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<h5>Key Takeaways</h5>  <ul> 	<li>The Supreme Court resolved a circuit split by ruling that district courts have jurisdiction to adjudicate certain constitutional challenges to the Securities and Exchange Commission’s (SEC) and Federal Trade Commission’s (FTC) administrative adjudication process without having to wait for the administrative process to conclude before having these constitutional claims heard by an Article III judge.</li> 	<li>The Supreme Court’s holding is another shot across the bow of the administrative adjudicatory process that will now play out at the District Court level with constitutional challenges that are sure to follow this opinion.</li> 	<li>It is likely that the administrative process will continue to face constitutional challenges as the Supreme Court decides whether to hear appeals that raise other constitutional challenges to the SEC, FTC and other agencies that have a similar administrative adjudicatory process.</li> </ul>  <h5>Background</h5>  <p>In <em>Axon Enterprise, Inc. v. FTC</em><a href="#_ftn1" name="_ftnref1" title="">[1]</a> and<em> SEC v. Cochran</em>,<a href="#_ftn2" name="_ftnref2" title="">[2]</a> the respondents in administrative agency enforcement actions brought suit in federal district court, challenging the constitutionality of each respective agency’s attempt to litigate its enforcement action in an administrative proceeding presided over by an Administrative Law Judge (ALJ), removable only for good cause as determined by the Merit Systems Protection Board (MSPB) rather than by the President. Respondents each argued “that [this] fundamental aspect of the Commission’s structure violates the Constitution; that the violation made the entire proceeding unlawful; and that being subjected to such an illegitimate proceeding causes legal injury (independent of any rulings that the ALJ might make).” Respondents premised jurisdiction on a district court’s ordinary federal-question authority under 28 U.S.C. § 1331 to resolve “civil actions arising under the Constitution, laws and treaties of the United States.”</p>  <p>Respondents filed their collateral Constitutional actions to enjoin the FTC’s and SEC’s administrative actions despite the fact that both the Securities Exchange Act of 1934 (Exchange Act, 15 U.S.C. § 78a et seq.) and the FTC Act (15 U.S.C. § 41 et seq.), provide that the SEC and FTC can bring enforcement actions by instituting administrative proceedings adjudicated by an ALJ, and each set forth the procedures which must be followed to appeal an ALJ’s ruling. Under these statutes, a losing party in the administrative forum can appeal an ALJ’s ruling to the respective agency, either the SEC or FTC. Only after a final commission decision is a respondent permitted to seek review by a federal court of appeals of the commission decision. <em>See </em>15 U.S.C. § 78y(a)(1); 15 U.S.C. § 45(c). Prior to this decision by the Supreme Court, lower courts were routinely rejecting similar collateral attacks on SEC and FTC administrative proceedings.</p>  <p>In both <em>Axon </em>and <em>Cochran</em>, the respondents sought to enjoin the administrative proceedings in federal district court prior to an ALJ decision. Specifically, in <em>Cochran</em>, the SEC brought an administrative action against a certified public accountant, Michelle Cochran, for allegedly failing to comply with auditing standards.<a href="#_ftn3" name="_ftnref3" title="">[3]</a> Cochran brought a federal district court action alleging that the ALJs who oversee the administrative hearings have tenure protections that make them insufficiently accountable to the President, and therefore the removal protections for ALJs unconstitutionally violate separation of powers principles and Article II of the Constitution. The Commissions’ ALJs are removable “only for good cause,” which is determined by the MSPB, whose members are removable by the President only for cause, such as “neglect of duty” or “malfeasance.”</p>  <p>In <em>Axon</em>, the FTC brought an administrative enforcement action against Axon Enterprise, Inc. (Axon), alleging that the purchase of its closest competitor violated the FTC Act’s ban on unfair methods of competition. Axon similarly brought an action in federal district court alleging the same violation of Article II as in <em>Cochran</em>, and additionally, that the combination of prosecutorial and adjudicatory functions in the administrative forum is unconstitutional.</p>  <p>Cochran and Axon brought their actions in federal court invoking federal question jurisdiction to resolve “civil actions arising under the Constitution, laws, or treatises of the United States.”<a href="#_ftn4" name="_ftnref4" title="">[4]</a> The district court in both cases held that it lacked jurisdiction to adjudicate the constitutional claims because both the Exchange Act and FTC Act required the parties to raise their constitutional claims in the administrative proceedings and thereafter appeal to the court of appeals only after a final commission decision was issued.</p>  <p>On appeal, the U.S. Court of Appeals for the Ninth Circuit affirmed the district court’s decision in the <em>Axon </em>case. The U.S. Court of Appeals for the Fifth Circuit initially affirmed the district court decision, then the <em>en banc</em> Fifth Circuit disagreed and reversed the district court decision, creating a circuit split. The Fifth Circuit, relying on <em>Thunder Basin Coal Co. v. Reich</em>,<a href="#_ftn5" name="_ftnref5" title="">[5]</a> reasoned that Cochran’s constitutional arguments were not the type of claims Congress intended to require respondents to exclusively adjudicate through the administrative forum. The Fifth Circuit held that if Cochran were forced to litigate exclusively in the administrative proceeding, she would not receive “meaningful judicial review” in the court of appeals, the constitutional claim at issue was “wholly collateral to the Exchange Act’s statutory-review scheme,” and her Constitutional claim was outside the SEC’s unique area of expertise.<a href="#_ftn6" name="_ftnref6" title="">[6]</a> The U.S. Supreme Court granted <em>certiorari </em>in both cases.</p>  <h5>The Decision:<em> Axon Enter., Inc. v. Fed. Trade Comm&#39;n</em>, No. 21-1239, 2023 WL 2938328 (U.S. Apr. 14, 2023)</h5>  <p>The Supreme Court held in both cases that federal district courts indeed have jurisdiction to hear collateral attacks on the constitutionality of the administrative proceedings against them. The Court explained that Congress may limit federal district court jurisdiction explicitly or implicitly, and the question is “whether the particular claims brought were of the type Congress intended to be reviewed within this statutory structure.” Because the instant challenges were not specific to any substantive decision of the ALJ, but rather challenges to “the structure or very existence of an agency,” the Court applied the <em>Thunder Basin</em> factors to determine that the SEC and FTC statutory review schemes did not strip the district courts of jurisdiction in these particular cases. The <em>Thunder Basin</em> factors consider: (i) whether precluding district court jurisdiction forecloses all meaningful judicial review, (ii) whether the claim is wholly collateral to the statute’s review provisions, and (iii) whether the claim is outside of the agency’s expertise.</p>  <p>Applying the<em> Thunder Basin</em> factors, the Supreme Court held that the challenges were not specific to any substantive ALJ or agency decision, but instead challenged the constitutionality of “the structure or very existence of an agency” or administrative adjudication process. Both respondents were alleging a “here and now” injury of being subject to an unconstitutional hearing. Requiring them to adjudicate this issue in the administrative process would deny these respondents the opportunity to avoid the injury of being subject to an unconstitutional hearing.</p>  <p>The Court stated that “[a] proceeding that has already happened cannot be undone.” Additionally, the Court held that the constitutional claims have nothing to do with enforcement-related matters that are typically adjudicated by the FTC and SEC, and nothing to do specifically with the claims brought against Axon and Cochran. Finally, the Court concluded that the claims are administrative and constitutional issues of law and thus not within either agency’s expertise. The Court reversed the Ninth Circuit’s decision and affirmed the Fifth Circuit’s decision.</p>  <h5>Concurrences</h5>  <p>Justice Thomas and Justice Gorsuch wrote concurring opinions, both going further than the majority opinion. After chronicling the history of the appellate review model applicable to administrative proceedings, which sharply limited Article III review of administrative adjudications, Justice Thomas detailed his view that it may not be constitutionally permissible for Congress to vest administrative agencies with primary authority to adjudicate matters involving the core private rights of life, liberty and property with only sharply limited review in an Article III appellate court. Justice Thomas indicated that the rights at issue in both Axon’s and Cochran’s cases which might result in significant economic consequences to the defendants appeared to be core private rights that belonged in an Article III court. Justice Thomas also expressed concern that the appellate review model may run afoul of the Seventh Amendment by allowing an administrative agency to adjudicate what might be core private rights without a jury. Thereafter, Justice Thomas invited the Court, in an appropriate case, to “consider whether such schemes and the appellate review model they embody are constitutional methods for the adjudication of private rights.”</p>  <p>Justice Gorsuch concurred in the judgment, but would have held that because the Exchange Act and FTC Act did not specifically preclude the type of relief being sought and Section 1331 was clear in assigning federal courts jurisdiction over federal and constitutional questions, there was no need to apply the <em>Thunder Basin </em>factors. Justice Gorsuch harshly criticized reliance on the judge-made multifactor <em>Thunder Basin</em> test because of his concern relating to the incoherence of the test and the need for “clear and easy” jurisdictional rules to avoid needlessly expensive and time-consuming litigation over jurisdiction.  Justice Gorsuch detailed the seven-year litigation experience of <em>Cochran </em>and the three year litigation history of <em>Axon </em>in making his point – noting that after all of this litigation not a single judge “yet has breathed a word about the merits of their claims.” Finally, Justice Gorsuch warned that the loss of a day in an Article III court in favor of one before an ALJ was no small sacrifice. Justice Gorsuch detailed well known criticisms of administrative proceedings for defendants:</p>  <p style="margin-left:40px">Agencies like the SEC and FTC combine the functions of investigator, prosecutor and judge under one roof. They employ relaxed rules of procedure and evidence—rules they make for themselves. The numbers reveal just how tilted this game is. From 2010 to 2015, the SEC won 90% of its contested in-house proceedings compared to 69% of the cases it brought in federal court. . . . Meanwhile, some say the FTC has not lost an in-house proceeding in 25 years.</p>  <p>Justice Gorsuch also noted that the initial ALJ who presided over Cochran’s case reportedly “made a practice of warning defendants during settlement negotiations that he had ‘never ruled against the agency’s enforcement division.’”</p>  <p>The concurrences of Justice Gorsuch and Justice Thomas certainly signal that at least two Justices have grave constitutional concerns about the continued use of administrative adjudicatory proceedings.   </p>  <h5>Conclusion</h5>  <p>This opinion has opened the door for certain constitutional challenges to the use of administrative proceedings to be heard at the outset of the proceeding through a collateral action in district court. The first of these actions was recently filed on April 18, 2023, a few days after the Supreme Court’s opinion. <em>See Gibson v. SEC et al.</em>, No. 1:23-cv-01273 (N.D. Ga.). The Supreme Court’s ruling greatly expands a respondent’s ability to challenge the administrative process itself. If Justice Thomas’ concurrence is a signal of what the future holds, it seems likely that the administrative adjudication process may receive additional constitutional scrutiny that may challenge the continued use of the administrative process.</p>  <p>The Court has yet to decide whether it will hear the appeal in<em> SEC v. Jarkesy</em> (No. 22-859). In <em>Jarkesy</em>, the Fifth Circuit held that (i) the respondent was deprived of his constitutional right to a jury trial by being forced to adjudicate in front of an ALJ, (ii) Congress unconstitutionally delegated legislative power to the SEC by giving full discretion to the SEC to determine whether to bring an action in federal court or an administrative forum and (iii) statutory removal restrictions on SEC ALJs violated the Constitution. The <em>Jarkesy </em>decision has created a circuit split. Should the Supreme Court grant <em>certiorari</em>, it may well make critical decisions that determine the fate of the administrative adjudicatory process.</p>  <p>The BakerHostetler White Collar, Investigations, and Securities Enforcement and Litigation team is composed of dozens of experienced individuals, including attorneys who have served in the Department of Justice and at the SEC. Our attorneys include a former U.S. attorney, former assistant U.S. attorneys, unit chiefs as well as partners who have served in the SEC’s Division of Enforcement and the SEC’s Office of the General Counsel, and attorneys with extensive experience in regulatory investigations, litigation and enterprise compliance counseling. Please feel free to contact any of our experienced professionals if you have questions about this alert.</p>  <div><em>By: John J. Carney, Jonathan R. Barr, Jimmy Fokas, Teresa Goody Guillén and Lauren P. Lyster</em>  <hr /> <div id="ftn1"> <p><a href="#_ftnref1" name="_ftn1" title="">[1]</a> <em>Axon Enter., Inc. v. Fed. Trade Comm’n</em>, 452 F. Supp. 3d 882 (D. Ariz. 2020).</p> </div>  <div id="ftn2"> <p><a href="#_ftnref2" name="_ftn2" title="">[2]</a> <em>Cochran v. Securities and Exchange Comm’n</em>, No. 4:19-CV-066-A, 2019 WL 1359252 (N.D. Tex. Mar. 25, 2019).</p> </div>  <div id="ftn3"> <p><a href="#_ftnref3" name="_ftn3" title="">[3]</a> Prior to Michelle Cochran’s district court action, an ALJ had found that Cochran violated the Exchange Act, but soon after the Supreme Court held in <em>Lucia v. SEC</em>, 138 S. Ct. 2044 (2018) that the SEC’s ALJs had been improperly appointed. The SEC ordered that Cochran be subject to a new hearing with a properly appointed ALJ. Cochran brought the district court action before the new ALJ hearing began.</p> </div>  <div id="ftn4"> <p><a href="#_ftnref4" name="_ftn4" title="">[4]</a> 28 U.S.C. § 1331.</p> </div>  <div id="ftn5"> <p><a href="#_ftnref5" name="_ftn5" title="">[5]</a> 510 U.S. 200 (1994).</p> </div>  <div id="ftn6"> <p><a href="#_ftnref6" name="_ftn6" title="">[6]</a> <em>Cochran v. SEC</em>, 20 F.4th 194, 207-208 (5th Cir. 2021).</p> </div> </div>




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Supreme Court Clears the Way for Constitutional Challenges to SEC, FTC Administrative Forums in Federal District Court

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