In the last week of 2016, the U.S. Securities and Exchange Commission (SEC) received some news that spoiled its New Year’s celebrations. On December 27, 2016, the 10th Circuit Court of Appeals held that the SEC’s procedure for appointing its administrative law judges (ALJs) is unconstitutional. ((Bandimere v. SEC, 844 F.3d 1168 (10th Cir. 2016).)) The 10th Circuit’s holding in Bandimere v. SEC not only brings into question the constitutionality of the SEC’s in-house court system, but also the appointment of all 1,792 federal administrative law judges across a wide variety of federal agencies. ((Alison Frankel, 10th Circuit Strikes Down S.E.C. ALJ Regime, Debates Reach To Other Agencies, Reuters (Dec. 28, 2016), http://www.reuters.com/article/otc-sec-idUSKBN14H1S3.))
The 10th Circuit’s holding is based on its interpretation of Constitution’s Appointments Clause. The applicable portion of the Constitution can be found in Article 2, Section 2 and reads as follows: “but the 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.” ((U.S. Const. art. II, § 2.)) The rationale for requiring “inferior officers” to be appointed by public officials is to promote public accountability and help with the day-to-day functioning of the administrative state. ((Bandimere, 844 F.3d. at 1172-73.))
In reaching its holding, the 10th Circuit determined that the SEC’s ALJs are “inferior officers,” and not mere employees, whose appointments do not trigger constitutional scrutiny. Since these ALJs were found to be “inferior officers,” the Constitution had been violated – in the eyes of the 10th Circuit – because the SEC’s ALJs were not appointed by the president, a court, or a department head. The 10th Circuit found a 1991 Supreme Court case, Freytag v. Commissioner of Internal Revenue, to be the controlling precedent. ((Id. at 1170 (citing Freytag v. Comm’r of Internal Revenue, 501 U.S. 868 (1991) ). ))
Under Freytag, an inferior officer is a position that (1) was “established by law”; (2) whose “duties, salaries, and means of appointment . . . are specified by statute”; and (3) “exercise[s] significant discretion in carrying out . . . important functions.” ((Freytag, 501 U.S. at 881-82.)) The 10th Circuit found these characteristics to be satisfied by the SEC ALJ position. The Circuit judges also noted that the SEC ALJs had the power to enter default judgments and “steer the outcome” of proceedings by implementing certain procedural requirements. Overall, these characteristics of the SEC’s ALJs meant that the position performs “more than ministerial tasks” and consequently triggers the Appointments Clause. ((Bandimere, 844 F.3d. at 1175-76 (quoting Freytag, 501 U.S. at 881-82).))
The most interesting aspect of Bandimere’s holding is that it directly conflicts with the D.C. Circuit’s August 2016 holding in Raymond J. Lucia Companies, Inc. v. S.E.C. ((832 F.3d 277 (D.C. Cir. 2016).)) In Lucia, the court held that the SEC’s ALJ appointment system did not violate the Constitution’s Appointment Clause because the ALJs were found to be mere employees, not “inferior officers.” ((Raymond J. Lucia Companies, Inc. v. SEC, 832 F.3d 277, 283-89 (D.C. Cir. 2016).)) When appellate circuits split on important topics like this, the Supreme Court is likely to grant certiorari.
Assuming the Supreme Court grants certiorari, the potential whiplash of a finding against the SEC has major implications. The SEC’s ALJ system has roots dating back to the Administrative Procedure Act (“APA”), which created the ALJ position in 1946. ((Frankel, supra note 2.)) On a practical matter, ALJs make the initial decisions in cases heard by a federal agency and their factual findings are given a degree of deference if the decision is appealed. ((See Moses Tincher, Timber! The SEC Falls Hard As The Georgia District Court Finds The Appointment Of The SEC ALJs “Likely Unconstitutional”, 67 Mercer L. Rev. 459, 463 (2016).))
If ALJs are indeed found to be inferior officers, the work of thousands of ALJs throughout the years could be called into question. In Judge Monroe McKay’s Bandimere dissent, he argues that the court’s holding is open to expansive application and that “all federal ALJs are at risk of being declared inferior officers.” ((Bandimere, 844 F.3d. at 1199 (McKay, J., dissenting).)) He then goes on to argue that this creates the potential that thousands of former administrative actions will be “effectively rendered invalid.” ((Id.))
The SEC’s use of ALJs came under a microscope after the 2010 enactment of the Dodd-Frank Act. Dodd-Frank is commonly understood to have significantly expanded the SEC’s regulatory authority, something many experts believe has gone too far. ((See generally Giled D. Beal, Judge, Jury, And Executioner: SEC Administrative Law Judges Post Dodd-Frank, 20 N.C. Banking Inst. 413 (2016).)) Specifically, “the Act authorizes the S.E.C. to file almost any case before in-house judges rather than in a Federal District Court.” ((Peter J. Henning, S.E.C.’s In-House Judges Face Supreme Court Scrutiny, N.Y. Times (Jan. 3, 2017), http://www.nytimes.com/2017/01/03/business/dealbook/secs-in-house-judges-face-supreme-court-scrutiny.html?_r=0.))
In light of the evils that Dodd-Frank was aimed at prohibiting, the SEC began to increase its use of its in-house ALJ system. In May 2015, the Wall Street Journal conducted a study that found that between October 2010 and March 2015, 90% of defendants lost their cases in front of the S.E.C.’s ALJs. ((Jean Eaglesham, S.E.C. Wins With In-House Judges, Wall St. J. (May 6, 2015), http://www.wsj.com/articles/sec-wins-with-in-house-judges-1430965803.)) When the SEC brought enforcement cases in federal courts instead of its in-house system, its winning percentage dropped to 69% over the same time period. ((Id.)) During a similar timeframe, if a defendant appealed a ruling issued by the ALJ against the defendant, the SEC commissioners who heard the appeal found in favor of the ALJ 95% of the time. ((Id.)) This winning percentage could simply be the result of better lawyering by the SEC lawyers or the merits of the case. But the SEC has the benefit of a quicker process between initiating an action against a defendant and reaching its conclusion, forcing the defendant to employ quick and agile representation. ((Brian E. Casey, D.C. Circuit Affirms Constitutionality of S.E.C.’s In-House Tribunals, Nat’l L. Rev. (Sept. 2, 2016), http://www.natlawreview.com/article/dc-circuit-affirms-constitutionality-sec-s-house-tribunals.)) Additionally, other procedural advantages such as limited discovery tip the scale in favor the SEC. ((Id.)) Overall, the investment and financial services sector has a lot to gain should the Supreme Court grant certiorari and affirm the 10th Circuit’s Bandimere decision.
Latest posts by Brian Arnfelt (see all)
- Change is in the Air at the S.E.C. - March 27, 2017
- The Potential Whiplash of Bandimere - February 16, 2017
- Regulation Crowdfunding: The Results Are In and the Future Looks Bright - January 17, 2017