August 8, 2018

Supreme Court Addresses Hiring of SEC Administrative Law Judges

August 8, 2018

Earlier this summer, the U.S. Supreme Court ruled that the SEC used unconstitutional methods to hire Administrative Law Judges.

In a highly anticipated decision, the U.S. Supreme Court ruled in Lucia v. SEC, 138 S. Ct. 2044 (2018), that the Administrative Law Judges (“ALJs”) of the Securities and Exchange Commission (“SEC”) are inferior Officers of the United States subject to the Appointments Clause of the U.S. Constitution.  As a result, only the President alone, the Courts of Law, and the Heads of Departments may appoint SEC ALJs. See U.S. Const. art. 2, § 2, cl. 2.  Previously, the SEC hired ALJs from a pool of candidates vetted by the Office of Personnel Management. In response to this decision, the SEC stayed all hearings before ALJs for one month.

Case Background

This decision arose out of SEC ALJ Cameron Elliot’s ruling that Raymond J. Lucia, Sr. and Raymond J. Lucia Companies, Inc. (collectively, “Lucia”) violated the Investment Advisers Act when they deceived prospective investors by presenting them with a misleading slideshow presentation marketing their “Buckets of Money” trading strategy.  To sanction Lucia, Judge Elliot imposed a $300,000 fine and a lifetime ban from the investment industry.

On appeal to the SEC, Lucia argued to the Commission that Judge Elliot’s ruling was invalid because Judge Elliot had not been constitutionally appointed.  Lucia argued that SEC ALJs are “Officers of the United States” and must therefore, in keeping with the U.S. Constitution, be appointed by either the President, Courts of Law, or Heads of Departments.  Like all SEC Administrative Law Judges, Judge Elliot was hired by the SEC Staff, not appointed by the Commission. The Commission rejected this argument and upheld the decision of Judge Elliot.  Lucia’s appeal to the U.S. Court of Appeals for the D.C. Circuit was similarly unsuccessful.

“Mere Employees” v. Officers

The Appointments Clause sets forth the mandatory procedures to appoint Officers of the United States. First, the President must nominate and the Senate must advise and consent to the nomination of “principal” or “superior” officers, such as Ambassadors, Supreme Court Justices, and Secretaries of Executive Branch Departments. Second, Congress may vest the appointment of inferior Officers in the President alone, in the Courts of Law, or in the Heads of Departments.  In Lucia, all parties agreed that ALJs are not principal officers.  Thus, the Supreme Court’s decision focused on whether ALJs were inferior Officers or “mere employees.”

“Mere employees” constitute the “broad swath of ‘lesser functionaries’ in the Government’s workforce” and the Appointments Clause “cares not a whit about who named them.” Lucia v. SEC, 138 S. Ct. at 2051.  These employees’ duties are occasional and temporary, rather than continuing and permanent.  In contrast, “inferior Officers” are individuals who occupy a continuing position established by law and “exercis[e] significant authority pursuant to the laws of the United States.”  Buckley v. Valeo, 424 U.S. 1, 126 (1976).

Comparison to Freytag

While both the Government and the amicus curiae that was appointed to defend the lower judgment urged the Supreme Court to expand on the Buckley “significant authority test,” the Court declined and instead extended its analysis of U.S. Tax Court Special Trial Judges (“STJs”) from Freytag v. Commissioner, 501 U.S. 868 (1991), to SEC ALJs.  Lucia, 138 S. Ct. at 2015-53.  First, the Supreme Court found that ALJs hold a continuing office established by law.  Id. at 2053.  Second, the Court ruled that ALJs exercise significant discretion when carrying out their important functions.  Id.  

This discretion was similar to, if not, greater than, the discretion of STJs whom the Court deemed Officers in Freytag.  ALJs, like STJs, take testimony, receive evidence and examine witnesses, take pre-hearing depositions, regulate the course of the hearing and the conduct of the parties and counsel, and rule on the admissibility of evidence.  Thus, ALJs critically shape the administrative record. ALJs also have the power to enforce compliance with discovery orders. Thus, ALJs have duties and powers similar to STJs in conducting adversarial proceedings.

At the end of this process, ALJs issue “initial decisions” wherein the ALJ recounts his or her findings of facts, presents legal conclusions, and recommends a remedy.  STJs similarly prepare findings of fact, present opinions, and assess tax liabilities. However, the Court found that ALJs possess potentially more independent power than STJs.  Id. at 2053-54.  In major cases, the STJ opinion’s must be reviewed by a regular Tax Court judge.  An ALJ’s initial decisions, in contrast, either are reviewed by the SEC or, if the SEC decides not to review the decisions, become final and are deemed actions of the Commission.  The Court thus concluded that if STJs were Officers, ALJs must be Officers as well. Id. at 2054.

And so the Court held SEC Administrative Law Judges to be inferior “Officers of the United States.”  Id. at 2055.  It therefore remanded the case to a new hearing before a properly appointed official.  Id.  That properly appointed official, however, cannot be Judge Elliot.  Id.

The ALJ Controversy

Conservative think-tanks have long chided Administrative Proceedings and the power of ALJs as a part of the so-called “administrative state.” See generally Ronald Pestritto, The Birth of the Administrative State: Where It Came From and What It Means for Limited Government, The Constitution, No. 16, The Heritage Foundation (Nov. 20, 2007); Philip Wallach, et al., Farewell to the Administrative State?, Cato Unbound, The Cato Institute, May 2016.  The “administrative state,” they argue, arose during the New Deal when Congress delegated to executive branch agencies the power to make and enforce rules and the authority to conduct Administrative Proceedings.  Pestritto, supra.  

The Dodd-Frank Wall Street Reform and Consumer Protection Act further aggravated the critics of administrative proceedings because the law expanded the powers of the SEC ALJs to impose civil penalties on non-registered entities and individuals. See Stephen J. Choi & A.C. Pritchard, The SEC’s Shift to Administrative Proceedings: An Empirical Assessment, 34 Yale J. Reg. 1, 3-4 (2017). Critics of the use of ALJs contend that this system gives the SEC a “home-court advantage” when enforcing its owns rules. On the other hand, the SEC argues this process results in judges with a sophisticated understanding of the securities laws and a speedier adjudicatory process.  

Interested parties on both sides of the political spectrum saw this case as an opportunity to either destroy or legitimize Administrative Proceedings.  Conservatives hoped the Court would rule that Judge Elliot was an “Officer of the Unites States,” and thus subject to the Appointments Clause. Further, they hoped that the Court would hold that Judge Elliot could be removed by the SEC Commission for any cause.  Progressives, concerned that termination at will would make the Administrative Proceedings process overly political, hoped the Court would find that Judge Elliot was a “mere employee” and could only be removed for good cause established by the Merit Systems Protection Board.  

The U.S. Solicitor General, however, wanted the Court to rule that ALJs, as inferior Officers, could be fired by agency chiefs.  If the President did not approve of the actions of an ALJ, the President could ask the head of the agency to fire the ALJ. If the head of the agency failed to act, the President could fire that person and appoint someone that would act on the President’s wishes.  

The power to fire ALJs became controversial because if the President could indirectly remove ALJs, the President would also be able to remove Robert Mueller, the special counsel heading the investigation into Russian election meddling.  If Mueller is held to be an Officer of the United States, and if the Court ruled that agency heads could fire inferior Officers for any reason, the President could direct Acting Attorney General Rod Rosenstein to fire Special Counsel Mueller without establishing good cause.

Executive Power Over SEC Administrative Law Judges

However, Justice Elena Kagan’s narrow opinion did not create the ripple effect many had hoped.  The Court only addressed the hiring of ALJs, not their removal, because petitioner Raymond Lucia did not mention the removal power in his appeal.  Since the opinion only addressed the appointment of ALJs, the ruling did little to dismantle the “administrative state.”  Despite that fact that Justice Kagan repeatedly stated the Court was not addressing the removal power, the Trump Administration released an Executive Order on July 13, 2018 exempting ALJs from the previously used hiring process and exempting ALJs from the previous removal procedures.  Thus, the Trump Administration took the position that it can fire ALJs for any cause, even though the Court did not address that issue.  

While this opinion did little to dismantle the “administrative state,” it did set the stage for a future battle over executive agencies’ use of administrative proceedings and the executive’s power and control over administrative law judges.  If conservatives really want to dismantle the administrative state, however, they will need the Court to address much more than the hiring of ALJs.

Article by Emily Hayes

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