In hurry-up ruling, SEC declares in-house judges are constitutional

September 8, 2015

The Securities and Exchange Commission’s 3-2 split decision last week in its administrative proceeding against the former syndicated radio host Raymond Lucia shows the far-reaching risk the agency faces if its administrative law judges are eventually determined to be subject to the Appointments Clause of the U.S. constitution.

The SEC commissioners clearly were in a big hurry to put on record their determination that – surprise! – they do not believe the SEC’s hiring process for the in-house judges who reach initial determinations about the liability of defendants in administrative proceedings to be unconstitutional. The commissioners first signaled their concern with the Appointment Clause argument that has swept across the white collar defense bar in May, in an appeal to the commission by the real estate investment manager Timbervest. Lucia’s lawyers at Gibson Dunn & Crutcher didn’t move to brief the constitutional issue until June, but they ended up beating Timbervest, which is bogged down in tangential briefing, to oral argument.

That argument took place on July 29, and the commission hustled out a decision so quickly that the dissent has not had time to publish its opinion. There’s no mystery to the fast turnaround. The constitutionality of the SEC’s appointment of in-house judges is also at issue in cases at the 2nd and 11th U.S. Circuit Courts of Appeal, after the commission asked for review of three federal district court decisions that held the SEC’s ALJ hiring process likely violates the Appointments Clause. As the commission said in its decision in the Lucia case, when cases implicate the agency’s own rules and procedures, the SEC considers it “important that the commission have an opportunity to address constitutional issues in the first instance.”

And as the Lucia case demonstrates, the ultimate determination of the constitutionality of SEC ALJs won’t just affect cases in which defendants have already challenged the appointment of the in-house judges. As my Reuters colleague Sarah Lynch reported Thursday, Lucia went to trial in an administrative proceeding back in 2013, years before defendants began challenging the appointment process of ALJs. At the time ALJ Cameron Elliot determined in July 2013 that Lucia gave investors false information about the results of his Buckets of Money investment strategy, his lawyers raised no argument that Elliot’s appointment tainted the proceeding. But if ALJ appointments turn out to be unconstitutional, every defendant found liable in an administrative proceeding, like Lucia, will have grounds to challenge the outcome.

That would be a gigantic headache for the SEC. The Securities Diary blog has described that eventuality as “near chaos,” hypothesizing that “perhaps the commission is counting on the appellate courts (and the Supreme Court) to blanche at the prospect of vacating such a large number of prosecuted cases.”

It’s worth pointing out that in the Lucia decision, the SEC seems to lay a foundation for the argument it will make if its ALJ appointment process turns out to be unconstitutional. The ruling emphasizes that the commissioners exercise de novo review of the determinations of in-house judges. That language appears to anticipate future arguments that the commissioners’ ultimate authority to decide cases cures any constitutional deficiency in the cases’ early stages.

The SEC majority’s reasoning in the Lucia decision is no less surprising than the outcome. The key question, for the purposes of deciding the constitutionality of the agency’s ALJ hiring and retention, is whether the in-house judges are “inferior officers” covered by the constitution’s Appointments Clause or mere employees without significant authority independent of the SEC commissioners. In Lucia, the commissioners concluded that under a 2000 ruling by the District of Columbia Circuit Court in Landry v. Federal Deposit Insurance Corporation, its in-house judges are employees because they don’t have the power to issue final decisions. I’m boiling down a much more detailed analysis, but basically, the commissioners said that SEC ALJs, like the FDIC in-house judges in the Landry case, can conduct hearings and issue intermediary rulings but do not ultimately speak for the agency, whose commissioners alone can reach a final determination.

SEC defendants, including Lucia, have argued that the controlling precedent on the status of the agency’s in-house judges is not the Landry case but the U.S. Supreme Court’s 1991 decision in Freytag v. Commissioner of Internal Revenue. In Freytag, the Supreme Court held that IRS special trial judges are covered by the Appointments Clause because they exercise powers similar to those of federal district court judges.

In considering recent constitutional challenges to SEC in-house judges, U.S. District Judges Leigh May of Atlanta and Richard Berman of Manhattan have agreed with defendants that, as Judge May explained in an Aug. 4 opinion enjoining the SEC from moving forward with an administrative proceeding against Gray Financial Group, SEC ALJs are more like IRS special trial judges than they are like FDIC ALJs. Among other things, Judge May wrote, FDIC judges’ decisions are only recommendations; SEC in-house judges issue initial determinations. “On this ground alone, FDIC ALJs are different from SEC ALJs,” she wrote.

She also said the SEC – and the D.C. Circuit in the Landry case – focused too intently on whether administrative law judges have authority to issue final decisions. In the Freytag case, the Supreme Court cited such power as a reason why IRS special judges are covered by the Appointment Clause. But according to May, the Supreme Court only discussed the judges’ authority to render final rulings after it had already offered other rationales for deciding the IRS judges are subject to constitutional appointment procedures.

Landry tried to persuade the Supreme Court to revisit what the incredibly prescient University of Georgia law professor Kent Barnett called the ALJ Quandary in a 2013 article in the Vanderbilt Law Review. (Barnett, who believes ALJs are covered by the Appointment Clause, proposed a going-forward solution to the constitutional problem, though I’m not sure it would resolve the issue of cases that have already been decided.) The Supreme Court denied Landry’s cert petition in 2000 and carefully avoided the whole issue of the constitutionality of administrative law judges in its 2010 decision in Free Enterprise Fund v. Public Company Accounting Oversight Board.

Depending upon how the 2nd and 11th Circuits decide the ALJ appeals before them, the justices may not be able to duck again.

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