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News September 28, 2015 Issue

SEC Proposes Changes to its Administrative Proceedings That Address Defense Concerns

Advisers and their defense attorneys won at least a partial victory on September 24. The SEC proposed amendments to its administrative proceedings rules that would permit attorneys to depose witnesses as part of the discovery process and would adjust the timing of proceedings, including by sometimes extending the time before a hearing occurs.

The proposed changes, now subject to a 60-day comment period, follow months of controversy involving the Division of Enforcement’s increased use of administrative proceedings over court litigation (ACA Insight, 12/8/14). Litigators representing  advisers and other respondents complained that the use of such proceedings provides the SEC with advantages over the use of federal courts.

Defense attorneys cited a number of reasons for this belief, including that the administrative law judges overseeing the proceedings are agency employees, the lack of a jury, and that defendants do not have the same rights and options available to them as they would in federal court, such as the right to depose witnesses.

SEC chair Mary Jo White, in a statement issued along with the proposed rule amendments, said the changes would "modernize" the rules of practices for administrative proceedings.

Defense bar reaction

Attorneys representing plaintiffs generally welcomed the changes, but said they did not go far enough or that the changes added new burdens:

The proposed changes "address some of the more egregious of the SEC’s ‘home court’ advantages in administrative proceedings," said Zaccaro Morgan partner Nicolas Morgan. "Depositions would be permitted, the timing may be extended, and hearsay would only be admitted if it’s reliable. However, more fundamental objections still exist such as the absence of juries, administrative law judges who are employed by the SEC, and appeals from ALJ decisions that are decided by the SEC itself."

"It appears to be a step in the right direction, but the depositions are limited to just three (or five when there are multiple respondents), and I’ve seen very few cases where there are only three key witnesses," said Rogers & Hardin partner Stephen Councill. The proposed rule, he said, "does not even seem to allow an ALJ to expand the number of depositions in appropriate cases. Obviously, three is better than none, but it still falls far short of the procedural protections offered by the court system. The SEC ought to offer respondents a choice between a court case and an administrative proceeding."

"We shouldn’t be naďve and think the SEC didn’t have its own interests at heart in promulgating these," said Stern Tannenbaum partner Aegis Frumento. "It’s great that respondents now can take from three to five depositions, but so can the SEC staff. That is a big bonus to the staff. Remember that the staff has had months and years to take unlimited depositions at their leisure before ever bringing a case. Under the current rules, the staff is deemed to be fully ready to try its case before it commences it, so it had no right to take further depositions. Now, the staff can take more depositions too. What this means in practice is that the trial team can go back and rectify deficiencies made by the investigatory staff."

"The proposed amendments represent some progress toward a more level-playing field in SEC administrative proceedings," said Foley Hoag partner Daniel Marx, "but what the SEC considers efficiency, many respondents see as unfairness. There are no comparable limits, for example, on the time the SEC may take for an investigation or the tools that regulators may use to gather evidence. In a sense, the more that SEC administrative proceedings come to resemble federal court cases, the harder it becomes to justify having ALJs and in-house tribunals at all. Rather than make the SEC rules look more like the federal rules, why not just bring federal cases before federal court judges in the first place?"

Defense costs

While the proposed modifications offer some sought-after changes to defendants and defense counsel, using them would likely raise the cost of defense, a point the SEC itself addressed in its commentary to the proposal. "We preliminarily estimate that potentially lengthening the overall administrative proceedings timeline by up to four months to allow more time for discovery may result in additional costs to respondents in a single matter of up to $462,400," it said.

"The effect (of the additional cost) on many smaller entities will be to force them to settle on terms they might have been able to avoid had they the resources to fight. This is something the SEC expects – and wants – to happen," Frumento said.

The SEC, its commentary to the proposed rule changes, noted that any additional cost because of increased discovery might be felt by both sides in a case. However, it also said that settlement negotiations might lessen those costs, noting that "to the extent that the proposed rules may result in the earlier resolution of cases through settlement or shorter, more focused, hearings, some of these costs may potentially be offset."