Why it matters: It is time for another installment in our continuing "Wherefore Art Thou Due Process?" coverage into the ongoing constitutional challenges to the SEC's "in-house" administrative proceedings. September 2015 saw the D.C. Circuit in Jarkesy et al. v. SEC (following the Seventh Circuit's August 2015 decision in Bebo v. SEC) rule in favor of the SEC on lack of subject matter jurisdiction and exhaustion of administrative remedies grounds. District court rulings that went the other way—holding the proceedings "likely" unconstitutional—in the Southern District of New York (Duka v. SEC) and the Northern District of Georgia (Hill v. SEC and Gray Financial Group, Inc. v. SEC) are now before the Second Circuit and the Eleventh Circuit, respectively, on appeal, with a potential circuit split in the works. Moreover, there is no consensus on the issue within the Southern District of New York itself, where, in contrast to Duka, a district court recently dismissed the plaintiff's case in Tilton v. SEC and, like the D.C. Circuit in Jarkesy and the Seventh Circuit in Bebo, sided with the SEC in finding lack of subject matter jurisdiction and failure to exhaust administrative remedies. TheTilton case is also on appeal to the Second Circuit, and all eyes will be watching to see on which side of the issue the Second Circuit comes down. In addition, September 2015 saw the SEC propose new rules for its in-house administrative proceedings in a likely attempt to appease critics who argue that the proceedings lack due process, and forcefully reiterate its position by rejecting the plaintiffs' constitutional challenge inIn the Matter of Timbervest, LLC. Read on for the latest.
Detailed discussion: Two circuit courts, the D.C. Circuit and the Seventh Circuit, have now ruled that a defendant in an SEC administrative proceeding must first exhaust all administrative remedies before turning to the federal courts for help. The Second Circuit and the Eleventh Circuit are currently considering appeals from Southern District of New York (S.D.N.Y.) and Northern District of Georgia decisions, respectively, that found the opposite and ruled the proceedings "likely unconstitutional." The Second Circuit is also considering an appeal from an S.D.N.Y. case that, like the D.C. Circuit and the Seventh Circuit, ruled in favor of the SEC on lack of subject matter jurisdiction/exhaustion of remedies grounds. For its part, the SEC recently proposed new regulations to amend its Rules of Practice concerning how its administrative proceedings are run with respect to discovery and timing of hearings, among other things, in an apparent attempt to appease critics who question their constitutionality on due process grounds. Moreover, the SEC Commissioners handed down their opinion in In the Matter of Timbervest, LLC (on review from the administrative law judge's initial decision), in which they forcefully rejected the plaintiffs' constitutionality arguments. We previously covered all of this in our April newsletter under "Wherefore Art Thou Due Process? SEC Administrative Hearings Under Attack," our June newsletter under "Wherefore Art Thou Due Process?: The Sequel" and in our August newsletter under "Keeping an Eye Out—Updates and Briefly Noted." We update you on the latest developments here.
D.C. and Seventh Circuit Opinions: On September 29, 2015 in the case of Jarkesy et al. v. SEC, in a unanimous opinion written by Judge Srinivasan, the D.C. Circuit affirmed the district court's dismissal of the case for lack of subject matter jurisdiction and held that "the securities laws provide an exclusive avenue for judicial review that Jarkesy may not bypass by filing suit in district court." Briefly, the relevant facts of the case are that the SEC initiated administrative proceedings against the defendant George Jarkesy, Jr. (Jarkesy) and the unregistered investment adviser company he managed, Patriot28, LLC (collectively, Jarkesy or plaintiffs), in March 2013 alleging that they engaged in fraudulent conduct in violation of the securities laws. On January 29, 2014, a few days before the administrative proceedings were scheduled to start, the plaintiffs filed an action in D.C. district court seeking injunctive and declaratory relief that the SEC's administrative proceedings violated their "fundamental constitutional rights" to due process and equal protection, among other claims. The district court denied the plaintiffs' request for injunctive relief, and the administrative proceeding went forward, resulting in the administrative law judge (ALJ) adversely ruling against the plaintiffs in October 2014. A petition for appeal before the SEC is pending. Further, the district court dismissed the case for lack of subject matter jurisdiction, finding that the "'statutory and regulatory regime under which the SEC's Enforcement Division brought the instant matter against the plaintiffs preclude[d]' the court from hearing their claims" and that they would have to exhaust their administrative remedies under that regime prior to seeking redress in federal court.
On appeal, the Court framed the issue before it as "whether the district court has jurisdiction over all, or any, of Jarkesy's claims, or whether Congress has implicitly precluded Jarkesy's district-court suit by channeling his challenges through the securities laws' scheme of administrative adjudication and judicial review in a court of appeals." The Court concluded that the district court did not have such jurisdiction in the face of the statutory scheme put in place by Congress, stating that "[t]he securities laws contain a … comprehensive structure for the adjudication of securities violations in administrative proceedings." Addressing and distinguishing or rejecting Jarkesy's constitutional and procedural arguments one by one, the Court stated that "none [of the arguments] dissuades us from our initial conclusion that Congress has implicitly precluded the district court's jurisdiction over cases of this type. Quite the contrary. The rationale underlying Congress's decision to create statutory schemes like the one before us is that 'coherence and economy are best served if all suits pertaining to designated agency decisions are segregated in particular courts'—here, in a court of appeals after a final Commission decision."
The Court noted that its ruling was "one of a growing number of decisions to address the same question," citing the "divergent conclusions" on the issue recently reached by district courts in the S.D.N.Y. and the Northern District of Georgia (citing in a footnote to theDuka and Hill cases, among others). The Court chose, however, to follow the decision recently reached by the Seventh Circuit on August 24, 2015 in Bebo v. SEC (discussed below), stating that its fellow circuit had "found no district-court jurisdiction . . . and we reach the same conclusion for many of the same reasons." The Court concluded that "[a]s the recent slew of cases demonstrates, Jarkesy's case is hardly unique. Many respondents in SEC proceedings join substantive defenses to their securities charges together with challenges to the Commission's actions or authority. It makes good sense to consolidate all of each respondent's issues before one court for review, and only after an adverse Commission order makes that review necessary. By contrast, a system like the one Jarkesy envisions—where respondents '"jump the gun" by going directly to the district court to develop their case' instead of seeing agency proceedings through to conclusion … has comparatively little merit. Such a system … would create substantial uncertainty about what sort of claims could properly be adjudicated outside the administrative scheme. And—again, as Jarkesy's case has shown—it could also likely result in parallel litigation of the same issues before a district court and an agency, with two courts of appeals possibly being confronted with two different sets of rulings down the road. We cannot conclude Congress had that intent. Jarkesy must continue to press his various challenges to the Commission's enforcement proceeding before the Commission itself. Should the agency's final order be adverse to him, Jarkesy can then raise his challenges in a petition for review to a court of appeals."
As noted above, the D.C. Circuit in Jarkesy specifically followed the Seventh Circuit's August 24, 2015 decision in Bebo v. SEC. Briefly, theBebo case involved administrative proceedings being initiated against Laurie A. Bebo (Bebo), the former CEO of Assisted Living Concepts, Inc., by the SEC in December 2014. The SEC alleged that Bebo had violated federal securities laws by manipulating internal books and records, making false representations to auditors, and making false disclosures to the SEC. The case was assigned to an ALJ and hearings were conducted through June 2015. At the time of the Seventh Circuit's opinion, the ALJ had not yet rendered an opinion. Rather than waiting for conclusion of the administrative proceedings, however, Bebo filed suit in federal district court challenging the constitutionality of the administrative proceedings. The district court dismissed Bebo's case for lack of subject matter jurisdiction on March 3, 2015, holding that "the administrative review scheme established by Congress stripped it of jurisdiction to hear this type of challenge," and Bebo appealed to the Seventh Circuit. Writing for the unanimous panel, Judge David F. Hamilton affirmed the district court's decision dismissing Bebo's case for lack of subject matter jurisdiction, stating that it is "'fairly discernible' from the statute that Congress intended plaintiffs in Bebo's position 'to proceed exclusively through the statutory review scheme' set forth in 15 U.S.C. § 78y" and that the facts of the case "do not adequately support Bebo's attempt to skip the administrative and judicial review process here… If aggrieved by the SEC's final decision, Bebo will be able to raise her constitutional claims in this circuit or in the D.C. Circuit. Both courts are fully capable of addressing her claims .... As a result, she must pursue judicial review in the manner prescribed by the statute." The Court concluded that "[w]e see no evidence from the statute's text, structure, and purpose that Congress intended for plaintiffs like Bebo who are already subject to ongoing administrative enforcement proceedings to be able to stop those proceedings by challenging the constitutionality of the enabling legislation or the structural authority of the SEC."
Recent Developments in S.D.N.Y. Cases: As we noted above, two S.D.N.Y. cases that reached divergent conclusions about this issue are currently on appeal to the Second Circuit, and it will be interesting to see on which side the Second Circuit comes down. On September 17, 2015, there was action in both of these cases. In Tilton v. SEC, the Second Circuit agreed to stay the SEC's administrative proceedings against Tilton while it considers Tilton's challenge to the constitutionality of those proceedings. S.D.N.Y. Judge Ronnie Abrams had dismissed Tilton's complaint for lack of subject matter jurisdiction and failure to exhaust administrative remedies on June 30, 2015. On that same date in Duka v. SEC, S.D.N.Y. Judge Richard M. Berman denied the SEC's request that he delay enforcement of his order staying the SEC's administrative proceeding against Duka pending a decision by the Second Circuit on appeal. In his lengthy opinion, Judge Berman reiterated his beliefs that, among other things, the district court does have subject matter jurisdiction over the matter, the SEC's administrative proceedings likely violate Article 2 of the Constitution (the "Appointments Clause"), and the SEC needs to address increasing allegations of "in-house bias" in the administrative proceedings and pressure on ALJs to rule in favor of the SEC. Judge Berman also addressed and respectfully disagreed with the Seventh Circuit's opinion in Bebo (the D.C. Circuit had not yet handed down its opinion in Jarkesy at the time of Judge Berman's opinion). Judge Berman had previously held in Duka on August 12, 2015 that the SEC's administrative proceedings were "likely unconstitutional," mirroring the holdings of Judge Leigh Martin May of the Northern District of Georgia in Hill v. SEC and Gray Financial Group, Inc. v. SEC, both of which cases are now on appeal to the Eleventh Circuit. We will be watching with avid interest to see how the Second and Eleventh Circuits rule in these cases, with a potential circuit split in the works.
Proposed SEC Regulations; SEC Ruling in Timbervest: On September 24, 2015, apparently as a result of all of these challenges to the administrative proceedings both in the courts and legal commentary, the SEC announced proposed amendments to the rules governing its administrative proceedings. SEC chair Mary Jo White said in the press release that the proposed regulations "seek to modernize our rules of practice for administrative proceedings, including provisions for additional time and prescribed discovery for the parties." The press release outlined "three primary changes" to the SEC's Rules of Practice that would serve to (1) "[a]djust the timing of administrative proceedings, including by extending the time before a hearing occurs in appropriate cases"; (2) "[p]ermit parties to take depositions of witnesses as part of discovery"; and (3) "[r]equire parties in administrative proceedings to submit filings and serve each other electronically, and to redact certain sensitive personal information from those filings." In addition, the press release states that the changes would also "make certain other clarifying and conforming changes," including instituting procedures "related to the mechanics of the proposed expanded deposition practice, such as location, methods of recording, forms of objections, and duties of the deposition officer." Finally, the proposed changes would "simplify the requirements for seeking Commission review of an initial decision and provide enhanced transparency into the timing of the Commission's decisions in such appeals." Our take on the proposals? There is less here than meets the eye. While the proposal regarding depositions is potentially significant, the proposed rule relating to continuances is simply an acknowledgement of the ordinary due process argument relating to defendants being given sufficient time to prepare for the hearing. As for the proposed rule regarding electronic filing, welcome to the 21st century! The public now has 60 days to comment on the proposed rules.
One last thing: To no one's surprise, on September 17, 2015, the SEC Commissioners specifically rejected the plaintiff's constitutional challenge to the SEC's administrative proceedings in In the Matter of Timbervest, LLC et al. (as we previously reported, respondent had petitioned the SEC for review of the administrative law judge's initial decision and oral argument was heard before a packed room on June 8, 2015), ruling that "we reject Respondents' challenges to the constitutionality of the Commission's administrative forum. Specifically, we find that: (1) Commission administrative law judges are not 'inferior officers' covered by the Appointments Clause of the U.S. Constitution; (2) the two layers of tenure protection that ALJs enjoy do not unconstitutionally impede the President's ability to 'take care that the laws be faithfully executed'; and (3) the decision to file this enforcement matter in the administrative forum as opposed to federal court did not violate Respondents' Fifth Amendment right to equal protection of the laws." Next step for Timbervest? It can choose to appeal to either the D.C. or Eleventh Circuits. We will keep an eye out and report back.
See here to read the D.C. Circuit's 9/29/15 opinion in Jarkesy et al. v. SEC, No. 14-5196 (D.C. Cir. 2015).
See here to read the SEC's 9/24/15 press release titled "SEC Proposes to Amend Rules Governing Administrative Proceedings."
For more on this subject, read (1) the Seventh Circuit's 8/24/15 opinion inBebo v. SEC, No. 15-1511 (Seventh Cir. 2015), (2) S.D.N.Y. Judge Richard M. Berman's 9/17/15 decision and order in Duka v. SEC, 15 Civ. 357 (RMB), and (3) the 9/17/15 opinion of the SEC Commissioners in In the Matter of Timbervest, et al., Admin. Proc. File No. 3-15519.