SEC Enforcement Division Issues Guidance on Use of Administrative or District Court Forum

On May 8, 2015, the Securities and Exchange Commission's Division of Enforcement issued its first formal guidance on how it evaluates whether to sue administratively or in a federal district court when bringing actions charging violations of the federal securities laws. The Division is the unit responsible for making charging and forum recommendations to the Commission, and has come under substantial criticism for recommending that an increasing number of cases should be heard by the Commission's own Administrative Law Judges rather than by judges and juries in federal district court.

The Division's guidance comes in the wake of numerous recent lawsuits claiming that the Commission's decision to pursue charges in an administrative forum constitutes a violation of the accused's constitutional rights. These suits have been premised on various theories, including violations of the due process clause (the SEC's administrative procedures are inadequate), the equal protection clause (to have one's case heard administratively while others similarly situated are tried in court is unfair) and the appointments clause (the appointment of Commission ALJs is constitutionally defective). Litigants and various commentators have raised questions as to the appearance of impartiality of the administrative process, given that the Commission both institutes proceedings before an ALJ and may affirm, reverse or modify the ALJ's initial decision on the charges that it has brought. These critics have also taken aim at the lack of procedural protections afforded by the administrative forum, where hearsay may be admissible in evidence and prehearing depositions are generally not allowed.

Without offering any response to such criticisms, the Division's new guidance sets forth four "potentially relevant considerations" for recommending "the forum that will best utilize the Commission's limited resources to carry out its mission.”

The availability of the desired claims, legal theories and forms of relief in each forum. The Division notes that not all claims, theories of liability and forms of relief are equally available in the administrative forum and district court. Thus, the Division's choice of forum may be driven by, for example, its desire to pursue emergency relief available only in district court (e.g., a temporary restraining order).

Whether any charged party is a registered entity or an individual associated with a registered entity. The Division favors proceeding in the administrative forum when the charged party is a registered entity or associated person. According to the Division, "[r]egistered entities and associated persons have long been subject to . . . Commission administrative proceedings"; "certain charges and forms of relief applicable to registered entities and associated individuals" are available solely in the administrative forum (e.g., associational bars and suspensions); and the Commission and ALJs have developed "extensive knowledge and experience concerning issues that frequently arise in matters involving registered entities or associated persons."

The cost-, resource- and time-effectiveness of litigation in each forum. The Division gives four examples of how this consideration may play out. First, when the Division determines that time is of the essence (e.g., when witness memories may be fading with respect to older conduct), the administrative forum may be favored because, "[i]n general, hearings are held more quickly in contested administrative actions than in contested federal court actions." Second, when the conduct of multiple parties is at issue, the Division will favor a single consolidated proceeding over many separate proceedings. Depending on the circumstances, this may favor either the administrative forum or district court. Third, to the extent that the Division expects that summary disposition of claims and issues may be appropriate, it may favor proceeding in district court as opposed to moving for "summary disposition in the administrative forum (which generally requires leave from the Administrative Law Judge to file and typically addresses a narrower range of claims and issues)." Finally, the guidance provides that "the additional time and types of pretrial discovery available in federal court may entail both costs and benefits." The Division does not say how it will weigh these costs and benefits, but the guidance notes that depositions are generally not available in the administrative forum and that the rules with respect to compelling testimony may also be different.

Fair, consistent and effective resolution of securities law issues and matters. Noting that "Administrative Law Judges, who adjudicate securities law cases, and the Commission develop extensive knowledge and experience concerning the federal securities laws and complex or technical securities industry practices or products," the Division may favor proceeding in the administrative forum when "a contested matter is likely to raise unsettled and complex legal issues under the federal securities laws, or interpretation of the Commission's rules," because "in light of the Commission's expertise concerning those matters, obtaining a Commission decision on such issues, subject to appellate review in the federal courts, may facilitate development of the law." The Division also notes that, when "similar charges are being or have been brought against similarly situated parties (e.g., registered entities or associated persons) in the same or closely related contested matters, it may be preferable to recommend charges against similarly situated parties in the same forum."

Notwithstanding the Division's effort to isolate the factors that may be considered as part of its approach to forum selection, the Division qualifies the importance of these factors, providing that "[t]here is no rigid formula dictating the choice of forum," and that forum selection will be driven by the "specific facts and circumstances of the case." Indeed, the guidance does not purport to constitute an "exhaustive" list of "potentially relevant considerations" and does not specify the weight that should be given to the factors that are included: "In any particular case, some factors may deserve more weight than others, or more weight than they might in another case."

One noteworthy aspect of the new guidance is the Division's reference to the "expertise" of the Commission, a likely allusion to the Commission's expectation that its rulings interpreting the federal securities laws may be entitled to Chevron deference. See also In the Matter of John P. Flannery & James D. Hopkins, No. 3- 14081 (SEC Dec. 15, 2014) (in which the Commission noted the "challenges lower courts have faced" in interpreting various provisions of the Securities Act and Exchange Act, and then “ set[ ] out our interpretation of these provisions - which is informed by our experience and expertise in administering the securities laws . . . intend[ing] to resolve the ambiguities . . . that have produced confusion in the courts and inconsistencies across jurisdictions"). The Division's position that "unsettled and complex legal issues under the federal securities laws" may be more appropriate for "a Commission decision..., subject to appellate review in the federal courts," would seem to raise the possibility that the Commission would determine the legality of any cutting-edge prosecutions that the Division may recommend with the federal courts deferring to the decision of the Commission. This puts the Division at odds with at least two Supreme Court justices who are on record saying that the federal courts should not give Chevron deference to agency interpretations of laws that contemplate both criminal and administrative enforcement, as many of the federal securities laws do.

Also noteworthy is the Division's stated preference for using a single forum to bring "similar charges…against similarly situated the same or closely related contested matters." This likely is a response to lawsuits against the Commission alleging that similarly situated parties have been singled out for administrative prosecution in violation of the equal protection clause. 1

The Division's new guidance ultimately leaves considerable uncertainty in predicting where the Commission will choose to prosecute alleged violations of the federal securities laws, and it is unlikely to satisfy the critics of the Commission's administrative forum. The guidance focuses on the Division's assessment of its own efficiency interests in selecting an appropriate forum, but does not seem to give weight to how a particular forum affects the rights of the defendant. In addition, the Division's guidelines do not address the more fundamental criticisms of the procedural rules governing the Commission's administrative proceedings, which, as SEC General Counsel Anne K. Small has explained, were devised "quite some time ago" for a more limited variety of generally less complex cases than may be pursued administratively today. It is, as Ms. Small agreed, "entirely reasonable to wonder" if those rules should be updated to reflect changed circumstances.

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1 [1] In Gupta v. SEC, 11-cv-01900 (S.D.N.Y. July 11, 2011), for example, Mr. Gupta alleged a violation of his right to equal protection resulting from the Commission's decision to prosecute charges against him administratively. Judge Jed Rakoff denied the SEC's motion to dismiss Mr. Gupta's complaint, citing a "well-developed public record of Gupta being treated substantially disparately from 28 essentially identical defendants [who were charged in federal district court], with not even a hint from the SEC . . . as to why this should be so." Kramer Levin Naftalis & Frankel represented Mr. Gupta in this action.