Pursuing enforcement actions in-house instead of through the courts has paid off for the Securities and Exchange Commission in recent years, but the agency might now be a victim of its own success.
As the SEC's enforcement division moves more cases through its internal administrative court process, some of the financial firms on the receiving end of those judgments are fighting back with their own court challenges, raising broader questions about due process.
Administrative proceedings are not new to the SEC, but several legislative changes in recent years have made them a more attractive option for agency enforcement officials. The biggest game-changer was the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, which gave the SEC the power to impose substantial monetary penalties on both registered and unregistered parties not normally under the agency's purview, such as people involved in insider trading.
Since then, the SEC's batting average with administrative proceedings has been impressive. In the fiscal year ended Sept. 30, the SEC won 100% of its internal administrative hearings, compared to 61% of trials, according to one of the agency's sharpest critics, U.S. District Judge Jed Rakoff in New York, who often presides over SEC cases.
“It is hard to find a better example of what is sometimes disparagingly called "administrative creep' than this expansion of the SEC's internal enforcement power,” Mr. Rakoff said in a speech to securities lawyers in November. With the SEC appointing and paying the administrative law judges who hear the cases, its success rate “is hardly surprising,” Mr. Rakoff said.
As SEC officials anticipate bringing cases in 2015 against hedge funds and private equity funds over conflicts of interest, undisclosed or misallocated fees, and valuations, many of those likely will go the administrative proceeding route.
“From where we sit, we see them opting for administrative proceedings more because they're being much more aggressive in their interpretations of the law, and they have a poor track record in federal court with their interpretations,” said Douglas Hirsch, an attorney with Sadis & Goldberg, New York, which represents several private funds. The possibility of an administrative action can have the same practical effect of a court case on a private fund, which is likely to settle in order to protect its reputation, Mr. Hirsch noted.
In fiscal year 2014, the SEC initiated 145 civil actions and 610 administrative proceedings. Of those, 10 civil actions and 120 administrative proceedings were initiated against investment advisers and investment companies, including private funds, compared to fiscal year 2010, during which it brought 33 civil actions and 80 administrative proceedings. Some cases also fell under other categories.