Tag Archives: subject matter jurisdiction

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:

Advertisements

SEC Wins First Skirmish on Constitutional Challenge to Chau Administrative Proceeding

On December 11, 2014, Judge Lewis Kaplan ruled that his court lacked jurisdiction to consider Wing Chau’s injunctive action to prevent an SEC administrative prosecution against him on due process and equal protection grounds.  Although the ruling was narrowly confined to the jurisdiction issue, it nevertheless was a significant victory for the Commission.

In October 2013, the SEC commenced an administrative proceeding against Chau and his firm, Harding Advisory, alleging misrepresentations in connection with the sale of collateralized debt obligations (“CDOs”) that imploded during the housing/mortgage crisis.  The allegations essentially charged that Chau and Harding misrepresented the nature of the process for selecting assets that went into the CDOs.  After seeking to work within the administrative process to get the kinds of discovery and preparation time that typically would be available if the action were brought in federal court, Chau and Harding commenced a federal action in the Southern District of New York to stop the administrative proceeding.  They asserted in their complaint (which can be reviewed here: Wing Chau v. SEC), that the SEC administrative action violated due process because it did not allow a fair defense to be developed, and denied equal protection of the law because they were singled out for administrative prosecution when similar actions against other persons were brought in federal court (and two of three were lost by the SEC).

The court had previously denied a temporary restraining order and the administrative trial went forward and was concluded.  The parties are awaiting an ALJ determination.

The threshold issue was whether such an action was permissible — whether the district court had jurisdiction to hear a claim to preempt the administrative action.  Applying the standards set forth in Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994), Judge Kaplan ruled there was no jurisdiction because (1) the plaintiffs could get meaningful judicial review in an appeal of the administrative action, (2) the claimed constitutional violations were not wholly collateral to the issues to be decided in the administrative action, and (3) the consideration of due process and equal protection claims were not outside of the SEC’s “expertise.”  A copy of the opinion can be found here: Chau v SEC Opinion.

The court found it significant that the due process claim “has been that the SEC’s procedural rules . . . are unfair in light of ‘facts and circumstances of [their] case'” and not that “the SEC’s rules are unconstitutional in every instance.”  Slip op. at 18-19.  The numerous grounds asserted to show that the respondents had been prevented from presenting a fair defense did not provide jurisdiction because they “all . . . are inextricably intertwined with [the] ongoing administrative proceeding and can be reviewed by a court of appeals.”  Id. at 20.  And because the challenges involve the day-to-day conduct of the proceeding, the due process arguments are not “wholly collateral” to the proceeding under Thunder Basin.  Id.  Finally, “plaintiffs fail to articulate any convincing reason why the SEC lacks the competence to consider the fairness of proceedings before its ALJs.”  Id. at 22.  The issue is the fairness of a particular hearing, not a determination that one of the SEC’s “constituent parts is unconstitutional,” and the “SEC is well equipped to evaluate claims of unfairness in proceedings before its ALJs — and if it fails to do so, the courts of appeals stand ready to correct the error.”  Id. at 22-23.

The equal protection claim yielded the same result.  Although a sister court found jurisdiction for such a claim in Gupta v. SEC, 796 F. Supp.2d 503 (S.D.N.Y. 2011), Judge Kaplan was not convinced to follow that decision.  He found the Gupta allegations of discriminatory conduct stronger, but also did “not find Gupta‘s application fo the Thunder Basin factors persuasive in these circumstances.”  Slip op. at 25.  In essence, he disagrees with the reasoning in Gupta and relied on modestly different facts to rule the other way.  He again also found no basis to conclude that the equal protection claim is outside of the SEC’s “expertise.”  But he did so with a circular argument.  He acknowledged that adjudicating such claims “is ‘not peculiarly within the SEC’s competence,'” but without addressing why equal protection analysis was within the SEC’s competence, stated that the SEC’s attempt to address the equal protection issues in an attempted interlocutory appeal from an ALJ decision “indicate that the SEC is competent to consider plaintiff’s constitutional claims.”  Id. at 31-32. 

At the end of the opinion, the judge noted that plaintiffs’ challenge “[t]aken to its logical conclusion . . . would upend all manner of administrative enforcement schemes.”  Id. at 32. He concluded that because “the normal channels of statutory review are adequate” his court lacked subject matter jurisdiction.

In an epilogue, Judge Kaplan took note that “the growth of administrative adjudication, especially in preference to adjudication by Article III courts and perhaps particularly in the field of securities regulation, troubles some.”  Id. at 34.  He singled out concerns that this approach could “increase the role of the Commission in interpreting the securities laws to the detriment or exclusion of the long standing interpretive role of the courts.”  This is a concern that has been raised by federal district judge Jed Rakoff (see here).  He also mentions concern that such SEC determinations might be accorded “broad Chevron deference to SEC interpretations of the securities laws in the determination of administrative proceedings.”  Id. at 34-35.  Concern about the proper scope of Chevron deference to SEC statutory interpretations was noted recently by Justice Scalia (see here).

Judge Kaplan said “[t]hese concerns are legitimate, whether born of self-interest or of a personal assessment of whether the public interest would be served best by preserving the important interpretative role of Article III courts in construing the securities laws – a role courts have performed since 1933.”  “But they do not affect the result in this case. . . .  This Court’s role is a modest one” — to determine subject matter jurisdiction.  Id. at 35.  In reaching its conclusion, the court “has not considered any views concerning the proper or wise allocation of interpretive functions between the Commission and the courts,” which “are policy matters committed to the legislative and executive branches of government.”  Id. at 35-36.

The takeaway from this decision is limited.  Although the jurisdictional issue required some consideration of the merits of the constitutional claims, the due process and equal protection concerns raised by Chau and Harding plainly were left for another forum to decide.  The very different constitutional issues raised by the plaintiffs in Stilwell v. SEC and Peixoto v. SEC (see here), were not mentioned.  As to those cases, even as to subject matter jurisdiction the analysis would have to be very different because, unlike Chau, they do involve a fundamental challenge to the structure of SEC administrative proceedings, i.e., they do require a determination whether one of the SEC’s “constituent parts is unconstitutional.”  It would be difficult to argue that the structural issues raised about SEC administrative law judges in Stilwell and Peixoto are even arguably within the competence of the SEC to decide for itself.  (For an in depth discussion of the merits of those issues, see here.)

But there remains no doubt that this is an SEC victory that, at a minimum, delays consideration of some aspects of the propriety of shifting SEC enforcement actions to its own administrative courts (see posts on this issue here and here).

Straight Arrow

December 15, 2014

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