2015 May Bring Steps Limiting Federal Criminal Enforcement

January 2, 2015Articles Law360

"Reprinted with permission from the January 2 issue of Law360. (c) 2015 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved."

The U.S. Supreme Court’s increasing willingness to rein in federal criminal power, and growing criticism of in-house agency proceedings, are among the notable 2014 trends that promise to make 2015 an interesting year in white collar practice.

Building on 2014 developments, 2015 may see steps toward curbing federal criminal jurisdiction and enforcement practices. In June, the Supreme Court released its decision in Bond v. United States, a case that had the potential to limit the federal government’s power to pass broadly phrased criminal statutes by way of the treaty power. The law in question was the federal statute banning use or possession of “chemical weapons,” a term defined broadly enough to supplant traditional state law enforcement domain and even reach (in Chief Justice John Roberts’ rather curious example) the use of vinegar to dispatch unwanted goldfish. The case facts were salacious, but “purely local,” per Chief Justice Roberts: “an amateur attempt by a jilted wife to injure her husband’s lover, which ended up causing only a minor thumb burn readily treated by rinsing with water.”

Reviewing the case for the second time (the court previously reversed and remanded on a standing issue), the court passed on the opportunity to invalidate the statute. Instead, the court found that, “Because our constitutional structure leaves local criminal activity primarily to the States, we have generally declined to read federal law as intruding on that responsibility, unless Congress has clearly indicated that the law should have such reach.” No such clarity existed with the chemical weapons statute as applied to the local facts of the Bond case, leading the court to find the statute inapplicable.

Bond signals the Supreme Court’s willingness to limit federal prosecutors’ overly ambitious applications of already broad statutes. That may continue in 2015, when the court is set to rule in the case of the evidence-discarding fisherman, Yates v. United States. In Yates, a state gaming official boarded the commercial fishing vessel that Yates captained, discovered that the vessel had caught grouper under the legal size limit, and ordered the vessel to shore. En route, Yates directed the crew to replace the undersized grouper with legal-sized fish.

Yates was convicted under the anti-shredding provisions of the Sarbanes-Oxley Act, which Congress enacted in the wake of the Enron scandal and the destruction of evidence that occurred as that scandal came to light. The provision states that “Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States” is subject to a 20-year maximum imprisonment.

The Yates case hinges on the meaning of “tangible object.” As in Bond, the issue is whether, despite the statute’s sweeping language, Congress actually intended the statute to reach such local conduct. Yates maintains that “tangible objects” includes only items that can store information, such as computers and CD-ROMs, and not fish. On this point, he has the support of the law’s co-author, Michael Oxley. The government, for its part, maintains that a narrower reading of the term leaves too much potential for destruction of evidence.

As in Bond, Yates presents an opportunity for the Supreme Court to rein in federal law enforcement’s broad application of already broad federal statutes and the more severe sentences that come with them. As in Bond, the Supreme Court in Yates seems concerned about the potential for abuse created by untethered application of broad criminal statutes. The court’s approach in Yates might emulate Bond, in that it leaves the statute intact, but limits its reach to the “heartland” of offenses that prompted the statute’s passage in the first place.

Such sentiment may also affect federal agencies’ regulatory enforcement practices in 2015. The 2008 economic collapse reinvigorated such enforcement activity by federal securities and financial industry regulators. Many of the statutes that the agencies administer, and the regulations that the agencies promulgate, can form the basis for either a civil case or a criminal charge. A bank fraud case, for example, might hinge on whether the loan underwriting satisfied the regulator’s interpretation of the applicable statute or regulation on valuation of the security. What the U.S. Securities and Exchange Commission defines as insider trading may affect whether a U.S. attorney’s office pursues a criminal case in addition to the SEC’s civil or administrative efforts. The same prosecutorial mindset that charged a chemical weapons offense in Bond and missing grouper as a Sarbanes-Oxley violation in Yates can likewise lead to aggressive regulatory interpretations that broaden federal criminal jurisdiction.

Justices Antonin Scalia and Clarence Thomas addressed this issue in a rare note to a denial of certiorari in Whitman v. United States. In that note, the justices encouraged practitioners to bring them a case that squarely addresses whether courts must defer to agencies’ interpretation of a law that contemplates both criminal and administrative enforcement. Whitman was an appeal of an insider trading conviction, and the trial court and Second Circuit deferred to the SEC’s interpretation of Section 10(b) of the Securities Exchange Act of 1934, and the SEC’s interpretation of the statute through Rule 10b5-1, as the basis for criminal liability.

The conflict, as framed by Justice Scalia, is between the deference courts owe to agency interpretations of the ambiguities in federal statutes under the 1984 decision in Chevron USA Inc. v. Natural Resources Defense Council, and the traditional rule of lenity, which requires that such ambiguities be read in the defendant’s favor in criminal cases. As Justice Scalia put it, “Legislatures, not executive officers, define crimes.” While Whitman involved other matters that made it difficult to squarely consider this issue, this year may see the Supreme Court “tap the brakes” on the adoption, at least for criminal purposes, of regulators’ interpretations of the statutes they police.

Incidentally, the trial judge in Whitman was Judge Jed Rakoff of the Southern District of New York, who also stands to shape developments in the white collar arena in 2015. Judge Rakoff previously voiced displeasure with the SEC’s longstanding practice of settling civil cases without the defendants admitting to wrongdoing, even rejecting such a settlement in 2011 before the Second Circuit reversed. In a November 2014 speech, Judge Rakoff criticized the SEC’s frequent practice of bringing enforcement actions before the SEC’s in-house administrative law judges rather than before Article III courts.

This practice is certainly not new, and it picked up steam following the Dodd-Frank Act’s expansion of the SEC’s administrative jurisdiction. The use of in-house administrative proceedings for enforcement purposes is certainly not unique to the SEC, but the choice of forum dramatically affects the process.

Administrative law judges — appointed and paid by the agency — hear the in-house cases. The Administrative Procedure Act governs rather than the Federal Rules of Evidence or Federal Rules of Civil Procedure. Hearsay is admissible, depositions are generally not allowed, written discovery is more limited than in an Article III court, and there is no jury. The agency writes the regulations governing liability, the agency hires and pays the judge, and the agency writes the rules of procedure. The initial appeal from the administrative law judge’s decision is to the head of the agency, and only after the politically appointed head of the agency rules is the litigant allowed an appeal to an Article III court. Even then, the review is deferential to the agency.

Not surprisingly, bringing cases before the in-house court leads to a striking difference in outcomes. As Judge Rakoff noted, the SEC won 100 percent of the cases it brought through the administrative law process, but won only 61 percent of the cases it brought in an Article III court.

The issue is not limited to the securities world. Many prominent and active regulators similarly rely on in-house administrative law proceedings to address enforcement issues. For example, banking regulators (the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Federal Reserve, and the National Credit Union Administration) frequently use administrative proceedings to pursue civil monetary penalties and orders excluding bankers from industry practice.

Multiple constitutional challenges to this practice are pending in the Southern District and other federal courts, and 2015 will likely see more developments in this area.

Between the Supreme Court’s questioning of prosecutors’ ambitiously broad applications of wide-scoped federal criminal statutes, and rising resistance to the use of in-house administrative law proceedings for enforcement matters, 2015 promises to be a significant year in white collar practice.

"Reprinted with permission from the January 2 issue of Law360. (c) 2015 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved."