Many key issues still left unaddressed in the Securities and Exchange Commission's attempt to modernize its rules of practice.

Author:Patterson, Joseph Quincy

"By bringing more cases in its own backyard, the agency is not only increasing its chances of winning but giving itself greater control over the future evolution of legal doctrine."

--Joseph Grundfest, former SEC Commissioner (1)


Towards the end of 2013, the Securities and Exchange Commission (SEC) lost three high-profile insider-trading cases in federal district court. (2) Shortly after, the SEC instituted a new policy in which it "signaled its intention to bring as administrative actions certain kinds of enforcement actions that historically it has more often brought in the federal courts." (3) This policy included bringing complicated insider-trading cases before Administrative Law Judges (ALJs) (4) rather than before a district court. (5) The SEC claims that the change was due to "recent statutory changes," (6) resulting from the Dodd-Frank Wall Street Reform and Consumer Protection Act. (7) By adding section 929 P(a) to the previously enacted statutes, Congress authorized the SEC to seek civil monetary penalties against "any persons or entities" regardless of whether they are regulated by the SEC. (8) The timing has caused some legal experts to question whether the reason had more to do with giving the SEC a home-court advantage. (9) For instance, on May 7, 2015, the Wall Street Journal published an article, in which it criticized the SEC for its ninety-percent success rate before an ALJ as compared to a sixty-nine-percent success rate before a federal district court. (10) By bringing cases in administrative proceedings rather than federal district courts, the defendant loses many procedural rights that are guaranteed in federal district court, such as a right to a jury, full discovery rights under federal law, and the Federal Rules of Evidence. (11) This change in policy has many of the defendants who won a decision against the SEC before a jury to "doubt [they] would have been able to develop the facts that convinced the jury to find in [their] favor." (12) Additionally, this change in policy by the SEC has led to an increase in the number of appeals questioning whether the procedures used by the SEC violate the defendants' right to due process (13) and whether the SEC properly appointed the ALJs according to Article II, section 2 of the United States Constitution, which states that "Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments." (14)

These constitutional questions and the seeming home-court advantage awarded to the SEC when it brings cases before ALJs rather than before federal district courts have led to much criticism. (15) For example, over the past few months, Jean Eaglesham has written multiple articles in the Wall Street Journal about the SEC's use of "in-house judges" and its high success rate. (16) This negative publicity has some lawyers concerned that the general public will begin to question the fairness of all administrative proceedings. (17) Additionally, the SEC's change in policy has many former SEC Commissioners, enforcement chiefs, and ALJs criticizing the expanded use of administrative proceedings. (18) Some federal judges, including Supreme Court Justice Antonin Scalia, have also echoed these concerns that ALJs are "in effect creating] (and uncreat[ing]) new crimes at will." (19)

As criticism continues to mount against the expanded use of internal administrative actions, the SEC has drastically decreased its use of administrative proceedings. (20) One reason for this could be the recent decision in Hill v. SEC, where the Federal District Court in the Northern District of Georgia ruled that Hill, the defendant, "ha[d] proved a substantial likelihood of success on the merits of his claim that the SEC ha[d] violated the Appointments Clause ... [and] the Court f[ound] a preliminary injunction [was] appropriate to enjoin the SEC administrative proceeding." (21) Another reason for the decrease in the SEC's use of administrative proceedings could be the U.S. Chamber of Commerce's recent recommendations on how to improve the SEC's Rules of Practice. (22) Regardless of the reason, the SEC recently proposed amendments to its rules of procedure, (23) in an attempt "to modernize [its] rules." (24) The proposed amendments, however, are still inadequate. (25) Additionally, the fact that the SEC is bringing fewer cases in administrative proceedings does not mean it will not increase the number of cases brought in the future. This is especially relevant if the Court of Appeals holds that Hill does not have subject-matter jurisdiction to bring a case in federal court, similar to Bebo v. SEC. (26)

This Note analyzes and explains the current issues and criticism regarding the SEC's use of ALJs. In particular, this Note recommends that the SEC ratify its ALJs in accordance with constitutional requirements, create a rigid formula for its forum selection, and amend its Rules of Practice to align more closely to the procedural due process rights in federal district courts. As many of these topics are currently being discussed in federal courts of appeals and within the SEC--through its proposed amendments to the Rules of Practice--this Note intends to add to the discussion on a topic with very little scholarly research. In the SEC's defense, the SEC's mission to "protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation" (27) is a necessary and important mission. Regardless of the mission, individuals are still guaranteed constitutional rights to procedural due process of law when there is a possibility of being "deprived of life, liberty or property." (28) The first Part of this Note will discuss the historical expansion of the SEC's enforcement powers. Part II will discuss the current enforcement procedures and the SEC's recently proposed amendments to its Rules of Practice. Part III will discuss the recent constitutional challenges that defendants have brought against the SEC and the issues regarding subject-matter jurisdiction in federal district courts. Part IV will propose three recommendations that the SEC should follow to avoid future criticism of its administrative proceedings.


    Following the collapse of the United States economy during the Great Depression, Congress enacted the Federal Securities Act of 1933 (29) in order to protect investors and "prohibit deceit, misrepresentations, and other fraud in the sale of securities." (30) In the following year, Congress passed the Securities Exchange Act of 1934. (31) Since the inception of the SEC, it has struggled to "balance competing interests," (32) arising from the three objectives mandated to the SEC: "to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation." (33) Therefore, it is important to give a quick summary of the history of the SEC.

    1. The Modest Expansion of Enforcement Power During the First Fifty Years of Existence

      Although the SEC was created through the Securities Exchange Act, (34) the Enforcement Division of the SEC was not created until 1972. (35) Up until this point, "the Regional Offices conducted '[n] early all of the investigations,' ... while the Commission's Trading and Exchanges Division played a largely supervisory and coordinating role." (36) Additionally, "its enforcement powers were largely limited to seeking injunctions in federal district courts to enjoin violations of the securities laws, and the only express provision for administrative hearings was to suspend or expel members or officers of national securities exchanges." (37)

      During the 1960s, with the adoption of new rules, the SEC's "enforcement program grew to become 'the life and breath of the Commission [,] ... the guts of the agency.'" (38) To bring about this change, William J. Casey, then-Chairman of the SEC, restructured the organization to include "one division devoted entirely to enforcement." (39) Additionally, in 1972, Chairman Casey formed "an advisory committee to 'review and evaluate the Commission's enforcement policies and practices and to make such recommendations as they deemed appropriate.'" (40) Later, this committee was termed the Wells Commission and provided many recommendations to protect defendants against an SEC enforcement proceeding. (41) In particular, the Wells Commission wanted to ensure that the defendants maintained their right to due process, "a hallmark of our Anglo-American judicial system." (42) It is important to note that with all of the expansions of powers from 1934 until 1972, "the expansion was tied to the agency's oversight of regulated entities or those representing those entities before the Commission" and any "broader remedies and sanctions it could [only obtain] by going to federal court." (43)

    2. The Post-Insider Trading Sanctions Act of 1984 Expansions of Powers

      The second Chairman of the SEC defended the powers of the administrative proceedings by stating the reason for these powers "is that no practical alternative exists in our complex society." (44) When the SEC had limited powers, this was true; however, the Insider Trading Sanctions Act of 1984 provided the SEC, at its own request, "the power to order prospective compliance through injunctions." (45) Although at the time this ancillary power only applied to "regulated persons and entities and only for certain violations of the securities laws," (46) the SEC in effect received similar powers through administrative proceedings as it would have had in federal courts. (47)

      Further, during the 1980s, the SEC switched from primarily having a remedial and deterrent purpose--through injunctive and disgorgement remedies--to being "punitive in nature." (48) Historically, the "power to seek 'penalties' in the form of prison sentences, criminal fines and restitution resided solely in the Department of Justice...

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