U.S. Supreme Court Holds That Appointment of SEC ALJs by Staff Members Violates the Appointments Clause of the United States Constitution

• Posted on: Jul 2 2018

On June 21, 2018, the United States Supreme Court resolved a split among the circuit courts over the constitutionality of administrative law judges (“ALJs”) appointed by the staff of the U.S. Securities and Exchange Commission (the “SEC” or the “Commission”). In Lucia v. U.S. Securities and Exchange Commission, the Court held that the appointment of the SEC’s ALJs by members of the Commission’s staff, rather than the Commission itself, violated the Appointments Clause of the Constitution (U.S. Const., art. II, § 2, cl. 2.). Lucia et al. v. Sec. Exch. Comm’n, No. 17-130, 585 U.S. __ (2018) (here). In doing so, the Court reversed the Court of Appeals for the District of Columbia (the “D.C. Circuit”), which held that the ALJs were “mere employees” rather than “Officers of the United States” within the meaning of the Appointments Clause. Raymond J. Lucia Cos., Inc. v. Sec. Exch. Comm’n, 832 F.3d 277 (D.C. Cir. 2016) (here).

This Blog previously addressed the case here.

Background

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 Supreme Court’s decision in Freytag v. Commissioner, 501 U. S. 868 (1991), finding that “Freytag [is] inapposite here.” Id. at 32.

The D.C. Circuit affirmed the Commission’s decision. 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. In so ruling, 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 which it 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 D.C. Circuit 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 (“STJs”) of the Tax Court who were held to be officers in Freytag. In the court’s view, the STJs 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 STJs 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.

Thereafter, Lucia sought a rehearing en banc. Before the entire D.C. Circuit heard the case, the Tenth Circuit determined that SEC ALJs were officers of the United States thereby creating a split among the circuits. See Bandimere v. SEC, 844 F. 3d 1168, 1179 (2016). Significantly, the Tenth Circuit read Freytag differently than the D.C. Circuit and, thus, ruled that the ALJs performed functions similar to judges of the Tax Court.

After hearing argument, an evenly divided D.C. Circuit, sitting en banc, issued a per curiam order denying Lucia’s claim. See 868 F. 3d 1021 (2017). As a result, the D.C Circuit was in conflict with the Tenth Circuit.

Lucia filed a petition for certiorari with the Supreme Court for its review.

Thereafter, the government changed its position from defending the Commission’s finding that its ALJs are mere employees, to asserting that SEC ALJs were officers within the meaning of the Appointment Clause. Additionally, the day after the government changed its litigation position, the Commission issued an order ratifying the prior appointment of its ALJs.

The Court’s Decision

Justice Kagan’s Majority Opinion

Justice Kagan wrote the opinion for a fractured six-justice majority. In concluding that SEC ALJs are officers rather than mere employees, Justice Kagan noted that the decision turned on whether the ALJs “exercise significant authority pursuant to the laws of the United States.” Slip op. at 6 (citing Buckley v. Valeo, 424 U.S. 1, 126 (1976)).

In framing the focus of the inquiry “on the extent of power an individual wields in carrying out his assigned functions” (id.), Justice Kagan found that “Freytag says everything necessary to decide this case.” Id. at 8. “To begin,” Justice Kagan observed, “the Commission’s ALJs, like the Tax Court’s STJs, hold a continuing office established by law.” Id. “The Commission’s ALJs exercise the same ‘significant discretion’ when carrying out the same ‘important functions’ as STJs do.” Id. And, importantly, noted Justice Kagan, SEC ALJs possess “all the authority needed to ensure fair and orderly adversarial hearings—indeed, nearly all the tools of federal trial judges” (id.), such as they “take testimony, conduct trials, rule on the admissibility of evidence, and have the power to enforce compliance with discovery orders” and “administer oaths,” “shape the administrative record,” may punish “contemptuous conduct” and, “at the close of those proceedings, ALJs issue decisions.” Slip op. at 8-9 (citations omitted). Thus, “point for point—straight from Freytag’s list—the Commission’s ALJs have equivalent duties and powers as STJs in conducting adversarial inquiries.” Id. at 9.

Justice Kagan rejected the argument advanced by an amicus that the Tax Court judges in Freytag differed because (1) “they had authority to punish contempt” (including discovery violations) through fines or imprisonment” and (2) under the Tax Court rules, their findings of fact are “presumed correct.” She found those “distinctions [made] no difference for officer status.” Slip op. at 10.

She found the contempt distinction of no moment because SEC ALJs could “enforce their will through conventional weapons” by excluding the wrongdoer (whether a party or a lawyer) from the proceedings” or, if the “offender is an attorney,” “[s]ummarily suspend[ing]” him from representing his client.…” Slip op. at 10-11 (internal quotation marks and citations omitted).

She also found the “amicus’s standard-of-review distinction” to “fare[] just as badly” because the Freytag Court never suggested that the deference given to STJs’ factual findings mattered to its Appointments Clause analysis.” Indeed, said Justice Kagan, “the relevant part of Freytag did not so much as mention the subject.” Slip op. at 11. In any event, “the Commission often accords a similar deference to its ALJs, even if not by regulation.” Id.

Justice Kagan also rejected Justice Sotomayor’s argument that “significant authority” requires the ability for judges to enter final decisions in at least some instances. Noting that this was only a “back-up” rationale of Freytag, Justice Kagan found that “Freytag has two parts, and its primary analysis explicitly rejects JUSTICE SOTOMAYOR’s theory that final decisionmaking authority is a sine qua non of officer status.” Slip op. at 8 n.4. Regardless, she noted that the Commission often defers to ALJ’s factual findings. Id. at 11 (“the Commission adopts [the ALJ’s] credibility finding[s] absent overwhelming evidence to the contrary.”) (citations and internal quotation marks omitted).

Having found that Lucia timely challenged the appointment of the ALJ, Justice Kagan found that the only “appropriate” remedy available was to hold a new “hearing before a properly appointed” official,” though that official could not be the ALJ who presided over Lucia’s case. Slip op. at 12. She reasoned that the original ALJ could not “be expected to consider the matter as though he had not adjudicated it before” he was improperly appointed. Id.  Justice Kagan observed that such a remedy comported with the Court’s “Appointments Clause remedies,” thereby rejecting Justice Breyer’s structural purposes argument. Slip at 12 n.5.

Finally, the Court passed on two issues raised by the parties. First, the Court declined to address the issue concerning the Commission’s attempt to ratify prior ALJ appointments. Slip op. at 13 n.6. Second, the Court declined to address the constitutionality of the statutory removal protections for ALJs, noting that it was premature to do so. Id. at 4 n.1.

Justice Breyer’s Concurrence

Justice Breyer with whom Justice Ginsburg and Justice Sotomayor joined in part, concurring in the judgment in part and dissenting in part, would have avoided the constitutional issue and found that the ALJs were wrongfully appointed under the Administrative Procedure Act (“APA”). Opinion of Breyer, J., concurring in the judgment and dissenting in part (“Concurring Opinion”), at 1. Justice Breyer reasoned that there was a question “embedded” in the “constitutional question,” which the majority left unanswered: “the constitutionality of the statutory ‘for cause’ removal protections that Congress provided for administrative law judges.” Id. Thus, if ALJs are officers under the Appointments Clause, then the statutory protection under the APA might be unconstitutional under the Court’s prior holding in another case that officers cannot have “multilevel protection from removal” by the President. Id. at 4-5 (citing Free Enterprise Fund v. Public Company Accounting Oversight Bd., 561 U. S. 477 (2010)).

Justice Breyer expressed concern that “If the Free Enterprise Fund Court’s holding applies equally to the administrative law judges,” then the majority’s holding “would risk transforming administrative law judges from independent adjudicators into dependent decisionmakers, serving at the pleasure of the Commission,” and “threaten[] to change the nature of our merit-based civil service as it has existed from the time of President Chester Alan Arthur.” Concurring opinion at 6 (orig’l emphasis).

Justice Thomas’ Concurrence

Although Justice Thomas joined the majority in its conclusion, Justice Thomas, joined by Justice Gorsuch, would have decided the case “based on the original public meaning of ‘Officers of the United States.’” Thomas, J., concurring opinion at 1. Under the Founders’ interpretation of the Appointments Clause, the definition of “Officer” “encompassed all federal civil officials with responsibility for an ongoing statutory duty.” Id. at 2 (citations omitted and internal quotation marks omitted). Thus, according to Justice Thomas, an officer would likely include individuals who “performed only ministerial duties.” Id. at 3. For that reason, and “[b]ecause the Court reache[d] the same conclusion by correctly applying Freytag, [he] join[ed] its opinion.”

Justice Sotomayor’s Dissent

Justice Sotomayor, joined by Justice Ginsburg, agreed with the decision of the D.C. Circuit and the Commission – namely, that SEC ALJs are not officers within the meaning of the Appointments Clause because they cannot issue final, binding decisions on behalf of the government. Dissenting opinion at 2. Notably, Justice Sotomayor read Freytag as “consistent” with her conclusion that “a prerequisite to officer status is the authority, in at least some instances, to issue final decisions that bind the Government or third parties.” Id. at 5.

Takeaway

In granting certiorari, the Court resolved the question it agreed to consider.  However, it left many more questions unresolved. Indeed, given the varying reasons advanced by the Justices for reaching their conclusions, the path forward for other agencies and their administrative judges, who exercise differing levels of authority than SEC ALJs, may find it difficult to determine whether their ALJs are constitutionally appointed.

For example, the various decisions do not explain the minimum amount of authority needed to consider an ALJ to be an officer within the meaning of the Appointments Clause. The absence of such guidance impacts the nearly 1,930 ALJs employed by the federal government in twenty-six agencies. See Brief for Federal Administrative Law Judges Conference, as Amici Curiae Supporting Neither Party, Lucia v. SEC, 585 U.S. __ (2018) (No. 17-130) (here). The Court’s decision leaves the issue up in the air for these agencies and the courts that will undoubtedly hear challenges on this ground.

After Lucia, the constitutionality of the removal protections for ALJs remains open to legal challenge. The Court expressly declined to address the issue, noting that it “ordinarily await[s] thorough lower court opinions to guide [its] analysis of the merits.”  Slip op. at 4 n.1. Thus, parties in administrative proceedings will have a viable basis upon which to challenge rulings that are issued against them.

More directly, Lucia should have an immediate impact on pending and resolved SEC proceedings.

Since the Commission ratified the prior appointment of all five of its ALJs, the Commission will most likely contend that it has already satisfied the constitutional mandate that it appoint its ALJs. The Court did not address the challenge to the validity of the Commission’s ratification, thereby leaving open the possibility that administrative proceedings commenced after the ratification order (i.e., after November 30, 2017) may continue. To remove any doubt about the validity of the prior ratification, the Commission may proceed with a formal appointment process for its ALJs in which the Commission formally votes on the ALJs, administers oaths of office, and delivers commissions.  If the Commission were to pursue such action, going forward, it should reduce the possibility of later challenges to the Commission’s ALJs.

Lucia is more likely to affect pending and resolved SEC administrative proceedings. Since the majority held that the remedy for a proceeding tainted by a violation of the Appointments Clause is a new hearing before a properly appointed official, pending and resolved SEC administrative proceedings may require the Commission to reassign (and possibly open resolved) cases to a constitutionally appointed officer.  Should that occur, respondents may have statute of limitations defenses. See, e.g., 28 U.S.C. § 2462 (imposing five-year statute of limitations from the date “when the claim first accrued” on commencement of government “enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise”). In that event, respondents could challenge subsequent administrative orders instituting enforcement proceedings on those grounds.

Given the uncertainties surrounding ratification and the constitutionality of pending and resolved cases presided over by a tainted or potentially tainted ALJ, the SEC may determine to litigate contested matters in federal court, rather than in administrative proceedings. Time will tell whether the Commission turns to federal court proceedings in the wake of Lucia.

The Court’s decision can be found here.