SEC Enforcement Division Issues New Guidance on Choosing In-House vs. Federal Courts

The SEC's Enforcement Division has issued its first formal guidance about factors bearing on the decision whether to bring a case before an in-house administrative court or a neutral federal district court. The new guidance follows closely on the heels of criticism that the SEC has recently brought more cases in its own administrative courts primarily to increase its chance of winning tougher (and some might argue, bad) cases. Although the guidance does not offer clear answers, the real headline of this guidance is the Enforcement Division's controversial decision to bring cases raising "unsettled and complex legal issues" in administrative courts instead of federal courts. In June 2014, Andrew Ceresney, head of the SEC's Division of Enforcement (the "Division"), announced that the SEC would start bringing more insider trading and similarly complex cases in its in-house administrative courts.[1] Although he denied this had anything to do with increasing the SEC's chances of winning, many commentators argued this was an attempt to exploit the SEC's far higher winning percentage in administrative courts (estimated at 90-100%) after losing several high-profile cases in 2013 and 2014.[2] One critic included Judge Jed Rakoff, who criticized this approach as replacing the impartiality of a federal court with "administrative fiat" from a Commission acting as a "law unto itself." [3]

This criticism led one SEC Commissioner to demand on February 20, 2015 that the SEC "set out and implement guidelines for determining which cases are brought in administrative proceedings and which in federal courts."[4] He argued this was necessary to "avoid the perception that the Commission is taking its tougher cases to in-house judges, and to ensure that all are treated fairly and equally."

Just two months after this call for action comes the "Division of Enforcement Approach to Forum Selection in Contested Actions."[5] This guidance was issued on May 8, and was the focus of Mr. Ceresney's Keynote Speech to the New York City Bar's White Collar Conference on May 12, 2015. The guidance warns "[t]here is no rigid formula dictating the choice of forum," but it lists "a number of factors" that the Division may consider in deciding which forum to choose. These include: 1. Availability of Certain Claims and Forms of Relief in Each Forum: Certain charges, such as (i) failure to supervise, or (ii) merely "causing" another person's violation of the law, are only available in an administrative proceeding. In contrast, only a federal district court can hear claims for (i) controlling person liability; (ii) liability as a relief defendant who did not commit wrongdoing but possesses recoverable assets; or (iii) emergency relief like a temporary restraining order or an asset freeze. 2. Cases Involving Registered Entities or Individuals Are More Likely to Be Pursued in Administrative Courts: Suspensions or associational bars against registered individuals or entities can only be imposed in administrative proceedings. So it is more efficient for the SEC to bring such cases in administrative court, to avoid having to first bring a district court action on liability and an injunction, and then bring a separate administrative proceeding for a bar or suspension. The Division also cited the expertise of Administrative Law Judges with registered persons and entities as a reason for this factor. 3. The Benefits of Procedural Resources in Each Forum: Administrative courts are favored for (i) resolving cases more quickly than federal district court, which may be important for cases involving older conduct or issues needing a more timely public airing (but do not involve emergency relief); and (ii) cases involving charges against multiple parties where one district court may not be a suitable venue for an action against all parties. Federal district courts are favored for cases (i) that can be narrowed or resolved at a preliminary stage on legal or generally undisputed issues; (ii) where the SEC may need depositions or pre-trial discovery to make out its case (since this is generally not available in administrative court), or (iii) the SEC does not want to highlight exculpatory documents to defendants, which it is only required to do in administrative cases. 4. Resolving Unsettled and Complex Securities Law Issues in Administrative Court: Unsettled and complex securities law issues should be brought in administrative proceedings, because "obtaining a Commission decision on such issues, subject to appellate review in the federal courts, may facilitate development of the law." But cases hinging on state law or other non-securities laws belong in district court.

The most controversial factor - by far - is that unsettled and complex securities law issues should be decided in administrative proceedings. Considerations of fairness and avoiding bias suggest that such unsettled and complex issues should first be decided in a neutral federal district court. Further, federal courts have the traditional role for resolving virtually all unsettled and complex legal issues. The greater publicity for federal district court cases would give securities professionals better notice of how such unsettled and complex issues are resolved. In addition, the Division's suggestion that Administrative Law Judges ("ALJs") have more expertise in securities law is undermined by the fact that two of the five ALJs were hired less than a year ago. These concerns are heightened by the SEC pattern of seeking increasingly harsh civil penalties and industry bars over the years.

Indeed, the Division's claim that unsettled issues should be decided in administrative courts creates tension with Supreme Court cases holding an SEC interpretation is not entitled to deference where it appears to be merely a "convenient litigating position" or "post hoc rationalization" of prior agency action (e.g., in bringing the case). Christopher v. SmithKline Beecham Corp., 132 S. Ct. 2156, 2166 (2012). If the SEC resolves an unsettled issue in a case brought by the Enforcement Division in its own, in-house administrative court, it is hard not to view that as a "convenient litigation position" or "post hoc rationalization."

At the end of the day, the Enforcement Division's guidance that unsettled and complex securities law issues should be decided in administrative courts appears to prove correct the criticism that the SEC is bringing more cases in administrative court so it can win more often. After all, such "unsettled and complex" cases are the ones the SEC are most likely to lose. And such "unsettled and complex" cases are the ones where the SEC's decision to bring charges are most controversial. Thus, it would be wise for the Enforcement Division to rethink its strategy of bringing such unsettled and complex cases in administrative courts. ----- [1] See, e.g., B. Mahoney, "SEC Could Bring More Insider Trading Cases In-House," Law360.com (June 11, 2014). [2] See, e.g., J. Eaglesham, "S.E.C. is Steering More Trials to Judges it Appoints," Wall St. J. (Oct. 21, 2014), available at http://www.wsj.com/articles/sec-is-steering-more-trials-to-judges-it-appoints-1413849590. [3] N. Raymond, "U.S. Judge Criticizes SEC Use of In-House Court for Fraud Cases," (Nov. 5, 2014). [4] M. Piwowar, "Remarks at the 'SEC Speaks' Conference 2015: A Fair, Orderly, and Efficient SEC," (Feb. 20, 2015), available at http://www.sec.gov/news/speech/022015-spchcmsp.html. [5] See https://www.sec.gov/divisions/enforce/enforcement-approach-forum-selection-contested-actions.pdf If you have any questions regarding the decision or would like to discuss this Alert further, please contact Litigation

Cheryl Spratt