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News March 13, 2017 Issue

Appellate Ruling Increases Chances SEC Use of ALJs Will Go to Supreme Court

Not only do the U.S. Courts of Appeals for the 2nd Circuit and the 10th Circuit disagree on the issue of whether SEC use of administrative law judges is constitutional, the 2nd Circuit will now look into a past ruling of its own three-judge panel on the same question in a review scheduled for May 24. It’s increasingly looking like the U.S. Supreme Court will provide the final answer.

The latest development occurred when the U.S. Court of Appeals for the District of Columbia (the 2nd Circuit) ruled last month to review, en banc – by the full court – the August 2016 decision of its three-judge panel in the Raymond Lucia case. That decision found the agency’s use of ALJs in an administrative enforcement action against Lucia to be constitutional.

The nub of the issue revolved around the question of whether ALJs are currently appointed correctly under the U.S. Constitution. In his appeal, Lucia, a nationally syndicated radio personality, argued that ALJs cannot be appointed by the SEC, but must be appointed by the President. His argument relied on an interpretation that ALJs are "inferior officers," not simply SEC employees, and that such officers must be appointed in accordance with the Constitution’s Appointments Clause.

The SEC’s point of view is that ALJs are not inferior officers, but simply agency employees. This was the position taken by the 2nd Circuit panel in its ruling, and it is that ruling which the full 2nd Circuit will now review.

What makes the matter likely to go to the Supreme Court is that another U.S. Court of Appeals, this one for the 10th Circuit, disagrees with their colleagues on the 2nd Circuit. A three-judge panel from the 10th Circuit on December 27 ruled that the ALJ in an SEC enforcement action against David Bandimere, a Colorado businessman charged with various securities law violations, was not constitutionally appointed (ACA Insight, 1/9/17).

"The splits among the circuits make this very ripe for Supreme Court review," said Georgetown University School of Law professor Donald Langevoort. "If judge Neil Gorsuch is confirmed and sits on this case, his skepticism about delegation to administrative agencies – which is greater than justice Antonin Scalia’s was – might be trouble for the SEC."

"I agree that the issue is likely to reach the Supreme Court and thus we likely are in limbo until the Supreme Court decides," said University of North Carolina at Chapel Hill School of Law professor Thomas Lee Hazen. He added, however, that, "should the full D.C. panel agree with the 10th Circuit, then that result may stick without eventual Supreme Court review."

Questions to be decided

In its decision to review, the 2nd Circuit Appeals Court limited the questions that will be decided to two issues:

  1. "Is the SEC administrative law judge who handled this case an inferior officer rather than an employee for the purposes of the Appointments Clause of Article II of the Constitution?" and
  2. Should the court overrule Landry v. FDIC? In that 2000 decision, the 2nd Circuit Court of Appeals upheld that the FDIC’s methods for appointing ALJs did not violate the Appointments Clause.

"The granting of en banc review suggests that a majority of the D.C. Circuit has some doubts about the court’s decision in Landry," said University of Michigan Law School professor Adam Pritchard. "The en banc court would have the power to overrule Landry, whereas the panel that initially decided the case did not. If the D.C. Circuit rethinks Landry, that might eliminate the current split over the inferior officers issue, but it would undoubtedly encourage the solicitor general’s office to encourage the Supreme Court to hear the issue."

The battle over ALJs

Objections to the SEC’s use of ALJs over federal district courts began with the 2010 passage of the Dodd-Frank Act, which expanded the agency’s authority to seek monetary penalties in administrative hearings. In more recent years, as the SEC increasingly relied on administrative hearings, defense counsel, a federal judge, and even some agency commissioners objected to the practice. Among the arguments they made was that ALJs, who work for the SEC, provide the agency with an in-house advantage when hearing cases.

SEC acting chairman Michael Piwowar is among those critics. "There is no jury and cases are presented to administrative law judges that are employees of the Commission. In addition, discovery available to defendants is more limited," he said in a February 2015 speech (ACA Insight, 3/9/15), during his tenure as an agency commissioner. He also noted that the SEC "has an extremely high success rate when litigating through administrative proceedings."

In response to the mounting criticism and resulting bad press, the agency in July 2016 adopted several changes to the rules governing administrative proceedings. These included more time for defense preparation and a longer pre-hearing period, the right to perform more oral depositions, and the ability to file more dispositive motions.

While some defense counsel welcomed these moves, others felt they did not go far enough, and the appeals of cases decided by ALJs, including the Lucia and Bandimere rulings, are among the results of the growing dissatisfaction with the SEC’s use of administrative hearings.

In addition, bills were introduced in the last Congress seeking changes that would result in the decreased use of administrative hearings. It is quite likely that similar bills will be re-introduced into the current Congress.

The Lucia and Bandimere cases

Neither of the appellate rulings on the two cases were based on the underlying issues in the cases, but on the constitutional questions raised by the use of administrative law judges.

In the Lucia case, filed in 2012, the SEC charged that Lucia and his advisory firm over-promoted and under-documented a "Buckets of Money" investment strategy in seminars designed to attract advisory clients. The agency took issue with what it said was Lucia’s claims that he had done "extensive" backtesting over decades that proved the success of his strategy. But, the SEC said, Lucia’s backtesting consisted only of calculations he performed manually back in the 1990s and two Excel spreadsheets an employee produced in 2003. In the Bandimere case, the SEC alleged that Bandimere failed to register as a broker before selling securities and then failed to register the securities he was selling.