- March 31, 2014
- Labaton Sucharow
Posted March 31, 2014
On March 21, Wing Chau – a subprime CDO manager who featured prominently in Michael Lewis’s best-selling book “The Big Short” – sued the SEC, claiming that the SEC violated his constitutional rights by choosing to bring its fraud claims against him in its own administrative forum, rather than in federal court. The SEC administrative proceeding in question focuses on allegations that Chau and his company allowed a hedge fund called Magnetar to help choose collateral for a 2006 CDO, even though Chau knew that Magnetar’s investment strategy would allow it to profit if the CDO failed, creating a conflict of interest that was not properly disclosed to CDO investors. Chau now claims that he will be denied due process and equal protection under the law if the SEC pursues its case through an administrative proceeding, instead of a traditional trial (similar claims were brought in 2011 by Galleon defendant and former Goldman director Raj Gupta, who was eventually convicted of insider trading in federal court and whose appeal was recently denied).
While the choice of a forum for an SEC case may not seem as gripping as the events underlying “The Big Short” and the substantive claims against Chau, this case raises crucial issues for everyone involved in SEC enforcement actions, including current and potential whistleblowers. These issues are now coming to the fore because the Dodd-Frank Act significantly expanded the jurisdictional scope of the SEC’s administrative forum, giving the SEC the right to seek through administrative proceedings civil money penalties from any person, instead of merely the “regulated persons” (including registered broker-dealers and investment advisers) who were previously subject to its administrative jurisdiction. In other words, the SEC now has much freer rein to bring cases in the administrative forum.
Enhanced Judicial Power
The SEC’s enhanced ability to bring cases in the administrative forum is noteworthy because there are crucial differences between an SEC administrative proceeding and a federal trial. Perhaps most significantly, an administrative proceeding is conducted and decided by an Administrative Law Judge (“ALJ”), without the option of a jury. While these ALJ decisions are eventually reviewable by a federal appellate court, litigants must first appeal any adverse decision to the Commission itself, which reviews the case de novo. Also important is the fact that, pursuant to the SEC Rules of Practice, SEC administrative proceedings must, in nearly every case, proceed on an expedited schedule, with far more limited pre-trial discovery than is allowed in federal court. For example, except in rare cases, the parties may not conduct pre-trial depositions (although the SEC Staff may, of course, take testimony during SEC investigations).
While conducting a complex litigation in the SEC administrative forum is not without risk to the SEC trial staff – which must also abide by the expedited schedule – administrative proceedings are widely seen as a way for the SEC to more efficiently and effectively bring enforcement actions. Indeed, enhancing the SEC’s enforcement capabilities seems to have been the driving force behind Congress’s decision to expand the scope of administrative proceedings. Top SEC officials have repeatedly indicated that they plan to take advantage of this new power and, in the words of Assistant Chief Counsel Charlotte Buford, will no longer “be bound by false ties to outdated presumptions” about which types of cases must be brought in federal court versus an administrative proceeding.
These developments are obviously nerve-wracking for defendants like Wing Chau – who believe they would have better luck in a federal court – but what do they mean for current and potential SEC whistleblowers? My view is that the SEC’s willingness to bring more cases in the administrative forum provides the agency with increased flexibility and will lead to more timely resolutions of enforcement matters, which bodes well for whistleblowers and investors (although most cases, including those based on whistleblower tips, remain likely to settle prior to the institution of either an administrative proceeding or a federal suit). Defendants who decide to contest SEC charges will inevitably continue to protest the expanded use of the administrative forum, but the Commission has an important mission and should use all of the lawful tools provided by Congress to protect investors and ensure a fair marketplace.
For more information about securities fraud, see our Securities Law Primer
