The SEC Urges Supreme Court Review Of The Constitutionality Of Its Administrative Law Judges

Orrick, Herrington & Sutcliffe LLP

On November 29, 2017, the Solicitor General filed a brief on behalf of the Securities and Exchange Commission (the "Commission") in Raymond J. Lucia et al. v. Securities and Exchange Commission, No. 17-130, asking the Supreme Court to resolve a Circuit split over whether the Commission's selection and use of administrative law judges ("ALJs") is constitutional.  In doing so, the Solicitor General agreed with petitioners Raymond J. Lucia and Raymond J. Lucia companies (collectively, "Petitioners") that Commission ALJs are inferior officers subject to the Constitution's Appointments Clause.  This brief is particularly significant because it reflects a stark reversal from the Government's prior position that Commission ALJs are mere employees.

Background

The Commission has historically used ALJs to act as hearing officers in its administrative enforcement proceedings.  The Commission's ALJs are selected by its Chief ALJ, subject to the approval of its Office of Human Resources.  The Commission grants its ALJs the ability to, among other things, administer oaths, issue subpoenas, and rule on motions and the admission of evidence.  Following an administrative hearing, an ALJ must issue an "initial decision" that may be reviewed by the Commission sua sponte, or at the request of a party or aggrieved person.  If the Commission reviews the ALJ's initial decision, it will either issue its own opinion or a "finality order" that makes the ALJ a final decision.  If a review of the ALJ's initial decision is not requested or is denied, the decision becomes the action of the Commission.

 Petitioners are registered investment advisers who marketed a wealth-management strategy called "Buckets of Money."  The Buckets of Money strategy divided investors' retirement savings among assets of different risk levels, and periodically reallocated the retirement savings based on changes in asset values.  The Commission instituted an administrative proceeding, alleging that Petitioners made false and misleading statements in how they presented the Buckets of Money investment strategy to prospective investors, in violation of the Securities Exchange Act, Investment Advisers Act, and the Investment Company Act.  The administrative proceeding ultimately was tried before an ALJ—Raymond J. Lucia Cos., Inc., Exchange Act Release No. 67781, 2012 WL 3838150 (Sep. 5, 2012)—with the ALJ issuing an initial decision finding liability and imposing sanctions, including a lifetime industry bar of Raymond J. Lucia.  See Raymond J. Lucia Cos., Inc., Initial Decision Release No. 495, 2013 WL 3379719 (July 8, 2013).

Petitioners appealed the ALJ's disposition of the case to the Commission, arguing that the administrative proceeding was unlawful because the assigned ALJ was an "Officer of the United States" under the Appointment Clause, and had not been appointed—in accordance with that Clause—by the President, a head of a department, or a court of law.  In support of this position, Petitioners relied on Freytag v. Commission, 501 U.S. 868, 881-82 (1991), in which the Supreme Court held that special trial judges of the Tax Court were inferior officers under the Appointment Clause because of the "significance of the duties and discretion" the judges possessed, despite the fact that the judges generally could not render final decisions.  The Commission rejected this argument, finding that its ALJs were mere employees who did not exercise significant and independent authority.  In reaching this decision, the Commission primarily focused on the fact that its ALJs lacked the power to issue final decisions.

Petitioners appealed the Commission's ruling to the D.C. Circuit, which affirmed the Commission's decision, relying on Landry v. FDIC, 204 F.3d 1125, 1133-34 (D.C. Cir. 2000), where it held that ALJs in the Federal Deposit Insurance Corporation are not inferior officers because they could not issue final decisions.  The D.C. Circuit distinguished Freytag from the instant case, noting that unlike the Commission's ALJs, the special trial judges in Freytag could exercise judicial powers, including issuing final decisions in certain situations.  The D.C. Circuit granted rehearing en banc but denied the petition for review by an equally divided 5-5 vote in June 2017 without an opinion

The Government Views Commission ALJs as "Inferior Officers" Under the Constitution

In July 2017, Petitioners filed for a writ of certiorari, arguing that Supreme Court review is warranted because the D.C. Circuit's decision was erroneous and created a split with the Tenth Circuit, which held in Bandimere v. SEC, 844 F.3d 1168 (2016), that the Commission's ALJs are in fact inferior officers.

Noting that in prior stages of the case it argued that its ALJs are employees, "upon further consideration, and in light of the implications for the exercise of executive power under Article II," the Government stated that it now agrees with Petitioners that ALJs are constitutional officers who exercise significant authority under United States law.  The Government contended that—like the judges in Freytag—Commission ALJs are inferior officers because their office is characterized by "significant duties and discretion," including the ability to conduct and control administrative proceedings and render decisions that can be treated as final.  It argued that the D.C. Circuit inappropriately gave dispositive weight to the fact that Commission ALJs have no authority to issue final decisions, as the Freytag Court found that special trial judges were constitutional officers despite their inability to issue final decisions.  Thus, while the ability to enter a final decision is sufficient to make ALJs constitutional officers, it is not necessary.

Additionally, the Government argued that Supreme Court review is necessary to assess not only whether the selection of Commission ALJs is constitutional, but also whether the manner by which ALJs can be removed impermissibly insulates ALJs from Presidential oversight.  The Government also noted that review is warranted to resolve the Circuit split between the D.C. and Tenth Circuits, and constitutional challenges made to ALJ decisions in pending actions.  The Commission echoed the position it took in Bandimere that the instant action is the preferred vehicle to resolve this issue, as Justice Gorsuch was a member of the Tenth Circuit when Bandimere was before that court and would thus likely recuse himself from that case in the Supreme Court.

Given that it was no longer supporting the D.C. Circuit's ruling that is subject to the certiorari petition, the Government asked the Court to grant certiorari and appoint an amicus curiae to defend the appellate court's decision.

The Commission Puts its Own Fix in Place

After the Solicitor General's brief announcing the reversal from its previously consistent position that its ALJs are employees, the Commission the next day took steps to bring its use of ALJs in line with this newfound position.  On November 30, 2017, it ratified the appointment of its ALJs—in its capacity as head of a department—and ordered the ALJs' reconsideration of the record in open causes before the ALJs and those on review before the Commission. 

The Commission's action may largely moot the dispute on this issue.  The broader fight over the constitutionality of ALJs, however, is not going away anytime soon.  The Government's opposition already portends future challenges to ALJ authority based on their tenure protection from Presidential removal.  Challenges to ALJ appointments in other agencies also continue to wind through the courts.  The Fifth Circuit, for instance, has already previewed its unease about the FDIC's appointment process for ALJs.

Orrick will continue to monitor developments in this case and Bandimere.  It will also monitor the Commission's use of administrative proceedings in light of its position that its ALJs are constitutional officers.

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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