Securities Regulation Daily High court will not address ‘reasonable grounds’ exception to administrative exhaustion
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Monday, March 9, 2020

High court will not address ‘reasonable grounds’ exception to administrative exhaustion

By Rodney F. Tonkovic, J.D.

The Court dropped a petition arguing that the SEC's firm opposition to Appointments Clause challenges was reasonable grounds for not raising a challenge during administrative proceedings.

The Supreme Court denied certiorari for a petition urging it to clarify exceptions to the requirement that administrative remedies be exhausted. The petition asked the Court to reconcile the 10th Circuit's conclusion that there were "no reasonable" grounds to excuse the petitioner's failure to raise an Appointments Clause objection with other circuits' more lenient standards. Justice Gorsuch, formerly of the 10th Circuit, took no part in the consideration or decision of this petition.

Commissions payment scheme. The SEC initiated administrative proceedings against petitioner Dennis Malouf in 2014. Malouf, the former CEO and majority owner of an investment adviser, had sold the branch office of a broker-dealer to eliminate conflicts of interest. Malouf then directed execution of trades for UASNM clients to that branch so that the purchaser could collect enough in commissions to pay Malouf. The Commission asserted that Malouf violated the securities laws by failing to disclose conflicts of interest arising from the payment agreement.

Later, an administrative law judge found that Malouf's actions had violated the antifraud provisions of the federal securities laws and that he had aided and abetted UASNM's violations. In addition to a cease-and-desist order, the ALJ imposed associational and officer/director bars and the payment of a civil penalty. On appeal, the Commission agreed, but added a lifetime industry bar and ordered disgorgement plus prejudgment interest.

Before the 10th Circuit. Malouf then took his case to the 10th Circuit, arguing, among other positions, that the administrative law judge was not validly appointed under the Constitution’s Appointments Clause. The panel declined to reach the merits of Malouf's challenge, stating that he forfeited the argument by failing to present it during the SEC proceedings. The court rejected Malouf's contention that he had reasonable grounds to avoid the exhaustion requirement because: (1) the SEC's position on the Appointments Clause made a challenge futile; and (2) the law changed after the Commission had ruled. The panel concluded that raising the challenge would not necessarily have been futile at the time (September 2015, immediately before Lucia ) because the SEC had yet to address the applicability of the clause to ALJs. And, while the Tenth Circuit and U.S. Supreme Court later held that SEC administrative law judges are subject to the Appointments Clause, the panel said that these cases merely applied the reasoning behind the Supreme Court's 1991 opinion in Freytag to SEC ALJs.

"Reasonable grounds." The petition asked the Court to address what constitutes "reasonable grounds" to apply an exception to the administrative exhaustion requirement. While there is no uniformity among the lower courts, the petition urged the application of reasoning from the D.C. and Sixth Circuits to this case. The 2013 D.C. Circuit decision held that an exception for "extraordinary circumstances" in the National Labor Relations Act could apply based on "the seriousness of the objection, or a constitutional infirmity of the tribunal." A 2018 case from the Sixth Circuit found "extraordinary circumstances" in the absence of directly applicable case law. The SEC's almost certain denial of any objection would have been "reasonable grounds" in 2015, the petition maintained.

Claims processing. Malouf argued further that the exhaustion requirement in the Securities Act (which has no express exceptions) is a "claims-processing" rule, as opposed to a jurisdictional condition. The petition asserted that the Securities Act's exhaustion requirement is a claims-processing rule since there is no clear statement that the provision is jurisdictional while all the other securities laws contain express exceptions. The Tenth Circuit, the petition said, effectively treated the provision as a jurisdictional condition while not directly addressing this issue.

Armstrong v. SEC. The Court also declined to hear Armstrong v. SEC, a petition from the Second Circuit focusing on the interplay between parallel civil and criminal proceedings. In this case, the government initiated parallel proceedings against Martin Armstrong, who had allegedly deceived non-U.S.-based investors about the nature and value of the unsecured notes they purchased. The SEC and CFTC obtained a freeze of all of Armstrong's assets, depriving him, he argued, of the ability to use his untainted assets to secure counsel of choice in the criminal proceeding. The petition argued that the Court should intervene to clarify the scope of the constitutional right to counsel of choice in the parallel criminal-and-civil enforcement context, and to enforce fundamental due process protections. Justice Sotomayor took no part in the consideration or decision of this petition.

Read the Supreme Court Docket. These cases and other selected securities-related matters pending before the Court can be referenced in the latest version of the Supreme Court Docket. Issued opinions, granted petitions, pending petitions, and denied petitions are listed separately, along with a summary of the questions presented and the current status of each appeal.

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