D.C. appellate court rejects challenge to SEC administrative proceedings



August 15, 2016

Securities Litigation Alert

Author(s): Matthew T. McLaughlin, Brian T. Kelly

The D.C. Circuit recently became the first appellate court to rule on a constitutional challenge to the SEC’s in-house enforcement actions. This alert discusses what those who may be subject to SEC enforcement actions need to know.

On Tuesday, the U.S. Circuit Court for the D.C. Circuit, in Raymond J. Lucia Cos., Inc. v . SEC,[1] rejected an investment advisor’s argument that in-house enforcement actions by the Securities and Exchange Commission are unconstitutional because the administrative law judges (ALJ) who conduct the hearings in such actions are not appointed by the president pursuant to the Constitution’s Appointments Clause. The D.C. Circuit is the first appellate court to reach the merits of a constitutional challenge to the SEC’s in-house enforcement actions.

Background

The 2010 Dodd-Frank Wall Street Reform and Protection Act significantly expanded the SEC’s authority to pursue enforcement actions in its in-house Administrative Law Courts rather than in federal courts, and the SEC has increasingly relied on administrative proceedings rather than federal court cases to pursue enforcement actions. As we previously noted,[2] in-house proceedings provide far fewer protections to defendants: limited preparation time, restrained access to discovery, the Federal Rules of Evidence are inapplicable and no access to jury trials. Moreover, ALJs are appointed and employed directly by the SEC, not via the Appointments Clause.

In recent years, respondents in SEC administrative proceedings have challenged the constitutionality of the in-house proceedings in court. However, prior to Lucia no circuit court had reached the merits of the constitutional question, instead concluding that a respondent must first exhaust the administrative review process before raising a challenge in federal court.[3]

The Lucia decision

In Lucia, the SEC brought an administrative enforcement action against the respondent investment advisor for alleged violations of the Investment Advisors Act. After the ALJ issued a decision against respondent, the respondent and the SEC’s enforcement division petitioned for review of the ALJ’s decision by the SEC, which the SEC granted. The SEC conducted an “independent review of the record” and imposed the same sanctions as the ALJ. The SEC also rejected the respondent’s constitutional challenge to the administrative proceeding, finding that its ALJs are merely employees, rather than Officers subject to appointment in accordance with the Appointments Clause. The respondent challenged the SEC’s finding before the D.C. Circuit.

As the court explained, the Appointments Clause provides, in relevant part, that the president “shall nominate, and by and with the Advice and Consent of the Senate, shall appoint . . . Officers of the United States.”[4] Further, the United States Supreme Court has held that the Appointments Clause extends to judicial Officers and those of administrative agencies; only employees or other “lesser functionaries need not be selected in compliance with the strict requirements of Article II.”[5] The Supreme Court has also explained that generally an appointee is an Officer, and not an employee, if the appointee “exercises ‘significant authority pursuant to the laws of the United States.’”[6]

The court first concluded that the SEC ALJ position met the threshold requirements of the “significant authority” test—the relevant position was “established by Law” and the position’s “duties, salary, and means of appointment" are specified by statute. Next, relying on its prior decision in Landry v. FDIC,[7] the court examined additional factors it identified in Landry to determine if an appointee is a constitutional Officer instead of an employee: (i) the significance of the matters resolved by the appointee, (ii) the discretion exercised in reaching a decision, and (iii) the finality of those decisions.[8]

The court concluded that because ALJs do not issue “final decisions” of the SEC, they are not Officers subject to the Appointments Clause. Pursuant to the SEC’s regulations, even if the SEC decides not to order a review of an ALJ’s initial decision, the SEC must still issue an order stating that it has decided not to review the ALJ’s decision. The court rejected the respondent’s argument that such a confirmatory order by the SEC is merely a “ministerial formality” and instead emphasized that, per the SEC’s rules, an ALJ’s initial decision becomes final only when the SEC issues a finality order and, therefore, the SEC “must affirmatively act—by issuing the order—in every case.”[9]

Impact of decision

The D.C. Circuit is the first circuit court to consider the constitutionality of the SEC’s in-house enforcement proceedings, but it certainly will not be the last. Indeed, at least two district courts have already determined that the SEC’s proceedings are “likely” unconstitutional.[10] In the meantime, the Lucia decision will likely provide ammunition to the SEC to continue to pursue its enforcement proceedings in its more advantageous home court rather than in federal courts, and respondents will continue to find themselves at a substantial disadvantage. We will continue to monitor constitutional challenges to these proceedings and highlight any circuit split that may arise, which would increase the likelihood that the Supreme Court ultimately resolves this issue.


  1. No. 15-1345, 2016 U.S. App. LEXIS 14559 (Aug. 9, 2016).
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  2. See our prior alert, “SEC changes to its administrative ‘in-house’ proceedings fail to protect fundamental fairness,” available here.
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  3. See Hill v. SEC, No. 15-12831, 2016 U.S. App. LEXIS 10946 (11th Cir. June 17, 2016); Tilton v. SEC, No. 15-2103, 2016 U.S. App. LEXIS 9970 (2d Cir. June 1, 2016);
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  4. Lucia, No. 15-1345, 2016 U.S. App. LEXIS 14559, at *10 (citing U.S. Const., art. II, § 2, cl. 2).
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  5. Id. (quoting Buckley v. Valeo, 424 U.S. 1, 126, 132 (1976)).
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  6. Id.
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  7. 204 F.3d 1125, 1132-1133 (D.C. Cir. 2000).
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  8. Lucia, No. 15-1345, 2016 U.S. App. LEXIS 14559, at *12.
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  9. Id. at *16-17.
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  10.  Duka v. SEC, 124 F. Supp. 3d 287, 289 (S.D.N.Y. 2015); Hill v. SEC, 114 F. Supp. 3d 1297, 1319 (N.D. Ga. 2015).
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The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.

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