Challenges to the constitutionality of SEC proceedings before administrative law judges (ALJs) are nothing new and indeed, we have been monitoring these cases closely in recent years. Resolving a circuit-split in 2018, the United States Supreme Court held in Lucia v. SEC that ALJs are “officers” subject to the requirements of the Appointments Clause of Article II of the U.S. Constitution, which we discussed in our June 2018 client alert on this case.  Lucia v. SEC, 138 S. Ct. 2044 (2018).  The Supreme Court vacated the administrative proceeding in that case, ordering rehearing of the matter before a constitutionally appointed ALJ or by the Commission itself. 

Ensuring that ALJ appointments pass constitutional rigor, however, is not the only issue that has clouded the propriety of SEC administrative proceedings.  A separate, embedded question in Lucia concerning the constitutionality of SEC ALJ removal restrictions was left unanswered by the Supreme Court.  The Supreme Court declined to resolve this issue on the ground that the question had not yet been adjudicated in the courts below.  Its decision to “punt” this question to a later day has left the SEC’s use of ALJs in agency proceedings post-Lucia in a state of flux.    

Not surprisingly, the removal question has gained some traction since Lucia was decided.  Currently, this issue is before the Fifth Circuit Court of Appeals in Cochran v. SEC.  969 F.3d 507 (5th Cir. 2020).  A threshold jurisdictional question, however, has surfaced in Cochran: whether a party may raise a constitutional claim concerning the President’s removal power in federal district court during the pendency of an SEC administrative proceeding. 

A divided panel of the Fifth Circuit held that under the Securities Exchange Act of 1934, 15 U.S.C. § 78(y), a party could not raise such a constitutional challenge until such agency proceeding ends—and only then in the court of appeals. The dissenting Judge would have held that federal district courts retain jurisdiction to resolve certain constitutional claims, such as those that pertain to the President’s removal power.  The panel’s decision is not the last word on this issue in the Circuit.  On October 30, 2020, the Fifth Circuit granted petitioner Cochran’s application for rehearing en banc, potentially setting the stage for Supreme Court review of this jurisdictional issue in the near future. 

Background

This case traces its origin back to April 2016 when the SEC filed an Order instituting Administrative and Cease-and-Desist Proceedings against Cochran and her former employer for allegedly violating the Exchange Act by failing to adhere to certain accounting standards in audits and quarterly reviews that Cochran’s employer had performed.  During the pendency of Cochran’s administrative enforcement action and, in the wake of Lucia, the SEC sought to remedy the constitutional infirmity of its ALJ appointment process.  The SEC “ratified” the existing ALJ’s previous appointments and reassigned all the pending enforcement matters, including Cochran’s, to different ALJs.

Once the new ALJ assumed responsibility over Cochran’s enforcement action, Cochran filed a lawsuit in federal district court on January 18, 2019, seeking to enjoin the administrative proceeding.  The crux of Cochran’s complaint is that the SEC ALJs continue to possess up to three layers of for-cause removal protection in violation of constitutional separation-of-power principles.

On March 25, 2019, the district court dismissed Cochran’s complaint.  Although the court expressed deep concern that Cochran “already has been subjected to extensive proceedings before an ALJ who was not constitutionally appointed . . . and, if she is correct in her contentions, she again will be put to further proceedings, undoubtedly at considerable expense and stress before another unconstitutionally appointed judge,” the court held, consistent with appellate precedent in other Circuits, that “district courts lack jurisdiction over challenges to SEC proceedings, including pre-enforcement attacks on their constitutionality, because Congress intended to divest them of that jurisdiction” under 15 U.S.C. § 78(y) of the Exchange Act.  Cochran v. SEC, 2019 WL 1359252, at *2 (N.D. Tex. March 25, 2019).  Cochran appealed to the Fifth Circuit. 

The Fifth Circuit’s Decision

A divided panel of the Fifth Circuit affirmed the judgment of the district court.  The Court first concluded that the “SEC judicial review scheme” under 15 U.S.C. § 78(y) “exhibits a general intent to deprive district courts of subject matter jurisdiction.”  Cochran, 969 F.3d at 512.  The Court began its analysis focusing on the text of § 78(y), which states, in part, that “[a] person aggrieved by a final order of the Commission . . . may obtain review of the order in the United States Court of Appeals for the circuit in which he resides or has his principal place of business or for the District of Columbia Circuit.” (emphasis added).  Construing this text, the Court reasoned that “the grant of jurisdiction to the aggrieved person’s local circuit or D.C. Circuit only after the issuance of the final order implies that other courts lack jurisdiction.”  Id. at 511.  The Court further noted that the SEC’s statutory enforcement scheme provides further support for the conclusion that district courts lack subject matter jurisdiction.  It observed that because the SEC has the authority to pursue a case in the district court or administratively before the Commission itself or an ALJ, such “power to select the forum would be illusory if defendants could file an action in district court.”  Id. at 512.

The Court’s analysis did not end there.  It also looked to whether Congress specifically intended to “funnel the claim” asserted by Cochran—i.e. the constitutionality of the SEC ALJ removal restrictions—through the statutory review scheme.  The Fifth Circuit examined the three factors enunciated in Thunder Basin Coal Co. vs. Reich that the Supreme Court has held guide this analysis: whether (1) administrative proceedings would foreclose all meaningful judicial review; (2) the suit is wholly collateral to a statute’s review provisions; and (3) the claim is outside the agency’s expertise.  See Thunder Basin Coal Co. vs Reich, 510 U.S. 200, 212-13 (1994); see also Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477, 489 (2010).

The Fifth Circuit determined that all three Thunder Basin factors demonstrate Congress’ intent to limit judicial review of Cochran’s constitutional claim.  First, the Court concluded that meaningful judicial review exists because Cochran can raise her constitutional challenge “to a court of appeals following an adverse agency ruling.”  Cochran, 969 F.3d at 514.  Second, the Court held that Cochran’s constitutional claim is not wholly collateral to the statute’s review provisions because it is “inextricably intertwined with the conduct of the very enforcement proceeding the statute grants the [SEC] the power to institute and resolve as an initial matter.” Id. at 515 (internal citations omitted).  In arriving at this conclusion, the Court declined to consider whether the substance of Cochran’s claims was intertwined with the administrative scheme, but rather examined whether Cochran’s claim arose “as a result of the actions the agency took during the challenged proceedings.”  Id.  Third, in assessing the SEC’s expertise to analyze Cochran’s separation-of-powers claim, the Court held the proper inquiry is not whether the SEC has specific expertise to resolve the constitutional question in play but whether it possesses an expertise to hear the “overall” dispute, which may “obviate the need to address the constitutional challenge.”  Id. at 516 (internal citations omitted).  Based on all these factors, the Court concluded that the district court lacked subject matter jurisdiction to preside over Cochran’s constitutional challenge.   

The Dissent’s View   

Judge Haynes’ dissent had a different take, contending that the Thunder Basin factors support federal district court subject matter jurisdiction.  On the issue of meaningful judicial review, Judge Haynes disagreed with the majority’s view that Cochran must wait until the administrative proceedings runs its course.  Judge Haynes reasoned that Cochran should not be subject “to an adjudicative process in front of an officer who may not have constitutional authority to decide her case, leaving her without recourse if she successfully defends her case” on non-constitutional grounds.  Id. at 520 (Haynes, J. dissenting).  Regarding whether Cochran’s claim is collateral to the statute’s review provision, Judge Haynes analyzed whether the claim is “substantively collateral” to the administrative proceeding.  Under that analysis, Judge Haynes concluded that Cochran’s separation-of-powers claim is substantively collateral because it challenges the “ALJ’s existence within their current structure” and not the “securities laws underlying the administrative proceedings.”  Id.  Judge Haynes also disagreed with the notion that Cochran’s constitutional claim is “inextricably intertwined” with the enforcement proceeding, finding that Cochran’s claim “challenges the structure undergirding the SEC’s administrative system, which transcends any particular proceeding.”  Id.  Finally, as to agency expertise, Judge Haynes concluded that the constitutional question raised by Cochran falls outside the agency’s expertise and is one that a federal district court is better “positioned to address.”  Id. 

Implications

Although the constitutionality of SEC ALJ proceedings remains in limbo, the SEC continues to press forward with these types of enforcement actions and does so successfully.  See Pet. for Reh’g En Banc, at 3 n. 2, Cochran v. SEC, 969 F.3d 507 (5th Cir. 2020) (No. 19-10396) (citing Jean Eaglesham, SEC Wins With In-House Judges, Wall St. J. (May 6, 2015).  Parties wishing to challenge the constitutionality of ALJs presiding over an administrative enforcement action, as Cochran illustrates, face uphill battles vetting such a claim in the federal courts.  Should the Fifth Circuit en banc reverse the panel’s holding that federal district courts lack subject matter jurisdiction over Cochran’s separation-of-powers claim, a pathway toward challenging the ALJ removal restrictions in other circuits may begin to open—potentially teeing this issue up for Supreme Court review.¹  Resolving this threshold jurisdictional issue, however, does not address the underlying substance of the claim posed by Cochran—i.e. whether the statutory SEC ALJ removal restrictions are unconstitutional.  Given the slow-moving nature these issues percolate through the courts and given the SEC’s success rate in proceedings initiated administratively, parties facing administrative enforcement action may opt to focus on the merits early on to determine whether favorable settlement terms can be reached before entering into a “dog-fight” with the SEC on an important, yet ancillary, non-merits constitutional issue that could take years to adjudicate.  Such a strategic decision should not be reached alone, and parties are wise to seek the advice of outside counsel adept at analyzing the strength of the SEC’s substantive claims before deciding how to move forward. 

If you have any questions about this alert, please do not hesitate to contact a member of our team so that we may further assist you.   

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