The defense bar recently won a significant victory in the battle to challenge the SEC’s expanded use of administrative proceedings, following the 2010 enactment of the Dodd-Frank Act, to seek penalties against unregulated individuals and entities.  As we previously wrote in SEC’s Administrative Proceedings: Where One Stands Appears to Depend on Where One Sits and There’s No Place Like Home: The Constitutionality of the SEC’s In-House Courts, SEC administrative proceedings have recently faced growing scrutiny, including skepticism about whether the administrative law judges (ALJs) presiding over these cases are inherently biased in favor of the SEC’s Division of Enforcement.  The Wall Street Journal recently reported that ALJs rule in favor of the SEC 90% of the time in administrative proceedings. Administrative proceedings have also been criticized for the ways in which they differ from federal court actions, including that respondents are generally barred from taking depositions, counterclaims are not permissible, there is no equivalent of Rule 12(b) motions to test the allegations’ sufficiency, and there is no right to a jury trial.

In the June 8, 2015 ruling in Hill v. SEC, Judge Leigh Martin May of the United States District Court for the Northern District of Georgia found that the SEC’s administrative proceedings against Charles Hill were likely unconstitutional, in violation of the Appointments Clause, because the ALJ in Hill’s case was not appointed by the President, a department head, or the judiciary.  The SEC had instituted an administrative proceeding action against Hill in February 2015, alleging that he had profited by nearly $750,000 on a series of stock transactions in 2011 that were the result of insider trading.  Hill filed an action for a preliminary injunction in federal district court to stop the administrative proceeding before a hearing scheduled for June.  Hill challenged the administrative proceeding on three grounds:

1. The Dodd-Frank Act violates the non-delegation doctrine in Article 1 of the Constitution by allowing the SEC “unfettered” discretion to select its forum;
2. The choice of an administrative proceeding violated Hill’s Seventh Amendment right to a jury trial; and
3. The appointment of the administrative law judge violated the Appointments Clause in Article 2 of the Constitution.

Judge May rejected Hill’s first two arguments.  The court found that the non-delegation doctrine was inapplicable as Hill had no right to choose the forum.  The court also found that there was no Seventh Amendment violation because Congress was permitted to assign “public rights” cases where a jury trial might not be compatible with administrative agency proceedings.

Judge May sided with Hill and against the SEC on the third issue, holding that Hill would likely win on the merits of his claim that the agency’s ALJ appointment scheme violated the Appointments Clause.  Judge May held that under the Supreme Court’s 1991 precedent in Freytag v. Commissioner, the SEC ALJs were “inferior officers” within the meaning of Article 2 because they exercised significant authority pursuant to the laws of the United States.  The appointment of the ALJ was “likely unconstitutional in violation of the Appointments Clause,” because the SEC’s ALJs are not appointed by the President, a department head or the judiciary.  Rather, ALJs are hired by the SEC’s Office of Administrative Law Judges, with input from the Chief Administrative Law Judge, the SEC’s human resources department, and the Office of Personnel Management.

While the decision is a seeming victory for Hill, the defense bar, and may even impact other agencies beyond the SEC, the order concluded by noting that the SEC could easily cure the deficiency itself by placing the proceedings before an SEC Commissioner (these individuals are appointed by the President), or pursuing the plaintiff in federal court.  The SEC could also potentially fix the constitutional issue by simply having an SEC Commissioner (a department head) issue the appointment of the SEC’s ALJs.

Regardless of this potential cure, the SEC may be showing signs of feeling some pressure from the increasing public scrutiny.  On June 4, 2015, in considering an appeal of a decision by ALJ Cameron Elliott in which constitutional challenges are at issue, the Commission “invited” ALJ Elliot to voluntarily submit an affidavit addressing whether he has ever felt any pressure to rule in favor of the SEC or if he knows of any instances in which other ALJs felt such pressure.  This move comes following the May 6, 2015 Wall Street Journal report referenced above that included an accusation by Lillian McEwen, an SEC ALJ from 1995 to 2007, that the SEC’s chief ALJ Brenda Murray had pressured her to find in favor of the SEC.  On Friday, June 12, ALJ Elliott “respectfully decline[d] to submit the affidavit requested.”  We will be closely monitoring to see whether other courts adopt Judge May’s reasoning as constitutional challenges to the SEC’s administrative process continue to work their way through the courts, including in the Seventh Circuit, which recently heard oral arguments in Bebo v. SEC, No. 15-1511 (7th Cir, argued June 4, 2015).  Stay tuned.