From a securities enforcement perspective, one of the most significant aspects of 2010’s Dodd-Frank Act was Section 929P: the authorization for the SEC to seek civil penalties in administrative proceedings. Before, the SEC could seek those penalties only against regulated entities. Now, anyone is fair game, and to get those penalties, the SEC does not have to file an action in federal court. It simply submits the case to an administrative law judge and has the matter resolved there.
The administrative process includes a number of advantages for a well-prepared Enforcement Division. It provides for very little discovery, and deadlines are short. The Commission’s Rules of Practice provide for a hearing within approximately four months of filing the order instituting proceedings, 17 C.F.R. § 201.360(a)(2), and hearing officers “strongly disfavor” extensions and postponements. 17 C.F.R. § 201.161(b). While depositions of witnesses who would be unavailable at trial are allowed, a party has to move for the right to take them. 17 C.F.R. § 201.233(a). In short, if the SEC isn’t ready to go to trial when filing the case, it should not go the administrative route. Defendants have not necessarily liked the administrative process, and have unsuccessfully challenged it on Due Process grounds. In Dearlove v. SEC, 573 F.3d 801 (D.C. Cir. 2009), the auditor of Adelphia claimed the short time frame and massive record deprived him of due process. Both the Commission and the D.C. Circuit rejected the argument.
So perhaps it should not have been surprising that when the SEC brought an administrative action against the Egan-Jones Rating Company and its principal, Sean Egan, that they would try to force the action into federal court. At least there, the perception of a “home court” for the SEC is lessened, and the litigation of the case would be drawn out into a more manageable pace. So last week Egan-Jones filed its own case in the U.S. District Court for the District of Columbia, seeking to compel removal of the administrative action to that forum.
The SEC has charged that in 2008, Egan-Jones made material misrepresentations to the Commmission when it applied to be a Nationally Recognized Statistical Rating Organization for financial institutions, insurance companies, and corporate issuers. To take an excerpt from the SEC’s order:
EJR falsely stated that, as of the date of its application, it had 150 outstanding ABS issuer ratings and 50 outstanding government issuer ratings. EJR further falsely stated in its application that it had been issuing credit ratings in these categories as a credit rating agency on a continuous basis since 1995. In fact, at the time of its July 2008 application, EJR had not issued – that is, made available on the Internet or through another readily accessible means – any ABS or government issuer ratings. EJR willfully made these misstatements and omissions to conceal the fact that it had no experience issuing ratings on ABS or government issuers, and therefore did not meet the requirements for registration of an NRSRO with respect to these categories.
In its complaint, Egan-Jones responds:
The SEC’s focus on Egan-Jones, the only independent credit rating agency, to the exclusion of bringing cases against Moody’s, Fitch, and Standard & Poor’s – all of which had suspect ratings that might have caused the most recent financial crisis – demonstrates the SEC’s bias against Egan-Jones.
The SEC inappropriately allowed staff members from its Office of Compliance, Inspections, and Examinations to participate in seeking testimony in the Enforcement Division’s investigation of Egan-Jones, and then to continue to seek information from Egan-Jones in their examination role.
The leak to a Reuters reporter of the Commission’s vote on whether to pursue enforcement action against Egan-Jones – before the vote had happened – further demonstrates the SEC’s bias against Egan-Jones.
I suspect Egan-Jones will have a steep hill to climb in convincing the federal court to wrest this matter away from the Commission. Compelling the SEC to forbear enforcement action against one party when other, perhaps similarly situated, parties have escaped enforcement action would seem to be a substantial intrusion on a federal agency’s determination on how best to marshal its resources. Still, using OCIE staff to participate in an Enforcement investigation is a bit odd, especially when they are then allowed to return to an examination where they are also seeking information from an entity under very different, and supposedly less threatening, circumstances. Also, leaking information about closed Commission meetings is never a good idea, and here it has only given Egan-Jones ammunition to challenge the legitimacy of the administrative process. Leaks like this have happened before, but they are quite unfortunate and serve no legitimate purpose. We’ll see if Egan-Jones can make enough of these circumstances to compel removal to federal court.