United States: Supreme Court Rules SEC Staff Picked Administrative Law Judges Were Unconstitutionally Appointed

This guest post was authored by Daniel Baker, a summer associate with Montgomery McCracken.

On June 21, 2018, the United States Supreme Court answered a seemingly straightforward question in Lucia v. SEC: whether the SEC's in-house administrative law judges are "officers," or "employees." Distinguishing between the two categories is important because "officers" must be appointed through specific procedures set forth under the Constitution's Article II Appointment Clause. Under this clause, individuals who are deemed to be "officers" must be appointed by the President, the courts, or head of their respective department. Such procedures do not apply if ALJs are deemed "employees," however, allowing for a less stringent selection procedure defined by Congress. The Supreme Court ruled the SEC ALJs are officers, meaning they were unconstitutionally appointed by SEC staff members.

The SEC charged Raymond Lucia, a financial advisor, for using misleading slideshow presentations to deceive potential clients, a violation of the Investment Advisers Act. The SEC instituted an administrative proceeding and assigned the matter to an ALJ. The ALJ found Lucia guilty of violating the Act and imposed a $300,000 fine, along with a lifetime ban from the investment industry. On appeal to the SEC's Commissioners, Lucia argued that the administrative proceeding was unconstitutional because the ALJ was an "officer" who must be appointed under the Appointment Clause. In support of his argument, Lucia stated that because the ALJ was appointed by SEC staff members, he lacked constitutional authority to impose the sentence. SEC Commissioners rejected Lucia's argument, holding that ALJs are "mere employees" and thus, do not need to follow Appointment Clause procedures. Lucia appealed to the D.C. Circuit, which affirmed. After rehearing en banc, the D.C. Circuit split 5-5, resulting in a per curiam order denying Lucia's claim and creating a circuit split with the Tenth Circuit.

In a 7-2 decision, the Supreme Court held that SEC ALJs are officers, and therefore must be appointed under the Appointment Clause. Prior to the Court's ruling, both parties agreed that if an SEC ALJ was appointed by the SEC's Commissioners, a group of five individuals appointed by the President with the advice and consent of Congress, then there would be no dispute, as the Commissioners qualify as a "head of department" for appointment purposes. Nevertheless, since the SEC ALJ in question was appointed by SEC staff through a merit-based civil service system, and not by SEC Commissioners, the appointment was deemed to be unconstitutional.

The Court's holding relies significantly on the reasoning in Freytag v. Commissioner, 501 U.S. 868 (1991). In Freytag, the Court held "special trial judges" in the Tax Court are officers, not mere employees. Special trial judges held ongoing positions defined by the Tax Code. The special trial judges could hear and rule on "comparatively narrow and minor matters" but could only prepare proposed findings on "major matters." The Court focused on the significance of the duties and discretion the special trial judges possessed such as taking testimony, conducting trials, ruling on the admissibility of evidence, and enforcing compliance with discovery orders. The Court held that these duties and discretion of the special trial orders were significant enough to render them officers, despite not all of their decisions being final.

The Supreme Court used the same reasoning in Lucia. The Court noted SEC ALJs hold ongoing positions as defined by statute. Similar to Freytag, the Court highlighted the fact that SEC ALJs take testimony, examine witnesses, take pre-hearing depositions, conduct trials, administer oaths, rule on motions, regulate the course of a hearing, rule on the admissibility of evidence, and have the power to enforce compliance with discovery orders. The Court found that SEC ALJs exercised the same discretion and carried out the same functions as the special trial judges in Freytag. Notably, in Freytag, a Tax Court judge had to review a special trial judge's opinion in major matters, whereas the SEC could simply decide not to review an ALJ decision at all, making the ALJ decision final. Therefore, the Supreme Court held that if special trial judges are officers under Freytag, then SEC ALJs must be officers as well. Because Elliot was not properly appointed as an officer under the Appointment Clause, the Supreme Court held Lucia is entitled to a new hearing, but swiftly sidestepped the question regarding the legality of statutory protections on ALJ removal, leaving the question for another day.

It is unclear how the holding will affect settled cases, the cases currently before the SEC, or the dozens of cases currently up for appeal in federal courts. Equally unclear, is whether this holding will extend beyond SEC ALJs to invalidate appointments of all ALJs across the executive branch, with the largest amount of ALJs sitting in the Social Security Administration. Without any clear limiting language, the opinion appears to open challenges to other ALJs who exercise similar authority and discretion to the SEC ALJs and special trial judges in Tax Court.

The Lucia holding does, however, provide a victory for the U.S. Chamber of Commerce, which backed Lucia's position that the SEC ALJs were officers who must be appointed through the Appointment Clause. The SEC's in-house appointment of ALJs was a non-starter until the 2010 adoption of Dodd-Frank, when the SEC began using SEC ALJs more frequently, and for a broader range of defendants. In an amicus brief, the Chamber of Commerce provided evidence that the SEC wins at a higher rate before ALJs than in civil actions in federal district courts. For example, between October 2010 and March 2015, the SEC won 90% of the cases it brought before ALJs, a 21% higher success rate than the 69% of cases won before district court judges. Even more telling, the particular ALJ in Lucia's case did not rule against the SEC a single time in his first 50 cases.

The Supreme Court's holding may be viewed as a victory for upholding constitutional procedures, and making administrative judges more accountable to the SEC's Commissioners. The most immediate impact will be the SEC's change in appointment method for its ALJs. The SEC must now appoint its ALJs through its five Commissioners, who constitute the head of the department, to comport with the Appointment Clause. This is a move the SEC had started to make even before the Court rendered its decision on Friday.

In sum, the Supreme Court changed the SEC's method for selecting referees, and only time will tell how these changes affect the ultimate score of the game.

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