The U.S. Securities and Exchange Commission (“SEC”) is considered by many to be the nation’s top watchdog on Wall Street — sniffing out insider trading, market manipulation, and financial fraud. But the reality is that any publicly traded company is subject to SEC regulation and enforcement. The tech industry, with its ever-changing landscape, may become a hot bed of SEC enforcement activity, especially as companies continue to navigate uncharted waters such as crypto currencies and innovative “initial coin offering” funding methods.
Tech companies should be aware that a key part of the SEC’s enforcement scheme will soon be reviewed by the Supreme Court. On January 12, 2018, the Supreme Court granted certiorari in Raymond J. Lucia Companies, Inc. v. SEC, 832 F.3d 277 (D.C. Cir. 2016), cert granted, 2018 WL 386565 (U.S. Jan. 12, 2018) (No. 17-130). The central issue in the case is whether SEC administrative law judges (“ALJs”) are “officers of the United States” per the Appointments Clause of the U.S. Constitution. If so, then ALJ decisions in pending SEC enforcement actions — and pending enforcement actions in similarly situated federal agencies — may be called into question.
The SEC has long faced criticism that it wields an unfair advantage when it brings enforcement actions before its own ALJs in internal administrative courts that lack the same rights and protections afforded to defendants in federal courts. ALJs are capable of imposing significant financial sanctions and lifetime employment bans, and while their decisions are not final until approved by the SEC Commissioners, they are rarely overturned. Despite wielding this broad power, ALJs are not subject to the same accountability checks as are other government officers, such as department heads and judges, because they are not appointed by the President, but were instead hired by SEC staff and are treated as regular federal employees.
In December 2013, an SEC ALJ fined Mr. Lucia and his company $300,000 and barred him from working as a broker or investment adviser. Lucia appealed and argued, as many before him have, that the ALJ was an “inferior officer,” rather than an employee, and was therefore not legitimately appointed pursuant to the Appointments Clause in the U.S. Constitution. Under the Appointments Clause, such inferior officers must be appointed either by the President, the head of the agency, or a court of law. See U.S. Const. art. II, § 2, cl. 2. The case made its way to the D.C. Circuit, which disagreed with Lucia, finding that ALJs were not inferior officers and therefore were properly appointed. But shortly thereafter, the 10th Circuit, in Bandimere v. SEC, 844 F.3d 1168 (10th Cir. 2016), ruled that ALJs are Officers of the United States who must be appointed pursuant to the Appointments Clause. Lucia filed a petition for writ of certiorari in the Supreme Court and, in an interesting turn of events, the government — in its reply brief opposing certiorari — changed its stance mid-briefing and agreed with Lucia that ALJs are inferior officers and urged the Supreme Court to grant certiorari to resolve the circuit split.
After the government announced its change of heart, the SEC has taken a number of steps to attempt to remedy the alleged deficiency in its appointment process. The day after the government filed its reply brief, the SEC Commission ratified the appointment of its ALJs, ostensibly to cure any Appointments Clause issues going forward. It also instructed ALJs to reconsider their actions in all open proceedings, provide an opportunity for the parties to submit additional relevant evidence, and determine whether to ratify those actions. Because of its change in stance, the government has recommended that the Supreme Court appoint an amicus curiae to defend the D.C. Circuit’s judgement.
With so many factors up in the air, many questions will likely remain unanswered until the Supreme Court makes its ruling. For example: Does the SEC’s ratification of ALJ appointments satisfy the Appointments Clause? Are SEC litigants’ constitutional rights adequately addressed by having ALJs reconsider their past actions in pending cases? Will the SEC use the opportunity to reopen unfavorable ALJ decisions? What is the retroactive effect of a Supreme Court ruling that ALJs are officers, on defendants whose cases were fully adjudicated before improperly appointed ALJs?
At the very least, defendants with administrative cases pending before the SEC may want to consider raising similar constitutional challenges to ensure these claims are preserved for appeal, in case the Supreme Court rules the ALJ appointment process was unconstitutional. Litigants before other agency administrative courts may also be wise to examine the appointment process of those adjudicators for constitutional deficiencies and raise constitutional challenges if appropriate.
A Supreme Court ruling that ALJs are in fact inferior officers may increase the President’s ability to influence the SEC’s enforcement regime. Currently, the SEC’s five Commissioners are appointed by the President with the advice and consent of the Senate. By requiring ALJs to be appointed by either those Commissioners or the President himself, rather than being treated merely as federal employees, the President may gain a more direct line of influence into the SEC’s administrative courts. Although this may prompt objections about politicization, it could also have the ancillary effect of lessening the “home court advantage” that the SEC may currently enjoy in its administrative courts.
With the SEC’s rising interest in the tech industry, such companies will be well served by monitoring these trends to be best prepared in case the SEC comes knocking on their door. We will continue to monitor and report on developments in this case.