One of the controversies in which the SEC recently has found itself involved has been the agency’s use of its own in-house administrative tribunals, where some believe that the agency has an unfair advantage. The increased use of its administrative courts has also drawn court challenges. In the following guest post, Elan Kandel, a Member at the Cozen O’Connor law firm, and Neil Lipuma, Senior Vice President, Underwriting Leader—Financial Services of Hiscox USA take a look at the controversies surrounding the SEC’s use of its administrative tribunals and examines the recent court challenges to the agency’s practices.
I would like to thank Elan and Neil for their willingness to publish their guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to readers of this blog. Please contact me directly if you would like to submit a guest post. Here is Elan and Neil’s guest post.
Earlier this month, the American League won this year’s Major League Baseball All-Star Game. The winner of the annual All-Star Game enjoys home-field advantage for the World Series. Some have questioned whether there is actually a correlation between “home-field advantage” and winning the World Series. There is nothing to question – there is a distinct advantage. Since 1985, the team with the home-field advantage has won 23 of 29 World Series.
The home field advantage extends beyond Major League Baseball. The Securities and Exchange Commission (SEC) enjoys a pronounced home-field advantage when trying enforcement actions in its own administrative courts as opposed to federal district courts. According to a recent analysis in The Wall Street Journal, the SEC “[w]on against 90% of defendants before its own judges in contested cases from October 2010 through March of this year.” For fiscal year 2014, U.S. District Court Judge Jed Rakoff remarked that the SEC had won 100% of the actions tried in its administrative courts, while its success rate in federal court for the same period of time was only 61%.
Given the significant disparity between the SEC’s success rate in its own administrative courts as compared to federal district courts, it is not surprising that SEC officials have publicly stated that the agency intends on bringing more of its cases as administrative proceedings. As one SEC official aptly noted, “It’s fair to say it’s the new normal.” With administrative proceedings comprising 81% of the enforcement actions filed by the SEC in 2014, it is indeed fair to say that the SEC’s use of administrative proceedings as the preferred enforcement venue is the agency’s “new normal.”
The SEC’s stated rationale for its decision to bring more of its cases as administrative proceedings is that it is simply making use of its new authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) to pursue monetary damages against non-regulated entities through administrative proceedings, rather than in federal court.
For those facing an enforcement action in an SEC in-house court, there are both distinct differences and disadvantages to a SEC in-house proceeding as compared to a civil action in federal district court. First, in administrative proceedings, the prosecutor is an SEC-employed attorney; there is no jury, and cases are presented to administrative law judges (ALJ), who also are SEC employees.
Additionally, in contrast to a civil action in federal district court, in which litigants are entitled to broad discovery, including depositions, administrative respondents are generally barred from taking depositions.
The Federal Rules of Evidence also do not apply in SEC administrative proceedings. Instead, “[a]ll evidence that can conceivably throw any light upon the controversy at hand should normally be admitted,” including hearsay.
Moreover, unlike civil actions in federal district court that are not subject to prescribed deadlines, in SEC administrative proceedings, an evidentiary hearing must occur within four months from the date on which the SEC issued its order instituting the proceeding, and the ALJ’s decision must be issued within 300 days of the instituting order. Respondents frequently find the SEC prescribed deadlines unduly burdensome, particularly when the SEC has had years to prepare its case, and the SEC’s investigative file is comprised of thousands of documents.
The ALJ’s decision is appealable to the SEC’s five-person Commission – the same body that brought charges against the respondent in the first place. As The Wall Street Journal has found, the Commissioners ruled in the agency’s favor in 95% of the appeals decided from January 2010 through March 2015. The agency’s staggering internal appellate success rate is not surprising given that, in SEC administrative proceedings, as one former SEC official recently commented, “the commission is akin to the prosecutor and then, in an appeal, the judge in the same case.” Only after the Commission’s final order becomes effective, may the order be appealed to a United States Court of Appeals, and then respondents must overcome the standard of appellate review that generally defers to the expertise of administrative agenies when the Court of Appeals reviews SEC orders.
With the odds increasingly stacked against respondents when the SEC enjoys home-field advantage, some respondents have mounted judicial challenges to the SEC’s ability to pursue enforcement actions in its in-house courts. It was not until last month, however, that a federal district court accepted subject matter jurisdiction over the challenge and found that the challenging party was likely to succeed on the merits of the claim. In Hill v. SEC, after first addressing and accepting subject matter jurisdiction, the U.S. District Court for the Northern District of Georgia found that the SEC’s ALJ appointment scheme is likely unconstitutional, as it does not comply with the Appointments Clause of Article II. The Appointments Clause mandates that “inferior officers” may be appointed by the President alone, by the heads of departments, or by the Judiciary. SEC ALJs are not appointed by the President, the judiciary or the SEC Commissioners. Instead, they are hired by the SEC’s Office of Administrative Law Judges with input from the Chief Administrative Law Judge and the Office of Personal Management.
The Hill court found that ALJs are inferior officers (as opposed to mere employees) and, as such, their appointment must comply with the Appointments Clause. Finding that their appointment does not comply with the Appointments Clause because SEC ALJs are not directly appointed by the SEC Commissioners, the Hill court granted Hill’s motion to preliminarily enjoin the SEC from conducting the administrative proceeding brought against Hill.
In the wake of Hill, several other SEC administrative forum respondents have filed judicial challenges latching onto the “inferior officer” argument, but thus far, Hill remains the only case to have been decided squarely in a respondent’s favor. It should be noted, however, that the SEC has appealed the District Court’s order to the Eleventh Circuit Court of Appeals. In addition, appeals are also pending before the Second and Seventh Circuit Courts of Appeals. Unless the Circuits decide the pending appeals uniformly, a split among the Circuits increases the likelihood that the jurisdictional and constitutional issues will ultimately be decided by the Supreme Court. Until this occurs, respondents may want to strongly consider challenging the SEC’s use of its in-house courts in an effort to level the playing field by depriving the SEC of its home-field advantage.
 Anthony Castrovince, Home Field in World Series a big advantage for AL, MLB.com., July 15, 2015, available at http://m.mlb.com/news/article/136761940/american-league-has-home-field-in-world-series (last visited July 16, 2015).
 Jean Eagelsham, SEC Wins With In-House Judges, Wall St. J., May 6, 2015.
 Nate Raymond, U.S. judge criticizes SEC use of in-house court for fraud cases, Reuters, Nov. 5, 2014, available at http://www.reuters.com/article/2014/11/05/us-sec-fraud-rakoff-idUSKBN0IP2EG20141105 (last visited July 16, 2015).
 Sarah N. Lynch, U.S. SEC to file some insider-trading cases in its in-house court, Reuters, June 11, 2014, available at http://www.reuters.com/article/2014/06/11/sec-insidertrading-idUSL2N00S1AT20140611 (last visited July 16, 2015).
 Jean Eagelsham, SEC Is Steering More Trials to Judges It Appoints, Wall St. J., Oct. 21, 2014.
 See Ryan Jones, The Fight over Home Court: An Analysis of the SEC’s Increased Use of Administrative Proceedings, Southern Methodist University Law Review (forthcoming), at p. 125, available at http://papers.ssn.com/sol3/papers.cfm?abstract_id=2589703.
 In the Matter of the Application of Jay Alan Ochanpaugh, Release No. 54363 (Aug. 25, 2006), 88 SEC Docket 2510, 2006 WL 2482466, at *6 n. 29.
 Jean Eagelsham, SEC Wins With In-House Judges, Wall St. J., May 6, 2015.
 See e.g., Duka v. SEC, No. 15 Civ. 357, 2015 WL 1943245 (S.D.N.Y. Apr. 15, 2015) (finding subject district court jurisdiction, but holding that plaintiff failed to demonstrate a likelihood of success on the merits); Bebo v. SEC, No. 15-00003, 2015 WL 905349 (E.D. Wis. Mar. 3, 2015), appeal pending, No. 15-1511 (7th Cir.) (no district court jurisdiction to hear challenge); Chau v. SEC, __ F. Supp.3d __, No. 14-CV-1903, 2014 WL 6984236 (S.D.N.Y. Dec. 11, 2014) (finding that the Exchange Act’s review scheme precluded suit to enjoin administrative proceedings).
 No. 15-CV-1801 (N.D. Ga. June 8, 2015), appeal pending¸15-12831-C (11th Cir.).
 Ironridge Global Partners, et al. v. SEC, No. 15-CV-02512 (N.D. Ga.) (complaint filed on July 15, 2015); Spring Hill Capital Partners, LLC v. SEC, No. 15-CV-4542 (S.D.N.Y. June 26, 2015) (district court lacked jurisdiction); Tilton, et al. v. SEC, No 15-CV-2472 (S.D.N.Y. June 30, 2015) appeal pending . 15-2103 (2nd Cir) (no district court jurisdiction to hear challenge); Timbervest, LLC, et al. v. SEC, 15-CV-2106 (N.D.Ga.) (complaint filed on June 12, 2015).