The SEC's Expedient "Follow-On" Rubber Stamp

Imagine you’ve just endured a nasty lawsuit during which your adversary waged a parallel media campaign to demonize you as a lawbreaker, ultimately convincing the court that you deserved to be punished as such.? Then imagine that, before you could even lodge your appeal, your adversary’s lawyers sued you again in a different tribunal to demand even more punishment—and that the judge assigned to decide that new case was … your erstwhile adversary!

Welcome to the dystopian world of SEC “follow-on” administrative enforcement proceedings, which typically account for more than 20 percent of the hundreds of enforcement cases the agency prosecutes each year.

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.”? Courts have required the SEC, before making such a finding, to weigh multiple factors including the nature of the misconduct, the wrongdoer’s degree of intentionality, and the likelihood of repetition.

This scheme has numerous constitutional problems, even when the predicate regulatory event occurred in a case where the SEC was not involved.? For starters, the SEC is not a court, and its commissioners are not judges.? They are part of the executive branch of government, and thus 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 having real judges and juries.

But where the predicate event for an industry bar or suspension was a court injunction secured by the SEC in one of its own enforcement cases, another uniquely insuperable constitutional defect emerges: The SEC cannot possibly serve as a neutral adjudicator of 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.? And after issuing a self-congratulatory press release further demonizing you, it then cites the court 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 case and itself as the judge and jury that will decide the case.

And you’re then supposed to trust the SEC to magically pivot from being your years-long nemesis to becoming the neutral and objective adjudicator of your follow-on proceeding?? Right.?

Guess how often the SEC ultimately decides that a follow-on bar or suspension is not in the public interest?? If you said rarely or never, go to the head of the class.

These sham proceedings violate core principles of due process, the most basic of which is a fair trial in a unbiased tribunal.? That means not only actual fairness but the appearance of fairness.? But 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 might 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 could easily ask the court that issues a predicate injunction to include an industry bar or suspension in the injunction, which would make more sense anyway.? 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 rigged process in court.? That challenge can’t come soon enough.

Russell G. Ryan, a former assistant director of enforcement at the SEC,?deputy chief of enforcement at the Financial Industry Regulatory Authority (FINRA), and partner with the law firm King & Spalding LLP, is now Senior Litigation Counsel at the New Civil Liberties Alliance.

The opinions expressed by this author are his alone and do not necessarily reflect the views of his past or present law firms, colleagues, or clients. His articles and postings are solely for general information purposes and are not intended to be, and should not be, read or interpreted as legal advice.

[Note: A similar version of this article was previously published by Bloomberg Law.]