In mid-June – following the third in a trio of high-profile losses by the SEC in insider trading cases tried in federal court – Andrew J. Ceresney, Director of the SEC’s Division of Enforcement, announced that the Commission will adjudicate more insider trading cases in SEC administrative proceedings decided by SEC administrative law judges (“ALJs”), as opposed to litigating such cases in federal court. Although the Dodd-Frank reforms that allow the SEC to use administrative proceedings to seek civil penalties against unregulated persons were enacted four years earlier, the SEC has largely continued to bring insider trading cases in federal court. Going forward, however, Ceresney explained that the Commission will decide the appropriate fora for its insider trading cases on a “case-by-case” basis, and its use of administrative proceedings will increase. Ceresney also claimed, incredibly perhaps, that the SEC’s decision to bring more cases on its home turf before its own ALJs was not a reaction to the Commission’s recent defeats in insider trading cases tried in federal court. Rather, the Commission has touted a host of so-called advantages to the use of administrative proceedings, such as its streamlined process, which allows for an initial decision to be rendered by the ALJ in as few as 120 days, or at most 300 days, from the date that the case was initiated.
As promised, early this fall, the SEC brought its first administrative proceeding alleging insider trading in three years. For its “test” in-house case, the SEC initiated Orders Instituting Cease-and-Desist Proceedings against Jordan Peixoto, a 30-year old Canadian MBA graduate, and his friend, Filip Szymik. The SEC alleged that an unnamed analyst at Pershing Square Capital Management provided inside information to Szymik, his roommate. The tip included information that Pershing’s head, activist investor William Ackman, had a “negative view” of Herbalife stock, which he would reveal at an upcoming public presentation. Szymik allegedly passed on the information to his friend, Peixoto. The SEC claimed that both Szymik and Peixoto knew that Pershing’s negative view of Herbalife likely would cause the stock’s price to plummet when the information became public. The SEC further maintained that Peixoto traded based on Szymik’s tip, earning $47,100 in profits due to a huge drop in Herbalife’s stock price following Pershing’s presentation and the announcement of its substantial short position in Herbalife’s stock.
Rather than pursuing the analyst tipper, who allegedly breached the fiduciary duty he owed to Pershing, the SEC instead elected to pursue Peixoto – a remote, downstream tippee – and Szymik – who did not even trade based on the tip. The SEC sought $47,100, the amount of Peixoto’s profit, as a civil penalty from both Peixoto and Szymik. Szymik quickly settled with the SEC, paying the relatively modest fine.
If the SEC anticipated that Peixoto would do the same, and that its test in-house case would be quietly wrapped up with the quick payment of two fines, the Commission’s calculation was way off. The SEC’s use of an administrative proceeding sparked an intense backlash against the Commission for bringing yet another insider trading case that is far from clear-cut, and is based on modest allegedly ill-gotten gains, as well as for bringing the case in the administrative forum. Many in the defense bar cried foul, accusing the SEC of pursuing a weak case that it simply could not and would not have brought in federal court. Peixoto, however, now faces an uphill battle in which his ability to present a complete defense in a neutral forum has been hamstrung.
That is certainly Peixoto’s take on the proceedings against him. But unlike Szymik, Peixoto did not capitulate. Instead, on October 20, Peixoto fought back by filing suit against the SEC in federal court, seeking declaratory and injunctive relief to prevent the Commission from violating his due process and equal protection rights under the Constitution. Peixoto claims that the SEC is selectively and disparately prejudicing him by diverting his case to an administrative proceeding, which deprives him of discovery, the protections of the Federal Rules of Evidence, and immediate appellate review rights in a judicial forum. He points out that since the enactment of Dodd-Frank in 2010, he is one of only three non-regulated persons – out of 159 – who have been charged with insider trading before an SEC ALJ, and he is the sole individual forced to litigate these charges in the administrative forum. Peixoto further complains that the proceedings violate Article II of the Constitution because the SEC ALJs wield “unchecked and unbalanced administrative power” and are impermissibly difficult to remove. The SEC has yet to respond to the complaint, though a pre-trial conference is set for December 17.
Prior to Peixoto, the SEC’s most notable past use of an administrative proceeding in an insider trading case involved Rajat Gupta. The SEC alleged that Gupta, then a member of the boards of Goldman Sachs and Procter & Gamble, disclosed material, nonpublic information about those companies to Raj Rajaratnam, the now-convicted principal of Galleon Management, LP, who then traded based on that information. Gupta sued the SEC in federal court in the Southern District of New York, asserting that the SEC had filed lawsuits in federal court against 28 other persons accused of Galleon-related insider trading, yet unjustifiably singled him out for unfavorable treatment in the SEC’s administrative court in violation of his equal protection rights. U.S. District Court Judge Jed Rakoff, who presided over the case, denied the SEC’s motion to dismiss, sharply criticizing the Commission’s “cavalier approach” in singling out Gupta. The SEC then dismissed the administrative matter, claiming that doing so was “in the public interest.” The Department of Justice later brought federal criminal charges against Gupta, and the SEC filed parallel civil proceedings in federal court on the same day.
While the constitutionality of the SEC’s use of an administrative proceeding was not ultimately decided on the merits in Gupta v. SEC, it appears that the issue will soon be addressed in federal court. Peixoto’s suit against the SEC is the latest of several recently-filed cases challenging the SEC’s attempts to flex its muscles by initiating securities enforcement actions in-house. This year alone, three investment advisory firms – Harding Advisory LLC, Patriot28 LLC, and Stilwell Value LLC – and their respective executives separately brought suit in federal court seeking to enjoin the SEC’s administrative proceedings against them. In each case, the defendants decry the obvious appearance of bias and lack of neutrality in having the SEC’s ALJs decide these cases.
If Judge Rakoff’s view is shared by others on the federal bench, the SEC has good reason to fear that its current practice will be short-lived. Earlier this year, Judge Rakoff wrote, “One might wonder: from where does the constitutional warrant for such unchecked and unbalanced administrative power derive?” Recently, he further noted that because ALJs work for the SEC, unlike independent Article III federal judges, they lack the appearance of neutrality.
The SEC’s chief litigation counsel, Matthew Solomon, however, sees no conflict. Dismissive of the avalanche of criticism in response to the SEC’s attempt to gain the home field advantage, Solomon explained: “Our ALJs call balls and strikes just like federal district court judges,” and they issue “well-reasoned decisions by sophisticated fact finders.” But even the SEC’s General Counsel, Anne K. Small, has acknowledged that it is “entirely reasonable” for attorneys to question whether the SEC’s rules for these proceedings are outdated and should be revised to allow, for example, more flexibility for trial preparation and depositions.
While the propriety of the SEC’s current practice is being teed up for review by both federal district and appellate courts, litigants in SEC administrative proceedings in the meantime must endure a fundamentally unfair process with possible draconian consequences. Hopefully, the courts will flag the SEC for “unnecessary roughness” and bring its forum-shopping to a grinding halt.
 Sarah N. Lynch, U.S. SEC to File Some Insider-Trading Cases in its In-House Court, REUTERS, Jun. 11, 2014, http://www.reuters.com/article/2014/06/11/sec-insidertrading-idUSL2N0OS1AT20140611
 Rules of Practice and Rules on Fair Fund and Disgorgement Plans, Rule 360(a) (establishing 120, 210, and 300 day timeframes for Initial Decision based on “nature, complexity, and urgency of the subject matter”).
See Order Instituting Public Administrative Cease-and-Desist Proceedings (“OIP”), In the Matter of Jordan Peixoto, Exchange Act Release No. 73263, Admin. Proceeding File No. 3-16184 (Sept. 30, 2014) (hereinafter “Peixoto OIP”); OIP, In the Matter of Filip Szymik, Exchange Act Release No. 73262, Admin. Proceeding File No. 3-16183 (Sept. 30, 2014) (hereinafter “Szymik OIP”).
 Daniel Wilson, SEC Administrative Case Rules Likely Out of Date, GC Says, Law360, Jun. 17, 2014, http://www.law360.com/articles/548907/sec-administrative-case-rules-likely-out-of-date-gc-says
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Caroline Simons is a trial lawyer who works with clients in practice areas spanning white collar criminal defense and investigations, complex commercial litigation, and cybersecurity. She represents clients facing scrutiny or enforcement proceedings by state and federal prosecutors as well as regulatory agencies, and has experience defending...
Thomas C. Frongillo, a former Assistant United States Attorney for the District of Massachusetts, is a trial lawyer with over 30 years of litigation experience, specializing in white collar criminal defense. He represents corporations and individuals in white collar prosecutions and...