Creating a split, en banc 5th Circuit OKs court challenge to SEC proceeding

(Reuters) - A Texas accountant named Michelle Cochran and her lawyers from the New Civil Liberties Alliance pulled off a remarkable feat on Monday: They persuaded the en banc 5th U.S. Circuit Court of Appeals to split with five other federal circuits and allow Cochran to bring a constitutional challenge in federal court to block an administrative proceeding brought by the Securities and Exchange Commission.

The 5th Circuit majority ruled in Cochran v. U.S. Securities and Exchange Commission that Cochran can sue in federal court without waiting for a final determination in the SEC’s enforcement proceeding against her.

That holding directly contradicts precedent from the 2nd, 4th, 7th, 11th and D.C. Circuits, which have all ruled that the Securities and Exchange Act – which explicitly specifies that targets can seek review of final SEC orders in federal circuit courts – implicitly divests trial courts of jurisdiction to hear constitutional challenges to ongoing SEC administrative proceedings.

Those other circuits, the 5th Circuit majority said in an opinion written by Judge Catharina Haynes, relied on a false dichotomy between SEC enforcement actions and investigations that have not yet led to enforcement cases.

In 2010, the U.S. Supreme Court ruled in Free Enterprise Fund v. Public Company Accounting Oversight Board that the Exchange Act did not implicitly strip the federal trial court of jurisdiction to hear an accounting firm’s separation-of-powers challenge to the constitutionality of the oversight board.

But the SEC has managed over the last decade to blunt the impact of Free Enterprise precedent by arguing that the accounting firm wasn't yet embroiled in an enforcement action. The commission has mostly prevailed in insisting that if an administrative proceeding has begun, the statute requires targets to wait for a final SEC order before bringing an appeal in a federal circuit court.

The 5th Circuit majority rejected that distinction as a “difference that lacks meaning.” Like the accounting firm in Free Enterprise, the appeals court said, Cochran might never obtain an adverse final order from the SEC. (She might, for instance, win her case.) So her suit in federal court, the 5th Circuit said, might be her only chance to argue that the SEC administrative law judge system violates Article II by shielding ALJs from removal by the president.

“Hence, just as in Free Enterprise Fund, it remains possible that Cochran will not be able to obtain judicial review over her removal power claim unless the district court hears it now,” Haynes wrote for the majority. “In short, Free Enterprise Fund still controls.”

Seven dissenting 5th Circuit judges warned in an opinion written by Judge Gregg Costa that the majority’s ruling will allow SEC targets to bring all kinds of collateral lawsuits in district court to challenge administrative proceedings against them, including due process or even statutory claims.

“Before today, every court of appeals to consider the question has answered that a person facing an SEC enforcement action may not mount a collateral attack against the agency proceeding in federal district court,” the dissent said. “This holding risks serious disruption of the administrative scheme that the Exchange Act created.”

The majority said in response that its holding was not as expansive as the dissent and the SEC asserted in their predictions of widespread disruption: “This case presents only the issue of whether the Exchange Act divested district court jurisdiction over claims that SEC ALJs are unconstitutionally insulated from the President’s removal power,” Haynes said. She also shrugged off the weight of appellate precedent contradicting the 5th Circuit’s analysis: “The consensus view,” Haynes wrote, “is not always correct.”

The 5th Circuit did not rule on the merits of Cochran’s removal argument. It just established that she can litigate her court case before the now-stayed SEC proceeding takes place.

In a lengthy concurrence joined by five other Republican-appointed judges, Judge Andrew Oldham attacked James Landis, the original architect of the SEC, as an acolyte of President Woodrow Wilson who, in order to counterbalance an expansion in voting rights, sought to vest power in administrative agencies that would “operate in a separate, anti-constitutional, and anti-democratic space — free from pesky things like law and an increasingly diverse electorate.”

An SEC spokesperson declined to comment on Monday’s ruling. It would not be surprising if the commission were to seek Supreme Court review, considering the explicit split between the 5th Circuit and every other appellate court to have opined on similar facts. The Supreme Court is right now considering a case that presents similar questions, albeit in a constitutional challenge to Federal Trade Commission ALJs, in Axon Enterprises Inc v. FTC. That case has been fully briefed since October but has been repeatedly rescheduled for conference. Presumably, Axon will alert the justices about the 5th Circuit’s ruling in Cochran.

“We’ve given Axon a circuit split,” said Cochran counsel Margaret Little of NCLA. “I must say, that was very gratifying to create.”

Little told me she was glad to see the majority opinion acknowledge the toll of “the labyrinth of proceedings” SEC targets must go through when they try to bring constitutional challenges. Cochran, for instance, has already been through a hearing before an SEC ALJ, who ordered her to pay a civil penalty of $22,500. Before the SEC entered a final order in her case, the Supreme Court ruled in 2018's Lucia v. SEC that SEC ALJs were unconstitutionally appointed. That ruling vacated the ALJ initial determination against Cochran – but the SEC reappointed its ALJs and re-initiated an administrative proceeding against the Texas accountant. That’s when she sued in federal court to enjoin the SEC proceeding.

Little also represented another SEC target, former radio host Raymond Lucia, after he successfully contested the appointment of SEC ALJs at the Supreme Court. When the SEC revived its case against him, Lucia sued in federal court in San Diego to challenge ALJs’ removal protections. But after his lawsuit was dismissed, Lucia settled rather than gird for more years of litigation.

“That’s the terrible injustice of these never-ending proceedings,” Little said.

Read more:

5th Circuit to decide en banc if constitutional challenge can block SEC administrative proceeding

Radio host Ray Lucia settles with SEC but war over ALJ removals wears on

Our Standards: The Thomson Reuters Trust Principles.