While On Firmer Ground, Uncertainty Remains For SEC's ALJs

In a 26-page decision, the U.S. District Court for the District of Columbia on May 27 rejected an effort by a hedge fund manager to derail a pending U.S. Securities and Exchange Commission in-house follow-on enforcement proceeding, in which he claimed the "deck [was] stacked decidedly against the accused."[1]

The SEC's administrative action sought to suspend or bar Emmanuel Lemelson from the securities industry following a November 2021 U.S. District Court for the District of Massachusetts jury verdict, which found him liable for violations under the anti-fraud provisions of the federal securities laws.

The D.C. District Court's comprehensive opinion in Lemelson v. SEC affirmed the legitimacy of the commission's administrative proceedings, but pointedly left unanswered the merits of whether tenure protection enjoyed by SEC administrative law judges violates Article II of the U.S. Constitution.[2]

Lemelson's constitutional challenge to the SEC's follow-on proceeding is a recent installment in the long-running battle between the parties.

In 2018, the SEC filed a contested civil action in Massachusetts federal court. In that suit, the SEC alleged that Lemelson and his hedge fund, Lemelson Capital Management LLC, had engaged in a short-and-distort scheme. The SEC claimed that Lemelson built a short position in San Diego-based Ligand Pharmaceuticals Inc. and then "orchestrated a public campaign" to "convince the investing public" that its shares were overvalued.

In November 2021, after a nine-day jury trial, the jury determined that Lemelson made three materially false and misleading statements about Ligand, in violation of Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder.

In March 2022, the court entered a final judgment against Lemelson, enjoining him from violating the anti-fraud provisions of the federal securities laws for a period of five years and imposing a $160,000 civil penalty.[3]

Following entry of the district court injunction, the SEC instituted its follow-on proceeding. In August 2024, Lemelson filed a complaint — and later a first amended complaint — for declaratory and injunctive relief against the SEC that sought to preliminarily "suspend its unconstitutional and unlawful follow-on" proceeding and permanently enjoin the "SEC from continuing with or adjudicating its follow-on administrative enforcement prosecution."

Lemelson challenged the SEC's "rubber-stamp" enforcement proceeding on an array of constitutional grounds:

• Claim 1: Due process violations under the Fifth Amendment;
• Claim 2: Usurpation of judicial power vested in the courts under Article III of the Constitution;
• Claim 3: Denial of a trial by jury under the Seventh Amendment;
• Claim 4: Violations of Article II of the Constitution based on multilayer removal
  protections enjoyed by ALJs; and
• Claim 5: Res judicata based on the SEC's failure to seek an associational bar against
  Lemelson in a separate Massachusetts federal district court action, which entered a
  final judgment permanently enjoining him from violating the anti-fraud provisions of
  the federal securities laws.[4]

The SEC responded with a motion to dismiss Lemelson's complaint pursuant to Federal Rules of Civil Procedure 12(b)(1)(lack of subject matter jurisdiction) and 12(b)(6) (failure to state a claim). It was during the briefing of this motion, on Feb. 18, 2025, that the SEC, represented by the U.S. Department of Justice, surprisingly withdrew its Article II defense of ALJs.

Nonetheless, as discussed below, this unexpected twist did not help Lemelson succeed.

In deciding that it lacked subject matter jurisdiction to hear Lemelson's third and fifth claims, the D.C. District Court relied on Section 203(f) of the Advisers Act.

The court noted that Section 203(f) explicitly authorizes the SEC to bring follow-on administrative proceedings in certain circumstances to oversee regulated participants. Section 203(f) empowers the SEC to "suspend or bar a participant" after "notice and opportunity for hearing" if that participant was enjoined "in connection with the purchase or sale of any security" in a separate federal district court action. Section 203(f) also provides that any order issued at the conclusion of a follow-on proceeding is reviewable in the U.S. courts of appeals.

After a detailed analysis of precedent, the court held that it lacked subject matter jurisdiction to hear Lemelson's jury trial and res judicata claims because Congress had provided an "alternative scheme of review."

The court observed that these claims are of "the type Congress intended to be reviewed within [the] statutory structure" of the Advisers Act, and that the "Advisers Act created a statutory scheme for follow-on proceedings that relies on decision-making by the SEC." The court also held that the Advisers Act provides Lemelson with an opportunity to seek meaningful review of any final SEC order — including Lemelson's claim that he is entitled to a jury trial — by challenging that order in a federal appeals court.

As for Claims 1, 2 and 4, the court held that Lemelson failed to state a claim. With respect to Lemelson's due process claim, he argued that his rights were violated because "adjudicators" were allowed to "decide their own cases." The court quickly dispatched this argument, however, by finding that "the D.C. Circuit has already rejected this [due process] argument."

The court relied on an opinion that turned aside similar due process challenges based on Section 15(b)(4) of the Exchange Act — an analogous "alternative scheme of review" to Section 203(f) — which permitted follow-on proceedings against broker-dealers based on the entry of a federal district court injunction. The court then went on to distinguish multiple cases that Lemelson argued contravened the precedent the court had relied on, and concluded that he did not state a claim.

The second claim asserted that follow-on proceedings usurp judicial power and therefore violate Article III. Relying again on U.S. Supreme Court precedent, the court noted that Congress has "significant latitude to assign adjudication of public rights to entities other than Article III courts."

Lemelson had vigorously argued that follow-on proceedings, however, do not involve public rights. Nonetheless, the court was unpersuaded and held that "Lemelson challenges a follow-on proceeding that deals with a public right, so the Court dismisses this claim."

Finally, the court addressed the fourth claim, relating to Article II. The SEC initially argued that ALJ removal protections were constitutional, and alternatively argued that, even if they were unconstitutional, Lemelson had not plausibly alleged that "ALJ tenure protections caused him any harm."

The SEC later filed a notice of change in position, which abandoned its argument that removal protections were constitutional, but continued to maintain that, in any event, Lemelson had not been harmed. Shortly after changing its position in this suit, the DOJ issued a press release on Feb. 20, 2025, announcing that "the Department of Justice determined that multiple layers of removal restrictions shielding administrative law judges (ALJs) are unconstitutional."[5]

To explore whether Lemelson had been harmed, the court first examined Supreme Court precedent, which held that "where plaintiffs showed no harm stemming from similar removal protections, there was 'no basis for concluding' that an agency 'lacked the authority to carry out [its] functions' and thus no unlawful action to remedy." Here, the court found that Lemelson had "not plausibly alleged facts" showing that ALJ tenure protection had caused him any harm.

Lemelson had argued that at this stage of litigation — before discovery or trial — he had no obligation to prove that ALJ tenure protection had harmed him. The court, however, rejected this argument and held that this does not free him of the "obligation to allege such harm," and dismissed the claim under Rule 12(b)(6).

Unlike the other constitutional challenges raised by Lemelson, the court did not reach the Article II issue. In doing so, the court was in accord with the "longstanding principle of judicial restraint [that] requires that courts avoid reaching constitutional questions in advance of the necessity of deciding them." As such, the merits of the constitutionality of ALJ tenure protection remain undecided.

Key Takeaways

The SEC has rebuffed a serious challenge to its in-house courts and, at least for the time being, the forum now rests on firmer ground. This decision provides a measure of certainty that its in-house courts can continue to play a role, especially in the context of follow-on proceedings.

Each step of the SEC's litigation with Lemelson has been hotly contested, and this decision does not signify the end of the story. On May 30, Lemelson appealed the district court decision to the U.S. Court of Appeals for the D.C. Circuit and, if this appeal is unsuccessful, it's highly probable that he will seek review by the Supreme Court. In the meantime, SEC administrative courts likely will continue to experience constitutional challenges in other cases until either Congress or the Supreme Court settles these issues.

Even though the DOJ announced that it will not defend the constitutionality of ALJs, it appears for now that it will oppose Article II challenges that fail to articulate some form of harm.

Constitutional challenges still loom large over SEC in-house courts. The Trump administration seems to be waiting for the right case to argue that ALJ tenure protection is unconstitutional. Arguably, this case may be the right vehicle for the administration to present its argument to the Supreme Court.

If indeed the Supreme Court agrees with the Trump administration and determines that ALJ tenure protection is unconstitutional, that does not necessarily mean the end of SEC administrative law courts. To the contrary, ALJs might simply lose their tenure protection and be directly accountable to the president. This probably would not have great practical
implications for ALJ adjudications, although, at least in theory, it would make them more directly subject to presidential influence.

Reprinted with permission from Law360.

[1] A follow-on proceeding is an SEC administrative action that "allows the SEC to suspend or bar someone if it finds on the record after notice and opportunity for hearing that (1) such a suspension or bar is in the public interest, and (2) that the person has been convicted of certain crimes or has been enjoined from any action, conduct, or practice" related to the federal securities laws.

[2] Lemelson v. Securities and Exchange Commission, No. 24-cv-2415, 2025 WL 1503815 (D.D.C. May 27, 2025).

[3] In April 2022, Lemelson appealed the verdict to the U.S. Court of Appeals for the First Circuit and in August 2023, the circuit court affirmed. In December 2023, the Supreme Court denied Lemelson's petition for writ of certiorari.

[4] An associational bar is an SEC administrative bar that restricts a person from association with any investment adviser, broker, dealer, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization pursuant to Section 15(b)(6) of the Exchange Act or Section 203(f) of the Investment Advisers Act of 1940 (Advisers Act).

[5] "Statement from Justice Department Chief of Staff Chad Mizelle," U.S. Department of Justice press release, February 20, 2025. Interestingly, in another case that contained an Article II challenge, Alpine Securities v. FINRA, DOJ opposed the petitioner's writ of certiorari. See Brief of the United States in Opposition. In that case, DOJ argued that the "tension in petitioner's pleadings would complicate this Court's review of the Article II issues in the petition, making this case an especially poor vehicle for review." On June 2, 2025, the Supreme Court denied the petition. DOJ's litigation posture in Alpine strongly signals that it's waiting for a better case to argue that the current ALJ appointment structure is unconstitutional.