SEC’s Appointments of ALJs Held Unconstitutional

By Andrew Friedman

By a 7-2 vote in Lucia v. Securities and Exchange Commission, the U.S. Supreme Court held that the SEC’s cadre of administrative law judges (ALJs) are “inferior officers” who may be appointed by the President, the courts or heads of departments…but not SEC staff. The Commission has delegated ALJ appointments to its staff for years. The opinion could have major consequences for past decisions by improperly-appointed ALJs, not only at the SEC but across many federal agencies.

In Lucia, the SEC accused Raymond Lucia of violating the Investment Adviser’s Act in the way he promoted his “Buckets of Money” retirement savings strategy. The SEC claimed that Lucia misled potential investors. After a nine-day administrative hearing, the ALJ held that Lucia violated the Act, imposed $300,000 in civil penalties and barred Lucia from the investment industry for life. Lucia’s appeals to the SEC and the U.S. Circuit Court of Appeals for the District of Columbia were denied. Among other things, Lucia challenged the SEC’s procedure for appointing ALJs.

The Appointments Clause appears in Art. II, Section 2 of the U.S. Constitution. The relevant passages provide that the President:

“Shall nominate, and by and with the advice and consent of the Senate, shall appoint ambassadors, other public ministers and consuls, judges of the Supreme Court, and all other 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.”

Cabinet members, senior Justice Department officials and Art. III federal judges are all considered “officers of the United States” who require the approval of the Senate. The question presented in this case was whether the administrative law judges appointed by SEC staff are “inferior officers” who may only be appointed by in the specified manner; both sides agreed that SEC staff, and not the Commission itself, appointed the SEC administrative law judges.

The Court analyzed whether the Appointments Clause applies to SEC ALJs using the analytical framework developed in Freytag v. Commissioner, 501 U.S.. 868 (1991). ALJs hold a continuing appointment, or a “career” appointment. They also exercise significant discretion and carry out important functions such as receiving evidence or taking testimony, and they issue decisions with factual findings, legal conclusions and appropriate remedies. Because of this, the Court found the ALJs are “officers” subject to the Appointments Clause, and the SEC improperly delegated the authority to appoint those ALJs to staff members, rather than the Commission itself approving the appointments.  Consequently, Lucia will receive a re-hearing on the merits of the claims against him.

One interesting feature of this Supreme Court appeal was that the Trump administration changed positions and concluded that the SEC ALJs had not been properly appointed.  Another issue, which the Court did not directly address, was whether the SEC’s after-the-fact “ratification” of its ALJs could cure the defective appointments. However, footnote 6 suggests the prudent course of action would be to remand the case to a properly appointed ALJ: “The Commission has not suggested that it intends to assign Lucia’s case on remand to an ALJ whose claim to authority rests on the ratification order.”

The hard question raised by the Court’s opinion is how it will affect other ALJs throughout the federal government, not just the SEC, including years of opinions rendered by them. Because the Supreme Court did not specifically address this question, it will likely get answered as other litigants challenge administrative law judge decisions, both by the SEC and other agencies. According to the U.S. Office of Personnel Management (OPM), the United States has nearly 1,900 administrative law judges, the vast majority of whom work in the Social Security Administration. Other agencies that have at least ten ALJ appointments include the Department of Health and Human Services Office of Medicare Hearings and Appeals, the Department of Labor, the Federal Energy Regulatory Commission (FERC), the Federal Mine Safety and Health Review Commission (MSHA), the National Labor Relations Board (NLRB) and the Occupational Safety and Health Review Commission (OSHA).  At worst, the opinion in Lucia could trigger thousands of rehearing requests by litigants who were unhappy with the decision by an unconstitutionally appointed ALJ, and the scope of the rehearing requests could be massive.

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Andrew Friedman, Shulman Rogers’ Financial Regulatory and Compliance Practice

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