SEC In Constitutional Danger Zone Following Several Recent Decisions

• Published date: 06 June 2022
• Subject Matter: Corporate/Commercial Law, Government, Public Sector, Litigation, Mediation & Arbitration, Corporate and Company Law, Constitutional & Administrative Law, Trials & Appeals & Compensation, Securities
• Law Firm: Holland & Knight
• Author: Scott Mascianica, Rich Phillips, Danny Athenour and Brandon Len King

Highlights

• Enforcement practices by the U.S. Securities and Exchange Commission (SEC) have come under constitutional scrutiny recently through a series of opinions and filings with high-level courts including the U.S. Supreme Court and U.S. Court of Appeals for the Fifth Circuit.
• Three matters in particular - SEC v. Cochran Jarkesy v. SEC and Romeril v. SEC - raise unique issues that could challenge some longtime SEC Division of Enforcement procedures and policies.
• How these cases play out could significantly impact not only the SEC's enforcement approach and settlement terms, but also how other federal agencies handle administrative proceedings.

The constitutional spotlight is shining on the U.S. Securities and Exchange Commission (SEC). In the last several weeks, the U.S. Supreme Court agreed to hear a case seeking broader federal jurisdiction for constitutional challenges, the U.S. Court of Appeals for the Fifth Circuit found multiple constitutional infirmities in SEC practice and procedures, and a petition for certiorari was filed seeking to end the SEC's longstanding "gag order" requirement for settlements.

Cochran: Supreme Court Agrees to Consider Jurisdiction for Constitutional Challenges to SEC Procedure

On May 16, 2022, the U.S. Supreme Court granted certiorari in SEC v. Cochran, ¹ a case that questions whether district courts have jurisdiction to consider claims challenging the constitutionality of the SEC's administrative proceedings.²

This case began with an SEC administrative action against a CPA, Michelle Cochran, for allegedly failing to comply with Public Company Accounting Oversight Board auditing standards. The SEC's Administrative Law Judge (ALJ) ultimately imposed fines and banned Cochran from practicing before the SEC for five years. Cochran objected to the Commission's adoption of the ALJ's decision.

Before the Commission ruled on Cochran's objection, the Supreme Court issued its opinion in Lucia v. SEC,³ which held that SEC ALJs are officers of the U.S. under the Appointments Clause, which requires that they be appointed by the President, a court of law or a department head. In response to Lucia, the SEC remanded all pending administrative proceedings for new hearings before constitutionally appointed ALJs. Cochran's case was thus sent back for a rerun before a new ALJ.

At that point, Cochran filed collateral litigation in federal district court to enjoin the SEC's administrative enforcement proceedings against her. Cochran argued the inverse of Lucia. She asserted that because SEC ALJs enjoy multiple layers of "for-cause" removal protection, they are unconstitutionally insulated from the President's Article II removal power. The district court dismissed Cochran's claim for lack of subject-matter jurisdiction, observing that, under 15 U.S.C. Section 78y, "a person aggrieved by a final SEC order may obtain review of it in the federal court of appeals."⁴ That statutory scheme, the district court reasoned, "implicitly divest[ed]" federal district courts of jurisdiction to hear any challenges to SEC proceedings.⁵ Cochran appealed to the Fifth Circuit.

The SEC advanced two primary arguments: 1) in Section 78y, Congress implicitly stripped district courts of jurisdiction to hear constitutional claims; and 2) Cochran's claims were not ripe. The Fifth Circuit, sitting en banc, was not swayed and held that the district court had subject-matter jurisdiction over respondent's removal-power claim.⁶ The court observed that Cochran's removal-power claim fell outside of Section 78y, reasoning that the statute

provides that only "person[s] aggrieved by a final order of the Commission" may petition in the relevant court of appeals to review that final order. The statute says nothing about people, like Cochran, who have not yet received a final order of the Commission. Nor does it say anything about people, again like Cochran, who have claims that have nothing to do with any final order that the Commission might one day issue. Cochran's removal power claim challenges the constitution of the tribunal, not the legality or illegality of its final order. Her injury has absolutely nothing whatsoever to do with a final order, and therefore her claim falls outside of ' 78y.⁷

The Fifth Circuit remanded for further proceedings. The Supreme Court granted the SEC's petition for certiorari. The date for argument has not been set.

Jarkesy: Fifth Circuit Finds Three Constitutional Violations in SEC Procedure

Only two days after Cochran, the Fifth Circuit handed down an opinion that held SEC ALJs were unconstitutionally insulated from presidential removal, among other constitutional infirmities. In Jarkesy v. SEC, the SEC sued Petitioners Jarkesy and Patriot 28 in an administrative proceeding.⁸ The ALJ ruled against Jarkesy, and the Commission affirmed the ALJ's...