In my second post on constitutionally-based affirmative defenses to SEC administrative proceedings, I discussed the shift of momentum in favor of the defense that the process of hiring SEC ALJs violates the Appointments Clause of the U.S. Constitution. This post examines the defense that the process of removing SEC ALJs violates the separation of power doctrine in the Constitution.

The U.S. Constitution, art. II, § 1, cl. 1, provides that “[t]he executive Power shall be vested in a President of the United States of America.” Article II, § 3, states the President “shall take Care that the Laws be faithfully executed ….”  The Constitution requires that a President elected by the People oversee the execution of the laws of the United States.  The Constitution nowhere addresses the power to remove, but it is derived from the power of appointment.  The President’s power to remove Heads of Departments such as the SEC Commissioners ensures that laws are executed in accordance with the President’s policies.  Even though Heads of Departments cannot be removed except for cause, this limitation was held constitutional because the President directly decides if cause exists for removal. Humphrey’s Executor v. United States, 295 U.S. 602 (1935).

Unlike SEC Commissioners appointed by and accountable to the President, SEC ALJs are hired by the Chief SEC ALJ and the Office of Administrative Law Judges (“OALJ”) from a register maintained by the Office of Personnel Management (“OPM”). SEC ALJs receive a career appointment without an initial period of probation and their salaries are set by statute.  They cannot be removed at-will by the President or even by the SEC.  They can only be removed “for cause” after a hearing before the Merit Systems Protection Board (“MSPB”).

The separation/removal defense asserts that the ALJs’ multiple-layer protections against removal violates the separation of power doctrine by placing impermissible limitations on the President’s power to see that the securities laws are faithfully executed. These protections are an aggrandizement of the Legislature, which authorized the delegation of adjudicating violations of the securities laws to the SEC ALJs, at the expense of the President’s Executive power.  Multiple layers of tenure insulate ALJs from direct Presidential control.  An ALJ cannot be removed by the SEC except for cause and the President cannot remove a Commissioner except for inefficiency, neglect of duty, or malfeasance in office.  The Commissioners are accountable, therefore, only for their decision to determine whether good cause to remove the ALJ exists.  The President can no longer hold the Commission fully accountable.

In Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. 477 (2010), the Supreme Court held that the creation by the Sarbanes-Oxley Act of 2002 (“SOX”) of a Board within the SEC to oversee accounting firms contravened the separation of power doctrine by conferring executive power on Board members without subjecting them to Presidential control.  Board members could be removed only for good cause by the Commission and the Commissioners could be removed by the President only for good cause.  Chief Judge Roberts wrote, this “second level of tenure protection changes the President’s review.  …  The President … cannot hold the Commission fully accountable for the Board’s conduct, to the same extent that he may hold the Commission accountable for everything else that it does.  …  That arrangement is contrary to Article II’s vesting of the executive power in the President.” Id. at 496.

Respondents in SEC administrative proceedings recognized Free Enterprise’s potential application to the multiple-layers of an SEC ALJ’s tenure and asserted the separation/removal defense in answers to administrative complaints.  The ALJs ruled they do not have authority to decide the issue.  The SEC ruled the defense lacks merit. In re Timbervest, 2015 WL 5472520 (SEC Sept. 17, 2015).  But, history shows that ALJs may be used willingly or unwillingly by the agency to which they are assigned to further a particular political agenda or policy of enforcement—exactly the responsibility the Constitution assigns to the President.  For instance, “a former SEC ALJ stated that she was pressured to rule in favor of the SEC and that Chief Judge Murray questioned her loyalty to the SEC because the former ALJ found in favor of defendants too often.  The former ALJ also alleged that the SEC instructed her to work under the presumption that defendants were guilty until proven innocent.” Timbervest v. SEC, 2015 WL 7587428, at *4 (Aug. 4, 2015).  This is not an isolated occurrence.  A similar brouhaha was widely reported in connection with CFTC ALJs when shortly before he retired one ALJ publicly accused another ALJ of having promised that he would never find in favor of customers.  “Notice and Order” (Sept. 17, 2010)  The Wall Street Journal then published an article accusing the retiring ALJ of mental unfitness and heavy drinking.  Lynch, “Case Sheds Light on Judge” WSJ (Oct. 21, 2010)

Rejection of the separation/removal defense by the SEC was countered by the defense bar filing collateral suits in federal court to enjoin SEC administrative proceedings, alleging that the multi-level protection of ALJs violated the doctrine of separation of power. Most collateral cases were dismissed for lack of jurisdiction without reaching the merits of this defense.  Those courts that held there was jurisdiction ruled favorably on the Appointments Clause defense—not the separation/removal defense.  The petition for certiorari pending in Tilton v. SEC, 824 F.3d 276, 298 (2d Cir. 2016), pet. for cert. filed 2017 WL 281861 (Jan. 18, 2017), raises only the jurisdictional issue and the Appointment Clause defense.  Similarly, none of the cases pending before the D.C. and Tenth Circuits presents the removal/separation of powers defense.  Accordingly, it is fair to say that there is no binding decision anywhere in favor of or against the merits of the separation/removal defense and no court is expected to rule on the issue soon.

Despite the futility of receiving a real hearing on the separation/removal defense at the SEC, respondents should continue asserting the defense in administrative hearings to set up a direct challenge of an SEC final order to the Court of Appeals on this issue. Respondents should be emboldened by the upswing of support for the Appointments Clause defense because the first hurdle to overcome on the separation/removal defense is to establish that SEC ALJs are “inferior officers.”  But, respondents must then argue that Free Enterprise’s separation of power holding applies to SEC ALJs.  Arguably, Free Enterprise is distinguishable in at least two significant respects: First, the accounting oversight Board had more authority than do ALJs.  Not only were the Board’s decisions not reviewable by the SEC, but the Board could initiate investigations unlike ALJs.  Second, ALJs have been around at many federal agencies since the 1940s when the Administrative Procedures Act became law; whereas, the Board was a recent creation of SOX in 2002 whose constitutionality had never been tested.  Even Judge May, who took the lead in finding that the Appointments Clause defense was likely to succeed on the merits, Hill v. SEC, 114 F. Supp. 3d 1297 (N.D. Ga. 2015), expressed doubts whether the separation/removal defense would be successful. In re Timbervest, 2015 WL 7597428, at *11 n.10 (N.D. Ga. Aug. 4, 2015).  These differences do not really negate the serious constitutional infirmity presented by multiple layers of tenure that troubled the Supreme Court in Free Enterprise, however.  They relate more to whether SEC ALJs are “inferior officers” than to whether the ALJs are directly controlled by the President or vulnerable to improper agency interference.  Accordingly, respondents should not lose heart.  The success of the separation/removal success is still very much an open issue.

In my fourth post, I will examine the defenses of whether the SEC’s “unguided discretion” under Dodd-Frank to file a case before an ALJ rather than in federal district court violates the Fifth Amendment equal protection and due process, and/or the Seventh Amendment right to a jury trial.