SEC Constitutionality Ruling May Embolden FTC Targets
In this article for Law360, partners Olivia Adendorff, Rich Cunningham and Matthew Rowen discuss the potential impacts of the decision in Jarkesy v. U.S. Securities and Exchange Commission.
In last month's Jarkesy v. U.S. Securities and Exchange Commission decision, the U.S. Court of Appeals for the Fifth Circuit held that aspects of the SEC's structure are unconstitutional.
This consequential holding may have ramifications beyond the SEC — the decision's logic applies with full force vis-a-vis the structure and administrative adjudication processes of other agencies, including the Federal Trade Commission.
Since the late 1990s, the FTC has become increasingly aggressive in pursuing high-dollar cases against some of the largest companies in the U.S.,[1] but during recent years litigants facing the FTC have also become increasingly successful in challenging components of the FTC's authority and practices.
Most notably, last year the U.S. Supreme Court unanimously rebuked long-standing FTC practices in pursuing monetary relief in AMG Capital Management LLC v. FTC. Jarkesy underscores other areas of potential FTC vulnerability and strengthens litigants' arguments challenging the core decision-making structure of the FTC.
Jarkesy began as an SEC administrative enforcement action against the founder of two hedge funds and an investment adviser. The SEC alleged that the defendants violated various anti-fraud provisions of the Securities Act, the Securities Exchange Act and the Advisers Act.
After the commission instituted an administrative enforcement action before an SEC administrative law judge, the defendants sued in the U.S. District Court for the District of Columbia, seeking to enjoin the administrative proceeding based on its alleged unconstitutionality.
But the district court held that it lacked jurisdiction to hear those constitutional claims preemptively, and the U.S. Court of Appeals for the D.C. Circuit affirmed. Back in the administrative proceeding, the ALJ ultimately concluded that the defendants had committed securities fraud, and the SEC affirmed. After the SEC imposed a civil penalty, disgorgement, and a cease-and-desist order, the defendants sought review in the Fifth Circuit.
The Fifth Circuit ruled in the defendants' favor on three constitutional challenges.
First, it held that the statutory removal restrictions on the SEC's administrative law judges, which insulate the ALJs from removal except in narrow circumstances, violate Article II of the U.S. Constitution.
Second, it held that Congress's delegation to the SEC allowing it to pursue enforcement actions either before an ALJ or in an Article III court at its discretion violates the nondelegation doctrine because it confers legislative power without an intelligible principle to guide the exercise of that power.
Third, it held that the particular administrative enforcement proceedings in the case fail to comply with the Seventh Amendment right to a jury trial.
Litigants are likely to make arguments premised on the logic of these first two holdings against the FTC.
ALJ Accountability
The statutory removal restrictions on the SEC's administrative law judges, which the Fifth Circuit held to be unconstitutional under Article II, are essentially identical to the statutory removal restrictions on the FTC's administrative law judges.
In 2010, the Supreme Court held in Free Enterprise Fund v. Public Company Accounting Oversight Board[2] that Article II officers wield executive power unconstitutionally if they are insulated from presidential control by multiple levels of tenure protection.[3]
At issue in Free Enterprise Fund was the Public Company Accounting Oversight Board, or PCAOB. Its members were protected from removal except "for good cause shown," but the president did not get to decide whether "good cause" existed.[4]
Instead, that decision was vested in SEC commissioners, who themselves could be removed only for cause, i.e., for "'inefficiency, neglect of duty, or malfeasance in office.'"[5]
While the Supreme Court had previously upheld a single layer of for-cause-removal protection, it found this dual-layer protection scheme to be "contrary to Article II's vesting of the executive power in the President," because "[n]either the President, nor anyone directly responsible to him, nor even an officer whose conduct he may review only for good cause, has full control over the Board."[6]
In Jarkesy, the Fifth Circuit held that the Free Enterprise Fund analysis yields the same results for the SEC's ALJs. Free Enterprise Fund did not decide whether its holding applied to ALJs, because it was unsettled at the time whether — or which — ALJs are Article II "Officers of the United States."[7]
But the Supreme Court resolved that latter question in 2018, holding in Lucia v. SEC that the SEC's ALJs are Article II officers, not mere employees, because they "hold a continuing office established by law … to a position created by statute" and "have equivalent duties and powers … in conducting adversarial inquiries" as other adjudicators that the court has found qualify as principal officers.[8]
Putting Free Enterprise Fund and Lucia together, the Fifth Circuit held in Jarkesy that the SEC's ALJs are unconstitutionally insulated from presidential control, just like the members of the PCAOB were.
That conclusion followed directly from the Supreme Court's opinions, given that, just like the members of the PCAOB, the SEC's ALJs may be removed only "for good cause established and determined by" someone other than the president — namely, the Merit Systems Protection Board or SEC commissioners — under Title 5 of the U.S Code, Section 7521(a), and MSPB members and SEC commissioners may be removed by the president only for "inefficiency, neglect of duty, or malfeasance in office" under Section 1202(d).
The Fifth Circuit thus held in Jarkesy that the president lacks constitutionally sufficient control over the work of the SEC's ALJs.
The same conclusion appears to apply to the FTC's ALJs — of which there is currently only one. The SEC's ALJs are virtually indistinguishable from the FTC's. Both may be appointed by their respective commissions, under Title 5 of the U.S. Code, Section 3105.[9]
Both "'exercis[e] significant authority pursuant to the laws of the United States.'"[10] Both "take testimony," "conduct trials," "administer oaths, rule on motions, and generally 'regulat[e] the course of' a hearing, as well as the conduct of parties and counsel."[11]
Both are empowered to "make and file initial decisions," which may then be appealed to the respective full commission.[12] And both "have all powers necessary" to "dispos[e] of" the proceedings over which they preside.[13]
There is thus no apparent constitutional difference between the SEC's ALJs and the FTC's. Nor is there any difference in their degree of insulation from presidential control.
Just like the SEC's ALJs, the FTC's ALJs may be removed only "for good cause established and determined by" the Merit Systems Protection Board (or the commission), who in turn may be removed only for "inefficiency, neglect of duty, or malfeasance in office," under Title 5 of the U.S. Code, Sections 1202(d) and 7521(a).
What was true in Jarkesy vis-a-vis SEC ALJs is thus also true vis-a-vis the FTC's ALJs: "Neither the President, nor anyone directly responsible to him, nor even an officer whose conduct he may review only for good cause, has full control over" them, which is "contrary to Article II's vesting of the executive power in the President," according to the Free Enterprise Fund decision.[14] Fund, 561 U.S. at 496.
Selecting Administrative Versus Judicial Enforcement Procedures
The Fifth Circuit held that the Dodd-Frank Act unconstitutionally delegated legislative authority to the SEC by providing it with unfettered discretion to choose whether to file anti-fraud actions administratively or in federal court, in violation of the nondelegation doctrine.
While the court recognized that the Supreme Court has not held that Congress had failed to provide an agency with a sufficient intelligible principle governing a delegation for nearly a century, it saw a difference in kind with the delegation here, as "Congress offered no guidance whatsoever."
The same is arguably true of the FTC. Like the SEC, the FTC has essentially limitless discretion to choose whether to file an administrative complaint or to sue in federal court. If anything, the situation is more pronounced on the FTC side. The FTC, in conjunction with the U.S. Department of Justice, decides whether to keep cases in-house or go to court via a nonpublic clearance process.
Yet the outcome of this black-box clearance process greatly affects the kinds of process afforded to regulated parties. If a case is put on the DOJ track it proceeds in federal district court, where the defendant gets all the procedures and protections that come with an Article III tribunal. Parties put on the administrative-enforcement track, in contrast, do not receive the same protections.
Rather than have their cases heard by an Article III judge, these parties face an ALJ "to whom the Commission, in accordance with law, delegates the initial performance of statutory fact-finding functions and initial rulings on conclusions of law," according to Title 16 of the Code of Federal Regulation, Section 0.14. If a silent statute is unconstitutional, as the Fifth Circuit concluded was the case with the Dodd-Frank Act's delegation, then the FTC process of determining which cases proceed in federal court is similarly suspect.
At the moment, some courts have held these challenges to the FTC's structure and process must wait until after a company in agency enforcement proceedings has lost in the administrative forum. But there is reason to believe that may change in the not-too-distant future.
The Supreme Court recently granted certiorari in Axon Enterprise Inc. v. FTC and SEC v. Cochran, which both present the question of whether federal district courts have jurisdiction to hear challenges to the structure and composition of administrative proceedings before the defendant endures those proceedings. The high court is likely to hear argument in both cases in the fall and issue a decision by next summer.
Either way, companies before the FTC now have strong procedural arguments set forth in Jarkesy that may disrupt enforcement proceedings against them.
Olivia Adendorff, Rich Cunningham and Matthew Rowen are partners at Kirkland & Ellis LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] See, e.g., Twitter (https://www.ftc.gov/business-guidance/blog/2022/05/twitter-pay-150-million-penalty-allegedly-breaking-its-privacy-promises-again); Facebook (https://www.ftc.gov/news-events/news/press-releases/2019/07/ftc-imposes-5-billion-penalty-sweeping-new-privacy-restrictions-facebook); Alphabet (https://www.ftc.gov/news-events/news/press-releases/2019/09/google-youtube-will-pay-record-170-million-alleged-violations-childrens-privacy-law).
[2] 561 U.S. 477 (2010).
[3] Id. at 483.
[4] Id. at 486 (quoting 15 U.S.C. § 7211(e)(6)).
[5] Id. at 487.
[6] Id. at 496.
[7] Id. at 507 n.10.
[8] 138 S. Ct. 2044, 2053 (2018).
[9] I.e., by the Heads of the Departments, see Free Enter. Fund, 561 U.S. at 511; 26 Fed. Reg. 6,191 at §1a, 75 Stat. 837 (Eff. July 9, 1961) (Reorganization Plan No. 4 of 1961).
[10]Freytag v. CIR, 501 U.S. 868, 881 (1991).
[11] Lucia, 138 S. Ct. at 2053 (SEC ALJs); see 16 C.F.R. § 3.42(c) (empowering FTC ALJs to, among other things, "receive evidence," "conduct … hearings," "administer oaths," "rule upon … motions," and "regulate the course of the hearings and the conduct of the parties and their counsel").
[12] 16 C.F.R. § 3.42(c)(9) (FTC); see 17 C.F.R. § 201.360(a)(1) (SEC).
[13] 16 C.F.R. § 3.42(c) (FTC); see 17 C.F.R. §§ 201.111, 200.14(a) (SEC).
[14] Fund, 561 U.S. at 496.
