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  • Posted on: Mar 5 2018

On February 23, 2018, the U.S. Supreme Court set oral argument in Lucia v. SEC, 17-130, a case involving the use of administrative law judges (“ALJ”) by the Securities and Exchange Commission (“SEC” or the “Commission”) as hearing officers in administrative proceedings. The issue presented to the Court concerns whether the use of ALJs violates the constitutional limitations of the Appointments Clause on “Officers of the United States” (here).  U.S. Const., art. II, § 2, cl. 2.  Resolution of the issue is important because there is a conflict among the circuits over the meaning of the Appointments Clause and the interpretation of the Court’s precedents addressing that provision (e.g.Freytag v. Comm’r, 501 U.S. 868, 881-82 (1991) (holding that non-Article III adjudicators, such as ALJs, who exercise discretionary powers are Officers of the United States who must be appointed pursuant to the Appointments Clause).

Lucia v. SEC


The case arose from an administrative proceeding brought by the SEC against Raymond J. Lucia and his investment company (collectively, “Lucia”).  Lucia marketed a wealth-management strategy, which they called “Buckets of Money,” under which retirement savings were divided among assets of different risk levels (e.g., bonds, fixed annuities, and stocks) and periodically reallocated as those assets changed in value.  The Commission instituted administrative proceedings against Lucia based on allegations that they had used misleading slideshow presentations to deceive prospective clients about how the Buckets of Money strategy would have performed under historical market conditions. The Commission charged Lucia with violating the Securities Exchange Act of 1934, the Investment Advisers Act of 1940 (“IAA”), and the Investment Company Act of 1940.

An ALJ conducted the initial stages of the proceeding. During a nine-day hearing, the ALJ presided over witness testimony and cross-examinations, admitted documentary evidence, and ruled on objections.  After the hearing, the ALJ issued an initial decision finding that Lucia had made fraudulent misrepresentations related to one of their investment strategies.  After the Commission directed the ALJ to make additional factual findings with respect to other alleged misrepresentations, the ALJ issued a revised initial decision finding that Lucia had willfully and materially misled investors, in violation of the IAA. The ALJ ordered a variety of sanctions to be imposed on Lucia, including revocation of his registration as an investment adviser; a permanent bar on associating with investment advisers, brokers, or dealers; a cease-and-desist injunction against future violations; and $300,000 in civil penalties. Lucia appealed.

On appeal, the Commission conducted “an independent review of the record, except with respect to those findings not challenged on appeal.”  Exchange Act Release No. 73,857, at 3, 2015 WL 5172953 (SEC Sept. 3, 2015) (here). The Commission determined that the ALJ had correctly found that Lucia had willfully made fraudulent statements and omissions in violation of the IAA. The Commission also largely “affirm[ed],” with limited exceptions, “the sanctions imposed” by the ALJ. Two Commissioners dissented with respect to one aspect of the Commission’s liability determination.

Lucia argued before the Commission that the proceeding against him was unlawful because the ALJ who had conducted the hearing and issued the initial decision was an “Officer[ ] of the United States” within the meaning of the Appointments Clause. Id. at 28. As such, the ALJ had not been appointed, in accordance with that provision, “by the President, the head of a department, or a court of law.” Id. at 29. The Commission rejected Lucia’s argument. In the Commission’s view, its ALJs were mere employees rather than constitutional officers because they do not exercise “significant authority independent of the [Commission’s] supervision.” Id. Among other things, the Commission explained, its ALJs “issue ‘initial decisions’ that are … not final”; a person aggrieved by an initial decision may seek review before the Commission, which “grant[s] virtually all petitions for review”; the Commission may review any ALJ decision sua sponte; review of an ALJ’s decision is de novo; and under the Commission’s rules, “no initial decision becomes final simply on the lapse of time by operation of law,” but instead becomes final only upon “the Commission’s issuance of a finality order.” Id. at 30 (citation and internal quotation marks omitted). The Commission also distinguished the Freytag decision, finding that “Freytag [is] inapposite here.” Id. at 32.

On appeal of the Commission’s order, a panel of the Court of Appeals for the D.C. Circuit denied the petition for review. Lucia v. SEC, 832 F.3d 277 (D.C. Cir. 2016). The court rejected Lucia’s Appointments Clause challenge, holding that the Commission’s ALJs are mere employees rather than officers under the Constitution because they do not exercise “significant authority pursuant to the laws of the United States.” Id. at 284. For that conclusion, the court relied on its prior decision in Landry v. FDIC, 204 F.3d 1125, 1133-1134 (D.C. Cir.), cert. denied, 531 U.S. 924 (2000).  In Landry, the court held that the ALJs used by the Federal Deposit Insurance Corporation (“FDIC”) were not officers of the United States because they could not issue final decisions on behalf of the agency – i.e., they could not exercise significant authority to bind third parties, or the government itself, for the public benefit. Id. at 1333; see also Lucia, 832 F.3d at 285. The Lucia court determined that an SEC ALJ’s initial decision is similarly non-final, and it rejected Lucia’s attempts to distinguish Landry. Lucia, 832 F.3d at 285. The court also rejected Lucia’s argument that the SEC’s ALJs “exercise greater authority than FDIC ALJs in view of differences in the scope of review of the ALJ’s decisions.” Id. at 288. The court acknowledged that “the Commission may sometimes defer to the credibility determinations of its ALJs,” but it concluded that “the Commission’s scope of review is no more deferential than that of the FDIC Board.” Id. The court further rejected Lucia’s attempt to equate the SEC’s ALJs with the special trial judges of the Tax Court who were held to be officers in Freytag. In the court’s view, the special trial judges were distinguishable because, as “members of an Article I court,” they “could exercise the judicial power of the United States” and “issue final decisions in at least some cases.” Id. at 284-85.  The court also found special trial judges to be different than SEC ALJs because “the Tax Court in Freytag was required to defer to the special trial judge’s factual and credibility findings unless they were clearly erroneous.” Id. at 288 (citation and internal quotation marks omitted). The Commission, by contrast, “is not required to adopt the credibility determinations of an ALJ.” Id.

On the merits, the court determined that substantial evidence supported the Commission’s finding that Lucia, acting with the requisite scienter, had made material misstatements and omissions in violation of the IAA. The court also concluded that the Commission had not abused its discretion in ordering sanctions against Lucia.

Lucia sought rehearing en banc, which the court of appeals granted on February 16, 2017. The order granting rehearing en banc vacated the panel’s judgment but not its opinion. The court directed the parties to limit their briefs to two issues: (1) whether “the SEC administrative law judge who handled this case [was] an inferior officer rather than an employee for the purposes of the Appointments Clause”; and (2) whether the court should “overrule Landry.” On June 26, 2017, an equally divided en banc court issued a per curiam judgment denying the petition for review.

Appeals Courts are Split on Administrative Proceedings

Since the original opinion of the three-member panel of the D.C. Circuit remains controlling, it is at odds with the ruling of the Tenth Circuit, which expressly disagreed with that decision. In Bandimere v. SEC, 844 F.3d 1168, 1170 (10th Cir. 2016), the court ruled that SEC ALJs are Officers of the United States within the meaning of the Appointments Clause.

In Bandimere, an ALJ issued an initial decision finding that the respondent had violated antifraud and registration provisions of the federal securities laws by operating as an unregistered broker and by failing to disclose potentially negative facts to investors. In re David F. Bandimere, Securities Act Release No. 9972, 2015 WL 6575665, at *1 (Oct. 29, 2015). On review of the ALJ’s initial decision, the Commission upheld the liability finding and imposed disgorgement and civil-penalty sanctions. Id. at *2. The Commission also rejected the respondent’s argument that its ALJs are officers under the Appointments Clause. Id. at *19-*21.

The Tenth Circuit granted the respondent’s petition for review, holding that the Commission’s ALJs are invested with powers that require their appointment as inferior officers under the Appointments Clause. Bandimere, 844 F.3d at 1179-1182. In reaching that conclusion, the court relied on Freytag, which it interpreted as turning on the significance of the special trial judges’ duties, not on their authority to render final decisions of the Tax Court. Id. at 1182-1185; see also id. at 1179.  The Tenth Circuit expressly “disagree[d]” with the D.C. Circuit’s decisions in Landry and Lucia, which, the court determined, had “place[d] undue weight on final decision-making authority.” Id. at 1182.

Judge Monroe G. McKay dissented, arguing that Freytag does not “mandate[ ] the result proposed here.”  Bandimere, 844 F.3d at 1194. Like the panel in Lucia, Judge McKay distinguished the special trial judges at issue in Freytag because of their authority to enter final decisions in a number of cases and because “the Tax Court was required to defer to its special trial judges’ findings.” Id. at 1197. Judge McKay emphasized that the Commission’s ALJs, by contrast, “possess only a ‘purely recommendatory power.’” Id. (quoting Landry, 204 F.3d at 1132).

In May 2017, the Tenth Circuit denied the Commission’s petition for rehearing en banc, with two judges dissenting. See Bandimere v. SEC, 855 F.3d 1128, 1128-1133 (10th Cir. 2017).  On September 29, 2017, the government filed a petition for a writ of certiorari urging the Court to resolve the question whether the Commission’s ALJs are inferior officers rather than employees. SEC v. Bandimere, No. 17-475.  But the government explained that Lucia, rather than Bandimere, presented the Court with the preferable vehicle for addressing the question. The government accordingly “request[ed] that the Court hold th[e] petition” in Bandimere “pending its consideration of the petition” in Lucia.

On July 21, 2017, Lucia filed his petition for a writ of certiorari. The Court granted the petition on January 12, 2018. As the docket shows, numerous amici filed briefs in connection with the petition. (Here.)

The Takeaway

Since the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the Commission has increased both the number and proportion of enforcement actions brought in administrative hearings before its ALJs. There are more than 100 cases currently under review by SEC ALJs, as well as a dozen on appeal in the federal courts. Given the foregoing, it is clear that the fact-finding and credibility determinations of the SEC’s ALJs are important to its ability to enforce the federal securities law.

Congress created the ALJ position pursuant to the Administrative Procedure Act (“APA”) (Pub. L. No. 79-404, 60 Stat. 237 (1946), codified at 5 U.S.C. §§ 551-559).  In doing so, Congress sought a mechanism by which federal agencies could provide for due process in administrative adjudications. Since the enactment of the APA, numerous federal agencies use ALJs in adjudicating administrative proceedings (e.g., the Commodities Futures Trading Commission, Federal Energy Regulatory Commission, the FDIC, the Consumer Finance Protection Bureau, National Labor Relations Board, the Environmental Protection Agency, and the Social Security Administration). Therefore, the decision by the Court will impact administrative proceedings beyond those conducted by SEC ALJs.

This Blog will be following the case as developments occur. Stay tuned for additional posts.

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