Earlier this week, newly-appointed Judge Leigh Martin May of the Northern District of Georgia dealt a major blow to the SEC’s use of administrative law judges (“ALJs”) to preside over enforcement proceedings. Judge May held that the SEC’s appointment of an ALJ was “likely unconstitutional” and granted a preliminary injunction halting the administrative proceeding against a defendant charged with insider trading. See Hill v. SEC, C.A. No. 1:15-cv-01801-LMM (N.D. Ga.). Judge May’s ruling is significant because it could lead to more challenges to the SEC’s practice of bringing enforcement actions as administrative proceedings, where the SEC has an approximately 90% success rate, defendants do not have the right to a jury trial, and the Federal Rules of Civil Procedure and Evidence do not apply.
The decision came at a time of increasing public scrutiny of the SEC’s growing use of administrative proceedings, a practice SEC Enforcement Division officials have strongly defended. The decision is likely to be appealed by the SEC.
The SEC brought an administrative proceeding against Charles L. Hill, an Atlanta real estate developer, charging him with insider trading for purchasing shares of Radiant Systems, Inc., a Georgia-based network technology company, just weeks before NCR Corporation’s buyout offer. In the administrative proceeding, Mr. Hill moved for summary disposition of the case, asserting that the proceeding was unconstitutional. ALJ James E. Grimes held that he did not have authority to address the constitutionality of the SEC’s in- house courts because those courts received their authority from Congress under the Dodd-Frank Act and commission precedent barred him from declaring the statute unconstitutional.
The SEC has long had the power to bring administrative proceedings to enjoin alleged violations of securities laws. But since Congress passed Dodd-Frank in 2010, the SEC also has the power to seek civil monetary penalties in such proceedings, including from unregistered individuals like Mr. Hill.
On May 19, 2015, Mr. Hill filed suit in the Northern District of Georgia, seeking to enjoin the SEC’s administrative proceeding against him on constitutional grounds. Among other things, Mr. Hill argued that SEC ALJs were “inferior officers” under Article II of the U.S. Constitution and that the SEC’s practice of having them appointed by its Office of Administrative Law Judges violated the Appointments Clause, which states that “the Congress may by Law vest the Appointment of … inferior Officers …. in the President alone, in the Courts of Law, or in the Heads of Departments.” The SEC countered that its ALJs are employees of the agency, not inferior officers, because their decisions are subject to commission review and are not final until the commissioners sign off on them.
Judge May acted swiftly in granting Mr. Hill preliminary injunctive relief, ruling on June 8th that Mr. Hill was likely to win on the merits of his claim that the SEC’s actions violated the Appointments Clause. Judge May found that the ALJs are inferior officers under the Appointments Clause because they have significant authority under U.S. law and, as a result, they must be appointed by the President, a department head, or the Judiciary. Judge May concluded that because the SEC ALJ “was not
appropriately appointed pursuant to Article II, his appointment is likely unconstitutional in violation of the Appointments Clause.” She noted, however, that the ALJ’s appointment “could easily be cured by having the SEC commissioners issue an appointment or preside over the matter themselves.”
Judge May is the first federal judge to rule that the SEC’s controversial in-house tribunal could potentially be unconstitutional under the Appointments Clause. Additional rulings regarding the constitutionality of the process are likely to follow – indeed, yesterday a case involving the same issue was transferred to Judge May by another Northern District of Georgia judge – and could lead to changes in the SEC’s administrative procedures. Critics have raised many constitutional challenges to such proceedings. Judge May’s ruling, if upheld, could possibly chill future use of administrative proceedings by the SEC or at least cause the SEC to be more selective in the cases it pursues administratively. As Judge May noted in her order, the SEC can cure the alleged defect in its proceedings under the Appointments Clause simply by changing the way it appoints the ALJs to have the SEC Commissioners themselves appoint the judges. According to a recent report in the Wall Street Journal, the SEC will most likely adopt this cure going forward, although that would still leave currently pending administrative proceedings open to challenge.