Divided Appellate Court Rebuffs Challenges to the SEC’s Administrative Proceedings

June 1, 2016

Earlier today, a divided Second Circuit panel (2-1) held that an individual or entity that is sued by the Securities and Exchange Commission in an administrative proceeding (rather than in an Article III federal court action), cannot challenge the propriety of that administrative proceeding, including whether using such a proceeding is constitutional, until after the administrative proceeding has concluded.

In other words, the subject of an SEC administrative proceeding must endure the full proceeding to conclusion, then petition for review before the SEC, before seeking review by a federal court of appeals. The Second Circuit held today that the constitutionality of the administrative proceedings is a defense which cannot be raised in federal court until the case reaches the federal court of appeals through its natural course.

By way of background, when the SEC seeks to enforce the federal securities laws, under the 2010 Dodd-Frank Act, the SEC may bring an enforcement action as a civil lawsuit in federal district court or as an administrative proceeding conducted by the SEC or an administrative law judge. The SEC has the choice of forum, although far and away the subjects of SEC enforcement actions prefer to be in federal court, which is viewed as a more open and impartial forum. The crux of the argument before the Second Circuit was whether the U.S. District Court has jurisdiction to enjoin the SEC’s administrative proceeding on the theory that the administrative law judge’s appointment violated the Appointments Clause of Article II of the Constitution, because administrative law judges are not appointed directly by the President and insulated from Presidential removal.

The Second Circuit held that requiring the subject of an enforcement action to submit to an administrative proceeding before raising any challenge with the federal court “enables the SEC’s Division of Enforcement to bring statutory charges before an administrative tribunal and affords respondents the opportunity to gather evidence, present a defense, and appeal any adverse rulings in federal court.” The Circuit Court further found that the “litigant’s financial and emotional costs in litigating the initial proceeding are simply the price of participating in the American legal system, and not an irreparable injury that necessitates interlocutory review of the initial court’s jurisdiction.”

Judge Droney dissented from the majority opinion, arguing that the District Court does have jurisdiction to hear the constitutional challenge to the SEC’s use of administrative proceedings, basing his argument almost entirely on his interpretation of prior Supreme Court decisions. Of note, Judge Droney stated that the SEC’s scheme does not provide meaningful judicial review, because the litigant would be forced to undergo an allegedly unconstitutional proceeding, which is a harm that cannot be undone even if the final SEC order is eventually vacated.

The decision resolved a split among judges in the Southern District of New York, some of whom had held that the district court did not have subject matter jurisdiction to review the propriety of the administrative proceedings, and others who held that jurisdiction did exist.

The party in the matter, Lynn Tilton (and several of her investment firms), may seek a rehearing or en banc consideration (i.e., rather than a 3-judge panel, the appeal would be heard by all 13 active judges).

For more information on the issues in this alert, or securities, futures & derivatives litigation matters generally, please contact:

Howard R. Elisofon at +1 212 592 1437 or [email protected]
Arthur G. Jakoby at +1 212 592 1438 or [email protected]

© 2016 Herrick, Feinstein LLP. This alert is provided by Herrick, Feinstein LLP to keep its clients and other interested parties informed of current legal developments that may affect or otherwise be of interest to them. The information is not intended as legal advice or legal opinion and should not be construed as such.