SEC Reforms Administrative Hearings Part 1

Guest Post by Expert Geoff Winkler

In Part 1, we will review the background and recent critiques of the Rules of Practice that govern Securities and Exchange Commission ("SEC") administrative proceedings. In part 2, we will then look at the reforms, newly approved by the SEC, to these proceedings and discuss their impact.

Introduction

On Wednesday of this week, the SEC approved reforms to its Rules of Practice (the “Rules”) that govern its in-house adjudication system (the administrative proceeding) in order to “…introduce additional flexibility into administrative proceedings, while continuing to provide for the timely and efficient resolution of the proceedings,” according to the SEC fact sheet. These reforms, based on the proposed rule that the SEC issued in September 2015, were in response to calls for change to the Rules from the financial industry, Congress and the courts.

Background

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the SEC was provided increased authority to bring more internal enforcement actions. However, unlike a federal district court, the SEC’s administrative hearings lack a number of due process protections which would otherwise normally be provided. Instead, they feature shortened preparation time, limited discovery, allowance of hearsay evidence, and no trial by jury. The SEC argues that these rules are necessary to ensure the timely and efficient resolution of the proceedings.

According to former SEC Commissioner and current Stanford University law professor Joseph Grundfest in his December 2015 testimony to Congress, this has created a “…crisis of confidence over the fairness of its internal administrative procedures.” These feelings are supported by a Wall Street Journal (“WSJ”) analysis of SEC decisions from October 2010 through March 2015 that found that the SEC enjoys a significant “home-court advantage,” winning 21% more of its cases brought through internal administrative hearings versus federal court cases.

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This significant home-court advantage, according to Scott Garrett, Chairman of the House Subcommittee on Capital Markets and Government Sponsored Entities, illustrates a “very troubling pattern of the SEC’s attempting to stack the rules and process in a way that the outcome of the case is, well, predetermined.”

The courts have also weighed in on this issue, with mixed results, as defendants have begun to challenge the constitutionality of these administrative hearings. In August 2015, the Seventh Circuit Court of Appeals in Bebo v. SEC ruled in favor of the SEC, stating, “courts consistently require plaintiffs to use the administrative review schemes established by Congress” even if expensive or flawed. However, federal district courts in Georgia and New York have issued injunctions to stop SEC administrative hearings because the SEC’s process for appointing internal judges was “likely unconstitutional.”

To be continued next week.