Developments in SEC Administrative Proceedings: An Evaluation of Recent Appointment Clause Challenges, the Rapidly Evolving Judicial Landscape, and the SEC’s Response to Critics

DEVELOPMENTS IN SEC ADMINISTRATIVE PROCEEDINGS: AN EVALUATION OF RECENT APPOINTMENT CLAUSE CHALLENGES, THE RAPIDLY EVOLVING JUDICIAL LANDSCAPE, AND THE SEC’S RESPONSE TO CRITICS Philip J. Griffin* The Dodd-Frank Wall Street Reform and Consumer Protection Act bestowed upon the Securities and Exchange Commission the right to pursue an enforcement action against any person either in federal court or through an administrative proceeding. Since 2012, the SEC has chosen to pursue an unprecedented percentage of its enforcement actions administratively, and it has prevailed in those administrative proceedings at a much higher rate than in federal court. Since mid-2015, administrative respondents have begun turning to the federal courts for relief, alleging that administrative law judges, the SEC employees who preside over administrative proceedings, are appointed in violation of Article II’s Appointments Clause and therefore have no lawful authority to hear cases. The challengers found early success in a number of district courts, both in establishing subject matter jurisdiction and in securing preliminary injunctions on the merits. Between August 2015 and December 2016, however, the momentum quickly shifted in favor of the SEC. Five federal appellate courts—the Second, Fourth, Seventh, Eleventh, and D.C. Circuit Courts of Appeals—have all found that the federal courts lack subject matter jurisdiction to hear challenges addressing an ALJ’s constitutional authority to preside over an enforcement action until the respondent has exhausted all administrative remedies provided by the relevant statute. In other words, the appellate courts have held that an administrative respondent may not collaterally attack the constitutionality of an administrative proceeding in federal court before the administrative proceeding is complete—rather, the administrative respondent must wait * J.D., 2016, University of Pennsylvania Law School. I would like to thank the Honorable Cheryl Ann Krause of the United States Court of Appeals for the Third Circuit and Mary Mulligan of Friedman Kaplan Seiler & Adelman LLP for their invaluable guidance in shaping the topic and execution of this Article. 209 210 U. OF PENNSYLVANIA JOURNAL OF BUSINESS LAW [Vol. 19:1 for an adverse ALJ decision, appeal that decision directly to the full Commission, and only then, once the administrative proceeding has concluded, may the respondent seek judicial review through a proper federal court of appeals. While the jurisdictional question is now all but settled, the merits question is very much alive. In August 2016, the United States Court of Appeals for the D.C. Circuit, the first federal appellate court to rule on a fully ripe Appointments Clause challenge, held that SEC ALJs are mere employees of the SEC, not “inferior officers” within the meaning of Article II, and thus do not trigger Article II’s protections. The D.C. Circuit’s decision represented a significant victory for the SEC. In December 2016, however, the United States Court of Appeals for the Tenth Circuit came to the opposite conclusion, holding that SEC ALJs are unconstitutionally appointed inferior officers and creating a significant circuit split worthy of Supreme Court review. While the judicial landscape continues to rapidly evolve, administrative respondents seeking to challenge ALJs’ constitutional authority to hear cases should be emboldened by the Tenth Circuit’s decision. Challengers should continue to assert that the SEC’s ALJ appointment scheme violates the Constitution, although they should now wait until the administrative proceeding is complete and should bring the subsequent judicial challenge in the federal court of appeals in the circuit in which they reside, rather than in the D.C. Circuit. This Article encourages courts hearing such challenges to follow the Tenth Circuit, not the D.C. Circuit, and to hold that the SEC’s ALJ appointment scheme violates the protections provided by the Appointments Clause of Article II of the United States Constitution. In addition to the Appointments Clause challenges, the SEC has faced a deluge of criticism from judges, academics, and practitioners over its administrative system as a whole, which many feel gives the Commission an unfair advantage when it decides to pursue an enforcement action administratively. While the SEC has steadfastly refused to reappoint its ALJs in accordance with the Appointments Clause, it has capitulated to the growing criticism by adopting a number of amendments to the Rules of Practice that govern its administrative proceedings and by promulgating guidance regarding forum selection. This Article argues that these concessions are a step in the right direction but that they do not go far enough in leveling the playing field between the SEC and administrative respondents. It also urges the SEC to undertake a number of concrete steps to restore public trust and to protect the constitutional rights of individuals and entities accused of wrongdoing. 2016] DEVELOPMENTS IN SEC ADMINISTRATIVE PROCEEDINGS 211 INTRODUCTION........................................................................................... 211
I.

SEC ADMINISTRATIVE PROCEEDINGS ................................................... 213
A.
Administrative and Federal District Court Proceedings Differentiated ........................................................................... 214
B.
Recent Trends in SEC Enforcement ........................................ 217
II.

CHALLENGES TO THE ADMINISTRATIVE SCHEME ................................ 218
A.
General Criticism ..................................................................... 218
B.
Constitutional Challenges ........................................................ 220
1.
Subject Matter Jurisdiction ................................................ 221
2.
Appointments Clause Violation ......................................... 223
C.
Consequences of a Finding of Unconstitutionality .................. 228
III.

COMMISSION RESPONSES .................................................................... 230
A.
Adopting Amendments to the Rules of Practice...................... 231
B.
Issuing Guidance Regarding Forum Selection ........................ 233
CONCLUSION .............................................................................................. 235
INTRODUCTION With its passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress authorized the Securities and Exchange Commission to seek civil penalties from any person accused of violating the securities laws either in an administrative proceeding or in federal district court.1 Prior to Dodd-Frank, if the SEC wanted to seek monetary penalties from non-regulated entities or individuals, it had to bring its case in federal court. Now, the SEC can bring such cases administratively in its in-house courts in front of its in-house judges. The newfound grant (...truncated)