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Federal Court Rules That SEC Administrative Proceeding Is "Likely Unconstitutional"

As we discussed in a post last November, the SEC's increasing use of enforcement proceedings before its own administrative law judges (ALJs), rather than before federal court judges, has spawned a number of constitutional challenges in the federal courts.  Most of these challenges have failed, but on Monday a federal judge in Georgia issued a preliminary injunction to stay an SEC administrative proceeding on constitutional grounds.

In Hill v. SEC, C.A. No. 1:15-cv-01801-LMM (N.D. Ga.), the plaintiff requested an injunction in federal court to halt an SEC administrative proceeding seeking civil penalties against him for alleged insider trading.  The plaintiff is a self-employed real estate developer and is not a "regulated person" under the federal securities laws.  As the court noted, prior to enactment of the Dodd-Frank Act in 2010, the SEC would have had to bring such a case in federal court, where the accused could invoke the right to a jury trial and other protections under the Federal Rules of Evidence and the Federal Rules of Civil Procedure, such as the right to take depositions and obtain document discovery.  But Dodd-Frank expanded the SEC's power to assess civil money penalties in administrative proceedings.

Hill argued that the SEC's administrative proceeding against him is unconstitutional because (1) the proceeding violates Article I of the Constitution and the non-delegation doctrine; (2) the proceeding violates his Seventh Amendment right to a jury trial; and (3) the proceeding violates the Appointments Clause in Article II of the Constitution.  U.S. District Court Judge Leigh Martin May sided with the SEC on the first two arguments, but held that Hill was likely to succeed on the third.  First, the court held that the SEC's decision to proceed against the plaintiff in an administrative proceeding rather than in federal court involves a proper executive exercise of prosecutorial discretion, rejecting Hill's contention that it was an unprincipled exercise of decision making authority that exceeded the limits of power that Congress can delegate to an executive agency.  Second, the court held that the SEC proceeding concerns "public rights" whose adjudication can be properly assigned to an administrative agency.  As to the third argument, however, the court agreed with Hill.  The Appointments Clause provides that "the Congress may by Law vest the Appointment of ... inferior Officers .... in the President alone, in the Courts of Law, or in the Heads of Departments."  The court held that ALJs are inferior officers because they exercise significant authority pursuant to the laws of the United States, citing the U.S. Supreme Court's similar treatment of Tax Court Special Trial Judges in Freytag v. Commissioner, 501 U.S. 868 (1991).  Since ALJs are not appointed by the President or SEC Commissioners, but rather are hired by the SEC's Office of Administrative Law Judges, the court concluded that the plaintiff had established a likelihood of success on the merits of his claim that the appointment of the ALJ in his case violated the Appointments Clause.

The court went on to observe that this ruling "may seem unduly technical, as the ALJ's appointment could easily be cured by having the SEC Commissioners issue an appointment or preside over the matter themselves."  But nevertheless, the court concluded, the Appointments Clause is "an important part of the Constitution's separation of powers framework," and goes to the validity of the SEC proceeding.

A report in the Wall Street Journal indicated that the SEC will likely resolve this issue by having the Commissioners appoint its ALJs directly.  But in the meantime the court's ruling could spur similar challenges to the validity of current and past SEC proceedings.


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Chip Phinney