Vedder Thinking | Articles SEC Administrative Proceedings Under Constitutional Scrutiny
Since the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), the SEC has come under greater scrutiny and criticism regarding its use of administrative proceedings.
Criticism stems mainly from the perceived one-sided nature of administrative proceedings, and the Defense Bar, in particular, views administrative proceedings as “stacking the deck” in favor of the Commission. Specifically, this “home court” alternative to pursuing claims in federal district court creates significant disadvantages for defendants, including accelerated hearing schedules, the inapplicability of the Federal Rules of Civil Procedure and the Federal Rules of Evidence, limited pre-hearing discovery and the elimination of a jury trial.
Many critics have also questioned the constitutionality of the administrative proceedings. These constitutional challenges include due process and equal protection concerns as well as Article II violations. The SEC has had success in fending off these constitutional challenges, mainly by arguing that the district courts lack subject matter jurisdiction to hear the constitutional challenges raised by defendants because Congress granted exclusive authority to review orders entered in administrative proceedings to the U.S. Circuit Courts of Appeal. The Commission has been very successful in asserting this jurisdictional argument, until recently.
On June 8, 2015, a Georgia federal judge issued a preliminary injunction halting an administrative proceeding against a real estate developer accused of insider trading. In Hill v. SEC, Case No. 1:15- cv-01801 (N.D. Ga. June 8, 2015) (Hill Opinion), Judge Leigh Martin May enjoined the SEC from moving forward with the evidentiary hearing in the administrative proceedings that had been instituted against Charles L. Hill, Jr. on the grounds that his claim over the constitutionality of the administrative proceeding was likely to succeed on the merits.
Hill challenged the constitutionality of the administrative proceeding on three grounds: (i) the proceeding violates Article II of the Constitution because administrative law judges (ALJs) are protected by two layers of tenure; (ii) Congress’s delegation of authority to the SEC to pursue cases before ALJs violates the delegation doctrine under Article I of the Constitution; and (iii) the proceeding violated his Seventh Amendment right to a jury trial.1 He raised these constitutional challenges in the administrative proceeding, moving for summary disposition on all three grounds.2 The ALJ ruled that he did not have the authority to address the second and third issues raised by Hill and was doubtful that he had authority to address the first issue.3 Five days after the ALJ issued his decision, Hill filed his complaint, asking the district court to declare the administrative proceedings unconstitutional and to enjoin the administrative proceedings from moving forward.4
Hill's initial complaint raised the same three grounds asserted in the administrative proceeding, but he later amended his complaint to add a claim that the SEC's appointment of ALJs violated the Appointments Clause of Article II of the Constitution.5
The SEC first challenged the court's subject matter jurisdiction. Specifically, the SEC argued that, under 15 U.S.C. § 78y, judicial review of Hill's constitutional claims could come from the Court of Appeals only after the administrative proceeding had concluded and the SEC issued a final order in Hill's case.6 Judge May initially noted that the SEC's position was 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,"7 and 28 U.S.C. § 2201, which authorizes declaratory judgments.8 After a lengthy discussion, Judge May concluded that the district court did have jurisdiction over Hill's constitutional claims.
The court then went on to analyze each of Hill's constitutional challenges, finding merit to only one—Hill's claim that the SEC's appointment of ALJs violates the Appointments Clause of Article II of the Constitution. Hill specifically claimed that, under the Appointments Clause, "inferior officers" must be appointed by the President, a court of law or a department head.9 Hill contended that ALJs are inferior officers because they exercise "significant authority pursuant to the laws of the United States," while the SEC contended that ALJs are "mere employees" based upon their treatment by Congress and the fact that ALJs cannot issue final orders and do not have contempt power.10 Relying on Freytag v. Commissioner of Internal Revenue,11 Judge May held that ALJs are inferior officers.12 Specifically, Judge May found that ALJs exercise "significant authority," including the ability to take testimony, conduct trial, rule on the admissibility of evidence and issue sanctions.13 Judge May also dispensed with the SEC’s "mere employee" argument, finding that "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."14 As a result of her conclusion that ALJs are "inferior officers," Judge May found that the ALJ’s appointment in Hill’s administrative proceeding is "likely unconstitutional in violation of the Appointments Clause."15 She went on to note, however, that while "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 matters themselves, . . . the Appointments Clause guards Congressional encroachment on the Executive and 'preserves the Constitution’s structural integrity by preventing the diffusion of appointment power.'"16
Notably, Judge May's order preliminarily enjoins the SEC from "conducting the administrative proceeding brought against [Hill] . . . before an [ALJ] who has not been appointed by the head of the Department."17 This left open the question of whether the Hill Opinion has any real teeth to it.
The SEC intends to appeal Judge May's decision and is awaiting the solicitor general's approval to move forward with the appeal to the Eleventh Circuit. In a separate case brought by Lynn Tilton, the owner of the Patriarch Partners investment companies, a New York federal court judge ruled that Tilton cannot challenge the constitutionality of the SEC’s administrative proceedings against her in federal court.18 Tilton has since filed an appeal with the Second Circuit.
In May of this year, in response to growing criticism over its use of administrative proceedings, the SEC issued a memorandum entitled "Division of Enforcement Approach to Forum Selection in Contested Actions." The memo first states that the "Division recommends the forum that will best utilize the Commission's limited resources to carry out its mission." Although there is "no rigid formula dictating the choice of forum," the Division of Enforcement then laid out four overarching considerations that factor into its forum selection: (i) the availability of the desired claims, legal theories and forms of relief;
(ii) whether the charged party is a registered entity or an individual associated with a registered entity; (iii) the cost-, resource- and time- effectiveness of litigation in each forum; and (iv) the fair, consistent and effective resolution of securities law issues and matters.
Regardless of the outcome of the Hill case, one thing is clear—the SEC's use of administrative law proceedings is likely to foster a continued attack by the defense bar.
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1 See Hill Opinion p. 10.
5 Id. p. 11.
6 Id. p. 12.
7 28 U.S.C. § 1331.
8 Hill Opinion p. 12.
9 Id. p. 34.
10 Id. p. 36
11 501 U.S. 868 (1991).
12 Hill Opinion p. 36.
13 Id. p. 38.
14 Id. p. 41.
15 Id. p. 42.
16 Id. p. 44 (citing Freytag, 501 U.S. at 878).
17 Id. p. 44 (emphasis added).
18 The case is Tilton v. SEC, 1:15-cv-02472 (S.D.N.Y.).