United States: Supreme Court Holds That SEC Administrative Law Judges Are Officers Of The United States Under The Appointments Clause Of The Constitution

On June 21, 2018, a 7-2 majority of the United States Supreme Court held in Lucia v. Securities and Exchange Commission that administrative law judges (ALJs) of the Securities and Exchange Commission (SEC or Commission) are "Officers" within the meaning of the Appointments Clause of the United States Constitution and that SEC ALJs were not properly appointed pursuant to that clause. While the decision clearly impacts matters currently pending before SEC ALJs, the Court's decision left open many important questions, including how the decision will affect cases previously brought before SEC ALJs that have not yet been challenged on constitutional grounds, whether the SEC's recent ratification of the appointment of its ALJs is valid, and whether the decision will apply with respect to ALJs in other federal administrative agencies.

BACKGROUND

The SEC has historically taken the position that its ALJs are employees (rather than Officers) and do not need to be appointed pursuant to the Appointments Clause. And, in the past,  there never was serious debate about the constitutionality of SEC ALJs or their authority. The SEC's position, however, came under scrutiny as a result of its 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. Indeed, as the number of administrative actions increased, criticism of the administrative process—including fairness concerns and constitutional challenges—became common, culminating in the Supreme Court's decision. 1

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 and collectively, Respondents). The order was based on allegations 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 imposing a lifetime industry bar on Lucia and civil penalties totaling $300,000. 3

Upon plenary review by the Commission, Respondents argued, among other things, that the administrative hearing was unconstitutional because the ALJ was not appointed properly pursuant to the Appointments Clause. Under the Appointments Clause, the President shall appoint "Officers of the United States," and "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." 4 In September 2015, the Commission affirmed the ALJ's initial decision and denied Respondents' constitutional challenge. 5

The DC Circuit affirmed, holding that SEC ALJs are not "Officers" within the meaning of the Appointments Clause because they lack authority to issue final decisions on behalf of the Commission. 6 The DC Circuit's decision was inconsistent with a decision of the Tenth Circuit and, according to Respondents, conflicted with the Supreme Court's 1991 decision in Freytag v. Commissioner holding that IRS special trial judges (STJs) appointed by the US Tax Court were Officers even though they lacked the authority to render final decisions. 7 In January 2018, the Supreme Court granted a petition for a writ of certiorari—and, because the Government had changed its position to agree with Respondents that SEC ALJs are Officers, the Court appointed an outside attorney as Amicus Curiae to defend the DC Circuit's ruling. 8

THE SUPREME COURT'S DECISION

In a decision by Justice Kagan, the Supreme Court reversed the DC Circuit and held that SEC ALJs are Officers within the meaning of the Appointments Clause.

The Court concluded that Freytag "says everything necessary to decide this case." According to the Court, SEC ALJs exercise the same "significant discretion" as Freytag's STJs when carrying out their responsibilities and have "nearly all the tools of federal trial judges." In particular, like the STJs in Freytag, SEC ALJs (i) "take testimony" by receiving evidence, examining witnesses at hearings, and taking pre-hearing depositions, (ii) "conduct trials" by administering oaths, ruling on motions, and generally regulating the course of hearings as well as the conduct of parties and counsel, (iii) "rule on the admissibility of evidence," thereby critically shaping the administrative record, and (iv) "have the power to enforce compliance with discovery orders." The Court also noted that SEC ALJs, similar to Freytag's STJs, issue decisions at the close of proceedings, but with potentially more independent effect due to the fact that SEC ALJ decisions contain factual findings, legal conclusions, and remedies. In addition, the Commission may decide not to review an ALJ decision and, when this happens, the ALJ decision "becomes final" and is "deemed the action of the Commission." According to the Court, this "last-word capacity makes this an a fortiori case: If the Tax Court's STJs are officers as Freytag held, then the Commission's ALJs must be too."

For purposes of Mr. Lucia's case, the Court held that on remand, there should be a new hearing before a "properly appointed" ALJ or before the Commission itself. The Court stated, however, that the new hearing could not be held before the same ALJ who initially heard the case, even if that ALJ "has by now received (or receives sometime in the future) a constitutional appointment." The Court held this prescription was needed to create "incentives" to raise Appointments Clause challenges because, if the same ALJs presided over new hearings, one would expect them to reach the same judgments. This notwithstanding, the Court stated that the remedy in Lucia did not mean that a hearing before "a new officer is required for every Appointments Clause violation."

Interestingly, the Court did not address any potential concerns about the effect of its holding on the independence of ALJs, which had been a focus of questions (including by Justice Kagan) during oral argument. 9 The Court also expressly declined to (i) rule on the Commission's ratification of the appointment of all of its ALJs during the pendency of the litigation, 10 (ii) "elaborate" on the general test for determining whether government officials are "Officers" (i.e., whether they exercise "significant authority") given the similarities between Lucia and Freytag or (iii) determine whether the "statutory restrictions on removing the Commission's ALJs are constitutional." In concurring opinions, other Justices wrote that they would have addressed some of these issues. Justice Thomas, writing for himself and Justice Gorsuch, agreed that Freytag was "indistinguishable" but also would have held that "all federal civil officials who perform an ongoing, statutory duty—no matter how important or significant the duty"—are Officers. Justice Breyer, in turn, criticized the Court for addressing the constitutionality of the appointment of SEC ALJs without also addressing the constitutionality of the statutory restrictions on removing such ALJs. 11 Finally, Justice Sotomayor, writing for herself and Justice Ginsburg, dissented and would have held that SEC ALJs are not Officers, in part because they lack the "authority, in at least some instances, to issue final decisions that bind the Government or third parties."

SIGNIFICANCE

The immediate impact of the Court's decision was that, on the day it was released, the Commission issued an Order staying administrative proceedings, presumably to give it time to determine the implications of the decision. 12 The Commission's Order states that it is "prudent" to stay any pending administrative proceeding that is set for a hearing before an ALJ, including "any such proceeding currently pending before the Commission." The stay is "effective immediately" and "shall remain operative for 30 days" or until "further order of the Commission."

Based on the Court's decision, it appears that the Commission will have to grant new hearings to at least those parties that previously made the same constitutional challenge as in Lucia and whose cases are pending judicial review. It may be difficult, however, for other parties to obtain relief if they had not made the constitutional challenge previously or if their cases are final. For example, the Commission may take the position that any attempt to raise an Appointments Clause challenge after an ALJ adjudication has become final would be comparable to a collateral subject matter jurisdiction attack upon an adverse judgment in a court action, which the Supreme Court has long held is not allowed. 13

In addition, it is unclear whether the Commission will reconsider the ratification of its ALJ appointments, given that the Court explicitly declined to address whether the ratification was appropriate. The Commission might decide to take additional steps to help ensure that its ALJs are found to be properly appointed, or it could instead rely on the ratification and risk additional litigation over this issue. It should be noted, however, that the SEC presumably would have the ability to refile charges if any cases are challenged and overturned.

The impact beyond the SEC is even less certain. Although the Court's holding appears to be limited to SEC ALJs, litigants likely will use the decision to challenge the constitutionality of ALJ appointments in other federal administrative agencies. Given that the Court declined to elaborate on the general test for determining whether government officials are Officers under the Appointments Clause, it is unclear whether such additional challenges will be successful. If they are, the implications could be transformative. As Justice Breyer noted, the Court's decision risks "unraveling, step-by-step, the foundations of the Federal Government's administrative adjudication system." 14

Footnotes

1 For more information about the history of the SEC's use of ALJs, see our previous Advisory, " Supreme Court to Decide Whether the SEC's Administrative Law Judges Are Officers of the United States Under the Appointments Clause of the Constitution."

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 U.S. Const. art. II, § 2, cl. 2.

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

6 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).

7 Bandimere v. SEC, 844 F.3d 1168, 1183–84 (10th Cir. 2016); Freytag v. Commissioner, 501 U.S. 868 (1991).

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

9 For more information on the oral argument, see our prior Advisory, supra note 2.

10 See Press Release, SEC, SEC Ratifies Appointment of Administrative Law Judges (Nov. 30, 2017), (ratifying the prior appointment of the SEC's five ALJs). In a footnote, the Court stated that it did not need to address the issue of ratification because the Commission has not suggested that it intends to assign Lucia's case on remand to an ALJ whose claim to authority rests on the ratification order."

11 Justice Breyer concurred but based his opinion on a violation of the Administrative Procedure Act rather than the Constitution. In addition, in a portion of his opinion joined by Justices Ginsburg and Sotomayor, Justice Breyer also dissented in part because he saw no reason why the same ALJ could not rehear the matter after remand given that the Commission "has now itself appointed the {ALJ} in question."

12 In the Matter of Pending Administrative Proceedings, Exchange Act Release No. 83495 (June 21, 2018).

13 See, e.g.Ins. Corp. of Ireland v. Compagnie des Bauxites de Guinee, 456 U.S. 694, 702 n.9 (1982) (citing  Chicot County Drainage Dist. v. Baxter State Bank, 308 U.S. 371 (1940) and Stoll v. Gottlieb, 305 U.S. 165 (1938)).

14 As discussed above, the Court also declined to address the constitutionality of the statutory restrictions on removing ALJs from office. These restrictions apply with respect to SEC ALJs as well as ALJs for other federal administrative agencies, and the Government had argued that such restrictions should be narrowly construed in order to avoid separation-of-powers concerns. See Brief for the Respondent, Lucia v. SEC, No. 17-130 (Feb. 21, 2018).

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