Earlier this month, the U.S Court of Appeals upheld a Securities and Exchange Commission ruling against Raymond Lucia Sr., a former investment adviser, in a case that exemplifies the appearance of unfairness in the commission's use of administrative law judges.
The Court of Appeals, in upholding the SEC ruling, ignored the dissents of two Republican com- missioners to the original findings of the administrative law judge in the case. The three Democratic commissioners upheld the decision. The decision, and the way it was reached, leaves the impression that the process is stacked against those brought before the commission and its judges.
Last month the
SEC approved reforms to its in-house system for trying enforcement cases — but the reforms do not go far enough.
(Related read: Federal court denies Ray 'Buckets of Money' Lucia's appeal to SEC ban)
PRIMA FACIE EVIDENCE
In fact, the current process, in which enforcement cases are tried in front of administrative law judges employed by the SEC, is still unfair, though the announced reforms make it less so. Much more needs to be done. The changes to the process the SEC has adopted are an admission that indeed the process has been unfair.
An analysis by the Wall Street Journal last year found the SEC won 90% of cases heard before its in-house judges from October 2010 through March 2015. Its success rate fell to 69% when cases were heard in federal court. That's prima facie evidence of an unfair system.
The changes the SEC has approved might reduce the agency's success rate before its judges, but probably not by much. Those charged by the SEC will have more time to prepare before their first hearing and will be allowed to take a limited number of depositions. The changes also clarify the types of motions that may be filed.
The problem of apparent bias remains. The administrative law judges are appointed by and paid by the SEC. With the best will in the world, it would be hard for any judge to decide against his or her employer, to decide against those representing the SEC and all the hard work they have done putting a case together. The Wall Street Journal's statistics show just how difficult it has been. There is an apparent inherent conflict of interest that is unacceptable in the pursuit of justice.
According to SEC Chairwoman Mary Jo White, the changes were made to “add flexibility to the timeliness of our administrative proceedings while continuing to promote the fair and timely resolution of the proceedings.” Note she did not say “improve” the fairness of the proceedings or the “appearance of fairness,” yet that is what is needed most.
(Related read: SEC enforcement actions trail last year's record numbers: Study)
The process must not only be fair, it must appear to be fair, and most outside the SEC would say it currently does not appear to be so.
Though two federal district judges found the process by which the agency hires in-house judges violates the appointments clause of the Constitution, appeals courts have rejected challenges to the SEC process. In one case, the United States Court of Appeals for the Eleventh Circuit wrote, “We find it 'fairly discernible' … that Congress intended the respondents' claims to be resolved first in the administrative forum, not the district court, and then, if necessary, on appeal to the appropriate federal court of appeals.”
That means the industry will have to seek congressional changes to the parts of federal law that allow such an apparently biased system, i.e., the Dodd-Frank financial reform law under which, in the courts' interpretation, Congress gave the SEC almost unfettered freedom to choose in which forum to bring cases by authorizing it to seek the same penalties for a violation regardless of the venue it chooses.
REPUTATIONAL COSTS
The current system requiring firms or individuals challenged by the SEC to first submit to the SEC's hand-picked judges, then appeal to the commission itself, and finally appeal to an appeals court when they lose the first rounds, imposes unfair reputational and monetary costs on them. The SEC, or Congress, must address this situation and make further changes.
