On June 1, the Second Circuit in Tilton et al. v. SEC, No. 15-2103 (2d. Cir. Jun. 1, 2016), echoed recent Seventh and D.C. Circuit decisions (respectively, Bebo v. SEC, No. 15-1511 (7th Cir. Aug. 24, 2015), cert. denied, 136 S. Ct. 1500 (Mar. 28, 2016), and Jarkesy v. SEC, No. 14-5196 (D.C. Cir. Sept. 29, 2015)) in finding that constitutional or other challenges to SEC proceedings cannot go forward in court until the administrative proceeding ends; review can only be sought as an appeal from a final decision by the Commission.  The Second Circuit’s decision in Tilton creates unanimity among the circuit courts that have addressed the issue to date, although, as we previously reported, the Eleventh Circuit is likely to rule on the issue sometime this year in Hill v. SEC, No. 15-12831. Unless the Eleventh Circuit bucks this trend and creates a circuit split, it now looks unlikely that the Supreme Court will weigh in on this issue (particularly because the Supreme Court previously denied a petition to review the Seventh Circuit’s decision in Bebo).

In Tilton, a three-judge panel of the Second Circuit decided (2-1) an appeal from a Southern District of New York decision in a case that Lynn Tilton, former CEO of Patriarch Partners, commenced two days after the SEC filed an administrative proceeding alleging that her firm hid poor performances of assets in the funds it managed and collected excessive management fees.  Tilton challenged the constitutionality of the SEC proceeding on the theory that the SEC’s administrative law judges are not appointed in accordance with Appointments Clause of the Constitution and therefore lack authority to adjudicate.  The Second Circuit upheld the Southern District’s decision that it did not have jurisdiction to hear this challenge while the administrative case was still pending, ruling that the constitutional challenge must first be raised in the context of the SEC proceeding and only once the Commission has issued a final decision can it then be appealed to a district court.

The Second Circuit based its decision, as did the Seventh and D.C. Circuits, on a set of factors which the Supreme Court identified in a 1994 case, Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994), to determine whether a statutory scheme allows a party to seek parallel review of an administrative proceeding in district court.  The Second Circuit found that the SEC’s scheme of administrative and judicial review “implicitly precluded federal district court jurisdiction.”  Applying the Thunder Basin factors, the court reasoned that Tilton could not seek review in federal court because she was able to obtain meaningful review of the question at hand through administrative channels; the question was not “wholly collateral” to the proceeding but rather a “procedurally intertwined” affirmative defense; and the claim was not outside the agency’s expertise, though this last determination was a “close question.”  The dissent objected that the majority’s application of the Thunder Basin factors stripped them of their meaning.  Judge Droney also dissented from the majority’s treatment of the Supreme Court’s decision in Free Enterprise Fund v. Public Co. Accounting Oversight Board, which found that requiring plaintiffs to wait until they are sanctioned before challenging the authority of adjudicators under the Appointments Clause would provide no meaningful avenue of relief, calling it “virtually indistinguishable” from the present case.  561 U.S. 477 (2010).

The result of the decision is that Tilton’s challenge must be reviewed in the first instance by the very judges whose legitimacy she challenges.  The SEC has increasingly pursued fraud cases in-house rather than in federal courts since the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 granted it that power.  But SEC administrative enforcement proceedings lack several protections and advantages of civil courts: there is limited discovery, the Federal Rules of Evidence do not apply, and SEC proceedings arguably do not offer adjudication by a neutral arbiter (or a jury).  The likely outcome of decisions in an SEC forum is statistically clear: the SEC prevails in a significantly greater majority of cases it pursues in-house than in federal courts.  Although in Tilton the Second Circuit decided a threshold jurisdictional issue and did not reach the constitutionality of the SEC’s use of administrative law judges, its rejection of a party’s ability to seek parallel review of the constitutionality of SEC proceedings means that respondents in SEC enforcement actions must endure the entirety of often lengthy proceedings before challenging their legitimacy.  As many SEC enforcement proceedings settle or otherwise resolve before final judgment, Tilton’s effect is to insulate the majority of SEC administrative proceedings from constitutional scrutiny.