When authorizing an enforcement action, the U.S. Securities and Exchange Commission (SEC or Commission) typically has discretion to choose whether to bring a civil action in federal district court or an administrative proceeding before an administrative law judge (ALJ). When the SEC chooses to bring an administrative proceeding, the Securities Exchange Act of 1934 (Exchange Act) and the rules promulgated thereunder require the respondent to appeal an adverse decision by an ALJ to the Commission before petitioning a federal appellate court for review. But on April 14, 2023, the U.S. Supreme Court held that a respondent in an administrative proceeding may bring a collateral attack on the constitutionality of the proceeding itself in federal district court rather than follow the judicial review process set forth in the Exchange Act. See Axon Enterprise, Inc. v. Federal Trade Commission, Securities and Exchange Commission v. Cochran, Nos. 21-86 and 21-1239, 598 U.S. ____, slip op. (2023) (Cochran).
Although the Supreme Court in Cochran decided merely a procedural question of federal court jurisdiction, it may open the floodgates to collateral attacks by respondents to pending administrative proceedings and mire the SEC in litigation. As such, Cochran represents another lost battle in the SEC's ongoing war to preserve its administrative proceedings against constitutional challenges brought by respondents to enforcement actions. Moreover, as discussed below, the Supreme Court has now been presented with another opportunity to resolve substantive questions about the constitutionality of SEC administrative proceedings.
Background of Cochran
In 2016, the SEC issued an order instituting administrative and cease-and-desist proceedings against a CPA, Michelle Cochran, and others for alleged violations of auditing standards in connection with public company audits. After a hearing, an SEC ALJ issued an initial decision finding Cochran liable, and she petitioned the Commission to review the ALJ's decision.
During the pendency of Cochran's administrative proceeding, the Supreme Court decided Lucia v. SEC, 138 S. Ct. 2044 (2018), which was a constitutional challenge to the manner in which SEC ALJs were appointed. In Lucia, the Court ruled against the SEC, holding that SEC ALJs are "officers" within the meaning of the Appointments Clause of the Constitution and, accordingly, were required to have been appointed by the President of the United States, the courts of law, or the Commission. The government in Lucia also asked the Court to decide whether statutory restrictions on the removal of SEC ALJs were constitutional, but the Court expressly declined to do so because that question had not yet been addressed by the lower courts.1
In response to Lucia, the Commission ratified the prior appointment of the agency's ALJs and provided all respondents to pending administrative proceedings — including Cochran — with the opportunity for a new hearing before a different ALJ. But rather than submit to additional proceedings before a new ALJ, Cochran sued the SEC in the Northern District of Texas, seeking to enjoin the SEC's administrative proceeding on the grounds that the ALJ was unconstitutionally insulated from the President's removal power because ALJs can only be removed by the Merit Systems Protection Board (MSPB) for good cause, and MSPB members themselves can be removed by the President only for inefficiency, neglect of duty, or malfeasance in office.
Following a motion for a preliminary injunction, the district court dismissed the case for lack of subject matter jurisdiction. Although 28 U.S.C. § 1331 provides district courts with "original jurisdiction of all civil actions arising under the Constitution, laws, or treaties of the United States," the district court in Cochran concluded that Congress had implicitly divested district courts of jurisdiction to hear challenges to SEC administrative proceedings because Congress, in the Exchange Act, had provided an alternative scheme of administrative review followed by judicial review in a federal court of appeals.
After a panel initially affirmed the dismissal, the en banc Fifth Circuit reversed, holding that the Exchange Act did not explicitly or implicitly divest federal district courts of jurisdiction to hear structural constitutional claims. The Fifth Circuit's decision conflicted with the decisions of the Second, Fourth, Seventh, Eleventh, and D.C. Circuits, as well as a contemporaneous decision by the Ninth Circuit in a case challenging the constitutionality of ALJs at the Federal Trade Commission (FTC). The Supreme Court granted petitions for writs of certiorari in both the Fifth Circuit SEC case and the Ninth Circuit FTC case and decided the cases together with a single opinion.
The SEC Loses the Procedural Battle in Cochran
In an opinion delivered by Justice Kagan, who also authored the Lucia decision, the Supreme Court agreed with the Fifth Circuit that Cochran's challenge to the constitutionality of SEC administrative proceedings could be brought in federal district court.
The Court began from the premise that "[a] special statutory review scheme" that provides a "comprehensive review process," like the one found in the Exchange Act, "may preclude district courts from exercising jurisdiction over challenges to federal agency action." The Court then considered "whether the particular claims brought were 'of the type Congress intended to be reviewed within this statutory structure.'" Cochran, slip op. at pages 7-8 (2023) (quoting Thunder BasinCoal Co. v. Reich, 510 U.S. 200, 208, 212 (1994)). In doing so, the Court applied the so-called Thunder Basin factors: (1) whether a finding of preclusion could foreclose all meaningful judicial review; (2) whether the suit is wholly collateral to a statute's review provisions; and (3) whether the claims are outside the agency's expertise.
First, according to the Court, a finding of preclusion would foreclose all meaningful judicial review, notwithstanding Cochran's right to have a federal court of appeals review any adverse agency action, because Cochran would nonetheless suffer the very injury of which she complains — being subjected to an unconstitutional administrative review process. As the Court explained, this is a "here-and-now injury" that is "impossible to remedy once the [agency] proceeding is over, which is when appellate review kicks in." Cochran, slip op. at 13. Second, the Court concluded that Cochran's suit was collateral to the Exchange Act's review provisions because she was challenging the Commission's "power to proceed at all," rather than an action taken in the administrative proceeding. Cochran, slip op. at 14. Finally, the Court concluded that Cochran's constitutional challenge to the ALJ removal provisions raised administrative and constitutional law questions that were "detached from 'considerations of agency policy.'" Cochran, slip op. at 16 (quoting Free Enter. Fund v. Public Company Accounting Oversight Bd., 561 U.S. 477, 491 (2010)).
Indeed, the Court concluded that Cochran from a "30,000-foot view" was similar to the Court's earlier decision in Free Enterprise Fund, which rejected an argument that the Exchange Act deprived a district court of jurisdiction to hear an accounting firm's constitutional challenge to the restrictions on removal of Public Company Accounting Oversight Board (PCAOB) members.
Justice Thomas joined the opinion in Cochran but wrote separately to express his "grave doubts about the constitutional propriety of Congress vesting administrative agencies with primary authority to adjudicate core private rights with only deferential judicial review on the back end." Cochran, slip op. at 1 (Thomas, J. concurring).
Justice Gorsuch concurred in the judgment but would do away with the Thunder Basin factors, which he criticized as a "throw-in-a-blender approach to jurisdiction [that] imposes serious and needless costs on litigants and lower courts alike." Cochran, slip op. at 9 (Gorsuch, J., concurring in judgment). According to Justice Gorsuch, the plain language of 28 U.S.C. § 1331 confers jurisdiction on federal district courts to hear an action like the one brought by Cochran, and neither the Exchange Act nor any other law divests district courts of such jurisdiction. Justice Gorsuch also criticized administrative proceedings generally, noting that agencies "combine the functions of investigator, prosecutor, and judge under one roof," "employ relaxed rules of procedure and evidence — rules they make for themselves," and use the fact that "few can outlast or outspend the federal government ... as leverage to extract settlement terms they could not lawfully obtain any other way." Id. at 12-13.
The SEC Faces a Constitutional Battle in SEC v. Jarkesy
Although the Supreme Court resolved the procedural question of whether Cochran's constitutional challenge could be made in federal district court, the Court did not address the substantive question at issue — i.e., whether there is a constitutional defect in the statutory provisions that govern the removal of SEC ALJs. Instead, the Court remanded the case for further proceedings.
The Court, however, may have an opportunity to decide the constitutional question sooner rather than later. Last month, the SEC filed a petition for a writ of certiorari in Jarkesy v. SEC, asking the Supreme Court to reverse a Fifth Circuit decision in a separate case challenging various aspects of SEC administrative proceedings, including the constitutionality of the removal restrictions for SEC ALJs.
The Jarkesy case began in 2013 when the SEC brought administrative and cease-and-desist proceedings against George R. Jarkesy, Jr. and his investment advisory firm. After an ALJ found that Jarkesy had violated the antifraud provisions of the federal securities laws, he appealed to the Commission and raised a number of constitutional claims. The Commission agreed with the ALJ that Jarkesy had committed securities fraud and rejected all of his constitutional arguments.
In May 2022, a panel of the Fifth Circuit, by a 2-to-1 vote, issued an opinion vacating the Commission's decision and held, in effect, that all SEC administrative proceedings are unconstitutional. As for the removal issue, the panel concluded that "the statutory removal restrictions for SEC ALJs are unconstitutional." The Fifth Circuit relied on Free Enterprise Fund, in which the Supreme Court held that removal restrictions for PCAOB board members were unconstitutional because they impaired the President's ability to execute the laws by holding subordinates accountable. This was because, like SEC ALJs, the PCAOB board members in Free Enterprise Fund were subject to two layers of protection against removal — PCAOB board members could be removed by the Commission only for "good cause shown" (defined as specific willful violations) and SEC Commissioners could be removed by the President only for "inefficiency, neglect of duty, or malfeasance in office."
The Fifth Circuit also held that the administrative proceeding against Jarkesy suffered from two additional "independent constitutional defects." According to the court, the SEC's securities fraud action seeking civil money penalties (among other remedies) was the type of action to which a right to a jury trial under the Seventh Amendment applied, and Jarkesy was therefore deprived of his constitutional right to a jury trial when the SEC chose to bring the action via an administrative proceeding. The Fifth Circuit also held that Congress "unconstitutionally delegated legislative power to the SEC when it gave the SEC the unfettered authority to choose whether to bring enforcement actions in Article III courts or within the agency." In particular, because "the power to assign disputes to agency adjudication is peculiarly within the authority of the legislative department," Congress was required, but failed, to "provide the SEC with an intelligible principle by which to exercise that power."2
In March 2023, after the Fifth Circuit declined to rehear the Jarkesy case en banc, the SEC filed a petition for a writ of certiorari. In the petition, the SEC asks the Supreme Court to review each of the Fifth Circuit's three holdings:
All three of the court of appeals' holdings warrant this Court's review. Each of them held a federal statute unconstitutional. Each of them is highly consequential, calling into question longstanding practices at the SEC and many other agencies. And each of them is incorrect.
Given the nature and breadth of the Fifth Circuit's decision, there is a good chance that the Supreme Court will grant the SEC's petition and hear the Jarkesy case next term.
Takeaways and Open Questions
The immediate impact of the Supreme Court's decision in Cochran is that respondents to SEC administrative proceedings may now choose to bring at least certain types of collateral attacks on the proceedings in federal district court. Presumably, such attacks can come from any respondent at any point in an administrative proceeding. This is notable given that, according to the SEC's website, there were 466 open administrative proceedings as of late March 2023 (with many proceedings involving multiple respondents). Indeed, within two business days of the Cochran decision, at least one such case already has been filed. SeeGibson v. SEC, Case No. 1:23-cv-01723-WMR (N.D. Ga. Apr. 18, 2023); see also Jessica Corso, "SEC Sees First Post-Cochran Challenge To In-House Courts," Law360 (Apr. 19, 2023).
In addition, because respondents can bring challenges in any court where venue is proper, they may seek out courts and circuits that have demonstrated skepticism about, or outright hostility towards, the administrative state. Indeed, both Cochran and Jarkesy filed actions in district courts within the Fifth Circuit and received favorable outcomes at the circuit level.3
In a prior Advisory, we analyzed in detail a number of open questions resulting from the Fifth Circuit's decisions in Cochran and Jarkesy, including the following:
- What is the appetite of the Supreme Court to significantly limit the powers of the SEC?
- Will the SEC's current aggressive stance on enforcement affect how respondents handle administrative proceedings?
- Will the combination of Cochran and Jarkesy lead the SEC to enter into more settlements in pending investigations or administrative proceedings?
- Will the SEC shift to bringing more actions in federal court until the landscape for administrative proceedings becomes clearer?
- Will constitutional challenges to other types of SEC enforcement actions be brought?
- Will the constitutional challenges result in new legislation?
- Will the constitutional challenges result in policy changes at the Commission?
- Will a major securities scandal or adverse market event swing the pendulum of public opinion and result in calls for more aggressive enforcement rather than more limited government?
These questions remain open following the Supreme Court's decision in Cochran, and the uncertainty surrounding the constitutionality of SEC administrative proceedings will persist, at least for now.
1. For more information on the Lucia case, see our prior Advisory.
2. For more information on the Fifth Circuit's Jarkesy decision, see our prior Advisory.
3. Notably, the Fifth Circuit's Jarkesy opinion began with observations about the tension between the administrative state, separation of powers, and individual liberty: "Congress has given the  substantial power to enforce the nation's securities laws. It often acts as both prosecutor and judge, and its decisions have broad consequences for personal liberty and property. But the Constitution constrains the SEC's powers by protecting individual rights and the prerogatives of the other branches of government. This case is about the nature and extent of those constraints in securities fraud cases in which the SEC seeks penalties."
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