SEC Use of Administrative Proceedings Challenged Again

The SEC was granted authority in the Dodd-Frank Act to initiate administrative proceedings against non-regulated persons. In those proceedings the full range of remedies are available – a cease-and-desist order, disgorgement, penalties and bar orders. Those remedies are comparable to the ones which can be imposed in a Federal District Court. Although Dodd-Frank was signed into law in July 2010 it was not until recently that the SEC began to shift cases from Federal District Court, its traditional venue of choice, to the administrative forum. For example, since September of 2014 the Commission has initiated a series of insider trading actions as administrative proceeding. This contrasts sharply with prior practice under which insider trading cases were brought in Federal District Court.

The genesis for this shift is unclear. The agency has portrayed it as one of convenience while some believe it is being driven by a series of unfavorable trial verdicts. Whatever the reason, one point is clear — the rights of those charged are very different depending on the forum the SEC selects. In District Court, for example, the Federal Rules of Civil Procedure provide for discovery to develop the required evidence. The Federal Rules of Evidence govern the admissibility of that evidence. A jury trial can be obtained to evaluate the evidence admitted and review in the first instance is by a Federal Circuit Court. In contrast, in the administrative forum there is virtually no discovery, the Federal Rules of Evidence do not apply, there is no right to a jury trial and the first appeal is to the agency which authorized the initiation of the proceeding – Circuit Court review is years away.

The shift to administrative proceedings is spawning suits against the Commission, claiming violations of fundamental constitutional rights. One action was Chau v. SEC, Case No. 14-cv-1903 (S.D.N.Y.). The case centered on claims regarding the sale of interests in a CDO during the market crisis. When the action was brought as an administrative proceeding Respondents Wing Chau and Harding Advisory LLC, the collateral manager charged with disclosure violations centered on the failure to inform investors that the collateral selection was heavily influenced by a hedge fund with adverse interests to investors, filed suit in District Court. The complaint alleged violations of the due process and equal protection clauses of the Constitution. The former centered on the difference in procedures available to Respondents while the latter focused on the fact that other similar cases were brought in Federal District Court. The Court, in an opinion by Judge Lewis Kaplan, rejected both claims. But see, Gupta v. SEC, 796 F. Supp. 2d 503 (S.D.N.Y. 2011)(insider trading case from expert network investigations brought as an administrative proceeding rather than in district court where every other such action brought – SEC eventually dismissed the administrative proceeding). The right to a jury trial was not a central claim in this case.

Bebo v SEC, Case No. 15-cv-00003 (E.D. Wis. Filed Jan. 2, 2015) is another suit challenging the decision to bring an action as an administrative proceeding rather than in Federal District Court. The underlying administrative proceeding named as Respondents Laurie Bebo and John Buono, respectively, the CEO and CFO of Assisted Living Concepts, Inc. In the Matter of Laurie Bebo and John Buono, Adm. Proc. File No. 3-16293 (December 3, 2014). The firm is a publicly-traded assisting living and senior residence firm based in Wisconsin. The Order, which alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)B) and 13(b)-5, centers on claimed false disclosures in the SEC filings of the company. Those filings represented Assisted Living was in full compliance with a lease for certain properties when in fact the Respondents had falsified certain occupancy data to deceive the lessee into believing that the company was in compliance, according to the Order.

The Bebo complaint alleges due process and equal protection violations, a violation of the right to a jury trial and presents a separation of powers issue. The suit is based on claims that the limited right to discovery in the administrative forum will effectively precluded the plaintiff from adequately presenting a defense. Specifically, plaintiff claims that the board of directors of Assisted Living specifically authorized the actions taken with respect to the lease. Because five of seven board members reside in Canada, they will not be available to testify and cannot be compelled to appear. Likewise, three of the four members of the audit committee will not be available to testify regarding an internal investigation the committee conducted which found no wrong doing. This evidence, plaintiff contends, is essential to presenting a defense but is beyond the reach of the limited discovery available in an SEC administrative proceeding.

Ironically, the Division recently found itself in the same position as plaintiff Bebo. When the Division could not obtain evidence critical to its case insider trading charges in an action brought as an administrative proceeding because two foreign national witnesses left the country and returned home, it filed a motion to dismiss. In In the Matter of Jordan Peixoto, Adm. Proc. File No. 3-16184 (Sept. 30, 2014). See James Sterngold, Wall Street Journal (Dec. 15, 2014), available at That option of course is not available to plaintiff Bebo who is relegated to trying to convince a District Court to enjoin a Commission administrative proceeding or cobble together a defense in that administrative proceeding without key witnesses and evidence.

Tagged with: ,