Messy Clouds and Inferior Officers—The SEC, ALJs and Order Maintained

SEC Seal 3

The Securities and Exchange Commission is an agency that tends to generate few headlines, and is also one that is not known for being particularly responsive to change in real time. In the last few days, however, the SEC found itself in the midst of a significant policy shift by the Justice Department in a key case that may be heard by the U.S. Supreme Court, and in less than a day, the Commission announced a fundamental change in the way it selects the judges that hear its administrative enforcement cases.

The controversy arose from challenges to the hiring process for the SEC’s administrative law judges (ALJs). According to the Commission, the ALJs are employees that could be hired through a merit-selection process administered by the Office of Personnel Management, with the final decision to be made by the SEC’s Chief ALJ. The court decisions come in the context of increasing criticism of the SEC’s administrative enforcement regime, where critics see the administrative proceedings as an unfair “home court” advantage for the Commission.

Several litigants in administrative actions have argued that these judges are inferior officers of the United States, rather than employees, because they carry out important functions and exercise significant authority under the securities laws. Under the Appointments Clause found in Article II, Section 2 of the constitution, such inferior officers must be appointed by “the President alone, in the Courts of Law, or in the Heads of Departments.” The SEC hiring procedure clearly does not comply with this provision.

Two circuit courts reached conflicting results on the constitutionality question based on the appointments clause. In Raymond J. Lucia Cos. v. SEC, the D.C. Circuit agreed with the SEC that its ALJs lacked the authority to bind the agency, and possessed only initial adjudicatory authority rather than the power to dispose of a case. Accordingly, they were employees and could not be considered “inferior officers” under the appointments clause. In a subsequent case, Bandimere v. SEC, the Tenth Circuit found that the judges were inferior officers, and that both the D.C. Circuit and the SEC erred in relying on the lack of ALJ authority to enter final decisions. While the authority to enter final and binding decisions may have been a relevant factor, noted the Tenth Circuit, the key determinant was whether the official exercised significant discretion in performing “important functions.”  

Lawyers filed a petition for Supreme Court review in the Lucia case in July. The case took an unusual turn in late November when U.S. Solicitor General Noel J. Francisco reversed course and announced in a filing with the Supreme Court that the government would no longer defend the constitutionality of the SEC’s ALJ hiring process. Solicitor General Francisco urged the high court to grant the petition and to conclude that SEC ALJs were in fact inferior officers of the United States. The solicitor general emphasized the limited ability to remove ALJs from their positions, the constitutional infirmity noted by the Supreme Court in the Public Company Accounting Oversight Board case. In the SEC case, the solicitor general stated that “the statutory scheme provides for at least two, and potentially three, levels of protection against presidential removal authority” for the administrative law judges.

As noted above, the SEC may not be the most nimble of agencies when reacting to challenges. Columbia University Law Professor John C. Coffee Jr., compared the Commission to the Vatican, with a bureaucracy that often moved at the pace of the Roman Curia when it came to fundamental changes. The Commission surprised many Nov. 30, however, when less than a day after the Justice Department pulled the government’s support for the ALJ process, it issued an order designed “to put to rest any claim that administrative proceedings pending before, or presided over by, Commission administrative law judges violate the Appointments Clause.”

The order implemented much of what Professor Coffee has long advocated. He has urged the SEC to reappoint all current ALJs, and then after the reappointment, the judges could reconfirm all prior rulings in pending cases without any new hearings. For future hires, he recommended that the SEC could also maintain the Chief ALJ’s role in the process by having the chief judge make recommendations for Commission consideration.

The current order does not deal with hiring going forward, but does provide for the ratification of the SEC’s prior appointment of all current ALJs. In addition, in all actions before an ALJ in which the judge has not yet reached an initial decision, the ALJ must:

  • reconsider the entire record, including all substantive and procedural actions taken;
  • grant parties until January 5, 2018, to submit any new evidence relevant to the reexamination of the record;
  • determine, based on the reconsideration, whether to ratify or revise any prior actions taken in the proceeding; and
  • issue an order by February 16, 2018 stating that the ALJ has completed the reconsideration and setting forth a determination regarding ratification.

For cases appealed to the SEC, the matters are remanded to the ALJ that handled the matter initially. The ALJ will handle the matter as described above for pending cases before ALJs.

Professor Coffee told Bloomberg Law that the SEC is acting to obtain the maximum degree of certainty and predictability from its order to deal with the solicitor general’s action. He noted that the Commission wants to avoid constitutional contests and “messy clouds” over its jurisdiction.

The SEC ratification order does not necessarily render the Lucia request for Supreme Court review moot. One question involves the personal fate of Raymond Lucia. The action by the SEC has, however, essentially stripped the class of interested persons down from all persons with cases pending before ALJs or on appeal to the SEC to—Raymond Lucia. His case may not be moot as a matter of law, but it has become significantly less interesting to a court with very limited space on its docket.

Another one of Professor Coffee’s “messy clouds” could be the question of retroactivity. Could respondents in closed cases, who paid penalties or who were barred from the industry, claim that their constitutional rights were violated by improperly appointed hearing officers and sue for damages based on a favorable high court holding in Lucia? According to Kent Barnett, Associate Professor at the University of Georgia School of Law, the answer is no. Professor Barnett told Bloomberg Law that the SEC order logically divides administrative enforcement actions into three categories by time. The first two, cases pending before ALJs and ALJ initial decisions on appeal to the Commission, are subject to the remedial measures described above.

The third group of cases are by far the largest group, those that have been decided against the respondents and closed, with any applicable appeal periods expired. According to Professor Barnett, no matter what happens before the high court in Lucia, these cases will in all likelihood remain closed.

In conclusion, the SEC appears to have acted effectively in dealing with the immediate aspects of the ALJ hiring issue. While some aspects of the matter, such as subsequent hiring practices, will have to be resolved by future rulemaking, the Commission’s order effectively blunted the possibility of a bureaucratic nightmare resulting from an adverse Supreme Court ruling. It is true that the SEC is one of the government’s oldest agencies, and it often shows it age, but over a 24-hour period, in dealing with a potential ALJ crisis, the Commission has looked positively sprightly.