Gray Financial Group, Inc. (“Gray”), an Atlanta based investment advisor, and two of its officers filed a lawsuit against the SEC in the U.S. District Court for the Northern District of Georgia. The lawsuit seeks to declare that the SEC’s use of administrative law judges (“ALJs”) violates Article II of the U.S. Constitution as an improper separation of powers and to enjoin the SEC from commencing an administrative proceeding against them. This is not a Due Process or Equal Protection-based challenge. Other cases, primarily in the Southern District of New York, have asserted similar Article II-based theories under somewhat differing circumstances. 

The underlying theory in part derives from a U.S. Supreme Court case, Free Enter. Fund v. Pub. Co. Accounting Oversight Bd. (“Free Enterprise”), 561 U.S. 477 (2010). There, the Court held that pursuant to Article II's vesting of the executive power in the President, executive officers cannot be separated from the President by multiple levels of tenure protection because it impedes the President's power to remove the officers. A key issue in Gray’s suit is whether SEC ALJs are "inferior officers" who are appointed by SEC Commissioners, thus triggering the Article II prohibition against multiple levels of tenure protection over inferior officers, as proscribed in Free Enterprise. See also Freytag v. Commissioner, 501 U. S. 868, 910 (1991) (Scalia, J., concurring). Gray’s lawsuit seeks to show that SEC ALJs are more than “mere employees;” they are legally “inferior officers” who are protected by at least two (and perhaps three) levels of tenure protection in violation of Article II.

Most significantly, there is no clear set test for determining whether a person is an inferior officer within the meaning of Article II, although the courts seem to consider traditional indicia of employment to decide the issue. That might include such matters as possible tenure, duration, pay, duties, lines of reporting, and authority to make the ultimate decisions. See, e.g., Edmond v. U.S., 520 U.S. 651, 662 (1997); U.S. v. Germaine, 99 U.S. 508 (1878).

Accordingly, and unlike other current pending cases, contemporaneous with the filing of the lawsuit, Gray served discovery in the form of interrogatories and document requests on the SEC. In that discovery, Gray is seeking information regarding, among other things, the policies and procedures for recruiting, reviewing and removing ALJs, the tenure protection afforded to ALJs, the scope of ALJs’ duties and authority, and the decision-making process as to whether an enforcement action should be brought before an ALJ or federal district court.

Such Article II challenges, if successful, will change the landscape for the SEC enforcement process because the SEC could be forced to bring cases exclusively in federal court and not before friendly SEC-employed ALJs. The fact that the SEC has increasingly been bringing more enforcement cases in administrative proceedings and not in federal court has been well publicized. That trend is no accident: one recent study reported that from October 2013 through last month, the SEC has had 219 consecutive victories before its ALJs. The SEC’s undefeated home winning streak is not surprising. The ALJs are themselves SEC hand-picked employees. Appeals are not made directly to an impartial court of law, but instead go to the SEC Commissioners themselves; the very SEC Commissioners who authorized the SEC to bring the enforcement case originally. Administrative proceedings do not recognize traditional procedural protections otherwise afforded in federal district court, including even-handed discovery and adherence to the Federal Rules of Civil Procedure and Evidence.

In the Gray case, the SEC has just under 20 days to file its answer to the Complaint, and shortly thereafter will need to provide responses to the discovery.