Tag Archives: Bebo v. SEC

SEC Hit with Double Whammy Rulings Barring It from Commencing Challenged Administrative Proceedings

On the afternoon of September 17, 2015, the SEC was rebuffed by two federal courts in separate cases challenging the constitutionality of the SEC’s administrative law enforcement proceedings.  As reported here, the Court of Appeals for the Second Circuit granted Lynn Tilton an order barring the SEC from proceeding with an administrative trial on charges against her, pending that court’s resolution of a dispute over whether the federal courts have jurisdiction to consider her complaint that the administrative proceeding would violate Article II of the Constitution.  At roughly the same time, New York federal district court Judge Richard Berman rejected a motion by the SEC to allow it to proceed with an administrative action against Barbara Duka while it appealed (to the Second Circuit) Judge Berman’s preliminary injunction barring that proceeding from moving forward, on the very same constitutional grounds.  Judge Berman’s preliminary injunction order can be read here: Order Issuing Preliminary Injunction in Duka v. SEC; and his order denying the SEC’s stay motion can be read here: Decision and Order in Duka v. SEC.

The result is that two more administrative proceedings are now barred by court orders, joining two others that were barred by orders of Judge Leigh May in the federal district court in Atlanta.  See Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding, and Order Enjoining SEC in Gray Financial Group v. SEC.

The Second Circuit order was brief and straightforward.  But Judge Berman’s denial of the SEC’s application for a stay is filled with meaty discussions of key issues, including reiterating that several of the SEC’s positions on jurisdiction and the merits are wrong, suggesting that the SEC plays a little fast and loose with the positions it argues, and emphasizing that the SEC might want to be more proactive in addressing allegations of potential bias in its administrative court.

Judge Richard Berman - NYLJ/Rick Kopstein 100614

Judge Richard Berman – NYLJ/Rick Kopstein

On the jurisdictional issue, Judge Berman restated his belief that his court does have jurisdiction over the Duka constitutional challenge (“The Court is, respectfully, convinced that it made the correct finding of subject matter jurisdiction,” slip op. at 3), and took the time to address the contrary position recently reached by the Seventh Circuit in Bebo v. SEC, 2015 WL 4998489 (7th Cir. Aug. 24, 2015) (see 7th Circuit Rules for SEC, Affirming Dismissal of Bebo Case on Jurisdictional Grounds).  He openly disagreed with the Seventh Circuit’s view that the Supreme Court decision in Elgin v. Dep’t. of the Treasury, 132 S. Ct. 2126 (2012), was on point because the factual circumstances differed significantly.  See slip op. at 8-9.

Judge Berman also made pointed statements elsewhere in his opinion arguing that immediate consideration of the consitutional issue was consistent with Second Circuit law and the public interest.  For example: “The SEC argues unconvincingly that a party in Ms. Duka’s shoes ‘must patiently await the denouement of proceedings within the [administrative agency],” . . . .  But Second Circuit precedent appears to refute such a notion.  See Touche Ross & Co. v. S.E.C., 609 F.2d 570, 577 (2d Cir. 1979) (‘[T]o require appellants to exhaust their administrative remedies would be to require them to submit to the very procedures which they are attacking.’).”  Slip op. at 15-16 (some cites omitted).  And: “With respect to the public interest, the Court submits that it is of the utmost importance to the public that complex constitutional questions be resolved at the outset, with finality, and by application of the expertise of the federal courts.  See, e.g., Massaro v. United States, 538 U.S. 500,504 (2003); see also Pappas v. Giuliani, 118 F. Supp. 2d 433, 442 (S.D.N.Y. 2000) affd, 290 F.3d 143 (2d Cir. 2002) (‘Although often highly competent in their designated area of law, administrative decision-makers generally have neither the training nor the experience to adjudicate complex federal constitutional issues.’); Austin v. Ford, 181 F.R.D. 283, 286 (S.D.N.Y. 1998) (‘Public interest in finality of judgment encompasses the development of decisional law, the importance of the opinion to nonparties, and the deterrence of frivolous litigation.’).”  Slip op. at 16 (some cites and footnote omitted).

All of these points could be impactful as the Second Circuit considers the same jurisdictional issue in the Tilton v. SEC appeal.

On the merits, Judge Berman restated his belief that Supreme Court case law leaves little doubt that the SEC’s administrative law judges are “inferior officers” within the meaning of that term in Article II, and, as a result, their appointments are subject to limitations in Article II’s Appointments Clause.  His finding that the High Court reasoning and holding in Freytag v. Commissioner, 501 U.S. 868 (1991), yields the conclusion that SEC ALJs are inferior officers because they exercised “significant authority pursuant to the laws of the United States” was not new – as he noted, he previously reached the same conclusion when he issued the preliminary injunction.  Slip op. at 9.  But it came within two weeks of the SEC reaching the opposite conclusion in its recent decision on the petition for review in In the Matter of Raymond J. Lucia Cos., Inc., File No. 15006 (see SEC Declares All Is Okay Because Its ALJs Are Just Employees and Not “Inferior Officers”), without even mentioning that decision or its analysis, suggesting Judge Berman found the SEC reasoning unpersuasive and sees no reason to defer to SEC views on the issue.  No doubt with knowledge of the specific analysis of the SEC in Lucia, he still wrote: “the SEC will not, in the Court’s view, be able to persuade the appellate courts that ALJs are not “inferior officers.”  Slip op. at 11.  Judge Berman’s bottom line: “Duka’s constitutional (Appointments Clause) challenge is (very) likely to succeed.”  Id. at 10.

On the SEC’s nimble willingness to revise its arguments to fit the circumstances, Judge Berman noted the “irony” of the SEC’s new-found emphasis on the compelling importance of judicial efficiency after it scoffed at Ms. Duka’s similar arguments in the original preliminary injunction hearing.  He wrote: “The Court’s reference to ‘irony’ [in an earlier ruling] refers to the fact that conservation of Duka’s resources was a core argument that she raised in objecting to participating in the SEC’s administrative proceedings prior to resolution of her constitutional challenge in federal court.  The SEC flatly opposed that argument, which it now appears firmly to embrace.”  He quoted his own statement during the oral argument that “I don’t understand why you reject that argument when Ms. Duka makes it but then at the same time in this Court you make the very same argument.”  Slip op. at 3 n.2.

And Judge Berman was surely making a point when he dwelled, without any apparent need, on the SEC’s opaque handling of publicly-disclosed evidence that its own administrative court could have a latent, or even intentional, bias in favor of the prosecution.  His opinion includes the following striking paragraph:

The Court is aware of recent allegations of undue pressure said to have been applied to an SEC ALJ to cause her to make SEC-favorable rulings.  “Lillian McEwen, who was an SEC judge from 1995 to 2007, said she came under fire from [Chief Administrative Law Judge Brenda] Murray for finding too often in favor of defendants.”  See Jean Eaglesham, SEC Wins with In-House Judges, The Wall Street Journal, May 6, 2015. . . .  And, in In the Matter of Timbervest, respondents allegedly sought to depose presiding ALJ Cameron Elliot, who was then allegedly invited by the SEC “to file by July I, 2015 an affidavit addressing whether he has had any communications or experienced any pressure similar to that alleged in the May 6, 2015 The Wall Street Journal article.”. . .  On June 9, 2015, ALJ Elliot emailed the following response: “I respectfully decline to submit the affidavit requested.”  See Jean Eagelsham, SEC Judge Declines to Submit Affidavit of No Bias, The Wall Street Journal, June 11, 2015. . . .  On July 24,2015, Chief Administrative Law Judge Murray issued an Order Redesignating Presiding Judge, designating Administrative Law Judge James E. Grimes “in place and stead of the Administrative Law Judge [ALJ Cameron Elliot] heretofore designated, to preside at the hearing in these proceedings and to perform other and related duties in accordance with the Commissioner’s Rules of Practice.”  See In the Matter of Barbara Duka, File No. 3-16349 (SEC).

During the September 16, 2015 hearing, the Court noted that it was “aware that there is some sort of flap at the SEC with respect to some of the ALJs,” that it “want[ed] to get further clarification about that matter,” and that “in this very case, [ALJ] Cameron Elliot . . . has been reassigned because he was not able or would not submit an affidavit.”. . .  While acknowledging that ALJ Elliot was removed from the Duka matter, Ms. Lin contended that “Judge Elliot has a very busy docket . . . and there is no suggestion, no connection whatsoever about [The Wall Street Journal article], about that particular former ALJ’s accusations to Judge Elliot’s reassignment in this case. . . .  And it’s not true that there would be any kind of connection.”. . .  The Court assumes that the SEC will want fully to investigate these matters.

Slip op. at 14-15 (citations omitted and emphasis added).

Apparently Judge Berman is as perplexed as yours truly when the Commission seems more insouciant than concerned in its reaction to serious public questioning of the fairness of its own administrative judicial process.  See SEC Bumbles Efforts To Figure Out How Its Own Administrative Law Judges Were Appointed; and SEC “Invites” ALJ Cameron Elliot To Provide Affidavit on Conversations “Similar” to Those Described by Former ALJ.  Indeed — although Judge Berman made no mention of this — it is downright embarrassing that 15 months ago the SEC’s General Counsel acknowledged that the Rules of Practice governing SEC administrative proceeding are archaic and need revamping and nothing has yet been done to address that issue.  See SEC Administrative Case Rules Likely Out Of Date, GC Says.  (Ms. Small said it was fair for attorneys to question whether the SEC’s rules for administrative proceedings were still appropriate, with the rules last revised “quite some time ago” when the SEC’s administrative proceedings dealt with different kinds of cases than the more complex administrative matters it now takes on or expects to take on — given the commission’s expanded authority under the Dodd-Frank Act — such as insider-trading actions.  It was “entirely reasonable to wonder” if those rules should be updated to reflect the changed situation, for instance by allowing more flexibility on current limits to trial preparation time or allowing for depositions to be taken.  “We want to make sure the process is fair and reasonable, so [changing] procedures to reflect the changes makes a lot of sense.”)

Anne Small -- SEC General Counsel

Anne Small — SEC General Counsel

When all of the dust settles on the Appointments Clause and other Article II constitutional challenges to these administrative courts, we will still be left with what every practicing securities litigator knows are vastly diminished due process rights in the SEC’s administrative courts as compared to the federal courts.  Judge Berman certainly seemed concerned about this in his opinion.  He said: “during the September 16, 2015 hearing, the SEC argued that administrative proceedings would serve the public interest because ‘it is a much faster process and it expedites the consideration and the determination of whether the underlying security violations had actually occurred and, more importantly, to impose the kind of remedy that would then help to prevent future harm.’. . .  The Court responded that ‘faster is [not] necessarily better because faster means no juries, no discovery, no declaratory relief.  In federal court you can get that . . . there’s a whole lot of protections, Ms. Duka argues, that are available in federal courts that are not available before the Commission.'”  Slip op. at 16.

If the SEC continues to be empowered to exercise effectively uncontrolled discretion over which cases are directed to the administrative courts (as a result of the expanded jurisdiction of those courts under the Dodd-Frank Act), and it continues to ignore obvious needs to modernize and balance the procedures for those proceedings to eliminate their “Star Chamber” similarities, the controversy over these actions will be unabated.

Straight Arrow

September 18, 2015

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7th Circuit Rules for SEC, Affirming Dismissal of Bebo Case on Jurisdictional Grounds

On August 24, 2015, the Seventh Circuit handed the SEC a major victory in the ongoing battle over alleged constitutional infirmities of the SEC’s administrative judicial process.  It agreed with the lower court that Laurie Bebo’s federal court challenge to her administrative proceeding cannot be heard in the case filed by her seeking injunctive relief against an SEC administrative proceeding.  The court found that the circumstances of Bebo’s case were such that she was required to wait to present her constitutional objections before a federal appellate court on review of whatever action the SEC might ultimately take against her.  The opinion can be read here: 7th Circuit Decision in Bebo v. SEC.

The court found that the Bebo case — and presumably others like hers — was not like the PCAOB case in which the Supreme Court decided the constitutional challenge could be heard immediately, in Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477 (2010).  The court summarized: “It is ‘fairly discernible’ from the statute that Congress intended plaintiffs in Bebo’s position ‘to proceed exclusively through the statutory review scheme’ set forth in 15 U.S.C. § 78y.  See Elgin v. Dep’t of Treasury, 567 U.S. —, 132 S. Ct. 2126, 2132–33 (2012).  Although § 78y is not ‘an exclusive route to review’ for all types of constitutional challenges, the relevant factors identified by the Court in Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477, 489 (2010), do not adequately support Bebo’s attempt to skip the administrative and judicial review process here.  Although Bebo’s suit can reasonably be characterized as ‘wholly collateral’ to the statute’s review provisions and outside the scope of the agency’s expertise, a finding of preclusion does not foreclose all meaningful judicial review. . . .  And because she is already a respondent in a pending administrative proceeding, she would not have to ‘‘bet the farm … by taking the violative action’ before ‘testing the validity of the law.’’ . . .  Unlike the plaintiffs in Free Enterprise Fund, Bebo can find meaningful review of her claims under § 78y.”

The court then addressed the arguments in greater detail:

The statutory issue here is a jurisdictional one: whether the statutory judicial review process under 15 U.S.C. § 78y bars district court jurisdiction over a constitutional challenge to the SEC’s authority when the plaintiff is the respondent in a pending enforcement proceeding.  Where the statutory review scheme does not foreclose all judicial review but merely directs that judicial review occur in a particular forum, as in this case, the appropriate inquiry is whether it is “fairly discernible” from the statute that Congress intended the plaintiff “to proceed exclusively through the statutory review scheme.” Elgin v. Dep’t of Treasury, 567 U.S. —, 132 S.Ct. 2126, 2132–33 (2012). 

This inquiry is claim-specific.  To find congressional intent to limit district court jurisdiction, we must conclude that the claims at issue “are of the type Congress intended to be reviewed within th[e] statutory structure.”  Free Enterprise Fund, 561 U.S. at 489, quoting Thunder Basin Coal Co. v. Reich, 510 U.S. 200, 212 (1994).  We examine the statute’s text, structure, and purpose. . . .

. . . .  Our focus in this appeal is whether Bebo’s case is sufficiently similar to Free Enterprise Fund to allow her to bypass the ALJ and judicial review under § 78y.  Based on the Supreme Court’s further guidance in Elgin, we believe the answer is no.

. . . .

Read broadly, the jurisdictional portion of Free Enterprise Fund seems to open the door for a plaintiff to gain access to federal district courts by raising broad constitutional challenges to the authority of the agency where those challenges (1) do not depend on the truth or falsity of the agency’s factual allegations against the plaintiff and (2) the plaintiff’s claims do not implicate the agency’s expertise.  That’s how Bebo reads the case.  She argues that Free Enterprise Fund controls here because her complaint raises facial challenges to the constitutionality of the enabling statute (§ 929P(a) of Dodd-Frank) and to the structural authority of the agency itself, and the merits of those claims do not depend on the truth or falsity of the SEC’s factual claims against Bebo or implicate the agency’s expertise.  While Bebo’s position has some force, we think the Supreme Court’s more recent discussion of these issues in the Elgin case undermines the broader reading of the jurisdictional holding of Free Enterprise Fund.

. . . .

[T]he Elgin Court specifically rejected the plaintiffs’ argument, advanced by Bebo in this appeal and by the dissent in Elgin, that facial constitutional challenges automatically entitled the plaintiffs to seek judicial review in the district court. . . .

The Elgin Court also read the jurisdictional portion of Free Enterprise Fund narrowly, distinguishing it on grounds directly relevant here. . . .  [In Elgin, b]ecause the [controlling statute] provided review in the Federal Circuit, “an Article III court fully competent to adjudicate petitioners’ claims [of unconstitutionality],” the statutory scheme provided an opportunity for meaningful judicial review.

. . . .

Elgin established several key points that undermine Bebo’s effort to skip administrative adjudication and statutory judicial review here.  First, Elgin made clear that Bebo cannot
sue in district court under § 1331 merely because her claims are facial constitutional challenges.  Second, it established that jurisdiction does not turn on whether the SEC has authority to hold § 929P(a) of Dodd-Frank unconstitutional, nor does it hinge on whether Bebo’s constitutional challenges fall outside the agency’s expertise.  Third, Elgin showed that the ALJ’s and SEC’s fact-finding capacities, even if more limited than a federal district court’s, are sufficient for meaningful judicial review.  Finally, Elgin explained that the possibility that Bebo might prevail in the administrative proceeding (and thereby avoid the need to raise her constitutional claims in an Article III court) does not render the statutory review scheme inadequate.

. . . .  We think the most critical thread in the case law is the first Free Enterprise Fund factor: whether the plaintiff will be able to receive meaningful judicial review without access to the district courts.  The second and third Free Enterprise Fund factors, although relevant to that determination, are not controlling, for the Supreme Court has never said that any of them are sufficient conditions to bring suit in federal district court under § 1331.  We therefore assume for purposes of argument that Bebo’s claims are “wholly collateral” to the administrative review scheme.  Even if we give Bebo the benefit of that assumption, we think it is “fairly discernible” that Congress intended Bebo to proceed exclusively through the statutory review scheme established by § 78y because that scheme provides for meaningful judicial review in “an Article III court fully competent to adjudicate petitioners’ claims.”

. . . .

Bebo’s counter to this way of synthesizing the cases is that the administrative review scheme established by § 78y is inadequate because, by the time she is able to seek judicial review in a court of appeals, she will have already been subjected to an unconstitutional proceeding. The Supreme Court rejected this type of argument in FTC v. Standard Oil Co., 449 U.S. 232, 244 (1980), holding that the expense and disruption of defending oneself in an administrative proceeding does not automatically entitle a plaintiff to pursue judicial review in the district courts, even when those costs are “substantial.”

This point is fundamental to administrative law. Every person hoping to enjoin an ongoing administrative proceeding could make this argument, yet courts consistently require plaintiffs to use the administrative review schemes established by Congress. . . .  It is only in the exceptional cases, such as Free Enterprise Fund and McNary, where courts allow plaintiffs to avoid the statutory review schemes prescribed by Congress. This is not
such a case.

Although several courts have now reached differing conclusions on this jurisdictional issue (see In Duka v. SEC, SDNY Judge Berman Finds SEC Administrative Law Enforcement Proceedings Constitutional in a Less than Compelling Opinion, and Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding), the Seventh Circuit is the first appellate court to do so, and that alone is likely to carry weight elsewhere.  But this is also a strongly-stated opinion, which examines seriously and in depth the somewhat varying Supreme Court precedent.  The fact that the court takes on Ms. Bebo’s arguments directly and rejects them on the basis of its interpretation of the Supreme Court precedent makes it even more likely to be influential.

The D.C. and Eleventh Circuits may be the next appellate courts to consider the jurisdictional issue.  The D.C. Circuit heard argument on this jurisdictional issue in Jarkesy v. SEC, and it may issue the next appellate opinion.  See Appeals panel considers SEC’s use of in-house courts.  And the 11th Circuit has already received the SEC’s brief on appeal in Hill v. SEC, which it appealed from the preliminary injunction issued by Judge Leigh May in the Northern District of Georgia.  See SEC 11th Circuit Appeal Brief in Hill v. SEC.  Because Judge May decided her court had jurisdiction, and then went on to find a likely constitutional violation, The 11th Circuit briefs will address both the jurisdictional issue and the merits of some of the constitutional arguments.  If the 11th Circuit agrees with the 7th Circuit that there is no jurisdiction to bring these cases, however, it will vacate the preliminary injunction and not address the merits of Mr. Hill’s claim.

Depending on what these appellate courts do, and whether they concur in the 7th Circuit’s analysis, the door to injunctive relief in the federal courts for these alleged constitutional violations may slam shut.  That would focus attention on the merits of the claims in cases decided by the SEC on a petition for review from an administrative decision.  The case likely to be the first such SEC decision that could be appealed would seem to be In the Matter of Timbervest, LLC, in which the SEC is still receiving supplemental briefing addressing constitutional and discovery issues.  See SEC Broadens Constitutional Inquiry into Its Own Administrative Judges in Timbervest Case and Division of Enforcement Continues To Refuse To Comply with SEC Orders in Timbervest Case.

Stay tuned.

Straight Arrow

August 24, 2015

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SEC Bumbles Efforts To Figure Out How Its Own Administrative Law Judges Were Appointed

The SEC’s handling of the controversy over whether its administrative law judges were properly appointed under the Appointments Clause of Article II of the Constitution continues to amuse, or horrify, depending on your point of view.  Putting aside the actual substance of the Appointments Clause issue itself, which will work its way through the courts, when it comes to the mere disclosure of the underlying facts at issue about the appointment of the SEC’s ALJs, the SEC staff has acted with questionable competence, and apparent insubordination.  That’s a strong statement, so you can decide for yourself, based on recent events in the In the Matter of Timbervest, LLC administrative proceeding.

You may recall that the Timbervest administrative enforcement action was tried to SEC ALJ Cameron Elliot, who issued an Initial Decision finding for the Division of Enforcement in all respects except that he concluded two of the individual respondents lacked the scienter required for aiding and abetting the firm’s violations, and that the five-year statute of limitations in 28 U.S.C. § 2462 precluded the associational bars sought against the individuals and the revocation of Timbervest’s adviser’s license.  Both sides petitioned for review by the Commission, which was granted.  Before the Commission itself, the respondents pressed their constitutional challenges to the administrative proceeding, and the Commission asked for further briefing on those issues.  See Briefing of ALJ Constitutionality Before SEC Leaves Resolution in Doubt.

Then the Wall Street Journal published a blockbuster article discussing potential issues of fairness in the SEC’s administrative court, including statements by former SEC ALJ Lillian McEwen that she had been pressured to issue rulings more favorable to the SEC staff.  See Fairness Concerns About Proliferation of SEC Administrative Prosecutions Documented by Wall Street Journal.  On the basis of that article, the Timbervest respondents sought to pursue additional discovery to obtain evidence relevant to its constitutional challenges.  The precise request made is not clear from the record because the SEC failed to post this motion on its docket.  But it is apparent that the information sought included data about SEC ALJs Cameron Elliot and Brenda Murray (who was the original ALJ designated to hear the case before it was transferred to Mr. Elliot), as well as information about the allegations made by Ms. McEwen.  The Commission responded with an Order Requesting Additional Submissions and Additional Briefing, stating that “The Commission’s consideration of the Appointments Clause challenge would be assisted by the submission of additional material for inclusion in the record and by the submission of additional briefing.”  It then “ORDERED that the Division of Enforcement shall . . . file . . . an affidavit from an appropriate Commission staff member, with supporting exhibits if appropriate, setting forth the manner in which ALJ Cameron Elliot and Chief ALJ Brenda Murray were hired, including the method of selection and appointment.”

A week later, the Commission issued another Order Concerning Additional Submission and Protective Order, in which it “invited” ALJ Elliot to provide an affidavit addressing whether he was ever aware of ALJs being subjected to such pressures.  See SEC “Invites” ALJ Cameron Elliot To Provide Affidavit on Conversations “Similar” to Those Described by Former ALJ.

The responses to these Orders were remarkable.  In response to the second Order, Mr. Elliot declined to provide the affidavit “invited” by the Commission.  That certainly raised the possibility that the content of such an affidavit would be problematic.  See SEC ALJ Cameron Elliot Declines To Submit Affidavit “Invited” by the Commission.  But that at least was consistent with the SEC’s Order, which made it clear it was not mandating that ALJ Elliot provide the affidavit.

The Division of Enforcement’s response to the first Order was even more extraordinary.  It refused to provide the ordered “affidavit . . . setting forth the manner in which ALJ Cameron Elliot and Chief ALJ Brenda Murray were hired, including the method of selection and appointment,” instead providing an affidavit only containing “the factual information the Division believes legally relevant to resolving Respondents’ Article II-based constitutional claims,” which said only that “ALJ Elliot was not hired through a process involving the approval of the individual members of the Commission.”  In further explanation, the Division justified failing to comply with the Commission’s Order because “the Division believes that the facts set forth in the affidavit — i.e., facts relating to ALJ Elliot’s hiring — are sufficient for the Commission’s consideration of Respondents’ Appointments Clause challenge.”  The precise language of the affidavit was: “Based on my knowledge of the Commission’s ALJ hiring process, ALJ Elliot was not hired through a process involving the approval of the individual members of the Commission.”  See Division’s Notice of Filing, with Attached Affidavit of Jayne L. Seidman.

The Division described “the hiring process for Commission ALJs,” as administered by OPM, and told the Commission: “It is the Division’s understanding that the above process was employed as to ALJ Elliot, who began work at the agency in 2011.  As for earlier hires, it is likely the Commission employed a similar, if not identical, hiring process.  But the Division acknowledges that it is possible that internal processes have shifted over time with changing laws and circumstances, and thus the hiring process may have been somewhat different with respect to previously hired ALJs. For instance, Chief ALJ Murray began work at the agency in 1988 and information regarding hiring practices at that time is not readily accessible.”

This submission was a stunning act of insubordination, bordering on contempt.  It plainly declined to address the specific issues ordered by the Commission, and did so on the presumptuous basis that “the Division believes” the information ordered by the Commission was not necessary for the Commission to decide the issues raised by the respondents.  If the Division wanted relief from the Order, it should have moved for it to be revised.  It was impermissible to ignore the command based on what the Division — at this point simply a party in the proceeding — believed should have been requested.  But even beyond this, the affidavit the Division provided was misleading.  It did not even attempt to state the facts of Mr. Elliot’s hiring.  Instead, it was only “based on” “knowledge of the Commission’s ALJ hiring process,” and the Division’s Notice was founded on an unsupported “understanding” that the normal process was used.  So, even in the single respect the Division responded to the Order, it did so based on presumption, not investigation.  The combination of brazenly ignoring the Order, and then providing an affidavit not founded on facts, is conduct that should be reprimanded, if not sanctioned.  If a respondent had acted this way in response to a Commission Order, there would be more than silence from the Commission.

That isn’t the end of the story, because it turns out the assumption used to support the affidavit, and the Division’s purported “understanding” of what occurred, was unfounded, which could have been learned with only a modicum of effort.  ALJ Elliot is now presiding over another case being challenged on constitutional grounds, In the Matter of Laurie Bebo and John Buono.  In that case, at a hearing on June 18, 2015, ALJ Elliot raised the issue of the circumstances of his hiring, and the Division’s filing in Timbervest,  and noted the “the Division’s description of how I was hired was erroneous.”  He went on, “The crucial language is in the first full paragraph on page 2. . . .  I have informed the chief ALJ.  I brought it to her attention that it was wrong.  Of course she knew because she hired me, so she already knew that it was wrong.  I also informed Jayne Seidman, who is the woman who gave the affidavit.”  He went on, “I certainly don’t want the Division to be, you know, embarrassing themselves by saying things that are wrong. . . .”

The next day, the parties asked that ALJ Elliot state “what you believe the inaccuracies to be.”  He explained that the SEC’s affidavit assumed he was newly hired as an ALJ by the SEC, but that was not correct because he had been an ALJ in the Social Security Administration.  That meant that he was hired “through the process that essentially everyone else goes through,” responding to a posting on the federal government’s job-posting website.  “I saw a posting on USA Jobs when I was at Social Security.  I sent in my resume, I had an interview, I got an offer; it’s as simple as that.  What’s described in the Division’s notice of filing in Timbervest is if you’ve never been an ALJ before.  And as I said, I did in fact go through that process, just not when I was hired by the SEC.”  He went on, “I think when I was hired by the SEC, the Office of Personnel Management did have to approve my transfer from Social Security to SEC. . . .  So OPM does actually get involved in every ALJ’s hiring, to my knowledge.”  When asked with whom he interviewed, he responded: “I interviewed with Judge Murray, with Jayne Seidman, . . . and an attorney with the general counsel’s office, whose name escapes me at the moment.”  He also said “I pulled out one of my forms that I got from HR, and it appears that someone in HR did sign off on my hiring. . . .  I’m not saying that the person who signed the paper itself was my appointment. . . .  Whether that constitutes my appointment or not, I don’t know.”  When asked if he knew who appointed him, or the actual act that constituted his appointment, he responded: “I would have to say no, I don’t know.  I have an educated guess, but it’s really just an educate guess.  No, I don’t know the answer.”

This response makes it clear that records available at the SEC, could have informed the Division that the affidavit it provided was inaccurate.  Numerous people knew that ALJ Elliot was initially hired to serve at the Social Security Administration, apparently including the affiant, Ms. Seidman, but this fact was ignored.  Presumably the Division did not find it convenient actually to search the SEC’s own HR records before submitting the erroneous affidavit.  The difference here may not be material, which was ALJ Elliot’s stated view, but that is surely not within the Division’s purview to decide.  When asked for the facts, the Division (a) declined to seek them out, and (b) made an inaccurate filing instead.

The Division finally corrected the record in the Timbervest case on June 23, with the filing of an additional Notice: SEC June 23 Notice in Timbervest Administrative Proceeding.  That Notice attached the transcript of comments made by ALJ Elliot in the Bebo hearing, but otherwise said the Division still had not taken steps to confirm whether these recollections were accurate, including, apparently, not even seeking to obtain documents that could clarify the record.  Interestingly, although the Division’s original, inaccurate, Notice is posted on the docket, the mea culpa corrective Notice, with the excerpted portions of the Bebo transcript, is strangely missing, just like Timbervest’s original motion for discovery.

Of course, as ALJ Elliot noted, at a minimum the Division of Enforcement is “embarrassing themselves by saying things that are wrong.”  If this weren’t the government seeking to impose major penalties and other sanctions, we could dismiss them as “The Gang That Couldn’t Shoot Straight” (credit to Jimmy Breslin, RIP).

Jimmy Breslin - The Gang That Couldn't Shoot Straight

Jimmy Breslin – The Gang That Couldn’t Shoot Straight

But what happened here is much worse.  The Commission, sitting in its adjudicatory capacity, ordered that the Division provide certain information.  The Division refused to do so, declined to seek relief from the order, and instead substituted erroneous information, which a modest amount of diligence would have shown was certainly incomplete, if not inaccurate.  If the Division were held to the standards of performance it routinely applies to those it investigates and prosecutes, there would be meaningful repercussions, if not outright accusations of reckless misconduct.

I won’t hold my breath.

Straight Arrow

June 30, 2015

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SEC Gambit To Avoid Judge May in Timbervest Case Seems To Have Failed

We previously wrote about the SEC’s desperate effort to avoid the assignment of Timbervest, LLC v. SEC, Civil Action No. 1:15-CV-2106 (N.D. Ga.), to District Judge Leigh Martin May.  See SEC, Desperate To Avoid Judge May, Challenges Related Case Designation in Timbervest Action and SEC Argues Common “Facts” Are Not Common “Issues of Fact” — I Kid You Not.  You recall that Judge May ruled in Hill v. SEC that the appointment of SEC ALJ James Grimes violated the appointments clause of Article II of the Constitution — see Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding.

Well, it appears that the SEC’s motion challenging the “related case” assignment of the Timbervest action to Judge May failed.  There is no order in the docket denying the motion, but a recent scheduling order issued by Judge May suggests she will continue to preside over the case.  See Timbervest v. SEC Scheduling Order.  In the Order, Judge May states that the SEC must respond to plaintiffs’ Motion for a Temporary Restraining Order and/or Preliminary Injunction by June 29, plaintiffs must file a reply brief by July 16, and “the parties will attend a hearing in this matter a hearing” on July 21, in Courtroom 2107.  Courtroom 2107 is listed in the N.D. Georgia directory as Judge May’s courtroom.

In the meantime, in the SEC administrative case brought against Gray Financial Group, In the Matter of Gray Financial Group, Inc. et al., File No. 3-16554, SEC ALJ Cameron Elliot declined to issue a stay of proceedings in response to an unopposed motion founded on the pending federal action for injunctive relief by Gray Financial in the same Georgia federal court, which was also assigned to Judge May.  He said: “Commission Rule of Practice 161 instructs that I ‘should adhere to a policy of strongly disfavoring’ stay requests unless ‘the requesting party makes a strong showing that the denial of the request or motion would substantially prejudice their case.’  17 C.F.R. § 201.161(b)(1).  Respondents have not made such a showing.  I will abide by an injunction if it is issued; however, as of now I have been instructed to resolve this proceeding within 300 days of service of the OIP.”  See Order Denying Unopposed Motion To Stay Administrative Proceeding Against Gray Financial Group.

So, chaos still reigns, and apparently the SEC is unsure about how best to bring it under control.  See SEC Rejects Easy Answers To Admin Court Challenges.  In that article, Law 360’s Stephanie Russell-Kraft reported on a discussion between Judge Richard Berman and a DOJ lawyer representing the SEC.  Judge Berman asked whether, in light of comments by Judge May that it might be easy to cure the appointments clause violation, the similar claims brought before him by Barbara Duka (in Duka v. SEC) could be resolved simply by having the Commission reappoint its current ALJs.  The DOJ lawyer declined to address whether that could be done, leading to the following colloquy:

“Is the commission opposed to an easy fix?” Judge Berman asked.

“The Department of Justice is very actively considering the best litigation approach to address this issue,” Lin answered.

“I’m asking you if [appointing the judges] would solve this issue,” Judge Berman pressed, pointing out that the case pending before him had nothing to do with the SEC’s litigation strategy.

“It’s not like if we pursue one of these options this case or other cases will go away,” Lin answered, adding that changing the way it appoints its judges is not a “meaningful way” to address Judge May’s decisions or a “practical way” for it to approach its long-standing administrative court scheme.

“The commission has to consider all the cases it has,” she said later, to which Judge Berman replied, “I don’t.”

Meanwhile, the SEC’s administrative proceeding against Laurie Bebo continues to be tried, even while the appeal of Ms. Bebo’s injunctive action moves forward in the Seventh Circuit.

The ship is plainly adrift.

Straight Arrow

June 23, 2015

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Timbervest Files Complaint and TRO Motion To Halt SEC Proceeding

Today (June 12, 2015), Timbervest, LLC filed a complaint in federal court in the Northern District of Georgia seeking a halt to its ongoing SEC administrative proceeding, In the Matter of Timbervest, LLC at al.  We have previously discussed the Timbervest SEC proceeding, including recent developments involving Timbervest’s challenge to the constitutionality of the SEC administrative process and requests for discovery into possible systemic bias within the administrative court.  See Briefing of ALJ Constitutionality Before SEC Leaves Resolution in Doubt, SEC Broadens Constitutional Inquiry into Its Own Administrative Judges in Timbervest Case, SEC “Invites” ALJ Cameron Elliot To Provide Affidavit on Conversations “Similar” to Those Described by Former ALJ, and SEC ALJ Cameron Elliot Declines To Submit Affidavit “Invited” by the Commission.

With its efforts to pursue the constitutional challenge before the SEC meeting obstacles before the Commission, Timbervest opted to seek federal court intervention, commencing an action for injunctive relief, and moving for a temporary restraining order.  Those documents can be found here: Complaint in Timbervest v. SECMemorandum in Support of Motion for TRO in Timbervest v. SEC.

Because Timbervest is located in Atlanta, it filed its complaint in the federal district court for the Northern District of Georgia.  That is the same court that days ago halted a different SEC administrative proceeding, In the Matter of Charles L. Hill, Jr., in the action Hill v. SEC.  In that case, Judge Leigh Martin May found the appointment of ALJ James Grimes violated the appointments clause of Article II of the Constitution.  See Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding. And another case filed in that same court by yet another SEC respondent, Gray Financial Group v. SEC, was just assigned to Judge May as a related case.  See Ga. Judge Who Blocked SEC Admin Suit Gets Similar Case.  The new Timbervest complaint, which is case number 1:15-cv-02106-LMM, was also assigned to Judge May.

Judge May. an Obama appointee who is only in her first year of service as a judge, was active in the Democratic party before her appointment.  An article discussing her background can be read here: The Atlanta Judge Who Stuck A Thorn In The SEC’s Side.

In the Timbervest SEC proceeding, ALJ Cameron Elliot issued an Initial Decision as to which both the respondents and the SEC staff petitioned for Commission review, which was granted.  After briefing of the issues before the Commission, and supplemental briefing addressing constitutional issues, Timbervest sought discovery after the Wall Street Journal revealed possible pressures on SEC administrative judges to favor the SEC staff.  See Fairness Concerns About Proliferation of SEC Administrative Prosecutions Documented by Wall Street Journal.  Only days ago, the Commission held oral argument on the petitions for review.  But after Judge May”s decision in the Hill case, and ALJ Elliot’s refusal to provide information about possible pressures requested by the Commissioners, Timbervest felt it had to seek relief in federal court, saying: “Plaintiffs have appealed the ALJ’s Initial Decision to the Commission, but it has become clear that the Commission should not hear these arguments.  First, the Commission itself did not properly appoint the ALJ.  Second, the Commission has argued in other cases that its administrative forum is constitutional.  Thus, Plaintiffs’ appeal to the Commission is nothing more than an exercise in futility.”  Complaint ¶ 8.

The Timbervest complaint reveals an interesting issue about the handling of its case by the SEC’s ALJs.  The case was originally assigned to Chief Administrative Law Judge Brenda Murray, but then handed over to ALJ Elliot.  (ALJ Murray is the person identified by former ALJ Lillian McEwen as having told Ms. McEwen that she “questioned her loyalty to the SEC” because she did not treat the SEC staff sufficiently favorably.)  ALJs Murray and Elliot allegedly made a critical decision preventing Timbervest from using Brady material (material tending to show the respondents were innocent):

Given the age of the case, the primary evidence presented in support of the Division’s alleged violations was the faded and inconsistent memories of two Division witnesses.  As to one of those witnesses, Plaintiffs argued that the SEC had in its possession Brady material that the Commission’s staff disagreed with and argued was inadvertently produced.  The Brady material consisted of notes of two interviews the Commission’s staff conducted with that witness.  The Plaintiffs argued that the notes were exculpatory and, at the very least, were inconsistent statements that were required to be produced.  Pursuant to the SEC’s own administrative proceeding rules, it is required to produce Brady material.  Even though the SEC conducted an investigation that lasted over three years,speaking to numerous individuals over that time, the Commission’s staff did not produce any documents or information that it identified as Brady to the Plaintiffs.  Ultimately, ALJ Elliot, as well as ALJ Murray, ruled in favor of the Commission’s staff that the notes were not Brady, even though the notes were clearly inconsistent and exculpatory.

Complaint ¶ 28.

The Timbervest complaint also revealed that the SEC staff acknowledged that “ALJ Elliot was not hired through a process involving the approval of the individual members of the Commission.”  The staff could not state how ALJ Murray was appointed because “Chief ALJ Murray began work at the agency in 1988 and information regarding hiring practices at that time is not readily available.”  Complaint ¶ 36.  At a minimum, then, if Judge May retains her view that the SEC’s administrative law judges are “inferior officers” of the Executive Branch, a finding that ALJ Elliot was improperly appointed may come soon.  The only thing that might prevent such a ruling is if Judge May concludes that because the Timbervest SEC proceeding has already gone through trial and is before the SEC on review of the Initial Decision — a different set of circumstances than she faced in the Hill case — a federal court should not take jurisdiction over the case.

The SEC’s pot is now boiling over in, of all places, Atlanta, Georgia.

Straight Arrow

June 12, 2105

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SEC ALJ Cameron Elliot Declines To Submit Affidavit “Invited” by the Commission

On June 4, 2015, we discussed the SEC’s Order in In the Matter of Timbervest LLC “inviting”  administrative Law judge Cameron Elliot to submit an affidavit “addressing whether he has had any communications or experienced any pressure similar to that alleged in the May 6, 2015 The Wall Street Journal article, ‘SEC Wins With In-House Judges,’ and whether he is aware of any specific instances in which any other Commission ALJ has had such communications or experienced such pressure.”  See SEC “Invites” ALJ Cameron Elliot To Provide Affidavit on Conversations “Similar” to Those Described by Former ALJ.  Well, ALJ Elliot either doesn’t think that fits his job description, or he just doesn’t like the idea of providing a sworn declaration to the SEC.  On June 9, after considering the matter for four days, he tersely declined the invitation, saying only “I respectfully decline to submit the affidavit requested.”  (This does suggest that, at least as to this ALJ, the President or his proxies at the Commission do not have much sway over an ALJ who has multiple layers of protection against being fired.)

That would seem to leave the SEC in a bit of a pickle.  The Commissioners obviously thought there would be some value in gathering information on the issue of pressure on ALJs to act favorably to the Commission, which was raised by former ALJ Lillian McEwen with Wall Street Journal reporter Jean Eaglesham.  See Fairness Concerns About Proliferation of SEC Administrative Prosecutions Documented by Wall Street Journal.  The invitation to ALJ Elliot to supply data specific to him has now been rejected.  The Commission apparently still has not acted on respondent Timbervest’s request for discovery on the issue.  So what next step can the Commission take that doesn’t smack of arbitrarily ignoring the question, even after acknowledging it could be relevant?  We can only wait and see.  The Wall Street Journal reported that in a recent interview, Ms. McEwen explained that a sitting SEC judge would have difficulty discussing whether he or she felt pressure to favor the SEC, but that she said “she would ‘of course’ be happy to give evidence about her own experience” to the commissioners “if the agency decided to ask her for that.”  See SEC Judge Declines to Submit Affidavit of No Bias.

We’ve called for the Commission to commence an open, independent, and transparent inquiry into what is now at least a potential appearance of bias in its administrative process.  If that kind of review is occurring, it certainly is not open and transparent to interested observers.  The outward appearance is that there is a strange paralysis on the issue.  The longer the silence prevails, the more the appearance of this being a real issue has a chance to develop.  With the courts now for the first time showing a willingness to scrutinize the SEC administrative law process in response to challenges raised by respondents (see Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding), paralysis — or stonewalling, if that’s what it is — would seem to encourage continued chaos.  (Speaking of chaos, doesn’t it seem a little strange that in the wake of Judge May’s decision in Hill v. SEC that the appointment of ALJ James Grimes violated the constitution’s appointments clause, the SEC has taken no steps to address that issue?  Instead, following Judge May’s ruling, ALJ Grimes was appointed to preside over a new proceeding: see Order Scheduling Hearing and Designating Presiding Judge in In the Matter of R. Scott Peden.)

Straight Arrow

June 11, 2015

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Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding

In a breakthrough development, Northern District of Georgia federal district judge Leigh Martin May found that Charles Hill, a respondent in a pending SEC administrative proceeding, had a “substantial likelihood of success” of showing that the proceeding against him is unconstitutional because the appointment of the administrative law judge presiding over his case violated the appointments clause of Article II of the Constitution.  That is one of several arguments that have been made against the legality of the SEC’s administrative enforcement proceedings, and this is the first court to treat any of those arguments seriously.

Judge May’s decision is here: Order in Hill v. SEC.

 

Judge Leigh May. Photo by John Disney/Daily Report.

Judge Leigh May. Photo by John Disney/Daily Report.

The opinion, while tempered, is an eye-opener for the SEC, which has so far convinced other courts (and no doubt themselves) either not to consider these arguments or give them short shrift.  The Commission now has no choice but to reconsider whether its recent determination to shift important enforcement cases from federal courts to its administrative courts still makes sense.  One can assume there will be every effort to appeal this decision and get this decision overturned on an expedited basis, but that could take months, even in an accelerated proceeding, and the Eleventh Circuit might end up agreeing with Judge May.  The availability of a stay pending appeal may be in doubt because the order only halts the one proceeding against Mr. Hill, making the need for a stay questionable.  Alternatively, the Commission could expedite its own consideration of this issue in the pending Timbervest administrative proceeding (see SEC Broadens Constitutional Inquiry into Its Own Administrative Judges in Timbervest Case), rule in its own favor, and possibly get the issue to an appellate court with an added argument that the SEC’s decision is entitled to some deference.  Since Timbervest is located in Atlanta, that may also end up before the Eleventh Circuit.  In the meantime, there is a cloud over the entire SEC administrative enforcement process, although, as noted, Judge May’s order itself only halts the impending adminsitrative trial of Mr. Hill.

Judge May’s opinion was careful and thorough.  In the end, it came down to a single issue: whether the SEC’s administrative law judges are “executive officers” subject to the appointments clause and other Article II limits on diminishing executive power.  Some time ago, we wrote that this was a serious issue on which Supreme Court precedent seemed likely create problems for the SEC.  See Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit.  Until now, however, no court has been willing to give the argument thorough consideration.  See In Duka v. SEC, SDNY Judge Berman Finds SEC Administrative Law Enforcement Proceedings Constitutional in a Less than Compelling Opinion.

The opinion begins with a discussion of many of the respects in which “SEC administrative proceedings vary greatly from federal court actions.”  Slip op. at 4.  These include: the rules of evidence do not apply; respondents “are generally barred from taking depositions”; “SEC administrative proceedings also occur much more quickly than federal court actions”; “[c]ounterclaims are not permissible”; there is no equivalent of Rule 12(b) motions “to test the allegations sufficiency”; and “there is no right to a jury trial.” Id. at 4-5.

It then discusses the respective powers of the ALJ and the SEC: the presiding ALJ is selected by the chief ALJ, presides over the matter and issues an initial decision; the SEC may order interlocutory review of any ALJ decision during the proceeding; the initial decision can be appealed by either party or reviewed by the SEC on its own initiative; a decision is not final until the SEC issues it, but if there is no appeal and the SEC does not review an ALJ decision “it is deemed the action of the Commission,” and the SEC issues an order making that decision final; SEC review is de novo and new evidence can be heard, but “the SEC will accept the ALJ’s ‘credibility finding, absent overwhelming evidence to the contrary.’”  An SEC decision can be appealed to a federal court of appeals (either the D.C. Circuit or the Circuit where the respondent resides).  On appeal, the “SEC’s findings of facts are ‘conclusive’ ‘if supported by substantial evidence.’” Id. at 5-7.

The court then describes that SEC ALJs “are ‘not appointed by the President, the Courts, or the [SEC] Commissioners.  Instead, they are hired by the SEC’s Office of Administrative Law Judges, with input from the Chief Administrative Law Judge, human resource functions, and the Office of Personnel Management.’”  Id. at 7.  Congress authorized the SEC to delegate any of its functions to an ALJ, and the SEC promulgated regulations making ALJs responsible for the “fair and orderly conduct” of proceedings and giving them the authority to: “(1) Administer oaths and affirmations; (2) Issue subpoenas; (3) Rule on offers of proof; (4) Examine witnesses; (5) Regulate the course of a hearing; (6) Hold pre-hearing conferences; (7) Rule upon motions; and (8) Unless waived by the parties, prepare an initial decision containing the conclusions as to the factual and legal issues presented, and issue an appropriate order.”  Id. at 8.

The court then moved to the specifics of Mr. Hill’s prosecution, noting that he moved for summary disposition on constitutionality grounds but that ALJ James Grimes ruled that he lacked the authority to address two of the three grounds asserted: that “Congess’s delegation of authority to the SEC to pursue cases before ALJs violates the delegation doctrine in Article I of the Constitution,” and that “Congress violated his Seventh Amendment right to jury trial by allowing the SEC to pursue charges in an administrative proceeding.”  Id. at 10.  See SEC ALJ Says He Lacks Authority To Decide Key Constitutional Challenges.  Mr. Hill sought relief from the federal court to prevent the proceeding on these constitutionality grounds, and later amended his complaint to assert that the proceeding was also unconstitutional because “the SEC ALJ’s appointment violated the Appointments Clause of Article II as the ALJ is allegedly an inferior officer and he was not appointed by the President, the courts of law, or a department head.”  Slip op. at 10-11.

Turning to the legal determinations, Judge May first rejected the SEC’s contention that the court lacked jurisdiction to hear the case.  The SEC made this argument successfully in cases previously brought by other respondents, including Wing Chau and Laurie Bebo.  See SEC Wins First Skirmish on Constitutional Challenge to Chau Administrative Proceeding; Court Dismisses “Compelling and Meritorious” Bebo Constitutional Claims Solely on Jurisdictional Grounds.  The SEC argued “that its election to pursue claims against Plaintiff in an administrative proceeding, ‘channels review of Plaintiff’s claims through the Commission’s administrative process, with review in the courts of appeals,’” that is, “judicial review can only come from the courts of appeal following the administrative proceeding and the SEC’s issuance of a final order in Plaintiff’s case.”  Slip op. at 11-12.  The court found this “in tension with 28 U.S.C. § 1331, which provides that federal district courts ‘have original jurisdiction of all civil actions arising under the Constitution, laws, or treaties of the United States,’ and 28 U.S.C. § 2201, which authorizes declaratory judgments.”  Id. at 12.  The court rejected the SEC’s argument that “Congress declared its intent for the administrative proceeding to be the exclusive forum for judicial review for these cases by allowing the SEC to make the administrative proceeding its forum choice,” finding instead that “Congress’s purposeful language allowing both district court and administrative proceedings shows a different intent.  Instead, the clear language of the statute provides a choice of forum, and there is no language indicating that the administrative proceeding was to be an exclusive forum.”  Id. at 13.

Moving beyond this point to the issue addressed previously by two other courts in the SEC’s favor – whether Supreme Court precedent on the issue supports a finding that Congress did withdraw jurisdiction – Judge May found otherwise because:

(1) “If Plaintiff is required to raise his constitutional law claims following the administrative proceeding, he will be forced to endure what he contends is an unconstitutional process.”  Slip op. at 15.  Critically, Mr. Hill “does not challenge the SEC’s conduct in that proceeding or the allegations against him—he challenges the proceeding itself” (id. at 17).  “Waiting until the harm Plaintiff alleges cannot be remedied is not meaningful judicial review.”  Id. at 18.

(2) The constitutional challenge is “wholly collateral” to the merits of the proceeding itself.  “Plaintiff is not challenging an agency decision; Plaintiff is challenging whether the SEC’s ability to make that decision was constitutional.  What occurs at the administrative proceeding and the SEC’s conduct there is irrelevant to this proceeding which seeks to invalidate the entire statutory scheme.”  Id. at 20.

(3) The constitutional issues are outside the SEC’s expertise.  “Plaintiff’s constitutional claims are governed by Supreme Court jurisprudence, and ‘the statutory questions involved do not require technical considerations of agency policy.’”  Id. at 21.

This aspect of the opinion is consistent with Judge Richard Berman’s decision in Duka v. SEC (SDNY).  Judge Berman, however, went on to reject Ms. Duka’s constitutional argument, finding the she was “unlikely to succeed on the merits” of that claim.

Having likewise found her court had jurisdiction over Mr. Hill’s claim, however, Judge May went in a different direction on the merits of the preliminary injunction sought by Mr. Hill.  The critical issue was whether Mr. Hill had “a substantial likelihood to succeed on the merits” on his constitutional claims.

Judge May found no such likelihood of success for the argument that the power given to the SEC in the Dodd-Frank Act to bring these cases in its administrative court was an unconstitutional delegation of legislative power.  Instead, she found this authority was a form of prosecutorial discretion that is an executive power, not a delegated legislative power.  “When the SEC makes its forum selection decision, it is acting under executive authority and exercising prosecutorial discretion. . . .  Because Congress has properly delegated power to the executive branch to make the forum choice for the underlying SEC enforcement action, the Court finds that the Plaintiff cannot prove a substantial likelihood of success on the merits on his non-delegation claim.”  Slip op. at 23-29.

On the Seventh Amendment jury trial issue, the court likewise found no substantial likelihood of success.  Judge May found Supreme Court precedent on this controlling because SEC prosecutions involve “public rights,” since the SEC “is acting as a sovereign in the performance of its executive duties when it pursues an enforcement action.”  The controlling Supreme Court case, Atlas Roofing Co. v. Occupational Safety & Health Review Comm’n, 430 U.S. 442 (1977), rejected the jury trial argument in administrative enforcement actions brought by OSHA.

One might question whether this addresses the true jury trial issue in SEC cases.  Unlike the OSHA case, the SEC traditionally prosecuted alleged violations of the securities laws by unregulated persons in federal court actions, in which there is a jury trial right as to non-equitable claims.  Only after Dodd-Frank was enacted was the SEC permitted to commence the same actions in its administrative courts.  That means the SEC was given the power to deny a defendant what for many years has been a jury trial right, and, because there are no standards governing how to go about doing this, currently does so without any enforceable or predictable guidelines for the decision.  That raises a combination of jury trial, equal protection, and arbitrary and capriciousness arguments that the Atlas Roofing case does not begin to address.  I expect a more definitive consideration of the jury trial issue is yet to come.   

Judge May did ultimately find a substantial likelihood of success on one of Mr. Hill’s constitutional arguments, which raises the question of whether it was prudent to decide these first two constitutional issues when they did not, in the end, have a bearing on her decision.  Normally, a court strives to avoid constitutional issues if possible.

But the blockbuster part of the opinion is certainly the discussion of the alleged Article II violations.  Judge May did find a substantial likelihood of success on at least one of Mr. Hill’s alleged violations of Article II – whether the appointment of ALJ Grimes violated the appointments clause in Article II, section 2, clause 2.  (Having reached that conclusion, she found it unnecessary to decide the other Article II issue – whether the double layer of tenure protection for SEC ALJs unacceptably encroached on the President’s executive power.  Why was that given different treatment than the delegation and jury trial issues?)

The threshold question for each of these arguments was whether SEC ALJs are “executive officers” within the meaning of Article II.  We previously discussed this issue at length (in the aforementioned Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit), and expressed the view that Supreme Court precedent in Freytag v. Commissioner, 501 U.S. 868 (1991), strongly suggested that the SEC ALJs were, indeed, “inferior officers” within the meaning of Article II.  Judge May agreed that Freytag was effectively controlling, as follows:

The issue of whether the SEC ALJ is an inferior officer or employee for purposes of the Appointments Clause depends on the authority he has in conducting administrative proceedings. . . .  The Appointments Clause . . . creates two classes of officers: principal officers, who are selected by the President with the advice and consent of the Senate, and inferior officers, whom “Congress may allow to be appointed by the President alone, by the heads of departments, or by the Judiciary.” . . .  The Appointments Clause applies to all agency officers including those whose functions are “predominately quasi judicial and quasi legislative” and regardless of whether the agency officers are “independent of the Executive in their day-to-day operations.” . . .

“[A]ny appointee exercising significant authority pursuant to the laws of the United States is an ‘Officer of the United States,’ and must, therefore, be appointed in the manner prescribed by § 2, cl. 2, of [Article II].” . . .  By way of example, the Supreme “Court has held that district-court clerks, thousands of clerks within the Treasury and Interior Departments, an assistant surgeon, a cadet-engineer, election monitors, federal marshals, military judges, Article I [Tax Court special trial] judges, and the general counsel for the Transportation Department are inferior officers.” . . .

Plaintiff claims that SEC ALJs are inferior officers because they exercise “significant authority pursuant to the laws of the Unites States” while the SEC contends ALJs are “mere employees” based upon Congress’s treatment of them and the fact that they cannot issue final orders and do not have contempt power. . . .  The Court finds that based upon the Supreme Court’s holding in Freytag, SEC ALJs are inferior officers.

 In Freytag, the Supreme Court was asked to decide whether special trial judges (“STJ”) in the Tax Court were inferior officers under Article II. . . .  The Government argued, much as the SEC does here, that STJs do “no more than assist the Tax Court judge in taking the evidence and preparing the proposed findings and opinion,” id., and they “lack authority to enter a final decision.” . . .  The Supreme Court rejected that argument. . . .

The Court finds that like the STJs in Freytag, SEC ALJs exercise “significant authority.” The office of an SEC ALJ is established by law, and the “duties, salary, and means of appointment for that office are specified by statute.” . . .  ALJs are permanent employees—unlike special masters—and they take testimony, conduct trial, rule on the admissibility of evidence, and can issue sanctions, up to and including excluding people (including attorneys) from hearings and entering default. . . .

Slip op. at 35-38 (citations omitted).

Judge May went on to consider the divided decision of a D.C. Circuit panel in Landry v. Federal Deposit Insurance Corp., 204 F.3d 1125 (D.C. Cir. 2000), that ALJs at the FDIC were not executive officers.  She was convinced that the concurring minority opinion in that case was more true to Freytag than the majority of the panel, and, like the concurring judge in Landry, concluded “that the Supreme Court in Freytag found that the STJs powers—which are nearly identical to the SEC ALJs here—were independently sufficient to find that STJs were inferior officers.”  Slip op. at 40.

Judge May also rejected the SEC’s argument that the court “should defer to Congress’s apparent determination that ALJs are inferior officers” because “Congress is presumed to know about the Appointments Clause, and it decided to have ALJs appointed through OPM and subject to the civil service system,” and therefore “intended for ALJs to be employees.”  Id. at 41.  Because the appointments clause “prevents Congress from dispensing power too freely,” Judge May found that argument unacceptable: “Congress may not ‘decide’ an ALJ is an employee, but then give him the powers of an inferior officer; that would defeat the separation-of-powers protections the Clause was enacted to protect.”  Accordingly, the court found “that SEC ALJs are inferior officers.”  Id.  Moreover, because the SEC “concedes that Plaintiff’s ALJ, James E. Grimes, was not appointed by an SEC Commissioner,” he “was not appointed by the President, a department head, or the Judiciary” as the appointments clause requires.”  As a result, “[b]ecause he was not appropriately appointed pursuant to Article II, his appointment is likely unconstitutional in violation of the Appointments Clause.”  Id. at 42.

We might add that by all appearances ALJ Grimes’s treatment of the constitutional challenges to the proceeding before him has been handled responsibly, even to the point of granting a subpoena on the SEC sought by Mr. Hill relating to a due process challenge on the basis of possible systemic bias in the administrative court.  See SEC ALJ James Grimes Issues Important Discovery Order Against SEC.

Judge May went on to find the other requirements for a preliminary injunction satisfied (id. at 42-43), and ruled that “a preliminary injunction is appropriate to enjoin the SEC administrative proceeding and to allow the Court sufficient time to consider this matter on the merits.”  Id. at 44.

The judge’s final words addressed whether all of this was important enough to support potentially debilitating relief (and least in the short term):

The Court notes that this conclusion may seem unduly technical, as the ALJ’s appointment could easily be cured by having the SEC Commissioners issue an appointment or preside over the matter themselves.  However, the Supreme Court has stressed that the Appointments Clause guards Congressional encroachment on the Executive and “preserves the Constitution’s structural integrity by preventing the diffusion of appointment power.” Freytag, 501 U.S. at 878.  This issue is “neither frivolous or disingenuous.” Id. at 879. The Article II Appointments Clause is contained in the text of the Constitution and is an important part of the Constitution’s separation of powers framework.

In addition, the Appointments Clause may not be waived, not even by the Executive.  Id. at 880 (“Neither Congress nor the Executive can agree to waive this structural protection.”).  As this likely Appointment Clause violation “goes to the validity of the [administrative] proceeding that is the basis for this litigation,” id. at 879, it is hereby ORDERED that Defendant, the Securities and Exchange Commission, is preliminarily enjoined from conducting the administrative proceeding brought against Plaintiff . . . including the hearing scheduled for June 15, 2015, before an Administrative Law Judge who has not been appointed by the head of the Department.

Slip op. at 44.

The SEC is likely unprepared for this occurrence.  But, as we previously wrote, the case law strongly supported the view that SEC ALJs are, indeed, inferior executive officers, and serious constitutional issues flow from that, including the appointments clause issue now decided against the SEC.

As the court notes, there may be some tweaks that could clear up this issue, although they may well require action by Congress amending the statutory provisions governing the appointment of administrative law judges (an issue I’ve not looked at).  But even if a “cure” is possible with such tweaks, they would not address the more fundamental question of whether the SEC is doing the right thing by bringing serious prosecutorial actions like these against persons not subject to SEC regulatory oversight in the administrative court.  The lengthy list given by Judge May of the respects in which respondents are impeded from presenting a defense in the administrative forum, as compared to federal courts, should give a fair-minded Commission pause about whether its recent policy of increased administrative enforcement actions needs to be reconsidered.  See Former SEC Enforcement Leaders Urge SEC To Reform Administrative Enforcement Process.  The bottom line is that when unregulated persons are prosecuted for alleged violations and face debilitating demands for penalties and purported “disgorgement,” plus the usual SEC effort to bar these people from future employment as officers or directors of public companies, perhaps the “right” thing to do is allow them to defend themselves in a forum that provides a more level playing field.  Is it really that hard to “do the right thing”?

Straight Arrow

June 9, 2015

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