D.C. Circuit Rejects Challenge to SEC's Use of In-House Administrative Law Judges
Commentary by Bob Zwirb
The U.S. Court of Appeals for the District of Columbia Circuit rejected a constitutional challenge to an ongoing SEC administrative enforcement proceeding. The Court held that a party to such a proceeding must first defend against it and then seek review from the SEC and, eventually, the federal appellate courts.
The three-judge panel affirmed a previous holding by the Federal District Court, and held that (i) the respondent to the SEC proceeding must finish the administrative process first before seeking judicial review and (ii) "the securities laws provide an exclusive avenue for judicial review that [the respondent] may not bypass by filing suit in District Court." The Court expressly rejected the notion that respondents in administrative enforcement proceedings may "'jump the gun' by going directly to the District Court to develop their case - instead of seeing agency proceedings through to conclusion."
Regarding the substance of the administrative proceeding: in 2013, the SEC charged a hedge fund manager with defrauding investors by overvaluing some assets in order to calculate excessive management fees. An SEC administrative law judge ruled that the accused and his firm had violated securities-fraud laws and ordered him to pay $1.7 million in penalties and returned profits. He appealed that ruling to the full Commission and the action is still pending. At the same time, the accused filed an action in the U.S. District Court for the District of Columbia seeking injunctive and declaratory relief "to prevent the SEC from proceeding with an administrative proceeding" that "ha[d] violated, and [would] continue to violate, [their] fundamental constitutional rights." In their federal court challenge to the SEC proceeding, respondents argued that they could not get a fair hearing before the SEC because the agency had already settled with one of their business partners and found that partner liable in connection with the alleged scheme. A District Court ruled that it did not have authority to weigh in on the issue, and the accused appealed that ruling.
Although the D.C. Circuit rejected the respondents' challenge, the D.C. Circuit observed that "[t]he result might be different if a constitutional challenge were filed in court before the initiation of any administrative proceeding (and the plaintiff could establish standing to bring the judicial action." Thus, the decision raises the issue of whether the timing of a challenge may affect the outcome in a challenge to ongoing enforcement proceedings.
Commentary
Administrative agencies like the SEC and the CFTC may prosecute violations in-house or in federal court. The choice of forum is left to the discretion of the agency. Many factors are considered in such a decision; e.g., whether injunctive relief is necessary (which favors going to federal court) and whether an agency's expertise is needed to resolve difficult issues (which favors in-house). In practice, this creates a parallel universe in which an agency's choice may have a bearing on the outcome. As a practical matter, such a decision may include an assessment of which forum may be more favorably disposed to the agency's case.
Recently, there have been allegations that the SEC's in-house administrative law judges ("ALJs") are captives of the agency. Last year, a report in The Wall Street Journal found that the SEC had a 100% win rate during a 12-month period when it brought cases before the SEC-appointed administrative judges, and similar rates for the two years before that. By contrast, the agency's success rate before federal courts stood below 80% during a similar timeframe.
Here, respondents argue that the SEC's decision to force them to go in-house while taking similarly situated respondents to court was motivated by "animus." Even so, as the D.C. Circuit noted, "it is of no moment that the securities laws provide for the possibility of civil enforcement both before the Commission and in federal district court" (emphasis in original). In most circumstances, respondents in administrative proceedings may not attack such proceedings collaterally until after those proceedings are over. That is what this decision holds.
However, the legal issue raised by the case – whether the use of in-house judges, as practiced by the SEC, is constitutional – is in fact a live issue. In an unrelated case, a federal court in Atlanta issued an injunction on an SEC administrative case against an Atlanta real estate developer accused of insider trading after concluding that he had a "substantial likelihood of success" of prevailing with his argument that the in-house judges essentially are hired by the SEC instead of according to the U.S. Constitution's appointments clause. "This likely appointment clause violation goes to the validity of the (administrative) proceeding." See Hill v. SEC, Civil Action No. 1:15-CV-1801-LLM (N.D. Ga. June 8, 2015).