On December 27, 2016, a divided panel of the Tenth Circuit Court of Appeals found the SEC’s use of administrative law judges (“ALJs”) unconstitutional, setting aside an ALJ’s administrative order finding David F. Bandimere liable for failing to register as a broker-dealer, securities offerings registration violations and violations of the anti-fraud provisions. This decision in Bandimere v. SEC, No. 15-9586, 2016 WL 7439007, --- F.3d ---, (10th Cir. Dec. 27, 2016) lies in direct conflict with the D.C. Circuit decision in Raymond J. Lucia Cos., Inc. v. SEC, 832 F.3d 277 (D.C. Cir. 2016), creating a split among the circuits.
The primary issue in Bandimere and Lucia stems from the argument that SEC enforcement actions brought against respondents are unconstitutional because the ALJs who hear them are appointed in violation of the Appointments Clause in Article II of the U.S. Constitution. Under the Appointments Clause, Congress may “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.” But because ALJs are not appointed directly by the President or SEC Commissioners themselves but rather through government personnel and human resources offices, respondents argued that the appointment of ALJs violates the Constitution. The SEC has responded that ALJs are merely government employees, not “inferior fficers,” because they do not issue final decisions – only proposed findings of fact and conclusions of law.
When the D.C. Circuit considered the issue in Lucia, the Court reasoned that because it is ultimately up to the SEC whether to adopt those findings, ALJs are not “inferior Officers” under Article II. The D.C. Circuit noted the “Commission retains discretion to review an ALJ’s initial decision either on its own initiative or upon a petition for review filed by a party or aggrieved person,” and the ALJ decisions become effective only when the SEC issues a finality order.
In contrast, the Tenth Circuit did not find that factor dispositive. Instead, the decision in Bandimere underscored the ALJs’ ability to “exercise significant discretion in carrying out important functions,” which included their authority “to shape the administrative record by taking testimony, regulating document production and depositions, ruling on the admissibility of evidence, receiving evidence, ruling on dispositive and procedural motions, issuing subpoenas, and presiding over trial-like hearings.” Although the SEC must issue a finality order to effectuate the ALJs’ decisions, the SEC affords “considerable weight” to the ALJ’s findings, and therefore ALJs were inferior Officers who must be appointed pursuant to the Appointments Clause.
Given the circuit split, the SEC may seek a petition for rehearing en banc in the Tenth Circuit or seek Supreme Court review (the Lucia respondent’s petition for rehearing en banc is currently pending in the D.C. Circuit). Until the circuit split is settled, respondents in SEC administrative proceedings will continue to challenge the SEC’s use of ALJs. This may encourage the SEC to avoid the controversy as much as possible by pursuing more enforcement actions in federal district courts and pushing for settlement in pending actions.
If the Supreme Court ultimately determines the current manner in which ALJs are used is unconstitutional, then the likely fix is for the SEC to modify the appointments of ALJs so that the head of the SEC appoints them directly. That would be relatively simple. The more troublesome issue for the SEC would be dealing with current and recent past respondents in cases before ALJs, such as Lynn Tilton, who will be able to challenge the constitutionality of the proceeding to which they were subject. The Supreme Court has consistently held that a judgment entered by an improperly appointed adjudicator is void and “should certainly be set aside or quashed by any court having authority to review it by appeal, error or certiorari.” However, once a judgment has become final, the defect generally cannot be raised collaterally later to reopen the matter. For Ms. Tilton, who recently endured a full trial before an ALJ after her own challenges to the SEC administrative proceedings were rejected by the Second Circuit, this could open a door to a reversal. The ALJ in Ms. Tilton’s case has not yet issued its ruling.
Another crucial factor in how this issue is resolved is the appointment of the next chairperson of the SEC under President-elect Donald Trump. On January 4, 2017, Trump announced his nomination of Walter J. Clayton. Clayton is a Wall Street lawyer who is known for his experience in corporate dealmaking and capital markets, unlike the two most recent SEC chairs under President Obama, who had backgrounds in criminal enforcement and regulation. Moreover, as we discussed in greater detail in the New York Law Journal, there have been some legislative efforts even before the election to rein in the SEC’s expanded use of administrative proceedings since the enactment of Dodd-Frank. Therefore, with the election of a Republican president, a Republican Congress in both chambers, a possible appointment of Mr. Clayton and a Supreme Court vacancy, one might expect a more balanced use by the SEC of the administrative forum and district courts for enforcement actions.