Tuesday, October 25, 2022

SEC ALJ proceedings still unavailable as court denies rehearing en banc

By Anne Sherry, J.D.

SEC Administrative Law Judge proceedings remain in limbo as the Fifth Circuit opted not to rehear a pivotal case striking down the SEC’s use of the in-house proceedings to adjudicate fraud actions. In May a panel ruled the proceedings unconstitutional by a 2-1 margin, and the full court has now voted 10-6 against rehearing en banc. A dissenting opinion joined by most of the judges who voted for rehearing argues that the panel opinion departed from over 80 years of settled precedent and merits a full review (Jarkesy v. SEC, October 21, 2022, per curiam).

Panel decision. In its May opinion, the panel vacated an SEC administrative decision imposing penalties and other sanctions for securities fraud. The appeals court held that the administrative proceedings violated the petitioners’ Seventh Amendment right to a jury trial and that Congress unconstitutionally delegated to the SEC the power to decide which proceedings should be kept in-house and which should be brought in the courts. The court also ruled that the statutory removal restrictions for SEC administrative law judges are unconstitutional, without deciding whether vacating would be the appropriate remedy for this error alone.

In holding that the administrative proceedings violated the petitioners’ right to a jury trial, the appeals court observed that the Seventh Amendment protects the right to a jury in “suits at common law,” which has been held to include suits with a statutory basis that seek legal remedies with an analog in the common law. Congress may assign actions for administrative disposition if the proceedings center on “public rights,” but the panel majority rejected the SEC’s argument that because the securities statutes are designed to protect the public, that makes them public rights.

As another, independent basis for vacating the SEC’s decision, the court held that Congress unconstitutionally delegated legislative power to the SEC by allowing it to choose to bring cases in Article III courts or in-house. Article I vests all legislative powers in Congress, and the Supreme Court has interpreted this to mean that Congress may grant regulatory power to another entity only if it provides an “intelligible principle” to guide the exercise of that power. Here, determining which subjects of enforcement action get a jury trial and which do not amounts to a delegation of legislative power, the panel majority reasoned. And Congress left the SEC with absolute discretion, providing no guidance at all on exercising the delegated power.

Finally, the panel found a third constitutional defect in the statutory removal restrictions for SEC administrative law judges, although it did not decide whether the removal defect would be fatal by itself. Under Article II, the President must “take Care that the Laws be faithfully executed.” Because SEC ALJs perform substantial executive functions, the President must retain adequate power over their appointment and removal. SEC ALJs can only be removed by the SEC Commissioners if the Merits System Protection Board finds good cause, and SEC Commissioners and MSPB members can only be removed by the President for cause. The court agreed with the petitioners that this is like the two-layer for-cause protection for PCAOB members that the Supreme Court held unconstitutional in Free Enterprise Fund v. PCAOB (U.S. 2010).

Denial of rehearing. Five judges joined in a dissent from the denial of the SEC’s request for rehearing en banc, which the enforcement respondents opposed. Also in agreement with the dissent was Senior Judge Davis, who was the lone dissenting voice on the original panel. Writing for the dissent, Judge Haynes reiterated Judge Davis’s explanation of why the panel was incorrect to conclude that the SEC was enforcing a wholly private right rather than a public one. Although the panel majority relied on dicta in Granfinanciera, S.A. v. Nordberg (U.S. 1989), it overlooked that the dicta applies only when the government is not a party to the case. “Under Atlas Roofing v. OSHA (U.S. 1977) and a fair reading of Granfinanciera, there is no question that the SEC’s enforcement action against Petitioners in this matter for violations of the securities laws involves ‘public rights,’” Judge Haynes wrote.

Regarding the nondelegation doctrine, the majority opinion incorrectly concluded that allowing the SEC to choose between in-house or in-court enforcement proceedings amounted to a delegation of legislative power. The majority borrowed a definition of “legislative power” from a case that did not discuss the nondelegation doctrine and then incorrectly applied it. Judge Davis’s original dissent addressed many real examples of executive actions that alter legal rights but are not considered exercises of legislative power. The government can charge a defendant with a misdemeanor rather than a felony, even though this would deprive the defendant of a right to a jury trial and remove the requirement of a grand jury. And agencies have the discretion not to take any enforcement action at all.

Finally, the dissent attributed the majority’s Article II holding to an incorrect reading of Lucia v. SEC (U.S. 2018) and Free Enterprise Fund v. PCAOB (U.S. 2010). In Lucia, the Supreme Court held that SEC ALJs are inferior officers for purposes of the Appointments Clause. The majority took this to mean that ALJs perform executive functions and therefore the President must retain authority over those functions, including the ability to remove the officer. But the dissent points out that inferior officers can be appointed by the courts and “heads of departments” in addition to the President. Neither the Constitution nor Lucia require that the President alone must appoint ALJs, so the President’s inability to remove them does not render their appointment unconstitutional. Similarly, Free Enterprise addresses inherently executive functions, but an ALJ’s duties are distinctly adjudicatory, Judge Haynes writes. Indeed, if the purpose of removal is to hold officers accountable to the executive, ALJs would not continue to be independent, and the majority’s concern with bias on the SEC’s side would be exacerbated.

The dissenters believe that beyond being wrongly decided, the panel majority opinion is more than worthy of en banc consideration because it upsets precedent and could have ripple effects throughout the executive branch. “Beyond its massive impacts on the directly involved statutes, the opinion’s potential application to agency adjudication more broadly raises questions of exceptional importance,” Judge Haynes writes.

The case is No. 20-61007.