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News January 22, 2018 Issue

Status of Administrative Law Judges Will be Reviewed by Supreme Court

It took just eight words: "The petitions for writs of certiorari are granted." With that sentence, the U.S. Supreme Court on January 12 let it be known that it will review a lower court decision in Lucia v. SEC, potentially overturning the way that the agency has traditionally classified its administrative law judges. The high court’s ultimate decision may upend a number of established lower court’s verdicts.

The Lucia case has some unusual aspects to it, perhaps most prominently the fact that both sides are now arguing the same point of view. The Department of Justice in November reversed its position – even though it had won with that position in appellate court – and agreed with the main thrust of Lucia’s argument: that ALJs are not merely agency employees that can be hired like other employees, they are officers that, under the U.S. Constitution’s Appointments Clause, must be appointed to their positions by the President, courts or the head of a government department (ACA Insight, 12/11/17).

Raymond Lucia, an investment adviser challenging an ALJ ruling against his firm, is arguing that because the ALJs were not properly appointed by the SEC, the ruling against him was invalid. Adding fuel to the judicial fire is that two U.S. Courts of Appeal have ruled in opposite ways on this issue. Lucia himself lost an appeal of his case with the 2nd Circuit (ACA Insight, 8/22/16), while the 10th Circuit, in a separate case with a different petitioner, agreed with the petitioner that the SEC was not properly appointing ALJs (ACA Insight, 1/9/17).

Should the Supreme Court now agree with Lucia and the 10th Circuit, it may have ramifications beyond this particular case, both in terms of cases already decided and in terms of cases yet to come. In terms of past cases, some parties in cases that were decided by employee ALJs may now seek review of those decisions.

"This is a Supreme Court that values predictability and precedent, but the arguments that administrative law judges do much more than ‘employee’ work is strong," said Georgetown University School of Law professor Donald Langevoort. "The most interesting part of the opinion, if the Court comes down against the status quo, is how it will deal with retroactivity: years of decisions under the old system potentially subject to challenge."

"The Supreme Court’s decision will affect the SEC ALJ decisions made prior to the ratification of the judges’ selection," said University of North Carolina School of Law professor Thomas Lee Hazen. "SEC proceedings instituted after the ratification should not be affected by the constitutional challenge."

However, depending on what the Supreme Court says in its decision, future cases may be affected in the sense that other government agencies and departments that have relied on ALJs, such as the Environmental Protection Agency, may now have to ensure that their ALJs are appointed as required by the Constitution’s Appointments Clause. The SEC, for instance, has already taken this step. The day after it reversed position and argued that ALJs should be considered as appointed officers, the Commission ratified the appointment of its five existing ALJs.

The agency also ordered the review of more than 100 administrative hearing cases that have not yet been decided. "Presumably this was to be able to immunize these post-ratification decisions from constitutional attack," said Hazen.

The government reversal

The Department of Justice, before its position reversal, had taken the SEC’s position and argued that ALJs were not what the Constitution refers to as "inferior officers," which would have required them to be appointed by the department, the courts or the President. Instead, ALJs were viewed by both the agency and the Justice Department as simply agency employees, meaning they could be hired without Commission approval. When the Trump administration came into office, however, the Justice Department’s view apparently changed.

"In prior stages of this case, the government argued that the Commission’s ALJs are mere employees rather than ‘officers’ within the meaning of the Appointments Clause," the U.S. solicitor general said in his Supreme Court brief on the matter. "Upon further consideration, and in light of the implications for the exercise of executive power under Article II, the government is now of the view that such ALJs are officers because they exercise ‘significant authority pursuant to the laws of the United States.’"

Further, when the SEC on the following day ratified the appointment of its existing five ALJs, it noted the solicitor general’s new position. It was ratifying the appointment, the agency said, "to put to rest any claim that administrative proceedings pending before, or presided over by, Commission administrative law judges violate the Appointments Clause."

The underlying case

The SEC’s case against Lucia goes back to September 2012, when it alleged that Lucia and his advisory firm promoted a "buckets of money" investment strategy at seminars designed to attract advisory clients.

The agency alleged that while Lucia claimed he had done "extensive" backtesting over decades that proved the success of his strategy, the backtesting consisted only of some calculations he performed manually back in the 1990s – copies of which the SEC said no longer exist – and two Excel spreadsheets an employee produced in 2003 that purported to represent backtesting from 1966 and 1973 through 2003.

The SEC also alleged that the backtesting wasn’t accurate, and used a lower rate of inflation than actually existed over the periods, which made the resulting performance look rosier. The backtests also allegedly failed to account for the negative effect of the deduction of advisory fees. Finally, the SEC argued that the testing performed did not allocate in the manner called for by Lucia’s strategy.

The ALJ, in a July 2013 initial decision, charged that Lucia’s firm violated Sections 206(1), 206(2), and 206(4) of the Advisers Act, and that Lucia himself aided and abetted his firm’s violations. The ALJ barred Lucia from associating with any investment adviser, broker, or dealer; and imposed a civil penalty of $50,000 on Lucia and $250,000 on the firm.

Lucia appealed the decision to the Commission, arguing that the ALJs were not properly appointed under the Constitution, but lost in September 2015 when the Commission affirmed the ALJ’s initial ruling. Lucia then took his appeal to federal court, and that is where the 2nd Circuit sided with the SEC.

The 2nd Circuit and the 10th Circuit

A three-judge panel of the court, in an August 2016 ruling that backed the SEC’s point of view, said that whatever an ALJ’s ruling, the SEC always makes the final ruling. Even in cases when it chooses not to review a case, that is also a final decision, it said.

The appellate panel rejected Lucia’s contention that the administrative proceeding was unconstitutional because the ALJ was not appointed in accordance with the Constitution’s Appointments Clause. Citing a previous case as precedent, the panel noted that "the Commission concluded its ALJs are employees, not officers, and their appointment is not covered by the clause. . . . Finally, petitioners point to nothing in the securities laws that suggests Congress intended that Commission ALJs be appointed as if officers."

The full 2nd Circuit Court of Appeals agreed to review the panel’s decision, but it deadlocked in a 5 to 5 vote last year, leaving the panel ruling in place.

The U.S. Court of Appeals for the 10th Circuit, however, went in the opposite direction. A three-judge panel, in a December 27 appeal of a 2013 ALJ ruling against Colorado businessman David Bandimere, charged with various securities law violations, held that the SEC ALJ who ruled in that case was "unconstitutionally" appointed.

The 10th Circuit panel, in its ruling, recognized that the 2nd Circuit had come up with a different conclusion, but said that it disagreed with both the SEC’s arguments and the 2nd Circuit’s ruling.

It’s up to the Supreme Court now.