SEC Behind Times in 'Modernizing' Administrative
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www. NYLJ.com
thursday, november 5, 2015
Volume 254—NO. 88
Expert Analysis
Corporate Crime
SEC Behind Times in ‘Modernizing’ Administrative Proceedings
B
y availing itself of the increased authority provided by the Dodd-Frank Wall Street Reform and Consumer Protection Act, the U.S. Securities and Exchange Commission has been bringing more enforcement actions than ever before, and making more use of its inhouse adjudication system—the administrative proceeding. With a reported 90 percent success rate in actions litigated in the administrative forum, compared with a noticeably lower 69 percent success rate in actions brought in federal district court over the same period,1 the SEC has come under fire from commentators, lawyers, and judges for depriving respondents of their due process rights. Amid this flurry of criticism, and coming on the heels of several successful constitutional challenges to the administrative system, the SEC has proposed amendments to its Rules of Practice in an apparent effort to provide a more fair process for respondents. These proposals, although a step in the right direction, still do not go far enough to leveling the playing field for respondents.
The Call for Change The structure of SEC administrative proceedings, and the rules g overning
William F. Johnson is a partner in the Special Matters and Government Investigations Practice Group at King & Spalding. Associate Yelena Kotlarsky assisted in the preparation of this article.
By William F. Johnson
the administrative process, create significant advantages for the SEC. Administrative proceedings are conducted pursuant to the SEC’s procedural rules (SEC Rules of Practice), and are brought before administrative law judges (ALJs) hired by the SEC. A respondent who disagrees with the ALJ’s decision must appeal to the SEC itself, and only afterward can appeal
The SEC’s administrative process is seen by many as a “homecourt advantage,” and it has been called into question by several judges, and recently Congress. the SEC’s decision to a federal court. Unlike a proceeding in district court, administrative proceedings lack several key due process protections, most notably the right to full discovery, the right to a jury trial, and the exclusion of hearsay evidence.2 The SEC’s administrative process is seen by many as a “home-court advantage,” and it has been called into question by several judges, and recently
Congress. Scott Garrett, Chairman of the House Subcommittee on Capital Markets and Government Sponsored Entities, has commented that the administrative process 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, pre-determined.”3 The SEC has consistently fought such criticism. Andrew Ceresney, Director of the Enforcement Division, has attempted to defend the administrative process, stating that it produces “prompt decisions,” gives respondents “more flexibility in offering evidence,” and has the benefit of “specialized factfinders” who “develop expert knowledge of the securities laws.”4 The SEC’s attempts to justify the fairness of the administrative process are beginning to sound hollow. Meanwhile, others within the agency have acknowledged the need for change. Former SEC ALJ Lillian McEwen commented that the administrative process was biased against respondents and felt that the burden fell on them to disprove the allegations of the SEC.5 SEC General Counsel Annie K. Small admitted as early as last year that suggestions to revise the rules for administrative proceedings are “entirely reasonable” given that it has been “quite some time” since the rules were revised.6 Indeed, the SEC’s Rules of Practice were last updated almost ten years ago, in 2006, before the Dodd-Frank Act broadened the
thursday, november 5, 2015
SEC’s ability to bring more cases in the administrative forum.7 As the tide of recent challenges to the fairness and constitutionality of the SEC’s administrative process has risen, the SEC finally appears to be getting the message.
Proposed Amendments Thus, although with one breath the SEC continues to maintain that the “administrative forum is eminently proper, appropriate, and fair to respondents,” 8 on Sept. 24, 2015 the Commission released several proposed amendments to its Rules of Practice. SEC Chair Mary Jo White called the proposed amendments an effort to “modernize rules of practice for administrative proceedings”9 and the proposal itself states that the amendments “introduce additional flexibility”10 into the administrative process. In what appears to be a step toward providing greater fairness for respondents, the proposed amendments address several key areas of criticism. Three of the most significant changes include: (1) permitting parties to take a limited number of depositions, (2) prohibiting “unreliable” evidence at hearings, and (3) extending the time before a hearing must begin. Although the proposed amendments are an improvement, they are still a very small step in the direction of what would truly be required to level the playing field between respondents and the SEC.
Depositions One of the most unfair aspects of administrative proceedings, compared to district court, is the restriction placed on respondents’ ability to obtain discovery from witnesses. Under the current rules, although respondents can serve subpoenas for documents or trial testimony, pre-trial depositions are not avail-
able except in the rare instance in which a witness will be unavailable to testify at trial.11 In situations where a witness did not testify during the SEC’s i nvestigation (and therefore no transcript is produced in discovery), respondents must call the witness to the stand with no knowledge of what the witness will say and no opportunity to develop in advance material that would undermine or impeach that witness’s testimony. And even for witnesses who did testify during the SEC’s investigation, the respondent’s counsel, who was not present, had no opportunity to learn whether the witness possessed facts material to the defense or to attempt to impeach
In stark contrast to federal district court, in administrative proceedings administrative law judges must admit all evidence that “can conceivably throw any light upon the controversy.” the testimony. The SEC, on the other hand, has years of time within which to question witnesses in order to attempt to develop evidence to support its case. The proposed amendment to Rule 233 would permit each party to depose either three people (in matters involving a single respondent), or an aggregate of five people (in matters involving multiple respondents).12 The new ability to depose individuals before trial will allow respondents to gather a modest additional amount of information from witnesses beyond the limits of what the SEC provides in its investigative record. But the proposed rule does not even come close to “leveling the playing field” between respondents and the SEC. One significant shortfall is that the proposed rule provides for the same number of depositions for both respondents and the Enforcement
Division. In multi-respondent cases, this means respondents who may have divergent interests must collectively decide which precious few individuals to depose. Even where interests of respondents are aligned, the number of relevant witnesses is highly likely to be greater than five. Therefore, this “collective” restriction is arbitrarily harsh and fails to reflect a realistic number of relevant witnesses in cases involving multiple respondents. The Enforcement Division, on the other hand, has the opportunity before bringing the enforcement action to gather testimony from an unlimited number of witnesses. Because the Enforcement Division starts the investigation from such an advantageous position, allowing an arbitrary three or five depositions per side does not provide real procedural protections for respondents. Moreover, with the Enforcement Division bringing more complex cases in the administrative forum, there is an increased likelihood that a significant number of witnesses will be relevant to explain the facts of a given case. The SEC’s release proposing the rule change does not even attempt a justification for the low number of depositions to be permitted. The SEC’s implication that three or five depositions is sufficient is belied by the number of witnesses that the Enforcement Division itself has called to testify at trial. In two recent cases involving single respondents, the Enforcement Division called nine witnesses at trial, and a look at the administrative hearings held over the past year reveals an average of eight witnesses called by the Enforcement Division. 13 In these cases, the eight or nine total trial witnesses for the government likely represents a subset of a larger number of witnesses who testified during the investigation or who have relevant information, including those who may have information useful to the defense. Plainly, the SEC’s modest
thursday, november 5, 2015
proposal will not facilitate the deposition of all key witnesses, especially in complex, multi-respondent cases. Whatever specific limit the new rule places on the number of depositions, the rule should also grant the ALJ discretion to allow additional depositions for good cause shown in a given case. After all, what is the SEC afraid of? If the SEC is truly confident in its case, it should permit a greater number of witnesses to be deposed, and if it has marshalled sufficient proof, it will prevail at trial regardless of the number of depositions conducted during discovery. If the concern is time and resources, the additional amount of time necessary to permit the depositions to occur is a small price to pay when compared to the enhanced due process those depositions would provide.
Exclusion Of “Unreliable” Evidence In stark contrast to federal district court, in administrative proceedings ALJs must admit all evidence that “can conceivably throw any light upon the controversy.”14 Although ALJs must exclude evidence that is “irrelevant, immaterial, or unduly repetitious,”15 SEC precedent dictates that if there is a doubt as to admissibility, the evidence should be admitted.16 According to the Commission, the Rules are permissive because they presume that ALJs can determine what evidence is more or less relevant and assign the proper weight to such evidence accordingly.17 The proposed amendment to Rule 320 purports to impose stricter limits on admissibility by directing ALJs to exclude evidence that is not only irrelevant, immaterial, or unduly repetitious, but also “unreliable.”18 While the Federal Rules of Evidence prohibit unreliable evidence through specific exclusions, the SEC’s proposed amendment provides no guidance about what constitutes “unreliable” evidence. In fact, it specifically clari-
fies that hearsay evidence should still be admitted if it is “relevant, material, and bears satisfactory indicia of reliability so that its use is fair.”19 The Rules leave the determination of reliability solely to the discretion of the ALJs. In practice, ALJs who admit hearsay evidence sometimes take pains to describe why the hearsay is reliable, corroborated by other evidence, or admissible under an exception to the hearsay rule.20 In Guy P. Riordan, for example, the judge admitted hearsay statements that two government witnesses made during an FBI interview. The judge explained that the evidence was reliable because, among other things, one of the witnesses testified at the hearing and confirmed his prior statements, and the hearsay was corroborated by other non-hearsay evidence.21 If hearsay is admitted in administrative proceedings because it meets the standards of district court, there is less cause for concern. But when administrative proceedings don’t follow district court standards, there is more opportunity for unfairness to infect the case. Occasionally, hearsay evidence deemed admissible in administrative hearings has been set aside on appeal as unreliable.22 There does not appear to be any principled basis for having a different standard of admitting hearsay between administrative proceedings and district court cases. If the SEC’s case is so thin that it depends on rank hearsay not admissible in district court in order to meet its burden of proof, perhaps the case should not have been brought in the first place. Whether or not other administrative agencies permit hearsay under the Administrative Procedure Act, the SEC has an opportunity to establish an administrative fact-finding system that distinguishes itself in a positive way, instead of hiding behind an archaic, unfair process. When the SEC has had the opportunity to gather
its evidence over a period of years before commencing a proceeding, relaxed evidentiary s tandards only deepen the inequity between the parties.
Lengthened Pre-Hearing Schedule Another proposed change to the administrative process is to slightly lengthen the time before a hearing commences to allow the parties more time for discovery. Administrative proceedings operate on an expedited schedule, and have been lauded by the SEC for producing “prompt decisions,” 23 although this claim is questionable when the lengthy time for the process of appealing to the Commission and receiving a decision is factored in. When the Enforcement Division institutes a proceeding, it indicates in its charging document (the Order Instituting Proceedings or OIP) whether the ALJ has 120, 210, or 300 days from the commencement of a proceeding to issue a decision. If the deadline is 300 days, the hearing begins within a maximum of four months from service of the OIP.24 This gives respondents a very short time to read the SEC’s voluminous investigative file, evaluate the merits of the Commission’s case, gather documents from potential witnesses, and prepare a defense. The proposed amendment to Rule 360 allows parties additional time to prepare prior to the administrative hearing. For example, in 300-day cases, hearings must no longer begin within four months from commencement of the proceeding, but can now begin within eight months.25 According to the SEC, the new amendment would provide “additional flexibility during the prehearing phase” to conduct discovery, and would allow respondents “more time to review electronic documents in cases involving an electronic production from the Division.”26 Extending time for discovery is an
thursday, november 5, 2015
improvement over the current scheme, but it does not materially increase the time for defendants to prepare a meaningful defense. This is especially true considering the significant head start that the Enforcement Division has due to its ability to investigate respondents long before bringing an action. The new eight-month timeframe also sharply contrasts with the length of time permissible in federal court, which allows parties to conduct discovery often for a year or longer before going to trial.27 Particularly in more complex cases, it is common to spend months combing through the extensive documents produced by the SEC that were collected from relevant parties. In a recent well-publicized case brought against investment adviser Wing Chau and his firm Harding Advisory LLC, the Enforcement Division’s investigative file was reportedly larger than the entire printed Library of Congress.28 Although the Rules of Practice permit postponement of the hearing for “good cause shown,” the SEC denied the respondents’ request in that case for additional time to review the expansive record. The proposed limited extension of time, coupled with the ALJs’ record of denying postponements even in highly complex matters, is insufficient to improve the gaping discrepancies between the Commission’s in-house forum and federal court.
Better, But Not Good Enough The proposed amendments to the SEC Rules of Practice represent a step, if still a small one, in the right direction and seem to acknowledge the criticisms that have recently targeted the administrative process. For this, the SEC deserves credit. Nevertheless, the proposals still leave much to be desired in a forum that so heavily favors the SEC. For that, the SEC can do better. Even with the changes, respondents have little time to prepare for hear-
ings, and discovery remains extremely circumscribed. The SEC’s inflexible limit on the number of permissible depositions, and its continued reliance on evidence that federal courts have deemed per se unreliable plainly illustrate that this supposed “modernization” of the Rules of Practice is not much of an update. Broader changes are necessary to bring the administrative process more in line with federal court proceedings. The SEC is seeking public comment on the proposed amendments for 60 days following each proposal’s publication in the Federal Register, and it remains to be seen whether continued criticism may lead the Commission to alter its proposal. Hopefully, after reviewing the comments, the SEC will expand the number of depositions and the time period within which hearings must occur, and will reconsider its use of hearsay in administrative proceedings. The federal district courts have adapted over the years to advances in litigation practices. But, the SEC’s proposed “modernization” of its Rules of Practice is still out of date and out of step. ••••••••••••••••
•••••••••••••
1. See Jean Eaglesham, “SEC Wins With In-House Judges,” WALL ST. J. (May 6, 2015). 2. See William Johnson, “SEC’s Administrative Enforcement Intensifies Fairness Debate,” N.Y.L.J. (Nov. 6, 2014). 3. Scott Garrett, Subcommittee Chairman, House Subcommittee on Capital Markets and Government Sponsored Entities, Hearing on the Oversight of the SEC’s Division of Enforcement, March 19, 2015. 4. Andrew Ceresney, Director, SEC Division of Enforcement, Remarks to the American Bar Association’s Business Law Section Fall Meeting, Nov. 21, 2014 (recognizing that the Enforcement Division’s use of administrative proceedings has been viewed as unfair, Ceresney responded that he categorically “reject[s] that assertion”); see also Andrew Ceresney, Director, SEC Division of Enforcement, Keynote Speech at New York City Bar 4th Annual White Collar Institute, May 12, 2015. 5. Eaglesham, supra note 1. 6. Daniel Wilson, “SEC Administrative Case Rules Likely Out Of Date, GC Says,” LAW360 (June 17, 2014). 7. See Claudius O. Sokenu et al., Shearman and Sterling, “Securities Enforcement 2015 Mid-Year Review,” at 3 (August 6, 2015). 8. Andrew Ceresney, Remarks to the American Bar Association’s Business Law Section Fall Meeting, supra note 4.
9. Press Release, “SEC Proposes to Amend Rules Governing Administrative Proceedings” (Sept. 24, 2015). 10. Securities and Exchange Commission, Release No. 34-75976, Amendments to the Commission’s Rules of Practice at 3. 11. SEC Rule of Practice 233. 12. Securities and Exchange Commission, Release No. 34-75976, Amendments to the Commission’s Rules of Practice, at 7. 13. In re Natural Blue Resources, Inc., et. al., Adm. Proc. File No. 3-15974 (Aug. 18, 2015); In re Khaled A. Eldaher, Adm. Proc. File No. 3-16326 (Aug. 17, 2015); In re David. J. Montanino, Adm. Proc. File No. 3-15943 (Apr. 16, 2015); In re Thomas R. Delaney II and Charles W Yancey, Adm. Proc. File No. 3-15873 (March 18, 2015); In re Julieann Palmer Martin, Adm. Proc. File No. 3-15613 (March 9, 2015); In re Stanley Jonathan Fortenberry, et. al., Adm. Proc. File No. 3-15858 (Mar. 2, 2015); In re Michael A. Horowitz and Moshe Marc Cohen, Adm. Proc. File No. 3-15790 (Jan. 7, 2015). 14. Jesse Rosenblum, 47 S.E.C. 1065, 1072 (1984). 15. SEC Rule of Practice 320. 16. In re Thomas C. Gonnella, Adm. Proc. File No. 3-15737, at 2 (July 2, 2014) (“When ‘in doubt,’ the evidence should be admitted.”). 17. Andrew Ceresney, Remarks to the American Bar Association’s Business Law Section Fall Meeting, supra note 4. 18. Securities and Exchange Commission, Release No. 34-75976, Amendments to the Commission’s Rules of Practice, at 18. 19. Id. 20. In re Guy P. Riordan, Adm. Proc. File No. 3-12829, at 25 (Dec. 11, 2009); Wheat, First Sec., Inc., 56 S.E.C. 894, 923 fn. 55 (2003). 21. In re Guy P. Riordan, supra note 20, at 25. 22. See, e.g., In re Mark James Hankoff, 50 S.E.C. 1009 (June 4, 1992). 23. Andrew Ceresney, Remarks to the American Bar Association’s Business Law Section Fall Meeting, supra note 4. 24. Luke T. Cadigan, “Litigating an SEC Administrative Proceeding,” BOSTON BAR J. (Winter 2014). 25. Securities and Exchange Commission, Release No. 34-75976, Amendments to the Commission’s Rules of Practice at 5-6. 26. Id. 27. U.S. District Courts–Civil Federal Judicial Caseload Statistics, Table C-5 (March 31, 2014). 28. In re Harding Advisory and Wing F. Chau, Adm. Proc. File No. 3-15574, at 2 (Jan. 24, 2014).
Reprinted with permission from the November 5, 2015 edition of the NEW YORK LAW JOURNAL © 2015 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382 or [email protected]. # 070-11-15-12
88 8
SER V
H NC
THE BE ING
1 BA R SINCE
www. NYLJ.com
thursday, november 5, 2015
Volume 254—NO. 88
Expert Analysis
Corporate Crime
SEC Behind Times in ‘Modernizing’ Administrative Proceedings
B
y availing itself of the increased authority provided by the Dodd-Frank Wall Street Reform and Consumer Protection Act, the U.S. Securities and Exchange Commission has been bringing more enforcement actions than ever before, and making more use of its inhouse adjudication system—the administrative proceeding. With a reported 90 percent success rate in actions litigated in the administrative forum, compared with a noticeably lower 69 percent success rate in actions brought in federal district court over the same period,1 the SEC has come under fire from commentators, lawyers, and judges for depriving respondents of their due process rights. Amid this flurry of criticism, and coming on the heels of several successful constitutional challenges to the administrative system, the SEC has proposed amendments to its Rules of Practice in an apparent effort to provide a more fair process for respondents. These proposals, although a step in the right direction, still do not go far enough to leveling the playing field for respondents.
The Call for Change The structure of SEC administrative proceedings, and the rules g overning
William F. Johnson is a partner in the Special Matters and Government Investigations Practice Group at King & Spalding. Associate Yelena Kotlarsky assisted in the preparation of this article.
By William F. Johnson
the administrative process, create significant advantages for the SEC. Administrative proceedings are conducted pursuant to the SEC’s procedural rules (SEC Rules of Practice), and are brought before administrative law judges (ALJs) hired by the SEC. A respondent who disagrees with the ALJ’s decision must appeal to the SEC itself, and only afterward can appeal
The SEC’s administrative process is seen by many as a “homecourt advantage,” and it has been called into question by several judges, and recently Congress. the SEC’s decision to a federal court. Unlike a proceeding in district court, administrative proceedings lack several key due process protections, most notably the right to full discovery, the right to a jury trial, and the exclusion of hearsay evidence.2 The SEC’s administrative process is seen by many as a “home-court advantage,” and it has been called into question by several judges, and recently
Congress. Scott Garrett, Chairman of the House Subcommittee on Capital Markets and Government Sponsored Entities, has commented that the administrative process 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, pre-determined.”3 The SEC has consistently fought such criticism. Andrew Ceresney, Director of the Enforcement Division, has attempted to defend the administrative process, stating that it produces “prompt decisions,” gives respondents “more flexibility in offering evidence,” and has the benefit of “specialized factfinders” who “develop expert knowledge of the securities laws.”4 The SEC’s attempts to justify the fairness of the administrative process are beginning to sound hollow. Meanwhile, others within the agency have acknowledged the need for change. Former SEC ALJ Lillian McEwen commented that the administrative process was biased against respondents and felt that the burden fell on them to disprove the allegations of the SEC.5 SEC General Counsel Annie K. Small admitted as early as last year that suggestions to revise the rules for administrative proceedings are “entirely reasonable” given that it has been “quite some time” since the rules were revised.6 Indeed, the SEC’s Rules of Practice were last updated almost ten years ago, in 2006, before the Dodd-Frank Act broadened the
thursday, november 5, 2015
SEC’s ability to bring more cases in the administrative forum.7 As the tide of recent challenges to the fairness and constitutionality of the SEC’s administrative process has risen, the SEC finally appears to be getting the message.
Proposed Amendments Thus, although with one breath the SEC continues to maintain that the “administrative forum is eminently proper, appropriate, and fair to respondents,” 8 on Sept. 24, 2015 the Commission released several proposed amendments to its Rules of Practice. SEC Chair Mary Jo White called the proposed amendments an effort to “modernize rules of practice for administrative proceedings”9 and the proposal itself states that the amendments “introduce additional flexibility”10 into the administrative process. In what appears to be a step toward providing greater fairness for respondents, the proposed amendments address several key areas of criticism. Three of the most significant changes include: (1) permitting parties to take a limited number of depositions, (2) prohibiting “unreliable” evidence at hearings, and (3) extending the time before a hearing must begin. Although the proposed amendments are an improvement, they are still a very small step in the direction of what would truly be required to level the playing field between respondents and the SEC.
Depositions One of the most unfair aspects of administrative proceedings, compared to district court, is the restriction placed on respondents’ ability to obtain discovery from witnesses. Under the current rules, although respondents can serve subpoenas for documents or trial testimony, pre-trial depositions are not avail-
able except in the rare instance in which a witness will be unavailable to testify at trial.11 In situations where a witness did not testify during the SEC’s i nvestigation (and therefore no transcript is produced in discovery), respondents must call the witness to the stand with no knowledge of what the witness will say and no opportunity to develop in advance material that would undermine or impeach that witness’s testimony. And even for witnesses who did testify during the SEC’s investigation, the respondent’s counsel, who was not present, had no opportunity to learn whether the witness possessed facts material to the defense or to attempt to impeach
In stark contrast to federal district court, in administrative proceedings administrative law judges must admit all evidence that “can conceivably throw any light upon the controversy.” the testimony. The SEC, on the other hand, has years of time within which to question witnesses in order to attempt to develop evidence to support its case. The proposed amendment to Rule 233 would permit each party to depose either three people (in matters involving a single respondent), or an aggregate of five people (in matters involving multiple respondents).12 The new ability to depose individuals before trial will allow respondents to gather a modest additional amount of information from witnesses beyond the limits of what the SEC provides in its investigative record. But the proposed rule does not even come close to “leveling the playing field” between respondents and the SEC. One significant shortfall is that the proposed rule provides for the same number of depositions for both respondents and the Enforcement
Division. In multi-respondent cases, this means respondents who may have divergent interests must collectively decide which precious few individuals to depose. Even where interests of respondents are aligned, the number of relevant witnesses is highly likely to be greater than five. Therefore, this “collective” restriction is arbitrarily harsh and fails to reflect a realistic number of relevant witnesses in cases involving multiple respondents. The Enforcement Division, on the other hand, has the opportunity before bringing the enforcement action to gather testimony from an unlimited number of witnesses. Because the Enforcement Division starts the investigation from such an advantageous position, allowing an arbitrary three or five depositions per side does not provide real procedural protections for respondents. Moreover, with the Enforcement Division bringing more complex cases in the administrative forum, there is an increased likelihood that a significant number of witnesses will be relevant to explain the facts of a given case. The SEC’s release proposing the rule change does not even attempt a justification for the low number of depositions to be permitted. The SEC’s implication that three or five depositions is sufficient is belied by the number of witnesses that the Enforcement Division itself has called to testify at trial. In two recent cases involving single respondents, the Enforcement Division called nine witnesses at trial, and a look at the administrative hearings held over the past year reveals an average of eight witnesses called by the Enforcement Division. 13 In these cases, the eight or nine total trial witnesses for the government likely represents a subset of a larger number of witnesses who testified during the investigation or who have relevant information, including those who may have information useful to the defense. Plainly, the SEC’s modest
thursday, november 5, 2015
proposal will not facilitate the deposition of all key witnesses, especially in complex, multi-respondent cases. Whatever specific limit the new rule places on the number of depositions, the rule should also grant the ALJ discretion to allow additional depositions for good cause shown in a given case. After all, what is the SEC afraid of? If the SEC is truly confident in its case, it should permit a greater number of witnesses to be deposed, and if it has marshalled sufficient proof, it will prevail at trial regardless of the number of depositions conducted during discovery. If the concern is time and resources, the additional amount of time necessary to permit the depositions to occur is a small price to pay when compared to the enhanced due process those depositions would provide.
Exclusion Of “Unreliable” Evidence In stark contrast to federal district court, in administrative proceedings ALJs must admit all evidence that “can conceivably throw any light upon the controversy.”14 Although ALJs must exclude evidence that is “irrelevant, immaterial, or unduly repetitious,”15 SEC precedent dictates that if there is a doubt as to admissibility, the evidence should be admitted.16 According to the Commission, the Rules are permissive because they presume that ALJs can determine what evidence is more or less relevant and assign the proper weight to such evidence accordingly.17 The proposed amendment to Rule 320 purports to impose stricter limits on admissibility by directing ALJs to exclude evidence that is not only irrelevant, immaterial, or unduly repetitious, but also “unreliable.”18 While the Federal Rules of Evidence prohibit unreliable evidence through specific exclusions, the SEC’s proposed amendment provides no guidance about what constitutes “unreliable” evidence. In fact, it specifically clari-
fies that hearsay evidence should still be admitted if it is “relevant, material, and bears satisfactory indicia of reliability so that its use is fair.”19 The Rules leave the determination of reliability solely to the discretion of the ALJs. In practice, ALJs who admit hearsay evidence sometimes take pains to describe why the hearsay is reliable, corroborated by other evidence, or admissible under an exception to the hearsay rule.20 In Guy P. Riordan, for example, the judge admitted hearsay statements that two government witnesses made during an FBI interview. The judge explained that the evidence was reliable because, among other things, one of the witnesses testified at the hearing and confirmed his prior statements, and the hearsay was corroborated by other non-hearsay evidence.21 If hearsay is admitted in administrative proceedings because it meets the standards of district court, there is less cause for concern. But when administrative proceedings don’t follow district court standards, there is more opportunity for unfairness to infect the case. Occasionally, hearsay evidence deemed admissible in administrative hearings has been set aside on appeal as unreliable.22 There does not appear to be any principled basis for having a different standard of admitting hearsay between administrative proceedings and district court cases. If the SEC’s case is so thin that it depends on rank hearsay not admissible in district court in order to meet its burden of proof, perhaps the case should not have been brought in the first place. Whether or not other administrative agencies permit hearsay under the Administrative Procedure Act, the SEC has an opportunity to establish an administrative fact-finding system that distinguishes itself in a positive way, instead of hiding behind an archaic, unfair process. When the SEC has had the opportunity to gather
its evidence over a period of years before commencing a proceeding, relaxed evidentiary s tandards only deepen the inequity between the parties.
Lengthened Pre-Hearing Schedule Another proposed change to the administrative process is to slightly lengthen the time before a hearing commences to allow the parties more time for discovery. Administrative proceedings operate on an expedited schedule, and have been lauded by the SEC for producing “prompt decisions,” 23 although this claim is questionable when the lengthy time for the process of appealing to the Commission and receiving a decision is factored in. When the Enforcement Division institutes a proceeding, it indicates in its charging document (the Order Instituting Proceedings or OIP) whether the ALJ has 120, 210, or 300 days from the commencement of a proceeding to issue a decision. If the deadline is 300 days, the hearing begins within a maximum of four months from service of the OIP.24 This gives respondents a very short time to read the SEC’s voluminous investigative file, evaluate the merits of the Commission’s case, gather documents from potential witnesses, and prepare a defense. The proposed amendment to Rule 360 allows parties additional time to prepare prior to the administrative hearing. For example, in 300-day cases, hearings must no longer begin within four months from commencement of the proceeding, but can now begin within eight months.25 According to the SEC, the new amendment would provide “additional flexibility during the prehearing phase” to conduct discovery, and would allow respondents “more time to review electronic documents in cases involving an electronic production from the Division.”26 Extending time for discovery is an
thursday, november 5, 2015
improvement over the current scheme, but it does not materially increase the time for defendants to prepare a meaningful defense. This is especially true considering the significant head start that the Enforcement Division has due to its ability to investigate respondents long before bringing an action. The new eight-month timeframe also sharply contrasts with the length of time permissible in federal court, which allows parties to conduct discovery often for a year or longer before going to trial.27 Particularly in more complex cases, it is common to spend months combing through the extensive documents produced by the SEC that were collected from relevant parties. In a recent well-publicized case brought against investment adviser Wing Chau and his firm Harding Advisory LLC, the Enforcement Division’s investigative file was reportedly larger than the entire printed Library of Congress.28 Although the Rules of Practice permit postponement of the hearing for “good cause shown,” the SEC denied the respondents’ request in that case for additional time to review the expansive record. The proposed limited extension of time, coupled with the ALJs’ record of denying postponements even in highly complex matters, is insufficient to improve the gaping discrepancies between the Commission’s in-house forum and federal court.
Better, But Not Good Enough The proposed amendments to the SEC Rules of Practice represent a step, if still a small one, in the right direction and seem to acknowledge the criticisms that have recently targeted the administrative process. For this, the SEC deserves credit. Nevertheless, the proposals still leave much to be desired in a forum that so heavily favors the SEC. For that, the SEC can do better. Even with the changes, respondents have little time to prepare for hear-
ings, and discovery remains extremely circumscribed. The SEC’s inflexible limit on the number of permissible depositions, and its continued reliance on evidence that federal courts have deemed per se unreliable plainly illustrate that this supposed “modernization” of the Rules of Practice is not much of an update. Broader changes are necessary to bring the administrative process more in line with federal court proceedings. The SEC is seeking public comment on the proposed amendments for 60 days following each proposal’s publication in the Federal Register, and it remains to be seen whether continued criticism may lead the Commission to alter its proposal. Hopefully, after reviewing the comments, the SEC will expand the number of depositions and the time period within which hearings must occur, and will reconsider its use of hearsay in administrative proceedings. The federal district courts have adapted over the years to advances in litigation practices. But, the SEC’s proposed “modernization” of its Rules of Practice is still out of date and out of step. ••••••••••••••••
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1. See Jean Eaglesham, “SEC Wins With In-House Judges,” WALL ST. J. (May 6, 2015). 2. See William Johnson, “SEC’s Administrative Enforcement Intensifies Fairness Debate,” N.Y.L.J. (Nov. 6, 2014). 3. Scott Garrett, Subcommittee Chairman, House Subcommittee on Capital Markets and Government Sponsored Entities, Hearing on the Oversight of the SEC’s Division of Enforcement, March 19, 2015. 4. Andrew Ceresney, Director, SEC Division of Enforcement, Remarks to the American Bar Association’s Business Law Section Fall Meeting, Nov. 21, 2014 (recognizing that the Enforcement Division’s use of administrative proceedings has been viewed as unfair, Ceresney responded that he categorically “reject[s] that assertion”); see also Andrew Ceresney, Director, SEC Division of Enforcement, Keynote Speech at New York City Bar 4th Annual White Collar Institute, May 12, 2015. 5. Eaglesham, supra note 1. 6. Daniel Wilson, “SEC Administrative Case Rules Likely Out Of Date, GC Says,” LAW360 (June 17, 2014). 7. See Claudius O. Sokenu et al., Shearman and Sterling, “Securities Enforcement 2015 Mid-Year Review,” at 3 (August 6, 2015). 8. Andrew Ceresney, Remarks to the American Bar Association’s Business Law Section Fall Meeting, supra note 4.
9. Press Release, “SEC Proposes to Amend Rules Governing Administrative Proceedings” (Sept. 24, 2015). 10. Securities and Exchange Commission, Release No. 34-75976, Amendments to the Commission’s Rules of Practice at 3. 11. SEC Rule of Practice 233. 12. Securities and Exchange Commission, Release No. 34-75976, Amendments to the Commission’s Rules of Practice, at 7. 13. In re Natural Blue Resources, Inc., et. al., Adm. Proc. File No. 3-15974 (Aug. 18, 2015); In re Khaled A. Eldaher, Adm. Proc. File No. 3-16326 (Aug. 17, 2015); In re David. J. Montanino, Adm. Proc. File No. 3-15943 (Apr. 16, 2015); In re Thomas R. Delaney II and Charles W Yancey, Adm. Proc. File No. 3-15873 (March 18, 2015); In re Julieann Palmer Martin, Adm. Proc. File No. 3-15613 (March 9, 2015); In re Stanley Jonathan Fortenberry, et. al., Adm. Proc. File No. 3-15858 (Mar. 2, 2015); In re Michael A. Horowitz and Moshe Marc Cohen, Adm. Proc. File No. 3-15790 (Jan. 7, 2015). 14. Jesse Rosenblum, 47 S.E.C. 1065, 1072 (1984). 15. SEC Rule of Practice 320. 16. In re Thomas C. Gonnella, Adm. Proc. File No. 3-15737, at 2 (July 2, 2014) (“When ‘in doubt,’ the evidence should be admitted.”). 17. Andrew Ceresney, Remarks to the American Bar Association’s Business Law Section Fall Meeting, supra note 4. 18. Securities and Exchange Commission, Release No. 34-75976, Amendments to the Commission’s Rules of Practice, at 18. 19. Id. 20. In re Guy P. Riordan, Adm. Proc. File No. 3-12829, at 25 (Dec. 11, 2009); Wheat, First Sec., Inc., 56 S.E.C. 894, 923 fn. 55 (2003). 21. In re Guy P. Riordan, supra note 20, at 25. 22. See, e.g., In re Mark James Hankoff, 50 S.E.C. 1009 (June 4, 1992). 23. Andrew Ceresney, Remarks to the American Bar Association’s Business Law Section Fall Meeting, supra note 4. 24. Luke T. Cadigan, “Litigating an SEC Administrative Proceeding,” BOSTON BAR J. (Winter 2014). 25. Securities and Exchange Commission, Release No. 34-75976, Amendments to the Commission’s Rules of Practice at 5-6. 26. Id. 27. U.S. District Courts–Civil Federal Judicial Caseload Statistics, Table C-5 (March 31, 2014). 28. In re Harding Advisory and Wing F. Chau, Adm. Proc. File No. 3-15574, at 2 (Jan. 24, 2014).
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