Insider Trading: the Problem With the Sec's In-house Aljs

• Citation: Vol. 67 No. 1
• Publication year: 2017

Insider Trading: The Problem with the SEC's In-House ALJS

Lucille Gauthier

INSIDER TRADING: THE PROBLEM WITH THE SEC'S IN-HOUSE ALJS

Abstract

Following the publication of an inculpating Wall Street Journal article, the United States Securities and Exchange Commission (SEC) has been under fire regarding the potential bias of its administrative law judges (ALJs). The success rate of the SEC in its administrative proceedings has raised questions concerning the SEC's increased use of administrative proceedings over the federal court system. Defendants have become frustrated, feeling that the deck is stacked against them and that the ALJs' minds are decided before the administrative proceedings begin. The image of bias has resulted in appeals in administrative proceedings and federal courts as defendants feel that they have been denied fair opportunities to be heard. The very appearance of justice is crucial to the legal system, particularly where the SEC seeks to circumvent federal courts to conserve resources and avoid overloading the federal docket.

This Comment analyzes the various sources of bias in the SEC's ALJs. It then evaluates three mainstream proposals to reduce bias: (1) eliminating administrative proceedings, (2) allowing defendants to select the forum for their cases, and (3) establishing a separate appeals board for defendants and non-parties to raise allegations of ALJ bias. Ultimately, this Comment rejects each of these proposals for failing to reach the root of the bias problem. This Comment concludes that the government should adopt a new solution by restructuring the ALJ system into a neutral pool of ALJs who would be randomly assigned to administrative proceedings at the various federal agencies.

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Introduction..............................................................................................125

I. Background of ALJs and the Hiring Process ...........................128

A. Role of ALJs in the Administrative System ................................ 128
B. Neutral ALJ Hiring Process Under the OPM............................ 131
C. Former Selective Certification Process..................................... 132

II. Reasons for ALJ Bias.....................................................................134

A. Are the SEC's ALJs More Biased? A Deceptive Assumption .... 134
B. Recent SEC Enforcement Trends............................................... 140
C. Employee-Employer Relationship: The ALJ-SEC Interplay...... 143

III. Solutions to the Appearance of ALJ Bias..................................146

A. Formerly Proposed Solutions and Their Shortcomings ............ 146
B. An Independent Pool of Neutral ALJs ....................................... 149

IV. Implications for a Neutral Pool of ALJs..................................152

A. Implications for the Federal Docket.......................................... 152
B. Implications for the Administrative Image of Justice ................ 152

Conclusion..................................................................................................153

Appendix.......................................................................................................155

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Introduction

"People generally see what they look for, and hear what they listen for . . . ."¹ Or in the case of the United States Securities and Exchange Commission (SEC), its in-house administrative law judges (ALJs) hear what they have been ordered by the agency to hear. The SEC faces constitutional challenges to its administrative proceedings and ALJs from numerous angles.² Its administrative proceeding practices have been the focus of both federal appeals³ and media scrutiny.⁴ Most concerning is the claim that the SEC's ALJs are biased in favor of the agency.⁵

The appearance of impartiality at the SEC, a financial industry watchdog, is critical.⁶ The SEC is unable to prosecute criminal charges, though it frequently refers criminal violations to the Department of Justice or appropriate state authorities.⁷ The agency is permitted to seek sanctions such as cease-and-desist orders, bars from the securities industry, disgorgement, civil penalties, and suspension or revocation of registered securities or the registration of a broker, dealer, investment company, investment adviser, or financial statistical rating organizations.⁸ The impact of SEC enforcement is therefore immense and felt nationwide.⁹ In the 2016 fiscal year alone, SEC ALJs issued 170 decisions in administrative proceedings, resulting in orders for $12.4 million in disgorgement and $14.5 million in civil penalties.¹⁰ From 2013 through 2016, the SEC charged more than 3,300 companies and 2,700 individuals in

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administrative and federal court proceedings, and obtained over $13.4 billion in sanctions.¹¹

The current challenges to the SEC's administrative proceedings include issues with the Appointments Clause,¹² the Seventh Amendment,¹³ Equal Protection,¹⁴ and Procedural Due Process.¹⁵ However, this Comment focuses solely on one challenge: the potential bias of the SEC's in-house ALJs.¹⁶ While the Supreme Court has declined to hear cases challenging the validity of ALJs under the Appointments Clause,¹⁷ the more disturbing claim is the possibility of a biased trier of fact.¹⁸ The SEC has been the center of media attention,¹⁹ but that does not exclude other agencies from scrutiny. While this Comment concentrates on the bias allegations at the SEC, all agencies bringing cases in administrative proceedings in front of in-house ALJs could face a similar problem.

Following the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) in 2010,²⁰ the SEC increased the number of cases it brought in administrative proceedings.²¹ In the 2014 fiscal year, the SEC brought four out of five enforcement actions in administrative

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proceedings rather than in federal courts.²² Further, the SEC boasted a 90% win rate in administrative proceedings, and only a 69% win rate in federal court, from October 2010 through March 2015.²³ Several commentators have questioned the independence of the SEC's ALJs given the significantly higher success rate in administrative proceedings.²⁴

While other agencies may also have biased ALJs,²⁵ public scrutiny has focused on the SEC.²⁶ All federal agencies use the same ALJ hiring process,²⁷ but only the SEC ALJs receive public scrutiny.²⁸ This Comment argues that SEC ALJs are still biased, despite a neutral hiring process. This Comment further argues that this systemic bias should be removed by restructuring the ALJ program to function as a neutral pool of available ALJs employed by the Office of Personnel Management (OPM) instead of by particular agencies.

Additionally, the agency's leadership remains up in the air.²⁹ ordinarily, five commissioners, appointed by the President of the United States and confirmed by the Senate, lead the SEC.³⁰ To prevent the appearance of political bias, "no more than three [c]ommissioners may belong to the same political party."³¹ Currently, only three of the five seats are filled, with one commissioner's term having expired in June 2017.³² The last SEC Chair, Mary Jo White, stepped down from her position at the conclusion of President Obama's second term.³³ Thus, the time is now for reform at the SEC.

This Comment proceeds in four parts. Part I explains the role and hiring of ALJs following the passage of the Administrative Procedure Act (APA) to

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demonstrate the facial neutrality of the ALJ infrastructure across agencies. Part II examines the reasons behind the bias allegations at the SEC and evaluates the risk of bias. Part III argues for overhauling the infrastructure of the ALJ program by assessing four solutions. Finally, Part IV describes the implications that the reform would have on future agency adjudications.

I. Background of ALJs and the Hiring Process

This Part provides an overview of ALJs. Section A details the role of ALJs in federal agencies. Section B explains the selection process of ALJs as prescribed by the APA and the OPM, which applies to all federal agencies as a means of ensuring impartiality. Finally, section C lays out the selective certification process that was reformed to prevent ALJ biases. Despite the repeal of the selective certification process and maintenance of a neutral hiring process, bias continues to affect the SEC's ALJs.

A. Role of ALJs in the Administrative System

The APA formally created the ALJ position in 1946 to "ensure fairness in administrative proceedings before Federal Government agencies."³⁴ In the APA, Congress carefully described the role of the ALJ to regulate the hiring process and power of the position.³⁵ Previously agencies used their own employees to oversee proceedings, and such proceedings were shrouded in vagueness.³⁶ While there were obvious favoritism issues when ALJs were former employees of an agency, agencies frequently ignored the decisions of ALJs and crafted their own with little or no given rationale.³⁷ The APA intended ALJs to be "impartial triers of fact."³⁸ "An employee or agent engaged in the performance of investigative or prosecuting functions for an agency in a case may not, in that or a factually related case, participate or advise in the decision, recommended decision, or agency review . . . ."³⁹

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Therefore, to preserve neutrality, the APA intends that ALJs be insulated from agency employees in charge of enforcement actions.⁴⁰

The duties of ALJs include "rul[ing] on preliminary motions, conducting] pre-hearing conferences, issu[ing] subpoenas, conducting] hearings . . . , review[ing] briefs, and prepar[ing] and issu[ing] decisions."⁴¹ Essentially, ALJs function as the agency counterpart to judges in a courtroom.⁴² While ALJs lack some of the independence and constitutional safeguards of Article III judges, they are still held to the same expectation of justice.⁴³ The SEC describes ALJs as...