The defense bar recently won a significant victory in the battle to challenge the SEC’s expanded use of administrative proceedings, following the 2010 enactment of the Dodd-Frank Act, to seek penalties against unregulated individuals and entities. As we previously wrote in SEC’s Administrative Proceedings: Where One Stands Appears to Depend on Where One Sits and There’s No Place Like Home: The Constitutionality of the SEC’s In-House Courts, SEC administrative proceedings have recently faced growing scrutiny, including skepticism about whether the administrative law judges (ALJs) presiding over these cases are inherently biased in favor of the SEC’s Division of Enforcement. The Wall Street Journal recently reported that ALJs rule in favor of the SEC 90% of the time in administrative proceedings. Administrative proceedings have also been criticized for the ways in which they differ from federal court actions, including that respondents are generally barred from taking depositions, counterclaims are not permissible, there is no equivalent of Rule 12(b) motions to test the allegations’ sufficiency, and there is no right to a jury trial.
SEC’s Administrative Proceedings: Where One Stands Appears to Depend on Where One Sits
As we have previously reported, practitioners and judges alike have recently been questioning the SEC’s increased use of administrative proceedings. Defense lawyers complain that administrative proceedings, which have historically been a rarely used enforcement tool, are stacked against respondents. Recently, Judge Rakoff of the U.S. District Court for the Southern District of New York publicly discussed the “dangers” that “lurk in the SEC’s apparent new policy.” Director of Enforcement Andrew Ceresney delivered a speech late last month responding to public criticism, in particular countering many points raised by Judge Rakoff.
There’s No Place Like Home: The Constitutionality of the SEC’s In-House Courts
Until recently, it was extremely rare for the SEC to bring enforcement actions against unregulated entities or persons in its administrative court rather than in federal court. However, as a result of the Dodd-Frank Act (and perhaps the SEC’s lackluster record in federal court trials over the past few years), the SEC is committed to bringing, and has in fact brought, more administrative proceedings against individuals that previously would be filed in federal court. Many have questioned the constitutionality of these administrative proceedings. As U.S. District Judge Jed Rakoff remarked in August 2014: “[o]ne might wonder: From where does the constitutional warrant for such unchecked and unbalanced administrative power derive?” Several recent SEC targets agree with Judge Rakoff, and have filed federal court suits challenging the constitutionality of the SEC’s administrative proceedings. (Notably, in a 2011 order regarding the SEC’s first attempt to use its expanded Dodd-Frank powers to bring more administrative cases, Judge Rakoff denied a motion to dismiss a constitutional challenge to the SEC’s decision to bring an administrative proceeding in an insider trading case against an unregulated person, following which the SEC terminated that proceeding and litigated in federal court.)
SEC Gives Itself the Home Court Advantage in an Accounting Fraud / Internal Controls Action Against a Corporate CEO
An otherwise mundane SEC announcement on July 30, 2014 of an enforcement action charging a public company CEO and CFO with accounting fraud and internal controls violations is significant because the SEC is proceeding against the non-settling individual (the CEO) in an administrative proceeding rather than in federal court. While not unprecedented, it has been, to date, exceedingly rare for the Commission to proceed against an unregulated entity or person administratively rather than in federal court. This decision reflects the Commission’s and Enforcement Division’s recently, but frequently, stated intent to bring more administrative proceedings that previously would have been brought in federal court, now that the Commission has expanded remedies under Dodd-Frank Act. The decision also raises significant due process issues.
The action itself charges Marc Sherman and Edward Cummings, CEO and former CFO, respectively, of QSGI Inc., a Florida-based computer equipment company, with violation of the antifraud and other provisions of the Securities Exchange Act of 1934 and the Sarbanes-Oxley Act of 2002. According to the Commission’s press release, Sherman and Cummings claimed they had disclosed all significant deficiencies in internal controls over financial reporting to the company’s independent auditors, but in fact did not disclose or direct anyone else to disclose ongoing inventory and accounts receivable issues or improper acceleration of recognition and the resulting falsification of QSGI’s books and records. The Commission also alleges that the executives signed SEC filings and Sarbanes-Oxley certifications that were rendered false and misleading due to the above issues. Cummings entered into an administrative settlement with the SEC, agreeing to a cease and desist order, a $23,000 civil penalty, a 5-year officer and director bar, and a 5-year bar on appearing or practicing before the Commission as an accountant. Sherman did not settle, and will instead litigate against the Division of Enforcement in an administrative proceeding. READ MORE