The U.S. Supreme Court this week recognized significant limitations on the SEC’s ability to prosecute financial violations using internal administrative procedures rather than federal courts.
While the SEC does have power to accuse, try, and punish parties for violating agency regulations, that authority is not irrevocable and does not prevent the accused from appealing the accusation in federal court rather than complaining to the agency, the Court said in a unanimous decision.
The ruling, handed down April 14, became the latest judicial blow to SEC authority, following a Fifth Circuit decision last May that prohibited the SEC from seeking financial penalties through its in-house administrative law judges (ALJs) rather than through jury trials. A Supreme Court decision last year limiting the ability of the Environmental Protection Agency to regulate greenhouse gas emissions without explicit congressional approval could also affect SEC regulatory efforts, observers have said.
The SEC case decided this week revolves around Michelle Cochran, a Texas-based accountant accused in 2016 of having failed to adequately follow federal accounting processes while working as an auditor for a small firm she left in 2013. The SEC fined her $22,000 during 2017 and barred her for five years from any accounting work regulated by the SEC.
She got another chance to plead her case in front of a different ALJ, after a 2018 Supreme Court decision found that ALJs must be appointed by the president like any other federal judge, rather than being hired by the agency.
At this point, Cochran filed suit in federal court to challenge the constitutionality of the ALJ proceedings, pointing to the fact that even if ALJs were properly appointed, the president could not fire them. This, she argued, is a constitutional flaw that still does not prevent the SEC from prosecuting Cochran and other registrants using a process that is questionable under the Constitution, according to the New Civil Liberties Alliance, which represented Cochran in the case.
In May 2022, the Court combined Cochran’s case with a case brought by Axon Enterprises against the FTC that raised similar issues. It heard oral arguments in November on the question of whether people accused by federal agencies could appeal the accusations in district court and whether they had to wait until the administrative procedures to which they objected were completed before they did.
“The ordinary statutory review scheme,” Justice Elena Kagan eventually wrote in the Court’s majority opinion, “does not preclude a district court from entertaining these extraordinary claims.”
It also does not prevent those accused by federal agencies of appealing to U.S. district courts “challenging as unconstitutional the structure or existence of the SEC or FTC,” she wrote.
The decision confirmed not only that those accused by agencies have the right to appeal to other courts, but also that they don’t have to wait until the administrative process is finished, because being forced to wade through a process they believed to be unjust represented a penalty for people who have been accused but not convicted, Kagan wrote.
A three-pronged test
The Fifth Circuit Court ruling on appeal of the Cochran case in 2021 disagreed with a Ninth Circuit ruling on the Axon Enterprises case against the FTC, which led to review by the Supreme Court, according to a Harvard Law Review analysis that laid out three reasons the Supreme Court gave Cochran the nod, based on a three-pronged test established in an earlier case, Thunder Basin Coal. Co. v. Reich.
Under the Thunder Basin result, courts have to assume a complaint going through a proper statutory scheme – such as the SEC’s administrative legal process – should remain within that context rather than being pushed out to other courts unless leaving it within the administrative process would “foreclose all meaningful judicial review.” The issue also has to involve a constitutional complaint that is integral to the case, and that the claims are outside the agency’s expertise.
“It is a longstanding principle of administrative law that courts will not intervene in an ongoing agency proceeding until that proceeding culminates in a rule or order that imposes sanctions or determines legal rights or obligations,” according to oral arguments made to the Court last November by deputy U.S. solicitor general Malcolm Stewart, as quoted in Courthouse News Service.
The Cochran case satisfied all three requirements, Kagan wrote, because being forced to go through the whole administrative adjudication process removed the possibility of a meaningful review of a complaint about the constitutionality of the ALJ and the SECs administrative process, the resolution of which was also outside the SEC’s sphere of expertise.
The SEC is expert in its evaluation of financial regulation and its violation, but does not provide any special expertise in how to separate legislative, executive and judicial powers of government – all three of which are involved in an administrative process authorized by legislation from Congress, adjudicated by an ALJ appointed by the president to an agency responsible to the executive branch rather than being part of the judiciary.
“The challenges are fundamental, even existential,” Kagan wrote. “They maintain in essence that the agencies, as currently structured, are unconstitutional in much of their work.”
The Court addressed only whether those claims can be brought up in district court, without touching directly on whether the authority of the agencies is constitutional or not, she wrote.
The ruling doesn’t eliminate the ability of the SEC to make regulations, accuse registrants of violating them or adjudicating and punishing violations, according to analysis by law firm Holland and Knight.
The SEC has already cut back drastically on the number of prosecutions it handles exclusively in-house, where it handles regulation-specific accusations against accountants, money managers and other professions that fall within its special sphere of knowledge, while sending accusations of fraud and other, more general claims to be dealt with in district courts, according to attorneys quoted in a Wall Street Journal story from April 14.