With the Securities and Exchange Commission (“SEC” or the “Commission”) favoring enforcement action through its own administrative proceedings rather than in federal court, the constitutionality and legitimacy of SEC administrative law judges’ decisions—an open question created by a split between the Tenth and D.C. Circuit Courts of Appeals—is an incredibly vital issue for all those involved in the securities industry.
To resolve this circuit split, the United States Supreme Court recently granted certiorari in Lucia v. SEC, No. 17-130 (Jan. 12, 2018), taking up the question of whether SEC administrative law judges (“ALJs”) are inferior officers or employees within the meaning of the Appointments Clause of Article II of the U.S. Constitution. Article II, § 2, clause 2 vests the President with the authority to appoint all “Officers of the United States” subject to advice and consent by the Senate. The Appointments Clause also provides that Congress may delegate the appointment power of “inferior Officers” without Senate approval to the President alone or “his heads of departments and the courts of law.” Freytag v. Commissioner of Internal Revenue, 501 U.S. 868, 882-83 (1991). The Supreme Court has held that the Appointments Clause serves two purposes: (1) it embodies a system of checks and balances, and (2) it promotes accountability by identifying the public officials who make the officer appointments. See Edmond v. United States, 520 U.S. 651, 659-60 (1997); Ryder v. United States, 515 U.S. 177, 182 (1995).
The question before the Supreme Court involves whether SEC ALJs are “inferior officers” subject to the Appointments Clause or employees of the SEC beyond the reach of the clause. If the Supreme Court determines SEC ALJs are inferior officers, the decision could call into question the legitimacy of past SEC cases and potentially throw the Commission into disarray until the ALJs are appointed in compliance with the Appointments Clause.
The Circuit Split
In late 2016, the Tenth Circuit Court of Appeals considered whether SEC ALJs are employees or inferior officers. Bandimere v. SEC, 844 F.3d 1168 (10th Cir. 2016). The court held that SEC ALJs are inferior officers, and because the ALJ who presided over the hearing at issue was not properly appointed, he held the office in violation of Article II.
In Bandimere, the ALJ had determined that defendant Bandimere violated securities laws, issued a cease-and-desist order, ordered disgorgement, imposed civil penalties, and permanently barred Bandimere from working in the industry. Before the Commission, Bandimere challenged the constitutionality of the administrative proceeding, asserting that the ALJ had not been appointed under Article II. The Commission rejected Bandimere’s arguments, concluding that ALJs are employees of the SEC rather than inferior officers. Id. at 1170-71. Bandimere appealed the decision to the Tenth Circuit.
The Tenth Circuit relied heavily on the Supreme Court’s decision in Freytag in determining that SEC ALJs are inferior officers. In Freytag, the Supreme Court held that inferior officers have three characteristics: (1) the position is established by law; (2) the duties, salary, and means of appointment are specified by statute; and (3) the officer exercises significant discretion in carrying out important functions. See 501 U.S. at 881. Because the special trial judge positions at issue in Freytag were established by law, their duties and means of appointment were specified by statute, and the judges exercised significant discretion over taking testimony, admitting evidence, and enforcing discovery orders, the Supreme Court held that the special trial judges were inferior officers subject to the appointment requirements of Article II. See id. at 892.
The Tenth Circuit concluded that SEC ALJs closely resembled the special trial judges in Freytag. The SEC ALJ position was established by law under the Administrative Procedure Act (5 U.S.C. § 556(b)(3)); statutes set forth the salaries, duties, and means of appointment; and SEC ALJs exercise significant discretion in performing their duties, including shaping the administrative record, regulating document production, ruling on admissibility, issuing subpoenas, and presiding over the proceedings. See Bandimere, 844 F.3d at 1181. SEC ALJs even have the authority to issue initial decisions that declare respondents liable and impose sanctions, and if review is not timely sought or the Commission declines to review the decision, the ALJ’s decision is “deemed the action of the Commission.” Id. at 1180. Therefore, because SEC ALJs satisfied the three requirements in Freytag for inferior officers, the ALJs are subject to the Appointments Clause. See id. at 1181.
Setting up the circuit split, the D.C. Circuit arrived at the opposite conclusion in Lucia v. SEC. See 832 F.3d 277 (D.C. Cir. 2016). In Lucia, the D.C. Circuit recognized that all officers of the United States are subject to the Appointments Clause unless they are considered employees. The court stated that someone is an appointee rather than an employee if the person exercises “significant authority” pursuant to the laws of the United States. See id. at 284. The main criteria for determining whether an individual wields “significant authority” are (1) the significance of the matters resolved by the individual; (2) the discretion the individual exercises in making decisions; and (3) the finality of those decisions. See id (citing Tucker v. Comm’r Internal Revenue, 676 F.3d 1129, 1133 (D.C. Cir. 2012)).
The D.C. Circuit’s analysis hinged on the third criterion. Relying on Landry v. FDIC (204 F.3d 1125 (D.C. Cir. 2000)), the D.C. Circuit held that SEC ALJs lack binding authority because the Commission must issue an order making any initial decision rendered by an ALJ final. The court concluded that this absence of binding authority rendered SEC ALJs employees of the Commission beyond the reach of the Appointments Clause. Lucia, 832 F.3d at 289; see also Landry, 204 F.3d at 1133-34 (holding that FDIC ALJs are not officers because their decisions are not final but constitute only recommendations to the FDIC board).
Notably, after the petitioner in Lucia sought certiorari in the Supreme Court, the Commission reversed its position and has now conceded that SEC ALJs are inferior officers subject to the requirements of the Appointments Clause. Brief for the Respondent, Lucia v. SEC, No. 17-130, at *9-10 (Nov. 29, 2017).
Potential Implications of this Decision
This Supreme Court decision could significantly affect the future of SEC proceedings. If SEC ALJs are deemed inferior officers subject to the Appointments Clause, this would mean some, if not all, prior decisions by those ALJs were unconstitutional. Indeed, it is no secret that in the wake of the Dodd-Frank Act, which augmented the SEC’s ability to procure civil penalties in administrative proceedings against both individuals and companies, the SEC’s Enforcement Division has increasingly opted for administrative enforcement rather than filing lawsuits in federal court. Publicly available data shows in fiscal year 2014, the SEC commenced nearly half of its “litigated actions as administrative proceedings, an increase of over 35% since 2012.” See Brief for The Chamber of Commerce of the United States as Amicus Curiae, Lucia v. SEC, No. 17-130, at *7 (Aug. 25, 2017) (quoting H.R. Rep. No 114-697, at 2 (2016)) (emphasis added). In 2016, this trend accelerated, with the SEC bringing 80% of its enforcement actions in administrative proceedings. See id.1 Given the SEC’s trend toward the use of administrative proceedings, the impact of a holding rendering these administrative decisions unconstitutional going forward would be particularly pronounced.
Other important questions, including SEC ALJ removal procedures, agency rulemaking authority, and retroactivity, will naturally flow from the Supreme Court’s resolution of this case. See Bandimere, 844 F.3d at 1188. We will monitor not only the Supreme Court’s decision in Lucia but also the impact, if any, that Lucia has on these related issues.
1 See also SEC, Select SEC and Market Data Fiscal 2016 at 3 tbl. 2, https://www.sec.gov/files/2017-03/secstats2016.pdf (last accessed Jan. 16, 2018) (showing the SEC filed 692 administrative proceedings out of a total 868 proceedings, equaling 79.7%).
*David Howard, a Baker Botts law clerk, assisted in the preparation of this article.
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