Supreme Court Says SEC ALJ Appointments Are Unconstitutional

SEC ALJ's are under scrutiny after the Supreme Court's decision.

Supreme Court Addresses SEC ALJ’s

On June 21, 2018 The Supreme Court handed down a ruling in Lucia et al. v. Securities and Exchange Commission; the Commission lost, 7-2.  At issue was whether the SEC’s method of appointing administrative law judges (ALJs) was unconstitutional because it was not consistent with the Appointments Clause of the Constitution.  Lucia and several other similar cases involving SEC ALJ’s have been making their way through the courts for the past five years or so.  In early 2017, we examined the situation as it stood at that time.

The Appointments Clause is part of Article II of the Constitution.  It specifies that:

[The President] shall nominate, and by and with the Advice and Consent of the Senate, shall appoint Ambassadors, other public Ministers and Consuls, Judges of the supreme Court, and all other 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.

The SEC has brought administrative proceedings, and used ALJs, for decades.  Most of the matters heard as administrative proceedings were relatively minor.  But the Dodd-Frank Act, signed into law in 2010, greatly expanded the powers of the ALJs.  Previously, the punishments the ALJs could apply, except to broker-dealers and investment advisers, were limited to disgorgement and injunctions against future violations of the securities laws.  Additional penalties designed to deter future misconduct could only be ordered by a federal district judge.

Section 929P of the act, titled “Strengthening Enforcement by the Commission,” expressly grants the SEC the right to impose hefty monetary penalties on the subjects of its administrative proceedings.  Some observers pointed out at the time that from the perspective of the respondent, administrative proceedings might be seen as unfair actions in which the SEC acted as prosecutor, judge, and jury.

Ray Lucia’s problems began on September 5, 2012, when the SEC instituted an administrative proceeding against him personally and the Raymond J. Lucia Companies, Inc (RLJ).  Lucia was a registered investment adviser and a licensed broker; he also owned two broker-dealer firms.  At the time, he hosted a daily radio show, was featured on two websites, and often appeared as a commentator on television programs.  He’d written three books on investing for retirement, and spoke at seminars hosted by RLJ all over the country.  At his seminars and in one of his books, Lucia promoted an investment strategy he’d developed, which he called “Buckets of Money.”  He claimed he’d thoroughly “backtested” the strategy, and said it was “a proven way to achieve both income and growth while guarding against the ravages of inflation.”  The SEC examined Lucia’s data and concluded it was materially misleading in a number of ways.  That was the Commission’s grievance.

Lucia’s case was heard by ALJ Cameron Elliot.  Lucia lost.  He was ordered to pay $300,000 in civil penalties; was barred from associating with investment advisers, brokers, or dealers; and he lost his investment adviser registrations.  On December 27, 2013, he appealed his case to the Commission, as was his right.  In his appeal, Lucia contended that “the administrative hearing was an unconstitutional procedure because the Commission ALJ who presided over this matter was not appointed in accordance with the Appointments Clause of the U.S. Constitution.”  The appeal was heard by the Commission.

The majority of the Commissioners agreed with ALJ Elliot’s conclusions, and affirmed the civil penalties and other sanctions he’d imposed on September 3, 2015.  As to the constitutional question, they asserted that while Elliot was not a “principal officer who must be appointed by the President and confirmed by the Senate, neither was he an “inferior officer” who must be appointed by the President, a “head of department,” or a court.  He was, like the “great majority of government personnel,” a “mere employee.”  They held further that Elliot could not be an “inferior officer,” as Lucia claimed he was.  Following Freytag v Commissioner and Landry v FDIC, they concluded that an inferior officer must have the power to issue “final decisions,” and maintained that the ALJs do not have that power:

[They] “do not issue final decisions that result from [administrative] proceedings. […] [T]he Commission’s ALJs issue “initial decisions” that are […] not final.  Respondents may petition us for review of an ALJ’s initial decision, and it is our “longstanding practice [to] grant virtually all petitions for review.”  Indeed, we are unaware of any cases which the Commission has not granted a timely petition for review.  Absent a petition, we may also choose to review a decision on our own initiative, a course we have followed on a number of occasions.  In either case, our rules expressly provide that “the initial decision [of an ALJ] shall not become final.”  Even where an aggrieved person fails to file a timely petition for review of an initial decision and we do not order review on our own initiative, our rules provide that “the Commission will issue an order that the decision has become final,” and it “becomes final” only “upon issuance of the order” by the Commission.  Moreover […] the Commission reviews its ALJs’ decisions de novo. […] We may also “hear additional evidence” ourselves, and may “make any findings or conclusions that in [our] judgment are proper and on the basis of the record. […] As we have explained before, we have “plenary authority over the course of [our] administrative proceedings and the rulings of [our] law judges—before and after the issuance of the initial decision and irrespective of whether any party has sought relief.”

That, for the Commissioners, was a clear and sufficient demonstration that the SEC ALJs are not “inferior officers” under the Appointments Clause.  The commissioners voting in the majority were Chair Mary Jo White, Luis Aguilar, and Kara Stein.  Daniel Gallagher and Michael Piwowar disagreed with their opinion, and wrote a brief dissent.  Although they believed “[t]he misdeeds of the respondents in this caase have been well established,” they felt the majority had “taken a relatively straightforward set of facts and needlessly engaged in ‘rulemaking by opinion.’”

More germane to our discussion is the dissent’s last paragraph, in which Gallagher and Piwowar note that Lucia has raised “important issues with respect to whether the administrative law judge overseeing the proceeding was appointed in a manner consistent with the Appointments Clause of the Constitution.”  They concluded that they believed it would be appropriate that Article III federal judges ultimately resolve the issue.

And Lucia was indeed headed for federal appellate court and beyond.

Lucia’s Road to the Supreme Court

Lucia was not the only respondent in an SEC administrative proceeding who challenged the constitutionality of the ALJs’ appointments.  In 2015, Charles Hill, whom the agency had charged with insider trading, went to federal district court in Atlanta, asking for an injunction stopping the proceeding.  Judge Leigh Martin May granted the injunction, noting that Hill was not challenging the SEC’s decision, because no decision had been rendered; he was “challenging whether the SEC’s ability to make that decision was constitutional.”  Hill contended that the ALJ in charge of his case was an “inferior officer,” in contrast to the SEC’s argument, by now familiar, that he was a “mere employee.”  Relying on Freytag, May found that the SEC ALJs are indeed “inferior officers,” and so preliminarily enjoined the SEC from conducting the administrative hearing.

Unfortunately for Hill, in June 2016, the Eleventh Circuit reversed May’s ruling in Hill and in a similar case, Gray Financial Group v. SEC, finding that the district court lacked subject matter jurisdiction.  In doing so, it followed the D.C. Circuit’s reasoning in overturning a district court’s decision in Jarkesy v. SEC.  It was at this time that Ray Lucia appealed his own case to the District of Columbia Circuit Court. In August 2016, the D.C. Circuit once again sided with the SEC, supporting the Commission’s use of ALJs.  One of the D.C. Circuit’s fundamental arguments in Lucia was that SEC ALJs cannot be considered “inferior officers” under the Appointments Clause because they are not empowered to make final decisions.

Another challenger, David Bandimere, fared better.  Bandimere, like Lucia, had been served with an OIP in 2012.  The SEC alleged that Bandimere, a Colorado businessman, had operated as an unlicensed broker between 2006 and 2010, selling millions of dollars’ worth of stock in what the agency described as Ponzi schemes.  His case, like Lucia’s, was heard by Cameron Elliot, and he was found liable.  He requested a review from the SEC Commission.  The commissioners affirmed Elliot’s decision.  And so Bandimere appealed to the Tenth Circuit in 2016.  In his petition, he raised the Appointments Clause issue, and also challenged the SEC’s findings of securities fraud liability.  The appellate panel chose to address only the Appointments Clause.  Unlike the DC Circuit, the Tenth concluded that “SEC ALJs are inferior officers who must be appointed in conformity with the Appointments Clause […],” adding that “[t]he SEC ALJ held his office unconstitutionally when he presided over Mr. Bandimere’s hearing.”

The Bandimere ruling created a split opinion among the circuits, raising questions that would need to be settled one way or another.  After the Tenth Circuit ruled on Bandimere, the D.C. Circuit reconsidered its decision in Lucia.  On February 16, 2017, it vacated the original judgment in the case, and agreed to rehear Lucia’s petition en banc on May 24.  On June 26, Lucia lost once again:  the 10 member panel’s vote was equally divided, and so the petition for review was denied, and the conclusions reached by the SEC in its review of the case stood.

The Supreme Court

As a result of the circuit split, the issue could only be resolved by the Supreme Court.  On July 21, 2017, Lucia filed a petition with the court for a writ of certiorari.  An appeal to the Supreme Court is not a right that can be demanded:  certiorari—sometimes abbreviated as “cert”—must be granted.  A writ of certiorari is a formal order to a lower court to deliver its record of the case so that the justices may review it.  The question presented in the writ was:

Whether administrative law judges of the Securities and Exchange Commission are Officers of the United States within the meaning of the Appointments Clause.

It should be borne in mind that neither the D.C. Circuit nor the Supreme Court was interested in, or would address, the merits of the SEC’s allegations against Lucia and his companies.  Appellate cases are about the law, and about the constitution.  The rulings handed down may or may not ultimately vindicate the appellant, but they will clarify the law so that it may easily be understood in future actions.

In the petition, Lucia points out that Congress created the SEC and charged it with, among other things, enforcing the federal securities laws.  The Commission may delegate any of its functions, except rulemaking, to administrative law judges, but in practice enforcement actions are either filed in federal court or heard by ALJs in an administrative proceeding.  When establishing these rules, Congress refers to SEC ALJs as “officers of the Commission,” and notes that the “agency shall appoint [its] administrative law judges.”  The petition makes clear that were that “manner of appointment” followed, it “would comport with the Appointments Clause.”  The ALJs are “hearing officer[s]” whose authority is extensive and includes the powers to oversee hearings and discovery, rule on motions (including summary disposition), enter default judgments, and impose or modify sanctions. […] SEC ALJs also rule on the admissibility of evidence, take testimony, and make credibility findings, to which the Commission defers absent overwhelming evidence to the contrary.”

Lucia and the SEC agreed that when an administrative hearing is over, the ALJ enters an “initial decision.”  The SEC’s contention has long been that the initial decision only becomes final with its consent.  We’ve seen that the SEC holds that “our rules expressly provide that “the initial decision [of an ALJ] shall not become final.”  Lucia disagreed, sustaining that “[a]lthough the Commission ‘retain[s] a discretionary right to review’… ‘[i]f the right to review is declined’ or not timely sought, the ALJ’s action is ‘deemed the action of the Commission.’’  The petition cites Bandimere’s contention that about 90 percent of decisions in administrative proceedings are not reviewed by the Commission, and that in such cases, the Commission “will issue an order that the decision has become final.

The petition additionally holds that SEC ALJs are not appointed by the Commission as a whole, which would make them “constitutional officers,” but are “selected by SEC staff from a pool of candidates identified by the Office of Personnel Management.”  Contrary to the SEC’s earlier assertion that its ALJs are “mere employees,” the petitioner notes that historically, the Supreme Court has the only actors whose employment by the federal government is not subject to the Appointments Clause are individuals with “no general functions, nor any employment which has any duration as to time,” whose posts lack “tenure, duration, continuing emolument, or continuous duties,” and who “ac[t] only occasionally and temporarily.”  In another case cited by the petitioner, employees are defined as “lesser functionaries subordinate to” officers.  Driving the point home, the petitioner goes further:  “This Court has never held that a federal adjudicator is a mere employee, while holding that many quasi-judicial officials—including clerks, commissioners, and non-Article III judges—are Officers. […] For example, court commissioners (the predecessors of today’s magistrate judges, are constitutional Officers. […] There is no difference of constitutional magnitude between magistrate judges and administrative law judges.”

Lucia recommends Freytag as the Supreme Court ruling that should direct and inform the Justices’ decision in the instant case.  The petition ends with a reminder that the current circuit split has created uncertainty that only the highest court in the land can put to rest.  Lucia’s plea ends with unnecessary and irrelevant drama:

The SEC’s regime of unaccountable adjudicators has left countless casualties on the field—not least Ray Lucia.  After an unblemished career spanning forty years, Mr. Lucia has been rendered unemployable in his profession and on the verge of bankruptcy—even though his free presentations, at which no securities were offered or sold and which concededly caused no investor harm, did not remotely account to intentional fraud.  The ALJ who presided of this case imposed on him “the securities industry equivalent of capital punishment.”  The Framers designed the Appointments Clause precisely to prevent such abuses of power by unaccountable officials.  This court need to decide, now, whether SEC ALJs are Officers of the United States.

The petition for certiorari was granted on January 12, 2018.

Over the next six months, 29 amicus curiae briefs were filed by parties ranging from Mark Cuban to the Federal Administrative Law Judges Conference to the Equity Dealers of America to the National Black Lung Association.

On February 21, 2018 the Department of Justice, in the person of Solicitor General Noel Francisco, filed a brief in support of Lucia’s petition. In the docket, the filing is called “Brief of respondent Securities and Exchange Commission in support of petitioners.”  When the case was reviewed by the D.C. Circuit, the DOJ had supported the SEC, as is normally its job.  The government’s new perspective on the issue is explained briefly as part of its argument:

The government took the position before the court of appeals that the Commission’s ALJs are mere employees, rather than constitutional officers. Upon further consideration, and in light of the implications for the exercise of executive power under Article II, the government is now of the view that such ALJs are officers because they exercise “significant authority pursuant to the laws of the United States.” […] The government has reassessed the importance of the functions that ALJs perform, as well as the proper interpretation of this Court’s decision in Freytag v. Commissioner, […] which held that adjudicative officials exercising similar functions were inferior officers for purposes of the Appointments Clause.

In the court’s eventual majority opinion, Elena Kagan notes only that “in responding to Lucia’s petition, the Government switched sides.”  To deal with this development, the court appointed Anton Metlitsky as an amicus curiae to brief and argue the case.  Kagan remarks that “he has ably discharged his responsibilities.”  Apparently the DOJ had informed the justices of its decision earlier; Metlitsky was invited to play this role on January 18, a little more than a month before the government filed its brief.

The practice of inviting non-parties to argue before the court as amici is neither new nor unusual, though it may be unfamiliar to casual observers of the court’s activities.  No official records are kept of these appointments.  The decision to extend an invitation is made around the time the justices agree to grant cert to the petitioner, and often the recipient is a relatively young attorney who in the past has clerked for one of the jurists.  Metlitsky, for example, had served as Chief Justice Roberts’ clerk in the 2007 term.  Former clerks stand a better chance of being asked because they’re intimately familiar with the way the court works.  Usually these amici are enlisted to support the lower court’s decision, as in this case.  The justices want to consider all sides of the issues raised by constitutional questions at hand, and the appointment of its own amicus to present the necessary legal analysis will ensure that happens

As noted above, the government’s explanation of its change of heart was not specific.  But on November 30, 2017, the SEC had news of its own.  The Commission, clearly concerned that the Supreme Court would accept Lucia’s petition, and that its decision would not be favorable, “ratifie[d] the agency’s prior appointment of Chief Administrative Law Judge Brenda Murray and Administrative Law Judges Carol Fox Foelak, Cameron Elliot, James E. Grimes, and Jason S. Patil.”  It additionally ordered all the ALJs to reconsider “all substantive and procedural actions” taken by them pursuant to Rule 111 of the Commission’s Rules of Practice.  They were to accomplish that task by January 5, 2018, and submit any new evidence they felt was relevant to their reexamination of the record, and to determine whether any of their former actions required revision.  Each judge was to revisit his or her own former cases, and issue reports on all of them by February 16, 2018.

While that may sound like a difficult, even overwhelming, job, given the thousands of administrative proceedings the ALJs handle each year, in reality it was not.  Most of those proceedings are uncontested actions like the deregistration of delinquent filers.  The judges evidently didn’t break a sweat completing their reviews, and those reviews contained no real surprises.  A few former respondents did attempt to reopen their cases, and submitted new briefs.  One Edward M. Daspin, also known as Edward (Ed) Michael, protested his earlier treatment at the hands of ALJs Carol Foelak and James Grimes, and was dealt with summarily.  Daspin argued that serious medical problems had prevented him from attending hearings or otherwise defending his case effectively.  In his new decision, Grimes recounted previous events, and concluded, “For starters, Daspin’s history of concocting false medical excuses, together with his penchant for inventing facts, would give anyone pause.”  He then ratified the actions he’d taken in the case, and denied Daspin’s pending motions.  While most of the other disputed cases required less attention, the same conclusions were reached.

In its November 30 directive, the Commission noted the Tenth Circuit’s decision in Bandimere, and—perhaps with its collective fingers crossed—announced that its ratification of the appointments of the ALJs had solved the constitutional question raised in the case.  The ALJs were now “inferior officers” who had been appointed by “heads of department.”  But the matter would not be truly resolved until the Supreme Court heard Lucia.

The Decision

Anton Metlitsky filed his amicus brief on March 26, 2018, and it was followed by replies from the petitioners and from the government.  Oral arguments were heard on April 23, and the court’s decision was handed down on June 21

The case was decided 7-2 in favor of the petitioners, and the slip opinion was written by Justice Elena Kagan.  Justice Clarence Thomas wrote a concurring opinion, in which Justice Neil Gorsuch joined.  Justice Stephen Breyer filed an opinion concurring in part, and dissenting in part, in which Justices Ruth Bader Ginsburg and Justice Sonia Sotomayor joined as to Part III.  Justice Sotomayor filed a brief dissenting opinion in which Justice Ginsburg joined.

The question before the court, as noted above, was whether SEC ALJs are officers of the United States “within the meaning of the Appointments Clause,” or “mere employees.”  In the government’s brief, Francisco had asked that a second question be considered:  whether the statutory restrictions on removing ALJs are constitutional.  Kagan explains that when the court granted certiorari, the justices chose not to take that step.  Francisco asked once again, and the court once again declined, Kagan says, because “[n]o court has addressed that question, and we ordinarily await ‘thorough lower court opinions to guide our analysis of the merits.’”

Kagan’s opinion relies heavily on Freytag v. Commissioner for its authority.  Freytag, heard in 1991, had to do not with the SEC, but with the Tax Court.  In Freytag, the issue was whether the Tax Court had the authority to appoint special trial judges (STJs) under the Appointments Clause.  The Tax Court could assign its STJs to four categories of cases.  In three of them, the STJ could both report on and decide the matter; in the fourth, the STJ could be authorized only to hear the case and propose findings, while the actual decision would be made by a regular Tax Court judge.  In Freytag, the fourth category applied.  The STJ issued a proposed opinion concluding the petitioners were liable, and the Tax Court ratified it.  The petitioners argued that the STJs were “inferior officers” under the Appointments Clause, and the clause had been violated because they were not appointed by the president, a court of law, or a department head.  The government argued that the STJs were not inferior officers because they lacked the authority to enter a final decision.

The Supreme Court held in 1991 that although the STJ who heard Freytag was not empowered to render a final decision, his powers and authority went well beyond those of a functionary, or “mere employee,” adding that even if if he “on occasion performs duties that may be performed by an employee not subject to the Appointments Clause,” that does not make him an employee.  The court unanimously found that STJs were inferior officers.

Kagan points out that all parties to Lucia agree that the SEC ALJ Cameron Elliot was not appointed by the President, a court of law, or a head of department.  (Not, at least, until the Commission ratified his appointment on November 30, 2017.)  Lucia’s position could only be defeated if it could be shown that Elliot was a “lesser functionary” performing mundane tasks.  Two earlier decisions, United States v. Germaine and Buckley v. Valeo, offer guidance on distinguishing between officers and employees.  Germaine established that “civil surgeons,” who performed physical examinations, were not officers because their duties were “occasional or temporary” rather than “continuing and permanent.”  Buckley showed that members of a federal commission were officers because they “exercis[ed] significant authority pursuant to the laws of the United States.”  It is Freytag, however, that considered the concept of “significant authority” with respect to “adjudicative officials who are near carbon-copies of the Commission’s ALJs.”  Kagan then explains that “our analysis there… necessarily decides this case.”

In Freytag, as we’ve seen, the court held that the Tax Court’s STJs were officers in the sense intended by the Appointments Clause, though they had not been appointed in accordance with it.  The government had proposed that the STJs were in fact mere employees, because they were unable to “enter a final decision,” but the court felt the government’s focus on finality “ignore[d] the significance of the duties and discretion that [STJs] possess.”  That and other factors meant they were officers, “even when their decisions were not final.”  The SEC’s ALJs exercise the same kind of “significant discretion,” and have “all the authority needed to ensure fair and orderly adversarial hearings—indeed, nearly all the tools of federal trial judges.”  One difference between the STJs and the ALJs is that an STJ’s opinion must always be reviewed by a regular Tax Court judge.  But at the SEC, the rules are different:  the Commission can decide against review, and the decision will “become final,” and be “deemed the action of the Commission” without the Commission having done anything at all.  The only conclusion that can be drawn is that SEC ALJs are “inferior officers” within the meaning of the Appointments Clause, and therefore must be properly appointed.

As to remediation of the injury to Lucia caused by ALJ Elliot’s lack of such a proper appointment, the court decided that he was owed a new hearing before a qualified official.  And so it reversed the D.C. Circuit’s judgment, and remanded the case to the SEC, with the stipulation that it cannot be heard by Elliot for a second time, even if he is now constitutionally appointed, because “[h]e cannot be expected to consider the matter as though he had not adjudicated it before.”

The Supreme Court’s review of Lucia was narrowly focused, and the decision leaves some questions unanswered.  Kagan herself was aware of the Commission’s “ratification” of the appointments of its ALJs on November 30, 2017.  Lucia himself had argued that the order is invalid.  The court, however, chose to refrain from comment

We see no reason to address that issue.  The Commission has not suggested that it intends to assign Lucia’s case on remand to an ALJ whose claim to authority rests on the ratification order.  The SEC may decide to conduct Lucia’s rehearing itself.  Or it may assign the hearing to an ALJ who has received a constitutional appointment independent of the ratification.

It is unclear who that ALJ might be, as the ratification order is apparently the only step the Commission has taken to fix the problem.  Perhaps to avoid trouble, the Commissioners will decide to conduct Lucia’s new hearing themselves, but it may be asked whether other unhappy respondents in earlier administrative proceedings will attempt to challenge the authority of the ALJ who presided over their cases.  Those ALJs have now, at least as the SEC sees it, been appointed by the Commissioners, who are “heads of department,” and they’ve “reviewed” their old cases, but respondents may feel that is insufficient, especially given that the court specifically forbade Elliot to “review” Lucia’s case.

While it may seem respondents have a shot at getting a new hearing, in her discussion of appropriate remediation for Lucia, Kagan makes a point of noting that “[t]his Court has held that ‘one who makes a timely challenge to the constitutional validity of the appointment of an officer who adjudicates his case’ is entitled to relief. […] Lucia made just such a timely challenge:  He contested the validity of Judge Elliot’s appointment before the Commission, and continued pressing that claim in the Court of Appeals and this Court.

Lucia did immediately request a review of his case by the Commission.  All respondents to administrative proceedings are, and always have been, entitled to that.  They are informed by the ALJ who renders an initial decision that they have 21 days in which to file a petition for review.  It could be argued that any who failed to do so in a timely manner forever lost their opportunity to reopen the case.  With luck, the SEC will not be facing thousands of requests to rehear old cases or, worse yet, to refund monies collected in disgorgement and penalties.

For now, the agency seems to be hedging its bets.  On June 21, the day the decision in Lucia was handed down, it announced that the agency “find[s] it prudent to stay any pending administrative proceeding by an order instituting proceedings that commenced the proceeding and set it for hearing before an administrative law judge, including any such proceeding currently pending before the Commission.”

The stay will remain in effect for 30 days, or until the Commission issues a further order.

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