Portfolio Media. Inc. | 111 West 19th Street, 5th Floor | New York, NY 10011 | www.law360.com Phone: +1 646 783 7100 | Fax: +1 646 783 7161 | [email protected] You're Hired! What Kavanaugh’s Nomination Means For SEC By Brian Rubin, Adam Pollet, Melissa Fox and Amber Unwala (July 16, 2018, 2:08 PM EDT) On the night of Monday, July 9, President Donald Trump interrupted one of America’s most-watched reality television shows, "The Bachelorette," to deliver his own metaphorical final rose to D.C. Circuit Judge Brett Kavanaugh as his choice to replace retiring U.S. Supreme Court Justice Anthony Kennedy. Trump, a veteran of reality television, used his broadcast to introduce Judge Kavanaugh to America and the world, and to tell the judge, in front of millions, “You’re hired.” Immediately, the news and social media were abuzz Brian Rubin about what a Supreme Court with Judge Kavanaugh would do on social “hot button” issues. Somewhat less discussed (but no less interesting to securities geeks) is how a future Justice Kavanaugh may impact securities enforcement matters. If this past Supreme Court term is indicative of future ones, the Supreme Court will continue to decide key issues that affect enforcement actions brought by the U.S. Securities and Exchange Commission. Thus, a Supreme Court with now-Judge Kavanaugh sitting on the bench will likely have a significant impact on the SEC and its enforcement program for years to Adam Pollet come. SEC Deference A newly constituted Supreme Court, with the added intellectual firepower of Judge Kavanaugh, could ultimately strike down many SEC rules and overturn enforcement actions through the dismantling of the Chevron doctrine,[1] which requires judges to defer to administrative agencies’ interpretation of federal law where the law may be ambiguous and the agency’s position Melissa Fox seems reasonable. When Trump tapped Neil Gorsuch to be on the Supreme Court last year, many observed that he had denounced Chevron as a judge- made doctrine for the abdication of the judicial duty.[2] Judge Kavanaugh’s opinions show a similar concern when administrative agencies — like the SEC — exceed their congressional mandate. This skeptical approach to agency power was evidenced in 2007 when Judge Kavanaugh sided with the Financial Planning Association and overturned the SEC’s “Merrill Lynch” rule that permitted broker-dealers to charge asset-based fees without having to register as investment advisers.[3] Judge Kavanaugh was the deciding vote in Amber Unwala a 2-1 decision that strictly adhered to the text of the Investment Advisers Act and found the SEC overstepped its authority. Judge Kavanaugh’s skepticism of agency power could limit the SEC’s enforcement program. In September 2017, he dissented in Lorenzo v. SEC, accusing the agency of attempting to expand the scope of primary liability under securities laws in circumvention of Supreme Court decisions.[4] In his dissent, Judge Kavanaugh showed little deference to the SEC (or for the majority opinion, written by a judge appointed by President Barack Obama), lambasting the majority for adopting “the SEC’s alternative facts.” Future Justice Kavanaugh may see his dissent in Lorenzo adopted by the Supreme Court, which recently granted Lorenzo’s petition for certiorari. A shift in the level of administrative deference afforded by the high court could also have a significant impact on SEC rulemaking. This is particularly possible given the fate of the U.S. Department of Labor’s fiduciary rule, which the U.S. Court of Appeals for the Fifth Circuit struck down earlier this year as arbitrary, capricious and exceeding its authority.[5] With Judge Kavanaugh on the bench, the fate of the SEC’s proposed Regulation Best Interest[6] may be subject to a successful challenge given his demonstrated opposition to wide-sweeping agency rule-making in the absence of clear instruction from Congress. SEC Administrative Law Judges In the weeks prior to Trump’s nomination of Judge Kavanaugh, the Supreme Court issued its decision in Lucia v. SEC, holding that the SEC’s administrative law judges, or ALJs, are inferior officers as opposed to employees, and thus should be appointed pursuant to the appointments clause of the Constitution.[7] Specifically, the six-member majority found that the SEC’s appointment of ALJs violates the appointments clause because they were appointed by commission staff, not the commission itself. While Lucia struck a major blow to a key aspect of the administrative law apparatus, the Supreme Court left open two key issues regarding ALJs: first, whether the ALJ removal process is constitutional; and second, whether the SEC was permitted to ratify the prior appointments of ALJs. A. Removal Process Because Lucia established that ALJs are inferior officers and must be appointed by the commission, a related question that may be litigated is how ALJs are removed from office. Indeed, in his partial concurrence, Justice Stephen Breyer argued that the court should have decided the removal issue prior to deciding the appointments issue. Given that this issue has been raised by a justice, it seems likely that individuals and companies will attempt to litigate the issue before the court. If that happens, a future Justice Kavanaugh will be well-positioned to hear the appeal because he has ruled on these issues previously. His dissent in Free Enterprise Fund v. Public Company Accounting Oversight Board[8] was adopted by the Supreme Court when it heard that case on appeal, ruling that the so called “dual layer” of protection from removal was an unconstitutional restriction on the president’s removal powers of officers.[9] B. The SEC’s Order Ratifying Appointments In response to Lucia’s challenge in the Supreme Court, the SEC issued an order last November ratifying the hiring of all its ALJs.[10] The order further required the ALJs to reconsider the record in cases pending before them. The Supreme Court acknowledged the SEC’s order, but stated in a footnote that the court was not addressing whether the SEC’s order was constitutional. However, Lucia required a new ALJ to review the case before the court. The decision therefore suggests that it might be unconstitutional for the SEC to have ordered that the same ALJs reconsider cases currently before them, as opposed to reassigning cases to new ALJs. If the SEC’s order reaches a Supreme Court with current Judge Kavanaugh on the bench, his prior decisions questioning Chevron deference may result in a holding that the SEC’s order is unconstitutional. C. Future Justice Kavanaugh’s Impact Justice Kennedy sided with the majority in Lucia. Based on his prior decisions, a future Justice Kavanaugh likely would have done the same. Given that Lucia appears to have opened the door for challenges to the appointments, removals and decisions of independent agency ALJs, as a justice, Judge Kavanaugh may have additional opportunities to express his views on the reach of the administrative state. While it remains to be seen which of these issues will be presented to the Supreme Court in the future, it appears that Judge Kavanaugh’s confirmation may limit the SEC’s authority. SEC Remedies Finally, the SEC may find its enforcement remedies further restricted by a future Justice Kavanaugh, in particular, its ability to ask courts to order disgorgement. When courts first ordered the remedy of disgorgement in SEC civil injunctive actions,[11] there was no statutory authorization for monetary remedies (monetary penalties or disgorgement). As a result, the SEC argued that courts had the inherent ancillary authority to order equitable remedial relief in the form of disgorgement to strip wrongdoers of their ill-gotten gains. Over time, Congress authorized the SEC to seek civil monetary penalties and additional sanctions but repeatedly chose not to expressly provide for disgorgement in district court proceedings.[12] In Kokesh v. Securities and Exchange Commission, the court reviewed whether disgorgement was subject to a statute of limitations.[13] In June 2017, the court unanimously found that the statute of limitations that applies to civil penalties also applies to disgorgement. The court found that disgorgement operates as a penalty (and is thus subject to the five-year statute of limitations) because: (1) courts impose SEC disgorgement as a remedy for violations of public laws against the United States rather than against an aggrieved individual, and (2) SEC disgorgement is imposed for punitive rather than compensatory purposes. Since the court’s decision was unanimous, a vote by a future Justice Kavanaugh would not have changed the outcome. Interestingly, as a judge, he had the opportunity to rule on the issue before Kokesh was before the Supreme Court. While on the D.C. Circuit, he authored an opinion, Riordan v. SEC, holding that disgorgement was not a penalty and thus not subject to the five-year statute of limitations on civil penalties.[14] But this holding primarily turned on circuit precedent, not on his own analysis of the relevant statute. As a justice, given his leanings in other cases, and the fact that he will not be bound by circuit court precedent, it appears that Judge Kavanaugh would have joined the court in its decision. The Kokesh decision left open one very important issue: whether disgorgement orders were permissible at all. As the court stated, “Nothing in this opinion should be interpreted as an opinion on whether courts possess authority to order disgorgement in SEC enforcement proceedings or on whether courts have properly applied disgorgement principles in this context.”[15] In addition, the court specifically questioned whether disgorgements were truly remedial, which was the SEC’s original argument on why courts had the authority to order such relief (disgorgement “cannot fairly be said solely to serve a remedial purpose”).[16] Litigants will likely seize on these chinks in the disgorgement armor and continue to challenge this judicial remedy.