(Article from Securities Law Alert, June 2022)
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On May 16, 2022, the Supreme Court announced that it would consider whether a defendant in an ongoing SEC administrative proceeding can sue directly in federal district court to challenge the SEC’s adjudication as unconstitutional—on the ground that the SEC’s in-house administrative law judges (“ALJs”) are unconstitutionally protected from removal—or whether the defendant must first complete a lengthy administrative process before being able to challenge the adjudication in federal court.[1] SEC v. Cochran, (No. 21-1239).
The case relates to an ongoing SEC enforcement proceeding against a CPA alleging that she failed to comply with Public Company Accounting Oversight Board (“PCAOB”) auditing standards. While the enforcement proceeding was pending, the defendant CPA filed suit in federal district court to enjoin the proceedings, claiming that SEC ALJs were unconstitutionally insulated from presidential removal. The Fifth Circuit held en banc that the defendant CPA could challenge the constitutionality of the ALJs in district court before undergoing an administrative adjudication, on the basis that the Exchange Act did not “explicitly or implicitly strip” the district court of jurisdiction to hear structural constitutional claims challenging SEC administrative proceedings. Cochran v. SEC, 20 F.4th 194 (5th Cir. 2021) (Haynes, J). Notably, Cochran joins another case, Axon Enterprise v. FTC, 21-86, which is already before the Supreme Court concerning largely the same issue. However, the Ninth Circuit reached the opposite result in Axon, holding that a district court lacks jurisdiction to hear constitutional challenges to ongoing FTC proceedings. Axon Enter. v. FTC, 986 F.3d 1173 (9th Cir. 2021). The Supreme Court has consolidated the briefing schedules for the two cases, but the cases will be argued separately.
The Fifth Circuit Holds That a Claim Challenging the Constitution of the Tribunal Falls Outside of Section 78y of the Exchange Act
The SEC argued before the Fifth Circuit that Section 78y implicitly stripped district courts of jurisdiction to hear structural constitutional claims. However, the Fifth Circuit pointed out that Section 78y provides that only those aggrieved by a final order of the Commission may petition to review that final order. The court observed that the statute does not address those who have not yet received a final order of the Commission or whose claims have nothing to do with any final order that the Commission might one day issue. Concluding that the claim fell outside of Section 78y, the court observed that the CPA’s claim challenged the tribunal’s constitution, not the legality or illegality of its final order.
The Fifth Circuit Concludes That Free Enterprise Fund v. PCAOB Applies
The Fifth Circuit stated that the Supreme Court had already rejected the SEC’s precise jurisdictional argument under Section 78y in Free Enterprise Fund v. PCAOB, 561 U.S. 477 (2010). In Free Enterprise Fund, the PCAOB inspected an accounting firm, issued a report criticizing its auditing practices, and opened a formal investigation. The accounting firm sued in federal district court, seeking a declaratory judgment that the PCAOB was unconstitutionally structured and arguing that the PCAOB’s double for-cause removal protection violated the President’s Article II removal power. The government in Free Enterprise Fund argued that Section 78y deprived the district court of jurisdiction to hear the accounting firm’s constitutional challenges. The Supreme Court disagreed, holding that the text of Section 78y does not expressly or implicitly limit the jurisdiction of the district court. The Fifth Circuit described Free Enterprise Fund as “squarely on point,” and concluded that it foreclosed any possibility that Section 78y strips district courts of jurisdiction over structural constitutional challenges. However, the Fifth Circuit’s conclusion concerning Free Enterprise Fund conflicts with rulings from other circuits, including the Second Circuit, which have concluded that Section 78y implicitly strips jurisdiction over prefinal challenges to enforcement proceedings.[2] The Supreme Court will consider the issue in its upcoming term.
[1] The administrative process includes a full hearing before an ALJ, appeal of the ALJ’s decision to the Commission, and appeal of the Commission’s final order to a circuit court.
[2] See, i.e., Tilton v. SEC, 824 F.3d 276 (2d Cir. 2016) (Exchange Act precluded district court jurisdiction over an Appointments Clause challenge to an ongoing SEC proceeding); Bennett v. SEC, 844 F.3d 174 (4th Cir. 2016) (Section 78y precluded district court jurisdiction over a removal power claim).