(Repeats earlier story with no changes to text)
By Nate Raymond
NEW YORK, Sept 15 (Reuters) - The U.S. Securities and Exchange Commission’s controversial use of in-house judges to enforce federal securities laws is about to undergo a major test.
The 2nd U.S. Circuit Court of Appeals in New York on Wednesday will hear arguments over whether to revive a lawsuit by Lynn Tilton, a private equity chief dubbed the “Diva of Distressed,” to block the SEC from pursuing fraud charges in an in-house administrative proceeding instead of federal court.
Critics say the proceedings are unfair because there are no juries, and defense lawyers have a limited ability to depose witnesses and gather evidence. Some, including Tilton, also say the appointment of administrative judges, who are on the SEC payroll, is unconstitutional.
The SEC charged Tilton, 56, and her Patriarch Partners firm in March with hiding the poor performance of assets underlying three collateralized loan obligation funds that raised over $2.5 billion.
Tilton and Patriarch deny wrongdoing, and have said their investment strategy was consistently disclosed. Should the court not intervene, Tilton faces trial on Oct. 13.
The decision by the 2nd Circuit could prove a major factor in the SEC’s ability to continue pursuing enforcement actions administratively, invoking the 2010 Dodd-Frank law granting it the authority to bring more cases before its in-house court.
The SEC has boosted its percentage of administrative cases to 80.8 percent in 2014 from 69.4 percent in 2013.
Critics said the increase followed a series of prominent jury trial losses for the SEC, including the 2013 insider trading trial of billionaire Mark Cuban.
Many lawsuits challenging in-house proceedings say they violate Article II of the Constitution because administrative law judges qualify as executive branch officers, but enjoy job protections that can make it impossible for the president to remove them.
The SEC contends the judges are merely employees, and in a 3-2 decision, the commission ruled that way on Sept. 3 in an unrelated case.
Some courts, including the federal appeals court in Chicago, have often declined to reach the issue, saying that constitutional challenges must first be made in the administrative proceedings themselves.
In dismissing Tilton’s lawsuit against the SEC in June, U.S. District Judge Ronnie Abrams in Manhattan likewise said she had no jurisdiction, saying Congress had designated the regulator and then a federal appeals court as the “exclusive avenue of review.”
In her appeal, Tilton’s lawyers noted that two federal judges have suggested that the appointment of SEC administrative judges was likely unconstitutional.
Last month, U.S. District Richard Berman in Manhattan blocked the SEC from going forward with an administrative trial against Barbara Duka, a former Standard & Poor’s executive.
Earlier in the year, U.S. District Judge Leigh Martin May in Atlanta blocked two other cases, and said the matter could “easily be cured” if SEC commissioners appointed the judges or presided over the cases themselves.
The SEC has resisted that approach, and is appealing Berman’s and May’s decisions.
Some defense lawyers have said a policy change might be viewed as a concession by the SEC that judges who handled past administrative cases never had constitutional authority.
Jodi Avergun, a lawyer at Cadwalader, Wickersham & Taft, said any change at the SEC could spur challenges to other agencies’ use of in-house proceedings.
“Anything the SEC may do to cure its problems as identified by the courts may have unintentional collateral impact on all other federal agencies that have these hearing officers,” she said.
The case is Tilton v. Securities and Exchange Commission, 2nd U.S. Circuit Court of Appeals, No. 15-2103. (Reporting by Nate Raymond in New York; Editing by Noeleen Walder and Andrew Hay)