Trial judges shouldn’t decide if SEC in-house cases unconstitutional – new ruling

March 5, 2015

As the Securities and Exchange Commission follows through with its promise – or threat, depending on how you look at these things – to bring more of its enforcement actions as administrative proceedings before judges employed by the commission, at least a half-dozen defendants have brought constitutional challenges to the SEC’s right to pursue charges outside of federal district court. They’ve asserted two different theories: First, administrative proceedings violate their Seventh Amendment and due process rights because there’s no jury and the evidentiary rules favor the SEC; and second, the entire administrative law judge system violates separation-of-powers doctrine under the U.S. Supreme Court’s 2010 decision in Free Enterprise Fund v. Public Company Accounting Oversight Board.

The good news this week for SEC defendants facing administrative proceedings is that U.S. District Judge Rudolph Randa of Milwaukee believes both constitutional arguments to be “compelling and meritorious.” But the bad news in Randa’s ruling in Bebo v. SEC is bad indeed. The judge dismissed Laurie Bebo’s suit seeking a preliminary injunction to block the SEC from moving ahead with its administrative proceeding against the former CEO of Assisted Living Concepts, concluding that he does not have jurisdiction to resolve the constitutional questions.

Instead, he said, Bebo must raise those arguments with the administrative law judge set to hear her case on April 20, even if she has to do so as an affirmative defense. Then, if she doesn’t like the ALJ’s decision in her case, she can appeal it to the full commission and thereafter to the federal appeals court, Judge Randa said. “This is so,” he wrote, “because Bebo’s claims are subject to the exclusive remedial scheme set forth in the Securities Exchange Act.”

Bebo’s lawyers at Reinhart Boerner Van Deuren had argued that federal district courts have original jurisdiction over constitutional questions. The SEC, represented by the Justice Department, replied that Congress intended for statutory provisions in the Exchange Act to be channeled through the administrative review process and appealed to federal circuits, bypassing U.S. district courts.

Judge Randa is the second federal trial judge to conclude in the past couple of months that he does not have subject matter jurisdiction over a defendant’s constitutional challenge to an SEC administrative proceeding. In December, U.S. District Judge Lewis Kaplan of Manhattan dismissed an injunction case against the SEC by CDO manager Wing Chau, finding that district court “is not an escape hatch to delay or derail an administrative action when statutory channels of review are entirely adequate.” Randa quoted that language from Kaplan’s ruling in the Bebo opinion.

Chau hadn’t raised Bebo’s argument that the ALJ system violates separation-of-powers doctrine, but Randa said the circumstances the Supreme Court addressed in the Free Enterprise decision – which involved appointments to the Public Company Accounting Oversight Board – were distinguishable from Bebo’s case because there was no pending PCAOB action against the petitioners who challenged the board’s membership at the Supreme Court. In Bebo’s case, by contrast, there is a mechanism for her to oppose the constitutionality of the action against her through the administrative process, according to Randa.

The Manhattan U.S. attorney’s office has already cited the Bebo ruling to the judge overseeing yet another constitutional challenge to an administrative proceeding, this one by Barbara Duka, a former Standard & Poor’s managing director facing an enforcement action over ratings of commercial mortgage-backed securities.

If Judges Kaplan and Randa are right, these claims about the unconstitutionality of SEC administrative proceedings are going to have to wait until they get to the federal circuits. That’s going to feel like an awfully long time for defendants.

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