A federal District Judge in the Southern District of New York appears to have conditionally sustained a facial challenge to an administrative enforcement proceeding conducted by Administrative Law Judges (“ALJs”) of the Securities and Exchange Commission. In an August 3, 2015 decision in Duka v. SEC, 1:15-cv-00357, Judge Richard M. Berman held that he had subject-matter jurisdiction to entertain the plaintiff’s application to enjoin the administrative proceedings, that SEC ALJs are “inferior officers” of the United States for purposes of the U.S. Constitution’s Appointments Clause, and that the ALJs at issue had not been appointed by the SEC Commissioners in seeming violation of the Appointments Clause. However, the court gave the SEC seven days to cure the defect “by having the SEC Commissioners issue an appointment or preside over the matter themselves.”

Judge Berman’s decision is the latest installment in litigation throughout the country challenging the SEC’s increasing use of administrative proceedings – rather than the federal courts – to bring enforcement actions especially against persons whom the SEC does not directly regulate.

In January 2015, the SEC brought an administrative enforcement action against a former employee of a credit-rating firm, alleging that she had sought to increase business for the firm by misrepresenting the way the firm issued certain credit ratings. The employee countersued and sought to enjoin the administrative proceeding as unconstitutional because it was overseen by ALJs who allegedly had not been appointed to their positions in accordance with Article II of the U.S. Constitution. Article II, § 2 provides: “[T]he Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.” Most SEC ALJs (including those overseeing the employee’s case) are not appointed by the SEC’s Commissioners but rather obtain their positions through the regular civil-service hiring process.

The court held that it had subject-matter jurisdiction to entertain the employee’s challenge and that the employee was not required to litigate the issue in the administrative proceeding, seek review from the Commission, and then appeal to a Court of Appeals. The court reached this conclusion because (i) the employee was mounting a facial attack on the administrative proceedings, not an as-applied challenge based on the particularities of the case, and (ii) the constitutional issues at stake were not within the SEC’s regular business or expertise.

Judge Berman then ruled that “SEC ALJs are ‘inferior officers’ because they exercise significant authority pursuant to the laws of the United States:” they “take testimony, conduct trials, rule on the admissibility of evidence, and have the power to enforce compliance with discovery orders.”

Having concluded that SEC ALJs are “inferior officers” under the Appointments Clause, Judge Berman held that “the Appointments Clause provides the exclusive means by which inferior officers may be appointed.” For purposes of the Appointments Clause, the SEC is a “Department” of the Executive Branch, and its five Commissioners function as the “Head” of that Department.

While Judge Berman did not definitively rule that the ALJs’ appointment violated Article II, he relied on a May 2015 decision from the Northern District of Georgia holding that because SEC ALJs exercise “significant authority” and are inferior officers, and because they are “not appropriately appointed pursuant to Article II, [their] appointment is likely unconstitutional in violation of the Appointments Clause.” Hill v. SEC, No. 1:15-cv-1801-LMM, 2015 WL 4307088, at *6 (N.D. Ga. June 8, 2015).

Judge Berman also followed the Georgia court’s proposed solution to the potential constitutional dilemma: he reserved judgment for seven days on the plaintiff’s application to enjoin the ALJ proceedings “to allow the SEC the opportunity to notify the Court of its intention to cure any violation of the Appointments Clause” by having the Commissioners either appoint the ALJs or preside over the proceedings themselves. The SEC chose not to accept that offer in the Georgia case; it appealed the ruling to the Eleventh Circuit. We will see how the SEC decides to proceed in New York.

We will continue to monitor this developing story.  We previously wrote about constitutional challenges to SEC administrative proceedings here: