United States: Supreme Court To Decide Whether The SEC's Administrative Law Judges Are Officers Of The United States Under The Appointments Clause Of The Constitution

On April 23, 2018, the United States Supreme Court heard oral argument in Lucia v. Securities and Exchange Commission to decide whether administrative law judges (ALJs) of the Securities and Exchange Commission (SEC or Commission) have been properly appointed. In particular, the Court was asked to determine whether SEC ALJs are "Officers" within the meaning of the Appointments Clause of the United States Constitution.1 The SEC has historically taken the view that its ALJs are employees (rather than Officers) and do not need to be appointed pursuant to the Appointments Clause. During oral argument, the Supreme Court appeared divided, with questioning focused on competing principles of judicial independence and political accountability. A decision is expected by the end of June.

BACKGROUND

This issue arises from the SEC's increased use of administrative proceedings during the past seven years and the widely held perception that the Division of Enforcement enjoys a "home court" advantage when it proceeds against respondents administratively. Throughout its 84-year history, the SEC, as an independent executive branch agency, has always had the authority to institute administrative proceedings in various circumstances involving regulated entities and individuals, and there has never been much debate about the constitutionality of the SEC's ALJs.

That changed around 2009 with an unprecedented wave of insider trading cases in which federal district courts began to raise concerns about staying SEC civil cases during the pendency of parallel criminal proceedings. Judge Rakoff of the Southern District of New York, in particular, criticized the Government for seeking stays of SEC civil cases filed contemporaneously with criminal charges for the same conduct. Other courts followed suit, and with increasing frequency district courts began denying stays of discovery that the Government previously presumed were all but automatic. In response, the SEC resorted to instituting cases administratively where it could avoid having federal district court judges determine when and under what circumstances stays in parallel proceedings would be granted. For example, the SEC's decision to bring an administrative cease-and-desist proceeding against Rajat Gupta for insider trading in 2011 was a turning point in the use of administrative proceedings and contravened decades of practice and precedent in which insider trading actions (with the exception of a few settled cases) were filed in United States district courts. The Gupta administrative case (which the Commission ultimately dismissed) unlocked the floodgates for these matters to be filed administratively rather than in district courts. With the increase in administrative actions, criticism of the administrative process—including fairness concerns and constitutional challenges by Mr. Gupta and others—became common, culminating in this challenge to the ALJs' authority before the Court.

LUCIA

In September 2012, the SEC issued an order instituting administrative cease-and-desist proceedings against Raymond J. Lucia and his investment company, Raymond J. Lucia Companies, Inc. (RJLC) (collectively, Respondents or Petitioners). The order was based on allegations by the SEC's Division of Enforcement that Respondents had violated the anti-fraud provisions of the Investment Advisers Act by making misrepresentations to prospective investors regarding a particular wealth management strategy.2 In July 2013, an SEC ALJ issued an initial decision finding RJLC and Lucia liable and imposed a lifetime industry bar on Lucia and civil penalties totaling $300,000.3

Upon plenary review by the Commission, Lucia argued, among other things, that the administrative hearing was unconstitutional because the ALJ was not appointed properly pursuant to the Appointments Clause. In September 2015, the Commission denied Respondents' appeal, affirming the ALJ's initial decision and denying Respondents' constitutional challenge.4

Respondents petitioned the D.C. Circuit for review, again arguing that the ALJ presiding over the matter was not appointed properly. In August 2016, a three-judge panel held that the appointment of SEC ALJs does not violate the Constitution because ALJs are not "Officers" within the meaning of the Appointments Clause.5 The D.C. Circuit concluded that SEC ALJs lack authority to issue final decisions on behalf of the Commission and that the Commission "has reasonably interpreted its regulatory regime to mean that no initial decision of its ALJs is independently final."6

Lucia and RJLC sought certiorari, arguing that the D.C. Circuit's decision was inconsistent with the Supreme Court's 1991 decision in Freytag v. Commissioner, which held that IRS special trial judges appointed by the U.S. Tax Court were Officers even though they lacked the authority to render final decisions.7 Petitioners also argued that the D.C. Circuit's decision was inconsistent with a recent Tenth Circuit decision concluding that, although "[f]inal decision-making power is relevant in determining whether a public servant exercises significant authority," this "does not mean every inferior officer must possess final decision-making power."8 Instead, the Tenth Circuit found that because the SEC's ALJs "exercise significant discretion while performing 'important functions' that are 'more than ministerial tasks,'" SEC ALJs are "inferior officers who must be appointed in conformity with the Appointments Clause."9

The United States, in response to the petition for certiorari, also requested that the Supreme Court resolve the circuit split.10 Notably, in its briefing, the Government reversed its prior position and conceded that the SEC's ALJs are Officers who should be subject to the Appointments Clause.11 In January 2018, the Supreme Court granted the petition and, because of the Government's change in positions, appointed an outside attorney as Amicus Curiae to defend the D.C. Circuit's ruling.12

ORAL ARGUMENT

At oral argument, the Supreme Court focused its questioning on considerations related to the ALJs' independence and political accountability. As for independence, Justice Breyer expressed concern that if ALJs—who traditionally have been selected as civil-service employees—were subject to the Appointments Clause, that could potentially result in saying "goodbye to the merit civil service at the higher levels and goodbye to independence of ALJs." Justice Breyer cautioned that a ruling in favor of Petitioners and the Government could possibly "driv[e] wedges of dependence into what was to be since Chester Alan Arthur a merit-based civil service."

Justice Kagan similarly stressed the importance of maintaining ALJs' decisional independence from political influence. As she noted, "[t]here are different ways to interfere with decisional independence. One is by docking somebody's pay. One is by having a removal power that you hang over your head. And another is by being the person who gets to decide who gets the job or not. And so all of these things in some manner tie the adjudicator more closely to the political system." In response, the Government argued that appointing ALJs pursuant to the Appointments Clause would not raise independence concerns because agencies would still be prohibited from impinging on the decisional independence of ALJs.

Meanwhile, Chief Justice Roberts observed that accountability was the driving principle of the Appointments Clause. Chief Justice Roberts expressed concern that "you don't have that accountability" with SEC ALJs because they are not appointed by either the Commission or the President. Thus, "[t]he Commission can say: Don't blame us. We didn't do it. The President can say: Don't blame me. I didn't appoint them. And, instead, it's something in the administrative bureaucracy which operates as insulation from the political accountability that the drafters of the Constitution intended." In response, Amicus Curiae argued that the Commission is always "held 100 percent accountable for every single decision, whether it's initially made by an ALJ or not," because the Commission (i) affirmatively sanctions every initial decision made by an ALJ and (ii) holds binding authority to enter final decisions.

Justices also inquired as to how a ruling in favor of Petitioners and the Government would impact other federal agencies that use ALJs. Petitioners argued that a ruling that ALJs are Officers would only impact approximately 150 ALJs across 25 federal agencies (i.e., only those ALJs who "decide adversarial proceedings"). According to Petitioners, "adversarial proceedings" are enforcement actions and other proceedings "where a private citizen is brought against his or her will before a government body to have his or her fate decided." Several Justices questioned this conclusion, including Justice Sotomayor, who noted that "virtually all" federal agency proceedings are "adversarial" in some way "because it's the government versus the individual."

Several Justices also noted that the Court's prior Appointments Clause jurisprudence cannot be ignored. Indeed, Chief Justice Roberts observed that Freytag is likely the starting point for determining who is an "Officer" for purposes of the Appointments Clause. The Government stressed that, because SEC ALJs "adjudicate disputes that impose liability and sanctions on private individuals" and issue binding decisions, there is "no meaningful difference between this case and Freytag." Justice Kagan appeared to agree with the difficulty of distinguishing Freytag, remarking that "it's just so hard to get around . . . the commonalities of these judges and the judges in Freytag." In response, Amicus Curiae acknowledged that the SEC ALJs and the judges in Freytag share a lot of the same functions but argued that the two cases are distinguishable because the judges in Freytag had "the power to bind," which has "always been understood to be crucial for Officer status." Petitioners disagreed, arguing that SEC ALJs do have authority to issue final decisions given the SEC's discretionary right of review, which means that the SEC has the discretion not to review an ALJ's initial decision and, accordingly, SEC ALJs are "authorized to enter final decisions of the Commission."

IMPLICATIONS

What began as a clever work-around to the unpredictability of whether federal district court judges would stay discovery in parallel criminal proceedings has evolved into a forthcoming Supreme Court decision that could have profound implications for the constitutionality of the SEC's administrative process. A decision that SEC ALJs are Officers who are subject to the Appointments Clause could have a near-term significant impact on cases heard by SEC ALJs. Such a ruling would enable parties whose cases are still pending judicial review to challenge prior rulings made by SEC ALJs. The longer-term effects, however, may be minimal because (i) the SEC has since ratified the appointment of all of its ALJs,13 (ii) defendants whose cases are already final may have difficulty retroactively challenging those decisions,14 and (iii) should any cases be challenged and overturned, the SEC would have the ability to refile charges (so long as the statute of limitations has not run).

The impact beyond the SEC would be less certain. Whether a decision that SEC ALJs are Officers would extend to ALJs in other federal agencies likely would turn on how the Supreme Court rules. While many federal agencies only employ a small number of ALJs (e.g., the SEC has 5), other agencies employ many more (e.g., Social Security Administration has more than 1,650). For agencies with a large number of ALJs, changes in the appointment process could procedurally and logistically become much more complex and involved.

Footnotes

1 Pursuant to the Appointments Clause, the President shall appoint "Officers of the United States," although "Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments." U.S. Const. art. II, § 2, cl. 2.

2 Press Release, SEC, SEC Charges Radio Personality for Conducting Misleading Investment Seminars (Sept. 5, 2012).

3 In the Matter of Raymond J. Lucia Companies, Inc. & Raymond J. Lucia, Sr., Initial Decision Release No. 495 (July 8, 2013); see also In the Matter of Raymond J. Lucia Companies, Inc. & Raymond J. Lucia, Sr., Initial Decision Release No. 540 (Dec. 6, 2013) (supplementing and confirming the initial July 8, 2013 decision).

4 In the Matter of Raymond J. Lucia Companies, Inc. & Raymond J. Lucia, Sr., Exchange Act Release No. 75837 (Sept. 3, 2015)/

5 Raymond J. Lucia Cos. v. SEC, 832 F.3d 277, 284–89 (D.C. Cir. 2016), reh'g en banc granted, judgment vacated (Feb. 16, 2017), on reh'g en banc, 868 F.3d 1021 (D.C. Cir. 2017) (per curiam judgment denying petition for review by an equally divided court), cert. granted sub nom. Lucia v. SEC, 138 S. Ct. 736 (2018).

6 Id. at 287. The D.C. Circuit relied on its prior decision upholding the Federal Deposit Insurance Corporation's use of similar ALJs that could issue only recommended decisions, not final decisions. See Landry v. FDIC, 204 F.3d 1125, 1133–34 (D.C. Cir. 2000).

7 501 U.S. 868 (1991).

8 Bandimere v. SEC, 844 F.3d 1168, 1183­­–84 (10th Cir. 2016) (emphasis in original).

9 Id. at 1181 (quoting Freytag, 501 U.S. at 881­–82).

10 Brief for the Respondent, Lucia v. SEC, No. 17-130 (Nov. 29, 2017).

11 Id. at 9–10.

12 Lucia v. SEC, 138 S. Ct. 736 (2018).

13 Press Release, SEC, SEC Ratifies Appointment of Administrative Law Judges (Nov. 30, 2017) (ratifying the prior appointment of the SEC's five ALJs).

14 Such final adjudications would be comparable to instances where parties in litigation are generally precluded from challenging a court's final decision on grounds that the court issuing the final decision lacked subject matter jurisdiction. See, e.g., Ins. Corp. of Ireland v. Compagnie des Bauxites de Guinee, 456 U.S. 694, 702, n.9 (1982).

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