Defendants widely view the SEC’s administrative courts as an unfavorable venue to square off against the SEC’s own enforcement staff. Accordingly, as the SEC has recently channeled enforcement proceedings away from the federal courts to its “home” courts, a number of defendants have brought federal court challenges attacking the administrative proceedings on a variety of grounds. Many such challenges have failed to reach the merits, as courts have accepted SEC arguments against the courts’ jurisdiction to interfere with an ongoing agency proceeding and found that defendants are limited to the ordinary post-hearing appellate process to obtain review. In a decision filed last week in Duka v. SEC, Southern District of New York Judge Richard N. Berman ruled that one such challenge seeking to stop an SEC administrative hearing cleared these preliminary hurdles, but ultimately did not make it across the finish line.
Because of its legal ingenuity, Duka’s federal suit has attracted particular attention, including a prior New York Law Journal article by this author. Former Standard and Poor’s Ratings Services Manager Barbara Duka asserts a constitutional challenge to the authority of SEC administrative law judges (“ALJs”) based on the rules governing how they may be removed from office. Duka relies on a recent Supreme Court decision, Free Enterprise Fund v. PCAOB, holding that under Article II of the Constitution, agency officials exercising significant discretion must be subject to the direct authority of the president. Duka’s suit also relies on another Supreme Court decision, Freytag v. C.I.R., which held that a Special Trial Judge appointed by the Tax Court had sufficient discretion such that the appointment was required to comply with Article II of the Constitution.
As a broad facial challenge to the SEC’s administrative structure, initiated before her proceeding got underway, Duka’s suit is well designed to clear the barriers to jurisdiction that had blocked prior federal court challenges by others. Perhaps most notably, Southern District of New York Judge Lewis Kaplan rejected jurisdiction over a challenge to an SEC enforcement proceeding by Wing Chau, whose exploits were the subject of the best-selling book “The Big Short.” Judge Kaplan found no jurisdiction on Chau’s challenge because, among other reasons, it raised specific problems that had arisen during the early stages of the SEC’s administrative proceeding against Chau, and thus was intertwined with that proceeding, which Judge Kaplan held must run its course prior to court review. Southern District Judge Jed Rakoff reached the opposite conclusion in the well- known case of Rajat Gupta, who was charged by the SEC and later, federal prosecutors, with insider trading arising from the Galleon Hedge Funds investigation.
Recognizing that Duka’s facial constitutional challenge should be treated differently from Chau’s claim, in his decision Judge Berman ruled that Duka’s suit met the requirements for federal court jurisdiction. Judge Berman found that failing to accept jurisdiction could preclude meaningful judicial review because the harm of going through the proceeding would have already occurred if Duka were required to await its completion to challenge it. Judge Berman also found that, as a facial challenge to the administrative structure, Duka’s suit was “wholly collateral” to the administrative proceeding itself; and that as an issue of administrative law governed by Supreme Court precedent, Duka’s suit was outside the agency’s expertise.
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Duka’s procedural victory was a hollow one, however, because Judge Berman found that she was not entitled to preliminary injunctive relief because she was unlikely to prevail on the merits of her claim. In short, Judge Berman found that the logic of adding together the Supreme Court’s holdings in Free Enterprise and in Freytag did not hold. Judge Berman found that even if the requirements of Article II applied to SEC ALJs, under the Supreme Court’s language and reasoning in Free Enterprise, the president’s attenuated removal power nevertheless did not violate Article II. The reason is that unlike the members of the PCAOB at issue in Free Enterprise, who were found to have broad “executive” authority to regulate the accounting industry, the power of SEC ALJs is “quasi judicial.” Judge Berman reasoned that their insulation from presidential removal authority is well suited to preserving the integrity and independence of their function, as recognized by older Supreme Court precedent upholding the exercise of adjudicatory authority by the Federal Trade Commission and other agencies.
Thus, unfortunately for Ms. Duka, it was not enough that she maneuvered around the obstacles that defeated Wing Chau and others from getting to the substance of their challenges to the SEC administrative enforcement structure. An appeal is certainly possible; whether the older Supreme Court precedent the district court relied upon is valid in this context after Free Enterprise has not been addressed by an appellate court. And other potential legal challenges remain open to others troubled to find themselves battling the SEC enforcement staff before an administrative law judge employed by the SEC. Thus, whether Ms. Duka and her legal team choose to appeal, or choose instead to direct their resources to defending the substance of the SEC’s administrative claim, the broader battle against the perceived unfairness of the SEC’s home court advantage is unlikely to be over.
From The Insider Blog: White Collar Defense & Securities Enforcement.