Duka v. SEC and the Constitutionality of Administrative Law Judges (Part 1)

Administrative law judges (ALJs) have been around for decades. Moreover, the system of appointment has rarely caused controversy, until now.  

The SEC has traditionally had a choice between bringing actions in federal district court or in administrative courts before an ALJ. The two forums were different, sometime benefiting the SEC and sometimes the defendant. Defendants wanting a jury benefited from actions in federal district court. At the same time, injunctions in district court had collateral consequences and could, for example, be enforced through actions for contempt.  In the case of an AP, the Commission historically had a more narrow set of remedies. For example, until the adoption of Dodd-Frank, the SEC could not obtain penalties against a non-regulated entity. Determining where to litigate, therefore, required the Commission to weigh a variety of factors, with no particular forum having a decisive advantage.  

That, however, has changed.  With the reforms set out in Dod-Frank, one of the notable disincentives to bringing APs for the Commission was eliminated.  Penalties against non-regulated persons were now permitted.  

In addition, district court judges, particularly those in the southern district of New York, seemed a bit less accomodating with respect to SEC enforcement proceedings.  The rejection by Judge Rakoff of the settlement in Citibank was an example. The SEC also had a better track record in APs than in federal district court. In the fiscal year ending Sept. 30, 2014, the SEC won all six litigated APs.  The record in federal district court:  less advantageous (11 trial victories out of 18).  

Whatever the precise reason, the SEC began to make greater use of APs. According to a Cornerstone Report, the SEC traditionally brought about 60% of its cases as APs, a percentage that had increased to 80% in the first half of the 2015 fiscal year.  

While some defendants presumably continued to prefer the administrative forum over federal district court (the collateral consequences are still likely to be less), some did not.  In attacking the use of the APs, defendants began to raise a number of constitutional challenges. There was precedent. In Gupta v. SEC, 2011 WL 2674840 (S.D.N.Y. July 11, 2011), Judge Rakoff allowed a collateral challenge to an AP to go to discovery.

In addition, FEF v. PCAOB, 561 U. S. 477 (2010) provided a possible avenue for challenge.  With ALJs subject to removal only for cause, ALJs at the SEC were subject to a double layer of insulation from the President, an issue similar to the one raised with respect to members of the PCAOB.  ALJs were even referenced in the case. As Justice Breyer noted in dissent:

  • The Court suggests, for example, that its rule may not apply where an inferior officer “perform[s] adjudicative … functions.” Cf. ante, at 26, n. 10. But the Accounting Board performs adjudicative functions. See supra, at 17–18. What, then, are we to make of the Court’s potential exception? And would such an exception apply to an administrative law judge who also has important administrative duties beyond pure adjudication?

For the most part, however, the courts were unsympathetic to these arguments.  The challenges generally failed, sometimes because there was insufficient likelihood of success on the merits and sometimes because the courts declined to hear a collateral challenge, forcing parties to litigate the issue in the AP and have the analysis reviewed by the Commission then the court of appeals.  

The success rate, however, took noticeable turn into positive territory with the advent of challenges under the appointment clause.     

For primary materials in the Duka case, go to the DU Corporate Governance web site.  

J Robert Brown Jr.