The Securities and Exchange Commission again rejected constitutional challenges to the use of administrative enforcement proceedings presided over by Administrative Law Judges (“ALJs”).  The Commission’s September 17, 2015 decision in In the Matter of Timbervest, LLC – the Commission’s second ruling on the constitutional issue in the past two weeks – rebuffed arguments that ALJ proceedings such as this one violated the Constitution’s Appointments Clause and removal provisions and deprived respondents of equal protection of the laws.

The Commission’s opinion arose from an ALJ’s initial decision that a registered investment adviser had committed fraud by selling property of one of its clients to another client at a below-market rate and by failing to disclose its conflict of interest in the transaction.  The Commissioners affirmed the ALJ’s findings that respondents had violated the Investment Advisers Act, although they altered the sanctions imposed.  The Commission also rejected all of respondents’ constitutional challenges to the ALJ proceedings.

First, the Commission held that the SEC’s use of ALJs appointed through the civil-service hiring process does not violate the Constitution’s Appointments Clause (Article II, § 2), which provides that “the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.”  The Commission ruled that the Appointments Clause does not apply to the SEC’s ALJs, because the ALJs are “mere employees,” not “inferior officers.”  This portion of the Timbervest opinion tracks the Commission’s September 3, 2015 opinion in In the Matter of Raymond J. Lucia Companies, Inc., about which we previously blogged here.

Second, the Commission held that the President’s lack of direct removal power over ALJs does not conflict with the Supreme Court’s 2010 decision in Free Enterprise Fund v. Public Company Accounting Oversight Board.  Free Enterprise held that the structure of the Public Company Accounting Oversight Board (the “PCAOB”) was unconstitutional because PCAOB officers – who wield “‘substantial executive authority’” – could not be directly removed by the President.  The Commission concluded, however, that Free Enterprise“did not establish a categorical rule prohibiting two layers of for-cause removal wherever it may be found in the Executive Branch.”  Rather, Free Enterprise “turned instead on the core constitutional question of whether ‘Article II’s vesting of the executive power in the President,’ including his authority to ensure that the laws are faithfully executed, was frustrated by the distinctive structure and features of the PCAOB.”  The Commission ruled that “ALJs differ from the PCAOB members in a number of significant ways, and those differences obviate any constitutional concerns from the dual for-cause removal restrictions in the context of ALJs.”

Third, the Commission held that the SEC’s decision to proceed against respondents administratively – rather than in District Court – did not violate their constitutional rights to equal protection of the laws.  The Commission gave three reasons for rejecting the equal-protection argument:

  • The claim was not legally cognizable, because some forms of governmental action “by their nature involve discretionary decisionmaking based on a vast array of subjective, individualized assessments. . . . The Commission’s choice of forum is such a discretionary decision.”
  • Even if respondents’ “class-of-one claim” were legally cognizable, respondents failed to show that they had been treated differently from others similarly situated. “Persons asserting a class-of-one claim ‘must show an extremely high degree of similarity between themselves and the persons to whom they compare themselves. . .  The mere fact that another case involves the same provisions of the Advisers Act does not demonstrate that Respondents are being treated differently from others similarly situated for purposes of equal protection.”
  • Respondents failed to prove that “no rational basis” existed for the alleged difference in treatment. “Respondents speculate that the Commission’s ‘motive is to disadvantage Respondents in their defense of this matter and to compel settlements,’ but there is no basis for this allegation.”  The Commission also noted that proceeding administratively was “particularly rational” here, “because the proceedings involved a request for an associational bar; had the Commission pursued this action in district court in the first instance, a follow-on administrative proceeding would have been necessary to consider the associational bar.”

The Commission’s 4-0 decision (with Commissioner Aguilar not participating) in Timbervest was unanimous.  This unanimity suggests that the two Commissioners who had dissented without issuing an opinion in Raymond J. Lucia (Commissioners Gallagher and Piwowar) might not have disagreed with the majority’s ruling on the constitutional issues.

We previously blogged about other constitutional challenges to SEC administrative proceedings [here,hereherehere, and here.]  As we noted, two principal issues are in play:  (i) whether District Courts have jurisdiction to review constitutional challenges to SEC administrative enforcement proceedings and (ii) whether those proceedings are constitutional.  Appeals are currently pending in the Second, Eleventh, and D.C. Circuits on the jurisdictional and/or constitutional issues.  We will continue to follow the latest developments.