The U.S. Court of Appeals for the Tenth Circuit on December 27, 2016, in Bandimere v. SEC,1 found the Administrative Law Judges (ALJs) used by the U.S. Securities and Exchange Commission (SEC) to hear its administrative enforcement cases to be “inferior officers,” subject to appointment under the “Appointments Clause” of the U.S. Constitution.2 This decision sets aside the SEC’s ruling on the petitioner’s alleged securities laws violations on the grounds that the ALJ who presided over the initial hearing held his position unconstitutionally.
The Appointments Clause requires that all “Officers of the United States,” including “inferior officers,” be appointed either by the President or by a Congressional delegation of power to the President, courts, or department heads.3 The Supreme Court has ruled that an inferior officer is “any appointee exercising significant authority pursuant to the laws of the United States.”4
Bandimere could have wide-ranging effects on both past and ongoing SEC enforcement actions.5 Further, the decision could provide a basis to challenge the decisions of the federal banking agencies (the Federal Reserve Board, FDIC and Office of the Comptroller of the Currency) that employ similarly-situated ALJs certified as qualified by the Office of Personnel Management (OPM) and hired by the Office of Financial Institution Adjudication (OFIA).
ALJs and the Appointments Clause
The SEC delegates to its ALJs responsibility for the fair and orderly conduct of SEC administrative enforcement proceedings.6 The ALJs are hired in accordance with the Administrative Procedure Act.7 In its argument before the Tenth Circuit, the SEC conceded that its ALJs were not appointed in accordance with the Appointments Clause, but argued that they were merely employees who did not require such a formal appointment because their initial determinations are granted no deference by the SEC’s commissioners (Commission) during the Commission’s review.
In its 1991 Freytag decision, the Supreme Court held that an appointee is an inferior officer if: (i) the position was established by law; (ii) the duties, salary, and means of appointment are specified by statute; and (iii) the appointee exercises significant discretion in carrying out important functions. The Bandimere court concluded that the SEC’s ALJs satisfied all three elements of the Freytag test.8
Other courts have disagreed as to whether the ability to make a “final decision” is dispositive of “significant discretion” under Freytag.9 The Tenth Circuit differed with the D.C. Circuit’s August 2016 decision in Lucia v. SEC,10 which relied on the 2000 D.C. Circuit decision in Landry v. FDIC11 to determine that final decision-making authority is necessary to satisfy the third element of the Freytag test.
Impact on the Constitutionality of ALJs at Federal Bank Regulatory Agencies
In Landry, the D.C. Circuit validated the appointment and authority of the FDIC’s ALJs because they did not satisfy the “significant discretion” prong of Freytag. The SEC has relied on the Landry decision to validate the appointment of its own ALJs because of their similarities with the FDIC’s ALJs. Like the FDIC’s ALJs, the SEC’s ALJs do not have final decision-making authority and instead merely recommend decisions to the Commission. The FDIC’s ALJs are part of a pool of ALJs at OFIA who are shared with the other banking regulators. While Landry is still good law in the D.C. Circuit, Bandimere could potentially implicate the enforcement proceedings of all of the banking agencies that, like the FDIC, use the OFIA ALJs. The constitutionality of the OFIA ALJs under the Tenth Circuit’s interpretation of the Appointments Clause and Freytag remains to be seen, and could potentially lead to a decision by the Supreme Court in light of the split in Circuit Court holdings.
SEC’s Use of Administrative Enforcement Proceedings
The SEC’s increased use of administrative proceedings following amendments contained in the Dodd-Frank Act12 has resulted in significant controversy about the fairness13 and due process14 of the proceedings. The SEC amended its rules of practice in July 201615 and, in doing so, addressed some of these criticisms.16 Continuing court challenges to the use of ALJs in administrative enforcement actions could result in additional changes by the SEC – and possibly the banking agencies – in regard to such proceedings.