SEC administrative overhaul welcomed, but critics seek more

Critics of the Securities and Exchange Commission's handling of administrative proceedings are welcoming the agency's latest efforts to modernize the rules but vow to push for more sweeping changes.

“The commission faces a crisis of confidence over the fairness of its internal administrative procedures,” Stanford University law professor and former SEC Commissioner Joseph Grundfest told a House panel Dec. 2 as it considered a legislative proposal that would implement even broader changes.

In addition to a growing number of court challenges brought by firms on the receiving end charged through administrative proceedings, the latest round of criticism was triggered by the SEC's proposed changes of practice, which were available for public comment through Dec. 4.

The SEC's proposed changes would expand the current mandatory timelines for proceedings — discovery depositions and expert witnesses, among other changes — and would simplify the process for seeking commission review of an initial decision. “These proposed rules are intended to introduce additional flexibility into administrative proceedings while still providing for the timely and efficient disposition of proceedings,” the SEC said in releasing the proposal.

Law firms representing clients in SEC proceedings said they were encouraged by the commission's efforts to add more protections for anyone accused of wrongdoing. But Theodore Olson, a partner in Gibson, Dunn & Crutcher LLP's Washington office and the former U.S. solicitor general, said in a Dec. 4 comment letter that “these proposed revisions do not go nearly far enough.” In urging the SEC to make more dramatic changes, he added: “The perception that administrative proceedings are fundamentally unfair has damaged the credibility of the SEC's enforcement system.”

What the proposed rules do not address, critics say, is a process that favors the SEC to the point that many respondents simply choose to settle. Critics complained in their comment letters that the proposed timeframe for discovery, up to eight months depending on the case, is still unrealistic for defendants, while a limit on the number of depositions or pages for petitions seeking review give an unfair head start to agency officials, who have already developed their case.

“There is a stark asymmetry between the time and tools that the SEC has to prepare its case and that which is afforded respondents,” attorneys with Skadden, Arps, Slate, Meagher & Flom LLP in New York, said in their comment letter. The SEC's proposed changes “do little to correct the imbalance,” said the firm, which represents Patriarch Partners LLC and its CEO, Lynn Tilton, in an ongoing administrative proceeding.

One particular sore point is that adverse initial decisions by administrative law judges must be appealed to the commission, which authorized the original complaint. “The Kafka-esque quality of an appeal to the body that authorized the prosecution cannot be denied,” Mr. Grundfest told the House panel.

Critics are finding some sympathetic ears in Congress. The December hearing before the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises touched often on legislation sponsored by subcommittee Chairman Scott Garrett, R-N.J., that would allow respondents in administrative proceedings to require the SEC to instead bring a civil action through the courts, and calls for “clear and convincing evidence” of violations before proceedings begin.

“In recent years, the agency has transformed into a veritable judge, jury and executioner with its blatant overuse of their in-house courts,” Mr. Garrett said when introducing the bill in October.

Consumer advocacy group Public Citizen, which generally supports individuals' legal protections in federal court, opposes Mr. Garrett's bill for sending the wrong message. “Congress should be looking for ways to strengthen the powers of law enforcement authorities rather than weakening them,” it told the subcommittee in a Dec. 2 letter.

Tom Quaadman, senior vice president of the U.S. Chamber of Commerce's Center for Capital Markets Competitiveness, said his group, which has made reform of the SEC's administrative proceedings a top priority, is “cautiously optimistic” that the Garrett bill will come up for a vote early next year. “Congress is moving pretty quickly on this. The commission is going to have do something sooner rather than later,” he said in an interview.

According to the Securities Enforcement Empirical Database, a joint project of New York University's Pollack Center for Law & Business and Chicago economic consulting firm Cornerstone Research that tracks SEC enforcement actions against public companies, “the data is saying there is increased use of the administrative proceedings venue,” said Cornerstone principal Sara Gilley, who focuses on securities and white collar litigation. The venue also leads to more settlements, Ms. Gilley noted. Of the 33 enforcement actions filed against public company defendants so far in 2015, 96% of the cases handled by in-house judges were filed and settled the same day, compared to 38% that the SEC pursued through a civil action in court.

“The SEC is an enforcement agency. They should consider their role within the judicial system and prosecute cases in a way that is fair,” said Deborah Meshulam, a partner in the Washington office of law firm DLA Piper LLP. “It is not simply winning and losing when lawyers represent the government. There is also an obligation to the integrity of the system.”

While case law continues to evolve, Mr. Quaadman noted the SEC's rules of practice for such proceedings have not changed since 1995, despite a dramatic increase in their use by the agency, which has racked up impressive success rates in recent years.

That success, in turn, has triggered a growing number of court cases challenging the constitutionality of the way in-house judges are appointed. So far, four SEC enforcement cases have been halted by U.S. District Court judges in Atlanta and New York, who considered the constitutional challenges likely to succeed. In other cases challenging the SEC on due process or agency bias, other courts have upheld the SEC's position, or in some cases declined to rule until a defendant completes the administrative process first. “Each step along the way, there's more and more riding on those decisions,” said Mr. Quaadman.

“That puts a lot of pressure on the SEC to take action.” n