January 9, 2017

Tenth Circuit Court of Appeals Finds SEC’s Process for Designating Administrative Law Judges to be Defective, Causing Split with DC Circuit

Catherine Botticelli, Christopher Geissler, Shayna Gilmore, Robert H. Ledig, Robert Rhatigan, Thomas P. Vartanian

Dechert LLP

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The U.S. Court of Appeals for the Tenth Circuit on December 27, 2016, in Bandimere v. SEC,¹ found the Administrative Law Judges (ALJs) used by the U.S. Securities and Exchange Commission (SEC) to hear its administrative enforcement cases to be “inferior officers,” subject to appointment under the “Appointments Clause” of the U.S. Constitution.² This decision sets aside the SEC’s ruling on the petitioner’s alleged securities laws violations on the grounds that the ALJ who presided over the initial hearing held his position unconstitutionally.

The Appointments Clause requires that all “Officers of the United States,” including “inferior officers,” be appointed either by the President or by a Congressional delegation of power to the President, courts, or department heads.³ The Supreme Court has ruled that an inferior officer is “any appointee exercising significant authority pursuant to the laws of the United States.”⁴

Bandimere could have wide-ranging effects on both past and ongoing SEC enforcement actions.⁵ Further, the decision could provide a basis to challenge the decisions of the federal banking agencies (the Federal Reserve Board, FDIC and Office of the Comptroller of the Currency) that employ similarly-situated ALJs certified as qualified by the Office of Personnel Management (OPM) and hired by the Office of Financial Institution Adjudication (OFIA).

ALJs and the Appointments Clause

The SEC delegates to its ALJs responsibility for the fair and orderly conduct of SEC administrative enforcement proceedings.⁶ The ALJs are hired in accordance with the Administrative Procedure Act.⁷ In its argument before the Tenth Circuit, the SEC conceded that its ALJs were not appointed in accordance with the Appointments Clause, but argued that they were merely employees who did not require such a formal appointment because their initial determinations are granted no deference by the SEC’s commissioners (Commission) during the Commission’s review.

In its 1991 Freytag decision, the Supreme Court held that an appointee is an inferior officer if: (i) the position was established by law; (ii) the duties, salary, and means of appointment are specified by statute; and (iii) the appointee exercises significant discretion in carrying out important functions. The Bandimere court concluded that the SEC’s ALJs satisfied all three elements of the Freytag test.⁸

Other courts have disagreed as to whether the ability to make a “final decision” is dispositive of “significant discretion” under Freytag.⁹ The Tenth Circuit differed with the D.C. Circuit’s August 2016 decision in Lucia v. SEC,¹⁰ which relied on the 2000 D.C. Circuit decision in Landry v. FDIC¹¹ to determine that final decision-making authority is necessary to satisfy the third element of the Freytag test.

Impact on the Constitutionality of ALJs at Federal Bank Regulatory Agencies

In Landry, the D.C. Circuit validated the appointment and authority of the FDIC’s ALJs because they did not satisfy the “significant discretion” prong of Freytag. The SEC has relied on the Landry decision to validate the appointment of its own ALJs because of their similarities with the FDIC’s ALJs. Like the FDIC’s ALJs, the SEC’s ALJs do not have final decision-making authority and instead merely recommend decisions to the Commission. The FDIC’s ALJs are part of a pool of ALJs at OFIA who are shared with the other banking regulators. While Landry is still good law in the D.C. Circuit, Bandimere could potentially implicate the enforcement proceedings of all of the banking agencies that, like the FDIC, use the OFIA ALJs. The constitutionality of the OFIA ALJs under the Tenth Circuit’s interpretation of the Appointments Clause and Freytag remains to be seen, and could potentially lead to a decision by the Supreme Court in light of the split in Circuit Court holdings.

SEC’s Use of Administrative Enforcement Proceedings

The SEC’s increased use of administrative proceedings following amendments contained in the Dodd-Frank Act¹² has resulted in significant controversy about the fairness¹³ and due process¹⁴ of the proceedings. The SEC amended its rules of practice in July 2016¹⁵ and, in doing so, addressed some of these criticisms.¹⁶ Continuing court challenges to the use of ALJs in administrative enforcement actions could result in additional changes by the SEC – and possibly the banking agencies – in regard to such proceedings.

Footnotes

1) Bandimere v. SEC, No. 15-9586, slip op. (10th Cir. Dec. 27, 2016).

2) U.S. Const. art. II, § 2, cl. 2.

3) The Supreme Court has identified the SEC as a whole, rather than the chair, as the SEC’s “head.” Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477, 512 (U.S. 2010) (“The Commission as a whole, on the other hand, does meet the requirements of the Act, including its provision that “the head of an agency [may] be an individual or a commission or board with more than one member.”).

4) Buckley v. Valeo, 424 U.S. 1, 126 (1976).

5) In a dissent, Judge Monroe McKay stated, “Despite the majority’s protestations, its holding is quite sweeping, and I worry that it has effectively rendered invalid thousands of administrative actions.” In her concurring opinion, Judge Mary Briscoe responded to the dissent, stating that the Supreme Court’s decision in Freytag v. Commission of Internal Revenue, 501 U.S. 868 (1991), requires courts to engage in a case-by-case analysis of the status of government employees, and that the Bandimere decision was limited to the SEC’s five ALJs.

6) 17 C.F.R. § 200.14.

7) 5 U.S.C. § 556.

8) Freytag, at 881-82.

9) In Freytag, the Tax Court was required to presume as correct the factual findings, including findings of intent, of special trial judges (STJs) and to defer to the STJ’s determinations of credibility. The dissent in Freytag argued that this constituted a delegation of significant authority (even if not per se final decision-making authority). Notably, the STJs at issue in Freytag were appointed by the Tax Court, which the Supreme Court determined to be a “Court of Law” for purposes of the Appointments Clause.

10) 832 F.3d 277, 281 (D.C. Cir. 2016).

11) 204 F.3d 1125 (D.C. Cir. 2000).

12) See Dodd-Frank Wall Street Reform and Consumer Protection Act § 929P.

13) See, e.g. Bob Van Voris and Matt Robinson, For the SEC’s In-House Court, a Question of Justice for All, Bloomberg (Aug. 10, 2015); Jean Eaglesham, SEC Wins With In-House Judges, WALL ST. J. (May 6, 2015).

14) See, e.g., Gupta v. SEC, 796 F. Supp. 2d 503, 506–7 (S.D.N.Y. 2011) (assertion by plaintiff that the SEC had “single[d] him out for uniquely unfavorable treatment” by selecting the administrative proceedings); Chau v. SEC, No. 14-CV-1903 LAK, 2014 WL 6984236, at *14 (S.D.N.Y. Dec. 11, 2014) (grant of SEC's motion to dismiss plaintiff's due process and equal protection claim for court's lack of jurisdiction, without addressing constitutional arguments); See also, Sarah S. Gold and Richard L. Spinogatti, Constitutional Challenges to SEC Administrative Proceedings, N.Y.L.J., Apr. 8, 2015, at 3.

15) 81 Fed. Reg. 50211 (July 29, 2016).

16) The amendments included expanded discovery and broadened opportunities for dispositive motions.

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