Tag Archives: Jarkesy

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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In Duka v. SEC, SDNY Judge Berman Finds SEC Administrative Law Enforcement Proceedings Constitutional in a Less than Compelling Opinion

Southern District of New York federal Judge Richard Berman yesterday decided that Barbara Duka, a former Standard & Poor’s employee charged with securities law violations by the SEC, cannot enjoin the SEC administrative enforcement action brought against her.  In doing so, Judge Berman rejected the argument that he lacked jurisdiction over the case, unlike two previous federal court judges.  See SEC Wins First Skirmish on Constitutional Challenge to Chau Administrative Proceeding, and Court Dismisses “Compelling and Meritorious” Bebo Constitutional Claims Solely on Jurisdictional Grounds.  As a result, he addressed the merits of Ms. Duka’s constitutional argument, finding the she was “unlikely to succeed on the merits” of that claim. Likely success on the merits of the claim is a requirement for granting the preliminary injunctive relief sought by Ms. Duka.  The opinion is available here: Order Denying Relief in Duka v. SEC.

Jurisdiction

Judge Berman rejected the jurisdictional argument accepted by two prior judges because, unlike them, he concluded that the relief sought by Ms. Duka could not be satisfied within the administrative adjudication process, the challenge made addressed not the substance of the claims against her but the very suitability of the forum to adjudicate those claims, and the constitutional issue fell outside of the SEC’s area of expertise.

On the availability of a remedy, here is what the court said:

The Court concludes that the absence of subject matter jurisdiction “could foreclose all meaningful judicial review” of Plaintiff’s claim. . . .  The Court of Appeals obviously would not be able, upon appellate review of any final SEC order, to enjoin the SEC from conducting the Administrative Proceeding, as Duka asks this Court to do.  And, while the Court of Appeals could, presumably, vacate an adverse decision (order) by the SEC on constitutional grounds, it would be unable to remedy the harm alleged by Plaintiff in this Court, i.e., the “substantial litigation and resource burdens incurred during [the] administrative proceeding,” and the “reputational harm” associated with her defending the Administrative Proceeding. . . .

Plaintiff is not here challenging the outcome of her Administrative Proceeding or any order(s) issued by the SEC.  Rather, Plaintiff seeks to enjoin the proceeding itself, and the (injunctive and declaratory) relief she seeks is to prevent the Administrative Proceeding from occurring in the first place. . . .  If Plaintiff were required, as the Government urges, to await the completion of the Administrative Proceeding to seek (any) judicial intervention, important remedies could be foreclosed.  That is, her claim for injunctive and declaratory relief would likely be moot at that stage because the allegedly unconstitutional Administrative Proceeding would have already taken place. Simply put, there would be no proceeding to enjoin. . . .

Slip op. at 10-12 (cites and footnotes omitted).

And this on whether the relief sought was collateral to the substance of the underlying proceeding, or an appropriate part of that proceeding:

The Court concludes that Plaintiff’s claim for injunctive and declaratory relief is “wholly collateral” to “any Commission orders or rules from which review might be sought” in the Court of Appeals. . . .  In Free Enterprise, the Supreme Court found that the petitioners’ Article II claim was collateral because “petitioners object[ed] to the Board’s existence, not to any of its auditing standards.”. . .  Similarly, Duka contends that her Administrative Proceeding may not constitutionally take place, and she does not attack any order that may be issued in her Administrative Proceeding relating to “the outcome of the SEC action.”  Chau [v. SEC], 2014 WL 6984236, at *13; see Gupta [v. SEC], 796 F. Supp. 2d at 513 (where plaintiff “would state a claim even if [he] were entirely guilty of the charges made against him . . . .”).

Unlike the plaintiffs in Chau, Duka does not assert an “as-applied” challenge to agency action “in light of the facts of a specific case.”  Chau, 2014 WL 6984236, at *6.  Rather, she contends that Administrative Proceedings are “unconstitutional in all instances—a facial challenge.”  Id.  As Judge Kaplan noted in Chau, “courts are more likely to sustain preenforcement jurisdiction over broad facial and systematic challenges.” Id. (internal quotation marks omitted).

Slip op. at 12-13.

On the issue of the SEC’s expertise to decide the constitutional issue, Judge Berman wrote:

Without in any way diminishing ALJ Elliot’s exceptional legal background, the Court concludes that the constitutional claim posed in this injunctive/declaratory judgment case is outside the SEC’s expertise.  This aspect of executive agency practice is governed by clear Supreme Court precedent.  See Thunder Basin [Coal Co. v. Reich], 510 U.S. at 215 (“[A]djudication of the constitutionality of congressional enactments has generally been thought beyond the jurisdiction of administrative agencies.”); see also Free Enterprise [Fund v. Pub. Co. Accounting Oversight Bd.], 561 U.S. at 491 (“Petitioners’ constitutional claims are also outside the Commission’s competence and expertise . . . .  [T]he statutory questions involved do not require ‘technical considerations of [agency] policy’. . . .  They are instead standard questions of administrative law, which the courts are at no disadvantage in answering.”).

Slip op. at 14.

Likelihood of Success on the Merits

When he turned to the merits of the constitutional issue, Judge Berman was unwilling to apply the Supreme Court’s Free Enterprise Fund decision to the SEC’s administrative law judges. Not, however, because he doubted that SEC ALJ’s are “inferior officers” of the Executive Branch in constitutional terms.  He did not decide that issue, because he said it was unnecessary, but plainly viewed prior Supreme Court precedent regarding Tax Court special trial judges in Freytag v. Commissioner likely to be determinative: “The 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. See Freytag, 501 U.S. at 881–82 (“[S]pecial trial judges perform more than ministerial tasks. They take testimony, conduct trials, rule on the admissibility of evidence, and have the power to enforce compliance with discovery orders. In the course of carrying out these important functions, the special trial judges exercise significant discretion.”).  Slip op. at 16.  As noted, however, Judge Berman decided he “need not resolve that issue.”  Id.

That is because he reasoned that even if the SEC’s ALJ’s are inferior officers, the double-layer of removal protection they are accorded by statute does not undermine the President’s Executive power.  He noted that the Free Enterprise Fund Court “specifically excluded ALJs from the reach of its holding,” and rejected Ms. Duka’s argument that Free Enterprise Fund established a “categorical rule” forbidding two levels of “good cause” tenure protection.  Slip op. at 17.

Instead, Judge Berman created “a functional test to determine whether and when statutory limitations on the President’s power to remove executive officers violate Article II” based on other Supreme Court precedent.  He relied on the Supreme Court’s special prosecutor case, Morrison v. Olson, 487 U.S. 654 (1988), to argue for a test focused on whether Congress “interfere[d] with the President’s exercise of the ‘executive power’ under Article II” (quoting Morrison, 487 U.S. at 689-90). Although Free Enterprise Fund had no similar language regarding the double-layer of removal protection, Judge Berman argued that the Free Enterprise Fund decision “likewise focused upon whether the statutory restrictions on removal of PCAOB members were so structured as to infringe the President’s constitutional authority by ‘depriv[ing] the President of adequate control over the Board.’ Free Enterprise, 561 U.S. at 508.”  Slip op. at 17-18.

Judge Berman went on to reason “that congressional restrictions upon the President’s ability to remove ‘quasi judicial’ agency adjudicators are unlikely to interfere with the President’s ability to perform his executive duties.”  He argued that SEC ALJs exercise adjudicative power rather than executive power, and therefore the limits on removal of ALJs do not interfere with the President’s exercise of executive power.  He contrasted the Free Enterprise Fund case, which involved a subordinate entity of the SEC that “determines the policy and enforces the laws of the United States.”  Slip op. at 19-20.  In contrast, he said: “SEC ALJs perform solely adjudicatory functions, and are not engaged in policymaking or enforcement.”  Id. at 20.  As a result, “[t]he challenged (good cause) limitations upon the removal of an SEC ALJ will in no way ‘impede the President’s ability to perform his constitutional duty.’  Morrison, 487 U.S. at 691.”

Indeed, he argues that if the President could dismiss ALJ’s without cause, that would “undermine” the agency adjudication process, citing an article by Elena Kagan, written before she became a Supreme Court justice. Slip op. at 21.

How Good Is the Opinion, and How Influential Might It Be

Having elided the issue of whether the SEC ALJs are “inferior officers,” the opinion strikes me as somewhat superficial and relatively weak effort at resolving the constitutional issues that arise if they are, indeed, officers in the Executive Branch.  Judge Berman dispenses with this issue in a mere 4-1/2 double-spaced pages. His treatments of the Supreme Court decisions in Morrison v. Olson, Wiener v. United States, and the grandfather of them all, Humphrey’s Executor v. United States, are largely superficial.  In Judge Berman’s view, the fact that ALJ’s perform their executive duties as part of an adjudicative process insulates them from the need for control or influence by the Chief Executive.  He makes no real effort to examine the constitutional consequences of exempting large numbers of Executive Department officers from the need for Presidential control, and fails even to address the conundrum of treating an Executive Department officer within a law enforcement agency as if he or she were just another judge.  The nuances of how to accord administrative judges the freedom to act as an independent judicial branch within a powerful law enforcement department of the Executive Branch are basically ignored.  In sum, the effort lacks the depth and studiousness of an opinion likely to persuade appellate courts, and possibly other district courts as well.  It may well be that a proper, complete, and thorough argument along these lines can be made, but it is not reflected in this opinion.

Judge Berman effectively creates an adjudicative exception to the need for Presidential control over “inferior officers” involved in an adjudicative process within the Executive Branch. That is, essentially, formed out of whole cloth.  His core argument — “that congressional restrictions upon the President’s ability to remove ‘quasi judicial’ agency adjudicators are unlikely to interfere with the President’s ability to perform his executive duties” — is pure ipse dixit.  Short references to Humphrey’s Executor, Wiener, and Morrison, none of which involved facts and circumstances even vaguely like this case, hardly suffice to justify such a broad-reaching conclusion.  Many of the Supreme Court decisions addressing the role of the Executive in non-Article III courts are not examined, or even mentioned. Included among these is the separation of powers discussion in Freytag v. Commissioner, which Judge Berman acknowledged in the first part of his opinion and ignored thereafter (Freytag has an extensive discussion of the separation of powers implications of performing adjudicative functions outside in non-Article III courts).  Since Free Enterprise Fund plainly treats the SEC as an Executive Department, and there is abundant case law addressing the constitutional treatment of non-Article III courts, an in-depth analysis of those cases would seem necessary before reaching Judge Berman’s conclusions. I haven’t delved into those cases any more than he does (which is to say, not at all), but I’m certain that a reasoned resolution of the issue requires a lot more spade work than I see reflected in Judge Berman’s four pages on the issue.

Judge Berman’s decision also proceeds on the assumption that it is not important – and, indeed, could be harmful – for the President to be able to exercise authority over officials within the Executive Branch who perform adjudicative-like functions. That fails totally to consider the context in which the SEC ALJs function.  Judge Berman seems to think all ALJs perform the same kind of function, and none of them do things the Chief Executive cares much about.  But some ALJs, like those in the SEC, are critical cogs in a law enforcement process addressing large portions of the Nation’s economic and financial infrastructure.  They play a critical role in an Executive process to enforce the law, and exercise considerable discretion in doing so, without any direct supervisors.  The SEC’s enforcement actions already proceed with, at best, limited input from, or control by, the President. To the contrary, the SEC touts itself as being “independent” of the President.  If the SEC’s ALJs are, indeed, executive officers playing key roles in implementing a quintessentially executive function – the enforcement of the laws – why does the fact that ALJs follow an adjudicative-like process as part of that function mean they should be doubly insulated from Presidential influence? Judge Berman effectively postulates this as a necessary aspect of having an agency-based adjudicatory function, but the stated support for that – even if it is a law review article by Elena Kagan — is slim indeed, putting aside whether the very concept of an independent judiciary, functioning within an independent law enforcement agency, has any place in Articles I, II, or III of the Constitution.

There also is no mention or apparent consideration of potential Appointments Clause issues in this context. That may well be because Ms. Duka’s counsel never pressed those issues.  But if the SEC’s ALJs are officers of the Executive Branch, the Appointments Clause applies, and it is not at all clear whether the appointment process for SEC ALJs complies with that process.

Conclusion

To be sure, this decision represents a victory for the SEC in another battle in this campaign.  The loss on the jurisdiction issue is more than outweighed by the favorable ruling on the merits issue.  (Although it may encourage the DC Circuit to reach the merits of the constitutional issue in the recently-argued appeal in Jarkesy v. SEC).  The approach taken by the court does suggest that the SEC may not fare well in its arguments that its administrative law judges are not “inferior officers,” but the overall rejection of the Free Enterprise Fund double-insulation theory provides the groundwork for future SEC arguments on the merits in other courts.  One of those courts may take the time and make the effort to provide a more thorough consideration of the merits issue, but for now, count this as a significant, if not definitive, victory for the Commission.

Straight Arrow

April 16, 2015

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SEC To Hear Wide Range of Constitutional Challenges to Administrative Proceeding in Jarkesy Case

Having just escaped district court consideration of constitutional challenges to the SEC’s use of an administrative proceeding in the Chau/Harding Advisory case, the SEC will now review a number of similar challenges to its administrative adjudicatory process in In re Jarkesy, SEC File No. 15255.   The petition for review of respondents John Thomas Capital Management Group and George Jarkesy, which the Commission agreed to hear on December 11, 2014, will be the first opportunity for SEC consideration of a number of constitutional issues since the recent hubbub about the increased use of the administrative court for these kinds of cases.  A copy of the Petition for Review is available here: Jarkesy Petition for Review.

The issues raised in the petition are extensive.  They include:

  1. The administrative proceeding is invalid because the Commissioners issued findings of fact and conclusions of law in advance of the hearing.
  2. The administrative proceeding is invalid because the Commission exercises unguided discretion on the choice of forum for its prosecutions even when they do not involve subject matters outside of the conventional experience of Article III judges, which violates the separation of powers doctrine.  
  3. The decision to require respondents to defend themselves in the administrative court violated the equal protection clause because others similarly situated have not been required to do so and they were deprived them of a Seventh Amendment right to jury trial, which they contend is a fundamental right.
  4. The assignment of their case to the administrative court violates the equal protection clause under the “class of one” doctrine.
  5. The proceeding is invalid because ex parte communications between the Division of Enforcement and the Commission were permitted during the discussions of settlements with co-respondents, which violates due process rights to an impartial forum.
  6. The effective denial of rights under the doctrine of Brady v. Maryland because relevant documents were hidden in a 700gb “document dump” incapable of being reviewed violates due process.
  7. The refusal to allow respondents to create a record for review of violations of rights is itself a due process violation.
  8. The requirement that respondents defend themselves within a “truncated” time-period prevented discovery of relevant facts or the opportunity to prepare a defense, which violated due process rights.

Whether any of this stocks is another question entirely.  Of course, we can be virtually certain that the Commission itself will give these arguments short shrift.  But where the appeals court comes out may be another question.   That would be either the Court of Appeals for the D.C. Circuit, or, it would appear, the Fifth Circuit, since the respondents appear to be located in Texas.

Straight Arrow

December 15, 2014

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