Improving Enforcement and Adjudication at the SEC

Earlier this year, the Office of Management and Budget solicited suggestions for “regulatory reforms that will better safeguard due process in the regulatory enforcement and adjudication settings.”  That invitation was a rare opportunity to comment on the procedures federal agencies use to investigate potential misconduct and to litigate charges in administrative proceedings.

My comments addressed several enforcement and adjudication procedures at the Securities and Exchange Commission:

(1)  Partiality issues with the heads of certain agencies including the SEC and with initial SEC administrative proceedings before administrative law judges.

Due process prohibits the same person from charging a defendant and then adjudicating that defendant’s case, but, at the SEC and other federal agencies, the standard practice is for the commissioners, at times the same commissioner, both to charge a person with a violation of law and then to sit as judges to decide whether the defendant committed the violation.  A commissioner should disqualify him- or herself from sitting in an adjudication if he or she voted on charging the defendant.

Initial SEC administrative proceedings before ALJs are unfair to defendants or appear to be unfair for several different reasons, including that the procedures used at the ALJ level hamper a defendant’s ability to prepare and present a full defense and fall well short of the rights available in federal court.  One solution is to abolish administrative enforcement proceedings in regulatory agencies that impose fines, financial sanctions, and other severe remedies and assign those proceedings to federal district courts, possibly using an expanded group of magistrates.  Another possibility is to give defendants in administrative proceedings the right to move the case to a federal district court.

(2)  Ways to make SEC investigations fairer for defendants and more efficient.

The SEC could extend more fairness and consideration to defendants without  detracting from tough enforcement by (a) using established and accepted legal theories and not basing claims on new, untested liability theories, (b) creating an objective and balanced investigative record that considers both potential wrongdoing and innocent explanations, (c) refusing to initiate an enforcement case unless the SEC believes that a reasonable person would conclude that the SEC is more likely than not to prevail on the facts and the law and that a proceeding would serve broad and legitimate enforcement goals, and (d) substantially shortening investigations and using narrower and more targeted subpoenas for information.

(3)  The need for a reasonable limitations period for bringing SEC enforcement claims.

Long SEC investigations are often damaging to the individuals and businesses involved, and, as a practical matter, the length of SEC investigations is tied to the current five-year limitations period for fines and penalties.  The end of the five-year period acts as a deadline for the commission and staff to complete investigations and make charging decisions.

Proposals to extend the statute of limitations for all cases when the concern is the rare situation in which the agency did not have a reasonable opportunity to detect and investigate misconduct within five years would disserve important social goals of repose and stability.  Accepting the proposals would increase the use of unreliable evidence, threaten the accuracy and legitimacy of proceedings, and aggravate the damage to possibly innocent individuals and businesses.

(4)  The need to reconsider instances in which the defendant has the burden to prove the absence of liability.

With one sentence in 1953, the U.S. Supreme Court created the rule that a defendant has the burden of proof to establish the private offering exemption from the obligation to have a registration statement in effect.  Making the defendant prove the applicability of an exemption from registration is not consistent with the Administrative Procedure Act, the text of the Securities Act, or the concept of affirmative defenses.  Use of an exemption is a method of complying with the Securities Act and is not an excuse for a failure to comply.  The government should have the burden of proving that a defendant committed a violation by failing to have a registration statement in effect and failing to meet the terms of an exemption.

(5)  The need for the SEC and other agencies to apply prior judicial precedent faithfully in adjudications.

The SEC and other agencies sometimes expand or depart from judicial precedent when applying law in an adjudication.  That creates constitutional, administrative law, and statutory interpretation concerns.  An agency should adhere to judicial interpretations of statutes and rules, and a court reviewing an agency adjudication should not give Chevron deference to an agency’s legal conclusions and should take an agency’s legal reasoning into account only to the extent it is persuasive.

This post comes to us from Andrew Vollmer, a former professor at the University of Virginia School of Law and a former deputy general counsel of the Securities and Exchange Commission.  It is based on comments he submitted, available here, in response to the request for information from OMB about reforms to protect due process in regulatory enforcement and adjudication, docket number OMB-2019-0006.