Will The Appointments Clause Thwart The SEC’s Administrative Enforcement Actions?

Thanks to two recent rulings, an unlucky recipient of a Securities and Exchange Commission (“SEC”) Wells notice has a second ray of hope. If the SEC approves an enforcement action in its administrative forum — an increasingly popular choice by the Enforcement Division — a defendant may still prevent the mater from going forward through a constitutional challenge.

Two federal judges have now ruled that the SEC’s process for appointing administrative judges to hear enforcement actions violates the Appointments Clause of Article II of the United States Constitution.

This month, in Duka v SEC, United States District Judge Richard M. Berman of the Southern District of New York followed a June 2015 decision by Judge Leigh Martin May of the Northern District of Georgia. In that case, SEC v. HillJudge May determined that the SEC’s in-house judges, or administrative law judges (“ALJs”), are “inferior officers” of the United States within the meaning of Article II of the Constitution and, therefore, must be appointed by the President, the head of a department/agency, or a court. Since the SEC’s ALJs are vetted and appointed by the SEC’s office of human resources, in consultation with the Chief ALJ and Office of Personnel Management, rather than the commissioners themselves, (i.e., the heads of the agency), Judge May ruled that their appointment likely violated the Appointments Clause of Article II.

Judge Berman in Duka agreed and gave the SEC a week to articulate if and how it intended to modify its appointments process. Citing seven decades of practice using its current appointments process, which was created by Congress, the SEC declined the court’s invitation and reasserted the propriety of its appointments process. It has also appealed the order in Hill to the 11th Circuit.

Thus, after many unsuccessful challenges of the administrative process in federal courts across the country, intended respondents and their counsel now have a colorable argument backed by two federal judges that the the SEC may not commence an administrative proceeding, but should launch a federal district court action in which the defendant has a much better chance of prevailing. Even if such a challenge is mounted and succeeds, it is not a merits determination and the underlying action will remain on the Division’s docket; the only issue will be where the matter gets adjudicated.

Administrative proceedings are typically commenced quickly, within 120 days of filing of the Order Instituting Proceedings (“OIP”), the administrative equivalent of a civil complaint. There’s no time for an SEC practitioner to waste in seeking an order enjoining an administrative proceeding. Moreover, recipients of Wells letters and their attorneys should begin preparing their defense as early as receipt of the Wells notice. Beyond reviewing the staff’s evidence, including witness transcripts and related exhibits, that includes identifying all sources of potential exculpatory information, witnesses and documents, and undertaking efforts to access those sources as soon as possible to increase the chances of being able to ultimately mount a comprehensive defense, in whichever forum is finally chosen.

Ron Wood

Ron Wood is a partner with Brown White & Osborn LLP. A former Assistant Director in the SEC's Division of Enforcement, Executive Director in the Law Division at Morgan Stanley, and litigation partner with Proskauer LLP, he practices securities law with a focus on regulatory and enforcement matters. He also conducts internal investigations and complex commercial litigation.
Ron Wood