Reforming SEC ALJ Proceedings

University of Michigan Journal of Law Reform Volume 50 Issue 3 Article 14 2017 Reforming SEC ALJ Proceedings Joanna Howard University of Michigan Law School Follow this and additional works at: https://repository.law.umich.edu/mjlr Part of the Administrative Law Commons, Constitutional Law Commons, Courts Commons, and the Securities Law Commons Recommended Citation Joanna Howard, Reforming SEC ALJ Proceedings, 50 U. MICH. J. L. REFORM 795 (2017). Available at: https://repository.law.umich.edu/mjlr/vol50/iss3/14 This Note is brought to you for free and open access by the University of Michigan Journal of Law Reform at University of Michigan Law School Scholarship Repository. It has been accepted for inclusion in University of Michigan Journal of Law Reform by an authorized editor of University of Michigan Law School Scholarship Repository. For more information, please contact . REFORMING SEC ALJ PROCEEDINGS Joanna Howard* This Note considers the current constitutional challenges to SEC administrative proceedings and suggests process reforms to enhance fairness for respondents. Challenges have developed since the Dodd-Frank Act expanded the SEC’s ability to use administrative proceedings. Arguments that there is a pre-existing flaw in the method of appointing administrative law judges provide the most potential for success. The Tenth Circuit’s December 2016 decision against the SEC in Bandimere has created a split, diverging from the D.C. Circuit’s analysis of that question in Lucia.1 Resolution by the Supreme Court may be inevitable. Even if the challengers do ultimately succeed, this will not improve substantially the fairness or efficiency of the process. The SEC’s recent rule changes consist of only limited reform of its rules of practice governing administrative proceedings. This Note suggests addressing fairness and efficiency issues directly, by reforming the SEC’s criteria for selecting cases to pursue in front of its administrative law judges, introducing a right of removal where the SEC alleges fraud, and establishing an affirmative obligation to ensure that the SEC identifies material and potentially undermining evidence to respondents. TABLE OF CONTENTS INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I. CONSTITUTIONAL CHALLENGES TO SEC ALJS . . . . . . . . . . A. Jurisdictional issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B. Inferior officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C. Removals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . D. Appointments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . II. PROCESS REFORM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A. Developing the law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B. Right of removal for fraud . . . . . . . . . . . . . . . . . . . . . . . . . . C. Disclosure obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 796 799 799 803 811 813 816 816 821 826 * J.D. Candidate, 2017, University of Michigan Law School, and former lawyer in the Enforcement Division of the UK Financial Conduct Authority. Although my prior experience conducting investigations did involve close cooperation with the SEC and other U.S. authorities, it is my personal view of the investigation process in general that informs my suggestions for SEC reform in Part II. With thanks to Professor Adam C. Pritchard, Professor William J. Novak, and the editors of the Michigan Journal of Law Reform for advice and assistance in the preparation of this Note. 1. Bandimere v. SEC, 844 F.3d 1168 (10th Cir. 2016); Raymond J. Lucia Cos. v. SEC, 832 F.3d 277 (D.C. Cir. 2016). On February 16, 2017, the D.C. Circuit ordered rehearing en banc in Lucia. Order Granting Rehearing En Banc, 832 F.3d 277. As this Note went to print, the SEC had been granted an extension of time to file a petition for rehearing in Bandimere, but no petition had yet been filed. Order Granting Extension of Time, 844 F.3d 1168. 795 796 University of Michigan Journal of Law Reform [VOL. 50:3 III. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 829 INTRODUCTION The SEC faces a number of challenges to its use of Administrative Law Judges (SEC ALJs), which it has relied on increasingly since the Dodd-Frank Act (DFA) expanded the SEC’s ability to use administrative proceedings.2 These challenges have ranged from equal protection claims in specific cases to arguments that the whole SEC ALJ scheme is unconstitutional. The greatest focus has been on arguments predicated on the contention that SEC ALJs are “inferior officers.”3 These arguments are two-fold: first, following the Supreme Court’s decision in Free Enterprise Fund v. PCAOB,4 ALJs, as inferior officers, should not be insulated by more than one layer of tenure protection. Second, and more convincingly, the appointments process violates Article II—as inferior officers, SEC ALJs should only be appointed by the President, the Courts, or a Head of Department (i.e. the SEC Commissioners); this is not currently the case.5 It has been a long road for the challengers, some of whom commenced their constitutional claims during SEC ALJ proceedings, making interlocutory applications to the district courts. The challengers achieved some early success. In Hill and Duka, district courts in the Northern District of Georgia and Southern District of New York issued preliminary injunctions temporarily halting the SEC’s administrative proceedings, finding sufficient likelihood of success on the merits of the argument that the process for hiring ALJs at the SEC violated the Appointments Clause.6 But other challenges were defeated by a jurisdictional hurdle. Certain district courts, citing a lack of subject-matter jurisdiction, declined to opine on the merits of the constitutional claims. Those courts found that the statutory regime correctly designates the courts of appeal as the appropriate level of review, but only after the conclusion of the ALJ proceedings and review by the SEC.7 2. See Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), Pub. L. No. 111–203, § 929P(a), 124 Stat. 1376, 1862–64 (2010) (codified at 15 U.S.C. § 780). 3. See infra Part I.B. 4. 561 U.S. 477. 5. See, e.g., Hill v. SEC, 114 F. Supp. 3d 1297, 1304–05 (N.D. Ga. 2015), vacated, 825 F.3d 1236 (11th Cir. 2016). SEC ALJs are appointed internally by the SEC’s Office of Administrative Law Judges. See infra note 125 and accompanying text. 6. Hill, 114 F. Supp. 3d at 1320–21; Duka v. SEC, 103 F. Supp. 3d 382, 385 (S.D.N.Y. 2015). 7. See, e.g., Bebo v. SEC, 799 F.3d 765 (7th Cir. 2015). SPRING 2017] Reforming SEC ALJ Proceedings 797 The district court cases have been circulating for some time. Appeals from interlocutory applications on the juri (...truncated)