Law empowers SEC to go after more U.S. market players

(This story first appeared on the Westlaw News & Insight website, here)

NEW YORK, Oct 27 (Reuters Legal) - As the Dodd-Frank financial overhaul bill moved through Congress this summer, the U.S. Securities and Exchange Commission -- virtually unnoticed -- gained a powerful new weapon that could significantly increase the agency’s force and reach.

A provision deep in the 2,323-page Dodd-Frank law empowers the SEC to bring many more cases for monetary penalties in administrative-law courts, where the rules are more favorable to the government than in federal court. Several constitutional and other due-process protections that are available to defendants in federal court -- from the right to demand a jury trial to broad discovery rights -- don’t exist in administrative courts, which are part of the agency itself.

Until now, if the SEC wanted to sue for monetary penalties and take advantage of the extra clout it has in an administrative-law forum, it could only go after a limited class of players: those it directly regulated, such as registered broker-dealers and investment advisers. Under the new regime, the SEC has the authority to go to administrative-law judges to seek financial penalties from anyone whose activities in any way involve securities -- from hedge-fund magnates, to bank CFOs, to day-trading retirees. The agency in the past could go after these people in an administrative-law court, but only to ask for a “cease-and-desist” order, often after the alleged damage had already been done, and not hit them in the wallet.

Getting this new power has been on the SEC’s wish list for years. In 2008, a bill granting the SEC authority to try more cases in administrative-law courts passed in the House of Representatives, but the bill, sponsored by Democrat Paul Kanjorski, died in the Senate. This time, in the wake of the financial meltdown and a growing consensus that the SEC needed broader enforcement powers, the SEC’s proposal easily slipped through. Under the heading “Strengthening enforcement by the Commission,” it was added to the Dodd-Frank bill by co-sponsor Barney Frank during conference negotiations with the Senate in June. A review of the Congressional Record by Reuters Legal found that the provision, Sec. 929Pa, wasn’t publicly discussed in either chamber.


“The new provision will benefit our investor-protection efforts,” SEC spokesman John Nester said in an e-mailed statement. A message left for the director of the Enforcement Division, Robert Khuzami, wasn’t returned. The agency has previously said that administrative proceedings provide adequate due-process protections.

In interviews, representatives of trade groups including the American Bankers Association, the U.S. Chamber of Commerce and the Securities Industry and Financial Markets Association -- all with constituents who could be disadvantaged by the new rule -- said Sec. 929Pa hadn’t been on their radar. One reason may be that at the time the provision was proposed, it was overshadowed by fights over sweeping changes such as the creation of a new bureau to oversee consumer lending practices. Referring to the SEC’s increased enforcement power in administrative courts, Thomas Quaadman, an official at the U.S. Chamber of Commerce, said: “It’s one of those areas people are just starting to comb through and come to grips with.”

Even now, three months after passage of Dodd-Frank, the new provision has largely escaped attention beyond a small circle of enforcement staffers and litigators on the other side. The provision isn’t included on the SEC’s “transparency” website, which lists about 30 new elements of the Dodd-Frank law and invites public input on its implementation.

“It may have just floated by,” said David Kornblau, a white-collar defense lawyer at Covington & Burling in New York, who served as chief litigation counsel to the SEC’s enforcement division from 2000 to 2005. “The regulated industry was already affected. (Now,) it affects everyone else, which is a very large potential group.”

The legislative win for the SEC comes at a sensitive time for the agency, which in the wake of the financial crisis has suffered two high-profile embarrassments in federal court. In the last 13 months, federal-district judges used sharp language in rejecting the SEC’s initial proposed settlements with Bank of America Corp and Citigroup Inc. (Settlements have subsequently been approved in both matters.)

It’s impossible to know how things would have played out had Sec 929Pa been in effect at the time -- the SEC tends to bring marquee cases in federal court. However, with the expanded option to use administrative proceedings, the SEC now has the choice to seek or avoid the harsh spotlight of a district-court forum. “Federal judges are a pain in the butt,” said Professor Adam Pritchard of University of Michigan Law School, who specializes in securities law. “They (the SEC lawyers) are not going to get that sort of static from administrative-law judges.”


The SEC’s administrative-law judges handle a variety of enforcement matters, mostly involving securities professionals who have been accused of misrepresenting investments to clients, pocketing investor money, or other securities-law infractions. Of the hundreds of administrative proceedings brought each year, only a fraction result in trials; typically, administrative-law judges rule on settlements that have been negotiated between the SEC and respondents, the term for defendants in administrative proceedings. So far this year, the agency’s four judges (one recently retired) have issued 13 initial decisions in litigated cases, consistent with the roughly 15 to 25 they’ve issued annually in recent years.

But the new provision could result in more trials in administrative-law courts, and that worries some in the defense bar. Lawyers for respondents in SEC administrative-law courts have limited subpoena rights, and except in rare circumstances, they can’t take depositions. Also, the SEC’s administrative-law judges are required to issue an initial decision within 300 days of a case’s filing. This strict time limit favors the agency, defense lawyers say, because commission lawyers typically have spent months or even years developing their investigation, while lawyers for the respondents may still be scrambling. “The SEC has had time to build that record, and it’s dumped on opposing counsel all at one time,” says Katherine Addleman, a white-collar defense lawyer at Haynes and Boone in Dallas.

Moreover, since the SEC’s administrative courts reside in the agency, the appeals process arguably gives the SEC a home-court advantage. Appeals from administrative-law courts are heard by the full five-member commission, which is the body that authorized the case in the first place. The commission’s decisions can be appealed to federal appeals court, but agency decisions can only be overturned if there was an “abuse of discretion,” which is a high bar.

To be sure, while the streamlining of administrative proceedings may favor the agency, experts say that because SEC administrative-law judges have lifetime tenure and can only be removed from their posts for cause, they enjoy a measure of independence that insulates them from political pressures. “I don’t think a hearing in front of an administrative-law judge is a rubber stamp for the government,” said Prof. Nina Mendelson, an administrative-law scholar at University of Michigan Law School.

And just because the SEC has new power doesn’t mean it has to use it. But merely possessing the option, for the first time, to sue a hedge-fund manager or derivatives trader in an administrative- law court and seek a big fine gives the agency additional leverage. For example, the agency could push for a quick settlement by offering a respondent the option of cutting a deal in a lower-profile administrative setting rather than federal court. Defense lawyers may rest a decision on whether to fight charges or not based on the mere possibility of such a maneuver.

“If you know they have an option of not going to a jury, the calculus is a little different,” said Russell Ryan, a defense lawyer in the Washington office of King & Spalding and a former assistant director of the SEC Enforcement Division. The new provision could potentially be the subject of a constitutional challenge, Ryan said, “although I’m not sure it’s a winner.”

Editing by Eric Effron, Amy Stevens and Howard Goller