SEC Should Cut Its Dystopian Follow-On Enforcement Proceedings
Imagine you’ve just endured a nasty lawsuit where your adversary convinces the court you deserved to be punished. Before lodging your appeal, you’re sued in a different tribunal for even more punishment—and the judge assigned to decide that new case is your erstwhile adversary.
Welcome to the dystopian world of Securities and Exchange Commission “follow-on” administrative enforcement proceedings, which typically account for more than 20% of the hundreds of enforcement cases the agency prosecutes each year. With in-house SEC administrative tribunals currently facing judicial scrutiny in the US Supreme Court and elsewhere, these follow-on proceedings are particularly vulnerable to constitutional challenge.
Federal law allows the SEC to bar or suspend securities industry participants if they’ve been convicted of certain crimes, restrained by court injunction from engaging in certain kinds of financial activity, or barred or suspended by a state securities regulator for fraudulent misconduct.
But even after one of these predicate legal events occurs, the SEC must also find, after notice and an opportunity for a hearing, that a bar or suspension is in the public interest. And before making such a finding, the SEC must weigh factors such as the nature of misconduct, the wrongdoer’s degree of intentionality, and the likelihood of repetition.
This has numerous constitutional problems, even when the predicate regulatory event occurred in a case where the SEC wasn’t involved. For starters, the SEC isn’t a court, and its commissioners aren’t judges.
They’re part of the executive branch of government and have no business deciding cases or controversies, such as whether an alleged wrongdoer should be punished and whether that punishment is in the public interest. Article III of the Constitution vests that role exclusively in federal courts with real judges and juries.
But where the predicate event for an industry bar or suspension is a court injunction secured by the SEC in one of its own enforcement cases, another uniquely insuperable constitutional defect emerges. The SEC can’t possibly serve as a neutral arbiter in the follow-on case. Yet it routinely pretends to do so, in case after case—though to my knowledge, no litigant has ever objected on this ground.
Think about it. First, the SEC sues you as an alleged lawbreaker and brands you as such in public news releases. The agency then pursues years of contentious litigation trying to prove its allegations against you—all in a fiduciary attorney-client alliance with its staff prosecutors.
If it succeeds, it then seeks and likely gets a court injunction against you, insisting you will repeat your wrongdoing unless restrained. It then cites the injunction as predicate to launch a follow-on proceeding to bar or suspend you from the securities industry, assigning the same staff lawyers to prosecute the follow-on and itself as the judge and jury.
And you’re then supposed to trust the SEC to be a neutral and objective adjudicator of your follow-on proceeding? Right.
The SEC rarely decides that a follow-on bar or suspension isn’t in the public interest.
These proceedings violate core principles of due process, the most basic of which is a fair trial in an unbiased tribunal. That means not only actual fairness, but also the appearance of fairness.
Any appearance of fairness is negated when the adjudicator decides its own case or a directly related case. That appearance is likewise negated when the adjudicator decides a case being prosecuted by its own lawyers and defended by the person it previously sued based on the same facts.
The SEC may say this injustice is not its fault, because Congress worded the relevant securities laws so that only the SEC can bar or suspend people from the securities industry. But that’s not true; the agency can easily ask the court that issues a predicate injunction to include an industry bar or suspension in the injunction.
The SEC doesn’t do that, however, because it prefers to leave that decision to its own discretion rather than having to convince a court that a bar or suspension is warranted.
Perhaps some SEC follow-on target will challenge this process in court—a challenge that can’t come soon enough.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
March 21, 2024
Originally Published in Bloomberg Law