A&O Shearman | Government Regulatory Enforcement Blog | Second Circuit Holds Federal Courts Cannot Hear Constitutional Challenges to SEC ALJs until Administrative Proceedings<br >  
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  • Second Circuit Holds Federal Courts Cannot Hear Constitutional Challenges to SEC ALJs until Administrative Proceedings

    On June 1, 2016, in Tilton v. SEC,  a divided Second Circuit panel affirmed the dismissal of a constitutional challenge to the SEC’s use of administrative proceedings on the grounds that the claim could only be brought in an appeal following the issuance of a final order by the SEC after the proceedings have concluded.  The panel’s decision to dismiss on jurisdictional grounds, and not reach the merits, may nevertheless result in a circuit split that could trigger Supreme Court review with implications for future SEC enforcement actions, depending on how the D.C. Circuit rules in the pending case of In the matter of Timbervest. 

    The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 greatly expanded the SEC’s ability to bring enforcement actions as administrative proceedings, and the SEC’s use of the forum has more than doubled since the law took effect.   The SEC’s increased use of administrative proceedings has been criticized by some as procedurally unfair to defendants and, more recently, attacked as unconstitutional.  Administrative proceedings are unconstitutional, defendants argue, because the administrative law judges (“ALJs”) hearing the cases have been hired by SEC officials, rather than appointed by the President, the courts, or “Heads of Departments,” which defendants claim is required under the Appointments Clause of Article II of the Constitution in light of the type of authority ALJs wield.  That basic challenge, if ultimately successful, could seemingly be addressed by the SEC simply changing the manner in which ALJs are appointed; but nevertheless, it has the potential to disrupt countless proceedings (at both the SEC and other agencies) in the meantime.
    On March 30, 2015, the SEC instituted an administrative proceeding against Lynn Tilton on the grounds that she and investment firms owned or controlled by her used misleading accounting to collect excessive management fees and disguise the performance of certain portfolio companies.  Tilton filed a complaint in the Southern District of New York seeking to enjoin the proceeding on the grounds that, among other things, the appointment of the presiding ALJ was unconstitutional. 

    The SEC moved to dismiss Tilton’s complaint on the grounds that the administrative proceeding structure established by Congress required Tilton to assert her constitutional claim before the ALJ in the administrative proceeding; Tilton could then appeal any adverse ruling by the ALJ to the full Commission, and finally to a federal court of appeals.  The district court agreed and dismissed Tilton’s case for lack of jurisdiction without reaching the merits.  Tilton appealed, but a Second Circuit panel affirmed, holding that Congress intended for the review process governing administrative proceedings to encompass Tilton’s constitutional claims. 

    The panel’s decision, however, conflicts with rulings by Judge Leigh Martin May in the Northern District of Georgia, which are currently on appeal to the Eleventh Circuit.  Judge May not only held, in Hill v. SEC and Gray Financial Group, Inc. v. SEC, that a district court had jurisdiction to consider the constitutionality of administrative proceedings; she also preliminarily enjoined both proceedings because the plaintiffs established a likelihood of success on their Appointments Clause claims.   If the Eleventh Circuit affirms Judge May, the resulting split between the Second and Eleventh Circuits would make the jurisdictional issue, but not the constitutional issue, ripe for Supreme Court review.  
    As for the constitutional question, although Tilton likely foreclosed Supreme Court consideration of the issue in the near term, the D.C. Circuit is expected to rule on the issue in the pending appeal in In the matter of Timbervest.  The defendants in Timbervest, unlike the plaintiff in Tilton, raised their constitutional claims in their appeal of a final ruling by the SEC, following an administrative proceeding, that they had violated § 206 of the Advisers Act.  Briefing for the matter was scheduled to conclude on August 12, 2016, but that schedule was suspended upon the SEC’s unopposed motion to allow Timbervest to adduce additional evidence.  As noted above, an eventual finding against the SEC would likely be addressable by changing the manner in which ALJs are appointed, but it would cause significant disruption to numerous administrative proceedings in the meantime. 
    Category: Financial Fraud