Shearman & Sterling LLP | Government Regulatory Enforcement Blog | United States Supreme Court Reverses And Remands SEC Administrative Proceeding - Finding That SEC Administrative Law Judges Are Subject To The Appointments Clause Of The Constitution And Were Not Properly Appointed By The SEC<br >  
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  • United States Supreme Court Reverses And Remands SEC Administrative Proceeding - Finding That SEC Administrative Law Judges Are Subject To The Appointments Clause Of The Constitution And Were Not Properly Appointed By The SEC
    On June 21, 2018, the Supreme Court held that Securities and Exchange Commission (“SEC”) administrative law judges (“ALJs”) are “inferior officers” of the United States, subject to the Appointments Clause of the Constitution. Lucia v. SEC, 585 U.S. ____ (2018). Under the Appointments Clause, Congress may authorize only the President, a court, or a department head to appoint such officers. None of the five SEC ALJs were appointed in such a manner, and the Court therefore vacated the ALJ’s decision that formed the basis for this appeal and remanded for a new hearing before a properly appointed ALJ. Although the opinion relied on strong and well-settled precedent, it could lead to appointment-based challenges in other contexts and before other agencies.

    As we have previously reported, see Shearman & Sterling LLP, D.C. Circuit Court Of Appeals Rejects Constitutional Challenge to SEC’s Use of Administrative Proceedings, Need-to-Know Litigation Weekly, Aug. 15, 2016, the case stems from an SEC enforcement action against Raymond J. Lucia and his namesake investment company, which were alleged to have violated anti-fraud provisions of the Investment Advisers Act by presenting deceptive sales pitches to prospective clients. The SEC ordered an ALJ to conduct a public hearing on these allegations, and the ALJ issued an initial decision finding Lucia and his company liable on one of the four alleged misrepresentations. See Raymond J. Lucia Cos., Inc., Initial Decision Release No. 540 (Dec. 6, 2013). After the Commission affirmed the ALJ’s findings, Lucia appealed the Commission’s ruling to the D.C. Circuit, arguing that the SEC’s ALJs are inferior officers who had not been appointed in conformity with the Constitution’s Appointments Clause. Specifically, Lucia primarily argued that because the relevant 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. On August 9, 2016, a three-judge panel of the D.C. Circuit rejected Lucia’s argument on the grounds that the SEC’s ALJs are not “inferior officers,” because they lack the authority to issue final decisions (i.e., the ALJs’ decisions are subject to review by the SEC itself). The D.C. Circuit later agreed to rehear the case en banc, but was evenly split, which effectively reinstated the panel’s decision. See Lucia v. SEC, 868 F.3d 1021 (D.C. Cir. 2016).

    As we previously reported, see Shearman & Sterling LLP, Tenth Circuit Splits With D.C. Circuit On Constitutionality Of SEC ALJs, Need-to-Know Litigation Weekly, Jan. 2, 2017, a circuit split emerged on the constitutionality of ALJs when a three-judge panel of the Tenth Circuit Court of Appeals held that the SEC’s ALJs are “inferior officers” of the United States and are thus subject to the Constitution’s Appointments Clause. Bandimere v. SEC, 844 F.3d 1168 (10th Cir. 2016). The Supreme Court granted certiorari after the U.S. Solicitor General submitted a brief urging the Court to take the case given the emerging circuit split. By the time of the government’s response to Lucia’s certiorari petition, however, the Department of Justice (which represented the SEC on appeal) had reversed its prior position and sided with Lucia’s argument that SEC ALJs are officers of the United States. Accordingly, when the Supreme Court granted the petition, it appointed an amicus curiae to argue for the judgment below and proceeded to hear the case.

    In Justice Kagan’s majority opinion, the Court solely addressed the question of whether the SEC’s ALJs are officers of the United States or simply employees of the federal government. The majority held that the Commission’s ALJs are indeed “inferior officers,” whose appointment Congress may vest only in the President, a court, or a department head.

    The Court found that its prior cases set forth two fundamental criteria to apply in determining whether an individual is an “officer”: an individual must (i) occupy a “continuing” position established by law, and (ii) exercise “significant authority” pursuant to the laws of the United States. See United States v. Germaine, 99 U.S. 508, 510-12 (1879); Buckley v. Valeo, 424 U.S. 1, 126 (1976) (per curiam). The Court then turned to its decision in Freytag v. Commissioner, 501 U.S. 868 (1991), where the Court applied this test to special trial judges (“STJs”) of the United States Tax Court. Noting that STJs “are near-carbon copies of the Commission’s ALJs,” the Court stated that its analysis in Freytag“ necessarily decides this case.” The Court noted that: (i) it is undisputed that the SEC’s ALJs, like the Tax Court’s STJs, hold a continuing office established by law; and (ii) the SEC’s ALJs carry out the same “important functions” as STJs and exercise the same “significant discretion” in doing so. The Court observed that the SEC’s ALJs, like the STJs, have the necessary authority to manage and preside over adversarial hearings, with almost all the same tools available to them as federal trial judges. At the end of the proceedings, the ALJs issue decisions containing factual findings, legal conclusions, and remedies—and those decisions can become final actions of the SEC, without any further review. The Court was not persuaded by the amicus’ arguments regarding certain limitations in the ALJs’ sanctions power as compared to STJs, or the standard of review that applies if and when the Commission reviews an ALJ’s decision.

    Since it was undisputed that the SEC ALJ who presided over Lucia’s proceedings was not appointed by the President, a court, or the Commission, the Court concluded that the administrative proceeding process afforded Lucia was constitutionally defective. Relying on well-settled precedent, the Court further held that the appropriate remedy was a new hearing before a properly appointed official.

    Justice Kagan’s opinion focused on the narrow issue before it—whether SEC ALJs are subject to the Appointments Clause of the Constitution. As both this opinion and Freytag make clear, this is a fact-specific inquiry, focusing on the roles and authority of the particular government employees whose actions were challenged. Other federal agencies forced to defend administrative decisions will likely argue that the authority of the decision-makers is different in kind from those of SEC ALJs. In this regard, however, there is nothing particularly unusual about the role that ALJs play in the SEC’s fact-finding process, and therefore it is quite possible that future litigation will result in the invalidation of other systems for appointing ALJs. See The Supreme Court Agrees To Review Appointment Requirements For SEC’s In-House Judges, Need-to-Know Litigation weekly, Jan. 17, 2018.

    And importantly, the focus of the decision is on the appointment process, not on the use or role of ALJs, nor on the adequacy of the SEC’s administrative proceedings themselves, which has been challenged in various other contexts. See, e.g., Shearman & Sterling LLP, Second Circuit Holds Federal Courts Cannot Hear Constitutional Challenges to SEC ALJs until Administrative Proceedings, Need-to-Know Litigation Weekly, Jul. 7, 2016; Shearman & Sterling LLP, Does the SEC’s Adoption of Amendments to Rules of Practice Mean It Will Resume Litigating Enforcement Actions as Administrative Proceedings?, Need-to-Know Litigation Weekly, Jul. 18, 2016. The Court emphasized that the Commission itself counts as a “head of department” for the purposes of the Appointments Clause, and defendants acknowledged that the Commission can, as a “head of department,” constitutionally appoint ALJs. Further, the Administrative Procedure Act, which governs the appointment of administrative law judges, provides that “[e]ach agency shall appoint as many administrative law judges as are necessary for” hearings governed by the Act.

    Thus, the Court’s decision and the existing statutory framework leave open the possibility that the Commission could remedy the constitutional issue by appointing its own ALJs, and the same may apply to other federal agencies as well. Although this would require a change in administrative process, it does not seem that it would eradicate ALJs or affect the scope of their authority. During the pendency of this case, the SEC sought to remedy the issue by “ratifying” the prior appointment of its ALJs. The Court declined to decide whether such a ratification—which defendant also challenged—was valid. But it seems likely that the SEC, and perhaps other federal agencies, will put in place a new procedure—which would not necessarily be significantly onerous—for formal approval of appointments by the agency itself.

    Furthermore, there is lingering uncertainty regarding the impact of this decision on past SEC ALJ decisions. The Court’s decision was silent on whether this opinion would be given full retroactive effect, though clearly stated that those who made a timely challenge to the constitutional validity of the appointment of the ALJ would be entitled to relief. While this reference by the Court could potentially be thought to implicitly limit the impact of the decision for already settled cases heard by a SEC ALJ in which no timely constitutional challenge was brought, this issue may be the subject of further litigation.