Prior to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission’s authority to impose penalties in a case brought as an administrative proceeding was restricted to regulated entities. The SEC could not impose a significant civil penalty in an administrative proceeding. That limited administrative proceedings to cease-and-desist proceedings against broker-dealers, investment advisers, and mutual funds. The alternative to the administrative brought before an SEC administrative law judge was a lawsuit brought in federal court.
Dodd-Frank changed that with its Section 929P. The SEC may now impose a civil penalty in an administrative proceeding against any person or company.
Administrative proceedings have many built-in advantages for the SEC: limited discovery, no right to a jury trial, an inherently biased administrative law judge, and a biased appeal to the SEC commissioners. The SEC has the “home court” advantage. According to a Wall Street Journal story, in the 12 months through September, the SEC won all six contested administrative hearings where verdicts were issued, but only 11 out of 18 federal-court trials.
There is an upside to the administrative proceeding. Some defendants will see it as a quicker or less costly proceeding.
One defendant thinks otherwise and has filed suit against the SEC in defense of an upcoming administrative proceeding. Joseph Stillwell runs an investment fund that is under investigation by the SEC. He received a Wells Notice and is expecting his case to end up as administrative proceeding after settlement talks have stalled.
A second defendant in a separate case also challenged an administrative proceeding. Jordan Peixoto was accused by the SEC of insider trading, but the SEC decided to use its new administrative proceeding alternative to federal court. Unlike Stillwell, Peixoto was not subject to SEC registration. The only other time the SEC has acted in this manner was with Rajat Gupta.
There is a constitutional question raised by each case. Each raises concerns about due process and presidential appointment powers. Since the SEC is an independent agency, the SEC commissioners can only be removed for good cause. The administrative judges also have tenure and can only be removed for cause. Prior federal cases have only permitted one level of tenure, not the two levels for the SEC administrative judges.
There is an ethical question. The administrative judges are appointed by the SEC and any appeal of the judges decision is appealed to the SEC commissioners. Since it takes a vote of the SEC commissioners to proceed with an enforcement action, those commissioners are hearing the appeal of the case they authorized to proceed in the first place. The judges are not held to any code of conduct or code of ethics. In the Peixoto complaint, the proceeding is called a “star chamber” where the accused is defenseless.
He also pulled up a statement by the SEC’s general counsel that called into question the adequacy of the administrative process for insider trading cases.
Sources:
- SEC Is Steering More Trials to Judges It Appoints by Jean Eaglesham in the Wall Street Journal
- Investment Adviser Challenges Constitutionality of SEC Administrative Proceedings
- SEC Admin Proceedings Are Unconstitutional, Suit Claims
- Should the SEC be prosecutor, judge, jury, and executioner?
- Changes in Securities Enforcement Thanks to Dodd-Frank by Bruce Carton in Securities Docket
- Stillwell versus the SEC complaint (.pdf)
- Peixoto complaint
- SEC Administrative Case Rules Likely Out Of Date, GC Says
- SEC ALJs Face Free Enterprise Challenge by Keith Paul Bishop in California Corporate and Securities Law
- Why Is It Called a “Wells Notice”?
