Introduction

A recent decision from the U.S. District Court for the Southern District of New York concludes that the manner in which Administrative Law Judges (“ALJs”) of the U.S. Securities and Exchange Commission (“SEC”) are appointed is improper under the Appointments Clause of Article II of the Constitution. cmb(1) The decision is important to the consumer finance industry for two primary reasons. First, the SEC asserts jurisdiction over certain categories of asset-backed securities transactions involving pooled residential mortgage loans and other types of consumer loans. (2) Second, the decision is relevant to pending constitutional challenges to the structure of the Consumer Financial Protection Bureau (“CFPB”).

Background

The plaintiff, Barbara Duka, is a former co-manager of the Commercial Mortgage-Backed Securities (“CMBS”) Group at Standard and Poor’s, where she was responsible for ratings of new CMBS issuance transactions. When the SEC informed her that it intended to initiate an administrative proceeding against her, to be adjudicated by an ALJ, she filed a complaint against the SEC in U.S. District Court asserting that the administrative proceeding would be unconstitutional.

The basis of Duka’s constitutional argument was that ALJs are effectively Executive Branch “officers” for purposes of Article II of the U.S. Constitution because of the significant authority delegated to them by the SEC. Pursuant to Article II, executive officers must be appointed by the President or the Head of an Executive Branch Department and removable by the President. Duka argued that the SEC violated these provisions of Article II in two respects. First, the appointment of ALJs is not necessarily approved by the President or the Commissioners of the SEC. Second, ALJs enjoy certain tenure protections that effectively shield them from removal at will.

The Decision

The Court agreed with Duka that ALJs are Executive Branch officers. The court did not concur with Duka’s position that the rules governing the removal of ALJs presented a constitutional problem. Specifically, the court held that “the statutory restrictions on ALJs’ removal from office are both appropriate and constitutional,” as such restrictions help to ensure that ALJs can exercise independent judgment.(3)

However, the court did find merit in Duka’s argument that the manner in which ALJs are appointed violates the Constitution. The court noted there was no dispute that the ALJs at issue were not appointed by the SEC Commissioners or the President.(4) The court held that the ALJs were thus “not appropriately appointed pursuant to Article II”(5), and preliminarily enjoined the SEC from proceeding further with its administrative complaint against Duka.

The SEC has appealed the decision and indicated that its principal argument for reversal will be that ALJs are not officers, as they “do not possess final decision-making authority” over individual cases, and the Commission itself “retains plenary control over the entire administrative process.”(6) The SEC also has signaled that, for purposes of future cases, it may seek to moot the issue that Duka raised by ensuring that ALJs are appointed directly by the Commissioners of the SEC.

The Importance of the Decision

Duka is potentially significant to the consumer finance industry for two reasons. First, the decision sets down a road map for challenging the authority of the SEC in administrative proceedings touching on consumer finance matters. If the appointment of ALJs is constitutionally invalid for purposes of commercial mortgage-backed securities cases, that same reasoning would apply in circumstances where ALJs are tasked to hear residential mortgage-backed and other asset-backed securities matters.

Second, in a somewhat analogous line of cases, parties recently have challenged the structure of the CFPB on constitutional grounds. For example, in a case that the CFPB brought against ITT Educational Services, Inc. (“ITT”), ITT moved to dismiss, contending that the CFPB is an unconstitutional entity. Among other arguments, ITT asserted that the President’s ability to remove the Director of the CFPB from office is unconstitutionally restricted and that the procedures governing the appointment of the Deputy Director of the CFPB are improper because neither the President nor the Head of an Executive Branch Department has a direct role in such appointments.(7) While this and other challenges to the constitutional authority of the CFPB have not succeeded to date, the reasoning of Duka would seem to lend support to certain aspects of such challenges to the CFPB’s authority.

— Notes —

(1) See Duka v. U.S. Securities and Exchange Commission, U.S. District Court, Southern District of New York, Index No. 1:15-cv-00357-RMB, Decision & Order dated Aug. 12, 2015 (Dkt. No. 60) (the “August 12 Decision”).

(2) See “Asset-Backed Securities,” Securities and Exchange Commission, Oct. 23, 2014 (https://www.sec.gov/spotlight/dodd-frank/assetbackedsecurities.shtml).

(3) See Duka v. U.S. Securities and Exchange Commission, U.S. District Court, Southern District of New York, Index No. 1:15-cv-00357-RMB, Decision & Order April 15 , 2015 (Dkt. No. 33).

(4) See Duka v. U.S. Securities and Exchange Commission, U.S. District Court, Southern District of New York, Index No. 1:15-cv-00357-RMB, Decision & Order dated Aug. 3, 2015 (Dkt. No. 57).

(5) See August 12 Decision at 4.

(6) See Duka v. U.S. Securities and Exchange Commission, U.S. District Court, Southern District of New York, Index No. 1:15-cv-00357-RMB, Aug. 26, 2015 Letter (Dkt. No. 65) at 2.

(7) See Consumer Financial Protection Bureau v. ITT Educational Services, Inc., U.S. District Court, Southern District of Indiana, No. 1:14-cv-00292, Brief in Support of Defendant’s Motion to Dismiss dated May 19, 2014 (Dkt. No. 23) at 9 and n. 6.