SEC Enforcement, ALJs and the Appointments Clause


The future of the SEC’s administrative enforcement process and, in particular its Administrative Law Judges, will be the focus of the D.C. Circuit later this month as the Court, sitting en banc hears oral argument in SEC v Raymond J. Lucia Companies, Inc., v. Securities and Exchange Commission, No. 15-1345 (D.C. Cir. Argument May 24, 2017). The question for decision is whether the SEC’s ALJs must be appointed to their positions in accord with the Constitution’s Appointments Clause, Art. II, sec. 2, cl. 2. The SEC admits that its ALJs are not appointed in accord with the dictates of the Clause – they are hired through a typical employee hiring process. If the ALJ’s must, as Petitioners’ contend, be appointed in accord with the Clause, it is a structural error which voids the proceeding. Its impact on other proceedings may be equally significant, although the question has been little attention discussed in other cases presenting the issue (here). In anticipation of the hearing this week the arguments presented in the briefs of the parties will be previewed in articles appearing today and tomorrow. </p>

Petitioners’ Brief

SEC registered investment adviser Raymond J. Lucia Companies, Inc., charged with, and found liable for, violating certain provisions of the Advisers Act, contends that the administrative proceedings in which the adverse ruling was made are a nullity. Specifically, the adviser asserts that the ALJ who presided over the hearing was not appointed in accord with the Constitution’s Appointment Clause, voiding the proceeding.

The Appointments Clause provides in pertinent part that that the:

President shall nominate, and by and with the Advice and Consent of the Senate, shall appoint Ambassadors, other public Ministers and Consuls, Judges of the supreme Court, and all other Officers of the United States, and all other Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law; but 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.

With this Clause the Framers sought to ensure that all officers of the United States would be the choice of the people, thereby preventing the type of abuses which took place at the time. The Federalist, No. 39 at 271 (James Madison). The Appointments Clause provides the exclusive means for appointing any officer of the United States whose position is established by law and who exercises significant authority pursuant to the laws of the United States. See, e.g., Buckley v. Valeo, 424 U.S. 1 (1976). The Clause recognizes two types of Officers: 1) Principal Officers and 2) Inferior Officers. The former includes ambassadors, ministers, heads of departments, judges and others who report directly to the President. They can only be appointed by the President with the consent of the Senate. The latter has been held to include a variety of positions. The appointment to those positions can only be made by the President, a Department Head or the Courts.

The limitations of the Clause serve to preserve the “Constitution’s structural integrity by preventing the diffusion of the appointment power. Freytag v. Commissioner, 501 U.S. 868, 878 (1991). Indeed, the safeguard is so fundamental that an impropriety in the Officer’s appointment “goes to the validity of the [underlying] proceeding.” Id. at 879. Stated differently, proceedings conducted by those appointed in violation of the Clause are a nullity.

The question here is whether SEC ALJs are “inferior” officials who must be appointed by the President, a Department Head or otherwise in accord with the Clause. The test, as established by Buckley and other decisions of the Supreme Court, is twofold: 1) Whether the position was “established by Law” and 2) if the person exercises significant authority under the laws of the United States. The first prong of the test has been construed to be very broad. This is reflected in the long list of those held to be Officers within the meaning of the Clause, according to Petitioners, which include: district-court clerks, a clerk to an assistant treasurer, an assistant-surgeon and cadet-engineer, numerous clerks in the Departments of the Treasury, Interior and others, election monitors, federal marshals, commissioners of the circuit courts who took bail for the appearance of those charged with a crime, extradition commissioners and U.S. attorneys.

Under the Clause, those who preside over adjudicative proceedings in the role of a trial judge have been held to be Officers within the meaning of the Clause. The leading case is Freytag. There the Supreme Court concluded that the appointment of “special trial judges” of the U.S. Tax Court who preside over trials and make preliminary dispositions is subject to the Clause. This is because their position was established by law and, while the ultimate case decision is subject to the ruling of a Tax Court judge, the special trial judges exercise a great deal of authority.

Under Buckley and Freytag it is clear that SEC ALJ’s must be appointed under the Clause. First, the position is established by law, according to Petitioners. The position of the ALJ’s is specified in U.S. Code Sections 556-557 of Title 5 and their duties are defined in the securities laws and by Commission regulations.

Second, there can be no doubt that SEC ALJs exercise significant authority under federal law. They are empowered, for example, to amend the charging documents, enter default judgments, consolidate proceedings, administer oaths, issue subpoenas, order the production of evidence, issue protective orders, reject filings for procedural noncompliance, grant extensions of time and stays, hold pre-hearing conferences, regulate the course of the hearing, receive relevant evidence and rule on its admissibility, rule on offers of proof, examine witnesses, regulate the scope of cross-examination, regulate the conduct of the parties and their counsel and impose sanctions. In sum, SEC ALJ’s have most of the powers of federal judges and magistrates, Petitioners argue. Indeed, all three branches of government have recognized them as Officers: The Congress refers to them in statues as Officers; they are Officers under the definitions of that term detailed by the Department of Justice Office of Legal Counsel; and the Supreme Court has noted that the role of an administrative law judge is comparable to that of a judge.

Finally, the decision of a panel of this Court in Landry v. FDIC, 204 F. 3d 9 (D.C. Cir. 2015) which suggests a contrary result here should be overruled, according to Petitioners. The Landry interpretation of the two prong test for determining whether the position falls within the clause over emphasizes the question of final authority, contrary to Freytag. The question under Buckley and Freytag is not one of final authority as Landry found, but of having the ability to exercise significant authority. Thus the Tenth Circuit recognized this point in choosing not to follow Landry in its recent decision in Bandimere v. SEC, 844 F. 3d 1168 (10 Cir. 2016).

Here it is clear that SEC ALJs do in fact exercise significant authority and in many instances make the final decisions. The rulings by SEC ALJs, for example, become the final decision in the proceeding in about 90% of the cases. And, as the Commission has conceded, Congress “indisputably permitted the SEC to treat ALJ initial decisions as final,” according to Petitioners (emphasis original). Accordingly, SEC ALJs are in fact Officers of the United States within the meaning of the Appointments Clause.

Recent Commission enforcement cases: On Friday, May 12, the Commission announced the following enforcement actions which will be discussed in posts later this week or in This Week In Securities Litigation on Friday:

SEC v. Ahmed, Civil Action No. 17-cv-1478 (D. Minn. Filed May 4, 2017), Lit Rel. No. 23834 (May 12, 2017)(offering fraud by unregistered investment adviser).

In the Matter of Registration Statement of Emerald Isle Exploration Ltd., Adm. Proc. File No. 3-17983 (May 12, 2017)(stop order proceeding).

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