Tag Archives: Timbervest LLC

Division of Enforcement Continues To Refuse To Comply with SEC Orders in Timbervest Case

Two days ago, we wrote about the Division of Enforcement’s refusal to comply with an SEC adjudicative order in In the Matter of Timbervest, LLC.  Instead of complying with a Commission Order to supply information about the circumstances of the hiring of ALJs Brenda Murray and Cameron Elliot, the Division provided information that it deemed sufficient to address the Appointments Clause issue raised by the respondents.  Then, amazingly, the partial response the Division deigned to supply, based on what it decided was relevant, was wrong, which was learned when ALJ Elliot corrected the errors on the record in a different proceeding.  See SEC Bumbles Efforts To Figure Out How Its Own Administrative Law Judges Were Appointed.

Well, paraphrasing a former President’s famous one-liner: “There they go again!”

Yesterday, the Division made another filing in the Timbervest administrative proceeding that refused to comply with a Commission Order.  Instead, the Division again told the Commission that it really shouldn’t have asked for the submission it ordered, and declined to respond.  If there were any further evidence needed of the inherent unfairness of the administrative adjudicatory process to respondents, and the inability of the Commission to address fundamental constitutional issues under its own roof, this is it.  The Division would not dare thumb its nose in the face of a district court judge in this manner, even if it were really upset that it was being ordered to make submissions it really preferred not to make.  But here, Mr. Ceresney has no reason for concern because the “chief judge” he is facing — Mary Jo White — is his former law partner, and the person who appointed him head of the Enforcement Division.  Conflict of interest?  Perhaps not, technically.  But how fair would you think this adjudicative forum is if you were in Timbervest’s shoes on the other side of the “v.” from Mr. Ceresney when the Division was allowed to make its own decisions about the extent it would comply with Commission orders?

Here is what happened.  In response to a motion from the respondents, on May 27, 2015, the Commission, sitting in its capacity as adjudicator of the Timbervest enforcement action:

ORDERED that the parties shall file simultaneous supplemental briefs, not to exceed ten double-spaced pages, by July 1, 2015. The briefs shall be limited to the following two issues: (1) whether, assuming solely for the sake of argument that the Commission’s ALJs are “inferior officers” within the meaning of Article II, Section 2, Clause 2 of the Constitution, their manner of appointment violates the Appointments Clause; and (2) the appropriate remedy if such a violation is found.

The Order “assum[ed] solely for the sake of argument” that the Commission’s ALJs are ‘inferior officers'” under Article II, Section 2, Clause 2, and mandated short submissions on two specific points: (1) under that assumption, have the appointments of SEC ALJs violated the Appointments Clause, and (2) “if such a violation is found,” what should be the appropriate remedy?

The parties’ responses were filed yesterday.  The respondents’ submission can be read here: Brief of Respondents In Response to the Commission’s May 27, 2015 Order.  The Division of Enforcement’s submission, personally signed by Enforcement Director Andrew Ceresney, can be read here: Division of Enforcement’s Response to the Commission’s May 27 Order

The respondents submitted what the SEC ordered.  They laid out their argument why the appointment of the ALJ who presided over most of their proceeding violated the Appointments Clause, assuming he was indeed an “inferior officer” under that clause.  They then argued that the violation makes the proceeding and findings of the ALJ invalid, requiring that the Initial Decision be vacated.  If a new proceeding is to be commenced (which they argue is not in the public interest), it must be, they say, before an ALJ properly appointed under the Appointments Clause.

The Division, on the other hand, chose (again) not to submit what the Commission ordered.  The Division’s brief acknowledges that, based on the known circumstances of the appointment of SEC ALJs, if one assumes “for the sake of argument” that the SEC’s ALJs are “inferior officers,” their appointments did not comply with the Appointments Clause:

In response to the Commission’s first question, “assuming solely for the sake of argument that Commission ALJs” who presided over Respondents’ administrative hearing are “‘inferior officers’ within the meaning of Article II, Section 2, Clause 2 of the Constitution,” the Division believes that their manner of appointment would be inconsistent with the terms of the Appointments Clause.

SEC Brief at 1.

But on the second issue — the appropriate remedy in the event such a violation is found — the Division gave no response.  Instead, it argued (again) that SEC ALJs are mere employees, and that therefore no remedy is needed.  In short, the Division refused to comply with the SEC’s Order:

In response to the Commission’s second question, the Division strongly urges the Commission to refrain from fashioning a fix for a non-existent constitutional violation. Rather, and for the additional reasons explained below, the Commission should find that ALJ Elliot was hired in a manner consistent with Article II, Section 2, Clause 2 of the Constitution because he is an employee, and not a constitutional officer, and that there is therefore no Appointments Clause defect to remedy.

SEC Brief at 2.  Later in the submission, the Division says:

Because there is no constitutional violation under the Appointments Clause, there is no basis for a “remedy.”  If, however, the Commission holds that SEC ALJs are inferior officers and that their hiring violated the Appointments Clause because they were not hired with the approval of the Commissioners, the Division requests that it be permitted to submit additional briefing about components of any appropriate remedy, such as ratifying SEC ALJs’ prior hiring.  To be clear, the Division does not seek any remedy, including as an alternative measure, at this juncture.  Because of the potential ramifications of such a remedy [fn] and because Congress has set out a scheme, implemented by OPM, for the hiring of these employees, the Division believes that any Commission efforts to superimpose on this scheme a remedy to rectify a problem that does not exist is inadvisable at this time.

[fn]: Such a remedy is not only unnecessary but also fails to resolve the ongoing litigation before the Commission and in district courts around the country given the other constitutional claims raised in this case and others that would not be addressed by such action.  Further, it seems likely to prompt new issues in litigation, whether in this case or others.

SEC Brief at 5-6.

Not to belabor the point, but if the Division believed the submission it was ordered to make was inadvisable at this time, for tactical litigation reasons involving other cases or for whatever other cause, it should have asked for relief from the Order and allows the Commission to decide whether the Order should be revised.  Simply refusing to comply and asking for the right to address the issue later if necessary is contemptuous of the adjudicator (here, the Commission), and of the proceeding itself, which does not permit parties to dictate when they will and will not comply with the administrative court’s orders.

Straight Arrow

July 2, 2015

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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

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SEC Gambit To Avoid Judge May in Timbervest Case Seems To Have Failed

We previously wrote about the SEC’s desperate effort to avoid the assignment of Timbervest, LLC v. SEC, Civil Action No. 1:15-CV-2106 (N.D. Ga.), to District Judge Leigh Martin May.  See SEC, Desperate To Avoid Judge May, Challenges Related Case Designation in Timbervest Action and SEC Argues Common “Facts” Are Not Common “Issues of Fact” — I Kid You Not.  You recall that Judge May ruled in Hill v. SEC that the appointment of SEC ALJ James Grimes violated the appointments clause of Article II of the Constitution — see Court Issues Preliminary Injunction Halting Likely Unconstitutional SEC Proceeding.

Well, it appears that the SEC’s motion challenging the “related case” assignment of the Timbervest action to Judge May failed.  There is no order in the docket denying the motion, but a recent scheduling order issued by Judge May suggests she will continue to preside over the case.  See Timbervest v. SEC Scheduling Order.  In the Order, Judge May states that the SEC must respond to plaintiffs’ Motion for a Temporary Restraining Order and/or Preliminary Injunction by June 29, plaintiffs must file a reply brief by July 16, and “the parties will attend a hearing in this matter a hearing” on July 21, in Courtroom 2107.  Courtroom 2107 is listed in the N.D. Georgia directory as Judge May’s courtroom.

In the meantime, in the SEC administrative case brought against Gray Financial Group, In the Matter of Gray Financial Group, Inc. et al., File No. 3-16554, SEC ALJ Cameron Elliot declined to issue a stay of proceedings in response to an unopposed motion founded on the pending federal action for injunctive relief by Gray Financial in the same Georgia federal court, which was also assigned to Judge May.  He said: “Commission Rule of Practice 161 instructs that I ‘should adhere to a policy of strongly disfavoring’ stay requests unless ‘the requesting party makes a strong showing that the denial of the request or motion would substantially prejudice their case.’  17 C.F.R. § 201.161(b)(1).  Respondents have not made such a showing.  I will abide by an injunction if it is issued; however, as of now I have been instructed to resolve this proceeding within 300 days of service of the OIP.”  See Order Denying Unopposed Motion To Stay Administrative Proceeding Against Gray Financial Group.

So, chaos still reigns, and apparently the SEC is unsure about how best to bring it under control.  See SEC Rejects Easy Answers To Admin Court Challenges.  In that article, Law 360’s Stephanie Russell-Kraft reported on a discussion between Judge Richard Berman and a DOJ lawyer representing the SEC.  Judge Berman asked whether, in light of comments by Judge May that it might be easy to cure the appointments clause violation, the similar claims brought before him by Barbara Duka (in Duka v. SEC) could be resolved simply by having the Commission reappoint its current ALJs.  The DOJ lawyer declined to address whether that could be done, leading to the following colloquy:

“Is the commission opposed to an easy fix?” Judge Berman asked.

“The Department of Justice is very actively considering the best litigation approach to address this issue,” Lin answered.

“I’m asking you if [appointing the judges] would solve this issue,” Judge Berman pressed, pointing out that the case pending before him had nothing to do with the SEC’s litigation strategy.

“It’s not like if we pursue one of these options this case or other cases will go away,” Lin answered, adding that changing the way it appoints its judges is not a “meaningful way” to address Judge May’s decisions or a “practical way” for it to approach its long-standing administrative court scheme.

“The commission has to consider all the cases it has,” she said later, to which Judge Berman replied, “I don’t.”

Meanwhile, the SEC’s administrative proceeding against Laurie Bebo continues to be tried, even while the appeal of Ms. Bebo’s injunctive action moves forward in the Seventh Circuit.

The ship is plainly adrift.

Straight Arrow

June 23, 2015

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SEC 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

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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

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Briefing of ALJ Constitutionality Before SEC Leaves Resolution in Doubt

We discuss today the SEC’s pending consideration of a challenge to its administrative law process in In the Matter of Timbervest, LLC et al., File No. 3-15519.

Briefly, the case involved alleged violations of sections 206(1) and 206(2) of the Investment Advisors Act.  Timbervest is an Atlanta company that manages timber-related investments. The SEC alleged that in 2006 and 2007, company officers received unauthorized and undisclosed real estate commissions paid out of the pension plan assets of Timbervest’s largest client.  The SEC further alleges that in 2005-2006, Timbervest made an undisclosed and unauthorized sale of a timberland property from a fund holding that same client’s pension assets to another investment fund the firm managed.

The order instituting proceedings was issued in September 2013.  The administrative proceeding was tried before SEC Administrative Law Judge Cameron Elliot, who issued his Initial Decision in August 2014.  Mr. Elliot found 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 the respondents and the Division of Enforcement petitioned the SEC for review, and both petitions were granted.  In their ensuing filings, the respondents argued, among other things, that the administrative process was unconstitutional because SEC ALJs are executive officers who enjoy “two-tiered tenure protection,” although they dedicated only two paragraphs in their opening brief to this issue, and the Division of Enforcement responded with only one paragraph in its opposition brief.  In response, the Commission asked that the parties file supplemental briefs on that issue.

Those supplemental briefs have now been filed.  The Division of Enforcement’s supplemental brief is here, the respondents’ supplemental brief is here, and a supplemental notice of authority by the respondents is here.  The SEC recently scheduled oral argument on the case for June 8, 2015.  We know, of course, that the SEC is going to uphold the constitutionality of its own ALJs, so the result at this stage is not really in question.  But there will be an appeal to a court of appeals (either the D.C. Circuit or the Eleventh Circuit are possibilities), so it’s useful to see how convincingly the Division of Enforcement argued the constitutionality issue to the Commission.  By my measure, the arguments made are pretty weak, which still leaves to $64,000 Question: will a court of appeals or the Supreme Court really be willing to invalidate the SEC ALJ framework on the basis of this record?

The Division of Enforcement argued that “Commission administrative proceedings do not violate Article II of the Constitution” because “Commission ALJs are not constitutional officers – the only Court of Appeals to have considered the status of an agencys ALJs concluded they are employees, see Landry v. FDIC, 204 F.3d 1125, 1132-34 (D.C. Cir. 2002) – and therefore the removal framework applicable to them does not implicate Article II. And even if Commission ALJs were constitutional officers, the President exercises adequate control to satisfy the Constitution.”  Division Supplemental Br. at 1.

Let’s examine those arguments.

The Argument that “Commission ALJs Are Not Constitutional Officers”

The first argument – that the SEC ALJs are “employees” rather than “inferior officers” from a constitutional standpoint – seems particularly weak.  Perhaps if the SEC were writing on a blank slate this might be sustainable.  But it is not deciding this issue without controlling guidance.  There are a number of Supreme Court decisions out there that must be taken into account.  The Division’s brief does a poor job of addressing these binding precedents.

As we previously wrote (see Challenges to the Constitutionality of SEC Administrative Proceedings in Peixoto and Stilwell May Have Merit), the Supreme Court addressed similar issues in decisions in Freytag v. Commissioner, 501 U.S. 868 (1991), Weiss v. United States, 510 U.S. 163 (1994); Ryder v. United States, 515 U.S. 177 (1995); and Edmond v. United States, 520 U.S. 651 (1997).  Freytag ruled that special trial judges for the Tax Court were “inferior Officers” under the constitution, and not “employees” who assisted Tax Court judges in taking evidence and preparing a ruling – even though they lacked authority to render “final decisions” – because they exercised significant discretion in performing tasks like taking testimony, conducting trials, ruling on the admissibility of evidence, and deciding and ordering compliance with discovery orders.  Weiss noted that military judges were Officers of the United States because of their authority and responsibilities, but the issue was not contested by the parties.  Ryder ruled that that judges serving on the Coast Guard Court of Military Review were officers covered by the Appointments Clause, even though they were subject to review by a higher appellate court.  And Edmond explained that intermediate appellate military judges were not “principal officers,” because they were subordinate to a higher ranking officer below the President, were subject to oversight, and could not render final decisions, but plainly considered them to be “inferior officers.”

These cases negate many of the arguments made in the Division’s brief.  It mattered not that these other officials found to be executive officers were involved in a preliminary process; could not render final decisions; were subject to being reversed; served in an adjudicatory, rather than a “core executive” capacity; were subject to supervision by others; and even were “subordinate” to others.  All of the Division’s arguments that ALJs are “employees,” and not “executive officers” for those reasons simply cannot survive contrary Supreme Court precedent.

The invocation of the D.C. Circuit decision in Landry v. FDIC cannot change this.  In Landry, a split D.C. Circuit panel ruled that an FDIC ALJ was not an “inferior officer,” but was instead a mere “employee.”   The opinion questioned the usefulness of the Supreme Court’s guidance in Buckley v. Valeo, 424 U.S. 1, 126 n.162 (1976), that “any appointee exercising significant authority pursuant to the laws of the United States is an ‘Officer of the United States.’”  But the Buckley language was the starting point for the analysis of this issue in Freytag, in which the Court found dispositive the “significance of the duties and discretion that special trial judges possess.”  501 U.S. at 881.  The Landry majority argued that the critical difference between the special trial judges in the Tax Court and the FDIC ALJs was that FDIC ALJs only made “recommendations” to the FDIC, and thus could never issue final decisions.  Not only did that misread Freytag, which focused on the array of “significant” “duties and discretion” of the special trial judges, and not final decision-making powers, but it also ignored the discussions in Weiss, Ryder, and Edmonds, which made it plain that being a final decision-maker was not a decisive factor in determining whether someone is an “inferior officer.”

But even accepting the Landry majority opinion on its face, it provides little assistance to the Division because in some cases SEC ALJs do make “final decisions” like the special trial judges of the Tax Court.  The FDIC was required to review every ALJ “recommendation.”  But the SEC can, and does, decline to review ALJ decisions, and in those cases, it matters little to constitutional analysis that these decisions require a ministerial Commission order to make them formally “final” and appealable.  Moreover, the SEC does not, and cannot realistically, review an ALJ’s management and oversight of the administrative trial itself, during which many “final decisions” are made on important issues that determine the record the SEC can review.  And, of course, the approach taken by a court of appeals panel – and a split one at that – hardly trumps the guidance of the Supreme Court on how to go about determining whether a government official is an “inferior officer.”

The final nail in the coffin of the Division’s argument that the D.C. Circuit decided once and for all in Landry that ALJs are only agency “employees,” and not executive “officers,” is laid out in the Timbervest respondents’ brief.  They point out that the Government itself admitted this is not so.  To avoid a writ of certiorari in Landry, the Government represented to the Supreme Court that the Landry court did not decide that issue.  Here is what the Solicitor General said: “The court of appeals did not purport to establish any categorical rule that administrative law judges are employees rather than ‘inferior Officers.’ . . .” Timbervest Respondents’ Br. at 16 (quoting the U.S. Government brief in opposition to the petition for writ of certiorari).

The Division’s brief presents another argument that carries little water on the “inferior officer” versus “employee” issue: that Congress already decided that ALJs are just employees, not executive officers, by its “placement of the position within the competitive service system,” and the courts must defer to that decision by Congress.  That is wrong in two respects.  First, there is no indication that Congress made any such decision when it placed ALJs within the overall civil service system, and the Division cites no support for that contention.  Second, and far more importantly, it should be wrong that Congress has the power to decide when double-tenure protection can prevent the President from influencing government officials simply by designating those officials to be mere “employees.”  The whole point of the separation of powers doctrine is to assure that Congress may not deprive the President of his constitutional authority to execute the laws; it would be bizarre if Congress could grant executive powers to officials and then insulate them from the President’s influence by exercising Legislative muscle.  The best the Division could muster on this point was language in Justice Souter’s concurring opinion in Weiss suggesting “deference to the principal branches’ judgment is appropriate” (Divison Br. at 8, quoting 510 U.S. at 194), but that is a slim reed that cannot, I believe, be sustained without doing serious harm to the separation of powers concept.

Freytag and the other Supreme Court cases make it crystal clear that whether an executive official is an “inferior officer” depends on the “significance of the duties and discretion” that the official possesses, not a Congressional designation.  The Division simply cannot avoid the obvious similarity – and near congruence – of the “duties and discretion” of SEC ALJs in comparison to the special trial judges at issue in Freytag.  The Court, which was otherwise divided, unanimously viewed the special trial judges as “inferior officers” within the meaning of the Constitution based on their duties, discretion, and overall role in executive department proceedings, which showed that they exercised “significant authority pursuant to the laws of the United States.”  The SEC ALJs have, in reality, at least as great, and almost surely greater, authority and discretion in SEC administrative law enforcement proceedings, and no argument made by the Division in its brief shows otherwise.

The Argument that “Even if Commission ALJs Were Constitutional Officers, the President Exercises Adequate Control To Satisfy the Constitution”

The Division’s argument that the President has adequate control over SEC ALJs faces only one major obstacle: the Supreme Court’s decision in Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477 (2010).  There, the Court found that a double layer of “for cause” protection for executive officers from removal by the President was constitutionally unacceptable.  The Division’s task is to identify differences that justify allowing double “for cause” protection for SEC ALJs despite the Free Enterprise Fund decision.  The Division is assisted here by footnote 10 of the opinion, which said: “our holding does not address that subset of independent agency employees who serve as administrative law judges. . . .   And unlike members of the Board, many administrative law judges of course perform adjudicative rather than enforcement or policymaking functions.”  561 U.S. at 507 n.10.

As we saw above, the mere fact that the SEC ALJs “perform adjudicative . . . functions” is not enough under Supreme Court precedent to prevent them from being executive officers performing executive functions.  And on this front, it does not help the Division that the SEC ALJs plainly serve as key players in the SEC’s law enforcement function.

The Division makes the argument, correctly, that the separation of powers doctrine does not create a rigid, formal structure of Branches hermetically-sealed from one another.  The Supreme Court recognizes that there are gray areas, and in such cases it is appropriate to conduct a functional analysis of the extent to which a statutory framework truly impairs a Branch from performing its constitutional duties.  Perhaps the best example of that is the special prosecutor case, Morrison v. Olson, 487 U.S. 654 (1988), which adopted a multifactor test to determine whether the statute that limited Executive control over the special prosecutor was consistent with the separation of powers doctrine.  The Division appropriately quotes Morrison’s statement that interference with removal of the special prosecutor can be acceptable if it does not “interfere with the President’s exercise of the ‘executive power’” or the duty to “take care that the laws be faithfully executed.”  Division Br. at 14 (quoting 487 U.S. at 689-90).

The Division’s brief goes on to draw distinctions between the PCAOB and the SEC’s administrative law judges, mostly by focusing on the PCAOB’s broader role in policymaking, as well as arguing that the PCAOB exercises power more independently than the ALJs.  Whether these are distinctions of constitutional dimension is not apparent, however, since in the realm in which the ALJs function, they have a high degree of independent control over a key law enforcement function, and the constitutional importance of whether they do or do not make policy (as opposed to performing other executive functions) is by no means clear.  But the point is sufficiently made that the analogy between the PCAOB and the ALJs is not so close that it is, in and of itself, compelling (as compared to the analogy of ALJs to the special trial judges in Freytag, which is so close that it is compelling).

Having made a credible showing that the unconstitutionality of the SEC ALJs does not follow inexorably from the Free Enterprise Fund decision, the Division turned to the argument that double insulation of the ALJs from Presidential removal does not significantly impair the President’s executive powers.  The Division makes five arguments.  Four of them are less than compelling; one is downright embarrassing.

First, the Division argues that the Commission decides when the ALJs get to decide cases, and the Commission has only one layer of “for cause” removal protection.  That formalistic argument would seem to carry little weight as part of a functional analysis, however.  From a realistic, functional standpoint, the Commission does – and in reality must – utilize the ALJs to do its enforcement work because it could not handle the workload without them. Put another way, the creation of the ALJs allows the Commission to expand its enforcement activity exponentially, and fueling that expansion with executive officers who cannot be influenced by the President has a real, functional effect on the President’s ability to execute the laws.

Second, the Division argues that “the functions that the Commission has assigned to its ALJs are limited in scope and do not rise to the level of core executive authority.”  Division Br. at 18.  This argument is, in essence, that because ALJs only adjudicate cases, and do not “make policy,” their activities do not significantly impair the President’s execution of the laws.  As the Division says: SEC ALJ adjudications “involve the application of the law to a discrete set of facts in individual cases.”  Id.  I see two problems with this argument. One, it runs headlong into the Supreme Court decisions (discussed above) that either hold, or assume, that officials performing adjudicative roles within an executive function are important facets of the President’s duty to oversee the faithful execution of the laws.  Two, overseeing individual prosecutions, finding facts in those cases, weighing the importance and implications of those facts under the law, and determining whether there are violations, and what remedies should be imposed if there are, are arguably the essence of “core executive authority” because law enforcement prosecutions are a core executive function.

Third, the Division argues that the President can “exercise constitutionally adequate control” over ALJ decisions because “the Commission retains ultimate authority over administrative proceedings” and “exercises sufficient control over SEC ALJs regardless of the limittations placed upon their removal.”  Division Br. at 19.  This is essentially a rehash of earlier points, and runs into the reality, and the buzzsaw of prior Supreme Court decisions, that adjudicators do, in fact, make essentially non-reviewable discretionary decisions that control how a case is presented to the Commission.  They mold the record the Commission gets to review, and that power substantially impacts – or certainly can substantially impact – the Commission’s substantive review powers.

Fourth, the Division argues that the double-tenure protection accorded to SEC ALJs is less extreme than the protection provided to the PCAOB members.  Id.  This is largely a one-paragraph throw-away point, as the Division makes no effort to explain how the difference it argues has a functional impact on Presidential control.

Fifth, “the Executive Branch’s use of tenure-protected ALJs for nearly seventy years establishes a gloss on the Constitution that supports the current removal framework.” Division Br. at 20.  The Division would have been better off leaving this out.  The SEC cannot seriously find that the structure of its administrative enforcement process should be deemed constitutional simply because it has been around for a long time.  The argument is revealing, however, because it reflects what the SEC staff – and probably the SEC itself – really thinks.  They could have written the point more eloquently if they said what they meant (paraphrasing the famous line in Treasure of the Sierra Madre): “Constitutional authority?  We don’t need no stinking constitutional authority.”

[The actual line in the movie is: “Badges?  We ain’t got no badges.  We don’t need no badges.  I don’t have to show you any stinkin’ badges!”  And, as a diversion, enjoy this clip, this one from Blazing Saddles, and this montage.]

Humphrey Bogart in Treasure of the Sierra Madre

Humphrey Bogart in Treasure of the Sierra Madre

Alfonso Bedoya as

Alfonso Bedoya as “Gold Hat” in Treasure of the Sierra Madre — He don’t need no stinkin’ badges.

Seriously, though, the Division’s discussion of why the double-tenure protection of ALJs does not significantly impair the President’s ability to control SEC administrative law enforcement decisions is light on focused analysis of the nature of those law enforcement decisions, the respects in which the Chief Executive may have an interest in influencing those decisions, and the ways in which he can achieve those goals notwithstanding the double-tenure protection.  That is the kind of functional analysis called for by Morrison v. Olson, and the Division brief fails to address those key issues.

Based on reviewing these briefs, this continues to be a close call. The hydraulics are in the Division’s favor – certainly before the Commission, but also before an ultimate court of appeals, which will stretch mightily to avoid undercutting the SEC ALJ framework, and presumably other similar independent agency administrative enforcement frameworks (executive agencies, however, would not present the double-tenure protection issue).

Straight Arrow

May 6, 2015

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