Tag Archives: Duka 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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SEC Declares All Is Okay Because Its ALJs Are Just Employees and Not “Inferior Officers”

On September 3, 2015, the SEC issued its first ruling addressing the constitutionality of its administrative law judges, in In the Matter of Raymond J. Lucia Cos., Inc., File No. 15006.  The opinion can be read here: SEC Opinion in In the Matter of Raymond J. Lucia Companies.  In substance, the SEC argued that its ALJs are “employees,” not “inferior officers” within the meaning of Article II of the Constitution.  In that respect, it disagreed with two federal courts that have addressed the merits of that issue, each of which found it “likely” that the ALJs are inferior officers, and therefore subject to Article II’s Appointments Clause.  See SDNY Court Ups the Ante, Allowing Duka Injunctive Action To Proceed on Appointments Clause Issue, and Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding.

The SEC now says “no,” arguing that its ALJs are sufficiently like the FDIC ALJ’s that were found not to be inferior officers in a split D.C. Circuit opinion in Landry v. FDIC, 204 F.3d 1125 (D.C. Cir. 2000).  That was an argument rejected by the two courts.  The SEC wrote:

Our consideration of this question is guided by the D.C. Circuit’s decision in Landry v. FDIC, which addressed whether ALJs should be deemed inferior officers or employees.  Landry held that, for purposes of the Appointments Clause, ALJs at the Federal Deposit Insurance Corporation (“FDIC”) who oversee administrative proceedings to remove bank executives are employees rather than inferior officers. Landry explained that the touchstone for determining whether adjudicators are inferior officers is the extent to which they have the power to issue “final decisions.”  Although ALJs at the FDIC take testimony, conduct trial-like hearings, rule on the admissibility of evidence, have the power to enforce compliance with discovery orders, and issue subpoenas, they “can never render the decision of the FDIC.”  Instead, they issue only “recommended decisions” which the FDIC Board of Directors reviews de novo, and “[f]inal decisions are issued only by the FDIC Board.”  The ALJs thus function as aides who assist the Board in its duties, not officers who exercise significant authority independent of the Board’s supervision.  Because ALJs at the FDIC “have no such powers” of “final decision,” the D.C. Circuit “conclude[d] that they are not inferior officers.”

The mix of duties and powers of the Commission’s ALJs are very similar to those of the ALJs at the FDIC. Like the FDIC’s ALJs, the Commission’s ALJs conduct hearings, take testimony, rule on admissibility of evidence, and issue subpoenas.  And like the FDIC’s ALJs, the Commission’s ALJs do not issue the final decisions that result from such proceedings. Just as the FDIC’s ALJs issue only “recommended decisions” that are not final, the Commission’s ALJs issue “initial decisions” that are likewise not final.  Respondents may petition us for review of an ALJ’s initial decision, and it is our “longstanding practice [to] grant[] virtually all petitions for review.”  Indeed, we are unaware of any cases which the Commission has not granted a timely petition for review.  Absent a petition, we may also choose to review a decision on our own initiative, a course we have followed on a number of occasions.  In either case, our rules expressly provide that “the initial decision [of an ALJ] shall not become final.”  Even where an aggrieved person fails to file a timely petition for review of an initial decision and we do not order review on our own initiative, our rules provide that “the Commission will issue an order that the decision has become final,” and it “becomes final” only “upon issuance of the order” by the Commission.  Under our rules, no initial decision becomes final simply “on the lapse of time” by operation of law; instead, it is “the Commission’s issuance of a finality order” that makes any such decision effective and final.  Moreover, as does the FDIC, the Commission reviews its ALJs’ decisions de novo.  Upon review, we “may affirm, reverse, modify, set aside or remand for further proceedings, in whole or in part,” any initial decision.  And “any procedural errors” made by an ALJ in conducting the hearing “are cured” by our “thorough, de novo review of the record.”  We may also “hear additional evidence” ourselves, and may “make any findings or conclusions that in [our] judgment are proper and on the basis of the record.”  For this reason, although ALJs may play a significant role in helping to shape the administrative record initially, it is the Commission that ultimately controls the record for review and decides what is in the record.  As we have explained before, we have “plenary authority over the course of [our] administrative proceedings and the rulings of [our] law judges—before and after the issuance of the initial decision and irrespective of whether any party has sought relief.”

Opinion at 30-31 (footnotes omitted).

The SEC rejected the argument, which the two courts found convincing, that the Supreme Court decision in Freytag v. Commissioner, 501 U.S. 868 (1991), supported the opposite conclusion, arguing that the “special trial judges” at issue in Freytag were more important than the SEC ALJs: “The far greater role and powers of the special trial judges relative to Commission ALJs, in our view, makes Freytag inapposite here.”  Opinion at 32.  The reasons for this view were:

First, unlike the ALJs whose decisions are reviewed de novo, the special trial judges made factual findings to which the Tax Court was required to defer, unless clearly erroneous.  Second, the special trial judges were authorized by statute to “render the [final] decisions of the Tax Court” in significant, fully-litigated proceedings involving declaratory judgments and amounts in controversy below $10,000.  As discussed above, our ALJs issue initial decisions that are not final unless the Commission takes some further action. Third, the Tax Court (and by extension the court’s special tax judges) exercised “a portion of the judicial power of the United States,” including the “authority to punish contempts by fine or imprisonment.”  Commission ALJs, by contrast, do not possess such authority.

Based on the foregoing, we conclude that the mix of duties and powers of our ALJs is similar in all material respects to the duties and role of the FDIC’s ALJs in Landry.  Accordingly, we follow Landry, and we conclude that our ALJs are not “inferior officers” under  the Appointments Clause.

Id. at 32-33 (footnotes omitted).

The reasoning is minimalist.  It ignores the decisions of the two federal courts.  It does not address the array of powers the SEC ALJs have that may differ from FDIC ALJs.  It does not explain why it believes that the differences it found between the “special trial judges” in Freytag and its own ALJs are of sufficient importance to warrant a different result.  And it does not discuss other Supreme Court decisions addressing when adjudicative officials should be considered to be “inferior officers.”  See Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit.

None of this is surprising.  There was zero chance the SEC was going to rule against its own appointments of ALJs.  That is one reason why decisions of several federal courts that the SEC should be given the chance to address the issue before the courts did, while perhaps lawyerly, seem so pointless.  But nothing about this opinion presents a compelling argument that the ALJs are mere employees, given the broad array of powers they have in determining how administrative cases are litigated and ultimately decided.  And, because the SEC essentially chooses to adopt the rationale of the majority in Landry v. FDIC rather than address the hard issues itself, it is unlikely that any appellate court outside of the D.C. Circuit, where Landry was decided, should, or would, be swayed by what the Commission had to say on the issue.

Straight Arrow

September 4, 2015

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What Is the SEC Backup Plan if It Loses the ALJ Constitutionality Issue in Court?

The saga of challenges to the constitutionality of the SEC’s administrative law proceedings — and in particular the appointments and removal protections of the administrative law judges — has played out over many months in both court and commentary.  After some early SEC victories on jurisdictional challenges, the Commission seemed content to try to fend off the court cases on such procedural grounds, and fight the merits by deciding the issue in its own favor on a petition for review of one of these proceedings (like the one now before it in the Timbervest case), with perhaps an upper hand once the case reached a federal appeals court.

If that was the early strategy, it now seems to be in need of reconsideration.  Two federal district court judges found jurisdiction over cases making such challenges in four separate cases, and ruled on preliminary injunction motions that the plaintiffs will likely succeed on the merits.  In three of those four cases, involving proceedings against Charles Hill, Gray Financial Group, and Barbara Duka, the SEC is now preliminarily enjoined from moving forward with its administrative proceedings.  (In the other, against Timbervest, the preliminary injunction was denied because the case had already been tried and was now before the SEC for review.)  See Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding; N.D. Ga. Judge Leigh May Issues Injunction for Gray Financial and Denies One for Timbervest; SDNY Court Ups the Ante, Allowing Duka Injunctive Action To Proceed on Appointments Clause Issue; Order Issuing Preliminary Injunction in Duka v. SEC.  The merits of the constitutionality issue now can no longer be dismissed as fringe advocacy.  The main issue in these cases — whether the SEC ALJs are “inferior officers” under Article II of the Constitution — has now been substantially vetted by two courts, which found they were, indeed, inferior officers under closely analogous Supreme Court decisions.  Beyond this, the SEC made embarrassing errors in court submissions about how its ALJs were appointed, and at a minimum seems incompetent at figuring out and reporting to the courts on this simple factual issue.  Indeed, even in the SEC’s own proceeding in Timbervest, the Enforcement Division refused to comply with an adjudicative order from the Commission to provide the Commissioners with a description of how the ALJs were appointed.  Whether it was because they couldn’t do so, or just didn’t want to do so, is not clear.  See SEC Bumbles Efforts To Figure Out How Its Own Administrative Law Judges Were Appointed.  In this context, the SEC itself will have difficulty writing an opinion in Timbervest upholding the constitutionality of the ALJs that would not be in significant danger of being overturned.

But the SEC continues to take a “business as usual” approach in its administrative court proceedings.  Many of these are ongoing, and more are assigned each day (or at least each week).  Any defense lawyer could be committing malpractice by failing to challenge a pending or new case on grounds of unconstitutionality.  Indeed, I question why the ALJs themselves don’t make clear in each such case that the constitutionality of their appointments is now at issue, and stating sua sponte that each respondent would be deemed to have challenged the proceeding on that ground, in the event the argument was ultimately upheld in the courts.

So, what happens if the SEC’s stonewalling defense posture fails; if the constitutionality challenge is ultimately upheld?  If the status quo prevails, my guess is near chaos.  To be sure, the ruling is likely to be applied prospectively, and stayed for some time to allow for some remedial steps to be taken, akin to the approach taken when the bankruptcy courts were ruled unconstitutional.  See Northern Pipeline Co. v. Marathon Pipe Line Co., 458 U.S. 50, 87-88 (1982).  But I don’t see how every case currently pending, or instituted between now and when such a decision occurs, in which such a challenge is made, would not be vacated.  See D.C. Circuit Invalidates Appointment of Former Acting GC for Labor Board (DC Circuit holds in SW General, Inc. v. NLRB, No. 1107, that NLRB action by Acting General Counsel serving unlawfully must be vacated).  That could be a lot of cases that need to be retried (or reconsidered or settled).  Perhaps the Commission is counting on the appellate courts (and the Supreme Court) to blanche at the prospect of vacating such a large number of prosecuted cases.

Even a Commission confident in its arguments needs to consider how to proceed in a way that minimizes chaos if it loses.  What could it do now to protect against that future result?  Two steps immediately come to mind.  First, at least for now, while the constitutionality issue remains in doubt, reverse its new policy of bringing more of its complex cases in the administrative court and go back to the model in which those cases were brought in federal court.  To save face, this need not be announced; it can be effected sub silentio.  The Commission seems to prefer secrecy over sunshine, although a little more open discussion of how it approaches these issues would probably do a lot more good than harm.  An open statement of this discretionary decision would evidence more good faith than we’ve seen over the past year.  Second, obtain a waiver of the constitutionality issue from fully informed respondents before commencing new proceedings, or continuing pending proceedings.  I haven’t researched the issue, but my bet is that the SEC and an opposing party can, by mutual consent, agree to any forum to resolve cases, and a fortiori, an agreement to use the administrative court with its current ALJs likely would be enforceable.  At a minimum, a party that agreed to proceed on this basis would likely be estopped from making a future challenge on this ground.  The SEC might have to make some concessions to get such an agreement — probably involving fairer rules for discovery and scheduling in these cases — but by now they should recognize that this might not be a bad thing.  Many respondents with limited defense resources could well prefer, and agree to, this approach.  That would take a lot of potential future vacated results off the table.

No doubt there are other steps that can be taken to avoid a potential future quagmire.  The important thing is that the Commission and its staff should be thinking about, and implementing, these kinds of steps, because, like it or not, the Commission may find itself on the losing end of the constitutional question.

Straight Arrow

August 12, 2015

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SDNY Court Ups the Ante, Allowing Duka Injunctive Action To Proceed on Appointments Clause Issue

Today, August 3, 2015, Judge Richard Berman rules that Barbara Duka’s action to enjoin an SEC administrative proceeding against her could proceed in his court.  In doing so, he endorsed the reasoning of Judge Leigh May in SEC v. Hill, on the issues of jurisdiction and whether the SEC ALJs are “inferior officers” for purposes of the Appointments Clause of Article II of the Constitution.  Judge Hill’s decision is discussed here: Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC ProceedingJudge Berman’s decision can be read here: Decision & Order in SEC v. Duka.  Judge Berman previously addressed the jurisdiction issue, ruling in Ms. Duka’s favor, but nevertheless denied her request for a preliminary injunction because he found she was unlikely to succeed in showing that the removal limitations protecting SEC administrative law judges from removal by the President violated the separation of powers.  See In Duka v. SEC, SDNY Judge Berman Finds SEC Administrative Law Enforcement Proceedings Constitutional in a Less than Compelling Opinion.  That decision can be read here: Order Denying Relief in Duka v. SEC.  The issue in this case, and others filed since then, has turned to whether the appointment of SEC ALJs violates Article II’s Appointments Clause.  Judge Berman was not prepared to dismiss an action on that issue, and seemed to be leaning in favor of Ms. Duka on the merits of the violations and the issue of relief.

Today, he did not address Ms. Duka’s motion for a preliminary injunction; he simply denied the SEC’s motion to dismiss the action.  The courts are badly split on the jurisdictional dispute over whether an SEC enforcement respondent may bring a court action to enforce a proceeding alleged to be unconstitutional, rather than litigation the case to completion and raising the constitutionality issue before the SEC and, eventually, likely years later, before a court of appeals.  On the other hand, the courts that have addressed the issue of whether SEC administrative law judges are “inferior officers” from a constitutional standpoint — and therefore subject to the constitution’s Article II appointment (and presumably other) restrictions — seem to be less divided.  The decisions seem to favor the view that these ALJs are to be treated as “inferior officers” under binding Supreme Court precedent.  They generally appear to favor the analysis laid out in our earlier discussion of this issue here: Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit.

Judge Berman’s decision was short and direct.  He reiterated that he found no reason to alter the jurisdictional analysis in his April 15 Order, despite the later differing views of SDNY judges expressed in other cases (Tilton v. SEC and Spring Hill Capital Partners, LLC v. SEC): “This Court confirms the reasoning and conclusions set forth in its Decision & Order.  The Court perceives no new facts or legal authorities that would warrant reconsideration, including, most respectfully, two recent decisions in the Southern District of New York in Tilton v. S.E.C., No. 15-CV-2472 RA, 2015 WL 4006165 (S.D.N.Y. June 30, 2015) and Spring Hill Capital Partners, LLC, et al. v. SEC, 1 :15-cv-04542, ECF No. 24 (S.D.N.Y June 29, 2015).”  Slip op. at 2.  Instead, he endorsed the reasoning of Judge May in Hill v. SEC: “The Court finds persuasive the reasoning in Hill v. S.E.C., No. 1 :15-CV-1801-LMM, 2015 WL 4307088, at *6 (N.D. Ga. June 8, 2015) (“Congress did not intend to . . . prevent Plaintiff from raising his collateral constitutional claims in the district court.”).”

On the Appointments Clause issue he wrote:

The Court stated in its Decision & Order that “[t]he Supreme Court’s decision in Freytag v. Commissioner, 501 U.S. 868 (1991), which held that a Special Trial Judge of the Tax Court was an ‘ inferior officer’ under Article II, would appear to support the conclusion that SEC ALJs are also inferior officers.” . . .  The Court here concludes that SEC ALJs are “inferior officers” because they exercise “significant authority pursuant to the laws of the United States.”  Freytag, 501 U.S. at 881. . . .  The SEC ALJs’ positions are “established by [l]aw,” including 5 U.S.C. §§ 556, 557 and 15 U.S.C. § 78d-1(a), and “the duties, salary, and means of appointment for that office are specified by statute.” . . .  And, ALJs “take testimony, conduct trials, rule on the admissibility of evidence, and have the power to enforce compliance with discovery orders.”  Freytag, 501 U.S. at 881.  “In the course of carrying out these important functions, the [ ALJ s] exercise significant discretion.” Id.; see also Hill, 2015 WL 4307088, at *17 (“like the STJs in Freytag, SEC ALJs exercise ‘significant authority.”‘).  The Court is aware that Landry v. FDIC, 204 F.3d 1125 (D.C. Cir. 2000) is to the contrary.

The Appointments Clause in Article II provides: “[T]he Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts ofLaw, or in the Heads of Departments.”  Constitution, Art. II,§ 2, cl. 2.  It is well-settled that the Appointments Clause provides the exclusive means by which inferior officers may be appointed. . . .  For purposes of the Appointments Clause, the SEC is a “Department” of the Executive Branch, and the Commissioners function as the “Head” of that Department. . . .

There appears to be no dispute that the ALJs at issue in this case are not appointed by the SEC Commissioners. . . .

As noted above, after thoroughly reviewing facts quite similar to those presented here, United States District Judge Leigh Martin May concluded that “Freytag mandates a finding that the SEC ALJs exercise ‘ significant authority’ and are thus inferior officers” and that, because SEC ALJs are “not appropriately appointed pursuant to Article II, [their] appointment is likely unconstitutional in violation of the Appointments Clause.”

Slip op. at 4-5.

Judge Berman also addressed a question that has been studiously avoided by the SEC — whether the infirmity in the appointments of ALJs can be easily remedied: “Judge May also determined that ‘the ALJ’s appointment could be easily cured by having the SEC Commissioners issue an appointment or preside over the matter themselves.’ . . .  Plaintiffs counsel in the instant case reached the same conclusion at a conference held on June 17, 2015, stating that ‘I think that [having the Commissioners appoint the ALJ s] is one of [the easy cures] .’ . . .  And, it appears that the Commission is reviewing its options regarding potential ‘cures’ of any Appointments Clause violation(s).” . . .  The SEC has generally declined to address this issue, noting a quick fix may not be available, and preferring instead to focus on beating back the court challenges.

Judge Berman, however, gave the SEC a chance to address the issue in his court before deciding the preliminary injunction motion: “The Court reserves judgment on Plaintiffs application for a preliminary injunction and/or imposition of such an injunction for 7 days from the date hereof to allow the SEC the opportunity to notify the Court of its intention to cure any violation of the Appointments Clause.  The parties are directed not to proceed with Duka’ s SEC proceeding in the interim.”  Slip op. at 6.

The SEC is unlikely to change course in response to this invitation (which also came up previously with him in the course of oral argument).  Judge Berman’s decision. however, adds fuel to the fire.  It seems unlikely that the issue will be resolved until it gets through the appellate courts, and possibly the Supreme Court.  That’s a long time to wait and see whether judges current adjudicating SEC administrative cases are doing so lawfully.  It also creates a risk that adjudicative decisions made in the interim may have to be vacated in the future if the appointment of these ALJs is ultimately found invalid.  There could be a better, less wasteful, and less risky approach if the SEC would address the issue as a problem to be solved rather than a challenge to be rebuffed.

Straight Arrow

August 3, 2105

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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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SEC Says It Will Appeal Hill v. SEC Decision, Seek To Stay the Case, and Try To Prevent Discovery

An SEC June 15, 2015 filing in Hill v. SEC, No. 15-cv-1801 (N.D. Ga.), informed Judge Leigh Martin May that the Commission will appeal her June 8 ruling that the administrative proceeding In the Matter of Charles L. Hill, Jr. violates the constitution because the appointment of the presiding administrative law judge, James Grimes, was unconstitutional.  See Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding.  The SEC also said it would seek a stay of the entire proceeding before Judge May, including any discovery the plaintiff intends to pursue as the Hill action moves beyond the preliminary injunction stage.  The SEC’s submission can be read here: SEC June 15 Filing in Hill v. SECThe submission on behalf of plaintiff Charles Hill can be read here: Hill June 15 Filing in Hill v. SEC.

These submissions were made in response to the portion of the June 8 ruling stating that the parties should “confer on a timetable for conducting discovery and briefing the remaining issues.”

Although Judge May’s preliminary injunction was narrowly drawn to halt only the single administrative action against Mr. Hill — and ALJ Grimes has since been appointed to preside over a new proceeding — the SEC still argues that the requirements for staying the Hill Order and litigation are satisfied.  The SEC wrote: “Defendant intends to appeal the preliminary injunction issued by this Court.  Defendant also intends to move to stay all proceedings in this Court pending appeal because the Eleventh Circuit’s ruling will have a significant impact on this case, and any further proceedings in this Court could prove largely superfluous and a waste of the parties’ and the Court’s resources.”  SEC Submission at 1-2.  Typically, however, the mere possibility of some wasted resources in the event of a reversal on appeal is insufficient to support a stay of proceedings.  Such a motion normally requires a showing that in the absence of a stay the status quo could be sufficiently altered that the moving party could suffer irreparable harm.  Because Judge May’s order does not go beyond the one proceeding, and the only harm to the SEC of the litigation going forward during the appeal would relate to discovery in the case itself, obtaining a stay should be an uphill battle.

Perhaps recognizing this, the SEC’s backup plan apparently is to slow play the Hill litigation.  It argued that if a stay is not issued, there is no urgency to resolve the matter.  Instead, the normal schedule for a civil action in the Northern District of Georgia should prevail: “There is no good cause for Plaintiff’s request that the parties begin discovery immediately.  First, this Court has already issued a preliminary injunction, and thus, there is no urgency for Plaintiff to proceed faster than the normal pace set by the Federal Rules and the Local Rules [under which] the government is entitled to have until July 20, 2015, to file its answer or other response to Plaintiff’s Amended Complaint.  There is no reason that the government should be deprived of the usual time that the Federal Rules provide for responding to the Amended Complaint nor that issues regarding whether discovery is warranted need to be resolved before the government has had that opportunity.  Moreover, under Local Rule 26.2(A), the discovery period does not commence until ‘thirty (30) days after the appearance of the first defendant by answer.'”  Id. at 2.

The SEC also said that plaintiff had not indicated the nature of discovery he intended to pursue, and argued that “no discovery is necessary because all of Plaintiff’s claims involve pure issues of law,” the “case can be resolved on dispositive motions without any factual development,” and “to the extent any facts are necessary, Plaintiff already has them in his possession.”  Id. at 2-3.  Accordingly, the SEC asks “that the Court should decide the case without permitting discovery.”  Id. at 3.

Plaintiff Charles Hill presented a different proposal.  After noting that counsel for the parties conferred “on multiple occasions” without reaching agreement on a proposed schedule, he proposed, without argument, simply that discovery begin “immediately,” end “90 days after Defendant files an answer, or, if Defendant files a Motion to Dismiss, 90 days after the Court denies the Motion to Dismiss,” and the deadline for motions for summary judgment be “30 days after the close of discovery.”  He presented no argument why the schedule should depart from local rules.

The best result probably lies somewhere between the two proposals.  The SEC’s notion that this should be treated as just another ordinary case seems a little tone-deaf, and strangely out of sync with the expectation that whatever the result, the Commission should want to avoid extending the period during which there is a cloud over its administrative proceedings.  It certainly seems in the public interest to expedite a case of this nature, and try to move quickly to a final result, while allowing the parties ample time to address complex issues.  On the other hand, it is the rare case that moves “immediately” to discovery when there is no pending deadline that causes the parties and the court to need to reach a quick result.  And the SEC has a point that the nature of discovery needed is unclear with respect to the appointments clause issue because the facts of ALJ Grimes’s appointment appear not to be in dispute.  (Although there could be a need for discovery or development of expert testimony on the equitable factors bearing on whether an injunction should issue, and, if so, what its scope should be.)  The same may not be true for the other Article II issue raised in the complaint — the alleged invalidity of the double layer of “for cause” protection for SEC ALJs against removal by the President — as to which Judge May’s opinion did not address the merits.  It is also not clear whether plaintiff will try to seek discovery on the two other theories in the complaint — the alleged improper delegation of legislative authority to SEC ALJs, and the denial of a 7th Amendment jury right — which Judge May found were not likely to succeed on the merits.

In any event, whether any discovery is appropriate, and if so what it would encompass, is not really a scheduling issue.  If the plaintiff wants to pursue discovery and the SEC objects, that dispute can be raised with the court.

The inability of the parties to reach a reasonable compromise on scheduling leaves it up to Judge May to decide what she believes is reasonable under these circumstances.  That probably should be something that allows the case to move forward expeditiously, but not quite at the breakneck pace Mr. Hill is suggesting.

In the meantime, as reported in Law 360 (SEC To Appeal District Judge’s Admin Court Injunction) the SEC informed Judge Richard Berman in a letter to the court in Duka v. SEC “that the agency has no plans to change the way it appoints its judges while it waits for the solicitor general to approve the appeal to the Eleventh Circuit it was not considering an effort to cure the appointments clause violation found by Judge May.”  The letter supports this position because “the SEC has over 100 litigated proceedings at various stages of the administrative process and the ALJ scheme has been in use for seven decades and is grounded in a highly-regulated competitive service system that Congress created for the selection, hiring and appointment of ALJs in the executive branch.”  That suggests that it may not be as straightforward as Judge May speculated that the appointments clause violation might be easily cured.

Straight Arrow

June 16, 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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