United States: SEC Proposes To Amend Rules Governing Administrative Proceedings

Last Updated: October 2 2015
Article by Molly White and Louis D. Greenstein

On September 24, 2015, the Securities and Exchange Commission (SEC) issued a press release announcing proposed amendments to its Rules of Practice governing administrative proceedings. The announcement comes at a critical time, when the SEC's use of administrative proceedings has come under increasing fire. The proposed rules attempt to address aspects of the administrative process that are most often criticized: the lack of discovery and the compressed hearing schedule. The proposed rules also seek to modernize the administrative process by requiring electronic filing, which the SEC hopes will increase transparency into the administrative process.

In recent years, the SEC's administrative process has been under heightened scrutiny. With the passage of Dodd-Frank in 2010, Congress gave the SEC the ability to seek monetary penalties in administrative proceedings, and to seek those penalties against "any person," not just registered entities and individuals. Since that time, the SEC has been bringing more and more of its contested enforcement actions as administrative proceedings, instead of filing them in federal district court.

While the SEC has heralded the efficiency of the administrative process as the reason for its increased reliance on that process, it just so happens that the SEC also enjoys a much higher success rate in the administrative process. In fact, in the past three years, the SEC has won 96 percent of the administrative proceedings that it prosecuted, but only 67 percent of its federal court actions. As a result, the defense bar often accuses the SEC of forum shopping, by bringing cases as administrative proceedings before biased administrative law judges instead of weathering more even-handed scrutiny in federal court.

In an effort to make its forum selection process more transparent, on March 8, 2015, the SEC published guidance on the four factors that it weighs when deciding the forum in which to file a contested action. But publication of the factors did little to silence critics, in part because the list of factors was not exhaustive and they were applied so flexibly that they shed little light on the forum-selection process. And some of the factors (like the cost-, resource- and time-effectiveness of the forum) highlighted the unfairness of the expedited administrative process.

The SEC's increasing reliance on the administrative process continues to draw a great deal of criticism. Because the current version of the SEC's Rules of Practice was adopted long before the passage of Dodd-Frank, the rules did not adequately address certain fairness issues that arise in more complex securities enforcement cases. In recent years, respondents have filed district court actions collaterally challenging the constitutionality of SEC administrative proceedings. While the early due process and equal protection challenges did not see much success, some of the recent challenges, which attack the appointment of the SEC's administrative law judges as a violation of the Appointments Clause, have succeeded. As a result, some district court judges have enjoined ongoing administrative proceedings.

With the increased scrutiny and the increased success of constitutional challenges, it is not surprising that the SEC is now taking steps to address some of the public's concerns about the process. And the SEC's proposed rules address two aspects of the administrative process that are most frequently attacked as unfair: (1) the absence of any real opportunity for a respondent to take discovery, and (2) the short period of time a respondent has to prepare for an administrative hearing.

One of the biggest complaints about the fairness of the SEC's administrative process has been the respondents' inability to take discovery. Given that most SEC investigations take years, and given that the Enforcement Division staff has almost unfettered access to information during an investigation, the lack of discovery undermines respondents' ability to defend themselves and calls into question the fairness of the entire proceeding. The proposed rules would permit each side to take up to five depositions in an administrative proceeding involving multiple respondents, and it would allow a party to ask the hearing officer to subpoena documents in connection with a deposition. The proposed rules would also adopt processes related to depositions that are similar to the Federal Rules of Civil Procedure. This is a step in the right direction, but one must question whether it goes far enough to address fairness concerns. After all, the Enforcement Division could still institute an administrative proceeding against 10 respondents, who collectively would be limited to five depositions. That hardly seems like leveling the playing field – particularly not in a complex securities case.

The SEC has also extended the deadline by which an administrative law judge must issue an initial decision. Administrative proceedings are designed to move quickly. The current version of the Rules of Practice requires an administrative law judge to issue an initial decision within 120, 210 or 300 days of the date of service of the order instituting proceedings. That means that within that timeframe the following must occur: A respondent answers the Order Instituting the Proceeding; a respondent reviews the SEC staff's often-voluminous investigative file; any motions for summary disposition are heard; the parties prepare for the administrative hearing; the administrative hearing is held; the parties review the hearing transcript; and the parties submit post-hearing briefs – all before the administrative law judge can issue an initial decision. Even in a 300-day case, this is a tight schedule. The proposed rules would do three things: (1) modify the timing of the initial decision to 30, 75 and 120 days from completion of the post-hearing or dispositive briefing; (2) provide a range of 4 to 8 months within which the administrative hearing must begin (thus doubling the maximum amount of time when a hearing must begin); and (3) create a procedure by which the deadline for the initial decision can be extended by up to 30 days. Although extending process is a welcome change, the rules will still require that the most complex administrative proceedings be decided within a 14-month schedule. Given the size of the SEC's investigative files and the sophistication of many securities fraud cases, it is doubtful that the proposed rules go far enough to ensure respondents adequate time to review the SEC's investigative files and prepare for the administrative hearing.

While the proposed rule changes take a step toward addressing critics' fairness arguments, they do nothing to address the arguments that the appointment of administrative law judges is unconstitutional because it violates the Appointments Clause.

The press release can be found here.

The proposed amendments to the timing of and discovery in the administrative process can be found here.

The proposed amendments to the filing requirements can be found here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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