US Supreme Court Allows Early Constitutional Challenges to SEC Administrative Proceedings in Federal District Courts

In Axon Enterprise Inc. v. Federal Trade Commission, the US Supreme Court on April 14 unanimously decided that a party may bring constitutional challenges to the US Securities and Exchange Commission’s (SEC’s or Commission’s) use of administrative law judges (ALJs) in its “in-house” administrative enforcement proceedings directly in federal district court without first litigating to conclusion the administrative proceeding. The Court likewise held that constitutional challenges to the Federal Trade Commission’s (FTC’s) use of ALJs could proceed in federal district court at the outset of the FTC’s similar in-house administrative process. The Court’s opinion does not resolve the question of whether the agencies’ use of ALJs is constitutional.

As the Axon Court described, the Securities Exchange Act of 1934 (Exchange Act) “authorize[s] the Commission[] to address statutory violations either by bringing civil suits in federal district court or by instituting their own administrative proceedings.” [1] When the SEC opts for an in-house administrative proceeding, it typically delegates authority over the proceeding to an ALJ, who has the authority to hold hearings, issue subpoenas, resolve motions, and issue decisions. [2] If the subject of such a proceeding disputes an ALJ’s decision, it may appeal the decision internally to the Commission. [3] Final Commission orders may then be appealed to a federal court of appeals. [4] As Justice Neil Gorsuch recognized in his concurring opinion, SEC in-house proceedings are “tilted” in the SEC’s favor: “[f]rom 2010 to 2015, the SEC won 90% of its contested in-house proceedings compared to 69% of the cases it brought in federal court.” [5]

In Axon, Cochran, the subject of an SEC in-house administrative enforcement proceeding, “sidestepped” the statutory “review scheme” by commencing a lawsuit in federal district court challenging the constitutionality of the SEC’s use of ALJs before engaging in the in-house proceeding. [6] Cochran asserted that the “tenure protections of the [SEC’s] ALJs render them insufficiently accountable to the President, in violation of separation-of-powers principles.” [7]

The United States District Court for the Northern District of Texas dismissed Cochran’s complaint for lack of subject matter jurisdiction in light of the statutory review scheme requiring the subject of a proceeding to first appeal an ALJ’s decision to the Commission and then to the appeals court. On rehearing en banc, the Fifth Circuit reversed dismissal of Cochran’s “removal power claim.” [8] The SEC then appealed to the Supreme Court.

In its opinion, the Court considered the factors set forth in Thunder Basin Coal Co. v. Reich, 510 U.S. 200, 207–13 (1994), which are used to determine “whether particular claims concerning agency action are ‘of the type Congress intended to be reviewed within the statutory structure[,]’” so as to be appropriately within an agency’s review authority. [9] Under Thunder Basin, a court considers three questions: (1) “could precluding district court jurisdiction ‘foreclose all meaningful judicial review’ of the claim?’”; (2) “is the claim ‘wholly collateral’ to the statute’s review provisions?”; and (3) “is the claim ‘outside of the agency’s expertise?’” [10]

On the first question, the Court focused on the fact that Cochran’s claim was based on her assertion that she was “being subjected” to “unconstitutional agency authority,” i.e., a “proceeding by an unaccountable ALJ”—in other words, “an illegitimate proceeding, led by an illegitimate decisionmaker.” [11] Because the Court has previously found that such a harm is “a here-and-now injury,” [12] it is a harm that cannot be remedied once the proceeding is over. As the Court explained, once the in-house proceeding occurs, “the court of appeals can do nothing [to remedy Cochran’s harm]: A proceeding that has already happened cannot be undone.” [13]

Although the SEC argued that there are other instances in which parties are required to wait before appealing, even if it results in a significant burden, the Court found that the injury in this instance was different in kind because Cochran would lose her right to not be subject to ALJ proceedings if she could not assert that claim until the proceeding concluded. [14]

The Court also found that the claim was “wholly collateral” to the review scheme established by the Exchange Act because Cochran objected “to the [SEC’s] power generally, not to anything particular about how that power was wielded.” [15] Finally, the Court concluded that the claims were “outside of the [SEC’s] expertise.” [16] It relied on its holding in Carr v. Saul, 141 S.Ct. 1352 (2021), which found that agency adjudicatory procedures are generally ill-suited to address constitutional challenges.

The Court determined that each of the Thunder Basin factors favored Cochran and remanded the matter for further proceedings.

This is a substantial blow to the SEC’s ability to pursue litigated matters in its administrative forum. Any respondent to an administrative proceeding will have the ability to effectively stay the proceeding while vindicating his or her constitutional rights in federal court. We have observed a dramatic decline in litigated administrative proceedings over the last several years as respondents raise similar constitutional issues, and the Court’s Axon opinion presents another obstacle to those proceedings going forward.

In a concurring opinion, Justice Clarence Thomas expressed “grave doubts” about the constitutionality of in-house proceedings. [17] He reasoned that private rights can only be adjudicated and divested by Article III courts, finding that the rights in Axon “appear to be core private rights,” because the types of “penalties and orders [sought by the SEC, including monetary penalties,] implicate the core private right to property.” [18]

The Court is currently considering a petition for certiorari by the SEC in SEC v. Jarkesy, which asks the Court to determine whether the SEC’s administrative enforcement proceedings violate the Seventh Amendment and whether enforcement by agency adjudication violates the nondelegation doctrine, which prohibits delegation of legislative powers to an executive agency.

Should the Court grant certiorari in Jarkesy, Justice Thomas’s concurring opinion may provide some insight as to the outcome in that case.