SEC Moves in the Right Direction with Proposed Amendments to Rules Governing Administrative Proceedings, but the Changes Do Not Go Far Enough

September 28, 2015

​On September 24, 2015, the Securities and Exchange Commission announced it had voted to propose amendments to rules governing its administrative proceedings.  SEC Chair Mary Jo White noted that the "proposed amendments seek to modernize our rules of practice for administrative proceedings, including provisions for additional time and prescribed discovery for the parties."[1]  These proposals follow the SEC’s June 2014 announcement that it intended to bring more cases through administrative proceedings rather than in federal court[2] and the release of the Division of Enforcement’s May 2015 guidance entitled "Approach to Forum Selection in Contested Actions," explaining how the SEC  chooses between administrative proceedings and federal court to litigate its claims.[3] 

The release of the Commission’s proposed amendments coincides with judicial actions challenging the SEC’s administrative process on due process and other constitutional grounds.  Recent court decisions under the Appointments Clause have required the Commission to halt its administrative proceedings in three separate matters on the basis that the manner in which its administrative law judges are appointed likely is unconstitutional.[4]  But the constitutional concerns do not end there:  the SEC continues to face serious criticism–in the media and from lawyers, academics, and federal courts–that the rules governing the SEC’s in-house court system fail to afford respondents a full and fair opportunity to defend themselves.   

The Commission has fended off most of the constitutional challenges by arguing that federal district courts lack jurisdiction to review such challenges pending the conclusion of the Commission’s administrative proceeding.[5]  The proposed rule changes complement the SEC’s judicial defense by providing for greater fairness in the discovery and hearing stages of administrative proceedings.   Whatever the genesis, the proposed rule changes are a step in the right direction.  But they do not appear to go far enough to establish the integrity of the in-house system on which the Commission has come to rely. 

The Proposed Rules Expand the Administrative Proceeding Schedule, but Not by Much

Respondents defending against SEC administrative action frequently complain that the short time afforded to prepare for a hearing is insufficient in light of the complexity of the claims and defenses and size of the records.  For most administrative proceedings, the current rules place a 300-day limit between service of the order instituting proceedings and the issuance of an initial decision by the administrative law judge.  They further impose a maximum of four months from when the order is instituted to begin the administrative hearing.  The Commission’s proposed changes expand these time limits, but not by much. For example, the amended Rule 360 in a 300-day case would permit an administrative hearing to be scheduled up to eight months following the service of the order instituting proceedings, doubling the current deadline of four months.  The amended rule would also run the deadline for the issuance of an initial decision from the time that the post-hearing briefing or briefing of dispositive motions has been completed, rather than from the date of service of the order instituting proceedings. While these amendments commendably would provide respondents with additional time to prepare for their hearings, they do not adequately remedy the discrepancy between the far longer time periods the Division of Enforcement allows itself to investigate and prepare its case, which frequently is measured in years rather than months. 

In addition, the proposed changes fail to allow respondents earlier access to the Division’s investigative file.  Under the current Rule 230(a), the Division must commence making the investigative file available to respondents no later than 7 days after service of the order instituting proceedings.  But the Commission should consider changes that would provide respondents access to these files before instituting proceedings.  Such routine disclosures would not only make the deadlines that follow the initiation of an action more reasonable, but they would also provide respondents with a greater ability to assess their case at an earlier stage and may prompt earlier settlement discussions or more useful Wells submissions.   

The Proposed Rules Make Discovery Available to Respondents, but Not to a Sufficient Degree

Recognizing that respondents frequently need to develop arguments and defenses through deposition testimony, the proposed changes would amend Rule 233 to permit three depositions (for single-respondent cases) or five depositions (for multiple-respondent cases) upon notice.  Each side–respondents and Enforcement Staff–may depose up to three or five witnesses regardless whether the witness provided testimony in the course of the Staff’s investigation.  In contrast, the current rules allow depositions only where a witness is unable to testify at the administrative hearing.  As to the conduct of the deposition itself and use of deposition testimony, the amended Rule 233 is generally consistent with the Federal Rules of Civil Procedure on depositions. 

The proposed rule amendment is significant.  Under the current rules, respondents have virtually no opportunity to discover what a witness might say prior to the witness taking the stand; the Staff discloses as part of the investigative file only transcribed testimony.  However, if the Staff only interviewed a witness during the investigation, respondents receive interview notes only on motion and if they constitute a written statement signed or adopted by a witness to be called at hearing.  If the Staff chose not to interview certain third-parties in the course of its investigation, respondents have no procedural mechanism for discovering potentially relevant testimony. As a result, under the current rules, the hearing would largely be shaped by what testimony the Staff chose to pursue in its investigation.

While the proposed rules appear to recognize this inequity, they do not go far enough in providing respondents with equitable discovery rights essential to preparing their claims and defenses.  In some cases, three or five depositions may be perfectly adequate.  But in complex cases, which the Commission has increasingly authorized to proceed in its in-house courts, three or five depositions per side could be woefully inadequate.  This is particularly true in proceedings against multiple respondents, who may have widely divergent interests and significant differences of opinion as to which witnesses should be deposed.  Particularly as compared to the alternative forum–a federal court where parties are not so nearly limited in discovery–the proposed changes deny  respondents the ability to depose all critical witnesses in complex cases, which generally exceed three or five in total. 

The Proposed Rules Exclude Unreliable Evidence, but Do Not Provide Sufficiently Specific Protections Against Hearsay Evidence 

The Commission proposes to amend Rule 320, which currently excludes all evidence that is irrelevant, immaterial, or unduly repetition, to also exclude evidence that is "unreliable." The amendment would also clarify that hearsay evidence may be admitted if it is relevant, material, and bears satisfactory indicia of reliability so that its use is fair.  While these proposals impose stricter limits on the use of hearsay evidence, they simply do not go far enough to provide equivalent protections against such evidence provided to defendants in federal court proceedings. While the Commission has indicated that this change would bring the rule in line with the Administrative Procedure Act, the pertinent goal should be to make the administrative hearing more akin to a federal trial so that the Commission, which has discretion in choosing a forum, cannot game which evidence gets admitted by forum shopping.  Both fairness and the appearance of fairness mandate this change.    

The Proposed Rules Streamline the Process for Appeals, but Impose Severe Page Limits on Petitions for Review

The Commission also proposes changes to its procedures for appeal, including collapsing the information required in a petition for review.  The current rule requires that the respondent identify every finding and conclusion in the initial decision to which an exception is taken, while the proposed rule would require only a summary statement of the issues presented for review. While this amendment will likely streamline the appeal process and will give respondents additional time to consider those facts and conclusions to which they take exception, the proposed three-page limit on petitions for review may foreclose the opportunity for respondents to adequately present even a summary of the issues presented for review.

The Proposed Changes Impose Deadlines on Commission Decisions, but the Deadlines Are Discretionary

Finally, in the midst of growing criticism regarding the length of time the Commission takes to issue decisions on appeal,[6] the proposed changes also include an amendment aimed at limiting the amount of time the Commission is permitted to issue a decision.  Specifically, the proposed amendment to the Rule 900 Guidelines specify that a decision by the Commission with respect to an appeal from the initial decision of a hearing officer, a review of a determination by a self-regulatory organization or the Public Company Accounting Oversight Board, or a remand of a prior Commission decision by a court of appeals ordinarily will be issued within eight months from the completion of briefing on the petition for review, application for review, or remand order.  If the Commission determines that the complexity of the issues presented in an appeal warrant additional time, the decision of the Commission may be issued within ten months of the completion of briefing.  However, the amendments would contain a provision permitting the Commission to extend this time period as it deems appropriate in its discretion.  While the proposed amendment may signal the Commission recognizes the importance of timely review, the preservation of the Commission’s ability to extend these time limits in its discretion likely provides little comfort to respondents who wait months or even years for a decision.

The Proposed Rule Requiring Electronic Submissions Is a Welcome Change by Practitioners

Finally, in a separate proposed amendment, the Commission has indicated its intent to amend Rule 151(a) to require electronic filings rather than filings in paper or by facsimile.  Practitioners, who have had to hand deliver or fax filings to the Commission in the past, surely will welcome this long-overdue step into the 21st century.  

*     *     * 

While all of the Commission’s proposed changes are a positive step in the right direction, they do not obviate the overarching concern that the Commission’s administrative process will remain unfair.  This is particularly noticeable when the Commission’s proposed amendments are compared to the rights and protections afforded to defendants in federal courts.  Moving closer to what a charged party might receive in federal court is salutary, but the remaining distance underscores that the SEC continues to favor a watered-down adjudicatory process, even in the face of continuing criticism. What would ensue if the proposed changes are adopted — including no jury trial, scant pre-hearing discovery, and appeals from adverse rulings to the Commission itself — simply does not equate to the principles of fairness and independence that predominate in a federal civil proceeding. 

The Commission will seek public comment on the proposed rule amendments for sixty days following each proposal’s publication in the Federal Register.  It remains to be seen whether the Commission will continue to hear and address practitioners’ concerns.    

 


 

   [1]   See SEC Press Release "SEC Proposed Changes to Amend Rules Governing Administrative Proceedings." Sept. 24, 2015, available at http://www.sec.gov/news/pressrelease/2015-209.html.

   [2]   See Andrew Ceresney, Keynote Speech at New York City Bar 4th Annual White Collar Institute, May 12, 2015, available at http://www.sec.gov/news/speech/ceresney-nyc-bar-4th-white-collar-key-note.html; Joel Cohen et al., SEC Plans to Play Insider-Trading Cases on Home Court, NATIONAL LAW JOURNAL, Sept. 16, 2014. 

   [3]   Division of Enforcement’s "Approach to Forum Selection in Contested Actions," May 18, 2015, available on the Division of Enforcement’s home page at http://www.sec.gov/enforce; see also Joel Cohen and Bennett Rawicki., Op-Ed: Welcome News from the SEC on Forum Selection, National Law Journal, June 1, 2015. 

   [4]   See Hill v. SEC, No. 1:15-cv-01801-LMM, 2015 WL 4307088, at *42 (N.D. Ga. June 8, 2015); Duka v. SEC, No. 1:15-cv-003570RMB, 2015 WL 4940083, at *2 (S.D.N.Y. Aug. 12, 2015); Gray Financial Group v. SEC, No. 1:15-cv-00492-LMM, Dkt. No. 56, at *13-14 (Dist. Ga. Aug. 4, 2015). 

   [5]   Most recently, the Commission prevailed on such an argument before the Seventh Circuit, which issued an opinion finding that the Commission has exclusive jurisdiction over due process and equal protection claims throughout the entirety of the administrative process. See Bebo v. SEC, No. 15-C-3, 2015 WL 4998489, at *9-10 (7th Cir. Aug. 24, 2015).

   [6]   For example, on July 24, 2015, Law360 published an article titled "SEC Admin Court Appeals Languish Under White," available at http://www.law360.com/articles/682264/exclusive-sec-admin-court-appeals-languish-under-white. Law360 had examined five years of commission opinions, from July 2010 through July 2015, and determined that the Commission has taken on average six months longer to decide appeals during Mary Jo White’s tenure when compared to her predecessor.  On average, such appeals are now taking nearly a year and a half to decide, with many cases pending far past that window of time.  

   

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