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  • D.C. Circuit Court Of Appeals Rejects Constitutional Challenge to SEC’s Use of Administrative Proceedings
    On August 9, 2016, a three-judge panel of the United States Court of Appeals for the District of Columbia Circuit found the use of administrative law judges (“ALJs”) by the Securities and Exchange Commission (“SEC” or “Commission”) to be constitutionally sound, holding that the SEC’s use of ALJs does not violate the Appointments Clause of the U.S. Constitution because, rather than acting as officers of the United States, these ALJs, who lack the authority to issue final decisions, act as employees.  Raymond J. Lucia Cos. Inc. v. Securities and Exchange Commission, No. 15-1345 (D.C. Cir. Aug. 9, 2016).  With at least one similar case pending before the Tenth Circuit, and a number of contested actions still pending in front of the Commission itself, the Lucia decision has the potential to be an important precedent-setting decision.

    In recent years, respondents have brought numerous challenges to the SEC’s use of administrative proceedings (“APs”), asserting that the SEC’s selective use of such proceedings for some, but not all, litigated enforcement proceedings is inherently unfair.  Specifically, numerous respondents filed actions in federal court seeking to preliminarily enjoin pending administrative proceedings as unconstitutional before they had concluded.  While the due process and equal protection challenges have generally been unsuccessful, respondents had achieved a measure of success in challenging APs on the grounds that the ALJs had not been properly appointed pursuant to the Appointments Clause of Article II of the Constitution and, thus, could not render decisions.  Under the Appointments Clause, “inferior officers,” or government officials “exercising significant authority pursuant to the laws of the United States” must be appointed by the President, the federal courts or the heads of the federal departments.  But SEC ALJs are not so appointed; instead, they are hired as though they are mere employees.

    The Lucia decision centers on an SEC administrative enforcement action against Raymond J. Lucia and his investment company, Raymond J. Lucia Companies, Inc. (“petitioners”), for alleged violations of anti-fraud provisions of the Investment Advisers Act.  After an ALJ issued an initial decision, the Commission subsequently reviewed and issued a final decision imposing a lifetime industry ban for Lucia as well as a $300,000 fine.  In its final order, the Commission rejected petitioners’ argument that the administrative proceeding was unconstitutional because the appointment of the presiding ALJ did not comply with the Appointments Clause.
    In Lucia, the D.C. Circuit affirmed the Commission’s decision and held that ALJs are employees not covered by the Appointments Clause.  The court held that the primary criteria for distinguishing between inferior officers and employees not covered by the Appointments Clause are: (1) the significance of the matters resolved by the officials, (2) the discretion they exercise in reaching their decisions, and (3) the finality of those decisions. 

    Though the Lucia court was careful to note that its prior decisions did not resolve the constitutional status of ALJs for all agencies, it nonetheless relied heavily on the logic of those decisions.  The D.C. Circuit in Lucia analyzed the statutory and regulatory framework underpinning the powers of Commission ALJs, and came to the conclusion that Commission ALJs do not have the power to issue final decisions.  Petitioners argued that because the delegating statute “contemplates that the ALJ’s initial decision becomes final in at least some circumstances when Commission review is declined,” Commission ALJs should therefore be viewed as having the authority to make final decisions.  The D.C. Circuit rejected this argument, noting that the same statutory provision on which petitioners relied also authorized the Commission to establish its delegation and review scheme through agency rulemaking.  Under the review scheme established by the agency’s rules, “the initial decision [by the ALJ] becomes final when, and only when, the Commission issues the finality order,” an affirmative act which must occur in every case.  The D.C. Circuit noted that “the Commission has retained full decision-making powers, and the mere passage of time is not enough to establish finality.”  Furthermore, the court noted that “even when there is not full review by the Commission, it is the act of issuing the finality order that makes the initial decision the action of the Commission within the meaning of the delegation statute.”

    As the first circuit court opinion to address the constitutionality of the use of ALJs by the SEC, the D.C. Circuit’s opinion in Lucia has the potential to be an important precedent-setting decision.  In recent years, even as district courts have found more frequently that the Commission’s use of ALJs violated the Appointments Clause, circuit courts addressing appeals from these decisions have reversed all decisions on jurisdictional grounds, holding that district courts lack standing to enjoin administrative proceeds because petitioners first must exhaust their appeals with the SEC’s administrative scheme before they can appeal to the courts.  In June, the United States Court of Appeals for the Second Circuit granted a motion to allow two ratings agency and private executives to jointly file a petition for rehearing of their appeals, challenging the constitutional validity of SEC proceedings before administrative judges. The Lucia decision, however, is a clear statement supporting the constitutionality of the Commission’s use of ALJs, a statement that is even stronger given that it emanates from the D.C. Circuit.  The decision could also herald an increase in the use of APs by the SEC, even in the face of continued public criticism about perceived unfairness.