SEC to vote Wednesday on rule changes for administrative proceedings

July 11, 2016

(Reuters) – The Securities and Exchange Commission’s three commissioners will vote Wednesday on tweaks to rules governing administrative proceedings before SEC in-house judges, despite complaints from the white-collar defense bar that the proposed rule changes do not resolve the fundamental unfairness of trying enforcement actions before in-house SEC judges.

The Dodd-Frank financial reform act of 2010 gave the SEC leeway to bring even complex securities fraud cases as administrative proceedings before judges hired by the agency, rather than as federal-court enforcement actions overseen by U.S. district judges. Ever since, defense lawyers have insisted that SEC administrative proceedings curtail their clients’ due process rights because the federal rules of civil procedure don’t apply. Those arguments mostly failed to persuade judges to enjoin administrative proceedings, which is why defense lawyers developed alternative constitutional challenges to the SEC in-house trials. The inherent constitutionality of the proceedings is now at issue before the District of Columbia U.S. Circuit Court of Appeals.

There is little doubt that, as The Wall Street Journal reported in a terrific piece in May 2015, the SEC enjoys a considerable home-field advantage when it brings administrative proceedings. The Journal found that between October 2010 and March 2015, the agency won against 90 percent of the defendants sued in administrative proceedings but only 69 percent of the defendants sued in federal court.

When the agency proposed rule changes for its in-house proceedings in September 2015, in what was widely regarded as a response to controversy over its increased reliance on its home court, the agency said the tweaks would “modernize our rules of practice.” Among the more substantive proposals, the SEC suggested lengthening the timeframe for administrative proceedings, which currently must be decided within 300 days (or less, depending on the complexity of the case) of the date the defendant receives service of an order instituting the case.

Under the current rules, hearings must begin within four months of the order of service. The amendment would extend the deadline for the hearing to eight months, giving defendants more time to gear up, and would start the clock on an initial decision at the end of post-hearing briefing, giving ALJs more time to decide cases.

The new rules would also allow witness depositions, which are only permitted under the current rules if a witness is not available to testify live. Under the proposed rule change, lawyers representing a lone defendant would be permitted to depose three witnesses; in multi-defendant cases, defense counsel could depose up to five witnesses.

The SEC is also proposing a modest restriction on the use of hearsay evidence in administrative proceedings and a slight tightening of the standard of admissibility to exclude “unreliable” evidence. Other than that, the proposals don’t really help defendants.

Only a dozen commenters submitted a response to the SEC’s invitation to address the proposal, all of them defense lawyers or business groups. Their universal theme: It’s progress that the SEC has recognized flaws in its administrative proceedings but the agency’s proposals don’t come close to fixing the problem.

“Even as amended, the rules put undue constraints on the time that respondents have to prepare to defend themselves, on their opportunity to develop a defense case, and on the protections that they have against incompetent evidence,” wrote defense counsel Susan Brune of Brune Law, in a comment cited by several other firms. “And they do not address the real issue: that when the Commission chooses to go administrative, it gets to play prosecutor, judge, jury and first-level appellate court. The proposed rules do not go far enough to protect the rights of respondents.”

Skadden Arps Slate Meagher & Flom, which pioneered legal theories challenging the constitutionality of the SEC’s appointment process for ALJs, said the only way to assure the fairness of the system is to allow defendants to decide where their cases are tried. “Without an independent adjudicator, no number of proposed changes to the SEC’s rules of practice will be sufficient to correct the impression that the SEC’s administrative system is conflicted and prejudiced,” the Skadden letter said. “Accordingly, the commission’s proposed rules’ greatest flaw is that they do nothing to correct this underlying problem. To remedy this, the commission should reform its rules to allow respondents in certain cases, such as those brought under the SEC’s anti-fraud provisions, to remove a suit filed administratively to federal court.”

Other commenters included lawyers from Gibson Dunn & Crutcher (which is representing the defendant challenging the constitutionality of administrative proceedings at the D.C. Circuit), Stern Tannenbaum & Bell, Kilpatrick Townsend & Stockton, Calfee Halter & Griswold, Stanford law professor Joseph Grundfest and the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness.

The SEC has not amended its proposal to reflect comments but it’s possible the commissioners will adopt a final rule that differs from the proposal.

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