Supreme Court's 9-0 Ruling Paves Way for Constitutional Challenges to Administrative Proceedings

The U.S. Supreme Court on April 14, 2023, issued a unanimous opinion holding that federal district courts can consider constitutional challenges to administrative proceedings before such agencies issue final rulings. In Axon v. FTC (consolidated with Cochran v. SEC), the Court held that the statutory review schemes for the Securities and Exchange Commission (SEC) and Federal Trade Commission (FTC) do not displace a district court's federal-question jurisdiction over claims challenging the constitutionality of the agency's in-house administrative proceedings.

In this post, we provide a brief background on the underlying action in Cochran, an overview of the Court's opinion and some notable takeaways, including peeking into the crystal ball to see how one concurrence may foreshadow the Court's position on broader administrative questions.

Background

In 2016, a certified public accountant named Michelle Cochran was banned from practicing before the SEC for five years because Cochran allegedly engaged in improper professional conduct, as defined by the SEC's Rules of Practice, by failing to comply with auditing standards established by the Public Company Accounting Oversight Board.¹ After a hearing, an SEC administrative law judge (ALJ) agreed with the SEC that Cochran caused and aided and abetted certain violations of the federal securities laws and, thus, engaged in improper professional conduct.²

Although Cochran objected to the decision, before the SEC could rule on her objection, the Supreme Court decided Lucia v. SEC,³ which held that SEC ALJs are officers of the United States who must be appointed by the President, a court of law or a department head. Therefore, the SEC remanded all pending administrative proceedings, including Cochran's, for new proceedings before constitutionally appointed ALJs.⁴ Thereafter, Cochran filed a lawsuit in federal district court, arguing that although SEC ALJs may be constitutionally appointed, they remained unconstitutionally insulated from Presidential removal power because of their multiple layers of "for cause" removal protections.

The district court dismissed her case for lack of subject-matter jurisdiction on the view that the Securities and Exchange Act of 1934 (Exchange Act) implicitly stripped district courts of jurisdiction to hear challenges to ongoing SEC enforcement proceedings.⁵ The U.S. Court of Appeals for the Fifth Circuit panel affirmed the district court's decision.⁶ However, the Fifth Circuit, sitting en banc, reversed, holding that Cochran's constitutional challenge was "wholly collateral" to the SEC's administrative proceedings and, thus, within the jurisdiction of the district court.⁷

The SEC appealed to the Supreme Court, posing the question: Does a federal district court have jurisdiction to consider claims challenging the constitutionality of the Securities and Exchange Commission's administrative proceedings?⁸

Supreme Court

First, Cochran was consolidated with a similar case, Axon Enterprise, Inc. v. FTC, which challenged the FTC over its in-house proceedings.⁹ By a 9-0 vote, the judgment was affirmed and remanded. Justice Elena Kagan authored the majority opinion, with Justice Clarence Thomas concurring and Justice Neil Gorsuch concurring in the judgment.

The Court held that the statutory review schemes in the Exchange Act and the Federal Trade Commission Act do not displace a district court's federal-question jurisdiction over claims challenging the constitutionality of the structure or existence of the SEC or FTC. In Cochran's case, Section 78y(a)(1) of the Exchange Act says that a "person aggrieved by a final order of the Commission … may obtain review of the order in the United States Court of Appeals …."¹⁰ However, Cochran had not received a final order. Does she need to go through the SEC's entire process to finally challenge the constitutional issues of the proceedings? The Court ruled that she does not.

To assess whether Congress intended to preclude collateral judicial review by district courts when it creates a review system within an administrative agency, the Court held the following factors must be assessed 1) whether Congress's intent to preclude district court jurisdiction was fairly discernible in the statutory scheme (such as the system of administrative review in this case), and 2) whether the dispute at issue is of the kind meant to be first reviewed within an agency's statutory scheme.¹¹

To analyze whether the dispute at issue was meant to be first reviewed within the agency's statutory scheme, the Court relied on three Supreme Court cases – Thunder Basin Coal Co. v. Reich, as further interpreted by Free Enterprise v. PCAOB and Elgin v. Dep't of Treasury – to apply a three-factor test known as the "Thunder Basin factors": 1) whether a finding of preclusion could "foreclose all meaningful judicial review"; 2) whether the claims at issue are "wholly collateral" to a statute's review provisions; and 3) whether the claims are "outside the agency's expertise."¹²

According to the majority opinion, regarding the first point, the challenged harm is "having to appear in proceedings" before an "unconstitutional agency authority," which appellate review cannot remedy.¹³ Justice Kagan pointed out that the Court had already made it clear in its 2020 Seila Law opinion that having to go through the unconstitutional proceeding is a "here-and-now injury" that a "court of appeals can do nothing" about.¹⁴ Therefore, without a collateral attack, the petitioner would be left without a meaningful remedy. For the second factor, the claims in these matters have nothing to do with the enforcement-related matters of the commissions, likewise making them collateral, "because they are challenging the Commissions' power to proceed at all, rather than actions taken in the agency proceedings."¹⁵ Third and lastly, the remoteness of the challenges from the agencies' expertise supports district-court adjudication. Pithily, Justice Kagan explained that "[t]he Commission knows a good deal about competition policy, but nothing special about the separation of powers."¹⁶

In his concurrence, Justice Thomas expressed 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."¹⁷ Justice Thomas stayed true to form and explained his view of the original understanding of judicial review and the distinction between public and private rights. He explained that "when private rights are at stake," such as "the three 'absolute' rights, life, liberty, and property," that "full Article III adjudication is likely required."¹⁸

Lastly, Justice Gorsuch's opinion concurred only as to the judgment, but rejected the Court's reasoning, explaining, "… to my mind the reason why [the Petitioners are entitled to their day in court] has nothing to do with the "Thunder Basin factors."¹⁹ Justice Gorsuch emphasized a textual analysis that the general federal question statute (Section 1331) holds that "district courts shall have original jurisdiction of all civil actions arising under the Constitution, laws, or treaties of the United States. Not may have jurisdiction, but shall."²⁰ Justice Gorsuch went on to criticize what he views as the Thunder Basin factors' "many problems" and "sheer incoherence."²¹ He continued that Congress, and not the judiciary, defines the scope of federal jurisdiction, but that the judge-made Thunder Basin factors reject that foundational principle.²² Justice Gorsuch summarized that a straightforward textual analysis of Section 1331 grants courts the power to review the constitutionality of the agencies' processes: "In both cases, the relevant statutes guide the way. Section 1331 grants district courts the power to hear Ms. Cochran's and Axon's claims and no other law takes that power away."²³ Therefore, while he agrees with the majority's result, he emphatically disagrees with the Court's reasoning.

Takeaways

Below are three key takeaways from the Court's opinion:

• Although the members of the Court may not have agreed on the proper factors to consider to reach the conclusion in Axon, the ultimate 9-0 decision evidences unanimous agreement that precluding petitioners from challenging the constitutionality of administrative proceedings until exhausting all administrative appeals is improper. The Supreme Court has made clear that the constitutionality of proceedings is a "here-and-now injury," so the ultimate decision to align with the Fifth Circuit on the limits of precluding federal court jurisdiction is not surprising.
• Justice Thomas's concurrence may foreshadow how the committed originalists on the Court will approach future constitutional challenges to administrative proceedings regarding the distinctions between public and private rights, as well as Seventh Amendment concerns. As we have previously discussed, the Fifth Circuit in Jarkesy²⁴ – decided two days after Cochran – held that administrative proceedings before the SEC violated the Petitioners' Seventh Amendment right to a jury, that Congress had violated the non-delegation doctrine by allowing the SEC to choose the forum for enforcement without guidance, and that the ALJs were unconstitutionally insulated from the President's removal power.

Although the Supreme Court has yet to take up Jarkesy, the SEC has petitioned the Court for review. Given the breadth of Jarkesy's holding, a cert grant on the issue is expected at some point in the future. Thomas's concurrence will likely stand as an originalist roadmap for affirming that opinion and track with conservative jurisprudence that is concerned with agency overreach and formal separation of powers between the branches of government.

• In terms of the immediate impact on SEC enforcement activities, given that the issues before the court were not the constitutionality of the ALJs, but rather where and when constitutional challenges may be heard, the immediate impact will be limited. As a practical matter, as it has done following Lucia, the agency generally will continue to file litigated proceedings in district court. However, certain proceedings can be heard only before ALJs, so it will be interesting to monitor the pace and quantity of constitutional challenges filed in district court to ongoing litigated administrative proceedings going forward.

The SECond Opinions Blog will continue to analyze these issues and provide further observations when opportunities arise. If you need additional information on this topic, please contact the authors or another member of Holland & Knight's Securities Enforcement Defense Team.

Notes

¹ In the Matter of David S. Hall, P.C. d/b/a The Hall Group CPAs, et. al, AP File No. 3-17228 (Oct. 24, 2016).

² Id. at AP-1114 (Mar. 7, 2017), www.sec.gov/alj/aljdec/2017/id1114ce.pdf.

³ Lucia v. SEC, 585 U.S. ___, 138 S. Ct. 2044, 201 L. Ed. 2d 464 (2018).

⁴ In the Matter of David S. Hall, P.C. d/b/a The Hall Group CPAs, et. al, AP-6126, File No. 3-17228 (Oct. 2, 2018).

⁵ Cochran v. SEC, No. 4:19-CV-066-A, 2019 U.S. Dist. LEXIS 49751, 2019 WL 1359252, at *3–6 (N.D. Tex., Mar. 25, 2019).

⁶ Cochran v. SEC, 969 F.3d 507, 2020 U.S. App. LEXIS 25525, 2020 WL 459322 (5th Cir. Tex., Aug. 11, 2020).

⁷ Cochran v. SEC, 20 F.4th 194, 207 (5th Cir. 2021) (en banc).

⁸ See, e.g., Question Presented Report, Supreme Court of the United States.

⁹ Axon Enter., Inc. v. FTC, No. 21–86, ___ U.S. ___ (2023) (slip op., at 1–4).

¹⁰ 15 U.S.C. § 78y(a)(1).

¹¹ Cochran v. SEC, 20 F.4d 194, 205 (5th Cir. 2021) (citing Thunder Basin Coal Co. v. Reich, 510 U.S. 200, 207 (1994)).

¹² Axon Enter. v. FTC, 986 F.3d 1173, 1178 (9th Cir. 2021) (citing Thunder Basin, 510 U.S. 200; Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477 (2010); and Elgin v. Dep't of Treasury, 567 U.S. 1 (2012)).

¹³ Cochran, 585 U.S. ___ (2018) (slip op., at 13).

¹⁴ Id. (citing Seila Law LLC v. Consumer Financial Protection Bureau, 591 U. S. ___, ___

(2020) (slip op., at 10)).

¹⁵ Cochran, 585 U.S. ___ (2018) (slip op., at 14).

¹⁶ Id. at 16–17.

¹⁷ Cochran, 585 U.S. ___ (2018) (Thomas, J., concurring) (slip op., at 1).

¹⁸ Id. at 3.

¹⁹ Cochran, 585 U.S. ___ (2018) (Gorsuch, J., concurring) (slip op., at 1).

²⁰ Id. at 2 (emphasis the Court's).

²¹ Id.

²² Id. at 4.

²³ Id. at 8.

²⁴ Jarkesy v. SEC, No. 20-61007, 2022 WL 1563613 (5th Cir. May 18, 2022).