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SEC Loses Again as U.S. Judge Rejects In-House Court Process

Bloomberg News

A second federal judge slapped down the Securities and Exchange Commission, ruling its method for appointing in-house judges was probably illegal.

The decision Wednesday by U.S. District Judge Richard Berman in Manhattan rejected the agency’s method of selecting administrative law judges, to whom it directs hundreds of cases a year. Berman said the SEC’s process is “likely unconstitutional.”

The legal setback, along with two other ones by an Atlanta judge in June, poses a dilemma for the SEC. The agency’s options include routing fewer cases to its in-house judges or trying to challenge the decision, potentially all the way to the U.S. Supreme Court.

The issue also has big implications for other government agencies that use administrative law judges, a factor in why the Justice Department is handling the SEC’s appeal in the Georgia case.

The latest decision came in a suit brought by ex-Standard & Poor’s executive Barbara Duka, the former co-head of S&P’s commercial mortgage-backed securities unit who faces an internal SEC claim that she pushed to change credit ratings to win more business for the firm. She sued, seeking to block the internal case because the agency’s appointment process was flawed.

Berman tentatively sided with Duka and blocked the SEC from moving ahead while he weighs additional legal arguments. Because of the power they wield in overseeing internal cases, administrative judges likely must be appointed by the president or SEC commissioners, he said. They’re now named through the agency’s normal hiring procedures.

Last week, the judge said the agency could adopt an “easy fix” and change its appointment process. The agency has so far refused.


“The court’s enforcement of Ms. Duka’s right to a constitutional proceeding is gratifying,” her attorney, Guy Petrillo, said in an e-mailed statement.

Kevin Callahan, an SEC spokesman, declined to comment on the decision.

The regulator has been holding administrative hearings for decades. The Dodd-Frank law, enacted in 2010, expanded the agency’s jurisdiction beyond brokers and investment advisers and empowered its judges to issue orders and levy fines that previously had been available only in federal court.

In fiscal 2009 the SEC filed 53 percent of its enforcement actions in-house. By the end of the last fiscal year, that figure had grown to 81 percent.

Defense lawyers say the SEC system is unfair, particularly in complex cases. Compared to federal courts, deadlines are tight and defendants have fewer legal protections and less access to potential evidence. They see the system as biased in favor of the agency.


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