D.C. Circuit Rejects Constitutional Challenge to SEC In-House Courts

Ruling is Likely to End the Tactic of Seeking Court Injunctions to Stop SEC In-House Cases The SEC’s increasing use of in-house courts has drawn criticism as a cynical ploy to increase its chances of winning while avoiding protections available to defendants in federal court – resulting in several constitutional challenges.[1] But the U.S. Court of Appeals for the D.C. Circuit has rejected a Constitutional challenge to the SEC’s use of in-house courts under the Appointments Clause, in Raymond J. Lucia Companies v. S.E.C., (D.C. Cir., Aug. 9, 2016). The SEC’s winning percentage in in-house courts has been 90%, compared to 69% in federal court contested cases.[2] Thus, defendants have challenged the constitutionality of SEC in-house courts to force the SEC into federal court. The D.C. Circuit’s Lucia ruling likely brings an end to this defense tactic, and means the SEC’s increasing use of in-house courts is here to stay.

In Lucia, an investment adviser challenged the constitutionality of SEC in-house proceedings under the Appointments Clause, Article II § 2 clause 2 of the U.S. Constitution, which requires that any “inferior Officer” of the U.S. government be appointed by the Head of a Department, who him-or-her-self was appointed by the President. The purpose of this requirement is to ensure that inferior officers who wield significant legal authority are appointed by an officer who was appointed by the President, who is directly accountable to the people.[3] The Lucia adviser argued that SEC in-house proceedings violate the Appointments Clause because the Administrative Law Judges (“ALJs”) presiding over the proceedings are not appointed by the head of the SEC (i.e., the Commissioners). Instead, ALJs are appointed by the SEC’s Chief ALJ, based on input from the U.S. Office of Personnel Management.

The D.C. Circuit rejected the challenge, ruling that SEC ALJ’s are not inferior Officers subject to the Appointments Clause because their decisions are not final and are subject to full review by the SEC Commissioner, who control the record and can reject any findings. Lucia, slip op. at 12-13, 16. First, the Court concluded that ALJ rulings can only become final when the Commission issues a “finality order” declaring the ALJ’s decision final, or issues its own ruling affirming the ALJ’s ruling on appeal.[4] In every case, the Commission must affirmatively take action to make an ALJ decision final. Second, the Commission has the right (even on its own motion) to review ALJ decisions findings and conclusions de novo – i.e., anew, without any deference – and even make its own findings.[5] Thus, the Court ruled that SEC ALJs are merely employees – not inferior officers – who do not fall within the scope of the Appointments Clause.

Importantly, the Lucia ruling likely means the end for the defense tactic of seeking Court injunctions based on Constitutional challenges to stop SEC in-house cases. D.C. Circuit rulings in this area of administrative law are usually given great weight, because the Court has “far more extensive” experience in this area than “other circuits.”[6] Indeed, a prior D.C. Circuit decision finding FDIC in-house proceedings and ALJ’s constitutional has been cited approvingly by the U.S. Supreme Court.[7]

Moreover, the Second, Seventh, Eleventh, and D.C. Circuits have all rejected preliminary injunctions to stop SEC in-house cases based on the Appointments Clause, on the ground that the issue can be adequately addressed on appeal after an SEC in-house case is over.[8] Those courts all ruled that Congress intended, under 15 U.S.C. § 78y, for such constitutional claims to be resolved first in the SEC in-house court, and then reviewed on appeal in federal court. Thus, even if another court could disagree with the D.C. Circuit’s decision in Lucia, it still would almost certainly not issue an injunction to stop the SEC in-house case but rather wait for an appeal after the SEC in-house ruling. By that time, the reputational harm to an industry professional from losing in SEC in-house court may be irreparable.

Accordingly, industry professionals faced with an SEC investigation should retain counsel with successful experience in SEC in-house cases. The Lucia decision will only embolden the SEC to bring more cases in-house before an SEC ALJ. Sadis & Goldberg LLP has successfully litigated in the SEC’s in-house court, including winning a rare victory at the summary disposition stage dismissing a major part of an SEC insider trading case.[9] We thus encourage clients facing an SEC investigation to contact us to build a successful defense.

[1] See, e.g., J. Eaglesham, “S.E.C. is Steering More Trials to Judges it Appoints,” Wall St. J. (Oct. 21, 2014), available at http://www.wsj.com/articles/sec-is-steering-more-trials-to-judges-it-appoints-1413849590. [2] J. Eaglesham, “S.E.C. Wins with In-House Judges,” Wall. St. J. (Mar. 6, 2015), http://www.wsj.com/articles/sec-wins-with-in-house-judges-1430965803. [3] Freytag v. Comm’r of Internal Rev., 501 U.S. 883-84 (1991). [4]Id. at 12-13 (citing 15 U.S.C. § 78d-1(c) and 17 C.F.R. §§ 201.360(d)(2), 201.411(c)). [5] Id. at 16 (citing 17 C.F.R. § 201.411(a)). [6] Chief Justice John G. Roberts, Jr., “What Makes the D.C. Circuit Different? A Historical View.” 92 Va. L. Rev. 375, 389 (May 2006). [7]Free Enter. Fund v. PCAOB, 561 U.S. 477, 507 n. 10 (2010) (citing Landry v. FDIC, 204 F.3d 1125 (C.A.D.C.2000)). [8]Hill v. S.E.C., — F.3d —-, 2016 WL 3361478, at *13 (11th Cir. June 17, 2016); Tilton v. S.E.C., — F.3d —-, 2016 WL 3084795, at *11 (2d. Cir. June 1, 2016); Jarkesy v. S.E.C., 803 F.3d 9, 12-13 (D.C. Cir. 2015) Bebo v. S.E.C., 799 F.3d 765, 775 (7th Cir. 2015). As of this writing, the time to seek review of Hill and Tilton has not expired. Other constitutional challenges to the SEC’s in-house courts have been even less successful. [9]S.E.C. Ad. Pro. Rulings Rel. No. 2309, Ad. Pro. File No. 3-16178 (Feb. 12, 2015)., available at https://www.sec.gov/alj/aljorders/2015/ap-2309.pdf.


Cheryl Spratt