SDNY Judge Deals Rejects Constitutional Challenge to SEC’s Use of Administrative Proceedings

Posted on April 20, 2015, by Mary P. Hansen, William L. Carr and Jennifer B. Dempsey in Administrative Proceedings. Comments Off on SDNY Judge Deals Rejects Constitutional Challenge to SEC’s Use of Administrative Proceedings

A former executive of Standard & Poor’s (S&P) Rating Services has lost an early constitutional challenge to the SEC’s use of administrative proceedings.

Barbara Duka filed suit in federal court in January, following the SEC’s decision to bring charges against her for violating Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which prohibits fraudulent conduct in the offer and sale of securities. Duka, formerly a co-manager of the commercial mortgage backed securities group of S&P’s Rating Services initiated the suit to prevent her from being compelled to submit to allegedly unconstitutional proceedings. Duka sought a preliminary injunction, arguing that administrative law judges (ALJs) who preside over administrative proceedings, are unlawfully insulated from oversight by the President in violation of Article II of the Constitution. Last week, District Judge Richard M. Berman of the Southern District of New York rejected Duka’s request.

Duka presented her claim as a facial challenged to the constitutionality of SEC ALJ proceedings, which aided the court’s determination that it had subject matter jurisdiction to entertain the suit.

Duka’s constitutional challenge was premised on the argument that SEC ALJs are “inferior officers” protected from removal by at least two levels of good-cause tenure protection and therefore the President cannot oversee ALJs in accordance with Article II. In considering the likelihood of success on the merits of Duka’s constitutional claim, the court rejected the argument that the Supreme Court’s decision in Free Enterprise Fund v. Public Accounting Oversight Board, 561 U.S. 477 (2010), supported the conclusion that SEC administrative proceedings are unconstitutional. In Free Enterprise Fund, the Supreme Court decided that the SEC’s Public Company Accounting Oversight Board created by Sarbanes-Oxley violated Article II because the act provided for dual for-cause limitations on the removal of board members. The Supreme Court held that “such multilevel protection from removal is contrary to Article II’s vesting of the executive power in the President” and that the President “cannot ‘take Care that the Laws be faithfully executed’ if he cannot oversee the faithfulness of the officers who execute them. Id. at 484.

Judge Berman noted that the issue of whether ALJs are “inferior officers” is subject to dispute, but he did not need to resolve that question because it concluded that the level of tenure protection afforded to ALJs was permissible. The court reasoned that the Supreme Court in Free Enterprise Fund addressed the narrow issue of whether Congress may deprive the President of adequate control over the board. The court also noted that ALJs were specifically excluded from the reach of the Free Enterprise Fund holding. Id. at 507 n.10 (“For similar reasons, our holding also does not address that subset of independent agency employees who serve as administrative law judges.”). In addition, the court noted, the decision in Free Enterprise Fund “supports the conclusion that restrictions upon the removal of agency adjudicators, as opposed to agency officials with ‘purely executive’ functions, generally do not violate Article II.” Op. at 19. Here, the court concluded, ALJs perform “solely adjudicatory functions, and are not engaged in policymaking or enforcement.” Id. at 20.

The Duka decision is a setback for defense bar challenges to the SEC’s use of administrative proceedings. As we have written in the previous post: “SEC Faces New Constitutional Challenge to Administrative Proceedings Based on Tenure Protection of Administrative Law Judges,” the SEC has faced a flurry of challenges to the use of administrative proceedings, which provide fewer protections to litigants than those provided in cases brought in federal court. Despite the decision, it is likely that the SEC will continue to face such challenges as they make their way through the federal appellate courts.

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