A win for the financial services industry | The Informed Investor

A win for the financial services industry | The Informed Investor

informed investor sigMay is a busy month for the justices of the U.S. Supreme Court.  Oral arguments have concluded, and the justices are finalizing opinions for the term — majority opinions, concurring opinions and dissenting opinions. Although unanimity among the nine is unusual, the Court’s unanimous decision last month in Axon Enterprise v FTC is likely to have far-reaching implications for government agency tribunals. It is also a win for the financial services industry.

In consolidated cases involving constitutional challenges to two separate agencies, the Court looked closely at the adjudicative processes of the Federal Trade Commission (FTC) and the Securities and Exchange Commission (SEC). While the 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 directly in federal court, without enduring the agency processes. The agencies had argued that their respective authorizing statutes precluded jurisdiction of the federal district courts.

The 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, thereby resolving a split between the circuit courts. Writing for the Court, Justice Elena Kagan stated that 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.

Agency processes

To fully appreciate the significance of the decision for those who may find themselves in an enforcement proceeding before the SEC, it is helpful to understand the structural aspects of the adjudicative processes commonly used by the agency. One of the SEC’s core missions is investor protection. The SEC’s Division of Enforcement plays an important role. Enforcement 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 and to compensate investors who have been harmed.

After an investigation identifies a violation of the federal 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 that it is considering filing charges and provide the target with 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. As a result, administrative proceedings have become the subject of numerous constitutional challenges. As described below, until the issuance of the Axon Enterprise decision, respondents in administrative proceedings have been required to participate in the administrative adjudicative process and have not been able to contest any aspect of the proceeding until a final order of the administrative forum has been issued.

Cochran v. SEC

Michelle Cochran, a certified public accountant and a single mother of two, accepted a part-time position at an accounting firm only to learn shortly thereafter that the founder of the firm was abrasive and dishonest.  Several years after she left the firm, she learned that the SEC had initiated an enforcement proceeding against the founder of the firm, another former employee of the firm and herself. She learned that she had been charged with a rule violation. Just as her hearing was about to begin, Ms. Cochran learned that her former boss had settled his own case and had agreed to testify against her.  The administrative proceeding resulted in a civil monetary penalty and a bar from practicing accounting before the SEC for five years.

As Ms. Cochran was pondering her options, the United States Supreme Court ruled in an unrelated case that the ALJ who had presided over Ms. Cochran’s case had been unconstitutionally appointed.  The SEC then vacated the initial decision against Ms. Cochran and assigned a different, properly appointed, ALJ to retry the case.  Rather than undergoing another administrative ordeal, Ms. Cochran sued the SEC in federal district court, seeking to enjoin the agency’s proceedings on the ground that all ALJs are unconstitutionally insulated from Presidential supervision.  The district court dismissed the case (on jurisdictional grounds) without reaching the merits. Three years later the en banc Fifth Circuit Court of Appeals reversed the ruling of the district court.

Significance of the ruling for the financial services industry

The Court’s decision is significant because it has the potential to reshape the contours of the SEC’s enforcement proceedings which, according to many commentators, have become more and more aggressive in recent years.  There has been considerable backlash.

Enforcement has had the wind at its back since 2010 when Congress expanded the range of penalties that the SEC could impose in administrative proceedings.  That legislation provided the SEC with the authority to impose civil monetary penalties against persons associated with entities that are 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 previously. As Ms. Cochran’s case illustrates, the “collateral bar” is an extremely severe penalty which is not necessarily reserved for severe misconduct.

As Justice Gorsuch stated in his concurring opinion: “Agencies like the SEC and FTC combine the functions of investigator, prosecutor and judge under one roof.  They employ relaxed rules of procedure and evidence – rules they make for themselves.  The numbers reveal just how titled this game is.  From 2010 to 2015, the SEC won 90% of its contested in-house proceedings   compared to 69% of the cases that it brought in federal court.” 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 financial services industry will eagerly await the results of these challenges.

Patricia Foster is a securities law attorney with Harris Beach PLLC.  Her experience in­cludes representation of clients in both registered and exempt securities offerings.  She also has experience in various sectors of the financial services industry, including broker-dealers, investment advisers and investment companies. This column is a collaborative work by Patri­cia Foster and David Peartree. David Peartree is an adviser with Brighton Securities Capital Management, Inc., a registered investment adviser offering fee-only investment and financial planning ad­vice. The information in this column is provided for educational pur­poses and does not constitute legal or investment advice.

© 2023. Patricia C. Foster. All Rights Reserved.