Wednesday, August 26, 2015

Laurie Bebo Must Go Through SEC Administrative Process

By Mark S. Nelson, J.D.

The Seventh Circuit upheld the dismissal of Laurie A. Bebo’s constitutional challenge to the SEC’s administrative enforcement procedures by finding that process will afford her adequate opportunity to get meaningful judicial review if the Commission issues a final adverse order. The panel said nothing in Exchange Act Section 25’s text, structure, and purpose implied that Congress wanted a person already subject to an SEC administrative proceeding to be able to ask a federal district court to shut down the proceeding on constitutional grounds (Bebo v. SEC, August 24, 2015, Hamilton, D.).

The Chicago-based panel is the first federal appeals court to rule on the jurisdictional issues that have plagued the many recent cases seeking to upend the SEC’s administrative law judge regime. Bebo could ask for panel or en banc rehearing of the decision, or she could appeal to the Supreme Court. Bebo’s administrative hearing was expected to end in June after several weeks of testimony. The latest order in the matter set a deadline of September 2 for Bebo and the SEC to work out the details for any exhibits.

Bebo’s case, like others brought against the SEC, has been stuck on the question of district court jurisdiction rather than on the plaintiffs’ merits claims about the SEC’s ALJ regime. The SEC faces at least nine cases in addition to Bebo’s, and appeals in a few of them are pending in the Second and Eleventh circuits with at least the potential to create a split of authority with the Seventh Circuit.

Dodd-Frank and home-court advantage. The SEC alleged in December 2014 that Bebo, the ex-CEO of Assisted Living Concepts, Inc., engaged in books and records violations, made false representations to auditors, and made false disclosures in SEC filings. Bebo unsuccessfully tried to get the federal district court in Milwaukee to stop the SEC’s enforcement proceeding against her.

Bebo’s complaint alleged that the SEC’s ALJ regime violated Article II of the U.S. Constitution by creating too many layers of good cause removal between the president and the ALJs. This merits claim was grounded in principles announced by the Supreme Court in its Free Enterprise opinion and the outcome in that court’s Freytag opinion, which found that special tax court judges were inferior officers. (The SEC has defended itself in Bebo’s case and others by relying on the D.C. Circuit’s Landry opinion, which held the Federal Deposit Insurance Corporation’s ALJs were employees).

Bebo also claimed that Dodd-Frank Act Section 929P amended the securities law in a way that facially infringed her Fifth Amendment rights of due process and equal protection. The 2010 financial reform law made it possible for the SEC to impose civil penalties against unregulated persons in administrative proceedings, which have fewer procedural and evidentiary safeguards than do similar proceedings in federal district courts. Previously, the SEC would have had to bring a matter like Bebo’s in federal court. The SEC’s choice of forum adds to its potential home-court advantage when it opts to bring an administrative enforcement action.

Meaningfulness omnipresent. The Seventh Circuit panel understood the Supreme Court’s seminal Free Enterprise decision to emphasize the omnipresent question of whether an agency’s administrative enforcement regime permitted a respondent to obtain meaningful judicial review. The panel said two other factors are relevant, but they are not “controlling.” Ultimately, Bebo can raise her constitutional claims about the SEC’s ALJs in the either Seventh Circuit or the D.C. Circuit, if the Commission rules against her in a final order.

In reaching this conclusion, the panel rejected Bebo’s expansive view of Free Enterprise which would have given the district court jurisdiction of her case because the outcome does not turn on the truth or falsity of the SEC’s allegations against her, and the case does not “implicate” the SEC’s expertise. The court said the Supreme Court’s teachings in its 2012 Elgin case favored a narrower reading of Free Enterprise, even if Bebo’s view “has some force.”

The Supreme Court held in Elgin that the Civil Service Reform Act of 1978’s statutory review scheme barred a district court from hearing constitutional claims raised by male U.S. treasury employees who had been fired because they failed to register for the selective service as required by the Military Selective Service Act.

The Seventh Circuit drew some lessons from Elgin: (1) the characterization of a claim as facial (as Bebo did) does not automatically get the case into a district court; (2) the jurisdictional question is not dependent on the agency’s authority to decide constitutional claims or whether such claims are beyond the agency’s expertise; (3) the looser procedural and evidentiary rules in administrative proceedings still can afford meaningful judicial review; and (4) the possibility that a respondent in an administrative matter might win and thus never get the chance to assert their constitutional claims in an Article III court does not necessarily cut against a statutory process.

As for the “wholly collateral” issue, the Seventh Circuit noted the Supreme Court’s decisions offer some basis for either of two approaches: (1) emphasize the ties between the administrative allegations and the constitutional merits claims; or (2) examine whether the constitutional claims are just a “vehicle” to shut down the agency’s administrative process.

Several district courts took the first option (based on Free Enterprise) for claims made in the related cases of Hill v. SEC (the judge in Hill recently reached the same conclusion in another case, Gray v. SEC, which the Seventh Circuit did not mention), Duka v. SEC, and Gupta v. SEC. The second option (based on Elgin) prevailed in Tilton v. SEC and in the lower court in Bebo. The SEC has appealed Hill and Gray to the Eleventh Circuit, and Lynn Tilton has appealed her case to the Second Circuit.

Still, the Seventh Circuit said the key Free Enterprise factor is whether an administrative respondent can get meaningful judicial review. According to the panel, even if it assumed Bebo’s claim is wholly collateral, that one omnipresent Free Enterprise factor still would lead the court to find that it is fairly discernable that Congress wanted matters like Bebo’s to go through the administrative enforcement regime. Bebo can still seek federal appellate review of any adverse Commission decision.

As the panel noted at the beginning of its opinion, Bebo can make use of the SEC’s statutory process. “Although Bebo’s suit can reasonably be characterized as ‘wholly collateral’ to the statute’s review provisions and outside the scope of the agency’s expertise, a finding of preclusion does not foreclose all meaningful judicial review.”

The panel later explained that Free Enterprise and another case, McNary, are exceptions: the first because no PCAOB standard was challenged and the plaintiffs there need not have violated a PCAOB rule in order to invoke federal court jurisdiction; the second because the plaintiffs did not have to surrender for deportation to get into federal court.

For good measure, the panel also rejected Bebo’s claim that she was unfairly being asked to defend herself in a costly, unconstitutional administrative proceeding. This argument is an outgrowth of her worry that, depending on how the administrative matter is resolved, she may never get a chance to dispute the validity of the SEC’s ALJ regime.

The panel noted that the Supreme Court’s Standard Oil opinion from 35 years ago counseled against giving administrative respondents easy access to federal district courts merely because the administrative process may be costly. The panel said Standard Oil’s holding “is fundamental to administrative law.”

The case is No. 15-1511.

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