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From Securities Regulation Daily, August 24, 2015

Injunction against SEC ‘likely unconstitutional’ enforcement proceeding should stand, adviser argues

By Lene Powell, J.D.

An investment advisory group told a Georgia federal district court that a preliminary injunction, enjoining the SEC from proceeding against the adviser in an SEC administrative enforcement action, was properly issued by the court and should not be stayed or reconsidered. The court granted the preliminary injunction on August 4 on the basis that the adviser was likely to succeed on the merits of its claim that the appointment of the administrative law judge hearing the enforcement action violated the Appointments Clause of the U.S. Constitution. The SEC is seeking to stay the preliminary injunction while it appeals to the Eleventh Circuit (Gray Financial Group, Inc. v. SEC, August 21, 2015).

Background. Gray Financial Group is an investment advisory group registered with the SEC, Georgia, and Michigan. Gray Financial offered Georgia pension plans an opportunity to invest in a fund of funds alternative investment, and in August 2013 the SEC alerted the group that it was investigating whether the fund complied with the Georgia Public Retirement Systems Investment Authority Law. On February 19, 2015, Gray Financial filed an action in federal district court seeking injunctive relief to prevent an administrative enforcement action by the SEC, arguing that the tenure protections of ALJs are unconstitutional under Article II and SEC administrative enforcement proceedings give the agency unfair procedural advantages. On May 21, the SEC instituted an administrative enforcement proceeding charging Gray Financial and two executives with fraudulently recommending and selling unsuitable investments to Georgia pension funds.

On August 4, the court granted Gray Financial’s motion for preliminary injunction to enjoin the administrative proceeding, ruling that SEC ALJs are inferior officers who must be appointed by the President, department heads, or courts of law, so the appointment of SEC ALJ Cameron Elliott, who was presiding over the enforcement proceeding, was “likely unconstitutional.” The court ruled that Gray Financial also met the remaining factors for preliminary injunction, and therefore preliminarily enjoined the SEC from conducting the administrative proceeding. On August 5, ALJ Elliott cancelled the SEC administrative proceeding. Subsequently, the SEC filed a notice of appeal of the preliminary injunction and a motion to stay the injunction pending appeal. The court stayed the district court proceedings, with the exception of the motion to stay the preliminary injunction.

Preliminary injunction was proper. According to Gray Financial, the district court correctly issued the preliminary injunction. First, the court and the Eleventh Circuit had previously denied a similar motion in a related case, Hill v. SEC. In that case, the court ruled that the respondent was likely to succeed on the merits of his claim that the ALJ presiding over his insider trading case was an inferior officer who should have been appointed pursuant to the Appointments Clause. Also, Judge Berman, the only other district court judge to have reached the merits of an Appointments Clause claim adopted the Georgia court’s “persuasive” analysis in an order granting preliminary injunction in a Southern District of New York case, Duka v. SEC.

Further, the court correctly analyzed and applied the relevant precedent from the Supreme Court and the Eleventh Circuit in holding that (1) it had subject matter jurisdiction over Gray Financial’s constitutional claims; (2) SEC ALJs are inferior officers under Article II’s Appointments Clause because they exercise “significant authority;” (3) Gray Financial would suffer irreparable harm absent the preliminary injunction; and (4) the balance of the equities favored the issuance of the injunction. Regarding jurisdiction, the court could be divested of jurisdiction only if there was Congressional intent to do so, and that intent was absent.

As to the inferior officer question, although it is true that SEC ALJs may not render final decisions, that ability is not dispositive to the determination of whether SEC ALJs are inferior officers, said the plaintiffs. Moreover, SEC ALJs satisfy the test articulated by the Department of Justice’s Office of Legal Counsel, which binds the Executive Branch for identifying Article II officers, the plaintiffs asserted.

In addition, said the plaintiffs, the court correctly found that Gray Financial and the executives would be irreparably harmed unless an injunction was issued. The harm to plaintiffs was more than the expense of litigation, as argued by the SEC, because they would be subjected to the very proceeding that the court found was likely unconstitutional.

No irreparable harm to SEC. The SEC had argued that both it and the public would be harmed without a stay, because the injunction harmed the SEC’s ability to enforce the federal securities laws, and the enforcement action concerned alleged illegal conduct by an investment adviser with billions of dollars under management. However, the plaintiffs contended that the SEC could not show that it or the public likely to be irreparably harmed absent a stay. The SEC did not identify any specific way the stay impeded its general ability to enforce the securities laws, nor why that interest justified brushing aside the plaintiffs' constitutionally protected rights. Also, any harm was self-inflicted, as the SEC has “myriad remedies” available to it through the federal district courts. The public interest did not support granting a stay of the injunction, because as the court correctly found, it is never in the public interest for the Constitution to be violated, and the public has an interest in assuring that citizens are not subject to unconstitutional treatment by the Government.

Finally, argued the plaintiffs, granting the stay would moot the claim. If the stay were granted, the plaintiffs would be subject to pre-hearing rulings by the unconstitutional ALJ and would have to defend themselves at the administrative hearing while the federal district court case awaited briefing, oral argument, and a decision on appeal. Thus, by the time the Court of Appeals reached a final decision on the constitutionality of the administrative proceeding, the plaintiffs would have virtually no relief left to request in the district court, and the Court of Appeals would have very little relief left to give.

The case is No. 1:15-cv-0492-LMM.

Attorneys: Kathryn S. Gostinger (Greenberg Traurig, LLP) for Gray Financial Group, Inc. Adam A. Grogg. U.S. Department of Justice Civil Division, Federal Programs Branch, for the SEC.

Companies: Gray Financial Group, Inc.

MainStory: TopStory Enforcement FraudManipulation InvestmentAdvisers GeorgiaNews

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