On June 30, 2015, U.S. District Judge Ronnie Abrams handed down an important decision affecting the SEC’s controversial practice of bringing insider trading enforcement actions in the form of in-house administrative proceedings instead of as civil court actions. In a 23-page opinion, Judge Abrams refused to enjoin the SEC from continuing with an ongoing administrative proceeding against Lynn Tilton, her fund Patriarch Partners and other related funds. The Court held that it did not have the power to hear Tilton’s claim that the SEC’s administrative procedure is unconstitutional under the Appointments Clause of the Constitution, because Congress already had constructed an administrative scheme which provided an avenue for meaningful judicial review by a federal court of appeals.
The Court’s decision followed shortly after an order issued on June 29, 2015, in which U.S. District Judge Edgardo Ramos dismissed an action brought by Spring Hill Capital Partners and its principal, Kevin D. White, on similar grounds. These decisions were a major departure from recent cases such as Hill v. SEC (Georgia district court, June 2015), where a federal court found jurisdiction existed and enjoined the SEC from continuing with an ongoing administrative proceeding, and Duka v. SEC (New York district court, April 2015), where the court found jurisdiction existed but refused to grant an injunction to the aggrieved plaintiff who was the subject of an SEC proceeding. In the Tilton case, the Court entirely rejected the premise that it had the power to hear the case at all, holding that Tilton had failed to carry her burden of showing, by a preponderance of the evidence, that federal subject matter jurisdiction existed.
The Court based its decision on, among other things, analogous Supreme Court decisions involving proceedings before the Federal Deposit Insurance Corporation and the U.S. Tax Court. In those cases, the plaintiffs who challenged proceedings as unconstitutional under the Appointments Clause were required to await the conclusion of the administrative proceedings before obtaining judicial review in an Article III court. In this case, the Court found that Tilton would obtain meaningful judicial review in the event that the SEC rendered a decision against her and that, in the interim, the SEC’s administrative law judge was capable of hearing and adjudicating her claims.
The SEC’s administrative proceedings have become highly controversial in recent years, as many defendants in the proceedings have complained that the process is inherently unfair. Among the concerns raised by defendants in the administrative proceedings are that discovery is limited and depositions are generally not permitted to be taken by defense attorneys, and that there are no juries. Perhaps the most significant criticism is that both the judge and the prosecutor are employees of the SEC, and appeals must be taken directly to the SEC commissioners, and only then to a federal court of appeals. According to the Wall Street Journal, the SEC prevailed against 90% of defendants in contested administrative proceedings from October 2010 to March 2015, a significant difference from the SEC’s 69% win rate in federal court over the same period.
These cases potentially represent a major setback for insider trading defendants in SEC administrative proceedings. The Hill case recently offered hope that defendants in ongoing SEC administrative proceedings could obtain injunctive relief in federal courts. Now, following the Tilton and Spring Hill cases, such claims are far less likely to be successful, at least in the Southern District of New York. Tilton will be required to wait for the SEC proceedings to conclude before she may eventually appeal an unfavorable decision to the Second Circuit or D.C. Circuit Court of Appeals. It remains to be seen whether Tilton’s claim that the SEC procedure is unconstitutional will eventually prevail.