There is a nickname litigators use for courts that push cases through the system with great alacrity: the “rocket docket.” Perhaps the most famous is the United States District Court for the Eastern District of Virginia, where complex civil cases will wrap up discovery in a few months and be decided in less than a year.
Another rocket docket can be found in the administrative proceedings before the Securities and Exchange Commission, whose rules provide that even the most complex case is supposed to be decided within 300 days of its filing. That means there is very little time to prepare for the hearing, which must start within four months after a case is filed.
This type of proceeding is decided by an administrative judge housed inside the S.E.C. Any appeal is first heard by the five commissioners before it ever gets to a federal court. Even the Eastern District of Virginia allows greater discovery of evidence through depositions and document requests than what is authorized by the S.E.C., which largely limits the evidence to whatever the agency gathered during its investigation.
A persistent criticism of the S.E.C. for using administrative proceedings was highlighted by Gretchen Morgenson in The New York Times last year regarding the perception of a “home court” advantage for the S.E.C., where there is no neutral judge involved.
A recent op-ed in The Wall Street Journal by Russell G. Ryan, a former assistant director of enforcement at the S.E.C. now in private practice at King & Spalding, argued that “today’s model of penal S.E.C. law enforcement is categorically unsuited for rushed and truncated administrative hearings in which the agency and its own employees serve as prosecutor, judge and punisher.”
The use of administrative proceedings to resolve complex securities law cases has been challenged by defendants in two cases. They are seeking to require the agency to file charges in federal court, where the parties would have the full range of discovery rights. In addition, any determination of a violation would be made by an independent judge and jury rather than an administrative judge employed by the S.E.C.
The two defendants offer different reasons for challenging the S.E.C.’s authority to use the administrative avenue, but either could result in requiring the agency to be more transparent about the reasons for choosing one forum rather than another.
The genesis of the complaints is a change in the law made by the Dodd-Frank Act in 2010, which authorizes the S.E.C. to seek penalties in an administrative case against any defendant. Before that, only those subject to the S.E.C.’s direct regulation, such as brokers and investment advisers, could be required to pay a penalty by an administrative judge. Securities cases – like those involving insider trading or accounting fraud – had to be filed in a federal district court if the agency wanted to impose a fine or sought to a bar a person from serving as an officer or director of a public company.
Armed with the Dodd-Frank law, the S.E.C. filed the first administrative case for penalties for insider trading against Rajat K. Gupta in 2011 over the disclosure of information about developments at Goldman Sachs to Raj Rajaratnam, the hedge fund founder who is serving an 11-year prison term. Mr. Gupta challenged the decision to file an administrative case. The judge presiding over his case in district court, Judge Jed S. Rakoff, questioned whether the S.E.C. had exceeded its authority by targeting conduct occurring before the Dodd-Frank Act was enacted for an administrative proceeding. The S.E.C. agreed to dismiss the case and later refiled the charges in federal court, which resulted in Judge Rakoff imposing a $13.9 million penalty after Mr. Gupta’s conviction for insider trading.
The more recent challenges to administrative cases involve securities fraud claims that would have been filed in federal court before the Dodd-Frank Act became law. The S.E.C. brought administrative charges against George R. Jarkesy Jr. The S.E.C. says Mr. Jarkesy, a Houston-based hedge fund manager, hired multiple stock promoters in 2010 and 2011 to create an artificial spike in the prices of two microcap stocks in which the funds were heavily invested.
In another case, the S.E.C. filed an administrative case against Wing F. Chau and Harding Advisory, a firm based in Morristown, N.J., accusing them of fraud in the selection of securities that were linked to a $1.5 billion synthetic collateralized debt obligation.
Mr. Jarkesy accused the S.E.C. of prejudging the matter by issuing findings against other defendants that implicated him in violations, claiming he could not receive a fair hearing before the agency. In June, the Federal District Court in Washington rejected his request to stop the case because it found that it did not have jurisdiction over his complaint. Mr. Jarkesy filed an appeal on Aug. 11, but that came after his administrative hearing, which took 12 days and produced over 3,000 pages of transcripts.
Mr. Chau and Hastings Advisory made a different argument by pointing out that the S.E.C. filed three other cases in Federal District Court claiming there was fraud in the marketing of C.D.O.s, but then brought this case before an administrative judge. Those other cases involved Goldman Sachs’s Fabrice Tourre, Citigroup’s Brian H. Stoker and Edward S. Steffelin, who selected the portfolio of loans for a C.D.O. sold by JPMorgan.
The reason for choosing one venue or another is completely within the S.E.C.’s discretion. The defendants’ argument is that the decision violates due process by depriving them of discovery and the opportunity for a jury to decide the case – something that was afforded to others accused of the same violations.
But the Federal District Court in Manhattan refused to stop the administrative proceeding against Mr. Chau and Hastings Advisory. The case required 17 days of hearings involving almost 1,400 exhibits, along with 500 pages of briefs filed after its conclusion.
The availability of a jury can be particularly beneficial to a defendant in a fraud case when the claim involves complex securities bought by sophisticated clients. Jurors found in favor of Mr. Stoker, a former midlevel manager at Citigroup, after he offered the “Where’s Waldo?” defense, which pointed to the government’s failure to pursue more senior officers for any violations. The S.E.C. dismissed its lawsuit against Mr. Steffelin before the case even got to trial.
While defendants have to deal the tight deadlines imposed by the S.E.C., there is a small bit of irony because it appears the administrative judges are unable to make their decisions in complex cases on the schedule imposed by the “rocket docket.” The rule requires the administrative judge to render a decision within two and a half months of the filing of the final briefs to meet the overall 300-day limit.
In both the cases, the S.E.C. had to grant extensions last week for the judge to file a decision because of the press of other matters and the volume of material generated by the hearings. So the initial decision in Mr. Jarkesy’s case won’t come out until Oct. 17, a two-month delay, while Mr. Chau and Hastings Advisory will have to wait another four months, until Jan. 12, to learn the outcome.
The argument that an administrative proceeding is unfair because of the benefits the S.E.C. gets from allowing only limited discovery and a short time to prepare is unlikely to generate much sympathy in the appeals courts. The use of administrative judges to hear cases is widespread in the federal government, and courts are usually loath to invalidate a process without looking to the facts of a particular case to see if there was actual prejudice from the procedures employed.
A stronger argument is that disparate treatment of defendants accused of similar violations, like those involving the C.D.O.s., should at least require the S.E.C. to give reasons explaining why it chose a particular forum. Courts get suspicious when an agency does not have explicit policies in place for choosing how to proceed, especially when the administrative route appears to give the S.E.C. some significant advantages.
Requiring the S.E.C. to provide at least some guidance about what drives a case to a particular forum would help potential defendants understand what they are up against before the charges are filed. Guidelines would impose a measure of accountability on the S.E.C. to explain how it will treat violations in a fair and consistent manner, rather than appearing to take advantage of the “rocket docket.”