Daily Journal

Administrative law judges have presided over enforcement actions for decades for the U.S. Securities and Exchange Commission. However, only in the past few years have defendants in such actions started to frequently challenge such processes as unconstitutional and become more vocal about the unfair differences between an administrative proceeding and federal litigation. Just last month, the U.S. Supreme Court denied certiorari in one such challenge, Bebo v. SEC. That case, however, is only the latest to dispute the validity of ALJ proceedings; there are similar cases pending in several circuits which may eventually require the high court to step in.

The tipping point appears to have been a speech in November 2014 by Andrew J. Ceresney, director of the SEC’s Enforcement Division, in which he confirmed the SEC’s practice over the prior few years of electing to employ administrative proceedings as opposed to federal litigation more frequently than in the past.

Unsurprisingly, administrative proceedings yield a much higher success rate for the SEC. In reviewing cases filed from October 2010 through March 2016, one commentator noted that the SEC won against defendants 90 percent of the time in administrative proceedings compared to 69 percent in federal litigation. See “SEC Wins With In-House Judges,” Wall Street Journal (May 6, 2015).

Defendants long have contended that administrative proceedings initiated by the SEC lack the due process of an action filed in federal court. They say the consequences of an SEC action just being filed, much less a judgment against a defendant, are enormous. While a defendant’s liberty is not in jeopardy as such actions are civil and not criminal, the mere fact that an action has been initiated is often enough standing alone to foreclose employment for defendants in their chosen field, thus depriving them of their livelihoods and ability to fund a challenge to the claims launched by the SEC. Because the consequences are so potentially dire, defendants have argued that such proceedings need more (if not all) of the hallmarks of due process afforded in federal litigation.

SEC administrative proceedings and civil federal litigation are a study in contrasts. In an administrative proceeding, the SEC selects the ALJs, appeals from ALJ rulings are taken to the SEC first and then only thereafter to a federal court of appeals. While there have been no studies of the reversal rate of ALJ decisions reviewed by the SEC, defendants anecdotally know that the success rate is extremely small. The FederalHeadline Rules of Civil Procedure and the Federal Rules of Evidence are inapplicable in an administrative proceeding. As a result, there is no prohibition on the admission of hearsay evidence, which the federal rules view as less credible and thus only admissible under certain circumstances. In addition, the administrative proceeding is resolved by an ALJ with no right to a jury trial, when the same claims if filed in federal court may have given rise to a right to a jury trial. The lack of adherence to the Federal Rules of Civil Procedure also means that there is no right to conduct depositions or take discovery for defendants in order to mount a defense. Finally, the rush to judgment in an ALJ proceeding unfairly favors the SEC which has the luxury of several years to conduct its own investigation including issuing subpoenas for documents and testimony or simply interviewing key witnesses without a transcript in order to avoid later being required to turn over any transcripts to defendants.

The SEC’s primary response is to point out that ALJs and administrative proceedings have existed for decades. The SEC also contends that being able to utilize the administrative proceeding in lieu of more time consuming federal litigation results in a conservation of its resources. To rebut due process concerns, the SEC has proposed some changes to the rules governing administrative proceedings. These proposals, however, do little to alleviate concerns by the defense bar. They provide for a handful of depositions that still does not remotely resemble the kind of robust discovery permitted in a federal litigation.

Defendants argue that ALJs - who have had the ability to impose sanctions under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 - are appointed in violation of the appointments clause of the U.S. Constitution. Several federal actions seek to halt those proceedings because the ALJs are “inferior officers,” as opposed to “mere employees,” and thus must be appointed by the president under the appointments clause rather than by the SEC.

In Bebo, the case the Supreme Court recently rejected, the court declined to review the 7th Circuit’s decision that found federal courts lack jurisdiction to consider the appointments clause argument because that defendant filed suit prior to concluding the ALJ proceeding. However, other cases are winding their way up through the courts. To date, judges in both the Northern District of Georgia and the Southern District of New York have found, contrary to Bebo, that they do have jurisdiction to consider this issue prior to completion of the ALJ proceeding and have enjoined such proceedings. In Jarkesy v. SEC, the U.S. Court of Appeals for the D.C. Circuit has agreed with Bebo. At present, there are appeals pending in the 2nd, 4th, 11th and D.C. Circuit Courts of Appeals that address appointments clause challenges to SEC administrative proceedings.

If the circuit split develops, the U.S. Supreme Court could elect to grant certiorari in another case. Some have suggested that the SEC itself could moot any challenges under the appointments clause by having the full SEC ratify all ALJ appointments. However, if that occurs and is successful in mooting the issue, it will not be an end to the matter as surely defendants in prior administrative proceedings may seek to unwind the final verdicts in those matters. Until either a split develops or a change is made in how ALJs are appointed, defendants faced with an administrative proceeding should, at a minimum, preserve all rights to make an appointments clause challenge and consider whether or not to mount such a challenge at the beginning of an administrative proceeding and if so, in what jurisdiction. This matter will take several years to settle.