A registered investment adviser and its principal recently sued the Securities and Exchange Commission for declaratory and injunctive relief to stave off an imminent administrative enforcement action, alleging that the tenure and removal provisions governing SEC administrative law judges (ALJs) violate Article II of the US Constitution.

Shortly after Stilwell Value LLC (SVL) registered as an investment adviser in SVL’s 2012 registration, the firm became the subject of an investigation by the SEC’s enforcement division. The SEC issued a Wells notice in October 2013 alleging that Joseph Stilwell, SVL’s managing member, violated the Investment Advisers Act of 1940 by executing certain inter-fund loans that were conflict-of-interest transactions, and by not properly disclosing the transactions to investors. In July 2014, the SEC indicated that it would initiate an enforcement action through an administrative proceeding unless Stilwell agreed to a settlement. Finding that the settlement terms would inflict a significant risk of financial harm to his investors, Stilwell rejected the settlement and filed an action to prevent the anticipated administrative proceedings. Relying on Free Enterprise Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477 (2010), which held that executive branch officers may not be separated from presidential supervision and removal by more than one layer of tenure protection, Stilwell and SVL allege that SEC ALJs exercise sufficient authority and discretion to make them “officers” under Article II, and that the scheme governing their removal violates Article II’s vesting of executive power in the president. In their complaint, Stilwell and SVL identify at least two levels of protection: SEC ALJs may be removed only for good cause, and SEC Commissioners, who exercise the power of removal, are themselves protected by tenure and may be removed only for “inefficiency, neglect of duty, or malfeasance in office.” Members of the Merit Systems Protection Board, who effectuate the removal decision, are protected by the same removal standard that applies to SEC Commissioners. Stilwell and SVL allege that, because the president cannot oversee SEC ALJs in accordance with Article II, SEC administrative proceedings are unconstitutional.     

Stillwell v. Sec. & Exch. Comm’n, Case No. 14-cv-7931 (S.D.N.Y.).