United States: Final SEC Administrative Decision Required Before Appeal To Court

Christine Walz is an Associate in Holland & Knight's Washington D.C. office

Co-author: Rachel Mueller

In a September 29, 2015 decision, the U.S. Court of Appeals for the District of Columbia Circuit affirmed the dismissal of a lawsuit brought by investment advisors who asked the Court to stop the SEC proceedings and to allow for judicial resolution of the enforcement action against them. The D.C. Circuit refused to intervene at this level of the dispute, finding that the investment advisors could not bypass administrative review when the security laws provide "an exclusive avenue for judicial review," which includes appeal from a final SEC decision.

The SEC began an action against the investment advisors and their business partners in March 2013. The SEC alleged that the investment advisors and business partners engaged in fraudulent conduct in violation of the Exchange Act, the Securities Act, the Advisers Act, and the Company Act.  The two business partners settled with the SEC in late 2013, and the SEC approved the settlement in an order that contained findings indirectly referencing conduct by the investment advisors. Publication of these findings in the settlement order and the continuing SEC administrative proceedings against the investment advisors prompted the advisors to seek relief in the United States District Court for the District of Columbia.

The investment advisors sought injunctive and declaratory relief to stop the SEC's administrative proceedings, alleging that the SEC proceedings violated their constitutional rights. Specifically, they alleged (1) Fifth Amendment Due Process violations based on the SEC's theoretical predisposition on their charges, (2) an Equal Protection Clause violation of their right to a jury trial, (3) Equal Protection abuse based on the SEC's discretion to charge the advisors in court or in administrative proceedings, (4) improper ex parte communications between the SEC's enforcement division and its administrative enforcement division under the Administrative Procedure Act, and (5) Due Process claims based on the SEC's failure to disclose certain evidence.

In dismissing the action, the District Court found that it was precluded from considering the constitutional question.  In other words, the investment advisors could only bring their action in court after exhausting all administrative remedies. The D.C. Circuit affirmed, applying a two-part approach established by Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994).  This approach is typically used to determine whether respondents are precluded from bringing an action before the agency issues a final order. 

Under Thunder Basin, judicial review is delayed where (1) Congress "fair[ly] and discernibl[y]" intended litigants to exclusively follow a statutory course for administrative and judicial review, and (2) the type of claim is one that Congress intended to be reviewed under the statutory structure. 

The D.C. Circuit held that, in this case, Congress fairly and discernibly intended to preclude suits by respondents during pending SEC administrative proceedings. Although the applicable law does not explicitly bar jurisdiction, the Court found that, by providing comprehensive and detailed rules dictating the course of administrative and judicial review, it implicitly bars jurisdiction over the action. 

In considering whether Congress intended judicial review of these types of claims, the Court looked at three main factors: (1) whether preclusion would prevent "all meaningful judicial review," (2) whether the respondents' claims were "wholly collateral" to the securities laws' review provisions, and (3) whether the claims are within the administrative agency's expertise.

First, the D.C. Circuit determined that administrative exhaustion would not prevent all meaningful judicial review of the respondents' claims. Specifically, the Court noted that there is no administrative scheme in place here that would require the respondents to "bet the farm" to have their claims heard in a judicial court on appeal from an administrative proceeding. In contrast, the Court examined two cases in which would-be plaintiffs had to "bet the farm" to be heard in court. In one case, the statute governing review only allowed for appeal to a court after an agency denied the plaintiffs' right to remain in the United States and the plaintiffs voluntarily surrendered themselves for deportation. The risk of impending deportation stripped the plaintiffs of an opportunity for meaningful judicial review, so the plaintiffs were allowed to bypass the administrative process set forth in the statute. In a similar case, under the statutory scheme, the plaintiff could have only gained access to judicial courts if it had "erect[ed] a Trojan-horse challenge to an SEC rule" or created a dispute or provoked a sanction. There, the court held that Congress likely did not intend to require a plaintiff to deliberately violate the statute and invite a sanction in order to access a court.

The D.C. Circuit also determined that, under the circumstances, meaningful judicial review would not be thwarted by an inadequate factual record. The SEC's Rules of Procedure provide for adequate development of the record, including through subpoenas for documentary evidence, tangible evidence and witness testimony. If the investment advisors do ultimately appeal an unfavorable Commission finding, the D.C. Circuit can also remand to the agency for further factual development as necessary. So, preclusion of the advisors' claims here leaves open options for meaningful judicial review.

Second, the D.C. Circuit found that the respondents' claims were not wholly collateral to the securities laws' review provisions.  Instead, their claims arose directly from the SEC's administrative enforcement procedures. The advisors pressed the same arguments before the administrative law judge and, on appeal of the administrative law judge's decision, before the full Commission.  This demonstrated that the advisors' claims were not collateral to the review provisions.

The D.C. Circuit highlighted that the advisors should not be able to bypass the administrative proceedings and be heard in a judicial court simply because they frame their claims as constitutional challenges or facial attacks on a statute. Additionally, the advisors do not qualify for judicial review if their only injury is the burden of going through agency proceedings. The advisors have no inherent right to avoid an administrative proceeding, even if the proceeding could moot claims before reaching a judicial court.

Third, the D.C. Circuit determined that the advisors' constitutional claims are within the SEC's expertise. Though the advisors argued that the SEC lacks constitutional expertise, the Court said that the SEC's administrative enforcement bodies have considered claims similar to the advisors' claims "in an unbroken line of decisions" and are equipped to also consider these claims.

The investment advisors must now await the SEC's final order before they will be eligible to appeal to the D.C. Court of Appeals. This case underscores the importance of administrative proceedings and the need for respondents in those proceedings to exhaust administrative remedies. Attempts to bypass the administrative agency's authority in favor of a judicial forum are likely to be carefully scrutinized in the D.C. Circuit. Based on the reasoning in this case, the D.C. Circuit is unlikely to allow for early judicial review unless there is a strong showing that such an appeal is required to prevent irreparable injury.

Jarkesy, Jr.v. S.E.C., Case No. 14-5196 (D.C. Cir. Sept. 9, 2015)

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