The Supreme Court Will Review District Court Jurisdiction Over Constitutional Challenges To SEC ALJs | Fifth Circuit Holds SEC ALJ Proceedings Unconstitutional

• Published date: 27 May 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: Kramer Levin Naftalis & Frankel LLP
• Author: Mr Alan Friedman, Dani R. James, Gary P Naftalis, Paul H. Schoeman, John "Luke" Pizzato and Jennifer S. Windom

This alert addresses proceedings in two SEC securities enforcement actions emanating out of the Fifth Circuit. Both pose issues relating to the SEC's power to bring enforcement proceedings in front of in-house administrative law judges (ALJs). In the first, on May 16, the U.S. Supreme Court granted the SEC's petition for certiorari in SEC v. Cochran.¹ The petition asked the Court to address the circuit split recently created by the Fifth Circuit's en banc opinion, holding, contrary to several other circuits, that the Securities Exchange Act of 1934 does not preclude federal district courts from exercising subject matter jurisdiction over constitutional challenges to protections insulating the SEC's ALJs from removal.² In addition to requesting that the Court address this circuit split, the SEC's petition also asked the Court to "hold" the petition "pending the decision of Axon Enterprise [v. FTC]," a second case that raised the issue of federal district courts' subject matter jurisdiction over constitutional challenges to ALJ removal provisions in the Federal Trade Commission Act. The Court, however, heeding the respondent's arguments, granted the petition without awaiting a decision in Axon Enterprise. Both Cochran and Axon Enterprise are now scheduled for oral argument during the October 2022 term,³ and the parties have asked to coordinate the briefing schedules, while keeping oral argument separate.⁴

Second, on May 18, a divided Fifth Circuit panel issued an opinion in Jarkesy v. SEC, holding unconstitutional on three separate grounds ' including the unconstitutional removal protection issue Cochran sought to pursue ' the SEC's administrative law process.⁵ The court concluded that SEC ALJ proceedings are unconstitutional because they deprive defendants of their Seventh Amendment right to a jury trial; the SEC's ability to bring such proceedings in either federal district court or before an SEC ALJ constitutes an unconstitutional delegation of legislative power; and the statutory provisions protecting SEC ALJs from removal are unconstitutional. At present it is not clear how Jarkesy will impact Cochran, but the holdings in Jarkesy raise fundamental questions about the constitutionality of the administrative law process governmentwide.

SEC v. Cochran

Michelle Cochran, the plaintiff in SEC v. Cochran, is an accountant who was subject to enforcement proceedings before an SEC ALJ immediately prior to the Supreme Court's decision of Lucia v. SEC in 2018.⁶ In Lucia, the Supreme Court held that SEC ALJs must be appointed in a manner consistent with the Appointments Clause of the Constitution and that the ALJ in Ms. Cochran's proceedings was unconstitutionally appointed. In response to Lucia, the SEC remanded Ms. Cochran's case for new proceedings before a properly appointed ALJ. Ms. Cochran, however, also alleged that removal protections enjoyed by SEC ALJs were unconstitutional. She then sought to litigate this further constitutional concern in an independent federal court action that she filed in January 2019 in the Northern District of Texas. Ms. Cochran argued that under Free Enterprise Fund v. PCAOB and Lucia v. SEC, the multilayer tenure protection insulating SEC ALJs is unconstitutional.⁷ Free Enterprise Fund scrutinized the statutory regime under which members of the Public Company Accounting Oversight Board (PCAOB) could be removed by SEC commissioners only for cause, while, similarly, the commissioners themselves could be removed by the president only for cause. Free Enterprise Fund held that these two layers of for-cause removal protection intervened with the president's constitutional obligation to "take Care that the laws be faithfully executed" because satisfaction of this obligation required that the president maintain sufficient control over "Officers of the United States," such as PCAOB members. Lucia held that SEC ALJs were also officers of the United States, and as Ms. Cochran's brief noted, Justice Breyer's concurrence in Lucia raised the concern that, after Lucia, the multilevel removal protections insulating SEC ALJs might be unconstitutional under Free Enterprise Fund.⁸

The district court, however, dismissed Ms. Cochran's complaint for lack of subject matter jurisdiction. The court reasoned that 15 U.S.C. '78y permits judicial review of final SEC orders in the courts of appeals and thus implicitly strips district courts of jurisdiction to hear challenges to ongoing SEC enforcement proceedings. The court held that Ms. Cochran was required to raise her constitutional claims in the ALJ proceeding and then petition for review in an appropriate court of appeals. Ms. Cochran appealed the district court's decision, but a divided Fifth Circuit panel initially affirmed the dismissal in August 2020.⁹ Subsequently, Ms. Cochran's petition for rehearing en banc was granted, and on Dec. 13, 2021, the Fifth Circuit sitting en banc held that the federal district courts did have subject matter jurisdiction over Ms. Cochran's constitutional claim.¹⁰ When the Fifth Circuit issued its en banc decision, a petition for certiorari in Axon Enterprise Inc. v. FTC had already been filed.¹¹ That case also raised the question of federal district court jurisdiction over constitutional challenges to removal protections insulating ALJs, in this case ALJs at the Federal Trade Commission (FTC). On Dec. 20, 2021, one week...