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(Article from Securities Law Alert, May/June 2018) 

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On June 21, 2018, the Supreme Court held that the administrative law judges (“ALJs”) for the SEC’s in-house courts are “Officers” subject to the Appointments Clause of the United States Constitution. Lucia v. S.E.C., 2018 WL 3057893 (2018) (Kagan, J.). Pursuant to the Court’s ruling, SEC staff members may no longer name ALJs. The SEC’s ALJs may only be appointed by the SEC itself, a court of law, or the President.

Background

The Appointments Clause states that the President “shall nominate, and by and with the Advice and Consent of the Senate, shall appoint … Officers of the United States.” U.S. Const. art. II, § 2, cl. 2. The Appointments Clause further provides that “Congress may by Law 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.”

In Raymond J. Lucia Cos. v. SEC, 832 F.3d 277 (D.C. Cir. 2016), the D.C. Circuit held that the SEC’s ALJs are not “Officers of the United States” within the meaning of the Appointments Clause because they have no authority to issue “final decisions” of the SEC. The D.C. Circuit found it significant that the SEC has a discretionary right to review the action of any ALJ as it sees fit, either on its own initiative or upon a petition for review filed by a party or aggrieved person. In the event that “no review of the initial decision is sought or ordered,” the SEC will issue an order stating that it has declined review and specifying the date that the ALJ’s sanctions, if any, will take effect. The D.C. Circuit emphasized that the ALJ’s initial decision becomes final only upon issuance of the SEC’s order.

In Bandimere v. SEC, 844 F.3d 1168 (10th Cir. 2016), however, the Tenth Circuit rejected final decision-making power as the key criterion for assessing whether the Appointments Clause applies. The Tenth Circuit relied on the Supreme Court’s decision in Freytag v. Commissioner of Internal Revenue, 501 U.S. 868 (1991) to hold that the SEC’s ALJs are “inferior officers” who must be appointed in conformity with the Appointments Clause.

The defendant in Lucia petitioned the Court for certiorari to resolve the circuit split, in hopes of erasing the adverse judgment of the SEC’s ALJ against him. The defendant argued that if the SEC ALJ who presided over his case was not properly appointed, then the ALJ lacked the constitutional authority to issue the ruling in that matter.

Court Relies on Freytag to Hold That SEC ALJs Are Officers Within the Meaning of the Appointments Clause 

The Court explained that the “sole question” before the Court was whether the SEC’s ALJs “are ‘Officers of the United States’ or simply employees of the Federal Government.”[1] If the SEC’s ALJs were considered “part of the broad swath of ‘lesser functionaries’ in the Government’s workforce,” then it would not matter how the ALJs were appointed. But if the SEC’s ALJs were deemed to be “Officers,” then the ALJs could be constitutionally appointed only by the President, a court of law, or the head of a department. The Court noted that the SEC itself “counts as a Head of a Department” for Appointments Clause purposes. Instead of appointing the ALJs itself, however, the SEC “left the task of appointing ALJs . . . to SEC staff members.”

The Court stated that there are two key requirements for an individual to qualify as an officer under the “Court’s basic framework for distinguishing between officers and employees.” First, “an individual must occupy a ‘continuing’ position established by law to qualify as an officer.” Second, the individual must “exercis[e] significant authority pursuant to the laws of the United States.” The Court explained that the “significant authority” test is “focused on the extent of power an individual wields in carrying out his assigned functions.”

The Court found it unnecessary to elaborate on the “‘significant authority’ test” established in Buckley v. Valeo, 424 U.S. 1 (1976) to resolve the question of whether the SEC’s ALJs are officers. The Court found that its ruling in Freytag v. Commissioner, 501 U.S. 858 (1991) “necessarily decides this case.” The Court stated that in Freytag, it “applied the unadorned ‘significant authority’ test to adjudicative officials who are near carbon copies of the [SEC’s] ALJs.”

The Freytag Court held that special trial judges (“STJs”) of the United States Tax Court were “inferior officers” subject to the Appointments Clause. In relatively minor matters, STJs had the authority to issue final decisions. In more substantial matters, STJs prepared proposed findings and an opinion for the Tax Court judge to consider. The Freytag Court determined that STJs were subject to the Appointments Clause because they held ongoing statutorily established positions and “exercise[d] significant discretion” in the course of executing “important functions” in connection with adversarial tax hearings.

The Lucia Court found that “Freytag says everything necessary to decide this case.” First, the SEC’s “ALJs, like the Tax Court’s STJs, hold a continuing office established by law.” Second, the SEC’s “ALJs exercise the same ‘significant discretion’ when carrying out the same ‘important functions’ as STJs do.” The Court emphasized that “[b]oth sets of officials have all the authority needed to ensure fair and orderly adversarial hearings—indeed, nearly all the tools of federal trial judges.” The Court explained that the SEC’s ALJs, like the STJs at issue in Freytag, (1) “take testimony,” (2) “conduct trials,” (3) “rule on the admissibility of evidence,” and (4) “have the power to enforce compliance with discovery orders.” The Lucia Court emphasized that “point for point—straight from Freytag’s list—the [SEC’s] ALJs have equivalent duties and powers as STJs in conducting adversarial inquiries.”

The Lucia Court further found that SEC “ALJs issue decisions much like that in Freytag—except with potentially more independent effect.” The Court explained that in major cases, a Tax Court judge must “always review an STJ’s opinion.” An STJ’s “opinion counts for nothing unless the regular judge adopts it as his own.” The Court noted that “[b]y contrast, the SEC can decide against reviewing an ALJ decision at all.” The ALJ’s decision then becomes final and stands as a decision of the SEC. The Court concluded that this “last-word capacity makes this an a fortiori case: If the Tax Court’s STJs are officers, as Freytag held, then the [SEC’s] ALJs must be too.”

Court Holds Petitioner Is Entitled to a New Hearing Before a Different SEC ALJ 

As a remedy, the Court held that petitioner was entitled to a hearing before a different SEC ALJ than the one who initially heard and ruled on his case. The Court reasoned that even if that ALJ has “received (or receives sometime in the future) a constitutional appointment,” he “cannot be expected to consider the matter as though he had not adjudicated it before.” The Court found that “[t]o cure the constitutional error, another ALJ (or the [SEC] itself) must hold the new hearing to which [petitioner] is entitled.”

Justices Thomas and Gorsuch, Concurring, Posit That the Test for an Officer Is the Exercise of an Ongoing Statutory Duty 

In a concurring opinion, Justice Thomas, joined by Justice Gorsuch, observed that “this Court will not be able to decide every Appointments Clause case by comparing it to Freytag.” Justice Thomas stated that any individual who is “continuously responsible” for an “an ongoing statutory duty” is an officer under the Appointments Clause.

Justice Breyer, Concurring, States That the Court Should Have Resolved the Case on Statutory Rather Than Constitutional Grounds 

In an opinion concurring in the judgment in part and dissenting in part, Justice Breyer, joined in part by Justices Ginsburg and Sotomayor, expressed the view that the Court should have decided the case based on an application of the Administrative Procedure Act rather than an interpretation of the Appointments Clause. Justice Breyer stated that it was not possible to resolve the constitutional question “without knowing the answer to [the] different, embedded constitutional question”—“the constitutionality of the statutory ‘for cause’ removal protections that Congress provided for administrative law judges,” which the majority declined to consider. Justice Breyer observed that holding that ALJs are officers “is, perhaps, to hold that their removal protections are unconstitutional.” Finally, Justice Breyer, joined here by Justices Ginsburg and Sotomayor, stated that he saw “no reason why” the same ALJ could not rehear petitioner’s case, as the same judges routinely preside over new trials on reversal.

Justices Sotomayor and Ginsburg, Dissenting, State That Only Individuals With Final Decision-Making Authority Are Officers Subject to the Appointments Clause 

In a dissenting opinion, Justice Sotomayor, joined by Justice Ginsburg, expressed the view that “one requisite component of ‘significant authority’ is the ability to make final, binding decisions on behalf of the Government.” Justice Sotomayor concluded that “[SEC] ALJs are not officers because they lack final decision-making authority.” She observed that “a person who merely advises and provides recommendations to an officer would not herself qualify as an officer.”