In a complaint filed recently in the Southern District of New York, an activist investor and his investment advisor company have gone on the offensive against the SEC. Joseph Stillwell and Stillwell Value LLC filed a complaint seeking injunctive and declaratory relief to prevent an administrative proceeding that the SEC “intends to initiate imminently.”
Stillwell claims that the SEC’s administrative proceedings violate Article II of the Constitution. Article II vests “[t]he executive Power . . . in a President of the United States of America” who must “take Care that the Laws be faithfully executed.” Art. II, § 1, cl. 1; id. § 3. According to Stillwell, SEC Administrative Law Judges (ALJs) are executive branch officers within the meaning of Article II and may not be separated from Presidential supervision by more than one layer of tenure protection. The constitutional violation occurs, Stillwell claims, because SEC ALJs enjoy two layers of tenure protection. That is, SEC ALJs can only be removed by the SEC for good cause, and the SEC Commissioners, in turn, can only be removed by the President for inefficiency, neglect of duty, or malfeasance in office. Because the President cannot oversee SEC ALJs as Article II requires, Stillwell claims, administrative proceedings are unconstitutional.
Stillwell relies primarily on the Supreme Court’s decision in Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477, 130 S. Ct. 3138 (2010). In Free Enterprise, the Supreme Court decided that the SEC’s Public Company Accounting Oversight Board created by Sarbanes-Oxley violated Article II because the act provided for dual for-cause limitations on the removal of board members. Specifically, board members could not be removed by the Commission except for good cause shown. And, SEC Commissioners themselves cannot be removed except for inefficiency, neglect of duty, or malfeasance in office (as Stillwell points out in his complaint). The Supreme Court held that “such multilevel protection from removal is contrary to Article II’s vesting of the executive power in the President” and that the President “cannot ‘take Care that the Laws be faithfully executed’ if he cannot oversee the faithfulness of the officers who execute them.” Id. at 3147. The Supreme Court, however, did not find the appointment clause unconstitutional; it merely struck down the for-cause removal provision of the appointment clause. Moreover, the Court rejected the petitioner’s argument that the constitutional infirmity made all of the Board’s prior activity unconstitutional. Instead, it severed the for-cause removal clause from the rest of Sarbanes-Oxley, leaving the Board itself intact.
Stillwell also raises the procedural advantages, such as limited discovery, the lack of jury trials, compressed time tables, and the unavailability of dispositive motion practice the SEC enjoys in administrative proceedings, which only compound the double layer of tenure issue.
Although Stillwell has received a Wells notice indicating that the SEC believes that Stillwell violated section 206 of the Investment Advisers Act, the SEC has not filed any charges against Stillwell. Accordingly, it is unclear at this point whether the district court will entertain this constitutional challenge given the potential ripeness issue.
Since the SEC announced its intention to step up its use of administrative proceedings, there have been several constitutional challenges lobbed at the SEC. For example, a few years ago Rajat Gupta, one of 28 insider trading defendants in the Galleon line of cases challenged the filing of an administrative proceeding on the basis that the administrative proceeding violated the equal protection clause. Judge Jed Rakoff rejected the SEC’s efforts to dismiss Gupta’s challenge and held, among other things, that Gupta’s challenge was “wholly collateral” to the SEC’s authority to institute administrative proceedings and that equal protection claims are outside the SEC’s expertise. Gupta v. SEC, 796 F. Supp. 2d 503, 511-13 (S.D.N.Y. 2011). The SEC subsequently dismissed its administrative proceeding against Gupta and filed an action in federal court.
In March 2014, an investment adviser and its CEO filed an action to enjoin administrative proceedings by the SEC on alleged violations regarding a 2006 collateralized debt obligation. Judge Lewis Kaplan denied the temporary restraining order for lack of irreparable harm, but the case remains pending with the motion for preliminary injunctive relief going “normal course.” Chau v. SEC, No. 14-cv-1903 (S.D.N.Y. Mar. 19, 2014).
A few months later, in June 2014, another investment adviser and his fund management group similarly sought to enjoin SEC administrative proceedings. The D.C. district court, however, dismissed the challenge and held it lacked jurisdiction over the controversy. Jarkesy’s appeal to the D.C. Circuit is pending. Jarkesy v. SEC, No. 14-114, 2014 WL 2584403 (D.D.C. June 10, 2014) appeal pending, No. 14-5196 (D.C. Cir. filed Aug. 12, 2014).
Whether or not Stillwell is successful in its challenge, it is very likely that the SEC will continue to face similar challenges as it attempts to bolster its enforcement program through the use of administrative proceedings.