The Defense Bar’s New Toy: Appointments Clause Challenge to SEC ALJs Prevails


SEC HQ4The recent decision by the U.S. Tenth Circuit Court of Appeals in Bandimere v. SEC called the constitutionality of the SEC’s system of in-house tribunals into question. The appellate panel determined that SEC administrative law judges carry out “important functions” and exercise “significant authority pursuant to the laws of the United States,” and are therefore “inferior officers” of the United States. Under the Appointments Clause, these officers must be appointed by the president, a federal court or a department head.

Clearly, the selection process for SEC ALJs does not meet this constitutional requirement. Under the Administrative Procedure Act (APA), agencies hire ALJs through a merit-selection process administered by the Office of Personnel Management (OPM), and ALJs fall under civil service requirements and protections. OPM administers an examination and presents the top three candidates to the SEC for review. The SEC's Chief ALJ then hires from the top three candidates subject to the approval and processing by the SEC's Office of Human Resources.

The SEC convincingly argued that their administrative judges lack the authority to bind the agency, and possess only initial adjudicatory authority. The SEC described how no ALJ decision can become final without Commission action, and asserted that the inability of ALJs to enter final binding judgments meant that they could not be considered “inferior officers.” The Tenth Circuit panel emphatically rejected the SEC claim.

The decision sets up a split between the circuits. In August 2016, the District of Columbia Circuit stressed the importance of the inability of ALJs to enter final decisions in Raymond J. Lucia Cos. v. SEC. According to the court:

the Commission's ALJs neither have been delegated sovereign authority to act independently of the Commission nor, by other means established by Congress, do they have the power to bind third parties, or the government itself, for the public benefit. The Commission's right of discretionary review and adoption of its regulatory scheme for delegation ensure that the politically accountable Commissioners have determined that an ALJ's initial decision is to be the final action of the Commission (internal citations omitted).

According to the Tenth Circuit, both the D.C. Circuit and the SEC erred in relying on the lack of ALJ authority to enter final decisions. The court recognized that the authority to enter final and binding decisions is relevant in determining whether a public servant is an inferior officer, but concluded that the relevance of this factor “does not mean every inferior officer must possess final decision-making power.” It is sufficient for the administrative personnel to exercise significant discretion in performing “important functions.” The court listed several ways in which ALJs may discretionarily influence the course of administrative enforcement proceedings. The most significant is the authority to make findings of fact and impose sanctions in initial decisions. In the appellate panel’s view, ALJs may also influence these cases by:

  • eliciting testimony;
  • regulating document production and depositions;
  • ruling on the admissibility of evidence;
  • receiving evidence;
  • ruling on dispositive and procedural motions;
  • issuing subpoenas;
  • presiding over trial-like hearings; making credibility determinations; and
  • holding and requiring attendance at settlement conferences.

The Tenth Circuit also rejected the SEC’s assertion that the court should defer to the will of Congress as expressed in the APA selection process. According to the SEC, the “limited authority vested in ALJs reflects Congress’s choices in determining the relative role of such adjudicative personnel as opposed to politically accountable agency officials. In establishing merit selection and civil service protections, Congress sought to ensure that hearing examiners would not “be paid, promoted, or discharged at the whim or caprice of the agency or for political reasons.” The SEC concluded that Congress did not elevate the status of ALJs within their agencies to that of officers of the United States by providing them with a measure of independence.

The Tenth Circuit stated that the SEC overplayed their hand in its congressional deference argument. Nowhere in the legislative record was there a discussion of the Appointments Clause or a specific congressional determination that ALJs should be classified as employees. "However 'carefully devised' the ALJ system may be generally and the SEC ALJ program particularly, that should not excuse failure to comply with the Appointments Clause," stated the court.

Although not cited by the Tenth Circuit majority, a 2007 Justice Department memorandum appears to support the court’s conclusion on congressional deference. A Memorandum Opinion for the General Counsels of the Executive Branch stated that “it is not within Congress’s power to exempt federal instrumentalities from the Constitution’s structural requirements, such as the Appointments Clause ... the 'methods of appointment' the Appointments Clause specifies 'are exclusive.'”

The court’s decision comes in the context of increasing criticism of the SEC’s administrative enforcement regime. Critics see the administrative proceedings as an unfair “home court” advantage for the Commission. The existence of a friendly home court can be hard to dispute when the Enforcement Division regularly racks up a higher winning percentage in its ALJ cases than did Michael Jordan and the Chicago Bulls in 1996. The agency has increased its usage of administrative actions since the enactment of the Dodd-Frank Act, which expanded the authority of the SEC to obtain civil penalties against parties other than regulated securities industry entities.

On the surface, there is a relatively easy fix to the problem. The SEC can still comply with both the APA merit selection process and the Appointments Clause by having the Commissioners, rather than the Chief ALJ, make the hiring decisions. It would not impose a burden on the SEC’s time, given that the agency only employs five ALJs (unlike the Social Security Administration, with more than a thousand). Lurking beneath that surface, though, is the impact of a decision by the SEC to re-appoint its ALJs. The defense bar would likely see this as a tacit admission that the ALJ regime was constitutionally flawed. While it could be a boon to defense lawyers, and would provide a wealth of story subjects for securities bloggers, the possibility of challenges to hundreds of ALJ verdicts would be a logistical nightmare for the SEC.

The Tenth Circuit carefully tiptoed around the questions of retroactive impact and the constitutional infirmities of ALJs in other agencies. As the court stated:

We recognize that our holding potentially implicates other questions. But no other issues have been presented to us here, and we therefore cannot address them. Nothing in this opinion should be read to answer any but the precise question before this court: whether SEC ALJs are employees or inferior officers. Questions about officer removal, officer status of other agencies' ALJs, civil service protection, rulemaking, and retroactivity … are not issues on appeal and have not been briefed by the parties. Having answered the question before us, and thus resolved Mr. Bandimere's petition, we must leave for another day any other putative consequences of that conclusion.