About-face on SEC in-house judges is startling

OCTOBER 2017 TERM

In what can only be described as a startling about-face, the Trump Justice Department is turning its back on decades of history and process to argue that the Security and Exchange Commission's administrative law judges are "officers" requiring appointment under the appointments clause of Article 2 of the U.S. Constitution. This argument reverses the SEC's long-standing position that these in-house judges, commonly referred to as "ALJs," are employees, not officers.

Last week, the Department of Justice filed its brief on behalf of the SEC in the U.S. Supreme Court in the case of Raymond J. Lucia v. Securities and Exchange Commission. The Nov. 29 brief announces the SEC's new position as follows: "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. 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.'"

The case is before the Supreme Court on appeal from the U.S. Court of Appeals for the D.C. Circuit. The SEC prevailed there in August 2016 in a challenge brought by Lucia, who appealed from the SEC's affirmance of an ALJ's earlier ruling against him. The Court of Appeals agreed with the SEC that because SEC ALJs lack authority to issue final decisions -- they only prepare "initial decisions" that the SEC must ultimately approve -- they are not "officers" for purposes of the appointments clause. That clause requires "inferior officers" of the United States, i.e., officers not requiring Senate confirmation, to be appointed by either the president, the courts or the head of a department. SEC ALJs are hired through a merit selection process carried out by the Office of Personnel Management, with final selection being made by the SEC's chief ALJ. They are not appointed by the SEC commissioners, who are the department heads.

The issue is important for accountability reasons, as officers must be subject to direct removal by the president as part of his constitutional obligation to faithfully execute the laws of the United States.

These challenges have become a flashpoint over the past few years as a number of respondents in SEC administrative proceedings have attacked the integrity of the process itself and the authority of ALJs. Supreme Court guidance on the question is woefully unclear. In the two prior cases where the high court was called upon to identify factors that distinguish between whether someone is an inferior officer or mere employee, the court did not articulate a clear standard, noting only that an officer is one who exercises "significant authority under the laws of the Unites States." That language, from the court's 1976 decision in Buckley v. Valeo, and cited in the DOJ's brief, simply begs the question of what constitutes "significant authority."

In the 1991 case of Freytag v. Commissioner of IRS, the Supreme Court provided a bit more detail, though not enough to set a standard. In Freytag, the court rejected the IRS commissioner's argument that because IRS special trial judges lack authority to issue final decisions in every case -- they do have such authority for certain lower level cases -- they are not officers within the meaning of the appointments clause. The court did not find this persuasive, stating, "this argument ignores the significance of the duties and discretion that special trial judges possess," and went on to discuss some of the non-ministerial, discretionary functions special trial judges perform, including the taking of testimony, conducting trials, ruling on the admissibility of evidence, and enforcing compliance with discovery orders. These are the same functions performed by administrative law judge.

Though the court appeared to signal that the functions the IRS judges perform and the discretion they exercise are sufficient to constitute the exercise of significant federal authority contemplated under Buckley, it then clouded the issue by focusing not on functions and discretion, but on the fact that special trial judges have final decision authority in certain cases. The court observed: "Even if the duties of special trial judges under [the section of the IRS Code denying them authority to issue decisions in more weighty cases] were not as significant as we and the two courts have found them to be, our conclusion would be unchanged. ... Special trial judges are not inferior officers for purposes of some of their duties under §7443A, but mere employees with respect to their other responsibilities [in cases where they lack final decision authority]. The fact that an inferior officer on occasion performs duties that may be performed by an employee not subject to the Appointments Clause does not transform his status under the Constitution. If a special trial judge is an inferior officer for purposes of [adjudicating certain lower level cases], he is an inferior officer within the meaning of the Appointments Clause and he must be properly appointed."

The Supreme Court was saying two things in Freytag relevant here: First, in cases where special trial judges lack authority to enter a final decision, the functions they perform are those that may also be performed by employees. Second, because they have authority to issue final decision in only some cases, making them officers for appointments clause purposes, that status does not toggle on and off, such that they are officers for one type of case but mere employees for another. In other words, officer status, once attained, persists even in cases where a special trial judge lacks authority to issue a final decision and merely performs employee functions. Significantly, the Supreme Court affirmed the lower court's decision that the judges are not officers within the meaning of the appointments clause.

Following the Supreme Court's analysis in Freytag, and an earlier D.C. Circuit opinion in Landry v. FDIC, which also cited Freytag, the D.C. Circuit ultimately arrived at its opinion that authority to issue a final decision is the pivotal determination.

Approximately four months after the D.C. Circuit held in Lucia that SEC ALJs are not officers, in December 2015, the 10th U.S. Circuit Court of Appeals reached the opposite conclusion in Bandimere v. SEC. Picking up on the Supreme Court's discussion in Freytag of the functions special trial judges perform and the discretion they exercise, and comparing them to similar functions and discretion exercised by SEC ALJs, the 10th Circuit decided that these attributes are more determinative of officer status than simply whether or not ALJs can issue a final decision.

Because of the number of cases affected by this conflict between federal appellate courts -- the SEC is presently holding in abeyance all administrative proceedings in circuits where challenges to the ALJ have been asserted -- the conflict cries out for resolution, and not just on behalf of the SEC. The DOJ's brief notes that numerous other federal agencies have administrative courts that use a hiring process similar to the SEC's, including, among others, the Department of Agriculture, Federal Deposit Insurance Corporation, Consumer Financial Protection Bureau, Federal Energy Regulatory Commission, National Labor Relations Board and Environmental Protection Agency. In other words, the outcome in this case may well trigger a significant ripple and cultural change across the administrative landscape, beginning with the establishment of a process for appointing ALJs. This would likely entail the SEC, and perhaps other agencies as well, having to freeze or recommence all of its pending administrative proceedings until a process is in place to appoint its ALJs in accordance with Article 2 of the Constitution.