In Reversal, SEC Agrees That Its Administrative Law Judges Are Inferior Officers That Require Commission Appointment, But Still Seeks Supreme Court Review To Resolve Circuit Split

by Shearman & Sterling LLP

On November 29, 2017, the U.S. Solicitor General submitted a brief to the United States Supreme Court in Lucia v. Securities and Exchange Commission, No. 17-130, urging the Court to grant certiorari and resolve a circuit split regarding the appointment process for the Securities and Exchange Commission’s (“SEC”) administrative law judges (“ALJs”).  In a notable shift, the Solicitor General agreed with Raymond J. Lucia and his namesake investment firm that the SEC’s hiring of ALJs, who preside over the initial stages of SEC enforcement hearings, was unconstitutional because ALJs serve as “inferior officers” who must be appointed in accordance with the Appointments Clause of Article II of the Constitution.  The following day, the SEC, in its capacity as a “head of department,” ratified the appointment of its five ALJs in an effort to make their prior hiring compliant with Article II’s Appointments Clause.  Although the SEC’s decision to ratify the hiring of its ALJs in some sense rendered the issue in Lucia moot, the Solicitor General is still seeking certiorari in order to resolve the existing circuit split.
Pursuant to Article II’s Appointments Clause, inferior officers of the United States may be appointed only by the president, the courts of law, or the heads of department.  However, the SEC has historically relied on an internal hiring process to select its ALJs, under which the federal Office of Personnel and Management (“OPM”) would identify an initial pool of ALJ candidates and the SEC’s Chief ALJ would select ALJs from that pool.  By implication, this hiring process treated the SEC’s ALJs as employees, rather than inferior officers. Over the last several years, an increasing number of respondents in SEC administrative proceedings have challenged the validity of those proceedings, arguing, among other things, that the ALJs who presided over them were acting in the capacity of inferior officers of the United States who had not been properly appointed.
The SEC has historically argued that the Commission’s ALJs were employees, not officers, primarily because initial decisions by ALJs only had binding authority after being ratified by the Commission itself.  However, a circuit split on the constitutionality of the SEC’s hiring of ALJs emerged in the last year. 
In Lucia v. Securities and Exchange Commission, 832 F.3d 277 (D.C. Cir. 2016), the D.C. Circuit held that the SEC’s ALJs are employees, not officers, insofar as the ALJs lack final decision-making authority.  That 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.  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 but had not been appointed in conformity with the Constitution’s Appointments Clause.  On August 9, 2016, a three-judge panel of the D.C. Circuit ruled that, because the SEC’s ALJs lack the authority to issue final decisions, they are not officers of the United States.  Lucia subsequently petitioned the D.C. Circuit for en banc review, and on February 16, 2017, the D.C. Circuit vacated the panel’s decision and agreed to rehear the case en banc.  However, the D.C. Circuit was split evenly in its June 26, 2017, en banc decision, 868 F.3d 1021 (D.C. Cir. 2017), effectively reinstating its earlier decision in Lucia
Meanwhile, a three-judge panel of the Tenth Circuit Court of Appeals held in Bandimere v. SEC, 844 F.3d 1168 (10th Cir. 2016), that the SEC’s ALJs are inferior officers of the United States and are thus subject to the Constitution’s Appointments Clause.  In that case, the SEC brought an enforcement action against Colorado businessman and investor David Bandimere, alleging that he violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities and Exchange Act of 1934.  Bandimere challenged the findings of the ALJ before the Commission and ultimately appealed the Commission’s decision to the Tenth Circuit, asserting that the ALJ was an inferior officer who had not been appointed under the Appointments Clause.  On appeal, the Tenth Circuit declined to adopt the D.C. Circuit’s emphasis on final decision-making authority in determining whether a federal employee is an officer of the United States.  According to the Tenth Circuit, final-decision making authority is not dispositive of whether an employee is an officer; rather, courts must take a broader approach in evaluating the employee’s duties and responsibilities.  The Tenth Circuit concluded that the ALJ’s duties and discretion weighed in favor of treating ALJs as inferior officers.
The SEC’s new position, as reflected in the Solicitor General’s brief supporting the petitioner’s petition for certiorari in Lucia, echoes the Tenth Circuit’s holding in Bandimere.  The Solicitor General now acknowledges that the SEC’s ALJs exercise a substantial degree of discretion and authority, which warrants treating them as inferior officers of the United States.  The Solicitor General’s brief explains that the SEC’s ALJs act as hearing officers in SEC enforcement proceedings and, in that capacity, administer oaths, hold hearings, take testimony, and rule on hearings, among other tasks, all of which collectively points to them being inferior officers.  Decisions issued by ALJs are not final: after an ALJ issues an initial decision, the Commission may, on appeal by a party to the proceeding or on its own terms, review the decision.  But, if no party appeals and the Commission declines to review the decision, the ALJ’s decision is treated as final and effective.  Citing the Supreme Court’s decision in Freytag v. Commissioner, 501 U.S. 868 (1991), in which the Court held that the U.S. Tax Court’s special trial judges exercised significant duties and discretion and were therefore officers, the Solicitor General asserted that the SEC’s ALJs are also officers.
Given the length of time the dispute over how to treat SEC ALJs has been pending, the shift in theory came as somewhat of a surprise.  However, its ultimate impact on SEC proceedings should be narrow, as the SEC quickly moved to remedy any Appointment Clause issue.  Specifically, in its capacity as a “head of department,” the Commission ratified the hiring of its five ALJs so that their hiring, in effect, complied with Article II’s Appointments Clause.  In a November 30 order, the SEC also required its ALJs presiding over proceedings for which no initial decision had been issued to reconsider the record and allow the parties to submit new evidence—effectively seeking to ensure that any prior error is cured in pending cases.  Moreover, the SEC remanded all matters pending before the Commission—on which an ALJ had issued an initial decision—to that same ALJ for reconsideration.  The SEC’s move to ratify the appointment of its ALJs should eliminate concerns about the legitimacy of future decisions handed down by its ALJs, although the order does not resolve the lingering uncertainty regarding the status of prior decisions issued by the SEC’s ALJs, particularly as to final decisions on which only an ALJ ruled.  

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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