federal court cases,” Rakoff said.

In Dirks v. SEC, 463 U.S. 646 (1983), the U.S. Supreme Court discussed many essential elements to insider trading cases, including violations concerning Section 10(b) of the Securities Exchange Act of 1934, fiduciary duty obligations and the use of material nonpublic information. “I think institutionally it would have been extremely difficult for administrative law judges to come out the way the Supreme Court came out in Dirks,” Rakoff said.

Rakoff , conceding he didn't fully know the answer, asked his audience whether an administrative law judge had ever ruled an SEC enforcement rule unconstitutional.

“I think myself that there is a danger here that putting these important cases before administrative law judges will skew the law in ways not because the administrative law judges aren't trying to do the right thing, but because they too often are the product of the milieu in which they operate. They don't have the same ability, realistically, to act the way a federal judge can,” he said.

To contact the reporter on this story: Stephen Joyce in New York at sjoyce@bna.com

To contact the editor responsible for this story: Heather Rothman at hrothman@bna.com