Yesterday, I wrote about a strategy of not showing up to prevent a quorum from being established at an annual meeting of stockholders. What happens when the Securities and Exchange Commission initiates administrative proceedings against you and you don’t respond? The likely result is the SEC will take your default. That is indeed what happened in Rapoport v. Securities and Exchange Commission, 2012 U.S. App. LEXIS 12336 (D.C. Cir. June 19, 2012). It’s what happened next that makes the case interesting.
The case arose from this default order entered by an administrative law judge against a Russian citizen, a Mr. Dan Rapoport, for willfully soliciting securities transactions in the United States without being registered as a broker (a violation of Section 15(a) of the Securities Exchange Act of 1934). Mr. Rapoport moved to have the default judgment set aside under SEC Rule 155(b). The same administrative law judge denied the motion but did correct a mathematical error in the determination of the amount of civil penalties in this order. Mr. Rapoport then asked the Commissioners to set aside the order. The Commissioners, however, concluded in this order that it was “not unjust” for the administrative law judge either to issue the default order or to impose sanctions. Mr. Rapoport then sought review in the U.S. Court of Appeals for the District of Columbia.
While the Court of Appeals found that the SEC is free to fashion its own rules of procedure, this freedom is not absolute. The SEC must apply its rules consistently. While one might expect the court to have grounded this constraint on the notion of horizontal fairness (like cases being treated alike), the court cited the need of a reviewing court to understand the basis for the agency’s action. The court also found that the SEC may not depart from its own precedent without offering a reasoned explanation.
Rule 155(b) requires that a motion to set aside a default be filed within a “reasonable time”. The Court of Appeals also faulted the SEC for failing “to provide any intelligible standard to assess what constitutes a ‘reasonable’ amount of time . . .”. This involved two questions. First, when does the reasonable time clock start ticking? Second, when does the reasonable clock stop ticking?
Finally, the Court of Appeals found that the SEC “must provide some meaningful explanation for imposing sanctions.” In this case, the court found that the administrative law judge failed both to follow the statute in determining the amount of civil monetary penalties and to justify imposing the maximum penalty on Mr. Rapoport.
This case is significant because the standard of review so clearly favored the SEC. Under the Administrative Procedure Act, the Court of Appeals was required to uphold the SEC’s legal conclusions unless they were “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law”. 5 U.S.C. § 706(2)(A).
It remains to be seen whether Mr. Rapoportwill ultimately prevail. The Court of Appeals vacated the SEC’s order and remanded it to the SEC. It may be that the SEC will come up with an explanation that satisfies the court should the matter be appealed again. That is what happened in the venerable case of Securities and Exchange Commission v. Chenery, 332 U.S. 194 (1947), a case cited by the Court of Appeals in Rapoport. The U.S. Supreme Court actually heard the Chenery appeal twice. The first time, 318 U.S. 80 (1943), the Supreme Court held that an order of the SEC could not be sustained on the grounds upon which the SEC acted. That opinion, which predates the Administrative Procedure Act, established the important principle that a reviewing court, in dealing with a determination or judgment that an administrative agency alone is authorized to make, must judge the propriety of the agency’s action solely by the grounds invoked by the agency. After remanding the case to the SEC, the matter was appealed to the Supreme Court a second time. In the second appeal, the Supreme Court sustained the SEC’s action as “the product of administrative experience, appreciation of the complexities of the problem, realization of the statutory policies, and responsible treatment of the uncontested facts.”