SEC Wins First Skirmish on Constitutional Challenge to Chau Administrative Proceeding

On December 11, 2014, Judge Lewis Kaplan ruled that his court lacked jurisdiction to consider Wing Chau’s injunctive action to prevent an SEC administrative prosecution against him on due process and equal protection grounds.  Although the ruling was narrowly confined to the jurisdiction issue, it nevertheless was a significant victory for the Commission.

In October 2013, the SEC commenced an administrative proceeding against Chau and his firm, Harding Advisory, alleging misrepresentations in connection with the sale of collateralized debt obligations (“CDOs”) that imploded during the housing/mortgage crisis.  The allegations essentially charged that Chau and Harding misrepresented the nature of the process for selecting assets that went into the CDOs.  After seeking to work within the administrative process to get the kinds of discovery and preparation time that typically would be available if the action were brought in federal court, Chau and Harding commenced a federal action in the Southern District of New York to stop the administrative proceeding.  They asserted in their complaint (which can be reviewed here: Wing Chau v. SEC), that the SEC administrative action violated due process because it did not allow a fair defense to be developed, and denied equal protection of the law because they were singled out for administrative prosecution when similar actions against other persons were brought in federal court (and two of three were lost by the SEC).

The court had previously denied a temporary restraining order and the administrative trial went forward and was concluded.  The parties are awaiting an ALJ determination.

The threshold issue was whether such an action was permissible — whether the district court had jurisdiction to hear a claim to preempt the administrative action.  Applying the standards set forth in Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994), Judge Kaplan ruled there was no jurisdiction because (1) the plaintiffs could get meaningful judicial review in an appeal of the administrative action, (2) the claimed constitutional violations were not wholly collateral to the issues to be decided in the administrative action, and (3) the consideration of due process and equal protection claims were not outside of the SEC’s “expertise.”  A copy of the opinion can be found here: Chau v SEC Opinion.

The court found it significant that the due process claim “has been that the SEC’s procedural rules . . . are unfair in light of ‘facts and circumstances of [their] case'” and not that “the SEC’s rules are unconstitutional in every instance.”  Slip op. at 18-19.  The numerous grounds asserted to show that the respondents had been prevented from presenting a fair defense did not provide jurisdiction because they “all . . . are inextricably intertwined with [the] ongoing administrative proceeding and can be reviewed by a court of appeals.”  Id. at 20.  And because the challenges involve the day-to-day conduct of the proceeding, the due process arguments are not “wholly collateral” to the proceeding under Thunder Basin.  Id.  Finally, “plaintiffs fail to articulate any convincing reason why the SEC lacks the competence to consider the fairness of proceedings before its ALJs.”  Id. at 22.  The issue is the fairness of a particular hearing, not a determination that one of the SEC’s “constituent parts is unconstitutional,” and the “SEC is well equipped to evaluate claims of unfairness in proceedings before its ALJs — and if it fails to do so, the courts of appeals stand ready to correct the error.”  Id. at 22-23.

The equal protection claim yielded the same result.  Although a sister court found jurisdiction for such a claim in Gupta v. SEC, 796 F. Supp.2d 503 (S.D.N.Y. 2011), Judge Kaplan was not convinced to follow that decision.  He found the Gupta allegations of discriminatory conduct stronger, but also did “not find Gupta‘s application fo the Thunder Basin factors persuasive in these circumstances.”  Slip op. at 25.  In essence, he disagrees with the reasoning in Gupta and relied on modestly different facts to rule the other way.  He again also found no basis to conclude that the equal protection claim is outside of the SEC’s “expertise.”  But he did so with a circular argument.  He acknowledged that adjudicating such claims “is ‘not peculiarly within the SEC’s competence,'” but without addressing why equal protection analysis was within the SEC’s competence, stated that the SEC’s attempt to address the equal protection issues in an attempted interlocutory appeal from an ALJ decision “indicate that the SEC is competent to consider plaintiff’s constitutional claims.”  Id. at 31-32. 

At the end of the opinion, the judge noted that plaintiffs’ challenge “[t]aken to its logical conclusion . . . would upend all manner of administrative enforcement schemes.”  Id. at 32. He concluded that because “the normal channels of statutory review are adequate” his court lacked subject matter jurisdiction.

In an epilogue, Judge Kaplan took note that “the growth of administrative adjudication, especially in preference to adjudication by Article III courts and perhaps particularly in the field of securities regulation, troubles some.”  Id. at 34.  He singled out concerns that this approach could “increase the role of the Commission in interpreting the securities laws to the detriment or exclusion of the long standing interpretive role of the courts.”  This is a concern that has been raised by federal district judge Jed Rakoff (see here).  He also mentions concern that such SEC determinations might be accorded “broad Chevron deference to SEC interpretations of the securities laws in the determination of administrative proceedings.”  Id. at 34-35.  Concern about the proper scope of Chevron deference to SEC statutory interpretations was noted recently by Justice Scalia (see here).

Judge Kaplan said “[t]hese concerns are legitimate, whether born of self-interest or of a personal assessment of whether the public interest would be served best by preserving the important interpretative role of Article III courts in construing the securities laws – a role courts have performed since 1933.”  “But they do not affect the result in this case. . . .  This Court’s role is a modest one” — to determine subject matter jurisdiction.  Id. at 35.  In reaching its conclusion, the court “has not considered any views concerning the proper or wise allocation of interpretive functions between the Commission and the courts,” which “are policy matters committed to the legislative and executive branches of government.”  Id. at 35-36.

The takeaway from this decision is limited.  Although the jurisdictional issue required some consideration of the merits of the constitutional claims, the due process and equal protection concerns raised by Chau and Harding plainly were left for another forum to decide.  The very different constitutional issues raised by the plaintiffs in Stilwell v. SEC and Peixoto v. SEC (see here), were not mentioned.  As to those cases, even as to subject matter jurisdiction the analysis would have to be very different because, unlike Chau, they do involve a fundamental challenge to the structure of SEC administrative proceedings, i.e., they do require a determination whether one of the SEC’s “constituent parts is unconstitutional.”  It would be difficult to argue that the structural issues raised about SEC administrative law judges in Stilwell and Peixoto are even arguably within the competence of the SEC to decide for itself.  (For an in depth discussion of the merits of those issues, see here.)

But there remains no doubt that this is an SEC victory that, at a minimum, delays consideration of some aspects of the propriety of shifting SEC enforcement actions to its own administrative courts (see posts on this issue here and here).

Straight Arrow

December 15, 2014

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7 thoughts on “SEC Wins First Skirmish on Constitutional Challenge to Chau Administrative Proceeding

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