On July 13, the Securities and Exchange Commission approved the
adoption of amendments to the Rules of Practice that govern its
administrative proceedings. The approval was announced with little
fanfare eight months after the Dec. 4, 2015, closure of the period
for public comment, although the amendments are largely consistent
with the Commission's original proposals, adopting most
"as proposed" or "substantially as
proposed."1 Most prominently, the amendments
potentially lengthen the prehearing stage of administrative
proceedings, permit some depositions as a matter of right for each
side in complex proceedings and explicitly provide for the
exclusion of "unreliable" evidence. The amendments will
apply to all proceedings initiated 60 days or more after their
publication in the Federal Register, and apply to some pending
actions, depending on the phase of the proceeding.
The amendments arrive amid a steady stream of legal challenges to
the Commission's increased use of its in-house forum following
the passage of the Dodd-Frank legislation in 2010. Dodd-Frank
authorized the Commission to impose monetary penalties in
administrative proceedings on persons not associated with entities
registered with the Commission; prior to Dodd-Frank, only the
federal courts had this power. This change, as well as the
Commission's enhanced authority to bar persons from the
securities industry in administrative proceedings (also granted by
Dodd-Frank), has contributed to a significant spike in the
Commission's use of the in-house forum. Moreover, where in the
past the Commission, even as to regulated persons, had tended to
sue in federal court on complex matters, such as insider trading
violations, more recently it has sued administratively in such
cases as well. The Commission's increased utilization of its
in-house forum has unfavorably highlighted the differences between
proceedings in that forum and in the federal district courts. The
disparity in the Commission's rate of winning verdicts —
90% in contested cases pursued in-house, compared with 69% in
federal court — has also raised eyebrows.2
Notably, in an SEC administrative proceeding, there is only limited
document discovery and no deposition discovery; review of the
administrative law judge's (ALJ) tentative decision goes to the
commissioners, who themselves approved the original filing of the
proceeding; and an appeal of the Commission's order is made to
a federal court of appeals whose review is deferential to the
Commission's findings. In contrast, in a district court
proceeding, the action is conducted before an Article III federal
judge, there is a right to a jury trial, there is plenary discovery
under the Federal Rules of Civil Procedure and the Federal Rules of
Evidence apply.
Beginning with Gupta v. SEC in 2011,3 litigants
have argued that the Commission's administrative proceedings
suffer from a number of constitutional deficiencies. These include
violations of the due process clause (the SEC's administrative
procedures are inadequate), the equal protection clause (see, e.g.,
Gupta, where Judge Jed Rakoff denied the Commission's motion to
dismiss Mr. Gupta's complaint, citing a "well-developed
public record of Gupta being treated substantially disparately from
28 essentially identical defendants [who were charged in federal
district court]") and the appointments clause (claiming that
ALJs are "inferior officers" and must under the
Constitution be appointed by the president or "Heads of
Departments").
The Commission has responded with incremental reform. In May 2015,
the Commission's Enforcement Division issued formal guidance on the factors it will
consider when choosing between instituting proceedings in-house or
in federal court. However, those factors centered on the
Commission's convenience and enforcement priorities, as opposed
to the fairness to the respondent. The Commission's recent
approval of the amendments to the Rules of Practice seems to be an
attempt to address specific criticisms of the in-house procedures,
while leaving broader criticisms to the side. Although commenters,
according to the Commission, "generally supported the
Commission's efforts to update the rules, expand the discovery
process and enlarge the timetables in administrative
proceedings," some "argued that the proposed amendments
were too incremental," while others questioned "the
legitimacy of the Commission's administrative forum"
altogether.
A number of the amendments are noteworthy:
- Rule 360, which concerns the timing
for the stages of administrative proceedings, more than doubles the
maximum prehearing period — the period between service of the
order instituting proceedings (OIP) and the start of hearings
— to 10 months for complex cases.4 According to
the Commission, the "longer prehearing period is intended to
provide parties, in appropriate cases, additional time to review
the investigative record, conduct depositions under amended Rule
233, and prepare for a hearing," although the Commission
"recognize[s] that some might view the maximum ten-month
prehearing period as not long enough." To take account of the
potentially longer prehearing period, the amended Rule scraps the
former requirement that the hearing officer's initial decision
be filed within 300 days from the date of service of the OIP, and
instead sets the date for the initial decision at 120 days after
one of multiple events that occur later — e.g., the
completion of post-hearing briefing — with the potential for
a 30-day extension.5
- Rule 233 governs depositionsand had
previously provided that any party could move for permission to
take the deposition of a witness likely to be unavailable to
testify at a hearing. The rule thus did not envision
"discovery-type" depositions. The amended rule retains
this provisionbut also allows for respondents and the
Commission's Enforcement Division to take discovery-type
depositions in complex cases. In a single-respondent proceeding,
each side will be permitted to notice the depositions of three
persons as of right. In a multirespondent proceeding, the
Enforcement Division will be entitled to notice the depositions of
five persons, while the respondents collectively will be entitled
to notice the depositions of five persons. Either side can move for
leave to notice up to two additional depositions. Most commenters
sought even more depositions, but in the Commission's view, the
amendments "provide parties with the potential benefits of
deposition discovery without sacrificing the public interest or the
Commission's goal of resolving administrative proceedings
promptly and efficiently."
- Rule 320, which sets the standards for admissibility of evidence at hearings, had prescribed the exclusion of "irrelevant, immaterial, or unduly repetitious" evidence. The amended rule adds "unreliable" evidence to that list, but also provides that hearsay may be admitted if it is "relevant, material, and bears satisfactory indicia of reliability so that its use is fair." Although most commenters sought full incorporation of the hearsay rules from the Federal Rules of Evidence, the Commission "continue[s] to believe that a case-by-case determination of the admissibility of hearsay evidence is more appropriate than . . .broad exclusionary rules," as well as being consistent with the Administrative Procedures Act.
While many of the amendments will be welcomed by defense
practitioners (even if they are viewed as not going far enough in
the right direction), not all of them favor respondents. For
example, Rule 220 introduces a new requirement that a respondent
must affirmatively state in her or his answer whether the
respondent intends to assert a reliance-on-counsel
defense.6 Commenters argued that the requirement
"prejudices respondents, provides an unfair advantage to
Division staff in administrative proceedings, improperly requires
respondents to disclose their trial strategy, and infringes on the
attorney work-product privilege." The amendment was
nevertheless adopted "substantially as
proposed."7
Although the new amendments are generally a step in the right
direction, they of course do not give respondents the same
procedural protections as trials in federal court, and they fail to
address the more fundamental criticisms of the Commission's
administrative forum. Commenters opposed the administrative forum
on the grounds that the "Commission will choose to shield
controversial cases from the full scrutiny of federal district and
appellate courts" and that"conflicts of interest preclude
the Commission from being perceived as a neutral arbiter."
However, the Commission determined that these comments, as well as
a recommendation that the Commission create a procedure for
respondents to remove certain cases to federal court, were
"outside the scope of the proposed amendments" and did
not address them.
Given Dodd-Frank's expansion of the Commission's penalty
authority and the Commission's increasing reliance on the
administrative forum, the recent amendments are unlikely to quiet
critics and curtail legal challenges. In Gupta v. SEC, in
the face of the respondent's Equal Protection claim of
disparate treatment, Judge Rakoff denied the SEC's motion to
dismiss, rejecting the Commission's arguments that Gupta's
claims were barred by sovereign immunity and that he had to exhaust
administrative remedies. The Commission then withdrew its
administrative proceeding and later sued Mr. Gupta in federal
court. More recent challenges have fared less well. Federal
appellate courts in the 2nd, 7th, 11th and D.C. Circuits —
dealing principally with appointments clause and due process
challenges to the Commission's rules — have all recently
held that such arguments must first be presented to the Commission
before they can be considered by a federal court. But these
jurisdictional setbacks do not extinguish — they merely delay
— challenges to the constitutionality of the Commission's
administrative proceedings. Indeed, the D.C. Circuit should rule on
the merits of one such challenge shortly,8 another
development to watch for in this ongoing saga.
Foonotes
1 Unless otherwise noted, all quotations are from the Commission's adopting release No. 34-78319.2 See Jean Eaglesham, SEC Wins With In-House Judges, Wall St. J., May 6, 2015 ("The SEC won against 90% of defendants before its own judges in contested cases from October 2010 through March of this year, according to the Journal analysis. That was markedly higher than the 69% success the agency obtained against defendants in federal court over the same period, based on SEC data.")
3 11-cv-01900 (S.D.N.Y. July 11, 2011). Kramer Levin Naftalis & Frankel represented Mr. Gupta in this action.
4 Under the amended rule, the least complex proceedings will have a prehearing period of no more than four months, and proceedings of medium complexity will have a prehearing period of no more than six months.
5 Under the amended rule, the least complex proceedings will have a 30-day deadline for initial decision, and proceedings of medium complexity will have a 75-day deadline.
6 The amendment also requires the respondent to state whether she or he relied upon the advice of accountants, auditors or other professionals.
7 The amendments also impact Rule 141 (Orders and Decisions; Service of Orders Instituting Proceedings and Other Orders and Decisions); Rule 161 (Extensions of Time, Postponements and Adjournments); Rule 180 (Sanctions); Rule 221 (Prehearing Conference); Rule 222 (Prehearing Submissions); Rule 230 (Enforcement and Disciplinary Proceedings: Availability of Documents for Inspection and Copying); Rule 232 (Subpoenas); Rule 234 (Depositions Upon Written Questions); Rule 235 (Introducing Prior Sworn Statements or Declarations); Rule 250 (Dispositive Motions); and certain rules of appellate procedure and the Rule 900 guidelines.
8 The case is Raymond J. Lucia Cos. v. SEC, 15-1345, and focuses on the Constitution's appointments clause.
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