Litigating an SEC Administrative Proceeding
by Luke T. Cadigan
Under its new Chair, Mary Jo White, the U.S. Securities and Exchange Commission (the “SEC”) has undertaken a more aggressive approach to enforcement, utilizing numerous new weapons at its disposal. In connection with this approach, the SEC has indicated that it intends to try more cases in the SEC’s administrative forum, a place with which relatively few attorneys are familiar.
Previously, the SEC could bring cases in this forum only when the respondents were regulated entities, such as investment advisers and broker-dealers, or individuals associated with such entities. The Dodd-Frank Act of 2010 expanded the forum’s jurisdiction so that the SEC can now bring as administrative cases essentially all the same cases it can bring in federal court. Assuming an enforcement action can be brought in either forum, the SEC can choose where it wants to litigate and the putative defendant/respondent has no voice in the matter. The SEC has numerous advantages when it brings a case in the administrative forum. This article will describe briefly some of the features that can make the SEC’s administrative forum an often challenging place to try a case. Nonetheless, armed with an understanding of these features, savvy counsel for respondents can often turn these features to their advantage.
Administrative Law Judges
There are no jury trials in SEC administrative proceedings (“APs”). All cases are tried to a single SEC administrative law judge (“ALJ”), who handles nothing but SEC matters. Once you know which ALJ has been drawn, you should review all the decisions issued by that ALJ. Particularly given the specialized nature of the forum, there are likely to be one or more decisions addressing issues in your case. These decisions may give you a sense of how the ALJ is likely to rule on particular issues and, of course, you will want to cite any favorable decisions in your briefs and distinguish the unfavorable ones. The ALJ’s decisions will also give you a template for structuring your proposed conclusions of law, findings of fact, and briefs. You will also want to talk to counsel who have tried cases before the ALJ to learn the ALJ’s preferences and pet peeves.
APs are governed by the SEC’s Rules of Practice (the “Rules”), which can be found on-line at http://www.sec.gov/about/rulesprac2006.pdf. The SEC commences an AP with an Order Instituting Proceedings (“OIP”), which contains the Division of Enforcement’s (the “Division”) allegations against the respondent(s) and serves as the charging document. A respondent has twenty days from service of the OIP to file an answer.
The ALJ will usually accommodate requests to have prehearing conferences conducted by telephone. The hearing itself will be conducted at a place designated by the ALJ with input from the parties “with due regard for the public interest and the convenience and necessity of the parties, other participants, or their representatives.” Rule 200(c). The location chosen is usually that most convenient to the witnesses and respondents and may even be moved mid-hearing depending on what witnesses are scheduled to testify.
In the OIP, the SEC will state whether the ALJ has 120, 210, or 300 days from the OIP service date in which to render its decision (the “Initial Decision”). This determination is made based on the “nature, complexity, and urgency of the subject matter.” Rule 360(a)(2). Most litigated APs are sufficiently complex to warrant the 300-day deadline. Assuming such a deadline, the ALJ will typically issue a scheduling order providing for only approximately four months from the service of the OIP to the hearing. The parties would then be given another approximately two months to obtain hearing transcripts and submit post-hearing briefs and proposed findings of fact and conclusions of law. The ALJ issues the Initial Decision approximately four months after briefing.
Given the expedited schedule and the head start that the Division will have by virtue of its investigation, respondent’s counsel should start preparing for the hearing as soon as possible. You should be ready to receive the Division’s investigative file shortly after service of the OIP, anticipate how the Division is likely to put on its case, prepare your cross-examination of the Division’s witnesses and presentation of your own case, and think through (if not write up) your position on the various legal and evidentiary issues that are likely to arise. Indeed, the optimal approach would be to start as soon as is practical a rough draft of your post-hearing brief, as well as of the proposed conclusions of law and findings of fact, so that you have a good feel for the facts that you will need to elicit at the hearing and those you will likely have to challenge. Assuming you submitted a “Wells submission” to the SEC staff, setting forth the reasons no action should be brought, it should provide a good starting point for these documents. You should also remember that the Division, which typically does not have the resources to dedicate numerous attorneys to any one hearing, will have its own challenges preparing to try a case on such an expedited schedule.
The Rules require the Division to turn over their investigative files, including any documents containing material exculpatory evidence (i.e., Brady material) within seven days after service of the OIP. Rule 230(d). The Division is permitted to withhold, among other items, privileged documents, work product, internal memoranda, notes and certain other writings prepared by SEC employees, as well as documents that would disclose the identity of a confidential source. See Rule 230(b). Clearly, respondent’s counsel needs to review the Division’s investigative files quickly and thoroughly. These files will reveal the facts and witnesses upon which the Division is relying. They may also show the facts and witnesses that undercut the Division’s case and reveal gaps in its investigation.
In addition, the Rules provide for production of documents pursuant to subpoenas in advance of the hearing. Rule 232. A party may serve a subpoena for documents on anyone, including a third-party or the SEC itself. Subpoenas for documents or to provide testimony at the hearing may be served nationwide. See 15 U.S.C. § 78u(b). With limited exceptions (e.g., Jencks material/witness statements, depositions to preserve testimony of witnesses unlikely to be able to attend the hearing), there is no other discovery permitted in an AP.
Given the limitations on formal discovery (such as depositions), you should make use of the Rule 232 subpoenas as appropriate and consider what informal discovery you can undertake. For example, you may be able to speak informally with potential witnesses with an eye toward calling or cross-examining them at the hearing.
The Rules provide that a party tendering an expert provide only a brief summary of expected testimony, a statement of qualifications, a list of other proceedings in which the expert has testified, and a list of publications authored. However, ALJs will often also require production of an expert report.
Admissibility of Evidence
In SEC administrative proceedings, ALJs are to admit all relevant evidence or, put another way, all evidence which “can conceivably throw any light upon the controversy.” Jesse Rosenblum, 47 S.E.C. 1065, 1072 (1984). If there is any doubt as to admissibility, ALJs are expected to admit the evidence. See City of Anaheim, 54 S.E.C 452, 454 & n.7 (1999). Even hearsay is admissible. Leslie A. Arouh, 99 SEC Docket 32306, 32323 (Sept. 13, 2010). The low threshold for admissibility is based on the premise that the ALJ and the SEC are capable of assigning appropriate weight to marginally relevant evidence. However, this threshold is not without limits. ALJs are required to exclude all evidence that is “irrelevant, immaterial or unduly repetitious.” Rule 320.
Notwithstanding the low threshold for admission of evidence, respondent’s counsel should strive to develop the relevance of the evidence they present and, as appropriate, to undercut that evidence presented by the SEC. Even though all the evidence will likely be admitted, you will want to make sure that the ALJ assigns appropriate weight to it. Also, despite the low threshold and assuming you do not do so too many times, you should not be hesitant to challenge any evidence that you believe to be “irrelevant, immaterial or unduly repetitious.”
Unlike actions in federal court, there is very little motion practice permitted in administrative proceedings. Little discovery generates commensurately little discovery motion practice.
As a practical matter, there are also no dispositive motions prior to the hearing. The Rules provide that a motion for summary disposition be granted “if there is no genuine issue with regarding to any material fact and the party making the motion is entitled to a summary disposition as a matter of law.” Rule 250(b). However, summary disposition is usually reserved only for follow-on actions brought by the Division seeking relief on an underlying judgment in a related matter, (e.g., an industry bar following a guilty plea) or those seeking to revoke registration of securities. As the revision comments to the Rule indicate, “the circumstances when summary disposition prior to hearing could be appropriately sought or granted will be comparatively rare.” 59 SEC Docket 1546, 1576 (June 9, 1995). During the hearing, at the close of the Division’s case, a respondent may make a motion for summary disposition the same way one might make a motion for a directed verdict in a federal action.
Because most motions are disfavored or not even permitted, counsel for respondents should think carefully before filing such a motion about whether it is necessary and permitted under the Rules.
Parties seeking to appeal the Initial Decision may make an appeal to the SEC itself, which will consider the record in the case, entertain briefing and argument, and render its opinion on a de novo basis, making credibility assessments as necessary from the written record. But because the SEC initially determined that there was a sufficient basis for bringing the action, a respondent has a difficult task in convincing the SEC upon appeal that there is no basis for liability.
A respondent may appeal any opinion by the SEC to the Court of Appeals for the District of Columbia or for the Circuit in which the respondent resides or has its principal place of business. See 15 U.S.C. § 78y(a)(1), 15 U.S.C. § 77i. Respondents who are concerned about a first appeal to the SEC should also appreciate that the D.C. Court of Appeals has not been a hospitable forum for the SEC.
The SEC has made clear that it will start trying more cases in its administrative forum. Defendants who had hoped to fight the SEC’s allegations in federal court may find that they are instead respondents in an AP and thus without many of the weapons they had hoped to use, such as the right to a jury, expansive discovery, dispositive motions, evidentiary challenges, or even much time to prepare for trial. The key to succeeding in this forum notwithstanding the absence of these weapons is understanding the unique features of the forum and preparing accordingly. Indeed, a respondent who does so may find that there are advantages to litigating in the administrative forum. A respondent who sees and presses these advantages will get a prompt hearing and has a fair shot of getting a favorable result much more quickly and less expensively than one generally would in federal court.
Luke Cadigan is a partner in the Government Enforcement Group of K&L Gates LLP (Boston office). Prior to joining K&L Gates, Mr. Cadigan was an Assistant Director and a Senior Trial Counsel in the SEC’s Enforcement Division. During his nine years at the SEC, he successfully tried several matters, both in federal court and the SEC’s administrative forum.