Friday, January 24, 2020

Supreme Court urged to address "reasonable grounds" exception to administrative exhaustion

By Rodney F. Tonkovic, J.D.

A new petition for certiorari asks the Supreme Court to address exceptions to the requirement that administrative remedies be exhausted. The Tenth Circuit found "no reasonable" grounds to excuse the petitioner's failure to raise an Appointments Clause objection before the SEC. The Tenth Circuit's reasoning conflicts with other circuits' more lenient standards, the petition says, urging the court to reconcile these disparate outcomes (Malouf v. SEC, January 17, 2020).

Commissions scheme. Petitioner Dennis Malouf is the former CEO and majority owner of an investment adviser, UASNM, Inc. Before 2008, he also owned the branch office of a broker-dealer, but sold the branch in order to eliminate conflicts of interest. The sale was financed by installment payments based on the branch's collection of securities-related fees. Malouf then directed execution of trades for UASNM clients to that branch, in order that the purchaser could collect enough in commissions to pay Malouf.

In 2014, the SEC initiated enforcement proceedings against Malouf, asserting that he violated the securities laws by failing to disclose conflicts of interest arising from the (also undisclosed) payment agreement. Later, an administrative law judge found that Malouf's actions had violated the antifraud provisions of the federal securities laws and that he had aided and abetted UASNM's violations. In addition to a cease-and-desist order, the ALJ imposed associational and officer/director bars and the payment of a civil penalty. On appeal, the SEC agreed, but added a lifetime industry bar and ordered disgorgement plus prejudgment interest.

Appeal. On appeal to the Tenth Circuit, Malouf argued, among other positions, that the appointment of his administrative law judge violated the Constitution's Appointments Clause. Malouf explained that he did not argue an Appointments Clause objection before the SEC because doing so would be futile: at the time, he said, the Commission's public position was that ALJs were not "inferior officers" and did not have to be appointed under the Appointments Clause. The court rejected the futility argument, stating that, at that time (September 2015, immediately before Lucia), the Commission would not necessarily have rejected an Appointments Clause challenge. And, while the Tenth Circuit and U.S. Supreme Court later held that SEC administrative law judges are inferior officers subject to the Appointments Clause, the court said that neither case changed the law but instead merely applied the reasoning behind the Supreme Court's 1991 opinion in Freytag to SEC ALJs.

"Reasonable grounds." The petition notes that many statutes require administrative exhaustion in order to preserve and issue for review by a federal court. The Exchange Act and Investment Advisers Act, for example, require exhaustion, but contain an exception if there are "reasonable grounds" for failing to urge the objection before the Commission. There is no uniformity among the lower courts, however, as to what constitutes "reasonable grounds" and other similar exceptions, leading to a "thicket of inconsistent case law" resulting in "an irreconcilable disparity of outcomes."

The petition urges the Court to apply reasoning from the D.C. and Sixth Circuits to Malouf's case. In a 2013 decision, the D.C. Circuit held that an exception for "extraordinary circumstances" in the National Labor Relations Act excused the failure to raise an objection to a recess appointment because that objection went to the NLRB's power to act and implicated "fundamental separation of powers concerns." In short, "the seriousness of the objection, or a constitutional infirmity of the tribunal, in and of themselves, are 'extraordinary circumstances' irrespective of whether the objection could have been asserted before the agency,” the petition maintains. A 2018 case from the Sixth Circuit found "extraordinary circumstances" in the absence of directly applicable case law. A different outcome would have been reached in these circuits, the petition says, and the Court should provide guidance to unify the lower courts' reasoning.

The petition goes on to argue that there were indeed "reasonable grounds" in Malouf's case based on the Commission's litigation conduct from 2014-2018. The Commission's vigorous opposition to Appointments Clause challenges to its ALJs was a matter of public record before it filed its proceeding against Malouf, and there was no judicial support for an objection. The Commission did not change its position until 2018, long after Malouf had appealed to the Tenth Circuit. The agency would certainly have denied any objection in 2015, the petition contends.

Claims processing. The petition argues further that the exhaustion requirement in the Securities Act (which has no express exceptions) is a "claims-processing" rule, as opposed to a jurisdictional condition. If a condition is jurisdictional, the court has no authority to hear the matter, but enforcement of a claims-processing rule is dependent on a party's litigation conduct. Malouf argues that the Securities Act's exhaustion requirement is a claims-processing rule since there is no clear statement that the provision is jurisdictional and due to the fact that there are express exceptions in all the other securities laws. The Tenth Circuit, the petition says, effectively treated the provision as a jurisdictional condition. No court has directly addressed this issue.

Finally, there is disagreement among the lower courts as to whether claims-processing rules are subject to equitable exceptions. The Supreme Court has noted this fact, the petition observes, but has not itself reached the issue. The Court should grant this petition to answer whether the exhaustion requirement in the securities laws is subject to equitable exceptions; such as, futility, changes in law, and miscarriage of justice, the petition says.

The petition is No. 19-909.