The SEC Suffers a Setback In Its Use of In-House Judges

Prior to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Securities and Exchange Commission’s authority to impose penalties in a case brought as an administrative proceeding was restricted to regulated entities. Dodd-Frank changed that with its Section 929P. The SEC may now impose a civil penalty in an administrative proceeding against any person or company. That means the SEC could use its in-house courts for insider trading cases. The SEC suffered its first major setback in that strategy.

SEC Seal 2

The SEC charged Charles L. Hill with the illegal use of material non-public information in the purchase of Radiant stock. The SEC alleged that Hill was tipped off by Radiant’s COO that the company was about to be acquired by NCR Corporation. Hill bought over 100,000 shares of Radiant and turned a profit of $744,000 in a month.

Hill is a real estate developer and is not a registered with SEC. The SEC chose to use an administrative proceeding instead of federal district court to bring the charges.

Hill fought back.

Hill filed for Temporary Restraining Order against the SEC, seeking to declare the administrative proceeding unconstitutional and to stop the SEC proceedings.

The judge found that the administrative proceeding does not provide meaningful judicial review. The SEC tried to deal with this challenge in the proceeding, but even the administrative judge admitted that the constitutional challenge was outside the SEC’s expertise.

The judge did not agree with Mr. Hill’s non-delegation claim. The SEC was free to chose the forum because Congress properly delegated that choice.

The judge also did not agree with Mr. Hill’s claim that the administrative proceeding wrongfully took away his Seventh Amendment right to a jury trial. Past interpretations of the Seventh Amendment have carved out the position that the jury is not the exclusive fact-finding mechanism for civil cases.

Mr. Hill did succeed in arguing that the administrative proceeding was a violation of the Appointments Clause of Article II of the Constitution.

Under that Clause, the President has principal officers who he or she selects, and are then confirmed by the Senate. There are inferior officers who may be appointed by the President, the heads of departments or the judiciary. The judge agreed that the SEC’s administrative judges are inferior officers.

As inferior officers, the administrative judges must be appointed by the five commissioners of the SEC. The SEC hired the judge in Mr. Hill’s case through its office of in-house judges.

The ruling is a setback for the SEC, but it seems it could be easily fixed. The SEC commissioners could directly make the appointments. That would likely cure the Appointment Clause violation.

The judge did not get to the two levels of tenure argument that might violate the Removals Clause of Article II. That issue is still out there and may be another roadblock to the SEC’s use of administrative judges for contested insider trading cases.