SEC Insider Trading Case Brought As Administrative Proceeding Enjoined
The SEC’s shift to administrative proceedings in recent months has spawned a series of suits against the agency challenging its forum selection authority. The suits have generally met with little success. Nevertheless, earlier this week, Judge Leigh Martin May, sitting in the Northern District of Georgia, issued a preliminary injunction against the Commission, precluding the agency from proceeding with a hearing in an insider trading case before an SEC administrative law judge. Hill v. SEC, Civil Action No. 1:15-cv-01801 (N.D. Ga. Filed June 8, 2015).
Plaintiff Charles Hill is a self-employed real estate developer. The SEC brought an administrative proceeding in which he was named as a Respondent alleging insider trading. In the Matter of Charles L. Hill, Jr., Adm. Proc. File No. 3-16383 (Feb. 11, 2015). The action centered on the tender offer by NCR Corporation for Radiant Systems, Inc., announced on July 11, 2011 after the close of the markets. The Order alleges that the COO of Radiant tipped a friend about the takeover who in turn tipped Mr. Hill (here).
Mr. Hill claims that he was not tipped. He claims to have purchased the shares based on personal knowledge and experience with the firm’s product and management.
In the administrative proceeding Mr. Hill moved for summary disposition based on three constitutional arguments: 1) That the proceeding violated Article II of the Constitution because ALJs are protected by two layers of tenure protection; 2) that Congress’ delegation of authority to the SEC to pursue cases against non-regulated persons before ALJs violates the delegation doctrine in Article I of the Constitution; and 3) that Congress violated his Seventh Amendment right to a jury trial by permitting the SEC to bring the action in an administrative forum. ALJ Grimes concluded he did not have authority to rule on issues 2 and 3 and probably not on 1, although he denied an Article II claim for removal on the merits. A hearing on the merits was set for June 15, 2015.
The district court complaint requests that the Court: 1) Declare the administrative proceeding unconstitutional for the same reasons asserted in the administrative proceeding; and 2) enjoin the administrative proceeding. That complaint was amended to include a claim that the SEC ALJ’s appointment violated the Appointments Clause of Article II. The Court granted a preliminary injunction based on the Appointment Clause claim, rejecting the others.
The Court first turned to the question of jurisdiction. The SEC claimed that the Court lacked subject matter jurisdiction because the administrative proceeding, with its review by a court of appeals, has exclusive jurisdiction over Plaintiff’s constitution claims. The Court rejected this claim. The SEC’s position “is in tension with 28 U.S.C. Section 1331” which grants the federal district courts original jurisdiction over all civil actions arising under the Constitution, laws or treaties of the U.S. the Court began. To restrict this grant of jurisdiction there must be evidence of Congressional intent. In Free Enterprise. Fund. V. PCAOB, 561 U.S. 477 (2010) the Court held that provisions regarding agency review do not restrict judicial authority unless the statutory scheme evidences “fairly discernible” intent to so limit jurisdiction.
In this case the Court concluded that “Congress’s purposeful language allowing both district court and administrative proceedings shows a different intent . . . there is no language indicating that the administrative proceeding was to be an exclusive forum . . . The SEC cannot manufacture Congressional intent by making that choice for Congress . . .” the Court stated.
To bolster its conclusion the Court considered three factors used in Free Enterprise Fund to analyze the question: 1) If a finding of preclusion could foreclose all meaningful judicial review; 2) if the suit is wholly collateral to a statute’s review provisions; and 3) if the claims are outside the expertise of the agency. Here, all three factors cut against the position of the SEC.
First, while judicial review is available through the administrative process following that path “could foreclose all meaningful judicial review” of Plaintiff’s constitutional claims since Plaintiff would be forced to endure what is claimed to be an unconstitutional process – the claim here does not depend on the outcome of the administrative proceeding but rather challenges that action. Indeed, “[w]aiting until the harm Plaintiff alleges cannot be remedied is not meaningful judicial review” the Court concluded.
The other two Free Enterprise factors also fail to support the SEC’s position. The claims here are wholly collateral to the SEC proceeding because they challenge the action itself, not the insider trading claim. Likewise, the constitutional claims presented are outside the expertise of the agency. Accordingly, the Court concluded that it has jurisdiction.
Turing to the merits of the claim for a preliminary injunction, the Court focused on the likelihood of success on the merits. The non-delegation claim turns on Article I, Section 1 of the Constitution which vests all legislative powers in the Congress. While Congress can delegate its decision making power to agencies it must by legislative act specify an “intelligent principle to which the person or body authorized to [act] is directed to conform.” Plaintiff claims this Article was violated because Dodd-Frank gave the SEC unfettered discretion to select the forum.
The Court rejected Plaintiff’s Article I claim, concluding that “[w]hen the SEC makes it forum selection decision, it is acting under executive authority and exercising prosecutorial discretion.” This is similar to the Court’s decision in U.S. v. Batchelder, 442 U.S. 114 (1979) which rejected a non-delegation challenge where the power Congress delegated to the official was no broader than the authority they routinely exercise in enforcing the law. The same is true here.
The Court also rejected Plaintiff’s Seventh Amendment claim. Mr. Hill argued that the SEC decision to prosecute the claims against him in an administrative proceeding rather than in district court deprived him of his Seventh Amendment right to a jury trial. While the SEC did not dispute the fact that if the case was brought in district court Mr. Hill would have been entitled to a jury trial, the Court rejected the claim based on Atlas Roofing Co. v. Occupational Safety & Health Review Commission, 430 U.S. 442 (1977). That case held that the “’Government could commit the enforcement of statutes and the imposition and collection of fines to the judiciary, in which event jury trial would be required . . ., but  the United States could also validly opt for administrative enforcement, without judicial trial.’” Atlas Roofing thus dictates that the Seventh Amendment claim be rejected.
Finally, the Court sustained Plaintiff’s claim under Article II of the Constitution that the AlJ’s appointment violated the Appointments Clause because he was not appointed by the President, a court of law, or a department head. The resolution of this question hinged on whether the ALJ was an inferior officer as claimed by Plaintiff or an employee as alleged by the SEC.
The Appointments Clause creates two classes of officers, the Court noted. One group is principal officers selected by the President with the advice and consent of the Senate. The other group is inferior officers who can be appointed by the president, heads of department or the Judiciary. The Clause applies to all agency officers, including those who function predominantly in quasi judicial and quasi legislative roles.
The critical question is whether the official exercises significant authority. If so, the official is an inferior officer. SEC ALJs are inferior officers, the Court concluded. To reach this conclusion the Court analyzed the duties of an SEC administrative law judge. The fact that they do not ultimately have the authority to issue a final order was not determinative. Rather, what proved critical is the fact that the office is established by law and the duties, salary, and means of appointment are specified by statute. The positions are permanent. In addition, ALJs take testimony, conduct trials, rule on the admissibly of evidence and can issue sanctions. Accordingly, and SEC Administrative Law Judge exercises significant authority. Thus they are inferior officers. Nevertheless, they are not appointed in accord with the Appointments Clause. Rather SEC ALJs are hired by the Commission’s Office of Administrative Law Judges in consultation with the Chief ALJ, human resources and OPM. Based on this conclusion the Court entered the preliminary injunction.
Hill stands out in a group of cases challenging the SEC’s right to select the forum in which it will bring an enforcement action. There is little doubt that the forum selection decisions of the agency have a significant impact on the rights of those named in its enforcement actions. In Hill, for example, the selection of an administrative forum deprived Mr. Hill of a right to a jury trial. The procedure limitations of the administrative forum can also have a significant impact on the ability of a party named as a Respondent to effectively defend the action.
Despite the impact of the forum selection decision, to date the courts have generally rejected challenges to the SEC’s unfettered discretion. At best Hill represents a temporary set-back for the agency. As the Court noted, the constitutional violation is easily remedied. At the same time, if the determination in Hill is sustained on appeal and the SEC is required to amend the appointment process for ALJs the real question may become whether the decision has retroactive effect, invalidating other administrative proceedings.