Tag Archives: separation of powers

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

IF YOU LIKE WHAT WE ARE DOING HERE, PLEASE NOMINATE THE SECURITIES DIARY IN THE ABA LAW JOURNAL’S ANNUAL REVIEW OF THE BEST 100 LAW BLOGS.  WE GET NO MONEY FOR THIS, SO A LITTLE RECOGNITION WOULD BE NICE.  VOTES MUST BE IN BY AUGUST 16.  THIS IS THE LINK FOR VOTING:

ABA LAW JOURNAL LAW BLOG VOTE

Contact Straight Arrow privately here, or leave a public comment below:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Jimmy Breslin - The Gang That Couldn't Shoot Straight

Jimmy Breslin – The Gang That Couldn’t Shoot Straight

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

I won’t hold my breath.

Straight Arrow

June 30, 2015

Contact Straight Arrow privately here, or leave a public comment below:

SEC Argues Common “Facts” Are Not Common “Issues of Fact” — I Kid You Not

Yesterday, we described the SEC’s desperate attempt to nullify the assignment of the case Timbervest, LLC v. SEC to Judge Leigh Martin May.  That was based on the argument that the other cases already before Judge May identified as “related cases,” Hill v. SEC and Gray Financial Group v. SEC, were not actually “related cases” because “the cases do not ‘involve the same issue of fact,’” and they “do not arise out of the same event or transaction.”  See SEC, Desperate To Avoid Judge May, Challenges Related Case Designation in Timbervest Action.  Timbervest argued this was wrong because “they all arise out of the same facts concerning how SEC administrative law judges (‘ALJs’) are hired and what authority and powers SEC ALJs possess,” and the factual differences in the underlying SEC allegations in each case have no bearing on the constitutional issues raised in the respective complaints in these actions.

Today, the SEC filed its response.  It can be read here: SEC reply in opposition to related case designation.  It acknowledges that the cases have some common “facts” but argues that common “facts” are not common “issues of fact.”  In the SEC’s words, “At best, Plaintiffs’ argument boils down to the contention that these cases involve some of the same ‘facts,’ rather than ‘issues of fact.’”  The SEC’s argument turns on the assertion, made without citation, that an “issue of fact” must be a “dispute of fact,” and because the SEC will not dispute the common “facts” in these cases, they cannot be considered “issues of fact” because they will be undisputed.  (“their arguments ignore the distinction between a mere ‘fact’ and an ‘issue of fact,’ i.e., a dispute of fact”).  The best the SEC can do to support this view is a cite to Black’s Law Dictionary, which is quoted as saying: “An ‘issue of fact’ is ‘[a] point supported by one party’s evidence and controverted by another’s.'”  I don’t have a copy of Black’s Law Dictionary handy, but I guarantee you this purported definition had nothing to do with the assignment of cases to district court judges.

I have to chuckle.  No wonder lawyers are not often trusted by ordinary folks.  They concoct these arguments whether they make sense or not.  What ordinary person out there would think that two paragraphs with identical facts would not have the same “issues of fact”?  In any case, that doesn’t really matter here because it is patently obvious that in the context at issue here — how to assign a newly-filed case — a court (actually, a clerk of court) cannot possibly apply the standard the SEC passionately espouses because there is no way to determine at that stage which “facts” will or will not be “disputed.”  At this stage, there is only one source that can be used to assign the case — the allegations in the complaint.  If the allegations in the complaint involve factual contentions that materially overlap the facts alleged in another pending case, then the “related case” designation should be appropriate.  Last I checked, no clerk of court sought input from the defendant in an action about what factual allegations would be disputed before making a “related case” assignment.  Got a cite for that, SEC?

I wonder whether, having made this cute argument, the SEC will argue against being judicially estopped from disputing any of the facts alleged in the complaint when it files its Answer.  SEC counsel has now represented there are no material “disputed” facts, right?

I also wonder what Judge May is thinking about all of these machinations conjured up by the SEC solely to avoid having her preside over the Timbervest complaint?  If she has a sense of humor, she’ll chuckle as well, and move on to the job of deciding whether the few important facts that differ between Timbervest v. SEC and Hill v. SEC — which involve the different status of the respective administrative actions when the complaints were filed — alters the jurisdictional analysis in her Hill opinion.

Straight Arrow

June 18, 2015

Contact Straight Arrow privately here, or leave a public comment below:

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

Contact Straight Arrow privately here, or leave a public comment below:

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

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

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

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

Straight Arrow

June 11, 2015

Contact Straight Arrow privately here, or leave a public comment below:

Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Slip op. at 44.

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

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

Straight Arrow

June 9, 2015

Contact Straight Arrow privately here, or leave a public comment below:

Former SEC Enforcement Leaders Urge SEC To Reform Administrative Enforcement Process

Two former high-level SEC enforcement officials took on the SEC today in the Wall Street Journal, addressing “how to rein in” the SEC’s move towards shifting enforcement actions from federal courts to the SEC’s own administrative courts.  See How To Rein in the SEC.  The two officials, one of the most highly regarded former Directors of the Division of Enforcement, William McLucas, and a recent SEC chief litigation counsel, Matthew Martens (both now partners at the WilmerHale law firm), note that “[a]dministrative proceedings involving litigation of independent agency enforcement actions have been part the regulatory landscape for decades,” and “it would be easy for the SEC to take comfort in both the court rulings to date and its own sincere belief that its proceedings are fair.”  But they argue that “legitimate questions loom regarding the agency’s authority to sit as prosecutor, judge and appellate tribunal on its own cases,” and “when those regulated by the SEC—a broad swath of the population—begin to view the exercise of governmental power as potentially unfair, there is a problem” because “Democratic self-governance requires that the governed be generally convinced of the system’s evenhandedness.”

They note that the “timing” of the decision “to move toward more in-house proceedings couldn’t have been worse” because it immediately followed several stinging federal court defeats, most notably the jury verdict in favor of Mark Cuban, who was prosecuted civilly by the SEC for alleged insider trading violations.  They gently observe that some could question the rationale of SEC officials for making an important policy change at this time to keep more cases away from the federal courts – and juries – when the authority to make such a move remained largely dormant until the SEC’s court losses started to proliferate.  They conclude: “One need not be a conspiracy theorist to wonder whether at least part of the SEC’s rationale was to avoid the federal courts. In government as in comedy, timing is everything.  And here the SEC’s timing raises serious questions about the agency’s move toward the in-house forum.”

The solution, they suggest, is for the SEC to “reclaim the high-ground in this debate and demonstrate the legitimacy of its in-house proceedings” by taking several steps:

  1. To develop “meaningful criteria for exercising its discretion to bring matters in-house,” meaning “objective criteria to guide the choice of forum” which would be determined only after considering “comments from interested parties, including the defense bar.”  This is an implicit swipe at the Division of Enforcement’s feckless attempt to describe a process for determining when to use its administrative courts, which commentators, including yours truly, universally saw as so vague and ridden with caveats that it served only as a transparent effort to justify the Commission’s continued unfettered discretion to decide where to commence its cases.  See Upon Further Review, SEC Memo on Use of Administrative Courts Was Indeed a Fumble.
  2. “[T]o modernize the rules of procedure governing its in-house proceedings,” which the SEC’s General Counsel recognized a year ago were antiquated.  They explain: “With cases now brought in-house that involve evidentiary records spanning millions of pages and testimony gathered over several years by the SEC’s enforcement staff, it is unfair to force a respondent to trial with, at most, 120 days to prepare.”  A respondent’s “limited ability to obtain documents needed for a defense, with no opportunity to depose witnesses like the SEC did during the often multiyear investigation leading to the charges, and with insufficient time to locate defense expert witnesses to respond to the SEC’s experts,” leave these proceedings “stacked in favor of the SEC.”  This only touches upon the many respects in which the Division of Enforcement has a huge advantage against respondents when prosecuting SEC cases on the administrative forum.  See Ceresney Presents Unconvincing Defense of Increased SEC Administrative Prosecutions.
  3. “SEC commissioners should avoid finding, on appeal, additional violations and imposing additional penalties beyond those assessed by the administrative law judges.”  Unlike the SEC itself, the ALJs who preside over the SEC’s in-house cases are independent government employees, have no role in authorizing the charges against defendants, and hear the evidence directly from the witnesses in the hearings. . . .  The commission, by contrast, is the same body that brought charges against the respondent,” and it “never hear[s] from witnesses themselves.”  That makes it “troubling” if the “commission, acting as an appellate body, [goes] further than the findings of the ALJ who conducted the hearing to find new violations and penalties.”

The authors conclude: “The Supreme Court has, for nearly 40 years, authorized federal agencies to use administrative proceedings to pursue enforcement cases.  But the agencies must use that power in judicious ways.  The SEC’s approach to administrative proceedings leaves something to be desired. It isn’t too late to fix that.”

These are not new points and new arguments.  Several commentators have raised these and other issues over the last year, and Andrew Ceresney, the Director of the Division of Enforcement, repeatedly responds by extolling the quality of the Emperor’s clothes . . . that is, insisting that the SEC is acting fairly, impartially, and in the public interest, and that its litigators have no material advantage over the defense in the SEC’s home court.  What is new here – or almost new (former Director of Enforcement George Canellos made similar comments recently — see SEC ex-enforcement chief calls for reforms to system of in-house judges) – is that respected former officials are telling Mr. Ceresney to open his eyes, get off his soap box, and work with the General Counsel and the Commission to fix what is a real problem.

One respect in which Messrs. McLucas and Martens give their former employer too much deference is their apparent acceptance of the view that it is settled law that the SEC can be lawfully empowered to bring enforcement actions in its administrative courts against persons the SEC does not oversee as a regulator.  There remain serious questions whether the powers granted by Congress to the SEC in the Dodd-Frank Act to commence such actions are constitutionally sustainable.

The “40 years” of Supreme Court authority for “federal agencies to use administrative proceedings to pursue enforcement cases” that the authors mention twice in their article is a judicial authority originally founded in the context of enforcement actions for the purpose of implementing and enforcing specific regulatory authority conferred on the agency.  Persons who engage in the regulated conduct effectively consent to resolve regulatory disputes in the agency’s forum of choice.  The Supreme Court has never approved the notion that Congress is empowered to transfer law enforcement prosecutions outside of those agency regulatory boundaries from Article III courts to administrative fora, which have no juries, and the decisions of which are reviewed by the agency itself.

Indeed, this issue is apparent from the Supreme Court’s most recent consideration of the exercise of judicial authority by non-Article III courts to decide common law disputes that arise in the course of bankruptcy proceedings.  In Wellness Int’l Network, Ltd., et al v. Sharif, 575 U.S. ___ (2015), the Court held that there is no violation of the separation of powers doctrine when a bankruptcy court, an Article I court, adjudicates claims normally required to be decided by Article III courts, as long as the parties mutual waive any objections to the use of the bankruptcy court for this purpose.  Even in that circumstance, Chief Justice Roberts vociferously objected to the decision, which he said allowed for the possibility of a piece-by-piece dismantling of exclusive Article III judicial powers.  And the recent Supreme Court case normally cited in support of allowing administrative courts jurisdiction over Article III cases and controversies itself also depended to a significant extent on the waiver of any objection to the proceeding.  See Commodity Futures Trading Comm’n v. Schor, 478 U. S. 833 (1986).

To be sure, the authors are correct that the SEC should – must – take compelling action to make its enforcement adjudication process fair, and to subject the exercise of discretion over the forum to be used for these cases to reasoned limits.  But even if this occurs, there remain serious due process, equal protection, jury, and separation of powers issues that may ultimately require this Dodd-Frank experiment with broadened administrative adjudication to be overturned.

Straight Arrow

June 3, 2015

Contact Straight Arrow privately here, or leave a public comment below: