The Private Equity for Families Blog

SEC Has Come Up With a Winning Formula

In a June 2 Wall Street Journal Opinion article, “How to Rein In the SEC”, the authors explored the current trend by the SEC to act as prosecutor, judge and appellate court under its own rules for matters where it has brought the charges against a person or corporation. The authors were former employees of the SEC. Mr. McLucas was the director of the SEC’s Division of Enforcement from 1989-98 and the co-author, Mr. Martens was the SEC’s chief litigation counsel from 2010-2013.

The authors are quick to point out that administrative proceedings have been supported by the Supreme Court for more than 40 years as legitimate venues for adjudication of proceedings stemming from a federal agency’s own rule making or legal authority. What is troubling here is the timing. SEC has shifted its docket from the federal courts to its own in house judges after a series of notable setbacks like the Mark Cuban insider trading case, a public company accounting fraud acquittal and other insider trading charges that were dismissed before trial or ultimately rejected by a jury. The SEC defends this trend to inside judges as an extension of powers granted by Dodd Frank, but the authors suggest that those powers were conferred in 2010 and the new policy only began with a new Chairman after a string of big losses in 2013.

So why the switch? It must be about winning!!! In a May 7 Wall Street Journal article “SEC Wins With In House Judges” the reporter, Jean Eaglesham,  showed that from 2010-2014 the SEC won 90% of the administrative actions that it adjudicated in house versus a 69% win rate in federal courts. The edge goes to the SEC because its internal process does not follow many of the fairness protocols that a defendant in the federal courts might expect like having adequate time to prepare a defense (only 120 days for hiring experts and review of millions of pages of evidence based on investigations spanning years and opportunities for deposing witnesses that SEC had already contacted and interviewed during that comprehensive investigation). Additionally, the SEC appeals process is to commissioners of the SEC and allows those commissioners to make findings and impose penalties that the independent Administrative Law Judge did not find or impose at trial. Those same commissioners must approve the original investigation of the defendant and, unlike the independent administrative law judge who has no involvement in authorizing the investigation and prosecution, might be seen as having a strong bias for proving themselves right.

The Commissioners of the SEC are appointed by the President, are confirmed by the Senate and serve for five year terms. President Obama has appointed 4 of the 5 sitting Commissioners and reappointed one Commissioner who was appointed by President Bush in 2008.

In fact, Ms. Eaglesham’s research shows that the SEC prevails in 95 % of the appeals to its own commissioners who authorized the prosecution in the first place. And be careful about appealing because in only one instance was the penalty reduced and in seven cases the Commissioners increased it!  This is contrasted to an 84% success rate in federal courts where appeals judges do not have the authority to impose new penalties. Given this edge, it is no wonder that the SEC has decided to use its own in house process in four out of five prosecutions since 2010. Before then the docket was split 50/50 between federal courts and internal judges.

Finally, the SEC administrative judges have much different profiles even within their group. For example, Judge Cameron Elliot has found 100% of those coming before him on contested charges guilty of at least part of the complaint. That contrasts with other administrative judges who find fault 85% of the time. Remember that the SEC hires these judges and pays their wages.  By contrast, in the federal courts a judge will quickly recues himself if he has any money connection to the lawyers or parties in a proceeding that comes to his docket. If he does not, a mistrial is the likely outcome.

Now consider a private equity manager that is investigated under Dodd Frank for failing to inform its investors of hidden fees and charges. An innocent manager with its reputation and livelihood at stake will undoubtedly hire his best defense and fight the charges. But if the SEC can steer its most difficult and highest profile political cases to its own kangaroo court where it has a 90% success rate and the commissioners who authorized the prosecution sit as the appeals court, I predict you will see wholesale capitulation and settlement. SEC begins to create law just like the “hanging judges” of frontier justice.

The concept of a Kangaroo court goes back to frontier justice where travelling judges were paid for outcomes- good or bad- and were thus accused of  “hopping” from venue to venue to increase their pay. Their justice was an illusion and the outcome was often decided before the trial began. Even someone as pugnacious as Mark Cuban might not have had a chance in a Kangaroo court. It is hard to believe any defendant would end up much better in today’s SEC perversion of a fair trial. 90% certainty at trial and 95% certainty on appeal where the appeals court hires the trial court and the appeals court are political appointees certainly gives the government an edge.

More recent criticism of the trend for aggressive enforcement comes from a court decision on May 21, 2015 regarding the failure of Caledonian Bank (SEC v. Caledonian Bank Ltd., et al, 15 Civ 894 (S.D.N.Y) where Judge William H. Pauley criticized the SEC for causing the Bank’s collapse by refusing to release $50 million of depositor funds above the bank’s net equity:


“THE COURT: Was the SEC aware at the time that it came before me with its ex parte application that Caledonian Bank’s net equity was only $25 million and that anything above that amount represented depositors’ money?

SIMPSON: No, you’re Honor.

THE COURT: When did you learn that?

SIMPSON: I believe we learned that over the weekend after the filing of the complaint.

THE COURT: When you learned that, did you bring that to the Court’s attention or seek a reduction in the assets that were being frozen?

SIMPSON: We did not, your Honor.

THE COURT: Why not?

SIMPSON: We were negotiating with Caledonian and I believe they requested a reduction in the freeze amount. We took that to a very high level within the commission and decided that we were not going to agree to that.

THE COURT: How could the commission think that they are entitled to a freeze of seizing moneys that belong to depositors?

SIMPSON: Your Honor, I believe that we were negotiating with Caledonian on that issue and we did not specifically address that issue.

THE COURT: The bank collapsed because of your actions, didn’t it?

SIMPSON: Yes, you’re Honor.

THE COURT: It’s stunning. Its incredible government overreach.”


The Court then took the extraordinary step of ordering the SEC to submit an affidavit explaining among other things, who at the SEC made the decision that the asset freeze should not be lowered to $25 million.

Normally, a repentant government would question its own activities but recently Andrew Ceresney, the head of the SEC’s Division of Enforcement, announced that the SEC would start filing more insider trading and complex cases within its own administrative courts instead of federal courts. I fear the power of the Kangaroo court will prevail and everyone will be presumed guilty until a lesser plea bargain is exacted.

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Rob McCreary

Rob McCreary has more than 40 years of transactional experience as an attorney, investment banker and private equity fund manager, and has spent his career in building entrepreneurial organizations with successful track records Founder and chairman of CapitalWorks, he is responsible for developing and maintaining senior relationships with investors and portfolio governance.

This blog represents the views of Rob McCreary and do not reflect those of CapitalWorks or its employees. This blog is not intended as investment advice. Any discussion of a specific security is for illustrative purposes only and should not be relied upon as indicative of such security’s current or future value. Readers should consult with their own financial advisors before making an investment decision.

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