Here is Part II of Ken Berg’s analysis of constitutional defenses that have been raised in response to the SEC’s increased use of administrative proceedings.  In the interest of full disclosure, note that the Malouf case referenced towards the end is one that Heidi VonderHeide and I are handling.  In addition, it also worth mentioning that in another appeal of an adverse SEC decision that Heidi and I presently have before the DC Circuit, the Division of Enforcement advised us on Friday that the Commission plans to file a motion requesting that the Court hold briefing in abeyance pending resolution of the Lucia case, and asking whether we would agree to it.  Clearly, the SEC is hardly presuming a positive outcome from the rehearing of the Lucia case, scheduled for May.   – Alan

In last week’s installment, I discussed how the expansion of the SEC’s authority to obtain civil monetary penalties in Dodd-Frank emboldened the SEC to vastly increase the number of cases filed with SEC Administrative Law Judges instead of federal district court. In response, the defense bar asserted constitutional defenses to the administrative proceedings and filed collateral attacks in federal district court.  Though the Courts of Appeals have shut the door on collateral attacks for now, and the SEC has rejected all constitutionally-based affirmative defenses, respondents must continue to assert them in the administrative proceedings in order to preserve the issues for consideration on appeal of the SEC’s final order.  In this post, I will examine the objection that the manner of hiring the SEC ALJs violates the Appointments Clause of Article II of the US Constitution and update the current state of the law as to this defense.

Though the SEC has repeatedly rejected this defense on the merits, and a panel of the D.C. Circuit affirmed the SEC, support for this defense is gaining momentum.  A split panel of the Tenth Circuit held that the SEC ALJs are unconstitutionally appointed and the D.C. Circuit has granted a request for an en banc re-hearing.

The US Constitution, art. II, § 2, cl. 2, states: The President “shall nominate, and by and with the Advice and Consent of the Senate, shall appoint … 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.”  The SEC concedes that when the Chairman acts together with the other four Commissioners, he or she is an Article II “Head of Department.”  Heads of Departments can and do appoint “inferior officers” to interpret policy and implement laws of the United States.  The issue is whether SEC ALJs function as “inferior officers” or just “employees” of the SEC?

To become an ALJ, an attorney must complete a four-hour written examination and submit to an oral exam before a panel made up of a member of the American Bar Association, a current federal ALJ, and a person from the federal Office of Personnel Management (“OPM”). OPM maintains a registry of qualified ALJ candidates.  At the SEC, there is a Chief ALJ and four other SEC ALJs.  The Chief ALJ heads the SEC’s Office of Administrative Law Judges (“OALJ”).  The OALJ selects a candidate on the OPM registry with input from the Chief SEC ALJ, the Department of Human Resources, and the OPM.  Section 78d-1(a) of the Exchange Act of 1934 gives the SEC authority to delegate to an ALJ or an employee any of its functions including “hearing, determining, ordering, certifying, reporting, or otherwise acting as to any work ….”

SEC ALJs are not appointed by the Chairman; they are hired by the OALJ from OPM. The SEC has ruled repeatedly that SEC ALJs are “employees” who do not have to be appointed.  As to other agencies, the Supreme Court has distinguished “employees” from “inferior officers” by whether the individual exercises “significant authority pursuant to the laws of the United States.” Buckley v. Valeo, 424 U.S. 1 (1976).  The Supreme Court has found Federal Election Commissioners and Special Trial Judges for the IRS are “inferior officers” who need to be appointed by a Head of Department.

In August 2016, the SEC’s position was affirmed by a three-judge panel of the D.C. Circuit in Raymond J. Lucia Companies, Inc., 832 F.3d 277 (D.C. Cir. 2016).  The judges reasoned that SEC ALJs are “employees” because the SEC has the right to review their decisions and no ALJ decision becomes final without the SEC issuing a finality order even if not appealed.  Unlike the IRS’ review of Special Trial Judges’ decisions, the SEC’s review is de novo.

But, in late December 2016, in a 2-1 decision, a panel of the Tenth Circuit expressly disagreed with the decision in Lucia.  In Bandimere v. SEC, 844 F.3d 1168 (10^th Cir. 2016), the majority held that SEC ALJs are “inferior officers,” reasoning the SEC ALJ’s lack of final decision-making authority was relevant but not determinative.  Since the SEC ALJs “exercise a great deal of discretion and perform important functions,” the majority concluded they are “inferior officers.” Just because the SEC supervises the ALJs through review of their decisions does not mean they are “employees.”  The majority also noted that there is no statutory language or legislative history expressly making ALJs “employees” for purposes of the Appointments Clause.  The SEC has been given to March 13, 2017, to petition for an en banc re-hearing before the entire Tenth Circuit.  Such petitions are granted only when there is an issue of “exceptional importance.”

The Appointments Clause issue was been presented to the US Supreme Court in a petition for a writ of certiorari filed on January 18, 2017, in Tilton v. SEC, 824 F.3d 276 (2d Cir. 2016), cert. filed, 2017 WL 281861.

In another case pending before the Tenth Circuit, the court provisionally granted petitioner’s motion to file a supplemental brief on whether Bandimere requires that an SEC final order be set aside even though the Appointments Clause defense had not been asserted before the ALJ or SEC. Malouf v. SEC, Docket No. 16-9546 (10^th Cir.).  Briefing is scheduled to be completed by March 20, 2017.

In the Lucia case, on February 16, 2017, the D.C. Circuit vacated the panel’s decision affirming the SEC and granted a petition for re-hearing en banc. Oral argument is set for May 24, 2017.

The momentum is clearly with the defense bar on the merits of the Appointments Clause issue, the first constitutionally-based affirmative defense to make it out of the SEC administrative morass.  This provides incentive to keep asserting the other constitutionally-based defenses in administrative proceedings.  In my next post, I will discuss constitutional objections to SEC ALJs arising from the civil service protections that insulate them from direct removal by the President and update the current state of the law as to this defense.