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SEC's New Court Powers Aren't Going Away

Noah Feldman is a Bloomberg View columnist. He is a professor of constitutional and international law at Harvard University and was a clerk to U.S. Supreme Court Justice David Souter. His books include “Cool War: The Future of Global Competition” and “Divided by God: America’s Church-State Problem -- and What We Should Do About It.”
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Should the Securities and Exchange Commission be allowed to act as prosecutor, judge and jury in pursuing civil penalties against alleged violators of the security laws? If you think the answer is yes, you can only be heartened by Tuesday's decision by the U.S. Court of Appeals for the D.C. Circuit refusing to hear constitutional challenges to the SEC’s new powers under the Dodd-Frank Act.

The court said that the defendant, George Jarkesy, could still bring his constitutional claims to the courts after the SEC reaches a final decision in this case, which hasn’t happened yet. In theory, the court could then reach a different result when reviewing the constitutional merits of the SEC’s powers.

But reading the tea leaves of the decision, it doesn’t look promising for challengers to the new powers. And that’s a shame. Even though administrative proceedings are a familiar feature of the U.S. legal system, the erosion of the authority of Article III courts should be a meaningful constitutional issue -- whether the defendants are Guantanamo detainees or white-collar fraudsters.

Before 2010, the SEC could only impose civil monetary penalties if a defendant chose to keep his or her case before the commission, otherwise it had to go to a federal court. The idea was that penalties are in a sense criminal or at least punitive -- and therefore should be the business of ordinary courts, which come with a guaranteed jury trial and all the other procedural protections of the judicial system.

Dodd-Frank was intended to enhance the SEC’s enforcement powers after the 2007-08 financial meltdown. One of its provisions changed the old norm, allowing the SEC to choose its forum for seeking monetary penalties. The SEC can still go to the courts, but it has an overwhelming incentive instead to go to an administrative law judge who works for the SEC. The ALJs, as they’re called, are quasi-independent: They work for an agency, but are supposed to exercise judgment independent of agency prosecutors.

After the hearing before the administrative judge, a defendant can petition the SEC commissioners to revisit the outcome. If still unsatisfied, the defendant can go to the federal appeals courts for further review.

As a policy matter, there was something to be said for this reform. It streamlined an enforcement process that had often been divided into two parts: a request by the SEC’s enforcement division for a cease-and-desist order and a federal court case for civil penalties.

Yet the countervailing concerns are essentially constitutional. Given the basic protections of due process, should an agency -- rather than a court -- be given the jurisdiction to assign penalties? In practice, this shift in judicial responsibility weakens the power of the courts created by Article III of the Constitution.

The securities markets are heavily regulated, and it may be pragmatic for expert agencies to judge when someone’s violated the regulations. And ALJs are capable of independence in most cases. But there’s still something unsettling about punishment being meted out by the same entity that engages in investigation and prosecution. This troubling aspect of the Dodd-Frank procedures is enhanced by the fact that the ALJ’s judgment is reviewed by the commissioners themselves, who are also ultimately responsible for enforcement.

In the Jarkesy case, the D.C. Circuit didn’t directly rule on the constitutional questions associated with the new SEC powers. Instead, it decided the more limited question of whether Jarkesy could go to the courts and challenge the SEC’s capacity to act while his case was making its way through the process.

But the court’s logic gave a broad hint about the approach it will take when it does consider that issue -- and it doesn’t look good for challengers like Jarkesy. The heart of the decision, written by Judge Sri Srinivasan, frequently mentioned as a confirmable Supreme Court nominee, compared the Dodd-Frank structure to other administrative review structures, most prominently the Federal Mine Safety and Health Act. The Supreme Court, in a 1993 case called Thunder Basin Coal Co. v. Reich, said that the detailed administrative review system created by Congress blocked any court challenges to that system before a given case had been fully decided by the administrative body.

This comparison hints that the D.C. Circuit in the future is likely to compare the SEC’s power to impose monetary penalties to analogous powers possessed by other administrative agencies. And since the 1970s at least, it has become very common for Congress to create administrative systems in which agencies impose monetary penalties subject only to appellate judicial review. In other words, the SEC’s power is actually pretty typical compared with other agencies’ powers. If there’s nothing special about SEC enforcement, then there’s no constitutional problem with Dodd-Frank.

The great probability that the SEC’s powers will be upheld is conventional wisdom. It turns out to be devilishly difficult to distinguish an agency’s enforcement powers, remedial powers and deterrence powers from punishment of the kind that would arguably trigger constitutional protection.

It’s also hard to distinguish the regulated activity of issuing or trading in securities from the regulated activities of running a workplace or a union or a coal mine.

Yet the nature of an SEC enforcement action is so remarkably close to a traditional trial, with allegations closely resembling criminal allegations (and sometimes running parallel to them), and defenses very similar to those in criminal trials -- to say nothing of the monetary penalties.

So it’s still worth noting, and mourning, this impending incremental erosion of the constitutional protections of a civil trial and the jury right that goes hand in hand with it. Last week, the D.C. Circuit vacated the judgment of its own panel barring military commissions at the prison at Guantanamo Bay, Cuba, from trying ordinary criminal offenses. That implied the court might be ready to allow military commissions to assume some of the courts’ traditional jurisdiction. Circumventing a jury trial for securities fraudsters isn’t as serious, but it isn’t trivial either.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Noah Feldman at nfeldman7@bloomberg.net

To contact the editor responsible for this story:
Stacey Shick at sshick@bloomberg.net