Supreme Court Rules Against SEC in ALJ Appointments Case

Background

 Lucia began as an SEC administrative enforcement action against Raymond Lucia. The Commission alleged that Lucia made misstatements to potential clients about his “Buckets of Money” retirement savings strategy. The case was assigned to an SEC ALJ who concluded that Lucia had violated the anti-fraud provisions of the Investment Advisers Act of 1940. Lucia appealed to the SEC, arguing, in part, that the ALJ appointment was unconstitutional because he had been selected by Commission staff, rather than by the Commission. The Commission concluded, however, that SEC ALJs are not “officers,” but instead are “mere employees” whose selection is not regulated by the Appointments Clause. Lucia appealed once more, but the D.C. Circuit agreed with the Commission that SEC ALJs are “employees” rather than “officers.” While Lucia’s case was pending before the D.C. Circuit, the Tenth Circuit held in another case that SEC ALJs are indeed “officers.” The Supreme Court granted the petition in Lucia to resolve the conflict. 

Ruling

The Court, in an opinion written by Justice Kagan and joined by five other justices, held that SEC ALJs are “officers.” According to the Court, that result followed directly from the Supreme Court’s holding in Freytag v. Commissioner, 501 U. S. 868 (1991). In Freytag, the Court held that special trial judges of the U.S. Tax Court were “officers” under the Appointments Clause because they (1) held a “continuing office established by law,” and (2) exercised “significant discretion” in wielding authority that resembles the powers of “federal trial judges,” including the power to “take testimony,” “shape the administrative record,” and “enforce compliance with discovery orders.” Here, the Court noted that SEC ALJs clearly hold “continuing office” because they have career appointments. Moreover, they have the same judge-like powers described in Freytag, plus an additional one — authority to issue final decisions for the Commission. For the Court, that made the case simple: “If the [special trial judges] are officers, as Freytag held, then the Commission’s ALJs must be too.” 

The Court also held that Lucia was entitled to relief, having timely contested the ALJ’s appointment in his appeal to the Commission. To remedy the constitutional violation, the Court vacated the Commission’s ruling and sent the case back to the SEC for a new proceeding before either the Commission or a properly appointed new ALJ, reasoning that the ALJ who presided over the original administrative proceeding “cannot be expected to consider the matter as though he had not adjudicated it before.”¹

Lucia Highlights Significant Open Questions About Agency Structure

Although Lucia definitely resolves the question of whether SEC ALJs must be appointed pursuant to the Appointments Clause, the Court’s ruling raises a number of other questions. 

At the Commission, a primary issue that will likely have an immediate effect on the Commission’s enforcement activity is whether there are any ALJs who have been properly appointed. In November 2017, the Commission issued an order that purported to ratify the ALJ selections that Lucia and others had challenged as unconstitutional. The Court expressly declined to rule on the validity of that ratification order, thus leaving open whether the Commission must take further steps to cure the constitutional problem identified in Lucia. Quickly recognizing the risk of ongoing challenges to ALJ appointments, the Commission immediately entered an order staying “any pending administrative proceeding initiated by an order instituting proceedings that commenced the proceeding and set it for hearing before an administrative law judge, including any such proceeding currently pending before the Commission.”² It remains to be seen whether the SEC will conclude that it must reassign all currently pending contested administrative proceedings to new ALJs, and restart those proceedings from initiation, in light of the remedy imposed in Lucia. The Court’s decision should not affect settled Commission actions, however, which do not typically involve ALJs.

Respondents (or potential respondents) in SEC administrative proceedings before ALJs should carefully monitor what the SEC does and evaluate whether to raise challenges to ALJ appointments. Further, the potential implications of Lucia go far beyond the SEC’s near-term efforts to reset its administrative enforcement proceedings. Two issues warrant particular attention.

The first issue is how Lucia may apply to hearing officials in agencies other than the SEC. Under the approach followed by the Court in Lucia, the “officer” determination will likely turn on the particular powers held by the adjudicator. That said, Lucia declined to set out any general test for determining whether a federal official is an “Officer,” and separate opinions by Justices Thomas and Breyer set out widely differing conceptions. Justice Thomas, in particular, contended that “all federal civil officials who perform an ongoing, statutory duty—no matter how important or significant the duty”— are “Officers.” If that standard was adopted, the result would sweep far beyond ALJs and hearing officers, and would dramatically expand the range of federal officials, of all stripes, whose manner of selection is governed by the Appointments Clause.

The second issue, principally relevant to the SEC and other “independent” agencies whose heads enjoy statutory protection from removal by the President, is how Lucia will intersect with the Supreme Court’s decision in Free Enterprise Fund v. Public Company Accounting Oversight Bd., 561 U. S. 477 (2010). In Free Enterprise Fund, the Court invalidated a statute that insulated members of the Board from removal, reasoning that “inferior officers” within an independent agency cannot be tenure-protected, because a double layer of insulation would too greatly interfere with the President’s authority to oversee the Executive Branch. After Lucia, a similar issue looms for the SEC. The SECs ALJs have now been held to be “officers” who sit within an independent agency and, by statute, may only be removed “for good cause established and determined by the Merit Systems Protection Board.” Moreover, members of the Board may only be removed by the President for “inefficiency, neglect of duty, or malfeasance in office.” Noting this issue, the Solicitor General argued in Lucia that the provision allowing ALJs to be removed only for “good cause” found by the Merit Systems Protection Board presents serious constitutional difficulties that can be addressed only by reading the statute to shift a greater share of the removal authority to the Commission. 

The Court declined to reach the issue, stating in a footnote that the lower courts should address the issue first. Justice Breyer’s separate opinion devotes significant attention to this issue, including by positing several reasons why the rule of Free Enterprise Fund may not apply to SEC ALJs. It is fair to expect that parties will soon take up the Court’s invitation to challenge the validity of these and other statutory removal restrictions. Litigants before the SEC or other similar agencies will need to consider whether to raise this additional separation of powers issue, as highlighted by the Solicitor General and left open by the Court’s Lucia opinion.

¹The Court suggested that this remedy might not be required in circumstances where a substitute decision-maker was unavailable to hear the case.

²Order, In re Pending Administrative Proceedings, Rel. No. 33-10510 (June 21, 2018).