Federal Judge Halts SEC Administrative Proceeding On Constitutional Grounds

6/10/2015

In a blow to the in-house administrative proceedings increasingly utilized by the Securities and Exchange Commission, a Georgia federal judge has issued a preliminary injunction based on constitutional grounds that halts a pending administrative action alleging insider trading against a Georgia real estate developer. The Commission filed an in-house action against Charles L. Hill, Jr., on February 17, 2015, alleging that Mr. Hill profited by nearly $750,000 in a series of stock transactions in mid-2011. While the action was scheduled to go to trial next week, Mr. Hill filed an action last month in Georgia federal court alleging that injunctive relief was proper to halt a process that was constitutionally infirm on multiple accounts. While the Commission has regularly defeated similar challenges as it increasingly eschews court proceedings in favor of its in-house process, Mr. Hill’s victory likely marks the first time a federal court has not sided with the Commission. As explained below, however, the victory is likely to be fleeting.

The Commission regularly brings actions against individuals and entities for violations of federal securities laws, and does so either in a federal district court or in an in-house administrative proceeding. The differences between these choices of forum are significant: a district court proceeding is before a federal district judge governed by the rules of evidence and subject to an individual’s constitutional right to a jury trial, while an administrative proceeding is before an administrative judge appointed and employed by the Commission who is not bound by rules of evidence and in which no constitutional right to jury trial exists. While the Commission was initially restricted to bringing administrative actions against only regulated persons, the passage of the Dodd-Frank Act in 2010 authorized the Commission to seek monetary penalties from “any person,” both regulated and unregulated, in an administrative proceeding. Owing to the perceived “home court advantage” and familiarity to Commission lawyers, the frequency of administrative proceedings has exploded in recent years and jumped over 43% from 2012 to 2014.

The Commission instituted an administrative proceeding against Mr. Hill in February 2015, alleging that Hill had traded in the shares of Radiant Systems, Inc. (“Radiant”) based on a tip from a friend of Radiant’s chief operating officer. After Hill purchased over $2 million in Radiant shares, a takeover announcement sent Radiant shares skyrocketing by over 30% and ultimately netted Hill nearly $750,000 in profits. The Commission alleged that Hill committed insider trading in violation of the Securities Exchange Act of 1933, and sought disgorgement and civil monetary penalties.

After an administrative judge ruled that he (and likely the Commission) lacked authority to resolve several constitutional challenges brought by Hill, an action was filed in Georgia federal court seeking an injunction to stop the hearing scheduled for June 15, 2015. In his pleadings, Hill cited three primary bases for his argument: first, that the Dodd-Frank Act violates the non-delegation doctrine in Article 1 of the Constitution by allowing the Commission “unfettered” discretion to select its forum; second, that the choice of an administrative proceeding violated Hill’s Seventh Amendment right to a jury trial; and third, that the appointment of the administrative judge violated the Appointments Clause in Article 2 of the Constitution.

U.S. District Judge Leigh Martin May rejected Hill’s first two arguments, finding that the non-delegation doctrine was inapplicable as Hill had no right to choose the forum and that there was no Seventh Amendment violation because Congress was permitted to assign “public rights” cases where a jury trial might not be compatible to administrative agencies. However, Judge May sided with Hill on his argument that the appointment of administrative judges was at odds with the Appointments Clause. The Appointments Clause covered two classes of officers exercising significant authority pursuant to the laws of the United States, known as principal officers and inferior officers. While the President, with the advice and consent of the Senate, appointed principal officers, inferior officers were appointed by the President, department heads, or the judiciary.

According to Hill, a Commission administrative judge was an inferior officer because he exercised “significant authority pursuant to the laws of the United States. The Commission countered that the administrative judge was simply a “mere employee” based on their Congressional treatment and their inability to issue final orders. Judge May cited Freytag v. Commissioner, a Supreme Court case that concluded a special trial judge of the U.S. Tax Court was an inferior officer, in support of her conclusion that a Commission administrative judge was an inferior officer. Because the Commission administrative judge was not appointed by the President, a department head, or the Judiciary, Judge May found that his appointment was “likely unconstitutional in violation of the Appointments Clause.”

While the decision represents a victory for Hill in delaying his upcoming administrative hearing, Judge May’s decision is not likely to have any beneficial precedential effect for similarly-situated individuals. The decision rejected constitutional arguments with more dire ramifications, and Judge May suggested that the Appointments Clause issue could be addressed in several ways:

“The SEC is not foreclosed from pursing Plaintiff in federal court or in an administrative proceeding before an SEC Commissioner, and thus any small harm which it might face could be easily cured by the SEC itself.”

Additionally, Judge May noted that the Commission could simply have the SEC Commissioner – a department head – issue the appointment and thus cure the deficiency. While it seems likely that the Commission will appeal this decision, the ultimate remedy appears to have already been prescribed to the Commission.

A copy of Judge May’s Order is here.

Jordan D. Maglich is an associate at Wiand Guerra King where he focuses his practice on securities and business litigation, securities arbitration, and white collar defense. You can contact Jordan at jmaglich@wiandlaw.com or 813-347-5100.