WASHINGTON – Lawyers with Orrick, Herrington & Sutcliffe are concerned about a ruling by a federal appeals court last week that found a constitutional challenge to the Securities and Exchange Commission's use of administrative proceedings to impose penalties in enforcement cases could not move forward until the proceedings end.
"The result of the decision is that [the defendant's] challenge must be reviewed in the first instance by the very judges whose legitimacy she challenges," wrote Jason Halper, a partner with the firm, along with three other lawyers, in an alert on the ruling. "[The decision's] effect is to insulate the majority of SEC administrative proceedings from constitutional scrutiny."
The two-to-one ruling from the U.S. Court of Appeals for the Second Circuit in Manhattan came in a case brought by Lynn Tilton, the former chief executive officer of Patriarch Partners, an investment firm that the SEC alleges hid poor performances of assets in funds it managed and collected excessive management fees.
Tilton challenged the constitutionality of the SEC proceeding against her based on the theory that the SEC's administrative law judges are selected in accordance with the Constitution's Appointments Clause because the judges are hired by the SEC and not appointed by the president or SEC commissioners.
SEC administrative law judges were first allowed to issue enforcement penalties after the Dodd-Frank Act of 2010 was passed.
The Second Circuit ruling mirrors an earlier decision from the Seventh Circuit Court of Appeals in Chicago in a case where Laurie Bebo, the former chief executive officer of Wisconsin-based Assisted Living Concepts Inc., made a similar challenge. Bebo appealed her case to the Supreme Court but the court did not take the challenge up.
A ruling on another related appeal pending before the Eleventh Circuit Court of Appeals in Atlanta is expected later this year.
"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," the Orrick lawyers wrote.
Most SEC muni enforcement actions are brought through administrative proceedings. The proceedings have proven controversial as media reports found that over a five-year period the SEC was successful in 90% of all administrative proceedings compared to a success rate of 69% in federal court cases.
Halper and the other Orrick lawyers have been warning since a prior alert issued at the end of March that the administrative proceedings lack several protections and advantages of civil courts in that they have limited discovery, federal evidence rules do not apply, and the arbiter of the case lacks neutrality. They previously suggested that anyone who is subject to administrative proceedings should challenge their constitutionality.
However, neither the circuit courts nor the lower federal courts where the challenges originated addressed the fairness of the proceedings. Instead they made their decisions after determining the federal courts did not have the jurisdiction to hear the challenge that early in the administrative process.
A defendant in an administrative proceeding can appeal the result of the proceeding to the commission, which will then issue a ruling. If the defendant is still unsatisfied, then the commission's ruling is subject to review by a federal court of appeals.
The dissenting judge in this most recent ruling, Judge Christopher Droney, disagreed with the majority's application of prior precedents, especially in the Supreme Court case 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 judges under the Appointments Clause would provide no meaningful avenue of relief, according to the Orrick lawyers. Judge Droney called that case "virtually indistinguishable" from Tilton's case.
Representatives for the Department of Justice, who have responded to constitutional challenges to the proceedings on behalf of the SEC, have argued that administrative law judges: "possess the limited adjudicatory authority that the commission has delegated to them, play a part in a process over which the commission retains ultimate control, enjoy ordinary tenure protection, and have a long history of use."
Andrew Ceresney, director of the SEC's enforcement division, said in a speech to the New York City Bar last year that the commission's "overriding goal is to achieve strong and effective enforcement of the federal securities laws in a fair and efficient manner."
