A Tale of Two Enforcement Venues: Why the SEC’s Choice of Where to File Cases Matters

The Dodd-Frank Act of 2010 allows the Securities and Exchange Commission (SEC) to bring enforcement actions and impose civil penalties in administrative proceedings as alternatives to federal district courts. Some argue that this gives the SEC a “home-court” advantage. For example, the SEC serves as both prosecutor and, through the administrative judges it appoints, adjudicator in an administrative proceeding, and no jury trials are allowed.[1] The SEC argues, though, that administrative proceedings can process cases more efficiently than federal courts.[2] Yet the opacity of administrative proceedings and the SEC’s discretion over the choice of venue have prompted criticism and challenges from politicians, members of the media, academics, and legal practitioners. Two questions naturally arise: How does the SEC decide between the two venues, and are the outcomes similar in both venues for comparable cases?

I address these two questions in my study, “A Tale of Two Enforcement Venues: Determinants and Consequences of the SEC’s Choice of Enforcement Venue After the Dodd-Frank Act.” I construct a sample of SEC enforcement actions initiated between October 1, 2010, and September 30, 2015, all occurring after the Dodd-Frank Act was implemented. These enforcement actions are taken against publicly traded firms or their managers and can be pursued in either SEC administrative proceedings or federal courts.

Using this sample, I first examine the determinants of the SEC’s choice of enforcement venue. Compared with federal courts, SEC administrative proceedings are less visible and less costly for the agency to use. I find that the SEC is more likely to route more material cases to federal courts than to administrative proceedings. Specifically, fraud and bribery cases, measures for case materiality, are about 35 and 28 percent, respectively, more likely to be routed to federal courts. I also find that the SEC is more likely to route politically connected defendants to administrative proceedings than to federal courts. Using a data set based on the SEC chair’s daily calendar, I develop a proxy for political connection that measures the frequency and length of meetings between the SEC chair and a defendant’s congressional representative(s). Results show that each additional meeting leads to about a 14 percent increase in the probability of being assigned to an administrative proceeding. These results suggest that the SEC’s private incentives affect its selection of enforcement venue. The SEC uses federal courts when it can obtain political benefits from visible and material enforcement actions, and it uses administrative proceedings when either political or economic costs associated with pursuing politically connected cases are high.

I next examine whether the SEC’s enforcement venue selection affects defendants’ monetary penalties among cases that are settled or won by the SEC. I find that politically connected defendants in administrative proceedings are associated with lower monetary penalties compared with defendants lacking such connections. Each meeting is associated with an 8.6 percent decline in the amount of monetary penalties for politically connected defendants in administrative proceedings. These results are simply associations, not necessarily causal, due to potential endogeneity.

Finally, I compare the processing speeds of the two enforcement venues. A striking finding is that administrative proceedings resolve cases in about 10 days, nearly 27 times faster than federal courts do. The faster processing time is due to the structural and procedural differences between administrative proceedings and federal courts. In my sample period, an administrative proceeding starts with the filing of an Order Instituting Proceedings (OIP). Once an OIP is filed, the administrative judge has 120, 210, or 300 days to issue a decision, depending on the complexity of the case.[3] This time limitation means that, for any administrative proceeding, the maximum amount of time for discovery is four months. Unlike SEC administrative proceedings, parties involved in most civil cases filed in federal courts work under a deadline for each motion they file. There is no general deadline for a judge to adjudicate a case. Although some observers argue that administrative proceedings may put defendants at a disadvantage due to the shorter discovery time, reducing the length of enforcement proceedings potentially lowers the uncertainty surrounding litigation outcomes and possibly the eventual cost to a defendant’s reputation. My findings provide some evidence that administrative proceedings offer greater cost efficiency for both the SEC and the defendants.

My paper highlights the potential costs and benefits of using administrative proceedings versus federal courts for SEC enforcement actions. It also identifies a potential mechanism, the enforcement venue selection process, through which the SEC is politically captured. Results of my study may be of interest to regulators who seek legislative solutions to ensure legitimacy and fairness for parties involved in SEC enforcement actions. The SEC’s enforcement process can be lengthy and is largely opaque due to data limitations. I encourage the regulator to make data available for various stages of the enforcement process in order to achieve a better understanding of that process.

ENDNOTES

[1] See Spunaugle, T. (2014). The SEC’s Increased Use of Administrative Proceedings: Increased Efficiency of Unconstitutional Expansion of Agency Power. Rev. Banking & Fin. L., 34, 406.

[2] See Securities and Exchange Commission. (2015). Division of Enforcement Approach to Forum Selection in Contested Actions. Division of Enforcement. Available at https://www.sec.gov/divisions/enforce/enforcement-approach-forum-selection-contested-actions.pdf

[3] See Securities and Exchange Commission. (2015). Enforcement Manual. Office of the Chief Counsel.

This post comes to us from Professor Xin Zheng at the University of British Columbia’s Sauder School of Business. It is based on his recent article, “A Tale of Two Enforcement Venues: Determinants and Consequences of the SEC’s Choice of Enforcement Venue After the Dodd-Frank Act,” available here.

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