A recent decision from the Seventh Circuit Court of Appeals highlights the ongoing debate regarding the Securities and Exchange Commission’s continued pursuit of administrative enforcement proceedings for securities violations. In Bebo v. SEC, a panel of the Seventh Circuit held that federal courts do not have jurisdiction to hear claims regarding the constitutionality of the SEC’s administrative hearing process and forum until all administrative remedies have been exhausted. The breadth and number of constitutional challenges raised by individuals subject to the SEC’s administrative process, however, signal that it may be time for the agency or Congress to make some changes.
In 2010, the Dodd-Frank Act provided the SEC with the option of pursuing internal administrative proceedings in lieu of filing an action in federal court in cases in which it sought monetary penalties. The agency embraced this option whole-heartedly. Securities fraud and insider trading cases, traditionally heard by federal district court judges, now routinely are brought before SEC administrative law judges (ALJs). These administrative proceedings are lopsided affairs which, not surprisingly, the SEC wins more than 90 percent of the time. When compared to the agency’s 69 percent success rate in federal court, there’s little wonder that the SEC prefers administrative proceedings.
Seeking to level the playing field, defendants subject to SEC administrative proceedings have sought judicial intervention by arguing that the SEC’s in-house process violates an individual’s constitutional right to due process or equal protection. Under the due process argument, defendants assert that they are injured by the significant procedural hurdles that exist in an administrative hearing – a defendant has no right to have a jury, the federal procedural rules which would allow a defendant to bring a motion to dismiss based on legal insufficiency of the pleadings do not apply, and a defendant has extremely limited discovery rights in comparison to the SEC’s opportunity to pursue documents and take witness testimony during its pre-complaint investigation. Defendants also have argued that the SEC uses its ability to opt between an in-house proceeding and a federal court case to single them out from other similarly situated defendants in violation of the equal protection clause.
Others have argued that the forum itself violates the Appointments Clause of Article II of the Constitution because the ALJs assigned to hear the cases are function as inferior “officers” of the executive branch because they exercise enforcement powers, some of which are not subject to review by SEC commissioners. Defendants have pursued two avenues of attack under the Appointments Clause. First, defendants have argued that because ALJs are career appointees who are removable only for good cause by SEC commissioners, who themselves only can be removed by the President for “inefficiency, neglect of duty or malfeasance of duty,” the ALJs are too far removed from the President in whom enforcement powers are vested and, therefore, the President’s constitutional obligation to ensure the faithful execution of the laws is contravened. This argument may strike some as ironic insofar as it is somewhat at odds with another objection: that ALJs are too connected and have no independence from the SEC, an agency of the executive branch.
The second argument based on the Appointments Clause asserts that in their function as “officers,” the ALJs are unconstitutionally appointed through a bureaucratic process rather than by the SEC commissioners. In response, the SEC has maintained that the ALJs are “agency employees” rather than “officers” covered by the Appointments Clause. According to a recent SEC filing, the hiring process for ALJs is overseen by the U.S. Office of Personnel Management (OPM) which administers the competitive examination for selecting all ALJs across the federal government.
Although the SEC has used this selection process to support its claim that the ALJs in fact are not executive branch officers under Article II, courts have disagreed. District courts in New York and Georgia have responded to the Appointments Clause arguments by freezing administrative proceedings on the grounds that the appointment of the ALJs was “likely unconstitutional.”
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In most cases, the SEC defends the myriad constitutional claims not on the merits, but by asserting that federal courts have no jurisdiction to hear the claims until a defendant has exhausted the agency’s hearing process – a process which generally moves at a snail-like pace. Data from 2014 revealsthat on average, the SEC’s administrative tribunals took 733 days to render opinions in enforcement cases. The Seventh Circuit agreed with the SEC’s position in Bebo, ruling that district courts have no jurisdiction to hear such constitutional claims outright. Buoyed by the Seventh Circuit’s decision, the SEC has since sought to use it to obtain the dismissal of cases currently pending in other federal courts of appeal.
To date, the SEC has been silent on the central issue of the fairness of administrative proceedings and the objectivity of the ALJs, despite the fact that courts have noted it would be a relatively “easy fix” for the SEC to change the way it appoints judges. Further, when encouraged to consider an expansion of a defendant’s discovery rights in such cases, the SEC’s director of enforcement responded that the changes “would significantly weaken the commission’s ability to protect investors through strong and effective enforcement of the federal securities laws.” Even though the constitutional issues raised by individuals facing ALJs ultimately are likely to be decided on the merits by the courts, the time already is ripe for the SEC to make substantive changes or, if not, for Congress to step in to mandate changes to the agency’s process that level the playing field for individual defendants.
From The Insider Blog: White Collar Defense & Securities Enforcement.