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10th Circuit strikes down SEC ALJ regime, debates reach to other agencies
December 28, 2016 / 10:01 PM / a year ago

10th Circuit strikes down SEC ALJ regime, debates reach to other agencies

(Reuters) - It looks like the U.S. Supreme Court may have to decide whether the Securities and Exchange Commission’s five administrative law judges were unconstitutionally appointed to their jobs. Is the entire ALJ regime – which includes 1,792 judges across a plethora of federal agencies – now at risk?

On Tuesday, a divided three-judge panel at the 10th U.S. Circuit Court of Appeals ruled in Bandimere v. SEC that the Constitution’s Appointments Clause applies to the SEC’s in-house judges because they exercise “significant discretion” in presiding over enforcement hearings, which resemble trials. The 10th Circuit decision vacated the SEC’s liability ruling against David Bandimere, a Denver businessman. More broadly, the 2-1 opinion creates a split on the constitutional issue with the District of Columbia Circuit, which held last summer in Lucia v. SEC that SEC administrative law judges are employees, not officers subject to the Appointments Clause.

As a result, according to administrative law expert Jonathan Adler, a law professor at Case Western and a blogger at the Volokh Conspiracy, “unless the SEC adjusts the manner in which it appoints ALJs — such as by providing for their ultimate appointment by the SEC chair — this case is likely on its way to the Supreme Court.”

That would be a remarkable achievement for the white-collar defense lawyers – including Bandimere counsel David Zisser of Jones & Keller – who have been trying for several years to end the SEC’s increased use of administrative proceedings, rather than litigation in federal district court, to resolve civil claims of securities fraud. The Dodd-Frank financial reform law empowered the agency to use administrative proceedings, which take place before SEC in-house judges without the safeguards of the Federal Rules of Civil Procedure. Defense lawyers first argued, mostly unsuccessfully, that administrative proceedings violated their clients’ due process rights. They then hit upon the contention that because SEC ALJs are appointed by bureaucrats and not by the commissioners themselves, they violate the constitutional requirement that even “inferior officers” be put in office by the president, the heads of departments or the courts.

There’s a good chance that even if the Supreme Court agrees to decide the constitutionality of SEC ALJs, enforcement via administrative proceedings will decline in the Trump administration. As I’ve mentioned, powerful Republicans in Congress have already called for the proceedings to be curtailed, giving defendants the choice to go to federal court even if the SEC files its case as an administrative action. Moreover, Dodd-Frank just gave the agency the discretion to use in-house proceedings, after all. The Trump SEC can choose not to exercise that discretion.

But the 10th Circuit’s opinion in the Bandimere case – or, more precisely, Judge Monroe McKay’s dissent – raises the unsettling prospect that the consequences of the ruling extend far beyond the SEC and its five ALJs. Judge McKay argued that under his colleagues’ interpretation of the U.S. Supreme Court’s 1991 decision in Freytag v. Commissioner of Internal Revenue, “all federal ALJs are at risk of being declared inferior officers,” McKay’s dissent said. “Despite the majority’s protestations, its holding is quite sweeping, and I worry that it has effectively rendered invalid thousands of administrative actions.”

Judge McKay compared the responsibilities of SEC ALJs to those of the more than 1,500 ALJs who oversee hundreds of thousands of Social Security Administration benefits hearings every year. “I cannot discern a meaningful difference between SEC ALJs and SSA ALJs under the majority’s reading of Freytag,” the judge said, warning that lawyers representing Social Security applicants have already begun filing Appointments Clause challenges to administrative proceedings, following the theory of SEC defendants.

“Today’s holding risks throwing much into disarray,” the judge wrote. “Since the Administrative Procedures Act created the position of administrative law judge in 1946, the federal government has employed thousands of ALJs to help with the day-to-day functioning of the administrative state. Freytag, which was decided 25 years ago, has never before been extended by a circuit court to any ALJ. And yet, the majority is resolved to create a circuit split. When there are competing understandings of Supreme Court precedent, I would prefer the outcome that does the least mischief.”

The two judges in the 10th Circuit majority in Bandimere – Judge Scott Matheson, who wrote the majority opinion and Judge Mary Beck Briscoe, who wrote a pointed concurrence addressing Judge McKay’s dissent – said his concerns were overblown. “We recognize that our holding potentially implicates other questions,” Judge Matheson wrote in the main opinion. “But no other issues have been presented to us here, and we therefore cannot address them. Nothing in this opinion should be read to answer any but the precise question before this court: whether SEC ALJs are employees or inferior officers. … Having answered the question before us, and thus resolved Mr. Bandimere’s petition, we must leave for another day any other putative consequences of that conclusion.”

Judge Briscoe argued that the Supreme Court’s Freytag decision demands exactly the kind of fact-specific analysis the 10th Circuit applied to decide the SEC’s ALJs are covered by the Appointments Clause. “The majority simply applies Freytag’s framework, as all lower courts must do,” she wrote in her concurrence. “In some future case, a litigant may argue that all ALJs are inferior Officers. But as the majority here explains — and Freytag commands — whether a particular federal employee or class of employees are officers subject to the Appointments Clause requires a position-by-position analysis of the authority Congress by law and a particular executive agency by rule and practice has delegated to its personnel. … The majority rightly does not attempt to answer whether each ALJ in every federal agency is an officer because Freytag disclaims such sweeping pronouncements.”

Judge Briscoe also said that even if Judge McKay’s worst imaginings come to pass and all ALJs are deemed to be unconstitutional under the Appointments Clause, there is an easy fix. ALJs are removable by the three members of the Merit Systems Protection Board, who, in turn, can be removed only for good cause. But according to Judge Briscoe, if MSPB members served at the will of the president, administrative law judges would be sufficiently accountable to the executive branch to withstand constitutional scrutiny.

“So even if this court were faced with the hypothetical future case that troubles the dissent, there is no cause for alarm that the administrative state will be eroded,” the concurrence said. “While the dissent opines on the hypothetical consequences of the majority’s opinion, today’s decision will have none of the consequences to the nationwide civil service that the dissent predicts.”

Bandimere lawyer Zisser told me Judge McKay’s dissent theorized about consequences that even the SEC didn’t bring up in briefing in the case. “It is a bit speculative, maybe more than a bit,” he said. “The government didn’t provide anything in the record and didn’t argue there would be huge disruptions to other agencies.” And even if the 10th Circuit decision does lead to uncertainty about the constitutionality of ALJs outside of the SEC, Zisser said, the appellate court isn’t to blame. The panel simply applied the test set out in Freytag. “This goes back to the Supreme Court,” he said. “The 10th Circuit didn’t make up the law.”

The SEC told my Reuters colleague Nate Raymond that it is reviewing the opinion. It’s intriguing to contemplate how the incoming Trump administration Justice Department will handle the 10th Circuit decision. If, as Judge McKay predicts, the opinion would require the Supreme Court to consider the constitutionality of all administrative law judges – an issue the justices have previously ducked – the Trump administration would have to think twice about appealing the Bandimere ruling. Meanwhile, it’s likely that SEC defendant Raymond Lucia, who lost a parallel case in the D.C. Circuit, will eventually file a petition for Supreme Court review unless the circuit court takes his case en banc.

Zisser said it would be just fine with him and his client if the 10th Circuit had the last word in Bandimere’s case. “This ruling means a very onerous order against my client has been vacated,” Zisser said. “I’d be happy to be done.”

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