Securities Litigation

Manhattan federal Judge Richard Berman yesterday (August 12) issued a preliminary injunction halting the SEC's administrative action against former S&P executive Barbara Duka, holding the SEC's in-house courts were "likely unconstitutional" based on the way the SEC selects its administrative judges. Earlier this summer, Atlanta federal Judge Leigh Martin May enjoined an SEC administrative insider-trading action against developer Charles Hill for the same reasons. A month later, May enjoined a second SEC action against Atlanta investment-advisory firm Gray Financial. On August 3, Judge Berman refused to dismiss Duka's challenge to the SEC proceeding and gave the agency seven days to indicate whether it would pursue the "easy fix" to the Appointments Clause issue -- simply by having the Commission formally appoint its ALJs as "inferior officers," as required by the Constitution's Appointment Clause. The Commission refused to do so - presumably because it might be an admission that could cast doubt on the legitimacy of many prior administrative actions. The "Appointments Clause" argument has gained traction among challenges to the SEC's administrative forum after it was used to successfully challenge the SEC's Public Accounting Oversight Board in Free Enterprise Fund v. Pub. Co. Accounting Oversight Bd, 561 U.S. 477 (2010). The Appointments Clause 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." Constitution, Art. II, § 2, cl. 2. Thus it requires the President or the Commission itself to appoint "inferior officers," but the SEC selects its ALJs through the civil-service process. The accompanying tenure protections arguably also violate the President's Constitutional removal authority, as Judge Berman held. The Appointments-Clause argument has been raised in a number of challenges, but most refused to consider the issue, holding Courts did not have jurisdiction to decide the issue until after a case wound its way through the administrative process and interim appellate review before the full Commission - only reaching the Courts afterward. Some Courts have felt constrained to decline the issue on that basis, even while holding the challenges had substantial merit. That all changed earlier this summer, when Federal Judge Leigh Martin May enjoined the SEC's administrative insider-trading prosecution against an Atlanta developer. Judge May held SEC ALJs were "inferior officers" and enjoined the Commission from proceeding administratively in that action. The SEC has appealed that decision to the U.S. Eleventh Circuit. The Dodd-Frank Act vastly expanded the SEC's administrative jurisdiction by extending it beyond those affiliated with registered companies (issuers or market participants) and their associated persons. Under Chair Mary Jo White, the SEC has ramped up its use of in-house courts to as much as 81% of the agency's actions last fiscal year (compared with under half in FY 2005). And the SEC's far greater success rate in its in-house Courts - along with procedural differences that arguably disadvantage respondents - has led to robust debate about their fundamental fairness. In fact, former SEC Enforcement Staff, federal judges, the U.S. Chamber of Commerce, and even some Commissioners have called for reforms to the process. The SEC likely will appeal Judge Berman's decision to the United States Second Circuit Court of Appeals, just as it appealed Judge May's decisions to the Eleventh Circuit. The case is Duka v. SEC, No. 15-cv-00357 (USDC - S.D.N.Y.) See also Gray Financial Group. et al. v. S.E.C., 15-CV -492-LMM, Dkt. No. 56 (N.D. Ga. Aug. 4, 20 15); Hill v. S.E.C., No. 1:15-CV-1801-LMM, 2015WL 4307088 (N.D. Ga. June 8, 2015). Thomas K. Potter, III (tpotter@burr.com) is a partner in the Securities Litigation Practice Group at Burr & Forman, LLP. Tom is licensed in Tennessee, Texas and Louisiana. He has over 29 years' experience representing financial institutions in litigation, regulatory and compliance matters. See attorney profile. © 2015 by Thomas K. Potter, III (all rights reserved).