Advisors in flux as SEC's in-house courts get a reset

Officials at the SEC's Enforcement Division will be working overtime as they gear up to retry potentially dozens of past cases following a legal challenge to the agency's internal judicial process.

The SEC has identified 126 pending cases that are eligible for a retrial before a new administrative law judge, offering parties until Friday, Sept. 7 to submit their request for how they would like their cases to proceed.

Financial Planning reviewed the cases that are eligible for a retrial and found that 23 of the 126 cases involved registered investment advisors. At least a dozen cases involved alleged broker violations or individuals acting as unregistered brokers.

In the process, the SEC has sought to put its in-house judicial process — the target of frequent criticism — on a stronger legal footing, likely insulating it from future challenges.

Bloomberg News

"I think that as far as the legitimacy of the [administrative law judges] themselves, this puts that question to bed," says Michael Liftik, a partner at the law firm Quinn Emanuel Urquhart & Sullivan and former deputy chief of staff at the SEC.

The move stems from a U.S. Supreme Court ruling that called into question the legitimacy of the SEC's in-house judges. In that case, barred investment advisor and radio host Raymond Lucia had defended the methodology behind his so-called "buckets of money" retirement strategy, and argued that the SEC's administrative law judges lacked the authority to adjudicate cases like his because they were hired through the federal government's civil service process.

The high court agreed.

"In Lucia, essentially they said the way that the judges were appointed was unconstitutional," Liftik says. "Then they have this problem — all these old proceedings happened under unconstitutional [administrative law judges]."

Last month, the SEC issued an order affirming that each of the five administrative law judges is, in fact, an appointee, following a similar move the commission had made last November, before the Supreme Court ruled in the Lucia case. In that decision, the high court held that administrative law judges are officers of the United States, meaning that they are subject to the constitution's appointments clause.

"In an abundance of caution and for avoidance of doubt, we today reiterate our approval of their appointments as our own under the Constitution," the commissioners wrote in their order.

That phrasing suggests that the commission is taking pains to ensure that its administrative enforcement proceedings can move forward free of legal jeopardy.

"I think that it's really a safety mechanism that the SEC is putting out there," says Sharron Ash, chief litigation counsel at the Hamburger Law Firm. "That's what the order looks like — we're going to dot our Is, cross our Ts, throw on a pair of suspenders and a belt."

Attorneys for Lucia did not immediately respond to requests for comment on how they plan to respond to the SEC's order, but industry experts stress that each advisor's case is distinct, and there is hardly any guarantee that a rehearing will result in a different outcome.

"If they're one of these pending cases and they're being given the opportunity for a retrial, it's something you have to consider very carefully," Ash says. "You get a second bite at the apple, but what about the economic impact of that — can they even afford to do that?"

According to Financial Planning’s review, the lion's share of the 126 cases involve defunct companies — many that were foreign-backed — that the commission took action against for failing to submit routine filings. Those so-called 12(j) cases may be unlikely to be relitigated, but the matters involving advisors, brokers and others could weigh heavily on the resources of the Enforcement Division.

"This is, to be clear, an enormous amount of work to redo these 130 decisions," Liftik says. "You could see any number of possibilities, from, ‘I want to start from scratch all over again,’ to, ‘No, I just want to get this over with.’"

Under the commission's order, parties face a Sept. 7 deadline to request what it is calling an alternative procedure. So, for instance, an advisor who has already been through an administrative trial could request that the case be reassigned to a different judge, but that the discovery phase of the trial not be repeated to save legal expenses. Or a party could request that their case not be reheard at all.

"These are not cheap undertakings," Ash says. "They may not have the resources to do that, and of course it elongates some finality to the dispute."

If the parties do not submit anything by that deadline, the SEC's Office of Administrative Law Judges will reassign their case by Sept. 21, according to the order.

Apart from the sheer expense of mounting a fresh legal defense, Ash notes that advisors will continue to face long odds in the Administrative Law Judge courts, where the SEC prevails in the overwhelming majority of the cases that it brings.

"There's nothing here that leaves anyone to conclude that these statistics are going to be any different or that the frequency of filing before [administrative law judges] is going to be any different," Ash says. "That's all going to remain. There's nothing that comes out of this that gives us any comfort that the actual conducting of the hearings and the likely outcome in favor of the SEC in that forum is going to be any different."

Liftik, who left the commission in April 2017 after nearly 10 years, pushes back against the notion that the system is an inherently favorable venue for the SEC.

"I know there's a perception out there that there's a home-court advantage, that the [administrative law judges] always decide for the commission," he says.

But he points out that the SEC's Enforcement Division also has a very high success rate in cases that it brings in U.S. district courts. Moreover, district courts are not equipped to handle many cases involving advisor issues, such as supervision failures, he says.

So for the nearly two dozen advisors whose cases could be reheard by one of the five administrative law judges, their fate could turn on which judge they draw.

"The ALJs, just like federal court judges, they have different reputations," Liftik says. Those judges, he says, try "to be fair and impartial and call balls and strikes based on the evidence, but everyone has their own take on things."

"Some are viewed as more enforcement friendly, some are viewed as less enforcement friendly. Depending on the [judge] you might think your case is stronger or weaker," he says. "I don't think you could paint the judges with one brush. I think just as with any other bench, there are different degrees of how they view things."