Former Standard & Poor Executive’s Case Against the SEC Over In-House Judge Can Proceed

A U.S. district court judge says that Barbara Duka’s lawsuit against the Securities and Exchange Commission can move forward. Duka used to be the head of Standard & Poor’s commercial mortgage-backed securities group. She is challenging the regulator’s decision to appoint an administrative law judge to preside over its securities fraud case against her. Duka wants her case heard in federal court.

The SEC claims that the former S & P executive hid the way the credit ratings agency had relaxed its requirements for calculating certain commercial mortgages. Their lawsuit against her came just as S & P consented to pay $77 million to resolve related charges by the regulator and the attorneys general of Massachusetts and New York.

Issuers and investors were not happy when in 2011 S & P withdrew a preliminary rating on a $1.5 billion security. Following a partial restructuring, that deal later went to market. The SEC would go on to launch probes into why the rating was pulled, and also into six other deals that were rated that year. The SEC’s own internal probe uncovered inconsistencies in the methodologies for the way S & P rated existing and new deals.

Duka, who oversaw the new ratings of commercial real estate deals and continued to supervise deals that were already rated, denies the civil allegations of securities fraud. She wants the SEC’s administrative case against her, which is scheduled to be presided over by an in-house judge next month, to be declared unconstitutional.

Judge Richard Berman said that with her case Duka demonstrated that to comply with the U.S. Constitution, the in-house judges have to be directly appointed by the SEC’s commissioners. While he didn’t declare in his ruling that the use of in-house judges is unconstitutional, he issued a temporary weeklong halt to the SEC case against Duka.

Berman said that this gives the regulator a chance to tell the federal court of its “intention” to remedy any violations of the Constitution that might have arisen because of the way the agency appoints its judges. Berman noted that one easy remedy is for the commissioners to make the appointments.

Currently, SEC staffers are allowed to appoint the in-house judges. Administrative cases presided over by an SEC in-house judge are typically fast-tracked. Critics, however, have expressed concern that the Commission has the at home advantage over defendants in an in-house forum.

Yet, since the 2010 Dodd Frank Act, the regulator has been depending more on these judges to preside over its civil cases. According to The Wall Street Journal, Cornerstone Research reports that from October 2014 through March 2015, the Commission sent 82% of its cases to the judges.

In June, a federal judge blocked the regulator from proceeding with an insider trading case that was to be presided over by one of its administrative judges. U.S. District Judge Leigh Martin May found that SEC’s in-house court was “likely unconstitutional” and agreed to place a temporary halt to the civil lawsuit. She also said that the commissioners are the ones who should be appointed SEC judges.

Appealing May’s ruling , the SEC argued that at this time it would not be “reasonable” to modify the way judges are appointed. Commission officials are concerned that the reappointment of its judges could potentially lead to legal challenges from defendants whose cases have already been heard.

Judge Adds to Pressure on SEC Over How it Names Its Judges, The Wall Street Journal, August 3, 2015

SEC’s Use of In-House Judge in Insider Trading Case is Likely Unconstitutional, Rules Federal Judge, Institutional Investor Securities Blog, July 9, 2015

Financier Lynn Tilton Sues the SEC After She is Charged with Securities Fraud, Institutional Investor Securities Blog, March 31, 2015