Tenth Circuit Decision in Bandimere v. SEC Creates Circuit Split on Question Whether the SEC’s Procedure for Appointing Administrative Law Judges Violates the Constitution’s Appointments Clause

Kramer Levin Naftalis & Frankel LLP

On December 27, 2016, in Bandimere v. SEC,1 the Tenth Circuit held that SEC administrative law judges (ALJs), who preside over the agency’s civil administrative proceedings, are “inferior officers” within the meaning of the Appointments Clause of the Constitution, and that the manner in which they are installed in office by the Commission violates the Clause. Bandimere directly conflicts with an earlier decision by the D.C. Circuit, which held that SEC ALJs are not inferior officers subject to the requirements of the Appointments Clause.2 Barring any changes in how ALJs are chosen, this circuit split may ultimately be resolved by the Supreme Court.

The Appointments Clause states:

[The President] shall nominate, and by and with the Advice and Consent of the Senate, shall appoint ... Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law: but the 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.3

Thus, if an agency appointee is deemed an “inferior officer,” the officer must be appointed by the president, a court of law or the head of a department, such as the chair of the SEC. If, however, an appointee is deemed an “employee” or other “lesser functionary,” he or she may be placed in office through other procedures decided upon by the agency. For example, the SEC hires ALJs through the Office of Personnel Management; OPM presents the agency with three candidates, one of whom the SEC’s chief ALJ selects, subject to approval by the SEC’s Office of Human Resources. Courts have held that the inferior officer vs. mere “employee” assessment depends upon the level of authority the appointee possesses, the discretion he or she exercises, and the nature of his or her duties.

Bandimere stems from a 2012 administrative enforcement action alleging violations of the securities laws. Following a trial-like hearing, an SEC ALJ found Bandimere liable and ordered relief including disgorgement and civil penalties. On appeal to the Commission, Bandimere maintained that the ALJ who presided over his case was an inferior officer subject to the Appointments Clause, whose appointment pursuant to the SEC procedure with OPM had therefore been unconstitutional. The SEC affirmed the ALJ’s decision, concluding that the ALJ was an employee, not an inferior officer.4

The Tenth Circuit reversed, relying on the Supreme Court’s 1991 decision in Freytag v. Commissioner of Internal Revenue,5 which held that the Tax Court’s special trial judges are inferior officers subject to the Appointments Clause. Citing the criteria underlying the Supreme Court’s Freytag decision, the Tenth Circuit noted that SEC ALJs occupy a position “established by law;” “the[ir] duties, salary, and means of appointment are specified by statute;” and they “exercise significant discretion in carrying out important functions” that are “adjudicative,” as opposed to “ministerial tasks.”6 The Bandimere panel, therefore, concluded that SEC ALJs, like the Tax Court judges in Freytag, are inferior officers whose appointment is subject to the Clause.

As noted, the Tenth Circuit’s decision conflicts with the D.C. Circuit’s 2016 decision in Raymond J. Lucia Companies, Inc. v. SEC, in which the court held that SEC ALJs are agency employees. The Lucia panel reached this conclusion on the ground that SEC ALJs do not have the power to issue final decisions in administrative actions. Rather, the Commission must affirmatively act in every case presided over by an ALJ – either by issuing its own decision or by declining to grant review of an ALJ’s decision, and (in either case) by issuing a final order concluding the matter. Absent such action by the Commission, the ALJs’ administrative decisions are not final or binding on the agency. The Lucia panel considered this limitation dispositive, establishing in the court’s view that ALJs are mere employees, not inferior officers subject to the Appointments Clause.

The Tenth Circuit in Bandimere disagreed with the D.C. Circuit’s finality analysis, concluding instead that, pursuant to Freytag, whether or not an official is an inferior officer rests not on the ability to exercise final decision-making power, but rather on whether the officer exercises discretion in the performance of significant duties. In dissent, Judge McKay cautioned that the Tenth Circuit’s “sweeping” decision “carries repercussions that will throw out of balance the teeter-totter approach to determining which of all the federal officials are subject to the Appointments Clause.” The dissent warned that “all federal ALJs [may be] declared inferior officers,” and that “thousands of administrative actions” may be “effectively rendered invalid” as a result of the decision.

In addition to Appointments Clause challenges, beginning with Gupta v. SEC in 2011, respondents in SEC administrative actions have asserted that such proceedings suffer from a number of constitutional deficiencies.7 Respondents have invoked, most often, the due process clause (the SEC’s administrative procedures are inadequate), as well as the equal protection clause (e.g., in Gupta, in which Judge Jed Rakoff denied the Commission’s motion to dismiss the complaint, citing a “well-developed public record of Gupta being treated substantially disparately from 28 essentially identical defendants [who were charged in federal district court]”). Many of these challenges, subsequent to Gupta , have failed for lack of subject matter jurisdiction, on the basis that the issues were required to be raised first, and exhausted, in the administrative proceeding, at which time an appeal to the Circuit Court of Appeals would lie. See, e.g., Hill v. SEC;8Tilton v. SEC;9Jarkesy v. SEC;10Bebo v. SEC.;11Bennett v. SEC.12  Because Bandimere had gone through the entirety of the SEC administrative process and had advanced his Appointments Clause argument there, the Tenth Circuit clearly had jurisdiction, on appeal from the Commission, to address the claim.

The D.C. Circuit is currently considering whether to review Lucia en banc, which the SEC has opposed. The SEC has not indicated if it will, in turn, seek en banc review in Bandimere, or ask the Tenth Circuit to hold the decision in abeyance while it seeks Supreme Court review.13

1 No. 15-9586, 2016 WL 439007 (10th Cir. Dec. 27, 2016).
2Raymond J. Lucia Companies, Inc. v. SEC,  832 F.3d 277 (D.C. Cir. 2016).
3 U.S. Const. art. II. § 2, cl. 2.
4 The Commission acknowledged that its ALJs were not appointed in conformance with the requirements of the Appointments Clause.
5 501 U.S. 868 (1991).
6 The Bandimere panel cited, as significant functions performed by SEC ALJs, the ALJs’ authority to issue subpoenas, control document production and depositions, rule on procedural and dispositive motions; enter default judgments, take testimony, rule on the admissibility of evidence; receive evidence, make credibility determinations during the course of trial-like hearings, and issue initial decisions on liability and impose sanctions.
7 796 F. Supp. 2d 503 (S.D.N.Y. 2011). Kramer Levin Naftalis & Frankel represented Mr. Gupta in his successful federal court challenge.
8 825 F.3d 1236 (11th Cir. 2016).
9 824 F.3d 276 (2d Cir. 2016) (Appointments Clause challenge to SEC ALJs, although raised in the administrative proceeding, dismissed as unexhausted).
10 803 F.3d 9 (D.C. Cir. 2015) (equal protection clause challenge based on the SEC “choos[ing] whether to bring cases in administrative proceedings or in federal court on a case-by-case basis” dismissed for lack of jurisdiction).
11 799 F.3d 765 (7th Cir. 2015), cert. denied, 136 S. Ct. 1500, 194 L. Ed. 2d 588 (2016) (challenge to the SEC’s “unguided authority to choose which respondents will and which will not receive the procedural protections of a federal district court, in violation of equal protection and due process guarantees” dismissed for lack of jurisdiction).
12 No. 15-2584, 2016 WL 7321231 (4th Cir. Dec. 16, 2016) (Appointments Clause challenge to SEC ALJs not adjudicated in administrative proceeding dismissed for lack of jurisdiction). 
13 These constitutional challenges to the SEC’s enforcement proceedings have arisen in light of the SEC’s expanded authority under the Dodd-Frank Act in 2010, which authorized the Commission to impose monetary penalties in administrative proceedings on persons not associated with entities registered with the Commission. Prior to Dodd-Frank, only federal courts had this power. This change has contributed to a significant increase in the Commission’s use of the in-house forum, where it has had a markedly greater success rate. According to a Wall Street Journal article, during the period October 2010 to March 2015, the SEC won 90% of all cases brought in-house, as compared with 69% in federal court.  See Jean Eaglesham, 
SEC Wins With In-House Judges, Wall St. J., May 6, 2015.

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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