United States: Tweaking The "Home Court" Rules For SEC Administrative Proceedings

Last Updated: October 5 2015
Article by Peter K.M. Chan and Amy J. Greer

SEC proposes modest amendments to AP process to enhance efficiency and address concerns regarding fairness.

In an effort to enhance the efficiency of its processes in administrative proceedings (APs) and bolster its argument that APs offer a fair forum for adjudicating complex matters, the US Securities and Exchange Commission (SEC or Commission) on September 24 proposed limited changes to its Rules of Practice. The rule proposals are subject to a 60-day comment period following their publication in the Federal Register. The proposed changes should be evaluated alongside the Commission's two recent opinions that upheld the constitutionality of its administrative process against attacks based upon the way in which SEC administrative law judges (ALJs) are appointed as well as the fairness to respondents of the SEC's administrative system.1

Taken together, the SEC's recent moves show a Commission that is "doubling down" on its increased use of APs in complex enforcement cases by rejecting all legal challenges to the administrative adjudication process, by instituting an electronic court filing (ECF) process to lighten the load on the SEC's Office of the Secretary, and by responding to some (but by no means all) of the fairness concerns that have been raised.

Proposed Changes to AP Deposition Process

From the perspective of a potential respondent, the most significant of the proposed changes would facilitate limited deposition discovery and adjust time limits to accommodate the discovery depositions as well as assimilate what is often a voluminous investigative record.

Historically, depositions have been allowed in SEC administrative proceedings solely to preserve the testimony of a witness who would not be available at the hearing. The proposed revisions would allow the SEC's Division of Enforcement and a respondent each to take up to three pre-hearing depositions. In the event the proceeding was brought against two or more respondents, the respondents (collectively) and the Division would each be entitled to take up to five depositions. The proposed changes expressly state that "[t]he fact that a witness testified during an investigation does not preclude the testimony of that witness." 

A deposition taken to preserve testimony could not "count" against the limit. However, expert and fact witnesses are both subject to the limitation.

With the approval of the ALJ, a party taking a deposition may also serve on the deponent a subpoena seeking the production of documents.

The proposed changes include rules with respect to formalities associated with depositions and how they are to be conducted. These are largely modeled on the Federal Rules of Civil Procedure (FRCP) (though the presumptive length of a deposition according to the proposed changes would be six hours as opposed to seven in the FRCP), with the noticing party required to leave reasonable time for cross-examination.

The SEC's release does not explain the basis for imposing a "hard cap" on the number of depositions that can be taken. It fails to explain why an ALJ should not have discretion to consider the complexity, nature, or significance of a proceeding in determining the appropriate number of depositions for each case. The SEC's proposal also gives the Division of Enforcement and the respondent(s) an equal number of depositions. The effect will be to leave the playing field tilted in favor of the Division. During an investigation, the Division generally has had an unfettered opportunity to take administrative testimony of multiple witnesses. Due to the non-public and closed nature of investigations, a potential respondent generally may not even attend investigative testimony and often has a limited ability to obtain information informally before a proceeding is instituted. Therefore, the parties do not come to the "starting gate" on equal footing. Providing the Division with three to five deposition "slots" can be expected to permit the Division to expand the record after the Commission has instituted the case or to reserve its slots for expert witnesses, while forcing the respondent(s) to choose between fact and expert discovery. Moreover, in a multiple-respondent proceeding, respondents may have differing interests and discovery plans that would inhibit or limit coordination; depending on the number of respondents, a particular respondent may be left with little latitude.

Proposed Changes to AP Hearing Date Process

The proposed changes would also allow an ALJ some flexibility in setting a hearing date in light of the complexity of a case and the anticipated scope of discovery. Even in a complex proceeding, that flexibility is limited; the hearing would be scheduled for four to eight months from the service of the order for proceedings, a period that the proposing release asserts "would be sufficient amount of time for parties to prepare for hearing, review documents, and take up to three depositions per side in a single-respondent proceeding, and up to five depositions per side in a multiple-respondent proceeding." 

There are a number of other elements to the proposal, none of which would materially change the administrative hearing process, including the following:

  • Requirements for expert reports and limits on discovery from expert witnesses, largely along the lines of the Federal Rules of Civil Procedure
  • Broadening the potential use of hearsay evidence determined to meet a threshold of reliability and allowing the exclusion of "unreliable" evidence
  • Prescribing the means by which service may be made in foreign countries
  • Altering appeal procedures, specifically relating to information required in the petition for review

Conclusion

The SEC's proposed rule changes represent limited progress toward addressing some of the issues raised by its increased use of administrative proceedings in enforcement cases. However, as described in our December 2014 LawFlash, " There's No Place Like Home: SEC Increasingly Uses Administrative Proceedings," the concerns raised by rerouting cases that assert fraud and seek substantial penalties into the administrative process go well beyond depositions and time limits. They include far more basic issues, such as the independence of the ALJs who serve as hearing officers, the lack of access to a jury, and the Commission's combined role as both prosecutor and adjudicator (and the effect of that combined role when the Commission takes the initiative to interpret securities laws aggressively).

The SEC's proposed procedural modifications are small steps that are not likely to temper continued challenges to the fairness of the AP process generally. No fix other than an outright re-evaluation by the Commission (or by Congress) of the Commission's use of administrative proceedings in contested cases will address the core question of whether a respondent facing serious allegations deserves a truly independent hearing. However, the SEC has at least begun a discussion regarding the AP process by inviting comments on the proposed rules. Interested parties will want to accept that invitation.  

1 See In the Matter of Timbervest, LLC, et al., Investment Advisers Act Rel. No. 4197, 2015 WL 5472520 (Sept. 17, 2015) and In the Matter of Raymond J. Lucia Companies, Securities Exchange Act Rel. No. 75837, 2015 WL 5172953 (Sept. 3, 2015).

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