A unanimous decision by the U.S. Supreme Court on April 14, 2023, is likely to have far-reaching implications for government agency tribunals. In consolidated cases involving constitutional challenges to two separate agencies, the Supreme Court looked closely at the adjudicative processes of the Federal Trade Commission (FTC) and the Securities and Exchange Commission (SEC). While the Supreme Court did not address merits of the specific constitutional challenges brought by the petitioners, it ruled that, as respondents in administrative proceedings, they could challenge the constitutionality of the agency proceedings in federal court, without enduring the established statutory review schemes customarily utilized by the agencies. The agencies had argued their respective authorizing statutes precluded jurisdiction of the federal district courts.

The Supreme Court’s decision reversed an earlier decision of the Ninth Circuit Court of Appeals in Axon Enterprise v. Federal Trade Commission and affirmed a contrary decision of the Fifth Circuit Court of Appeals in Securities and Exchange Commission v. Cochran. Writing for the Supreme Court, Justice Elena Kagan stated the statutory review schemes set out in the Securities Exchange Act and Federal Trade Commission Act do not displace a district court’s federal-question jurisdiction over the respondents’ far-reaching constitutional claims, thereby giving respondents in enforcement proceedings a green light to proceed directly to federal court.

In each of the cases before the Supreme Court, the respondent had challenged the constitutional authority of the agency to proceed, claiming the agency’s administrative law judge (ALJ) was insufficiently accountable to the president, in violation of the separation-of-powers principle. Both agencies had adopted a process which required a respondent who objected to the administrative proceedings to make his or her claim first with the agency and then, upon a final adjudication, in a federal appellate court. However, the respondent in each case sidestepped the prescribed statutory review process and sought to enjoin the administrative proceedings in a federal district court. In each case, the district court dismissed the claim for lack of jurisdiction, finding that the prescribed statutory review process divested the district court of federal question jurisdiction which would otherwise apply.

On appeal, the Ninth Circuit affirmed the district court’s dismissal of Axon’s constitutional challenge to the FTC’s statutory review process. The Fifth Circuit disagreed as to the comparable claim made by Cochran, finding Cochran’s claim would not receive “meaningful judicial review in a court of appeals, that the claim was “wholly collateral” to the statutory review scheme and that the claim fell outside the SEC’s expertise.” The Court granted certiorari in both cases to resolve the split between the circuit courts and, without addressing the constitutional challenges, concluded neither of the statutory review schemes displaces district court federal-question jurisdiction over the far-reaching claims presented by Axon and Cochran.

Significant Decision Allows SEC Targets to Proceed Directly to Federal Court

In order to fully appreciate the significance of the decision, it is helpful to understand the structural aspects of the adjudicative processes commonly used by federal agencies. For example, one of the SEC’s core missions is investor protection. Market participants are expected to conduct operations in accordance with the comprehensive regulatory regime established by the SEC. The Division of Enforcement plays an important role in carrying out the agency’s mission to protect investors. The division investigates and brings actions against those who violate the federal securities laws and rules. By vigorously enforcing these laws and rules, it furthers the SEC’s efforts to deter, detect and punish wrongdoing in the financial markets, to compensate harmed investors, and to maintain investor confidence in the integrity and fairness of the capital markets.

After an investigation identifies a violation of the securities laws, the SEC has multiple options. It can make a referral to the Department of Justice for consideration of criminal charges, file a civil lawsuit in federal district court or commence an administrative proceeding. When the agency opts for an administrative proceeding, the division will customarily notify the target it is considering filing charges and provide the target an opportunity to contest the charges and possibly settle with the agency. When a settlement does not materialize, the agency will issue an Order Instituting Proceedings and assign an administrative law judge (ALJ) to the case. The administrative forum does not provide a respondent with the fundamental procedural protections offered in federal court. Unlike federal judges who are appointed in accordance with Article III of the Constitution and, as such, part of the Judicial Branch, ALJs are appointed in accordance with Article II of the Constitution, and, as such, are part of the Executive Branch of the federal government.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) expanded the range of penalties the SEC could impose in administrative proceedings. It provided the SEC with the authority to impose civil monetary penalties against persons associated with entities not registered with the SEC. It also provided the SEC with the authority to impose “collateral bars” against individuals, essentially banning them from associating with firms across the entire securities industry rather than a distinct sector of the industry, as was the case under prior law. The “collateral bar” is an extremely severe penalty which is not necessarily reserved for severe misconduct.

Following Dodd-Frank, there has been a noticeable increase in the SEC’s use of its administrative forum. Moreover, statistics confirm the SEC wins more cases when they are adjudicated by the agency in its administrative forum than it does in federal district court. Industry commentators describe a more aggressive enforcement program since Dodd-Frank, and there has been considerable backlash. Now that targets of the SEC’s Enforcement Division can proceed directly to federal district court to challenge the constitutionality of the agency’s forum, the securities industry will eagerly await the results of these challenges.

If you have questions about this legal alert or related matters, please reach out to attorney Patricia C. Foster at (585) 419-8723 and pfoster@harrisbeach.com, or to the Harris Beach attorney with whom you most frequently work.

This alert is not a substitute for advice of counsel on specific legal issues.

Harris Beach has offices throughout New York state, including Albany, Buffalo, Ithaca, Long Island, New York City, Rochester, Saratoga Springs, Syracuse and White Plains, as well as Washington D.C., New Haven, Connecticut and Newark, New Jersey.