The SEC's Administrative Law Courts Are At A Crossroads

In the aftermath of the 2008 financial crisis, Congress set out to tighten regulatory oversight of Wall Street and embed robust safeguards into the financial system. The outcome of that legislative effort was the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in July 2010, which delivered sweeping financial regulatory reform.

To effectively enforce the provisions of Dodd-Frank, Congress enhanced the enforcement weapons that the U.S. Securities and Exchange Commission had in its arsenal. To that end, Dodd-Frank expanded the SEC's authority to impose civil penalties against "any person" — as opposed to only "registered" parties — in its in-house administrative law courts, or ALCs.

After Dodd-Frank was signed into law, the SEC ramped up the use of its newfound administrative power, and, by the end of fiscal year 2015, it had significantly increased the number of enforcement actions filed in its SEC-friendly tribunal (645) — where it maintained a healthy 90% success rate in contested cases — while at the same time significantly decreased the number of cases filed in federal district court (162).[1]

The spike in administrative filings, however, triggered various legal challenges that gradually eroded the utility of ALCs. Ironically, Dodd-Frank's intention to strengthen the SEC's tribunal may have unwittingly set the stage for its demise.

Prior to the passage of Section 929P of Dodd-Frank, the SEC was authorized to seek civil penalties against nonregulated parties only in federal district court, thereby limiting the number and type of cases it could file administratively.

For example, an insider trading case against an architect from Wisconsin — seeking a civil penalty as the SEC routinely does — could only be filed in federal district court. After the passage of Dodd-Frank, however, the commission now had the discretion to file the same enforcement action in either its ALCs or federal district court, and, more often than not, the SEC opted for the home-court advantage.[2]

The practical impact of this expanded jurisdiction meant that someone — like the architect far removed from the securities industry — might now end up being a respondent in an SEC administrative enforcement action without the same procedural and constitutional safeguards available in federal district court.

Among other things, this means the respondent's fate would be in the hands of an SEC-appointed administrative law judge who would conduct an evidentiary hearing and issue an initial decision. Further, fact discovery would be limited as compared to federal district court, the administrative hearing would not be governed by the Federal Rules of Civil Procedure, and — prior to the U.S. Supreme Court's 2024 decision in SEC v. Jarkesy — the respondent would be deprived of a jury trial as guaranteed by the Seventh Amendment of the U.S. Constitution.[3]

Under these circumstances, it's not surprising that legal challenges to the constitutionality and fairness of SEC administrative proceedings surged after the passage of Dodd-Frank. One of the still-unresolved challenges focused on the constitutionality of how and by whom SEC ALJs are appointed.

In its 2018 decision in Lucia v. SEC, the Supreme Court held that ALJs were "officers of the United States" subject to the Constitution's appointments clause.[4] Before the Lucia opinion was handed down by the Supreme Court, however, the SEC took preemptive actions that sought to put to rest constitutional challenges to the appointment of ALJs.

The SEC acknowledged in a statement that ALJs were "inferior officers who must be appointed consistent with the Appointments Clause of the Constitution" — a position the SEC echoed in its Lucia brief — and consistent with this view, the commission "ratified its prior appointment" of its ALJs. The SEC then concluded that its ratification of ALJs had "resolved any concerns that administrative proceedings presided over by its ALJs violate the Appointments Clause."[5]

These proactive steps, however, did little to quiet the storms swirling around the appointment of ALJs and legal challenges to the dual-layer tenure protection[6] enjoyed by SEC ALJs — a question not addressed by Lucia[7] — not only persisted but intensified after the inauguration of President Donald Trump in January.

On Feb. 18, Trump issued Executive Order No. 14215, with the stated purpose of making federal agencies, including independent regulatory agencies like the SEC, "truly accountable to the American people" by exercising "Presidential supervision and control of the entire executive branch."[8] Notably, the executive order states that "authoritative interpretations of law for the executive branch" shall be made only by the president and the attorney general.

To limit agency discretion and authority, the executive order further states that no agency employee may advance a legal interpretation that "contravenes the President or the Attorney General's opinion on a matter of law," including "positions advanced in litigation."

At the time Trump issued the executive order, a case styled Lemelson v. SEC was also pending in the U.S. District Court for the District of Columbia. Lemelson, an unregistered hedge fund adviser, sought declaratory and injunctive relief to prevent the SEC from continuing an alleged unconstitutional follow-on administrative enforcement proceeding.

A follow-on enforcement proceeding takes place in the SEC's administrative courts and is based on an injunction entered against the same defendant in a separate federal district court action. The purpose of an SEC follow-on proceeding is to impose a bar or suspension — if it is in the public interest — against securities industry participants.

In his complaint, Lemelson alleged that the SEC's administrative courts were unconstitutional because, among other things, ALJs were not independent Article III judges and jury trials are unavailable in a proceeding before an ALJ. Lemelson later amended his complaint to add a claim that follow-on proceedings were unconstitutional because ALJs were not controlled or removable by the president, in violation of Article II of the Constitution.

This constitutional challenge was previously rejected by both the first Trump administration and the Biden administration. Indeed, the U.S. Department of Justice forcefully argued in an opposition brief filed in Lemelson — in the twilight of the Biden administration — that SEC ALJ tenure protections, which restrict the direct removal of ALJs by the president, were
constitutional.

Against this backdrop, on Feb. 18, the DOJ filed a notice of change in position in Lemelson stating that "the Acting Solicitor General has decided that the multiple layers of removal restrictions for administrative law judges in 5 U.S.C. § 7521 do not comport with the separation of powers and Article II and that the United States will no longer defend them in litigation."[9]

Two days later, the DOJ issued a short press release that announced,

the Department of Justice determined that multiple layers of removal restrictions shielding administrative law judges (ALJs) are unconstitutional. Unelected and constitutionally unaccountable ALJs have exercised immense power for far too long. In accordance with Supreme Court precedent, the Department is restoring constitutional accountability so that Executive Branch officials answer to the President and to the people.[10]

The DOJ's seismic departure from its prior defense of the constitutional legitimacy of the SEC's ALJs reflects the president and attorney general's view of how independent regulatory agencies align — or not — with principles of separation of powers.

With the DOJ and SEC no longer defending the constitutionality of ALJs, it's arguably only a matter of time before a court holds that the appointment of the SEC's ALJs violates the appointments clause.[11] In the meantime, it's doubtful that the SEC will administratively file any new contested enforcement cases in a forum that DOJ has now, in essence, declared to be unconstitutional, especially in light of Executive Order No. 14215.[12]

Absent some action by Congress to remedy the alleged constitutional defects of ALCs, it's difficult to see how the SEC's forum continues to function as anything other than — at best — a destination for settled actions or a limited category of cases such as a revocation of the registration of an issuer's securities under Section 12(j) of the Exchange Act. Indeed, as the pressure from constitutional challenges mounted near the end of fiscal year 2015, the SEC's use of administrative courts for contested cases began to taper.[13]

Although the SEC can file nearly all of its cases in federal district court, with the exception of disciplinary actions brought under Rule 102(e) of the SEC's Rules of Practice, the pivot back to more resource-intensive federal district court actions taxes the enforcement program's limited resources.[14] This environment correspondingly limits the number and also the types of cases — e.g., complex accounting and financial fraud cases — that can be filed in any given year.

Finally, if ALCs were eventually declared by the courts to be unconstitutional, something distinctly possible, then the overall number of enforcement actions arguably would decline. This development would limit the number of programmatically important, but resource-heavy, enforcement actions filed, and less serious cases that historically were filed administratively may be dropped entirely.

Nonetheless, a window remains open to resolve the constitutional challenges surrounding ALCs. Congress should create a new appointment structure that denies ALJs removal protection so that they are directly accountable to the president. This blueprint would be consistent with Executive Order No. 14215 and end the frequent constitutional challenges surrounding the appointments clause.

Congress should also allow nonregulated parties to remove administrative enforcement actions to federal district court. The Trump administration, however, has not indicated that it intends to ask Congress to change how ALJs are appointed, so it's likely that the SEC's tribunal will remain in constitutional limbo for the time being.

Reprinted with permission from Law360.

[1] See, e.g., Select SEC and Market Data Fiscal 2015 and SEC Wins With In-House Judges - WSJ (SEC had a 90% success rate against defendants before its own judges in contested cases from October 2010 through March of 2015).

[2] See, e.g. SEC Is Steering More Trials to Judges It Appoints - WSJ (former director of enforcement stated in 2014 that the SEC was "using administrative proceedings more extensively").

[3] See SEC v. Jarkesy, No. 22-859, 2024 WL 3187811, at *8-9 (U.S. June 27, 2024) (when the SEC seeks civil penalties in a securities fraud action the defendant is entitled to a trial by jury under the Seventh Amendment).

[4] Lucia et al. v. Securities and Exchange Commission, 585 U.S. 237 (2018).

[5] https://www.sec.gov/newsroom/press-releases/2017-215.

[6] An SEC ALJ cannot be directly removed from office by the President. The Commission may terminate an ALJ's employment "only for good cause established and determined by theMerit Systems Protection Boardon the record after opportunity for hearing before the Board." 5 U.S.C. § 7521(a). The MSPB is an independent, quasi-judicial agency that oversees the federal civil service system whose board members also enjoy for-cause removal protections.

[7] But see Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477 (2010) ("for cause" limitation on the removal of Public Company Accounting Oversight board members under the Sarbanes-Oxley Act was unconstitutional under Article II's broad vesting of executive power in the President).

[8] https://public-inspection.federalregister.gov/2025-03063.pdf.

[9] Lemelson v. SEC, No.1:24-cv-02415-SLS (D.D.C., Feb. 18, 2025).

[10] Office of Public Affairs | Statement from Justice Department Chief of Staff Chad Mizelle | United States Department of Justice.

[11] As of the writing of this article, the Court in Lemelson has not entered any orders after the filing of DOJ's Notice of Change in Position.

[12] As of the writing of this article, it appears that settled administrative actions are still being filed in ALCs and pending matters are still proceeding.

[13] See, e.g., SEC Trims Use of In-House Judges - WSJ ("A review of 160 cases affecting more than 500 defendants shows that in the three months through September [2015], the SEC sent just 11% — four of 36 — of its contested cases to its administrative law judges.").

[14] Rule 102(e) proceedings seek to censure or bar accountants, attorneys, and other professionals from appearing or practicing before the SEC due to improper professional conduct. This type of disciplinary proceeding, however, cannot be filed in federal court, putting the SEC in a difficult position given the headwinds facing its in-house courts.