Corporate Governance/Securities Law
Stephen M. Bainbridge, William D. Warren Distinguished Professor of Law, UCLA School of Law.
Las Vegas odds makers say that having the home field is worth about three points to the average National Football League team, which is helpful but not a guarantee of victory. For some teams, however, the home-field advantage gives them an almost insurmountable edge. Between 2012 and 2015, for example, the Seattle Seahawks won 27 out of 32 home games and all four of their home playoff games. During that period, no other NFL team had a bigger home-field advantage.
Despite the huge advantage playing at home gave the Seahawks, it didn’t make them unbeatable. After all, they did lose five out of those 36 games. All of which is why the press hullaballoo over a Securities and Exchange Commission administrative law judge’s (ALJ) decision in In re Hill1 is much overblown.
SEC charged Charles L. Hill, Jr., with insider trading in Radiant Systems, Inc., in violation of SEC Rule 14e-3. Hill had traded in Radiant Systems stock in the summer of 2011, making a profit of over $740,000. During the same period Radiant Systems had been in confidential negotiations to be acquired by NCR Corporation. Although Hill had no direct connection with Radiant Systems, he had a close friend named Todd Murphy, who was a close friend of Radiant Systems COO Andrew Heyman. SEC theorized that Heyman passed confidential information about the NCR deal to Murphy who passed it to Hill.
SEC initiated proceedings against Hill before an ALJ under Securities Exchange Act 21C. Hill then filed suit in federal district court seeking to block SEC from conducting the case before one of their in-house judges.
Prior to passage of the Dodd-Frank Act in 2010, SEC administrative proceedings were essentially limited to securities professionals who were registered with SEC, such as broker-dealers. The Dodd-Frank Act hugely expanded the universe of cases litigable before ALJs by authorizing SEC to seek civil monetary penalties against any person, including persons like Hill who are not registered with SEC, under § 21C.
Critics claim that despite the ALJs’ nominal independence, they function as a home court in which SEC’s advantage makes the Seahawks’ home-field advantage seem puny. In 2014, for example, SEC only prevailed in 61% of the cases it brought in federal court. In contrast, SEC won every case—a 100% record—that it brought before an ALJ.2 Not surprisingly, SEC is bringing an increasing number of cases before ALJs. “In fiscal year 2013 SEC filed only 2% of its insider trading cases in-house,” for example, “but this figure increased to 23% in fiscal year 2014 and 35% in the first half of fiscal year 2015.”3
Critics claim that SEC’s success rate before ALJs is no accident. SEC administrative proceedings lack the full panoply of due-process protections available in federal court, “including an independently appointed judiciary, the opportunity for extensive discovery, and juries.”4 The administrative proceedings “are judged first by an ALJ appointed by and beholden to the SEC and again on an appeal to the SEC’s commissioners.”5 Other critics claim that SEC abuses its discretion to choose between administrative proceedings and federal court by bringing its weakest cases in the former. As evidence of that claim, they point to insider trading cases, which “are virtually the only cases that the SEC frequently litigates based simply on circumstantial evidence.”6 As we have seen, the proportion of insider trading cases being brought before an SEC ALJ rather than in federal court has increased dramatically, which critics attribute to the SEC Enforcement Division “probably assum[ing], correctly, that an SEC ALJ will be more receptive to such evidence than would a federal jury.”7
Hill fought and lost the argument that his case should be tried in federal court. The district court rejected his due process arguments, but granted an injunction barring SEC proceeding from going forward on grounds that Hill had established the requisite likelihood of success on his Appointments Clause arguments.8 On appeal, however, the US Court of Appeals for the Eighth Circuit reversed on grounds that the constitutional arguments should be resolved in the SEC administrative forum before being appealed to federal court.9
Hill thus found himself before SEC ALJ James E. Grimes. With respect to Hill’s due-process claims, Judge Grimes cited several law review articles finding that SEC has no statistically significant advantage in cases brought before an ALJ versus those brought in a federal court.10 Without resolving the constitutional issues, Judge Grimes found for Hill on the merits. Basically SEC had two sets of circumstantial evidence: the timing of Hill’s trades and the fact that Hill had a friend, with whom he had communicated often during the relevant period, who was friends with—and with whom he had communicated during the relevant period—a Radiant Systems insider.
Heyman testified that he never gave Murphy any confidential information about Radiant Systems. Judge Grimes found that to be credible testimony. Likewise, Murphy testified that he had neither received such information from Heyman nor passed any such information to Hill. Again, Judge Grimes found that evidence to be credible. In light of their credible testimony, the judge held, SEC’s circumstantial evidence was not sufficient to prove Hill had violated Rule 14e-3.
The Hill case broke no new law. It didn’t resolve the ongoing dispute over the constitutionality of the SEC administrative proceeding system. Instead, it simply turned on witness credibility, like so many thousands of other cases every year. So why was it newsworthy?
There’s an old journalistic aphorism to the effect that a dog biting a man is not news, but a man biting a dog is news. That is precisely what we have here. Although some scholars claim that SEC does not have a statistically significant advantage in ALJ proceedings, many academics and practitioners continue to believe that SEC has a huge home-court advantage in administrative proceedings. In their view, an SEC loss before an ALJ is a man bites dog story. But don’t make too much of the story. After all, even the Seahawks lose at home sometimes.
- SEC Administrative Proceeding No. 3-16383 (Apr. 2017).
- Linda Jellum & Moses M. Tincher, The Shadow of Free Enterprise: The Unconstitutionality of the Securities & Exchange Commission’s Administrative Law Judges, 70 SMU L. Rev. ___ (forthcoming), available at SSRN: https://ssrn.com/abstract=2919644.
- Gideon Mark, SEC and CFTC Administrative Proceedings, 19 U. Pa. J. Const. L. 45, 52 (2016).
- Sarah A. Good & Laura C. Hurtado, Questionable Proceedings the Constitutionality of Adjudication by SEC Administrative Law Judges Faces Judicial and Legislative Challenges, L.A. Law., Feb. 2017, at 30, 31.
- Ibid. Defendants are also bringing claims that the process is unconstitutional under the Appointments Clause because the ALJs are appointed by SEC rather than the President. See Thomas Glassman, Ice Skating Up Hill: Constitutional Challenges to SEC Administrative Proceedings, 16 J. Bus. & Sec. L. 47 (2015).
- Stephen J. Crimmins, Insider Trading: Where is the Line?, 2013 Colum. Bus. L. Rev. 330, 362-63 (2013).
- Mark, supra note 3, at 52.
- Hill v. S.E.C., 114 F. Supp. 3d 1297, 1319 (N.D. Ga. 2015), vacated and remanded sub nom., Hill v. S.E.C., 825 F.3d 1236 (11th Cir. 2016).
- Hill, 825 F.3d at 1245-52.
- In re Hill, supra note 1, at 19 n.14.