On June 2, 2023, the United States Securities and Exchange Commission (“SEC”) dismissed 42 administrative enforcement actions and vacated 48 collateral industry bars because its Division of Enforcement (“Enforcement”) staff improperly had access to memoranda prepared to assist SEC Commissioners in deciding those matters.
The SEC investigates potential violations of the federal securities laws and is authorized by law to prosecute civil enforcement actions in its own in-house administrative courts or in federal court. The investigative and prosecutorial responsibilities are carried out by Enforcement staff and are required to be kept separate from the SEC’s in-house adjudication function. However, on April 5, 2022, the SEC issued a statement disclosing that it identified a “control deficiency” in which certain SEC databases improperly allowed Enforcement staff to have access to memoranda prepared by the Office of the General Counsel Adjudication Group (“Adjudication Group”) to advise Commissioners in making decisions in administrative proceedings.
The April 5 statement identified two high-priority matters that were potentially affected by the control deficiency: SEC v. Cochran, No. 21-1239 (S. Ct.) and Jarkesy v. SEC, No. 20-61007 (5th Cir.). Both cases arose from administrative proceedings and were under review in federal courts. In an internal review, the SEC determined that administrative personnel in Enforcement accessed Adjudication Group memoranda related to these two cases and uploaded them to a database accessible to all Enforcement personnel. The SEC found no evidence that Enforcement staff assigned to investigate and prosecute those actions actually reviewed the memoranda. Further, based on the timeline of filings and SEC actions, it found that any Enforcement staff access to the Adjudication Group memoranda would not have affected any Enforcement filings. The SEC indicated in its April 5 statement that its review was ongoing.
On June 2, 2023, the SEC issued an additional statement disclosing that Enforcement administrative staff accessed and uploaded to an Enforcement database, Adjudication Group memoranda specific to another 28 cases and additional Adjudication Group memoranda broadly applicable to 61 more. It also disclosed that administrative staff in the SEC’s New York Regional Office (“NYRO”) sent Adjudication Group memoranda concerning four matters to the NYRO Enforcement Supervisor, an attorney responsible for overseeing the work of other Enforcement attorneys in NYRO. In two instances, staff uploaded the memoranda into a NYRO Enforcement database. The SEC further revealed that thirteen reports distributed to senior Enforcement staff regarding outstanding recommendations from the Enforcement Division on which Commissioners were to vote (“Outstanding Seriatim Reports”), contained information from Adjudication Group memoranda. The SEC again found no evidence that the control deficiency resulted in harm to any respondent or affected the SEC’s adjudication in any proceeding. The SEC also found no evidence that Enforcement staff assigned to investigate and prosecute the relevant matters actually accessed any case-specific memoranda before the SEC took the action recommended in those memoranda. Nevertheless, the SEC issued two orders: one dismissing 42 proceedings and one granting 48 pending petitions to vacate collateral bars that prevented petitioners from association with certain types of businesses in the financial industry.
The internal control deficiency breaching the barrier between the SEC’s prosecutorial and adjudicative functions is the most recent of several blows to the agency’s in-house administrative proceedings. In 2021, the Supreme Court held that SEC administrative law judges (“ALJs”) were unconstitutionally appointed. Lucia v. Securities and Exchange Commission, 138 S. Ct. 2044 (2018). Last year, in Jarkesy v. Securities and Exchange Commission, the Fifth Circuit held that: SEC ALJs were unconstitutionally insulated from removal; SEC administrative proceedings to impose monetary penalties for fraud violated the Seventh Amendment right to a jury trial; and Congress unconstitutionally delegated legislative power by granting the SEC unfettered authority to select between administrative proceedings or federal courts as a forum for agency enforcement actions. Jarkesy v. Securities and Exchange Commission, 34 F.4th 446 (5th Cir. 2022). A petition for a writ of certiorari is currently pending before the Supreme Court in Jarkesy. And, on April 12, 2023, the Supreme Court held that respondents in Federal Trade Commission and SEC administrative proceedings may challenge the constitutionality of those proceedings in federal district court while the administrative process is still ongoing. Axon Enterprises v. Federal Trade Commission and Securities and Exchange Commission v. Cochran. Our articles on the Axon, Cochran and Jarkesy decisions can be found here and here. Coincident with these recent developments, the SEC has become more selective in its use of administrative proceedings. It continues to bring such actions when the circumstances of a case are particularly well suited to the administrative forum or when the relief sought, such as an industry bar, is only available there. However, the SEC is increasingly bringing enforcement actions in federal court. That trend is likely to continue. Notably, the SEC determined that its Enforcement staff accessed 10 Adjudication Group memoranda relating to the Jarkesy matter. The SEC did not dismiss Jarkesy because it had already issued a final order in the action. However, if the Supreme Court grants the pending certiorari petition in Jarkesy, the SEC’s internal control deficiency that allowed Enforcement staff to access Adjudication Group memoranda may make it harder for the agency to successfully defend its administrative proceedings before the Court. The SEC’s decision to dismiss 42 other matters including Cochran as well as vacate 48 collateral bars previously imposed in administrative proceedings may reflect its desire to avoid additional litigation, appellate review, and more adverse rulings over its administrative proceedings.