Seventh Circuit Closes A Path Out of SEC Administrative Proceedings And Into Federal Court

Practitioners and parties familiar with the SEC’s administrative proceedings avoid them whenever possible, preferring federal court. Recently such respondents have drawn hope from a spate of district court rulings suggesting that they may invoke constitutional grounds to have their administrative proceedings enjoined or re-routed to federal court. Now, a Seventh Circuit opinion and a SEC administrative ruling cast doubt on that remedy.

On August 24, 2015 in Bebo v. SEC, the Seventh Circuit relied upon a series of prior cases to foreclose the path to federal court. The court drew on Supreme Court decisions in Elgin et al. v. Department of the Treasury, et al. 132 S. Ct. 2126 (2012), Free Enterprise Fund v. Public Co. Accounting Oversight Bd., 561 U.S. 477 (2010), and Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994) to find that it was “fairly discernible” that Congress intended the SEC’s administrative process be the exclusive path through which enforcement claims not filed in federal court (and defenses to those claims) are to proceed. That path is followed, where necessary, by judicial review in the courts of appeals. In so finding, the Seventh Circuit affirmed the district court’s holding that Congress, in providing a statutory scheme that allows for appellate review of SEC orders, effectively stripped the district courts of jurisdiction to hear challenges to the SEC’s administrative process.

As the first appellate decision to address this highly charged issue, Bebo offers cold comfort to the growing queue of respondents eager to launch similar attacks on their administrative proceedings based on encouraging decisions from the Northern District of Georgia and Southern District of New York. Those courts struck a bold departure from longstanding Supreme Court precedent echoed in Free Enter. FundElgin and now Bebo. Wing Chau of “Flash Boys” fame is briefing a related issue before the Second Circuit in his appeal from the opinion of Judge Lewis Kaplan of the Southern District of New York.  Judge Kaplan ruled against Chau based on the well-established proposition that “when Congress creates procedures ‘designed to permit agency expertise to be brought to bear on particular problems,’ those procedures ‘are to be exclusive,’” so long as they don’t foreclose meaningful judicial review.  Memorandum Opinion, 1:14-cv-01909-LAK, Dkt. 27, at 5-6, and n. 20 (quoting Free Enter. Fund and the Supreme Court’s 1965 decision in Whitney National Bank in Jefferson Parish v. Bank of New Orleans & Trust Company, 379 U.S. 411, 420).

In Bebo the court, relying primarily on Elgin, rejected the challenge asserted by Laurie Bebo, former CEO of Assisted Living Concepts, Inc., to the facial constitutionality of the SEC’s authority to decide which matters would be filed in district court (and thereby enjoy the benefits of the federal rules of procedure and evidence and the right to trial by jury) and which in its administrative court, in alleged violation of her Fifth Amendment, due process and equal protection protections. Rejecting Bebo’s arguments, the court echoed the Supreme Court’s observation that a challenge to the facial constitutionality of a statute is not always easily distinguished from a challenge to how the statute is applied such that it automatically implicates a district court’s federal question jurisdiction, and that the better analysis focuses on the status of the party asserting the challenge and the action being challenged. Since Bebo was already party to a SEC administrative action when she asserted her challenge and the issues in the action, including the constitutional issues, could be addressed by the administrative law judge (“ALJ”) – after which review could be had in the court of appeals – the court concluded, consistent with the Supreme Court’s opinions in Thunder Basin and Elgin, that it was “fairly discernible” that Congress intended the administrative process to be the exclusive path for adjudication of the SEC’s claims against Bebo, and Bebo’s defenses.

While Bebo represents yet another hurdle to opponents of the SEC’s administrative court, SEC v. Ruggieri represents a resounding victory by a respondent over the SEC in that same forum. On September 14, 2015, SEC ALJ Jason Patil, in a 50 page initial decision, rejected the Division of Enforcement’s (the “Division”) insider trading allegations against Joseph Ruggieri. Ruggieri is a former Wells Fargo Securities trader whom the Division accused of receiving and trading on advance notice of securities ratings changes by Gregory Bolan, then a Wells Fargo research analyst. (Bolan settled out of the case in May.) ALJ Patil found the Division had not carried its burden to show that information Ruggieri received from Bolan was given as a quid-pro-quo, or personal benefit. The personal benefit test was one of two heightened standards articulated by the Second Circuit Court of Appeals in December 2014 for the tipper-tippee theory of insider trading. The case adopting this standard, U.S. v Newman, followed a string of more than 90 insider trading prosecutions commenced by the SEC and Department of Justice between 2009 and 2014. In those cases the SEC often charged remote tippees, i.e., persons one or two (or more) levels removed from the persons believed to have passed or received an improper tip.

In Ruggieri’s case, the Division alleged that on at least six occasions Ruggieri traded in a direction consistent with ratings changes prepared by Bolan, but before publication and, as a result of these trades Ruggieri and his employer profited by more than $117,000. The Division has 21 days to appeal the ALJ’s initial decision to the full SEC. Whether it does or doesn’t, this is a stinging defeat – on the Division’s home turf, under a heightened standard with which the Division, the SEC and the Department of Justice all strongly disagree (and are seeking Supreme Court review) – and will blunt to some extent the criticism of the SEC’s use of its administrative forum. For the time being, at least, Ruggieri gives the SEC the ability to argue that the outcome in this case shows that the Commission does not always win on its home court, and that respondents have as much opportunity to prevail in administrative proceedings as in federal court.

In the meantime, the SEC is appealing the handful of lower court rulings that have blocked a number of administrative proceedings from going forward on constitutional grounds.

Ron Wood

Ron Wood is a partner with Brown White & Osborn LLP. A former Assistant Director in the SEC's Division of Enforcement, Executive Director in the Law Division at Morgan Stanley, and litigation partner with Proskauer LLP, he practices securities law with a focus on regulatory and enforcement matters. He also conducts internal investigations and complex commercial litigation.
Ron Wood