Tag Archives: Elgin v. Dept. of Treasury

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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