A recent federal appellate decision casts new doubt on the SEC’s practice of using its own administrative law judges (ALJs) to hear actions brought by the SEC Enforcement Division.
In a decision late last month, the U.S. Court of Appeals for the 10th Circuit held that SEC ALJs are “Officers” subject to the Appointments Clause of the U.S. Constitution but were not appointed in compliance with that clause. Accordingly, the ALJ in the case under review did not hold office constitutionally, and the resulting decision imposing civil penalties on the respondent was set aside. Bandimere v. SEC, No. 15-9586 (10th Cir., December 27, 2016).
The decision conflicts with an opinion of the U.S. Court of Appeals for the District of Columbia Circuit, which held that the ALJs are not subject to the Appointments Clause. That conflict between the circuits increases the likelihood that the issue will be addressed by the Supreme Court.
There has been a series of challenges in recent years to the SEC’s power to bring cases before ALJs, but most have failed. These defeats, however, have largely been based on a procedural issue, the failure of respondents to challenge the appointment of ALJs in proceedings before the SEC prior to bringing an action in federal court. Three circuit courts have held that respondents cannot stop SEC enforcement actions to raise the Appointments Clause issue, but rather must stand trial before an ALJ and seek review by the SEC before pursuing an action in federal court.
That is what happened in Bandimere, where an ALJ, after a trial-like hearing, found Mr. Bandimere was liable for violating the securities laws, barred him from the securities industry, and imposed civil penalties, among other things. The SEC reviewed that decision, and reached the same result. In addition to agreeing with the ALJ’s decision on securities law liability, the SEC also considered and rejected Bandimere’s argument that under the Appointments Clause, the ALJ lacked authority to hear the case. That made the matter ripe for review by the Tenth Circuit.
In the only other SEC enforcement action to follow a similar procedural course, the D.C. Circuit last August addressed the Appointments Clause issue, and reached a different result from the Tenth. It held that SEC ALJs are merely employees, not Officers subject to the Appointments Clause, and therefore do have the authority to hear enforcement actions. Raymond J. Lucia Cos., Inc. v. SEC, 832 F.3d 277 (D.C. Cir. 2017). The D.C. Circuit had also reached a similar determination regarding FDIC ALJs. Landry v. FDIC, 204 F.3d 1125 (D.C. Cir. 2000).
The legal dispute turns on section 2 of Article 2 of the Constitution, which sets forth certain requirements for how “Officers” of the United States are to be appointed. It states that the President shall “by and with the Advice and Consent of the Senate, … appoint Ambassadors, other public Ministers and Consuls, Judges of the supreme Court, ….” As to other “Officers of the United States,” it states that “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.”
It is not disputed that SEC ALJs are not appointed in conformity with the Appointments Clause. The question is whether they have to be, which in turn depends on whether such ALJs are “such inferior Officers” as referred to by the clause.
The SEC contends they are not, principally because the Commissioners of the SEC retain the authority to review ALJs’ decisions, and thus the ALJs lack final decision-making power. The D.C. Circuit in Lucia agreed with that argument, which was the basis for its holding that SEC ALJs are not subject to the Appointments Clause.
The Tenth Circuit, however, rejected the notion that “final decision-making power is dispositive to the issue at hand.” Given the full range of authority ALJs have in conducting hearings in SEC enforcement actions, the court found that they fall within the scope of “Officers.”
Among the issues on which the D.C. and Tenth Circuit disagreed, and which the Supreme Court would need to address, is the application of an earlier Supreme Court case, Freytag v. Commissioner of Internal Revenue, 501 U.S. 868 (1991). That case addressed the status of “special trial judges” appointed by the Tax Court. The Court in Freytag ultimately held that the special trial judges at issue there were appointed in conformity with the Appointments Clause. But it also devoted attention to discussing whether the judges were Officers or employees, and the Tenth and D.C. Circuits took contrary views as to the implications of that discussion for SEC ALJs.
In recent years, the SEC has relied heavily on administrative proceedings to pursue enforcement actions. The importance of the issue, as well as the division among Circuits, increases the chances the Supreme Court will address the issue. And the Tenth Circuit could also hear the case en banc. The issue seems unlikely to be going away any time soon.