Supreme Court rules SEC ALJs unconstitutionally appointed

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Securities Enforcement Alert

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The US Supreme Court has decided Lucia v. SEC, holding in a 7-2 vote that an Administrative Law Judge (ALJ) of the Securities and Exchange Commission (SEC) lacked the authority to preside over administrative proceedings because his appointment was not constitutional. The decision may have far-reaching effect, including re-litigation of ALJ decisions pending before the SEC and casting doubt on the appointments of other agency ALJs.

In its June 21 opinion, the Court explained that agency officials who hold continuous positions and exercise significant authority are "Officers of the United States." The Constitution requires that they be appointed by the President, a court or the head of an agency. If they are not constitutionally appointed, the hearings they preside over and the decisions they issue are invalid.

The Court did not decide whether the SEC's ratification of the appointments of its ALJs met constitutional standards, and, in a concurring opinion, Justice Stephen Breyer raised the specter that the majority's ruling rendered the statutory limitations on removal of SEC ALJs unconstitutional. These unresolved questions leave the status of the SEC's administrative process open to question.

The legal framework of the Appointments Clause

The Appointments Clause of the Constitution requires that "Officers of the United States" must be appointed only by the President, a court of law or a head of a department. Two primary factors distinguish constitutional officers from ordinary government employees. First, officers hold continuous, rather than occasional or temporary, positions. Second, officers exercise "significant authority" in carrying out their duties under the law. In determining whether an individual is an officer, the Supreme Court examines "the extent of power an individual wields in carrying out his assigned functions."

In Freytag v. Commissioner, the Supreme Court applied the significant authority test to special trial judges (STJs) of the United States Tax Court. The Supreme Court held that STJs were officers because they exercised significant discretion in carrying out their responsibilities in presiding over hearings, including taking testimony, conducting trials, ruling on the admissibility of evidence, and enforcing compliance with discovery orders.

The Supreme Court's ruling in Lucia

The SEC, like many other administrative agencies, typically delegates its administrative proceedings to ALJs, who, much like STJs, preside over trial-like proceedings and exercise powers similar to those of federal district judges. All of the SEC's current ALJs were selected by SEC staff members, rather than by the SEC itself. After certiorari was granted in Lucia, the SEC ratified the ALJs' appointments.

An SEC ALJ found that Raymond Lucia had violated the Investment Advisers Act. On appeal to the SEC, Lucia argued that the ALJ's decision was invalid because the ALJ had not been constitutionally appointed. Lucia asserted that SEC ALJs are Officers of the United States, and therefore must be appointed by the SEC itself, rather than its staff.

In an opinion written by Justice Elena Kagan, the Court agreed with Lucia. SEC ALJs, the Court said, are "near-carbon copies" of the STJs whom it found to be officers in Freytag. SEC ALJs hold continuous positions because they receive career appointments, and they exercise significant authority in carrying out their responsibilities. They conduct trials, issue subpoenas, enforce compliance with discovery orders, examine witnesses, take pre-hearing depositions and can punish those who violate their orders. When proceedings conclude, they issue findings and an opinion. The SEC may choose to review the findings, but if it does not, the ALJ's decision is considered the final action of the SEC. The Court held that exercising such significant authority and discretion means that SEC ALJs are officers. The appointment of the ALJ who decided Lucia's case was therefore invalid, and he was without authority to issue the order against Lucia.

Is the ratification process enough?

Even though the SEC has now ratified the appointment of the agency's ALJs, the Court declined to decide whether the SEC's ratification process was enough to fix the problem. The Court was clear that it was not opining upon whether the SEC's retroactive appointment of SEC ALJs was constitutional.

What now for Lucia?

The Court suggested that Lucia could receive a hearing directly before the SEC. In addition, because Lucia challenged the constitutional validity of the appointment of the ALJ who heard his case on appeal to the SEC, the Supreme Court held that Lucia was entitled to have his case heard again before a different ALJ.

Another ALJ issue identified by Justice Breyer

Although seven justices agreed with the result, Justice Breyer would have decided the case on statutory, rather than constitutional grounds. Justice Breyer opined that under the Administrative Procedures Act (APA) the SEC was permitted to appoint ALJs, but could not delegate that appointment power to its staff. For that reason, the appointment of ALJs by SEC Staff violated the APA. According to Justice Breyer, the Court's ruling that the SEC's ALJs are "Officers of the United States" rather than finding a violation of the APA, may unwittingly lead to the conclusion that the ALJ "for cause" removal protections under the APA are unconstitutional under the Court's decision in Free Enterprise Fund v. Public Company Accounting Oversight Board. In Free Enterprise Fund, the Court found similar "for cause" removal provisions enacted under Sarbanes Oxley unconstitutional as applied to PCAOB board members.

Where are we now?

  • The status of the SEC's administrative process remains an open question. The SEC's ratification of its ALJs may not have addressed the constitutional issues. Even if the SEC resolves the appointment issue, its administrative process may remain open to challenge under the rationale of the Free Enterprise case.
  • For the next 30 days, all pending SEC administrative proceedings are stayed, although, notably the SEC reserved the right to assign any proceeding pending before an ALJ to the SEC or any SEC member. The Lucia Court held that the SEC could hear such cases without violating the Appointments clause.
  • The legality of all pending SEC proceedings may be in doubt, if those proceedings are in front of or were initially decided by an ALJ even after the SEC's ratification of its ALJs appointment. Thus, we expect defense counsel will challenge such proceedings (after the stay is lifted) under Lucia. Those challenges will likely confront the issue of whether the SEC's ratification of ALJs does indeed cleanse the constitutional infirmity of their initial appointment. Those challenges may also raise the separate constitutional question that Justice Breyer raised in his concurrence – that is, does the APA's removal provision for ALJs run afoul of Free Enterprise?
  • With respect to those proceedings that have already become final, but were adjudicated by an unconstitutionally appointed SEC ALJ, we expect defense counsel to assert that there was a structural defect in the proceeding so that the violation of their clients’ constitutional right to a properly appointed ALJ cannot be treated as harmless error even though the Court suggested that relief was appropriate for those who made a timely challenge.

  • Defense counsel may also assert that under Lucia, the Division of Enforcement must first dismiss a pending case and then bring it before a constitutionally appointed ALJ or the SEC. While the Court indicated that Lucia could be reheard by the SEC or heard before a constitutionally appointed ALJ, the opinion did not address the question of whether the Division of Enforcement must recommence the case. Note that if reinstitution of pending cases is required, if the 5 year statute of limitations for penalties or disgorgement has expired since commencement of the initial proceeding, we anticipate that defense counsel will also seek dismissal based on the statute of limitations.
  •  Beyond the SEC context, Lucia will likely have effects on other agency ALJs, and whether those ALJs were constitutionally appointed.We would expect litigants in such proceedings to point to Lucia as authority for finding the ALJ unconstitutionally appointed. During oral argument, counsel for Lucia stated that the issue before the Court would affect approximately 150 ALJs across 25 federal agencies that preside over adversarial enforcement proceedings like the SEC ALJs do. Key agencies that Lucia may affect include the Department of Labor, the Federal Energy Regulatory Commission, and the Occupational Safety and Health Administration.

DLA Piper submitted an amicus brief in this case – see it here.

Annika Boone is a summer associate at DLA Piper.