This is the first in a series of posts by my partner, Ken Berg, discussing the constitutional defenses to SEC administrative enforcement actions, which we are called upon regularly to defend. Each subsequent post will discuss one of the constitutional issues and report the current state of the law as to that defense. Ken’s next post will examine the Article II Appointments Clause issue and update the current state of the law as to this defense. – Alan
As has been well reported, both in this blog and elsewhere, after Dodd-Frank expanded the SEC’s authority by giving it discretion to obtain civil monetary penalties against non-registrants in administrative proceedings, the SEC embraced its new powers by vastly increasing the number of cases filed before ALJs. For FY2015, 80% of all cases were filed before ALJs compared to less than 50% for FY2005. (J. Eaglesham, “SEC Wins with In-House Judges,” WSJ, 5/6/15.) For FY2015, 419/502 settled cases were filed before ALJs compared to only 216/434 for FY 2007. (U. Velihonja, “SEC Settlements in the Shadows” 126 Yale L.J. Forum 124, 9/7/16.) Filing before an ALJ statistically disadvantages respondents. From October 2010 to March 2015, the SEC prevailed in over 90% of administrative cases (WSJ 5/6/15), while winning only 69% of the time in federal court. (J. Eaglesham, “SEC Trims Use of In-House Judges,” WSJ, 10/11/15)
The defense bar reacted to this change in two ways: First, various affirmative defenses based on constitutional rights were asserted in the administrative proceedings. Second, collateral actions were filed in federal district court to enjoin the administrative proceedings. The constitutional objections raised include: i) the manner in which SEC ALJs are appointed and removed violates the non-delegation doctrine in Article I and the Appointments Clause in Article II; ii) the SEC’s “unguided discretion” to prosecute before an ALJ or a district judge violates the Fifth Amendment rights to equal protection and procedural due process; and iii) the absence of a jury violates the Seventh Amendment.
Not surprisingly, at the SEC, these constitution-based affirmative defenses have not gotten any traction. The ALJs decided they lacked authority to rule on them. To no one’s surprise, the SEC on review has never held that any of these constitutional defenses has merit. One might think it is futile, therefore, to continue asserting these constitutional defenses in an answer to an administrative complaint. But, hold on ….
In contrast, the defense bar achieved some impressive initial successes in federal district courts. In Gupta v. SEC, 796 F. Supp. 503 (S.D.N.Y. 2015), District Judge Rakoff denied the SEC’s motion to dismiss a collateral attack complaint. The facts of Gupta are somewhat unique, however, because the SEC filed an administrative action only against Gupta after having filed nearly identical complaints for insider trading against 28 other alleged violators in federal court. Gupta argued that by treating him differently, the SEC violated his Fifth Amendment right to equal protection.
In Hill v. SEC, 114 F. Supp. 3d 1297 (N.D. Ga. 2015), rev’d 825 F.3d 1236 (11th Cir. 2016), District Judge May found that a registrant had a “substantial likelihood of success on the merits” that SEC’s hiring practices of ALJs violates the Article II Appointments Clause. Though as explained below, the Second and Eleventh Circuits have held that District Courts lack jurisdiction to decide these issues, this does not diminish the significance of the fact that these District Judges ruled favorably on the merits of these constitutionally-based defenses in well-reasoned opinions.
The SEC seems to have taken notice of these criticisms by the courts and modified its course somewhat. Between July and September 2015, the SEC filed only four out of 36 contested cases to its ALJs. (WSJ 10/11/15) For FY2015, it sent only 28% of its contested cases to ALJs compared to 43% for the previous 12 months. (Id.)
Unfortunately, for now, the Courts of Appeals have shut the door to the federal courthouse. Five Circuit Courts of Appeals have held that District Courts do not have jurisdiction to enjoin SEC administrative proceedings, finding that Congress intended these constitutional issues first be decided by the ALJ and SEC. Even though appellate review of an SEC final order comes years later after respondents have incurred substantial defense costs, the Courts of Appeals hold that this provides “meaningful judicial review.” As one dissenting judge notes, however, by that time respondents “will already have suffered the injury they are attempting to prevent ….” Tilton v. SEC, 824 F.3d 276, 298 (2d Cir. 2016) (Droney, J., dissenting). This issue is included in a petition for a writ of certiorari to the US Supreme Court in the Tilton case filed on January 1, 2017. The petition argues, “an error is an error, whether it is made once or repeatedly.” 2017 WL 281861, at *20.
Despite the SEC’s certain rejection of constitutionally-based affirmative defenses, respondents must keep asserting them in their answers to administrative complaints to preserve the issue for appeal. If the constitutional affirmative defense is not asserted before the SEC, the court of appeals may refuse to hear the issue on appeal. The one defense that has already made its way to court on direct appeal, the Appointments Clause issue, has been gaining momentum in the federal courts. See Bandimere v. SEC. On Feburary 16, 2017, the D.C. Circuit granted a petition for rehearing en banc to reconsider the panel’s decision affirming the SEC in Raymond J. Lucia Companies, Inc.