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(Article from Securities Law Alert, January 2017) 

For more information, please visit the Securities Law Alert Resource Center

On December 27, 2016, the Tenth Circuit held that the SEC’s appointment of administrative law judges (“ALJs”) for its in-house tribunals violates the Appointments Clause of the United States Constitution. Bandimere v. SEC, 2016 WL 7439007 (10th Cir. 2016) (Matheson, J.). The Tenth Circuit expressly disagreed with the D.C. Circuit, which recently held that the SEC’s ALJs are not “Officers of the United States” for purposes of the Appointments Clause. See Raymond J. Lucia Cos. v. SEC, 832 F.3d 277 (D.C. Cir. 2016) (Rogers, J.).[1]

Tenth Circuit Relies on the Supreme Court’s Decision in Freytag v. Commissioner of Internal Revenue to Hold SEC ALJs Are “Inferior Officers” Subject to the Appointments Clause 

The Tenth Circuit began its analysis with the text of the Appointments Clause, which provides in relevant part that Congress may “vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.” U.S. Const. art. II, § 2, cl. 2. The court explained that “[t]he term ‘inferior officer’ connotes a relationship with some higher ranking officer or officers below the President.” The Tenth Circuit observed that while “the Supreme Court has not stated a specific test for inferior officer status,” the Court’s prior decisions indicate that “the term’s sweep is unusually broad.”

The Tenth Circuit stated that the Supreme Court’s decision in Freytag v. Commissioner of Internal Revenue, 501 U.S. 868 (1991) “provide[d] the guidance needed to decide” the question of whether SEC ALJs qualify as inferior officers. In Freytag, the Supreme Court held that special trial judges (“STJs”) of the federal Tax Court were inferior officers within the meaning of the Appointments Clause because (1) the position of STJ was “established by Law”; (2) “the duties, salary, and means of appointment” of STJs were “specified by statute”; and (3) STJs “perform more than ministerial tasks” and “exercise significant discretion” in “carrying out [their] important functions.” Id. (quoting Freytag, 501 U.S. 868).

The Tenth Circuit found that these three Freytag factors apply equally to SEC ALJs. First, the court noted that “the position of the SEC ALJ was established by Law” pursuant to the Administrative Procedures Act. Second, the Tenth Circuit explained that “statutes set forth SEC ALJs’ duties, salaries, and means of appointment.”

Third, and most importantly, the Tenth Circuit determined that “SEC ALJs exercise significant discretion in performing important functions commensurate with the STJs’ functions described in Freytag.” The court noted, for example, that SEC ALJs have the “authority to shape the administrative record by taking testimony, regulating document production and depositions, ruling on the admissibility of evidence, . . . and presiding over trial-like hearings,” among other responsibilities.

Finding that “SEC ALJs closely resemble the STJs described in Freytag,” the Tenth Circuit held “SEC ALJs are inferior officers who must be appointed in conformity with the Appointments Clause.”

Court Rejects Final Decision-Making Power as the Key Criterion for Determining Whether the Appointments Clause Applies 

In Raymond Lucia, the D.C. Circuit held that SEC ALJs were not “Officers of the United States” for purposes of the Appointments Clause because “no initial decision of [the SEC’s] ALJs is independently final” under the SEC’s regulatory framework. 2016 WL 4191191.

The Tenth Circuit expressly disagreed with the D.C. Circuit’s decision. While the court acknowledged that “[f]inal decision-making power is relevant in determining whether a public servant exercises significant authority,” the Tenth Circuit determined that not “every inferior officer must possess final decision-making power.” Bandimere, 2016 WL 7439007. The Tenth Circuit stated that the Freytag Court “did not make final decision-making power the essence of inferior officer status.” Rather, the Freytag Court focused on the nature of the officers’ duties and the discretion they exercised in executing those duties.

Court Holds Deference to Congress Does Not Mandate a Different Result 

The Tenth Circuit also rejected the SEC’s contention that it must defer to Congress’s intent that SEC ALJs be categorized as employees rather than inferior officers subject to the Appointments Clause. Once again, the court found Freytag “instructive.” The Freytag Court stated that the Appointments “Clause forbids Congress to grant the appointment power to inappropriate members of the Executive Branch.” 501 U.S. 868.

Judge McKay, Dissenting, Emphasizes That SEC ALJs Lack the Power to Issue Final Decisions 

In a dissenting opinion, Judge McKay expressed his view that “the special trial judges at issue in Freytag had the sovereign power to bind the Government and third parties” while “SEC ALJs do not.” Bandimere, 2016 WL 7439007. He stated that “under the Appointments Clause, that difference makes all the difference.”

Fourth Circuit Holds Constitutional Challenges to Pending SEC ALJ Proceedings Are Premature

In a related decision, the Fourth Circuit joined the Second, Seventh, Eleventh and D.C. Circuits in rejecting as premature claims brought in federal court by a respondent in a pending SEC enforcement proceeding challenging the appointment of the SEC ALJ on constitutional grounds.[2]  Bennett v. SEC, 2016 WL 7321231 (4th Cir. 2016) (Duncan, J.). The Fourth Circuit relied on the Supreme Court’s decision in Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994), to hold that “it is fairly discernible that Congress intended to channel all objections to [rulings by SEC ALJs] — including challenges rooted in the Appointments Clause —through the administrative adjudication and judicial review process set forth in the statute.” The Fourth Circuit further determined that the Thunder Basin factors “indicate[d] that [petitioner’s constitutional] claims [were] of the type Congress intended to be reviewed within [the SEC’s administrative] framework.”