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Supreme Court Resolves Constitutionality of SEC’S ALJ Appointments — Now What?

Last week, the United States Supreme Court settled a circuit split regarding the constitutionality of the appointment of Administrative Law Judges (“ALJs”) by the Securities and Exchange Commission (“SEC” or the “Commission”).  In Lucia v. SEC, the Court held that the Commission’s five ALJs are “officers” subject to the Constitution’s Appointments Clause, which requires officers to be appointed by the President, “Courts of Law,” or “Heads of Departments.”  And because the SEC’s ALJs were hired by the agency’s staff, the Court reasoned, their appointments were unconstitutional.  The SEC reacted quickly, immediately issuing an order staying all pending administrative proceedings, the constitutionality of which is now unclear.

The Road to the Supreme Court

The Supreme Court’s decision arose from an SEC administrative proceeding against radio personality Raymond Lucia, charging him with violations of the Investment Advisers Act.  An ALJ, Cameron Elliot, heard the case and issued an initial decision finding against Lucia.  Lucia appealed to the SEC, arguing that because ALJ Elliott had not been constitutionally appointed, he lacked authority to issue such findings.  The SEC disagreed and affirmed the initial decision, prompting Lucia to appeal to the D.C. Circuit Court of Appeals.  Siding with the SEC, the D.C. Circuit held that SEC ALJs are not “inferior officers,” as Lucia argued, but rather “employees,” and therefore not subject to Appointments Clause requirements.  Meanwhile, in a similar case, Bandimere v. SEC, the Tenth Circuit reached the opposite conclusion, creating a circuit split requiring Supreme Court resolution.

The Ruling

In last week’s majority opinion, authored by Justice Kagan, the Court applied a test articulated in Freytag v. Commissioner, 501 U.S. 868 (1991) for distinguishing between officers and employees for Appointments Clause purposes.  In concluding that SEC ALJs are officers, the Court relied on the following facts: (1) they have career appointments and hold a continuing office established by law; (2) they exercise “significant discretion” when carrying out “important functions,” such as taking testimony, receiving evidence, examining witnesses, and enforcing discovery orders; and (3) when the SEC declines to review an ALJ’s initial decision, it becomes final and is deemed the action of the Commission.  In short, the Court held, the SEC’s ALJs are “near carbon copies” of the tax court judges found to be “officers” in Freytag.

Issues Left Unresolved

While the decision clearly settles the matter for Mr. Lucia, it leaves a number of issues unresolved, and its broader implications remain unclear.

Validity of SEC’s Prior Ratification

The biggest question left unanswered is whether the SEC’s attempt last year to cure any constitutional defect in its appointments scheme was sufficient.  While Luciawas pending before the Court, the Commission issued an order “ratifying” the prior appointments of its ALJs.  (See our prior blog post for additional discussion).  Lucia argued that the ratification was invalid and that the action did not in fact resolve the appointment defect.  The Court, however, declined to address this argument, noting in a footnote that the SEC had not indicated whether it intended 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.”  The Court’s observation could be taken to suggest that the SEC’s ratification of the prior ALJ appointments did not in fact satisfy the Appointments Clause.  Perhaps in recognition of that possibility, the SEC promptly issued an order staying for thirty days, or until further other from the Commission, all of its pending administrative proceedings, including those in which an ALJ has already issued a decision.  The Commission presumably is now evaluating whether it needs to go beyond ratification to immunize its administrative proceedings from further constitutional attack.

Impact on Other Agencies

Another open question concerns the impact on other agencies’ administrative proceedings.  At oral argument, Justices Breyer and Sotomayor expressed concern that, if the Court were to rule in Lucia’s favor, proceedings in other federal agencies could be undermined as well.   While the majority opinion is silent on that question, Justice Breyer warned in his concurrence that the majority’s approach “risks . . . unraveling, step-by-step, the foundations of the Federal Government’s administrative adjudication system as it has existed for decades.”

ALJ Removal

Last, as noted in Justice Breyer’s concurrence, the Court’s decision raises questions about the constitutionality of limitations on ALJ removal under the Administrative Procedures Act (“APA”).   The APA provides that ALJs may only be removed “for cause.”  But if an SEC ALJ is a constitutional “officer,” that limitation may be invalid, as duly appointed officers are subject to removal at will.  Justice Breyer observed that, if ALJs are vulnerable to removal at any time, it could transform them “from independent adjudicators into dependent decisionmakers, serving at the pleasure of the Commission,” and therefore raise fundamental doubts about the legitimacy of their decisions.

Next Steps

As a result of the Court’s decision, Lucia himself will be entitled to a new hearing before a properly appointed ALJ or the Commission itself.  Given the questions that the Court declined to answer, and the SEC’s decision to temporarily stay its proceedings, however, we can expect further developments and continuing litigation in this area in the days and years to come.

© Copyright 2018 Squire Patton Boggs (US) LLP

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About this Author

Coates Lear, Squire Patton Boggs Law Firm, Goverment Inquires Attorney
Principal

Coates Lear specializes in assisting companies and individuals involved in government inquiries and enforcement proceedings, especially investigations and actions by the US Securities and Exchange Commission (SEC). Coates also advises on compliance matters, with a focus on asset management, and represents clients in complex litigation.

303-894-6141
Elizabeth Weil Shaw attorney Squire Patton Boggs
Associate

Elizabeth Weil Shaw assists clients primarily with government enforcement actions and inquiries, as well as internal investigations and compliance reviews. Liz has analyzed matters involving investigations by the US Securities and Exchange Commission, Department of Justice and State Attorneys General. She is a contributor to the firm's Anticorruption Blog.

303-830-6129